Welcome And Today’s Big Picture

SPEAKER_01 0:00

Hello and welcome once again to Equital Conversations. I'm Gerald Ashley, and is always the way I'm joined by my good friend and colleague George Cooper. George, welcome.

George 0:13

Morning, Gerald.

SPEAKER_01 0:14

Good to talk to you again. We're gonna do a slightly extended one today because I think we're we're picking on a I was gonna say a single topic, but it's kind of a lot of uh topics interwoven. Um so we may give ourselves an extra five or ten minutes. And what we're I think we're talking about here is the the sort of current state of play in economics, politics, and markets and the sort of complex Venn diagram that uh is unfolding before our eyes. Um, George, I usually kick off by saying, give me a quick sort of horizon of of the topic, but um, I'm gonna try and restrict you a bit, but there's some big themes going on here and they're and they're pulling against one another, aren't they?

Three Forces Driving Global Turmoil

George 0:59

I I'll just warn the listeners ahead of time. We're not gonna be able to reach a conclusion on any of this because we're going to talk about broadly a set of things that are driving the world um in an increasingly unpredictable way. And I think I'd characterize them in three broad camps. We've got first a series of pretty important um factors driving economic turmoil. Um, and that's really, I think we've got a bursting of the AI bubble. Yeah. And I do describe it as a bubble. And by that I mean I think the the losses incurred in this bursting of the bubble are not going to be recovered. I think that's almost the definition of a bubble. And then I think we've got the energy shock, which may or may not be fading as as we talk, but nonetheless it's going to have uh big ongoing impacts. Then two flavors of political turmoil, what I've called domestic political turmoil. So we've got we've got riots in France, we've got something that looks suspiciously like a coup going on in Poland. It hasn't really got um got much press coverage.

SPEAKER_01 2:09

That's quite an extraordinary state of affairs, actually, but maybe we come back to that.

George 2:14

Yeah, a dispute between the the president and the prime minister in Poland. Uh, we've got the elections in Israel with what looks like might be the unseating of Premier Netanyahu. We've got the midterm elections in America, which it's certainly not unseated Donald Trump, but it has unseated a lot of Republicans, and that is potentially changing both the foreign policy agenda, the domestic policy agenda, and particularly the agenda towards uh continued AI investment spending. So that's important. And then we've got the riots in France, uh, which I think I spoke about, and they're into interplay with the foreign policy agenda, which I think is is very important. So those are all domestic issues feeding from and into three big geopolitical, uh sort of international political issues, which of course is Ukraine. We've got President Trump seemingly weighing in to try to reduce that conflict. We've got Iran, and we've got the ongoing uh conflict in Gaza, which are all inciting different degrees of problems in in other fields. So trying to tie all of these together and just discuss some of the implications is what we're gonna attempt to do today.

SPEAKER_01 3:37

Um so hence our title of turmoil, and it it is turmoil, and um I think what happens with a lot of market participants, they they quite naturally focus on their area that they think they know well. But this is a time where one's got to be aware of these broad themes as well, because they're to my mind, they're pulling things in financial markets in in many different directions and in different time horizons, which may explain why it has been quite a well, you could almost say a violent financial market this year, with some of the moves. I'm I'm sensing from you, George, is that this may go on for quite a long time.

US Politics And The AI Spend Pullback

George 4:18

Let's pick off some of the easy ones to start with. I think the the US midterm elections, the equity markets, particularly the uh the markets with regard to um investment spending in AI, so the the semiconductor stocks, the um the stocks associated with data center builds out and build out and things like that, they've all taken those results very badly.

SPEAKER_01 4:42

Yeah.

George 4:43

Um, because uh a lot of the Democrats that have come to power are much less enthused about building new data centers because they're taking too much power out of the grid and and other issues. I think the the election is real and it is changing the agenda, but I also suspect what was already happening in boardrooms across the well across the world is the management of some of these companies were beginning to get a bit queasy about the the level of the spending and the lack of the revenue that was coming through to justify the spending. So I suspect the election's being used as an excuse to to slow down investment spending.

SPEAKER_01 5:21

There there were some early signs a few weeks ago, weren't there? People maybe starting to pull back on on capital expenditure.

George 5:28

Yeah. So that's that's an interesting one. Now, if that happens, if we are seeing an end to the most euphoric phase of the AI investment boom, then my guess is we're going to see quite a sharp slowdown in economic activity, wage growth, things like that. And it strikes me that we may be about to sense that the central banks, which have all been hiking interest rates, may be caught on the wrong foot. They this latest round of rate hikes might prove to be unnecessary and ill-timed. That's just in terms of their investment implications for the economy, as in they're going to slow down an investment spend that was already slowing.

