Global Investments w/ Lyn Alden (TIP386)
Stig Brodersen (00:28): Welcome to The Investor’s Podcast. I’m your host, Stig Brodersen, and I can already feel that this is going to be a great episode because today we are joined by the one and only Lyn Alden. Lyn, welcome back on the show. Lyn Alden (00:40): Hey. Happy to be back. Always glad to be here.
Stig Brodersen (00:43): So Lyn, I wanted to talk to you and the audience about global investment opportunities but I wanted to talk about inflation first because inflation is just such a tax on everything that we do. So I wanted to have that part as our foundation before we venture into the different investment opportunities that you see in the market. And you recently wrote a great blog post about treasury inflation protect securities or TIPS.
So let’s kick this off and perhaps you could explain how TIPS work and whether it’s a good inflation hatch in today’s environment. Lyn Alden (01:15): Yeah. So at the current time we’re seeing a pretty good amount of inflation compared to the historical average over the past couple decades.
And it looks like in certain areas that’s rolling over but it’s still quite elevated, especially compared to bond yields. And so investors find themselves … The risk is that if you hold cash or bonds that are yielding 0%, 1%, 2% while inflation is 4%, 5%, 6%, you’re getting devalued. You’re losing purchasing power. And so one of the ways that investors can deal with that is to buy treasure inflation protection securities or TIPS. And so some countries issue those as a small part of their sovereign bond market. So my article focused on US TIPS. And basically what they say is we’ll adjust the bond coupon that you’re getting based on inflation levels. Official CPI in the United States. And so that kind of takes away that risk
of inflation. But my whole article focused on the fact that TIPS can be very useful as an inflation defense but they’re not perfect. And so obviously if you have that extra inflation protection built into your bond there’s no free lunch and so that comes with some costs. Lyn Alden (02:24): So the main cost is that the TIPS yields are lower than normal treasury bonds. And so in the United States currently you’re getting like a negative 1% yield on your TIPS. You’re basically going to earn inflation minus about 1%. Ironically you’re guaranteed to underperform inflation
by owning inflation protected securities which sounds terrible but it’s one of those things where right now the 10 year treasury yield is under one and a half percent and the inflation expectations by the market are maybe two and a half percent while inflation’s currently 5%. Because they’re expecting that this is not going to stay at this level for a very long time and that the average inflation over the course of, say the 10 year duration of this bond, will be lower in the mid two range. Now if that’s the case, if the inflation expectations are true then normal bonds and TIPS will have about the same return. They basically are optimized around kind of that break even point. However, if inflation ends up being higher than those inflation expectations, like if inflation is 3%, 4%, 5% averaging over the decade, then those TIPS, despite the fact that they will mildly underperform inflation, will still do better than normal treasury yields that are yielding one and half percent while inflation’s 3%, 4%, 5%.
Lyn Alden (03:44): That’s kind of the trade off that you get by owning TIPS is that you’re not guaranteed to keep up with inflation but you have more protection if inflation runs notably higher than people expect. The other big risk of TIPS is that you’re reliant on a government’s statistics for inflation which include a specific basket of good with hedonic adjustments and people can debate endlessly about how accurate that measurement is. I’ve done a work on this and I think it at least mildly understates “true inflation”. But everybody has their own unique inflation basket. And so basically with TIPS you risk having your official inflation metric not keep up with real inflation and then you also will mildly underperform even that official metric because of the negative yield. Stig Brodersen (04:26): It’s always hard whenever you ask questions like, so for us investors … Which I know I tend to do. Because who are us investors? Like how old are we?
What’s our consumption? What’s our income level? What’s our debt like? There’s so many things that go into a discussion about investors in general. So are TIPS … With the flaws that you listed, would you recommend that to any specific type of investor and perhaps not to others? Lyn Alden (04:52): I think anyone who has bonds in their portfolio at this time, which is not everyone. Because younger investors might choose to exclude bonds because of the poor yields and the inflation and to focus on other assets and take the higher volatility that comes with that. So obviously TIPS might not be ideal for them. But I think anyone who has bonds in a portfolio could benefit from having a percentage of those bonds be TIPS. And so I think this is an environment where TIPS are I think useful to have if you own bonds.
Stig Brodersen (05:24): So giving that TIPS aren’t good assets to protect against inflation, at least for many different investors, what’s the best way if you want to defend themselves against inflation? And perhaps I can give you this unreasonable constraint that you can’t say Bitcoin. And the reason why I’m saying that is because I’m sure there’s a lot of people out there who are saying, “Lyn, we had here on the show a bunch of times speaking with the Preston about Bitcoin. Can we talk about that?” It’s not that there’s anything wrong with that. We have like a bunch of great episodes for that. But we also have a lot
of listeners who do not believe in Bitcoin. They don’t want to invest in it. More like traditional stock investors who look into different asset classes than crypto. What can they do? Lyn Alden (06:03): Generally commodities. And so it’s hard to get sustained inflation while commodity prices stay low. Generally a history of inflation is a history
of commodity price inflation. Commodities historically are a very poor performing asset class. If you look over say a century of data, commodities are one of the worst places to hold money over a long term. Because if you’re holding the commodity outright it doesn’t compound.
