Two interesting short video interviews conducted by the Kennox team with Russell Napier and Angus Tulloch towards the end of 2020. Some notes below – these are for personal reference only, so any mistakes in the transcription are my own.
Russell Napier – the biggest mistake we are making right now is calling something a business cycle which isn’t; major structural changes only come along every 30 years, so it is very easy not to spot them when they do occur. The main thing we should focus on in this “money tree revolution” is that governments have seized control over the power to make money by guaranteeing bank lending. Governments now control when and where banks expand loans, the interest rate, maturity, who the loans are going to etc. This is not a policy just for Covid-19, will eventually be seen as the route to fund all sorts of politically necessary ventures, including green initiatives. Conclusion from all this is when governments control the supply of money, you are going to get more inflation.
If he was given the choice by a genie to only look at one economic variable for the next 10 years, it would be inflation. You don’t want to own government bonds in an environment like this. What inflation means for equities is more nuanced, not universally good, but more in favor of value equities. He is doing a study right now on the correlation between levels of nominal GDP growth and relative returns from value/growth stocks. In higher nominal GDP eras, value stocks have done better than growth stocks, potentially for as long as a decade. Good time to be in the equity market generally in the early stages of this, but as it continues it becomes less good for other reasons. Key beneficiaries should be those companies who for a generation people have thought had no pricing power (e.g. companies who had problems competing with China) suddenly getting pricing power because of an inflationary environment.
Take on market valuations right now? If you go back to the last time there was a shock on inflation, from the mid-1960s up to mid-1980s, equity valuations collapsed. We are sitting today with a CAPE of ~32x for the US market, in 1966 it was ~25x, but by 1982 it was below ~10x. The capital index fell 40% in nominal terms. Period of rampant inflation and the price of equities actually came down, even as corporate earnings per share tripled. Warren Buffett wrote a wonderful article about this on how inflation swindles the equity investor; not necessarily true that all equities protect you from inflation.
What is the risk of Covid-19 morphing into a financial crisis? Incredibly low, due to the extent to which the government is prepared to get involved with this. You can see this with the recent extension of the furlough program, recent extension of the coronavirus bounce bank loan scheme etc. Every government in the world knows we are much closer to the end than the beginning, would be churlish to withdraw support at this stage. Question is how big will the recovery be next year? Thinks could be massive – when he looks at the aggregate data, he sees that inventories are really low and you have a lot of pent up demand, could lead to a very strong recovery in economic activity.
Angus Tulloch – is this time different? Length of this cycle seems to be much longer than any other cycle he has experienced in his working life. Self-fulfilling to a certain extent – the longer it goes on, the more people just give up and say you’ve cried wolf so often about inflation, the need to focus on valuations etc. and it’s not happened. But at the end of the day, it will happen and will happen very suddenly.
ESG – it must be more than a tick box exercise. He has always focused on governance as part of his investment process, never had time for companies that didn’t genuinely care about minority shareholders or other stakeholders. If a company polluted rivers, had poor labor relations and so on, there was usually something wrong with the culture. You could perhaps make money in the short-term, but in the long run he found these companies were not good investments.
Portfolio construction and diversification – if you are building a portfolio, you want to have something coming out and flourishing the whole time, don’t want it to be feast or famine. A camel is a horse designed by committee – you can’t have a group of people constructing a portfolio, you need one person responsible for making sure that all the things fit in, but the rest of the team have to make sure that person isn’t taking ridiculous risks, is sticking to the philosophy and so on. Have to find underlying profit drivers that are truly differentiated, that is where you are going to get the best diversification. That’s how you avoid the one bullet risk where one thing can take out a large percentage of your portfolio. No one knows what is coming next, so have to be very careful where you put your eggs these days.