Stig Brodersen  1:33  
Modest, I like that. I just want to say for the record, Edward started this interview out in Swedish. He, of all people before the interview just started speaking Swedish because apparently, he knows how to speak Swedish. He is probably the last person in the world who should be modest. So putting a lot of pressure on you there Ed.

Ed Harrison  1:55  
Yes. The reason I speak Swedish as we’re talking before is that Danish was too difficult for me to learn. I went with Swedish instead.

Stig Brodersen  2:04  
Alright, Ed. I wanted to kick off with the discussion about growth and value. Whenever people hear growth stocks, most of them think about FAANG stocks and they relate their outperformance to an accelerated digital world. You have a very interesting but different thesis of why growth is performing better than value right now, what is that?

Ed Harrison  2:31  
The macro view that I would posit is that we’re in a very low growth, low inflation environment, which means that nominal GDP (Gross Domestic Product) growth is lower as a result. It’s lower both on the inflation front and it’s also lower in terms of the actual GDP growth.  If you look at cyclical turns in the past, say for instance, in the 1970s or 80s, you had this massive jolt up in GDP and then the cycle continued higher both on a real GDP basis and on an inflation basis. 

That means nominal GDP growth is low. When you look at companies throughout the indices, the S&P 500, Russell 2000, whatever it might be, in some senses, you can look at them as a proxy for GDP. Companies in the aggregate are not going to outperform drastically what the nominal growth of the economy is doing. 

As a result, you’re seeing a lower trajectory of earnings growth. That means that to the degree that people want to hit their earning hurdles, that is they want to hit their hurdles for investing 7% or 8%, whatever it might be, they’re going to have to go to the companies that are going to have the highest growth. To me, that’s one of the key factors driving growth over value, at least since the great financial crisis.

Preston Pysh  4:01  
So you’re doing some amazing writing Ed and you have a very interesting equation: you have momentum equals growth, growth equals long duration, and long duration equals secular stagnation. What does this mean? How do we complete the equation?

Ed Harrison  4:20  
I wrote a post very recently fleshing out these ideas. If you take what I was just talking about and you move it forward to what’s happening right now and you look at nominal GDP growth across a wide swath of countries being lower this particular go-round, just as they were in the last financial crisis, the last recession that we had, what you see is a need for yield.  

What you see is that we’re seeing the yield curve compress in a way that you have a flattening of the yield curve with interest rates pinned at zero in the short-term and then the rest of the curve flattening toward zero or even in negative rates in Europe. What that means is that you’re going to need to have some yield pickup somewhere else. 

To the degree that you need the yield pickup, the question is: where can you get it? And why is it that it’s there? Let’s talk about it from a discount factor perspective. If you look at the discount factor because the yield falls then that means that companies that pay their investors based upon prospects that are 5-20 years down the line are companies whose prospects are more interesting in a low yield environment. 

The discount factors mean that those earnings are relatively speaking more valuable than they would be in a 5% yield environment or 7% yield environment. I’m looking at those growth companies which are the companies that pay investors. Let’s say the Teslas of the world. What would be a good example of that is Nikola. Another great example that’s similar to Tesla. 

Those kinds of companies are going to pay much further down the line. Those payments that they’re going to get, the prospects of those payments are worth much more. You’re getting a long duration play. It’s a bond proxy, as a result, because you want to go to the longest duration. This is what you get when you get a growth company: you get a long duration play. That is what’s going to win in a low growth environment.

Preston Pysh  6:42  
Ed, what do we do as investors to position ourselves based on this information that you just shared with us?

Ed Harrison  6:48  
I think that the real problem is, you can look at it from a portfolio perspective. I look at it in terms of the optionality that if you look at 2000 or the run-up in the NASDAQ in the 1990s up to 2000. What you saw was that some of these companies that had the prospects of great profits down the line went to 0. They went Boston, they went out of business. 

Perhaps if you took a portfolio approach and then you had the Amazons in there, eBay’s, as well as the *Inaudible* in those portfolios, you would make out. But what people are doing today is that they are saying to themselves, not only do we want to have the Nikolas and Teslas in our portfolio that don’t have any proven profitability but because the world that we live in is different now. The companies that are going to IPO (Initial public offering) have more profit. 