It just sits there. And if you’re holding commodity companies it generally tends to be lower quality businesses. Now there are some commodity companies that have done very well. Especially in energy because they’ve been protected by a cartel for decades. But generally it’s not good
to have a company who doesn’t control the price of their own product. So they generally are not the highest quality wide moat businesses that might be appreciated. The caveat there is that during an inflationary decade commodities generally trounce everything else. Like it’s not even close. And so in the ’70s it’s pretty much all you would want to own. In the 2000s commodities and emerging markets
which have a lot of commodity exposure were the way to go. They trounced everything else. And so generally when you have these inflationary decades you want to have some commodity exposure. Lyn Alden (07:11): And ideally you want to mix it up a little bit so you’re not too focused on one commodity. You don’t want to pick the one commodity that maybe doesn’t do very well. Oil and gas are the biggest commodities. I mean that market is bigger than all other commodities combined so a lot of it comes down to what that’s going to do over a given three to five year period. But overall, I think one of the best ways to have protection against inflation is to have commodities and commodity companies. And if someone wants to reduce the
risk they can use commodity trend following, which is basically saying … You’re kind of acknowledging that it’s not a great asset class to hold long term and that you generally want to restrict your exposure to them when they’re in an upturn. Because the upturns can be pretty violently good. Just explosive gains. But then the downside can be brutal in the opposite direction. So I think some sort of either commodity exposure or commodity related investments. Could be commodity trend following, could be commodities, could be commodity equities. They’re generally the better way. There’s also real estate if you can get it at appropriate prices which is harder these days than it was maybe a couple years ago. But obviously certain zip codes, certain
regions of the world of your country wherever you might live can be protection against inflation. Lyn Alden (08:17): And partly it’s because with real estate you can leverage it more than most other asset classes without it being silly. You can leverage it with a mortgage because it’s a stable asset. And so what you’re essentially doing is you’re shorting currency. You’re shorting the currency you borrowed that in. So if you have a reasonably priced house and then you have a 30 year fixed rate mortgage on it at a rate that’s at or below the inflation rate, you’re shorting a depreciating asset and you’re going long on an appreciating asset. And so that’s historically been a better way. At least better than stocks historically. And when
it comes to stocks you generally want to focus on ones that can control their costs very well. And so people sometimes assume stocks will perform better than bonds and inflation and that’s a mixed track record. So obviously if you have something like hyperinflation, you’d rather own stocks than bonds because bonds will become worthless, stocks will still be worth something when the dust settles because you still own productive assets. But if you have double digit inflation, like the United States had in the ’70s, stocks can perform about as poorly as bonds can in that environment.
Lyn Alden (09:20): It really depends on some other factors like what’s happening to their own costs, what’s happening to their evaluations, what’s happening to treasury yields. But generally if you do equities other than commodity equities, you generally want to find companies that their revenue is variable. That they have decent pricing power, but then also that their costs are rather fixed or controlled. Maybe they have large depreciation write offs for example. Those sort of assets which ironically tend to be some lower
quality assets in good times can actually do pretty well in those inflationary times. Stig Brodersen (09:53): Interesting. So Lyn, identifying the most attractive asset class, that is just something that constantly changes. Because circumstances change. For example, gold was relatively cheap in the late 1990s and the price was less than $300 an ounce. I know it probably sounds crazy to some people out there. The real rates were high so opportunity costs for being in gold were just correspondingly seen as high and on top of that gold was coming off this 20 year bear market. Like no one wanted to own it.
But then the price of gold just exploded in the years after that. And today we have a new situation, not just with gold but just in general. So if you have to be ranking different asset classes on how attractive they are, how would that look like? Lyn Alden (10:38): Overall I think a diverse mix of asset classes is far better than any one asset class, especially in this really uncertain environment where partially whether or not we’re going to get inflation or not is based on government decisions. Because it’s going to come down to their fiscal decisions. And so you have this somewhat binary outcome where you’re dependent on variables that are currently unknowable. You kind
of know more as you go along. And so the first thing I would do is diversify but then I would tilt that towards asset classes that I find to be more attractive. And so overall I generally think that high quality commodity producers … I think looking back at the end of this decade I think this will probably be a commodities decade similar to the 2000s or the 1970s or the 1940s. And so I like mid stream energy transporters. I like some of the higher quality energy producers. Ones that
have low cost production, strong balance sheets, long reserves. I like copper. Certain metals for example, especially related to electrification I think is an attractive area. They got a little bit overheated earlier this year. They became
quite consensus. So whenever they’re maybe not on fire is a good time to maybe go into those. Lyn Alden (11:45): I think many emerging markets are reasonably attracting for a long term at the current time. That doesn’t mean they’re going to do well next year or the year after. But I’d be somewhat surprised if emerging markets have another lost decade like they have the past decade. So they had this period of consolidation.
A lot of that was valuations going down and stronger dollar which tend to go in cycles. A lot of capital’s kind of really very much shoved in the United States at the current time. And so overall all I find that valuations and overall fundamentals in emerging markets are actually pretty attractive, especially if you go country by country. And so that’s generally my approach here. Also I still like US equities. I’m more selective with them because many of them are at very above average valuations but I still go through US equities and find that in general growth year stocks are more likely to overvalued even compared to their history than value stocks.
