I think the great risk with inflation is that if you treat it as transitory, it becomes
permanent. On the other hand, if you treat it as permanent, it'll probably be transitory.
Today I'm very excited to welcome Keurin Lynch to the podcast, the most experienced man
in the guilt market in this whole country. More importantly, he taught CJ everything that
he knows. So stick around for a great show coming up. Welcome to the art of investing brought
to you by IG, the Global Investment Platform. Some news before we start, the art of investing
is going live. Yes. On the 13th of October, from 6.30 pm onwards, we're going to be in
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sure you get your name into the link in the show notes below. There's going to be special
guests. There's going to be prizes. There's going to be England Cricket gear. It's a famous
place to go. I mean, it's a really desirable place to go. Unfortunately, you have to listen
to us. But that's the upside down the downside. And talking about listening to us, let's get
into it. So this week, I heard we had a guest coming in, but I didn't realize Spice was
bringing his dad to work. Thank you. Here it is, lovely to meet you. I wish I had a boy
like Spice. Thanks very much. I joined the Giltedge Market in 1976, so that's 50 years ago.
My first week in the Giltedge Market was the week that Britain entered a crisis and Dennis
Healy had to go to the IMF to beg for some money to bail us out. Unfortunately, he only got
to Heathrow Airport before he had to turn around, come back to Downing Street to manage
the foreign exchange crisis. So that was my first week in the market 50 years ago. I was
at that point working for Mullins and Coe who were a Giltedge stockbroker, but their main
client was the Bank of England. And we used to execute all the Bank of England's business
in the Giltedge Market, which meant that even as a blue button, the lowest form of life
on the stock exchange floor, I was obliged to wear a silk top hat. So that was where I
started. We after big bang merged with Warburg, which was a great British investment bank
of the day. So I was currently worked for Deutsche Bank and then finished my career at JPMorgan.
So I have worked for a top quality British bank, a European bank and an American bank,
which I think gives me quite a wide perspective on the market. So you've shown your lost
guess around, you've shared it with everybody. Well, they've all had that experience and
you would be called the father of the Gilt market. Well, that's fair. If you were still
around today, the grand father even. I mean, that's very kind of you, Chris. I do realise
that I'm here to make you look even younger. But yeah, one of the things I've enjoyed
in my career, I spent my whole life talking about the Giltedge Market. It's been my bread
and butter. But that is as well as talking to clients and traders, it's meant talking
to the UK authorities. So I had pretty good relationships over the long term with the
Treasury, with the Bank of England and the debt management office. Wonderful. Well, it
is an absolute pleasure to have you on the show. We're going to be talking a lot about
your history and experience in the markets, but also about the current climate and what
is going on, especially in this country and in the bond market. So we look forward to
that. So just to hand over to my second most experienced bond trader in the room, just
to hand over to Chris C. G. Fellingham. Yeah, I mean, it's going to be wonderful to actually
listen to Karen. I've had the advantage of everybody else of listening to him for probably
the last 30 or years. And maybe my first or second call in the morning would hear his
dulcy tones, but he will be able to talk us through what's happening in the past.
But more importantly, what should we expect to happen going forward, given how these
bond markets have moved? We've talked a lot about the bond markets in the last two or
three weeks. And so we felt it was right to get somebody on who is really an expert,
rather than me pretending to be one. Because it's getting down to crunch time, isn't it?
So we're going to go through that later. But of course, as always, my equity expert,
Mark Holden, it's time for the spice market update. Well, thank you, Rich and welcome,
Karen. It's been an interesting few days. We only recorded last Thursday. So this is
only a few days after that. And it's been dominated by the fact that the oil price has pushed
up again. Another five or six percent up to Brent, or as up to $108. And more importantly,
for Trump ahead of the midterms, West Texas intermediate, which is the one that Americans
sort of tend to consume, hit $100. And the price of the gasoline hit a $4.21 average across
the country. But the only all time higher can report on this week is that USD's all prices
hit at all time high of $6 a gallon. So that's not going to help Trump as he goes into
his midterms in just a few days. What were they trading out before the crisis?
Well, they've down at sort of three or four dollars of the double sort of thing.
Basing around that sort of. Well, gas that sort of diesel was down at about sort of three
and half four dollars. And unleaded was down at sort of two dies fifty three dollars.
So yeah, it's been, it's been ahead of squeeze. The crack spread, which is where airline
fuel trades over the oil price, that's at $30 at the moment. And no, that usually only
trades around eight to 10. Isn't this what they're warned about in the, when the, when
the war first started, everyone was going, gosh, the price of diesel, gosh, the price
of aviation fuel is going to go as much. And of course, nothing really happened. So
it was a bit like the, the boy who cried wolf. Now it's happening. It is happening.
Yeah, well, remember last week we taught them fact that Ryan air or warning that air fares
are going to have to go up substantially and we were speculating that they might be trying
to get you to book early. But yeah, as you say, the crack spreads have pushed them up
and over time, it looks like prices are definitely going up there. And we'll obviously build
that into what's happening in bonds because in the US this week, the US 10 year yield picked
over five percent this morning. This is a Tuesday. And that's, that's been a big psychological
level for equity markets. We saw that happen. So it's been a tough week at equities and
particularly bad for commodities. As you'll see when we look at our portfolio, we've
been hit hard by that. And that's because we've talked in the past about the fact that
when oil price goes up, countries and governments who have spare cash can't reinvest that in
things like copper or iron or other sorts of commodities, they have to use their extra
cash to pay the higher prices that they haven't used to keep their economies going. And
so that's certain. And you'll see there's been big hits to most of the commodities apart
from oil as I say, that's up five, six percent. And the US dollar actually this week is
up one percent, which is a double whammy for a member for commodities. When the dollar
price goes up, the commodity prices tend to go down. So it's been tough week around
that. So added to the woes of the equity markets, the hank to deal with those that higher
oil price. We also had a group of leading AI executives from anthropic, from open AI
companies, from SpaceX and Tesla, all basically saying you're going to have to slow down the
pace of development of some of these AI models, because they're worried about the safety
risks going forward. And that sort of over the weekend had lots of people speculating
about how bad and which companies were going to be hit very hard, but the key expert,
Voldemort, he said, don't worry. And he knows everything. So why bother?