The companies that have moats and that are going to give us profits 5 years and 10 years down the line are bigger like the Facebooks, Amazons, Apples of the world. We’re going to invest in those. It’s a barbell strategy that is combining the growth companies of today and the growth companies of tomorrow. Amazon and Apple on one side, Tesla and Nikola, on the other.

Stig Brodersen  8:16  
Our audience is primarily value investors that is the very root of where we’re coming from. We’re used to all of this price to book ratios and price to earnings ratio and key metrics that the way that we were brought up just look different. The ratios are the same but the performers for a long time have been different than what we have been taught. What is the outlook for all of us school value investors in this environment?

Ed Harrison  8:46  
That it’s a question of picking winners and losers at a particular time in the market. Even though I’m giving you the thesis as to why right now you might be outperforming with growth overvalued. Throughout a business cycle, there’s going to be a reversion to the mean in terms of the outperformance of growth over value because we’ve seen such a huge run-up in the shares that I was talking about. 

I’ll give you an example of something that I was looking at earlier. For instance, one of the divergences that we’ve seen between growth and value is as a result of what I would call the buy at-home strategy versus the COVID oriented companies. A lot of the value stocks are in the COVID oriented companies like travel and leisure. 

A perfect example of that is Wyndham. I saw that Wyndham gets 96% of its revenue from U.S.-based travelers. If you’re thinking to yourself, “here’s a sector that’s completely beaten down. It’s gone down 40% on aggregate. Where would I have found value within that sector on a relative basis that would be able to beat out the odds?”. In this particular environment. Windham is an example of that thing. 

Even within the value world in certain categories, there are winners and then there are losers. You want to be able to pick the winners not just in terms of: “Do they have the wherewithal over time?” but in terms of “what’s their price-earnings? are they relatively cheap?” Those are the kinds of plays that we’re talking about.

Stig Brodersen  10:33  
Let’s transition and talk more specifically about COVID-19 and the implications for us as investors. Previously this month, white house coronavirus advisor Dr. Fauci said that the chances of a scientist creating a highly effective vaccine that would be 98% or more guaranteed protection. The chances of that happening were slim. Rather, scientists are hoping for a coronavirus vaccine that is at least 75% effective but even 50% or 60% effective would be acceptable too. 

If we, on the contrary, as investors believe that we actually will have an effective vaccine within the next 12 months to 18 months like you hear a lot of people talking about, we need that called “medical bailout”. That’s a term that I got from you. If that is how we think about it, how can we best position ourselves?

Ed Harrison  11:29  
I was thinking exactly of that term: the medical bailout. That’s what we’re looking for. Either you have the bail or you don’t have the bail. I think what Dr. Fauci said is that we’re not going to get a medical bailout. Even to the degree that we get a vaccine, it’s going to be incomplete. It’s going to take time to roll out. 

Effectively, we’re going to lose 2 years of earnings growth in a normal world. We have 2 years of COVID associated growth. When we talk about this bifurcation in the market between the at-home companies and the COVID affected companies like leisure and hospitality, when you look at it from a discounted cash flow perspective, you’re talking in the order of 6% to 12% to 15%. 

Just think about a DCF. How far can you go? Even if you have a 2% discount rate you’re still going to have a hit on year 1 and year 2 of those earnings. That could be as much as 15% or 20% that you’re losing for certain companies. Then, you have to ask yourself: which of the companies are valued? Given that we’re going to be in this bifurcated market is the differential that’s been in play in the markets greater than the actual differential that you think that discount is 15% this 20% discount would call for. 

Going back to Wyndham as an example. The answer is: perhaps yes, you could pick the differential between a stock which is a mature stock like Apple versus a Wyndham in terms of the P/E ratio (Price-earnings ratio). Is it something that you’re willing to pay for over 7 years? 

The answer is probably no, you wouldn’t want to pick up a company like Wyndham even though some of its earnings are going to be discounted over the 1st year and 2nd year. They are going to be discounted less their earnings and are going to fall less than the average company. Over time, you’re going to see benefits as a result of that differentiation.