So obviously growth stocks are going to be more expensive than value stocks. We’re always happy to pay up for a better company. But if you look at say how much growth you get for your money they’re a worse deal than they were say three years ago, where the value stocks are about the same deal that they were three years ago. So that’s varied over time. Lyn Alden (12:53): But overall I generally like value stocks and then if I go into growth stocks which I still do I just have a higher hurdle rate.
I’m more selective with those in saying, what are my absolute highest conviction growth stocks because I’m concerned about maybe the broader valuations in that factor. Stig Brodersen (13:11): Let’s specifically talk about equities. I know from reading your blog, this is just amazing … Absolutely amazing blog. I encourage everyone to go read it. We’ll make sure to link to that in the show notes. But what you put on the blog is that you pay attention to CAPE and also the market capture GDP.
That’s commonly referred to as the Buffett indicator. That’s probably how many of our listeners know it. Could you please talk about the methodology of both factors, why you look at it and perhaps also what the empirical evidence suggests for those two factors? Lyn Alden (13:42): So in addition to looking at individual company valuations I do like to pay attention to broad valuation measures for different markets. And so the most popular one is probably Shiller’s CAPE ratio. So that’s the cyclically adjusted price earning ration. And the theory there is that instead of just looking at price earnings
… Earnings can be quite ephemeral. So they can go away in recessions and then the stock looks expensive. And then earnings can be very high during the peak of the cycle and the stock looks cheap. And so Robert Shiller’s approach there says okay, let’s look at a full business cycle of average earnings either for that company or for the stock market as a whole. So the common version takes the last 10 years of earnings, averages them together, inflation adjusts them, and you’re comparing current price to that more structural earnings average which normally includes a recession or two in the mix. Not always but usually. And so you get this smoothed out approach. And historically that
has been a very good indicator for long term returns. Not short term returns. CAPE ratio tells you virtually nothing about what stocks are going to do over a six to a 12 month period. But generally if you look forward 10 years, higher CAPE ratio periods provide much lower returns than low CAPE ratio periods. Lyn Alden (14:55): And it’s challenging because you have tax changes, you have changes in how corporations operate in terms of say share buybacks for example. And so generally for a number of reasons the United States has had higher valuations over the past 25 years than most other periods in history. And yet
they still provide decent returns. There was a good study by Meb Faber a couple of years ago and he’s updated it once or twice where he says okay, so he noticed that the United States had good returns even when you had a high CAPE ratios. However, if you had an approach over this 25 years where you invested in whatever markets had the cheapest CAPE ratio, you did way better. And not every year. Sometimes you would invest in the cheapest markets and they just got cheaper and then you’d invest in them again and they got even cheaper. But over the course of his, say, 25 year data set last I checked, if you had a habit of buying, say, the 25% cheapest markets around the world and then updated that every year, you crushed the S&P 500 even though there could be a three year stretch or a five year stretch where you don’t.
Lyn Alden (15:57): And so generally valuation matters over the long run even though it does not matter over the short run. But then you want to say okay, what if a certain valuation metric has some sort of data artifact in it that is throwing it off or making it unrepresentative? How much faith should I have in one metric? So we can actually say, well that’s one useful metric but we can go look at a bunch of others. We can look at the average price to sales ratio of the market. We can look at the average dividend yield of the market. We can look at the sector adjusted valuations to compare one market to another. A popular one is the market cap, the GDP ratio as popularized by Warren Buffett. If you add the market capitalization off all companies in that market together what percentage of the GDP is that? And you actually can’t … Unlike the CAPE ratio you can’t really compare that between countries because some markets are just inherently far more financialized than others.
But you can compare it to its history pretty well. And so generally speaking that follows CAPE ratio pretty closely. And generally during periods of unusually high market cap to GDP you generally are unlikely to get good penny or forward average returns whereas when it’s unusually cheap you’re much more likely to get very good forward 10 year returns.
Lyn Alden (17:11): And again, it’s not guaranteed and it doesn’t tell you much about the short term. But when you’re combining multiple of these evaluation indicators together it gives you an idea of forward return potential long term. Which by extension if you do that to multiple markets can give you an idea of where you should invest or what areas you might want to over weight or under weight without being certain what’s going to happen but with having greater probabilities of putting the odds in your favor. Stig Brodersen (17:37): One might come to the conclusion that investing globally from a fundamental standpoint is just buy the cheapest market. What I really like about your research is that you go dig deeper than that. Because aside from value which is a great starting
point for your analysis but you’re also looking at growth, debt, stability and the currency. So could you please talk to us why are you using those as your key metric to include a type of value? Lyn Alden (18:05): So the funny thing is that according to data the value might be enough. So using Meb Faber’s data for example, you could ignore everything else and just buy what’s cheap. The problem is you have to put faith that that’s going to keep working. Which it might or might not. We don’t know. And so you have to give it a long time to know and so you won’t be sure until 10, 15 years later when you had a big opportunity cost if you were wrong. And so what I like to do is, I like to say okay, value
is a very, very important component but there’s other things. And so one is we want to adjust things for growth and sector exposure for example. If you have one country, they have a whole bunch of fast growing tech stocks and then you have another company that’s got a bunch of kind of lousy businesses and they’re cheaper and you say well, I’m only going to buy that cheap company, it’s like well, it might be worth paying up … How much more expensive is that other country market compared to this one? Because it is worth paying up if you can get better companies. Lyn Alden (18:57): If you can pay 30% more but get companies that are twice as good or growing twice as fast, that’s worth it. It’s good to compare things on a sector by sector basis and to look at various macro factors with those countries. And so for example
in addition to valuation, I like to look at growth. So for example you generally expect higher valuations out of faster growing countries. So a higher population growth or gross sector exposure. And so you should for example expect higher growth out of India than Russia. And if we’re
looking to support sustainably for a long period time higher equity valuations than Russia. You can also look at debt levels because they affect forward growth as well. They also affect the possibility of currency devaluation or other undesirable things that can throw off your investment. That’s why you can rank countries based on both public and private debt levels. Then you can look at things like stability. So there’s different ways to measure that. There’s human rights indices. There’s terrorism indices. There’s corruption indices. There’s how many coup attempts have happened in the past 10, 20 years for example.