And Darryl and Thropic came out and admitted that one of them had gone on a runaway tear
and started talking about how to develop biological weapons. That's the level that we're
talking out here. And Voldemort, no, it's fine. Nobody's going to stand in the way.
Yes. It's a hoax. It's like, it's like, it's like, it's like, the green agenda of
stuff is what he said. It's a hoax. The only thing that's pulling less popular than
Voldemort at the moment is data centers. Now that is a story. We may be returning to
that a little later. That's a very good spot. That's interesting. So, you know, the fall
out from those comments of the weekend was that the chip sector around the world fell
about 7% and as you'll see when we look at the portfolio, that did affect some of those
big Asian stocks in markets like Korea and Taiwan. And so that hurt emerging markets
generally. So chips are down about 7%. But actually, ironically, softwares stocks, which
had been hit remember early in the year because there's such speed of development of AI models
had hurt, potentially hurt their businesses. They're up 3% this week. And actually, the
Magnificent 7 who have a lot of software included in them were up 1%. So as you'll see, it's
not been all bad news, but certainly the markets had to grapple with this in the background.
And also people are really hoping, does this actually give the hyperskills a chance to reduce
their capex spent? If we're not going quite as fast, why are you spending hundreds of billions?
So meta, Amazon, they really responded well as all the chip sectors, hold up. It's always
a silver lining behind any cloud when you're actually going. Well, if you want me to talk
wax lyrical about that, I think, you know, the simple thing is if you have lower AI
capex, then you're going to have lower capital demand. Maybe it looks low growth, maybe
at the margin, but that'll lead to lower inflation, potentially.
that's what Bonyl's have run. Oh no, they have sold off. But importantly, it does reduce
that demand for capital from the big AI producers and that should, therefore, obviously, be better
ultimately for this competition for capital and take the pressure of some of these Bonyl's
that have been rising up there and maybe lead to more dovish fed. But we will talk about that later
because we have this week, we've got three central banks reporting. On Thursday last week,
we had the European central bank and they raised, as we predicted, they're here and as the market
predicted, they raised by a quarter percent, which is broadly expected. But actually, they added
comments to the statement which would quite hawkish, as we say, which when they implied there were
going to be likely extra rate rises, probably sooner than the market than anticipated. And now there's
a 90% chance of another quarter percent rise in December from the European central bank. And I think
that took a few people by surprise. They weren't expecting that. They were expecting maybe one,
and then we'll wait and see. Is it normal? I mean, maybe Kirin will answer here. But is it normal
for people to say, well, they've found quite hawkish and then not to put the rates up for another
three months? I mean, it sounds a bit ridiculous, doesn't it? That, oh, they're going to get hawkish,
they're going to put rates up. But not for another three months, you can have another three months
with it. Is it really wanted to do something? Why didn't they just do it? Well, I agree with that.
I'm looking forward to my chance to talk because I think I. You think you're going to get a chance
to talk, right? But I do think there's great value in the central bank being preemptive,
being timely in its interest rate hikes when inflation is a threat. And to say, well, we'll do a
little bit and wait to see how that goes down is not a good message for markets who are worried about
inflation. Yeah, interesting. So then on Thursday, we have the Bank of England. And to no doubt,
Kirin will tell us what he thinks about that. But the markets at the moment are the way I've read it
is not looking for any rate rise this week. And we'll see. We will see. But Thursday, for those of us
with mortgages or loans, et cetera, then that's. Then that's. We are welcome bit of relief,
but it may be short-lived, as we'll talk about. But then on Friday, well, another big event,
probably much bigger than the Bank of England, will be the Bank of Japan, who on early on Friday,
morning, our time will be nearly 100 percent expected now to put up interest rates by a quarter
percent there. And they're expected to talk quite hawkishly again about sort of implementing more
interest rate rises quite quickly over the next six months. And another sort of two to three
interest rate rises now expected in Japan, which, you know, going back a year or two, you would never
thought that. But we won't see. So do you think some of those hawkish reactions to data has caused
our portfolio performance this week? Because we're down 1.2 percent, which leaves us up only 10.8
percent year to date? Well, the big hit for us this week was. was commodities. So copper was
down 6 percent. And that was that really hurt us. Black rock world mining was down 5 percent. And,
you know, that, as I said, is partly to do with this high oil price sucking capital away central
banks money and sort of government's money into paying for this higher oil price. And the
strongest dollar, one percent in a week is quite a big move, actually. Doesn't sound like a lot,
but it is, actually. And that's very, very much on commodities. CJ, what was the best performer
in the week then? What saved us from? Well, you know, if they said it would never happen. And it
doesn't often happen. But the FTSE 100 is up there at the top with a marginal increase. So,
well done, the FTSE. Everything else of our risk assets is in negative territory. Of course, cash
was small positive. But we've got S&P 500 small down. And we've got the now stack down as well.