Preston Pysh  13:39  
Ed, I want to flip this on its head, how will the economy look if we don’t find an effective vaccine and we have to live with COVID-19 until everyone reaches a herd immunity years from now? How should we position ourselves?

Ed Harrison  13:56  
It becomes a little bit more complicated in terms of differentiation the markets are already playing out for us. The market is saying that certain sectors of the economy are just going to be crushed because COVID-19 is going to be with us for the long term and there’s going to be a wholesale shift and other sectors of the economy are going to do well. 

The question is: Do the prices that are implicit in the price-earnings ratios, the discounted cash flows represent value on a relative basis in that scenario that you’re painting? The run-up in the more speculative areas of the market doesn’t represent a value from that perspective. Tesla and Nikola are perfect examples of that. Certainly, big cab companies are going to do better. 

However, it remains to be seen whether or not the huge run-up that we’ve seen in the technology companies is going to compensate you for the differential in outcomes especially if you’re looking at Walmart. Large-cap companies that have economies of scale and scope are going to figure out how to deal with this. They’re already online. They’re already allowing you to shop at home. 

I just saw something about Tesco hiring 16,000 employees to take advantage of the new at-home shopping. Tesco is one of the biggest supermarkets in the UK. That’s a perfect example of a company that should not be trading at a huge discount to other companies given the fact that it can adapt and it will have the wherewithal to be able to have the growth going forward. In that case, you will still see a relative outperformance but it would probably be the larger cap companies within the value space over smaller companies.

Stig Brodersen  15:58  
Without asking you to second guess Dr. Fauci, how are you thinking about it in terms of probabilities? A lot of people see this as a binary thing like it’s going to happen or it’s not going to happen. You can make the argument for that but there’s a huge difference in binary income if it’s 99/1 or if it’s 50/50. Without putting you on the spot, it’s 62% versus 38%. 

How do you think about it? How do you gather information? How do you process your information whenever you are considering this thesis which is so important in the investment climate that we’re in right now?

Ed Harrison  16:36  
I’m thinking of it in terms of standard deviation and the bell curve. What a lot of people know from financial markets is that financial markets are not shaped by a normal bell curve in terms of the distribution of outcomes; there are fat tails. Then the question is: why are their fat tails and where are we within that distribution? 

The reason that there are fat tails is that even though there’s a certain degree to which outcomes are random, in the middle of the curve, the closer you get to either side of the curve to either tail, the more psychology comes into play. 

We’re at a period in time where when you talk about what are the probabilities one way or the other we’ve moved well over on the curve in terms of people talking about the probabilities of massive bifurcation in the market where certain companies go to 0 and other companies just do outlandishly well that taken on a feeding frenzy gets you 2-3 standard deviation differentials between different parts of the market. 

That’s the setup for underperformance for those sectors like the ones we were talking about earlier. The growth sectors over the medium term that eventually whatever happens probability wise is going to move you out of the fat tail edge of the curve. Probably over to the other side immediately. That’s how it usually works, you go from one fat tail to the other fat tail. From the outperformance to huge underperformance before you revert to the mean in some capacity. 

That’s what my expectation is: irrespective of what the probabilities are of outcomes for COVID and in terms of the medical outcome that we’re already into the second and third standard deviation differential move, and I wouldn’t call it a bubble per se. I would just call it that. We’re into the psychology segment of the market.

Stig Brodersen  18:44  
That’s interesting that you say that so I have to put you on the spot. Again, I could say and see if that is how you think about it. From a portfolio perspective, for those extreme outcomes that you just mentioned before, how should we position ourselves and what are some of the risks if we go x versus y? What is your thought process around that?

Ed Harrison  19:05  
I’m much more oriented towards the value side in terms of how I’m thinking about it. This is a valued podcast, what I started out talking about is how a growth investor might think about it. If you’re thinking about growth, let’s say you’re thinking about the portfolio period, think about it from the optional aspect. For instance, all of your earnings come from 5 years, 10 years, or 20 years out on a relative basis, there’s a lot of uncertainty there. 

There’s high embedded optionality in terms of the equity prices that you’re paying for those stocks. As a result, some of them aren’t going to do well. Others are going to do well in this period as compared to 20 years ago. 