Lyn Alden (20:04): And so generally if you’re investing in emerging markets you’re accepting a higher level of these various risks. These lower levels of stability in exchange for higher growth and usually lower valuations. And then the last one will be more specific currency metrics. Like does the country have a current account surplus or a current
account deficit? Especially for emerging markets, do they have very high foreign exchange reserves relative to their GDP or are they low? Because if they’re low and they’re running a current account deficit they’re at risk of becoming an Argentina or a Turkey where their currency loses tons of value and they have little way to defend it. And so I look at various currency metrics. And so what I do is I try to rank countries around the world or at least have a map of kind of what’s going on so I can spot anomalies. Areas that might be very risky or that might be very opportunistic. So that I go in and then qualitatively look around and see what I think. And so I like to maintain that big quantitative metric to find where is a good combination of both quality and price? Stig Brodersen (21:06): Whenever you specifically look at the US dollar, I can’t help but think, how do you weigh the euro? Because I’ve seen a lot of different baskets that it’s compared to. The euro always takes up a lot in that basket for obvious reasons. But always makes me wonder, so is the dollar strong? Is the euro weak? Is that actually what we’re seeing right now or vice versa? How do you weigh that relationship with the euro whenever you’re evaluating the dollar? Lyn Alden (21:31): Well, the dollar index is the go to one which yeah, the euro is over 50% of that. But you do have the other
40 some percent of it is a basket of other major currencies. That’s still a pretty useful metric. But then you want to double check that by going in and comparing the dollar to specific currencies. Especially major ones. How does the dollar compare to the yen? How does the dollar compare to the renminbi? How does it compare to say a basket of emerging market currencies? And so that can tell you is one currency weak or is the other currency strong? And so historically the dollar because we are the global reserve currency and we have a more unusual currency situation than other countries, we tend to go through these big cycles of dollar strength and dollar weakness.
Because we’re kind of the funding currency for the rest of the world. And so that has implications. And so over the past five, six years we’ve been in what I would consider a strong dollar period where the dollar is elevated compared to the majority of other currencies. Lyn Alden (22:30): Not necessarily every single currency but the vast majority of them the dollar’s been elevated compared to say if you measured it 10 years ago.
Now over the very long run the dollar’s actually gone down say over almost 50 years of being free floating. The dollar has gone down against a basket of major currency comparisons. But it’s been these kind of big three waves. It had a big period of weakness in the ’70s and a huge spike in the ’80s and that rolled over with the Plaza Accord. Then another spike in the late ’90s, early 2000s. That rolled over. And then ever since around 2015
we’ve been in another big spike. And so it hasn’t gone as high as the previous ones but we’ve remained somewhat elevated, where the dollar is pretty strong. And that has implications. Lyn Alden (23:15): So that’s historically … Strong dollar environments are very problematic for emerging markets that often have a lot of dollar denominated debt. So that kind of acts as sort of like a quantitative tightening for them. Generally you have … Every time the dollar goes through one of those big strengthening cycles usually some emerging markets get absolutely crushed. In the ’80s it was Latin America. In the late ’90s it was Asia. In this recent cycle it’s been a little bit more varied. You have Turkey, you have Argentina and just overall you just kind of have a stagnation worldwide with these high dollar based debts that have gone up in value.
And so a big thing to watch going forward is, is this cycle of dollar strength ending because if so you probably want to be in things like emerging markets and commodities. Or are we kind of going higher or staying at this plateau for a number of years which can prolong this cycle and make it so that maybe emerging markets continue being lost money for at least a few more years. Stig Brodersen (24:14): Lyn, I would like to transition into talking about this wonderful report here. And I’m holding this up to the camera which clearly works a lot better if you’re on YouTube than if you’re listening to this as a podcast. But you give all the markets a score which I found to be really useful and interesting because you’re right. If you follow the Meb Faber approach which is very interesting whenever you study, it works for all countries aside from Denmark and Sweden. Those countries are very specific for different reasons.