I mean, I mean, if I just quickly just mentioned bond yield just very briefly, I think the interesting
thing this week has been actually that those forward rates we've talked about in the last few weeks,
those longer term rates haven't really moved very much. What's happened is the front ends,
the short ends, the ones that are most linked to where interest rates are moving have moved
quite a lot. Because we've gone from expecting one or two rate rises to now sort of three or four
or eight rises. And so that's being priced in. And it's, you know, you could, you can look at this
one of two ways. You can say, well, you know, gosh, there's a lot that's has to be priced in.
But the other way you can look at it say, well, a lot has been now priced in with oil now
up at a hundred. Yet look at the performance of these asset classes. And most of them are still
pretty close to their all-time highs. So there's a lot of strength being shown in the market.
And I think later on when we talk about the portfolio in more detail and what we might want to do
this week, I think we need to answer that question as to is the strength in these risk assets,
strength, you know, which, which, which we should be comfortable by and think, oh, actually,
they're showing us underlying trend is strong. Or is it a mirage that's going to fade away?
Because that's going to be really cool. Your capital is at risk. The value of your shares, ETFs
and ETCs can fall as well as rise, which could mean getting back less than you originally put in.
This content is for information purposes only and is not investment advice. Pass performance is not
an indication of future results. I wonder if there's any chance to learn from the past and learn
from the huge wealth of experience that we've got with us today. It's safe to say nobody in this
country is more experienced than the bond market than you, Mr. Lynch. Well, that's a very kind
introduction. I think, I think, as you've got an old guy on the program, you might as well talk
about the past, you know, and that's something I do know about. But we have to be very careful when
talking about the past because there is a temptation as they say for generals to always fight the
last war, you know. And if you were talking about military strategy, someone who've been through
the First World War might be quite useful if you learned the right lessons from it, but
not useful at all if you learned the wrong lessons. So, so everything we say about the past has
to be set in that context. My slice of the past, I've taken the 1970s, which was when this country
first, I suppose, confronted inflation in, you know, red in tooth and claw type of inflation,
just to give you an idea of the background. In the early 70s, they introduced something called
current cost accounting, which was inflation accounting, because they were so worried about the
inflation rate that they thought normal conventional accounting can't, well, I hope I can't cope with
it. Well, bankrupt companies, if we continue with this. So, this current cost accounting was
introduced by the accountancy profession when inflation hit what they considered the crisis rate
of 4%, 4%, well, what happened next? What did the rest of the authorities do? So, the accounting
profession did something. What did the Bank of England do? Well, they weren't independent then,
they were a creature of government. What did the government do? And the answer is pretty well
nothing. There was a valent attempt by a chancellor called Barbara to increase the supply of goods
to cope with the increased in supply of money. And he thought you could defeat inflation that way.
It led to an inflation re-boom. That's actually funny because that's exactly what Elon's argument is.
AI is going to produce so many things that are so cheap to produce that will solve all inflation
problems. The trouble is, as we're finding at the moment, globally, you have to gear up to produce
all that stuff. You have to build factories. And you have to tool them. That's an inflationary
wave. The problem for the UK became intense because the politicians in charge of monetary policy
wouldn't do anything. And the politicians in charge of fiscal policy wouldn't do anything.
So they presided over a rising inflation without a corresponding rise in bond yields. So
we ended up by 1976 with bond yields substantially below inflation. So no one would buy bonds on
negative real yields. Let's just make that clear to people. So because interest rates weren't moved,
or not moved sufficiently, or weren't moved very much, yet inflation moved a long way. Yes,
because the price of a longer-dated bond is linked to the price of a short-dated bond.
If those short-dated bonds aren't moving up, because interest rates aren't moving up very much,
then long bonds can't move up too much. What was the long bond yield? Approximately, I'm not
asking them exactly, but just so we can illustrate this negative gap. So off the top of my head,
I would have said eight or nine percent. So they were eight or nine percent at the long end,
and inflation was probably 13 by then. 13. So you've got 13% inflation and eight or nine percent
along bond yields. So you had a minus four minus five minus four minus five percent real yield.
I mean, don't assume if I've got those numbers. No, no, I'm just trying to explain to all,
I'll read how ridiculous it's had got. And before you go any further, I would just like to say
something. People know I'm not a political person, but we have a prime minister who wants to go
back to the 70s, doesn't he? He said everything that's happened since then has been a disaster.
Well, I couldn't possibly comment, Chris, but yes, you're right. So I think one of the things
that really unnerves me and would terrify the guilt market, if there was any question of the
the Bank of England being.
re-nationalized. One of the most fundamental events in my career in the market was 1997 when
the bank was made independent. Over the following year, long guilt yields halved because that was
an expression in confidence of the authorities to control inflation through independent monetary
policy. Can I actually now apologize to the guilt market and people I spoke to in 1997,
including Kiran, because when they announced the bank of England was going to be made independent,
that was a really good thing for long bombs. The problem was I was short about 200 million of them
because I had thought the election had happened, but we're in, they were going to spend lots of
money. It wasn't a problem. The second day they come in, they say we're making the bank of England
independent. Suddenly, I've got completely the wrong position. The market is not liquid enough
for me to go and buy 200 million. So I and a colleague of mine, who will remain
nameless, John Morgan, are seven, eight, nine counterparts and said to them, we'd like to buy
25 million longs each of them separately, just pick out the phone and they would say,
is that all you're buying? We go, yes, that's all we're buying. We went and bought them all back
and went long. We actually had a fantastic year because it was exactly the right thing,
but I apologize now to those people. Many of them will be listening to this show who will go
at last. It is a bit like Danish Averand at last. Chris created a long position and eight short
positions simultaneously in the market. Talking of buying guilds, going back to 1976,
with negative real yields, as explained, UK investors stopped buying and there was a period during
the summer of '76 when the government broker, i.e. the senior partner in balancing co-my shop,
could not sell guilds for love nor money. This was a crisis because the government needs to sell
guilds to fund its debt. By October, this crisis had come to the boil. Something had to be done.