Rate Hikes Versus Energy Inflation

George 6:15

Yeah. But also, I think we we need to be having a bigger think about monetary policy generally and asking ourselves: does it really make sense to hike interest rates to fight an inflation when the inflation is itself caused by an energy shock, which has nothing to do with endogenously generated credit?

SPEAKER_01 6:36

I mean, what I think is quite interesting as a slight bystander is the quite sharp divide now amongst economists. Certainly here in the UK, there are people decrying that the Bank of England have raised rates, and others, some others have been demanding the rates should have been risen even higher. In fact, I think two members of the MPC, the Monetary Policy Committee, voted for a half percent increase. So, you know, who's going to be right and wrong on that? I know it's one of your great mantras that although we talk a lot about monetary policy, in a sense it comes all the way back to fiscal incontinence. And whilst we've got the background of all the elements we've just discussed, they're discussed, right around the world, government spending and government borrowing just keeps going up week by week. And uh is is there going to come a point where that will just simply have to stop? I I don't know.

George 7:33

Difficult to see how it does given all of these issues that we're we're talking about at the moment.

France Riots And Immigration Tensions

George 7:39

Let's look at what's happening in France, for example. We've had riots which the press tell us are due to a lack of spending in education. Yeah. Now, you know, it it it may be that that the the inability to get the latest uh Pulitzer Prize winning literature to to French students is causing them to riot. I doubt it. I think it's something very different. And if you watch if you watch the images, what struck me is to be blunt, you see a lot of these riots with Palestinian flags. Yeah. And this this I think gets to a an important point here that we've got one of the big political flashpoints in Europe is we've got mass immigration, which is upsetting a lot of the the sort of the the legacy incumbent population, if you like, with governments effectively encouraging that immigration on the one hand, whilst also conducting foreign policy in places like Gaza and Iran designed to inflame the people that are coming in.

SPEAKER_01 8:50

Yes, I mean it no joined up thinking there at all at government level.

George 8:54

No, not not at all. So I think this is just extraordinarily unwise. And one of the questions that I keep asking is why are those in power conducting policy in this way? Because it's it's obviously not popular with the people, and we're meant to be in a in a democracy. So what is pushing in this direction? And one of the the the analysis that's I'm sort of drawn to is there's a fundamental schism between the way people look at their place in society and the way the elites or the government is looking at it, and that is the people, the citizens, sort of see themselves as shareholders of their country.

SPEAKER_01 9:39

Yeah.

George 9:40

They they think they they get to vote, they have sort of shareholders' rights, and they see the mass immigration issue as effectively a dilution of their shareholders' rights.

SPEAKER_01 9:51

Yeah.

George 9:52

So that you know that that's a simplistic way to look at it, but I think it's it's a useful framework. Whereas the the state itself sees things differently, they see the people as the state's assets, yes, yes. And they want more and more and more of them. So there's a dichotomy between uh between the the the way the two systems are working, and I think this is leading to uh a lot of the social unrest, a lot of the discontent, and I'm drawn to an author that I know you pay a lot of attention to, Gerald, which is Peter Turchin, who talks about the overproduction of elites and and a situation where the economy can't generate enough jobs for them.

SPEAKER_01 10:39

Yeah, I mean, I think one thing that well, a couple of things um Turchin says. The first one you've mentioned. The second one is this um rather strangulated word of immiseration, um, which perhaps let's put it in slightly plainer English, was is the suppression of wages. And um, you know, there we have certainly in British society, and I think across the G7, um, there's a large body of really not just working class but middle class people who can genuinely claim they're unable to manage. And they often would appear to be on pretty large salaries, but when you strip out the fact that a lot of them, for example, have got student loans to repay, um, or you could call it a graduate tax, but it's still got to be repaid in some form or another. Um, the the cost of childcare is extremely high. Um, the cost of property, despite the fact that property um has certainly come off a boil, is still not cheap. Um a friend of mine was visiting this weekend and showed me a flat she quite liked in uh in West London in not the ritsiest address. Not the ritsiest address, two bedrooms was on the market for 950,000. Well, I would have thought maybe you want to halve that before it starts to look like a half sensible price. So all of what Turchin is saying is that, in a sense, society is starting to act against itself. You know, we're dividing into these groups of people who, you know, not just feel they're missing out, but are missing out. And as you say, maybe an increasingly isolated elite at the top who can't understand what all the problem is. I think sometimes historic parallels are dangerous, but there is a slight echo here of the last sort of 20 years before the French Revolution, um, with a deeply indebted state virtually bankrupt, a totally out-of-touch elite, and the vast majority of people, not just how to say peasants in the field, but a large majority of people in France are extremely both upset and impoverished. So, with that sort of very bright picture, um, one of the things that comes out of this is is the economic system now so unbalanced that somebody's going to have to give? I mean, I before I hand back to you, this thought of billionaires in the United States with unimaginable amounts of money, with Elon Musk maybe becoming a trillionaire, we we know that a lot of this is just fluffy nonsense because it's book values that can disappear overnight. But the divide between people at the bottom and at the top, I mean, we're getting back to plutocratic levels last seen before the First World War. Not that that was the cause of the First World War, but that whole Edwardian era where there was enormous um divergence between poor and and rich. Um this is gonna this is gonna rock things seriously, I I sense.