When we had the tech bubble, companies are more mature. The optionality is a little bit less than it was before but you still have to take a portfolio approach to not get caught out being overly allocated to companies that end up not doing well over the longer term. 

Ultimately I think that you’re going to underperform. Even if you take the portfolio approach because we’ve moved into the 2nd and 3rd standard deviation. A differential that the price-earnings ratios within the at-home segments of the market are extremely higher than the industrials, value stocks, bank stocks, financials, and consumer staples.

If you take a large-cap portfolio of stocks within those segments you’re much more likely to do well over the medium term. I’m talking about that in terms of a half or three-quarters of a business cycle, say 5 years or 7 years’ timeframe.

Preston Pysh  20:52  
Ed, Stig, and I are both big fans of Real Vision and the work that you do. One of the things you cover quite well is this contrast between economic expectations or impacts versus political decisions and the fallout from those decisions. When you look at these 2 variables, it’s amazing to see how COVID has produced a binary outcome effectively for businesses based on policy decisions. Talk to us a little bit about your thoughts on some of this stuff.

Ed Harrison  21:21  
As you were saying that I was thinking about how it’s reflected in terms of markets and bifurcation because the bifurcation that is the potential for companies, especially small companies that are leveraged to close contact, what I would call the COVID companies. Their potential to go to 0 or bankrupt is greater in places that don’t handle it well. 

It makes a big difference as to how government policy is. The way I’m looking at it now, especially if Dr. Fauci is right that there’s no civil bullet and we’re looking at another 12 months or 24 months from now that we’ll still be in the post COVID period on some level, you want to have a long term sustainable perspective. 

An example would be here in the United States where my son is going to go to high school. It’s remote. The reason that it’s remote is that the contamination levels, the infection rates are so high that we’re so afraid that you could get it in school and then bring it back to your family so they have to do it virtually. It’s about getting the virus levels down to a level where the community transmission is low and then starting again. 

The biggest mistake that the United States made relative to other countries is that we didn’t do that. We did the lockdown like other countries like Denmark and Norway, but then we left the lockdown before community transmission was low. We weren’t ready for the testing associated with the levels of community transmission that we had when we came out of the lockdown. 

Now we had a huge second wave. Then the knock-on effects in terms of what I just said about schools and also shopping are great. So what happens in that environment to companies like small businesses that don’t have economies of scale and scope? Either they merge or they potentially go bankrupt. 

If you’re a restaurant and you have 3,000 different restaurants, it’s a greater opportunity for you to have restaurants in places that have low transmission and people are spending money at the restaurant than one individual restaurant which is completely at the behest of a local economy. That restaurant is much more likely to go bankrupt. In a country like the United States, that’s what’s going to happen. We’re going to have a much more concentrated industrial economy after the fact.

Stig Brodersen  24:01  
Let’s zoom out a little here and talk about the U.S. and the European economies. Given everything that has happened with COVID-19, what stands out for you?

Ed Harrison  24:16  
I would say that the Nordic standout for me are 2 different parts of the Nordics. There are what say, Finland, Denmark, and Norway have done versus what Sweden has done. I think both of the countries, both of the models are geared towards what’s sustainable in Sweden long-term. What they decided is that they want to have as close to the normal life that they had over a longer period. That’s come at a cost in terms of the lethality of the virus and also in the community spread. 

However, the community spread in Sweden relative to places like the United States has been going down and has been stable to going down versus the United States, we had a second tick up. 

Then, you have the Danes and Norwegians defense which said, “Okay, we’re going to lock it down but when we come out of the lockdown we’ll be in a much closer position to do exactly what the *Inaudible* had been doing the whole time”. That has also been affected. It’s in the rearview mirror with regard to what Sweden did but that dichotomy is interesting in terms of thinking about where you are today. 

Therefore, how can you talk about Europe versus the United States over time? The way that I’m looking at it is that it’s really about community spread. It’s about sustainability. The U.S. has done the least effective job on both of those fronts. What we see in the rest of Europe, like for instance, Spain, France, and Germany, sustainability is a big problem. 