So Dennis Healy, the Chancellor of the Exchequer,
went, decided to go to the IMF and asked for a loan to tie the UK through this problem.
Unfortunately, the crisis was so bad, as we've mentioned earlier, that the foreign exchange market
sort of collapsed on the Monday morning before he could get on the plane. The pound came under
intense pressure. So he had to go back to Downing Street to manage the crisis. Anyway, long story short,
by the end of '76, things were beginning to look a lot better. And the reason for that was that
the loan from the IMF came with strings attached, and those strings were a monetary policy
framework that the Chancellor had to impose on the UK economy for the first time. So if anybody
tells you that Margaret Thatcher was the first person to try and monitorism in the UK, they're wrong,
it was Dennis Healy. Could you give me a couple of examples of what you mean by monetary
monetary policy for all this? Well, in those days, it consisted of monitoring the monetary
aggregates, so the extent to which money is expanding within the economy. Inflation is the concept
of inflation is too much money chasing too few goods. So you try to control. So if you need
to control the industry. One of the best ways of controlling the money supply is by selling guilt.
Because when an investor buys guilt, his cash comes out of circulation in the economy and goes
into the bank of England. So in effect, that cash disappears and is no longer able to chase
up the price of goods. But they can't sell the guilt. They can't sell the guilt, but they can,
they can sell guilt if the yield is high enough. So that was the period between October and December
when the 15 and a half percent 1998 bond was issued, which is the highest coupon ever issued in
in the guilt edge market. So you're saying they issued a bond with a 15 and a half percent interest
right? Yes. Yes. So that attracts buyers. That's the sort of thing. When you're in a highly
inflationary environment, you need to be compensated for it. That actually started a buying
stampede. But only because investors understood that inflation would be controlled by the monetary
policy framework that was in place. There was a second thing that happened in the run up to
Christmas 76, which was that two brokers, P&D and Hogvedd wrote research notes on the value of
North Sea oil. And that's been massively underestimated by the market in general. That was going to be
transformational for the economy. It was going to actually, it was going to enable Britain to run
a trade surplus, which of course would drive up the value of the pound. As the pound goes up,
inflation goes down and people want to buy and people want to buy it. Inflation's going down,
that 15 and a half percent coupon on the 98 looks very attractive. So in a way that could have been
the end of the story. But what's important to remember about inflation and I think this applies
to the era we're living in now, is that it comes in waves. So this inflation might have been
sparked by the Yom Kippur War in 1974, which forced the oil price up. But there was another accident
waiting to happen, which was the Iran Iraq War of 1979. And also, unfortunately, although we got
monetary policy in place, and we got an improving economy, we hadn't got control of fiscal policy,
and the labour government, which was desperate to win the next election, kept on spending money.
Now I'm seeing some similarities. Yeah. So if you think about the current environment,
exactly. Yeah. So we've had the inflationary environment, COVID, Ukraine was probably the real
problem to start with. But as soon as we've got through that, we've got the Straits of Four
Moos are closed. So we've got a second wave of inflation coming. And inflation in the 70s,
actually peaked, I believe in 79 at 29%. 29? Yes. So the start of the 70s, people were worried about
4% inflation. The end of the 70s, it's at 29%. Now, fortunately, Mrs. Thatcher won the election
in 1979, and she was able, eventually, to get a grip on fiscal policy. So the 1981 budget,
which was Geoffrey House budget, came at a time of very high interest rates, a struggling economy,
we were in a recession, and he tightened fiscal policy, really quite a lot. When you say tight
in fiscal policy, you mean? I mean that he cut government spending and he increased taxes.
Wow. At the bottom of a recession, 365 economists wrote the FT saying, this is going to be a disaster.
He's turning a recession into a slump. Well, in fact, that move, that restoration of credibility
in the government, it now had monetary policy and fiscal policy working together to contain
inflation laid the ground for an eight-year boom. Yeah, an eight-year boom, up to 89. In terms of
stock market crash in 87, but the growth lasted longer. Not only that, in 1982, guilt yields halved.
So it created an enormous bull market in guilds because all those pieces were in place.
So by aligning monetary policy fiscal and then taking a little bit of pain in the short term,
started to pay benefits. Yes. I mean, successful economic policy, in my view, is about deferred gratification.
That's not a popular phrase at the moment. I mean, particularly post-COVID, everybody thinks
the government can write a check and everything will be fine. But the two winners in the 70s,
while America and Britain were delaying the medicine and making things worse,
the two winners were a Japan and Germany who decided when the oil price started going up,
not to accommodate it through loose monetary policy. So if you take a firm stand at the beginning,
it's a bit painful, but it works, and it's not nearly as painful as waiting for 10 years
to get this thing right. So I think the lessons I would take away, and speaking as a first world
war general, I think these still apply. If you're going to control inflation, you have to do it
early. I mean, it's horrible old fashioned expression, but a stitch in time saves nine. And you have
to do it with conviction so that not just the bond market or even the wider financial market,
but everybody in the country believes that you're on top of inflation. It's about credibility.