George 14:00

I think you're right, Gerald. And I think we what we're seeing in so many different fronts seems to be unmanageable crises. And I I rather suspect that when we get to situations like this, wars and foreign conflicts actually become a sort of lightning rod. It's much easier for an elite, uh a government, uh if you like, to start pointing the finger at foreigners and blaming Iran for the energy problems, blaming all all sorts of external shocks, when in fact the problems are actually internal, they're endor endogenous. But that requires facing some very tough choices if you recognize that. So I I suspect these conflicts are are not being incubated for this reason, but they're being allowed to run because the the elites don't have the ability to to control what's going on. And particularly, they you just practically they don't have the ability to generate the tax revenue to pay for their spending goals. That's the essence of the problem.

SPEAKER_01 15:12

Yeah, we we come on to another favorite topic of the laffer curve. If people are interested to see that in real time go to Scotland, where Scotland's increasing use of taxation is actually pretty much halted any increase in revenue and in government revenue, and in fact may actually be going slightly into reverse. So there is clearly a level at which diminishing marginal returns really kick in. Um, if we pull all this back to maybe more our locality of the markets, um you didn't use the word, but I think what we're saying here is a recession, aren't we?

Recession Risk And Bond Buyer Strikes

SPEAKER_01 15:52

Close with the central bank activity to possibly trigger triggering a recession. At a very time, if we get a recession, is when governments normally step in and put money into the system to sort of, you know, steady the ship and try and turn things around. And isn't that the crux of a really serious problem here?

George 16:15

This is where I do have concerns because we're already at a s situation where we're running enormous deficits at the moment. We're running effectively wartime deficits in in what we're told is a boom-time economy. If we go into a recession now, say the the AI investment bubble has burst and it stays burst for a protracted period, then we're going to need governments to step up their spending because tax receipts are going to fall, unemployment's going to rise, and we're going to be potentially talking about double-digit fiscal deficits. So who who's going to who's going to fund that? You know, we come back to uh the lovely phrase that I know you've used a few times in the in the past, Gerald, from uh from your past experience, a guilt buyer strike.

SPEAKER_01 17:06

Yes.

George 17:07

And and I think we're seeing elements of this in the in the private sector bond market, where I think we've got a a bit of a buyer strike going on for private credit, and private credit, particularly for funding the uh the data centers, etc. Does that roll into a buyer strike for government bonds? Arguably it's happening because the governments are being forced to issue much more at the front end of the curve, uh, because they they simply can't sell the bonds at the longer end of the curve. So is that already starting to happen? What then happens if we do get a slowdown and governments have to issue even more debt, with with the central bank saying, sorry, energy price inflation means we've got to push up interest rates. Something's got to give here.

SPEAKER_01 17:58

Yeah. I'm gonna try and strike a positive note somewhere in all of this. Maybe one way through part of the tangle, um, but may not be a practical thing to do, is somehow what what face do you to use? I was gonna say emasculate, that's too strong a word, but to to weaken greatly the power of these elites in some way or another. So that in in British terms, I think a lot of people think a state is far too big. And in fact, government policy seems to be hell for leather to make it bigger, and at some point they're gonna find tax revenue won't won't do it. I'm not advocating we all get out on the streets with our pitchforks, but somehow um we have to reduce the size of the state, get in a way, just get them out of the way so the rest of us can get on and try and grow the economy, which would grow taxation, and then get back into a into a sort of positive cycle.