But there’s also a question about accessing. I know that you’re spoiled in the states. I live in Denmark and we don’t have the same access. So just because we can see a study like oh, the Filipino market is just great or whatever it is, that’s great. We can’t access that ETF. And so our selection is different generally in Europe. It’s just regularly different than Europe. It’s not just in Denmark. But all of the European Union. So we have different types of access
and if we can find ETF we can typically only find one. And sometimes those terms can be outrageous. But whenever you look across the globe, which countries perform at the top and which at the bottom in terms of attractiveness? Lyn Alden (25:28): Yeah. So the ratings change every year and they’re based on those previous metrics I discussed. So some of them have very high ratings in certain areas and very low ratings in other areas and they average out to in some cases like a medium high rating. And so at the current time … And again, this is not based on what’s going to happen in six to 12 months because it incorporates things like valuation that don’t tell you almost anything about short term performance. It’s more about what areas are likely to do well over the
next say five to 10 years versus what areas are at risk of kind of meltdowns or doing very poorly? And so overall at the current time southeast Asia scores pretty well among multiple metrics. So that would include … So you can look at a developed market like Singapore. You could also look at emerging markets like Malaysia for example. India, Indonesia. So overall that market was very, very strong obviously decades ago. It had another bout of strength in the 2000s decade. But many of those markets have been in kind of a loss decade. But they have generally very high currency fundamentals, generally current account surpluses, generally high reserves relative to their GDP, and just overall decent demographics and growth trends.
Lyn Alden (26:39): On the other side of the coin I’m also pretty bullish on Russia long term. They’ve done very poorly over the past decade which was a commodity bear market decade and obviously Russia’s a very commodity oriented market. So if you expect decent body performance in the 2020s then in Russia generally you get very high quality commodity companies that generally have less debt than their western counterparts and for lower evaluations. And often longer reserve life. Now, the cost for that is you put up with some higher degree of political tail risk. You don’t have the same rule of laws you have in the United States or most of Europe. But many of
those companies are very, very well managed. Many of them are managed like their western peers. I often like to point out that Lukoil for example, the Russian energy company, has outperformed most of its western super major peers over the past 20 years. And it’s in large part because they didn’t do bad acquisitions or things like that. They’re just really well managed. And so low debt levels
and good production and not making any major mistakes. And large insider ownership for example. And so overall I kind of like that barbell approach where … Lyn Alden (27:50): A lot of southeast Asia is energy importer and has good growth demographics. And then Russia you have bad growth demographics and cheap but it benefits from a higher commodity price. And so I kind of like that barbell approach.
South America doesn’t currently score as well as some of those regions but I do think that if you were to get a weaker dollar period, probably would also see a pretty powerful I think resumption of growth in those markets and they would have a decent shot at moving out of this kind of loss decade that they’ve experienced. Stig Brodersen (28:21): Whenever we look at the list what I really like is that you give them this score. You have this moderate opportunity that’s more than 20. A better investment opportunity like 23 and above. Like Singapore you have top ranked as 26. And then you have the United States 15 points together with France. So everything else equal the worst countries to be in. So how do you think about position sizing according to the overall country score? Should you for instance still be invested in the states? How much should you invest in Singapore? And if I could just add a third one to that, because you did mention that you did a few individual picks in the states but does that just mean like if you rank that you shouldn’t be indexing at all? Lyn Alden (29:07): This report’s kind of meant so that very different types of investors can use it. So some people might want to express
that view through ETS. Some people might want to say, “Oh, this market looks interesting. Let me go see if I can find individual stocks there that might be attractive.” And so that’s the first caveat, that it’s going to be used in different ways by different people. I think another thing obviously to keep track of is where you are. What are your expenses based in? Let’s say an American finds that the US market is over valued. They might not want to put 100% of their assets in other countries because now they’re taking on currency risk which could be favorable currency risk. The foreign currencies could appreciate compared to their home currency.
But the point is they’re taking on potentially more volatility because now their assets are denominated in a currency that’s different than what their expense are denominated in. And so generally I think it makes sense for the majority of investors to have a home country bias to a certain extent. Obviously it depends on the size of their market. If they live in a very small country it’s hard to over weight that too much without having too much concentration risk. Lyn Alden (30:09): But overall I think generally you start with a home bias but then you can tilt in certain directions based on where value is. If you generally approach with say a value oriented or a contrarian oriented mindset, when a market has done very poorly for a decade and when it’s cheaper than normal and you’re seeing some … If you understand why that happened and you’re seeing signs of reversal it’s worth potentially over weighting that market. Probably compared to most Americans I have more non American equity exposure than I think the average would. And generally what we’ve seen over the past
decade is the United States outperform pretty much every other market and so we see unusually high capital concentration in the United States at the current time. It’s a very crowded trade. Lyn Alden (30:51): If you look at the MSCI ACWI index which is one of their broadest indicis, the United States market is just under 60% of global market capitalization which is pretty remarkable. Every other country combined is 40% or 41%. Partially that’s warranted because the United States benefited from these huge FAANG companies for example. But it has though … There’s not a lot of more places to get capital to then keep shoving into the United States. It’s very … Everyone’s on one side of the boat. There might be still a couple of stragglers on the other side of the boat but it’s not like we still have tons of people getting on that side of the boat. And so the big risk I think is that if everyone’s piled into that trade, then it may go through one of these big dollar bear cycles and the United States market just performs poorly then everyone’s kind of caught off on the wrong side. I mean there was a brief moment of time in