That's incredible, really useful stuff. Thank you, Kiran. Now, if you agree at home and you like to
hear more from the kind of guests that we can get, make sure you hit that subscribe button,
because that's the only way that you'll be informed when new episodes come out. And also,
remember, drop us a comment below in the comments section and we will read those and often reply.
So Kiran, coming back to more of the modern day then, what similarities have you seen over
the past months and years that make you think that 76 is the right period to compare this to?
Well, I think the first thing is the inflation background.
feels quite similar. It's oil-priced driven and it's sort of crisis-driven, if you like.
Maybe in the 70s people didn't really understand what inflation was, so you could perhaps forgive
the policymakers for getting it wrong in the early stages. Although some policymakers in
Germany and Japan got it right. What I would say at the moment that worries me quite a lot is that
we know what to do, but we're just not doing it. So we know we have an independent central bank
that presided over 11% inflation a few years ago after the Ukraine oil price spike. The governor
of the central bank referred to that inflation uptick as transitory. Now I believe that transitory
as a word, the bond market absolutely hates. It means I'm not going to do anything about it. So
had he acted early, he could have headed off that inflation spike or at least he could have
ameliorated it. If you take the view that inflation is transitory, there's a probability it will
become permanent. If you take the view that inflation is permanent, then it's likely to be transitory.
And it's easy to solve the transitory off the event that is to solve the permanent off the event.
And inflation seems to be getting embedded now. I just did some numbers before the show and I think
inflation has averaged 5%. That's the CPI inflation over the last five years.
Now the Bank of England target is 2%. But I don't detect much in the way of activity or concern
at the Bank of England about that outcome. If we were to take, say, the 10-year average,
so 5 years from now, what will that average look like? Well, for them to hit their target of 2%
on average over the previous decade, it would have to average below zero for the next 5 years.
So it feels to me that the Bank of England is not being as proactive as it should be.
A sleep at the wheel. You might say that. Yes, you might well say that. What I think is interesting
is how the markets are treating this. So Chris mentioned that the forwards hadn't moved much
in the last week. That is because the short end of the market has sold off. And on my calculations,
looking at the short sterling strip, the market is pricing in at least four interest rate
hikes between now and September next year. And actually, some would argue five, but it depends
where you see them are. Let me just interject there. You said short sterling strip. And some people
will be wondering if that's somewhere in Los Angeles or what's going on there. Essentially,
there are contracts available in the UK fixed income market where actually in all the major
markets where you can bet on where you think interest rates will be. And they are known as
the short whatever contracts are short dollars, short sterling, short euro, short yen. And the
strip is just joining them all together. And by joining them all together, you can see what the
market is forecasting for the rate of interest rates, how they're going to move over that period.
What is the short sterling strip telling us at the moment? It's telling us that the Bank
is not going to increase interest rates on Thursday. And there's a small chance priced in,
but basically it's not. But then it's going to do quarter point increases every three months
for the next year or so. And to my mind, given the extent of the inflation problem we have right now,
that looks like a very timid approach. The reason that a guilt, long guilt yields are so high
is because the long end of the guilt market is arguing something needs to be done now. And to
take an incremental approach to a problem that's persistent like this isn't enough. So if
when it comes to buying guilt, I think we need to feel that the Bank of England has taken inflation
by this graph of the neck and is doing something about it. And now from that, you can see why
and the different styles there were in the guilt market in my day. My friend here has just said
a timid approach. Basically means they're absolutely cocking it up. And they need to do something
much more aggressive. But because he used to be the government broker, because he has been around
such a long time. And maybe there's a knight who's coming at some stage who never knows. He's
taking a very, very soft approach to it. But what he's, I think what you're saying is they should
be acting. They should be doing it. And every moment they waste is a lack of credibility moment.
You about 76. If people believe you're getting on top of inflation,
bonials will fall. And then they'll be able to fund things at a much better rate. If they think
everything's slow and not going to happen, you've got a problem. And that's where we probably are.
Is there any time do you think when they are right to say things are transient?
I mean, I totally agree. I think the Bank of England should be doing something now. Don't
get me wrong. But I can also see a slight argument to say, if this all price reversed and start to
get went back down to $70 a barrel from the 108 we saw this morning, then that will be very good news
for the inflation outlook. And I think, you know, for global growth and, you know, equity markets.
And then, so in a roundabout way, is there any right, is there any time you can say it's right to
be transient? I don't think central banks should use the word transient because ultimately, transient
is about the future. They're making a forecast of where inflation is going to go. And their
forecasting track record isn't great, but nobody says great. None of us around this table can see
into the future, sadly. And when central banks start second guessing the inflation rate,
the bond market gets nervous. It gets very nervous. The bond market needs reassurance that this
transient inflation isn't going to turn permanent. And this is where it's an expression that's
in common parlance now, which interests me, being ahead of the curve or behind the curve.
You, you, you hear this used all the time and people could be talking about some, I don't know,
TV show or the media or whatever. A head or behind of the curve comes from the US bond market.
It does really. Yeah, of course. And it's, it's whether the central bank is ahead of the curve
or behind the curve, the bank of England is well behind the curve. Because if you look at 10
year guilds, they're saying the bank is not going to be able to control inflation. It's certainly
not going to hit its target. So the central bank is behind the curve. And I just have to ask,
you know, I'm a domestic guy, not an international. But what is the bank of England doing in a week,
you know, when every other central bank in the world is raising rates. Absolutely. And we've just
had a July growth number of 0.4%. I mean, if you annualize that as they do in America,
we're talking 5% per annum. You know, this is not. But my point would be, interest rates are a
mile from being restrictive. And inflation is, you know, it's the enemy here. You say that a
high oil price is a break on growth. So if we get oil back down to 70, then that is going to
propel growth ever higher. And yet again, that's why we should have higher rates.