Right now, there’s an increase in the number of cases in Spain, France, and Germany. We’re now going into the fall where we have the flu. We also have people moving indoors. It’s not clear whether or not this is sustainable. Tamping down in those countries in the way that there has been or at least there seems to have been in places like New Zealand.

Stig Brodersen  26:30  
Let’s talk about some of the implications of COVID-19. Let’s first start with the U.S. dollar. Do you see the U.S. dollar losing its status as the main global reserve currency in the decades to come?

Ed Harrison  26:43  
No, I don’t. I think that if you look at DXY (U.S. Dollar Index) which is the index of the dollar, over, a 30-year or 40-year period, what you’ll see is that DXY has been much higher and it’s been much lower than that. The channel that we’ve been trading in recently is both much below the highs for the dollar and much above the lows for the dollar. 

We’re not anywhere close to some sort of systemic crisis. Then the question becomes: because a systemic crisis is something that will cause people to overthrow the dollar, what’s going to replace the dollar? What’s going to replace the dollar is freely convertible. 

Something that has a lot of collateral in that currency that you could use to create money, make loans, and things of that nature. Treasury bonds as an example, you have nothing like that. In China and Europe, you have nothing like that because at a European wide level there’s not enough collateral there.

Japan’s not going to replace the U.S. in terms of issuing the reserve currency. When you go through all of the different possibilities, the only possibility is the U.S. Dollar loses some of its role relative to a group of different currencies and different options including gold or bitcoin. However, it doesn’t lose its status as the principal reserve currency. 

I don’t think that there’s either a meltdown coming in the dollar as a result of its losing its reserve currency or meltdown that’s going to create the loss of the reserve currency. Ultimately, we’re still range-bound with the U.S. dollar. We’re sort of now at an oversold level. We’re hitting levels with 92 on the DXY that are bumping up against resistance for the dollar in terms of its low.

Stig Brodersen  28:41  
Interestingly, you mentioned the DXY that’s very often being quoted. One of the things that always stood out to me looking at it is the weight of the euro. It’s very much an *Inaudible* that you’re doing index and this is not necessarily saying that there’s anything wrong with that, because it is the second most important currency. 

But how would you say that the U.S. dollar has fared against the other *Inaudible* currencies? In general, are you specifically looking at the euro here? Is that the benchmark? Is it the basket? Should that basket be different one way or the other?

Ed Harrison  29:07  
Yes, DXY. What you’re pointing out is it’s a flawed way to look at the dollar. Especially given that other countries there are a wide plethora of countries that have different characteristics than the euro which is a large percentage of the basket. The fiat currency countries have relatively stable currencies versus the U.S. dollar. Those are the countries that I’m thinking about when I think about DXY, whereas the emerging markets are a completely different story altogether. 

The biggest problem with the emerging markets and the dollar is the extremes in terms of debtors and also in terms of assets. That is emerging markets are using dollar assets and dollar liabilities as an anchor in terms of creating credit. That creates problems when the dollar goes up or down in drastic amounts versus their currency. 

If the dollar goes way up in value versus emerging market currencies, suddenly, if you’re a $1 debtor, you’re in big trouble because now your liabilities potentially have gone up at a huge percentage compared to your assets. 

On the other side is the fact that if the dollar goes down a decent amount, then the same thing is true with regards to those who hold U.S. dollar assets that suddenly now their assets aren’t worth anywhere near as much. They have the same problem in terms of their balance sheet. 

There’s a lot more volatility there in terms of emerging markets and so there’s also the potential for trouble in emerging markets as a result of the bands being much wider than they are for the more stable fiat currencies.

Preston Pysh  31:08  
Ed, if the central banks keep printing like this, do we ever get to a position of hyperinflation? What happens?

Ed Harrison  31:16  
My view in terms of hyperinflation is that hyperinflation is a resource phenomenon that means you are a country that needs real resources. Let’s say you need steel, you need food stocks, you need all sorts of raw materials, whatever it might be. To get those raw materials, those boot stocks you need, not necessarily in your own money, you need other people’s money because you can’t get those stocks on your own. 