the late ’80s where Japan’s market capitalization exceeded base market capitalization. And we all know that that went very poorly for everyone involved over the next few decades. And I’m not saying that the United States is in that position. Their CAPE ratios were even higher back then. Japanese … They had like the highest CAPE ratios on record from what I’ve seen. Lyn Alden (31:59): So it’s not to that extent but it is a very crowded position and so I do think this is a time worth, at least for very patient investors, buying quality assets outside of the United States and having some degree of geographic and currency diversification. Because on a sector by sector basis you can generally get higher quality
companies for lower prices. Like you can get a … Say an apples to apples comparison, you can get a similar bank for a cheaper price. You can get a similar healthcare company for a cheaper price. You can get a similar tech stock for a cheaper price. And so when you go down that list generally I think that there is a lot of opportunity outside of the United States. But in the US, again, we see a larger valuation gap than normal between growth and value. So I think commodity
stocks in the United States just are attractive. I think mid stream assets are attractive. I think the healthcare sectors are easily attractive. I still think a number of value oriented exposures in the US are also attractive. It’s just that we’re very tilted towards growth at the moment. Stig Brodersen (32:56): Lyn, we have a huge set of investors here following the podcast who like to look at individual stock picks. Foreign stock picks. And typically not always in developed markets. I was curious to hear how we should think
about currency exposure. Say that our home currency is the US dollar and the Euro for instance. You mentioned Lukoil. I remember looking into that many years ago and the fundamentals were just so amazing. It was so cheap. So I bought a bunch and the company performed well but the ruble just plummeted at the same time. So it was a very painful experience. And then as well as today,
I do think it’s tricky to figure out what’s the strength of the currency? Could you talk to us about how do you evaluate that specific currency and where that might go short, mid, or long term. Lyn Alden (33:45): Yeah. Currencies can move for all sorts of reasons. A lot of it’s sentiment based. So around sanctions or perceptions of the country. Now, what’s interesting about Russia, they’ve had some of the biggest disconnects between currency fundamentals and currency performance. So if you’re looking at countries like Argentina and Turkey, they’ve had very, very poor currency performance but this was predictable. And in fact I weighted Argentina’s currency very poorly in multiple reports in a row leading up to the ongoing weakness that they’ve experienced. And so when they exhibit things
like low foreign exchange reserves relative to either their GEP or their money supply that’s a big warning sign for emerging markets because they’re very reliant on that. You also want to look for current account deficits or trade deficits. That implies that either their economy’s not producing well or that their currency’s over valued and it’s basically making their exports less competitive and making their imports too strong. And so generally when you have a structural situation like that it eventually reverses and can be pretty violent when it reverses. Usually a recession or some sort of catalyst happens. Capital moves out of the country and suddenly that reverts. It’s like you took the escalator up and the elevator down in a way. And so generally for currency fundamentals I want to find countries with current account surpluses, reasonable fiscal debt situations that have high reserves relative to GDP.
Lyn Alden (35:12): Another factor for emerging markets is you specifically want to look at dollar denominated debt relative to size of their GDP or relative to the size of their foreign exchange reserves. Because these emerging markets that have these truly spectacular currency failures, it’s usually because they owe liabilities in a currency that they can’t print. Usually dollars. So they borrow from the foreign sector in dollars and so they’re actually at risk of nominal default and hyperinflation because they have no ability to relieve themselves of those liabilities in the way that a developed market can. And so if you look at Turkey they had huge dollar based debts in the corporate sector. Their government sectors not been very leveraged but it’s specifically in their corporate sector.
With Argentina, it’s been the reverse where they actually … They’ve gone through this so many times there’s actually not a lot of leverage in their private markets but their government takes on dollar based debts and that’s been a source of problems multiple times. And that happened with southeast Asia back in the Asian financial crisis in the late ’90s. It happened in South America in the ’80s where these emerging markets they get too much dollar based debts, run into problems. Lyn Alden (36:18): And so if you look at Russia they have one of the highest foreign exchange reserves relative to GDP among markets. Most years they have a current account surplus. They actually run a very tight fiscal situation. Often they have
surpluses. Like most countries they had a deficit in 2020 but less so than most others. They were pretty conservative with how managed that. They also have pretty low dollar denominated debt relative to the size of their economy and relative to their foreign exchange reserves. So they’ve actually managed themselves very well financially. I think that the had of their
central bank is one of the smarter ones out there and I think she’s done a very good job. But they obviously have other issues. So one is, Putin is not very popular on the world stage for good reason. They have human rights issues. They have corruption issues. They have sanction issues. And then they’re also heavily exposed to commodity prices. So when oil went [inaudible 00:37:11] last year obviously the ruble lost a lot of its value. At least temporarily. And going forward I’m pretty optimistic on the ruble. If you look at most of the fundamental aspects around it, especially
if you get an ongoing commodity bull market, that should be pretty good for the currency over time. Lyn Alden (37:27): Another thing you can look at for example is the big mac index, which says if you do a purchasing power parody comparison, that’s another way of kind of measuring if currencies are overvalued or undervalued. And by most metrics the ruble’s undervalued. Especially when you, again, look at all those other metrics. And so if you were to consider currencies to be like value stocks,
right now the ruble would be an example of a company with like a great balance sheet, super low valuation, but just know one wants to own it at the current time. Stig Brodersen (37:55): Lyn, one of the things that you mentioned in your report is that some of the problems of the US don’t matter until they matter. I love that phrase in itself. But like the structural deficit that seems to gradually starting to matter. Can you please elaborate more on that?