There's very useful article out this morning. Interestingly, Kieran and I spotted together,
which shows just how boring we are. It was in the FT, and it shows the average earnings in the UK
for the last month that got record. So the average earnings in the last month, including bonuses,
I think it was, was something like 3%. And excluding bonuses three and a half, three and a half,
three and a half. Across the economy. Six point three in the public sector and 2.9 in the
private sector. Giving the average out of every set. And I think my understanding is that already
public sector in general adds more than the private sector. So the point I'm trying to make is that
we have inflationary public spending in this country. So even if the oil price comes back and
everyone goes, oh, isn't that great? Oh, it's all much better now. We've got an inflation problem
still. We hadn't inflation problem before the oil price went up. We've still got it now. It's
just getting worse. We have got to get in control of our fiscal situation. And until we do that,
we have a problem. And it leads me onto a question here for Kieran, which is, what do you think he's
going to happen next? I mean, it's fine for us to say, you know, someone's going to raise their
rates by this, whatever. What do you think is going to happen? What's the picture that we should
be planning for? Because that will help when we think about what we should be doing in the portfolio.
Well, I think what I always do, my starting point is what are the markets telling me is going to
happen? And the markets are pricing in a timid bank of England, incremental quarter point hikes.
I think unless Andrew Bailey has a sort of massive change of character or personality,
that's probably what we're going to get, which in my view, will keep inflation bubbling along.
This is an economy that's doing okay, given all the headwinds. And we're still a long way from
restrictive monetary policy. So I see inflation continuing to be a problem. And I don't see a rally
in the guilt market until it's convinced that
the central bank, the Bank of England, has got inflation under control. I think the
second aspect of this is obviously fiscal policy with the budget coming up. What are
the politicians going to do? It's not their job to control inflation, by the way. It's
their job to control the public finances, and we know the two things are interlinked.
I don't see any appetite from Andy Burnham or John Haley to cut spending. I'm afraid
if they increase taxes, the guilt market won't enjoy that very much. Technically it ought
to, because it's addressing the deficit, but actually there's something called a laffaker
of which suggests that they've plucked the gold and goose, and it's not going to yield
much more. So let's just spend a minute on the laffaker. This time I'll let you explain
it to us. Well, I'm not a trained economist, Chris, but as I understand it, a laffaker,
and Mr Laffer, or Dr Laffer, was in the UK last week, and his judgment is that if you
go on increasing taxes, it ends up becoming self-defeating. So taxes get so high that people
stop paying them. And you were discussing on the show last week, Chris Rocco's departure,
that is precisely what happens when you push tax up too much. So I believe the guilt market
will not regard a tax-hiking budget as a solution to the budget deficit. It will just potentially
make things worse. That's what the Laffer curve tells us.
Yeah, I mean, to me, the way I might say that rather than getting lost in all these
wonderful economists and things like, the market actually likes to see that it's going
to get its money back at some stage. If I'm lending money to the government, I want
to know I'm going to get my money back. If I can see tax revenues going up because
growth is going well, I know I'm going to get my money back. That's okay. The minute
I think I'm not going to get it back because I keep putting taxes up and frightening people
away from the country, or not creating conditions where wealth creation is welcomed, should
we put it that way, rather than I bet controversially last week, I told it to what's about
rock, or some people didn't like that so much. So we'll take it back very slightly on that.
If we don't create the conditions for wealth creation, we will not have the growth. We
don't have the growth. The guilt market's going to say, I don't believe I'm going to
get this back. We're going to, I need some more yield. And point though, you talked about
what level of, you talked about guilt yields. And I'm going to just explain that to everybody
why this is important. The inflation target is two. Long guilt yields today are close
to six. So you've got four percent real. Okay. Now my understanding of the guilt market
from where I've been and long as I've been in it, is that we've seen real rate rates
as high as five. But normally when you get that level is slowing down everything. You
say you would not buy guilt at the moment. I am getting more of the order that I would
buy guilt. And the reason is because I believe the Bank of England will do the right thing
in the end. They may not be doing it the right thing tomorrow. I wouldn't buy any guilt
before tomorrow. I don't think I don't want to do. But if they were doing something, if
they do something tomorrow, then maybe I'll be more inclined to because those real yield
are pretty attractive at four percent. What do you say to that?
What one can never do really is disagree about what the right level is because as explained
earlier, we can't see into the future. And 6% could be an absolute bargain. I would say
over years and years of speaking to clients, when people came onto me and said, oh, guilt's
are looking cheap. What do you think? That actually usually translated is guilt prices
were higher yesterday than they are today. So there's a temptation to look at 6% and say,
not that long ago, or even one. So 6% does look attractive in some respects. Yes, attractive
relative yesterday. My difficulty. If it's 4% real, that means you believe the Bank of
England is going to hit 2%, it's inflation target for the next ideas. If Andrew Bailey
tomorrow morning said, I'm going to get ahead of the curve here, not only am I going to put
out rates against expectations, I'm going to put them up half a point to show that we
should agree that sort of. At that point, the guilt market becomes a buy. Yeah, because
it shows a central bank wants to do something serious about inflation. But if we get yet
another statement from them, which I think highly probable that they're on the case and
one day they're going to do something about it.