George 19:00

Now, is that too much of a pipe dream? The conditions to get that to start to happen may be forming. And uh and I think the the trigger is probably funding. If the if the bond market simply won't fund it, then um then they're going to have to trim the the expenditure at some level. Unless, of course, they they just lean on the central banks to print even more money, uh, which I think will that will happen as well. But I think the it will also trigger a a rethink of the spending plans, which simply has to happen.

SPEAKER_01 19:34

So we we are back to our usual chat we have with Helen Thomas. We did it last year and we did it in the autumn. At some point we're going to have a crisis, but whether that crisis will be in the bond market, we can't say it definitely will, but that would be a very strong candidate.

Dollar Weakness And Why Gold Fell

SPEAKER_01 19:51

Um, personally, I sometimes bang on about the fragility of the British electricity so-called national grid, which seems to be uh increasingly operating on the wing of the prayer. Again, today we have um looking out the window, no sign of sunlight and uh no wind either. And so the whole renewables uh calculation um comes under serious doubt in in days like this. From a markets point of view, and another element here is to look at the US dollar. And some people have said, well, look, the US dollar is kind of okay, and uh, you know, there's uh if anything, there was a bit of dollar buying when when the uh Middle East uh thing blew up again. But of course, if you look in terms of the dollar against things other than other currencies, um, it looks pretty weak against base metals, it looks pretty weak against the whole commodity sector. One slight puzzle may be that the precious metals market, um, which I know you and I have favored for at least the last two years, has has come off a boil, to say the least, a lot this year. Um, and in a way that doesn't suit the narrative. So, in the turmoil of all of this, what what might be pulling gold the wrong way at the moment?

George 21:13

Well, I suspect what's happened is we we had an overly aggressive rally at the end of last year and into the beginning of this year, and we would probably do a technical correction at about the time that the Gulf War started, the era the war on Iran. And that the war in Iran had the effect uh because of the way the Iranians responded, which seemed quite logical to me that they would respond this way. They responded by trying to shut down the energy flow out of the Straits of Hormuz, and that shut down the revenue flow in the other direction into the Gulf states. Yeah. And a lot of these Gulf states, especially Saudi Arabia, had very, very aggressive spending plans. So those those countries were pushed into deficit. Very, very quickly, and I suspect have been offloading their gold to try and fill the hole. So I think we've probably got a technical event where the war in the Middle East has masked what would be otherwise a sort of progressive deterioration of currencies against precious metals. And certainly it looks to me like the Chinese uh authorities, which seem to me to be the rather smarter players in this geopolitical turmoil, they look to have taken advantage of this. They've carried on buying gold as it's fallen in price, and interestingly, uh reduced their purchases of oil as oil increased in price. They moved to using their own reserves. So they seem to have done the trade of the century, if you like. They've bought gold at a bargain price and saved themselves from buying oil at an expensive price.

SPEAKER_01 22:58

Yeah.

George 22:58

All told quite impressive.

SPEAKER_01 23:01

I'm going to pull it right into a narrow focus and looking from a view of a private investor or myself with a modest portfolio.

The Equity Market Bubble And Anti-Bubble

SPEAKER_01 23:11

Recession, still inflationary, lots of turmoil. We just talked about, um, maybe slightly talking our book here, but equities, and one has to say the right sort of equities. Um, there's a big caveat there. Um, could well be the best way to keep some form of protection through all of this. Could you expand on that a little bit about what to be in and what to avoid? I don't mean individual stocks, but you know, in terms of the cycle.

George 23:42

I I'm not sure if we've said it on the podcast before, but I've I've certainly said it in for for quite a while elsewhere. I sort of view the equity markets as being in both a bubble and an anti-bubble at the same time. Um we've we've got some extraordinarily overvalued companies. You know, the anything associated with Elon Musk seems to carry an extraordinary valuation that just baffles me. Uh, but that's just one area. There's all sorts of other companies that I think are are trading at huge valuations because of AI euphoria. And then at the other end of the spectrum, we've got companies on extraordinarily low valuations. And I think what's happened there is there's actually been a migration out of one sector of the market into another, and it's left undervaluation and overvaluation coexisting together, which is quite unusual. Um, so I don't I don't actually think them the overall market is particularly risky, or it's not right to look at the overall market. It's better to look at the two different components. Yeah. And the the cheaper side of the market, I think, is an extraordinary value, uh, an extraordinary opportunity in a world where we're likely to see an inflationary debasement of money going forward. So I think it's there there is a setup there that's very attractive. Um, and that's where I think people should focus on. I I would certainly still stay away from government bonds where I think that we're going to get a lot more issuance because there's there's simply no way to s to turn this spending off in the near term.