Lyn Alden (38:11): So because the US is a world reserve currency we have an unusual situation where ever since the ’70s specifically, due to the specific deals we made with OPEC, most energy worldwide is only priced in dollars. So if France buys oil from Saudi Arabia they pay in dollars. What that means is that any country in the world that needs to import oil needs dollars. And so that has made it so that essentially the US props up the value of the dollar. So it makes our exports less competitive and it gives us more
importing power. And so for the United States the downside for us is that we started running these massive structural trade deficits that they just never close. It just pretty much keeps getting bigger over time. And that supplies the rest of the world with dollars. And those countries then take those dollars and it filters up to the central banks and the stock wealth funds. And then they reinvest those dollars. And a lot of that goes back into US markets. And so they buy our bonds, they buy our stocks, they buy our real estate. Which
sounds good. You want the rest of the world investing in your country but the downside is that it means that our net international investment position keeps deteriorating. Lyn Alden (39:19): That basically the foreign sector owns a larger and larger percent of our productive assets. It’s like we’re becoming kind of a nation
of renters as the foreign sector increasingly owns our most valuable things. Our land, our companies. They’re creditors to our government. And so this cycle’s been in place for … You can call it about 45 years now. And there’s been counter rallies where
other markets do better. Like so the ’80s you had Japan do very well. In the 2000s you had emerging markets do very well. But this has been a very strong period of performance for US assets somewhat at the cost of say the US industrial base and the US blue collar workers. So we’ve kind of
run into this big engine of trade deficits to get recycled back into our capital markets which are very good for those of us that own assets. But we’re starting to see signs of that reversing. So for the longest time oil was only priced in dollars, now we see Russia pricing it in Euros which is important because they’re one of the biggest exporter of oil. They also have enough military protection. There’s nothing we can do about that from the United States perspective. Lyn Alden (40:19): China … They’re doing trade with Russia and Europe doing trade with Russia increasingly in euros rather than dollars. And so that’s more currency diversification. And we’re starting to see for example Saudi
Arabia is still pricing their oil in dollars but as we see many tensions between Saudi Arabia and the United States, as we see that now China is the biggest customer of Saudi Arabia, that situation could potentially change over time. And so overall this system has probably run its course. The rest of the world is finding it restrictive and Americans, especially those didn’t benefit from the huge appreciation and capital markets, are also finding it rather restrictive. And so I think for a variety of kind of just mathematical reasons and geopolitical reasons, that is probably going to change over the next decade or so. But it’s one of those things that it’s got a very strong network effect and takes a lot of time to change.
And so we’re used to this big trend of say bond yields going down. United States running these big trade deficits. The rest of the world shoving that capital back into its equity markets. Lyn Alden (41:20): But I think as we go forward that could start to look pretty different. If that does start to look different, if that starts to turn, generally foreign markets could have a big catch up period similar to how I would describe in the 2000s decade where going in the dotcom bubble, US outperformed everything else. You had the strong dollar. But then when that reversed US equity markets did poorly for a while and once the dust settled you had a huge boom in emerging markets and commodities.
Stig Brodersen (41:47): What do you think that the Chinese game plan here is in terms of currencies? Whenever you see this increase in trade that’s been settled in Euros, is that where it’s going? Is it more like an intermediary step into the whole China’s increasing power one belt one road. Being the most important training partner for more and more countries now than the states and have been for some time. Not necessarily just in volume but number of countries. That sounded like a leading question. But is that the Chinese plan? Like if you had to put a horizon on like 10 years, decades, centuries, is the whole euro play right now just an intermediary step? Lyn Alden (42:26): I think so. China’s long term goal
is that it wants to be self sufficient and powerful. And in its current framework it’s still reliant on the dollar in many ways. Because as we discussed before at least until very recently most energy pricing, most commodity pricing globally was dollars. And the United States likes that because we can sanction any country that doesn’t play ball. We can cut them off from the dollar based system. And that makes it very hard for them to secure the things that they need to get. And for China they are a huge export nation in terms of manufactured
goods. And they’re also good with technology in recent years. Their big achilles heel is that they’re a huge energy importer and commodities importer broadly. And so in order to make sure they get enough energy, get enough food, they have to ensure that they can have commodity exposure. And so partially the belt and road initiative is to make sure they have access to infrastructure and reserves in those different countries that they can get those commodities that they need.
Two, they want to be able to diversify the ways that they acquire them. So they don’t want to be exclusively reliant on the dollar like they used to be in order to get those. Lyn Alden (43:37): The first step is it just includes diversification. So dollars and euros, if in the worst case scenario their dollar access gets shut
off they still have the euro root that they can go through. And so Russia will still sell them oil in euros even if both of them were cut off from the dollar based system. So there’s that. Longer term, obviously China’s interested in lodging its central bank digital currency. And so that can potentially reduce the friction of using its currency with some of those trading partners. And so there’s no indication that China wants to have the same sort of global reach as the United States has had, both militarily and with its currency, but it certainly wants regional sovereignty. Lyn Alden (44:14): Like it wants to have control over its own region and it wants to not have any sort of foreign power be able to cut itself off from the financial system. And so we’ve actually been in a weird case where for most of this 45 year history of
the petrodollar system, the United States has been the largest commodity importer and it was in our currency. Now we have this weird situation where China’s the largest commodity importer in many cases. They’re using the second biggest commodity importer’s currency to do it. They have a pretty strong incentive to diversify the currencies and then ideally in the long run for them to use their own currency as much as possible. Not that other countries will necessarily use their currency,
but that China will be able to use it with some of their trading partners at least. Stig Brodersen (44:56): A lot of Europeans and Americans, whenever they think developing markets they’re thinking India and China. There’s so many interesting narratives. Not just the size of the population. Especially India has an attractive demographic outlook. A lot more than China has. If you had to compare India and China, which of the two countries are most attractive for investors and why? Lyn Alden (45:18): I think it depends on the timeframe.