Yeah, I agree. I agree with that. I don't understand. Burn them. And Bailey have got
to be like you guys, sitting them down and explaining this to them. Why aren't they taking
that action? Well, three members of the NPC voted for hike at the last meeting. So that's
three out of nine. If it went up to four tomorrow, then Bailey would have the casting vote.
And I'd quite like to see that because it will put him personally under pressure. And
I think at the end, if you're governor of the central bank, you should be under pressure.
You should be held accountable for what happens to the economy when inflation gets out of control.
So it might happen tomorrow. Who knows? But my thinking is that it won't. And the advisors
will advise. And the governor and the prime minister will reject that advice.
So I'll try not to rant this. We don't have experts in those positions. We don't have
experts advice in the chancellor. We have people who have qualifications saying that the
greatest economists in the world, or they've been to the best universities in the world.
But what you want are people who have been in the trenches. You want people who have been
there buying and selling these things. None of those people have ever bought and sold
a guilt in their lives. Right? I have done it for many years, curious on it for many
years. And if they'd like our phone numbers, we are available for consultation. But at the
end of the day, that's the problem. They don't have someone saying as clearly as Kirin
has said, if you want to get ahead of this, 50 beeps up, you go. If you don't, if it
works, you're going to be the hero. If it's too much, you can cut it at the next meeting.
You don't have to keep them there. But you show you have credibility. The same is true
of the government and the advisors in the treasury. The treasury haven't got people who have
done and bought these things. They're all theoretical people who don't know what they're
talking about. Sorry, let's you're over. And to underline that point, Kirin, you said
the first thing you look at is what the market's telling you. Now, you need the experience
to interpret what the market's telling you. Why do you treat that market price so important?
That's real money. Every day, there are people out there using their own money or their
bank's money to make investments. And so when I look at the short-stirling strip or
the 10-year guilt yield, I know there's a weight of money behind that. I think that was an
expression in the US treasury market some time ago that the 30-year bond contained some
total of human wisdom, the yield on the 30-year bond. And that's what I believe. So look,
the market's not always right. I mean, you know, the market's pricing in it and incremental
baili at the moment. And he could surprise us tomorrow. And the market would move dramatically
if he did, if he braids up by half a point in what way? I think the long end would rally.
It would show that the central bank cares about inflation and is determined to do something
about it. The short end would sell off because that's linked to interest rate expectations.
So you would immediately have got more than was priced in. So it would have to sell off.
But the long end would say they mean this. They mean they're going to try and get inflation
at 2. I think you'd probably see a 20 basis point rally at the long end. You'd see a massive
move, different move between the long end and the short end. Like not until we know what
they're doing, can we say what will happen? Well, that was my next point in that do you
want to have the chance of that happening by any movements in the portfolio this week?
Okay. So let's move on to the portfolio this week. We have these three moves by central
banks to think about. We have the US Federal Reserve. We have the UK. We have Japan.
We have a very poor performance this week by the commodities in our portfolio. I think
had a really strong period. And equities have done actually pretty much okay given the
background. So the real question to me is, do we take the relaxed approach of risk assets
as showing us the way i.e. you don't have enough yet to destabilise anything. So don't
worry, everything will be fine. Maybe the all price will come off because Voldemort stands
up and he says that he's chatted to someone in the rail and it's all sorted. Because that
could happen, right? Or are we being lulled into a full sense of security looking at these
asset prices and saying, oh, everything's okay. He said, don't worry. Everything's okay.
Don't worry until, oh, my God, something's gone wrong. Where do you think we are on that?
Well, I think, you know, Kirin talked about central banks being ahead or behind the curve.
From an equity standpoint, we love central banks being behind the curve.
because they're basically letting the economy bubble away
and start to getting boiling hot
without turning down the gas on it
by putting a just race up and slaying it down.
So while the UK is behind the curve,
and I totally agree that they are,
the UK mid-small size companies should be beneficiaries
that the domestic economy should do better.
And particularly as wage growth is six and a bit
percent of the public sector,
they can keep those people going into pubs,
restaurants, retailers, et cetera.
And that should help the real economy.
So instinctively, and then I also think,
by the way, that obviously the US Federal Reserve
is behind the curve.
And that's one of the reasons I think
the US market is doing well.
And that's one of the reasons that the Russell 2000,
which is one of my favorite markets for the year,
has done well pretty much as years.
It's hit a bit of a plateau at the moment
and come down a little bit because, funny off,
they're starting to talk about interest rate rises
in the US and maybe trying to catch up with that curve.
But they're still behind it.
While they're behind the curve
and they're running the economy's hot,
I want to be as long as I can,
personally, inequities.
And I want to avoid bonds, because as you say,
until they get to the curve and get ahead of it,
then I don't want to buy bonds.
So is that a clue for us then that we wait to see
whether they do something unexpected?
If they just carry on doing the expected stuff,
bond yields are going to continue drifting upwards.
Equities should hold on quite nicely.
And of course, if you get that relief because of oil,
study equity will do a lot better.
Rich, is that too simplistic?
There's a big question at the moment.
Bank of America came out with a study this week
and it looked at private clients asset allocation
and was an all-time high inequities at 68%.
Whereas they're holding in bonds,
we're at one of the lowest points
and the holding in cash even lower.
So it looks to me like private clients just refuse to sell.
And we've seen it all through COVID,
all through the tariff war.
There was no selling, it was by the dip even more
and add to allocations.
Now at the moment, we're amazed
that equities haven't sold off
with the amount of risk that's going on.