SPEAKER_01 25:22

But to coin a phrase, lots of people talk or people want to um predict the next crash. And you know, crashes are always um well, they're always supposed to happen in the autumn, um, although they pretty much happen any time they want to. Perhaps a better uh word to use here is fractured, that it's a fractured market between just exactly what you said, the the high flyers who are clearly flying incredibly close to the sun, and um, I think a phrase you've used in the past, that the so-called fallen angels, which are quite high-quality companies, but almost at a fashion reason have been ignored whilst money is busy chasing the high flyers. So from that, can we take the view that if you take a fairly conservative equity uh stance, um it may be a safe haven uh to an extent?

George 26:20

I think the conservative end of the equity market is the safe haven asset now. You know, we've all been told, uh primarily by governments, we've been told that the government bond market is the safe haven asset. Um I think that's really that uh that fairy tale has be is being debunked as we as we speak.

SPEAKER_01 26:41

Right. Well, we've gone

Next Month Preview And Book Picks

SPEAKER_01 26:43

on a little longer, not a great deal longer. Um again, I think these three themes um that we've sort of uh kicked around um are going to be around for a long time. As a preview, we have one more podcast coming up in December where we're going to um uh invite in uh Doug McWilliams, uh very distinguished economist, and um maybe he can tease out some of the uh uh factors that will um impact in 2027. So that will be out in about a month's time. Lord knows what the world will look like in a month's time, but we'll we'll leave it till then. Um we come to our sort of final little bit, which is um a book recommendation. Um increasingly I've had a reputation for only ever recommending history books. I think I wanted two others than that. But today there is um a definite um uh move away from that area. I'm gonna recommend a book called The Flavor Thesserus. And to explain it, there is um subtitle uh Pairings, Recipes and Ideas for the Creative Cook. It's by a lady called Nikki Segnit. I believe she is a professional cook, but what she's done over her many years of experience is to essentially ride a thetera. So I don't know, you look up cucumber and it tells you all the spices and foods that go with Cucumber and all the things that would be a complete disaster or if or be, you know, positively revolting if you put them. And it's 600 pages. It's not a reading, it's not a reading book, it's a reference book. But it's a for anybody who's interested in trying to dream up new ideas and think about flavorings in their cooking. I mean, it it it's got absolutely every combination you could imagine. So there we go. The flavor thesorus.

George 28:41

That's a nice antidote to the topic, which is uh which is good, uplifting. Um, I'm I'm going to stick on message and talk about another um sort of investing trading book, um, which I read several years ago. Um it's by an author called John Coates, who I think from memory used to be a trader at Deutsche Bank and then became an academic at Cambridge, researching human physiology. Uh, and the book is called The Hour Between the Dog and the Wolf. And it's an interesting book. It's basically talking about the hormone systems in the body and how they control risk appetite and uh and risk-taking behavior, particularly among traders, but generally above you know anybody involved in in taking risk. And there's a few things that struck me as interesting about the messages in the book. One is that he talks about how we have evolved hormonal response to danger to sort of trigger a fight or flight response. And that's designed to help us sense danger and take action quickly. And the action we should be taking, fight or flight, is usually physical. So when we get these surges of uh fear hormones, they're meant to come uh just before we get some physical exercise to help us burn them off. But in the modern world, what happens is we experience these long periods of fear uh with a hormonal response, and we never take the physical exercise to go with it, and that has bad health implications. So that's one thing. The other uh another little anecdote from there is it talks about the the pleasure of acquiring something, but there's also the pleasure of anticipation. Oh, and that they're two quite distinct things. So if you've ever um you know hankered after buying something or acquiring something, and then you get it, and then you find this sudden sort of feeling of hmm, that wasn't quite as fantastic as as I expected, it might be because you are uh actually being driven by the pleasure of anticipation. And once the anticipation's gone, you're left with, why did I buy the Ferrari? What a waste of money. So it's a very interesting book, the The Hour Between Dog and Wolf.

SPEAKER_01 31:10

Okay, George, thank you for that. Um, I don't know if that was uplifting or not. It's a very interesting book. It is a book that's on my bookshelf, and I must confess, I took away on holiday one year and never got round to reading it. So it's still on my to do list. Um, that's all for today from George and I. As I say, we'll be back in about a month's time for a sort of year end review and looking into 2027. But from both of us for now, thank you and goodbye. Goodbye.