Longer term, I think India has more opportunity. With the bloodbath we’ve seen in Chinese equities this year combined with rather strong Indian equity growth, I think China’s a more interesting contrarian play. I could have had a very different answer if I was asked maybe a year ago, whereas now I’d actually maybe lean a little bit more towards China than I normally would have.
But basically, the difference is that India has stronger demographics. So their population’s expected to overtake China’s quite soon because India didn’t do the one child policy that China did so they have a younger population on average and a faster growing population. So they have that going for them. Lyn Alden (45:59): Two, a large part of China’s growth over the past decade has been from leverage. So they’re about as leveraged as the United States is now. And it’s in slightly different areas. So for example, China has less leverage on the sovereign level than
most developed countries and they have kind of moderate leverage on the household level, but their corporate sector has had a very large debt bubble, particularly in the real estate area. And we’re seeing some of the negative implications of that play out now with, say, Evergrand risking of defaulting. So we’re going to see how far that goes. They seem to be finally addressing some of that and letting that play out. And it remains to be seen how much contagion that
will have. But essentially, if you were to compare China to India over the past decade, they both grew very quickly but China used leverage partially to grow at that speed, whereas India did that rather unleveraged. They did not build up large amounts of leverage on any of their public or private platforms to have that growth. It was more organic growth. Lyn Alden (46:57): The other difference is that China has a higher per capita GDP at this point. Decades
ago they were closer. So in some ways China’s model’s been more successful in the sense that that top down organizational structure’s been able to, for better or worse, accelerate certain things and the leverage has increased average standard of living in China compared to India. But the question of course that opens up is how sustainable that is. So with India you have a
democracy. Obviously there’s still human rights issues there but it is a democracy. And you have better demographics. So that’s generally how I would sum up those two differences between those two countries. Also China has been very export driven, whereas India is much less export driven. It’s more somewhat separate from the rest of the world. Obviously it’s very strong
in software so it exports software services. And it imports and exports various things. But overall it’s less tied in with the global economy than China is. Stig Brodersen (47:56): Lyn, thank you for sharing your framework for global opportunities. Could you talk to us about how investors could build
his or her own personalized global portfolio? What should we consider? How do we do it in practice? Lyn Alden (48:10): I start out with a big diverse mix. I have companies from my country, which is the United States. I have foreign companies. Because over the very long term equities are big compounder wealth. Generally equities or real estate are the ways we compound wealth over decades. And then you can look around for certain counterbalances. So
there might be environments where you want bonds in your portfolio and then you can choose what types of bonds are most attractive. Do you want them as a big deflation hedge or do you want to have them as dry powder to rebalance into more equities? And then if you’re in a decade where there’s a reasonable chance of inflation and being a commodities decade, one of the most powerful things is to have some sort of commodity exposure. Could be commodities themselves, could be commodities equities, could be commodity trend following where you ensure that you’re most exposed in the upside and limiting your downside because it’s a more boom bust lower quality area than other types of equities. So overall I think it’s about starting from that diverse starting point and then tilting into areas where you think there’s more value. Lyn Alden (49:12): So it could be certain countries, it could be certain factors, it could be, say, commodities versus tech for example if you think it’s going to be more inflationary, more kind of emerging market based.
And then wherever someone has expertise or that they follow markets closely. So I incorporate, say, bitcoin into a portfolio where obviously not everybody would. And position size is what manages the risk there. So when you add together equities, some bonds, some real estate, commodities and
some digital assets, generally I think that’s a very attractive way to kind of preserve and grow wealth over the long term, even though of course you’re going to encounter periods of volatility. Stig Brodersen (49:51): Fantastic. Well, Lyn, I want to be respectful of your time. I know you’re super busy and before we started recording you were also saying that you were going overseas. A bunch
of stuff are happening right now. So I will let you go but before I do I would like to give you the opportunity to give a handoff to any other resources to our audience. Lyn Alden (50:09): I appreciate that. I’m at lynalden.com for people that want to follow my work. I have free newsletters, free articles. I also have a low cost research service. And I’m active on Twitter, @lynaldencontact.
Stig Brodersen (50:20): Fantastic Lyn. And I can only endorse. I’ve done that throughout this episode but I absolutely love reading anything that Lyn’s putting out there so make sure to go to lynalden.com. It’s always worth a read. Or go to a Twitter profile. Stig Brodersen (50:35): Lyn, thank you so much for yet again making time for The Investor’s Podcast. I hope we can do this again soon.
Lyn Alden (50:41): Happy to. Thanks so much for having me.