In the bond markets, in Iran, oil price.
I mean, the AI names have actually come off 20%,
but the money is going into other areas of the market.
So will it ever sell off?
Is it different this time?
But don't you think they would have just listened
to our podcast on episode one where we said,
the long-term waiting for our portfolio
when we're trying to make 10% a year
should be 75% inequities.
Because the long-term returns from equities
have been far superior to any other asset class,
you know, averaging six and a half percent real
and the long-term inflation rate has been about 3%.
So over 125 years, equities have given you six and a half percent
above that.
Bonds have given you 1% give or take over that period
and cash has lost your money.
Now if they listen to us, then there's still behind the curve
if they've got to use, you know, Kirin's phase
if they've only got 63% in equities, they should have more.
But that's one of the things that's happening in the US.
The US employment market is really interesting.
They're getting people dropping out of the job market
because they've made so much money in the stock market
and they are much more heavily invested in equities
than the UK,best of us have been.
Now to me, when retail investors are getting to that stage
that they're quitting their jobs
and they want to become full-time traders,
that is the sign of the stock market.
It's certainly not a promising sign of it.
It's a bit like the taxi driver.
Turn around to you and say, you know,
what do you think about ABC stock?
It's never a good sign when you start to see those sources happen.
I must say when Spice said what he said there,
that was another one of those bells started to ring
in the background.
But I'm still, I'm not convinced.
I've stuck to this for the last few weeks.
We took a little bit of stock out last week,
which I think was a good idea just to keep us going.
I'm not brave enough at the moment to sell out of the eight,
to sell out because I think the central banks
will do what is expected of them.
But it is getting tricky.
So the question I think then is,
we have a holding in cash of 15%.
And we have a holding in short guilds of 2.5%.
So the question is, should we think about buying some guilds,
for example, some longer dated guilds to just in case,
I mean, you know, a lot of what Kiran said earlier,
I mean, if everything Kiran said earlier was fantastic.
But one of the things that you've got to listen to a lot
is nobody knows the future.
So at the end of the day, do we want to buy any guilds
ahead of the announcements this week?
And I say guilds because they're the highest yielding,
but we could buy treasuries if we want to.
But do we want to buy some bonds to just sort of log
an interest and see why I'm,
because if they do come out and surprise us,
then long guilds will rally.
If there's a 25 bit rise, they will rally.
Because even if they say, oh, we're not going to do anything
for a bit, it will just show they're doing something
unexpected.
And we might not see these prices again.
I started buying long guilds last week.
I added to it on Monday of this week.
And so that gives you my answer.
But don't you think that if, and I'll
be interested in Kiran's view here as well,
is that if the, we just had the European Central Bank
be more hawkish?
Well, if the Federal Reserve, I think Kevin Warsh
might talk a hawkish game, he may not ultimately deliver it,
but I think he needs to be talking a hawkish game tomorrow,
which is Wednesday.
And then you get the Bank of Japan on Friday,
also talking about more regular interest rate
rises in Japan, quicker than people expected.
The UK will stand out as the idiots amongst the central banks.
And the bond vigilantes, if I were them,
would be turning my guns very, very fast and very quickly
onto UK guilds.
Yeah, so make those yields go to a point where the--
No, go to the has to do something.
I completely take that point.
And I'm perhaps being a bit vigorous in my refusal
to buy long guilds six percent.
Because I think if we believe, which I do,
that the guild market is your best source of information
about what's going on, perhaps the guild market has already
anticipated all this.
It sees an incremental bank of England losing the battle
against inflation and eventually curing it.
Six percent could be the absolute top in yields here.
My problem about buying it right now
is that I don't really trust the central bank
to do the right thing.
But I could be coming back to you in a year's time
with long guilds of 5%, having missed the opportunity
of a lifetime.
And I've fully accepted trying to finesse it,
as long as you don't mind the market
and the weekly performance.
I've never mind mine the last market, yes,
because I blame it on rich.
[LAUGHTER]
I think we'll stay as we are.
I'm going to stay as we are.
Let's see what happens.
I think it's the safest way of playing it.
And leave the portfolio as it is.
So no change recommended this week.
And let's get our heads in the bunker waiting
to see what happens.
Can I just say, Chris, that one way
of looking at this might be, let's
see what the Bank of England does on Thursday.
I think if the Bank of England was unexpectedly proactive,
it's too late to be proactive.
Let's just call it active.
I'd rather buy gilts at five and three quarters
with a strong Bank of England behind me
than at six percent with a weak bank.
And when you have expertise like that,
we have experience of that.
Why do you need me in spots?
[LAUGHTER]
I'm surreting for an answer.
Yeah, thanks, Rachel.
Thank you, Elizabeth.
If you have an answer to that question,
please drop in the code section below.
But seriously, if you have enjoyed today's episode,
then hit that subscribe button.
Give us a like and give us a comment.
Thank you all for joining this week.
But most of all, thank you, too, our special guest,
Mr. Keer and Lynch.
Thank you very much for having me.
I've really enjoyed it.
Wonderful.
I work with a lot of colleagues who would always
tell me of their experience in the '80s,
but I've never met anybody using the market in the '70s.
So really appreciate it.
Thank you.
Jens, thank you very much.
And we shall see each other in about nine days.
Wow.
Yeah.
Lot can happen in nine days.
Let's hope not too much.
Finally, if you've got a question to ask,
then please drop us an email at the art of
[email protected].
Have a wonderful rest of the week.
And we'll see you next week.
[BLANK_AUDIO]
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