Let’s say you need oil, what happens is you start printing up money to get that material or even within your currency, your industrial base is depleted as a result of the war which is an example that you had with Germany during its hyperinflation, then you start printing up the money. The money is chasing at a finite amount of assets but it’s increasing exponentially in its amount. 

That led to hyperinflation. The real constraint there is real resources as compared to when you have massive overcapacity as we do now in the United States and other places where you could just ramp up the number of things that you can do with the money. No hyperinflation is going to result from that.

Stig Brodersen  32:43  
People out there listening and reading in financial news that it’s just been printed: the trillion dollars and then another trillion dollars. It’s like the Fed’s balance sheet is just exploding right now. If the first thought that we already covered must mean that we’ll have inflation, you laid out the arguments why that’s not the case. The follow-up question to that would be: where’s that money going? Where can we now see those trillions and trillions of dollars?

Ed Harrison  33:13  
That is the question. What happens as a result of that if you think of the credit outstanding United States economy and then you think of treasuries and the Fed’s balance sheet as being a small percentage of that, what you get is a sense that the private sector banks are the ones that are most important in terms of creating Velocity of Money in terms of creating more credit. 

What the Fed is doing is, in essence, is filling a hole in the highest value areas of the economy. They’re buying up treasury bonds, mortgage-backed securities, investment-grade bonds, and they’re giving the people who sold them bonds money. Then the question is: what happens with that money? Well, if there are no creditworthy customers to loan that money to, if you’re a bank you’re not going to loan them money to them. 

If you already have tons of your capital tied up in dodgy credit as it is to oil companies as an example, probably you will be credit constrained. If you’re a customer of those banks of those financial institutions and you have in some way shape or form problems with your balance sheet, you’re less likely to take on more debt unless you want the risk of bankruptcy. 

At the end of the day, what we see is that the money is going to make it to the holders of very illiquid assets. From there the question becomes: where does the money go beyond those liquid assets? It gets displaced potentially into less liquid assets but also still liquid like stocks and bonds, financial assets.

It doesn’t necessarily make its way into lending into the broader economy. One of the reasons that you see QE (Quantitative easing) money printing leading to asset prices going up is because this is where you can take the money. You’re displaced out of certain assets and then you move into the next available assets in quality down the line.

Preston Pysh  35:37  
How about the Euro? Talk to us a little bit about that, Ed. As far as how you see it being positioned today in the global economy and how that plays out moving forward.

Ed Harrison  35:48  
I see the Euro as a currency for Europe. That is for the euro area and for those who deal with the euro area principle. If you think about countries like Poland, Romania, Bulgaria, Hungary, you can take out mortgages in euros even though the Polish Lahti or the Hungarian Forint is your currency. Those are countries that would be within the euro area market. 

However, when it comes to the global market when you think about things like commodity prices: oil, etc. The euro plays no role. Why? Because there are no euro assets that you want to hold other than specific country assets like German bonds or Finland and their government assets, which aren’t that great or you could hold Italian bonds which are not highly rated. That’s not an asset necessarily that you want to use as collateral for loans. 

When I think of the euro, I think of it as a domestic currency. The euro area and the area around the Euro. Only when the euro area creates assets that people can use as collateral then I think we’ll see the Euro become more important. These corona bonds/ eurobonds that they’re trying to start to put out, there’ll be an interesting test to see whether the Euro can create assets that have some sort of applicability that are triple A. That people might want to use as collateral for loans. 

People will look at them almost like money in the same way that they look at treasuries almost like money. What is it that a reserve currency needs to have? It has to be freely convertible, that’s the case. It has to be a large market that’s behind it. That’s the case with the euro. 

Then you start to go down the line. Where you run into trouble, for the most part, is where you come across the assets for collateral. Where you come across the stability of the euro as a bloc. When you think about Brexit as an example where you could have a country from within the eurozone leave the EU and therefore leave the euro as well. Those are the things that create a certain level of instability that make you question whether or not the Euro is moving in the direction of becoming much more of a reserve currency asset. 

 It depends upon where the Euro is as the Eurozone. Where is it from a political perspective? Is it politically holding together? Italy is top on the list when you think about that because the greatest thing would be going forward. 

Let’s imagine you say to yourself, “Okay, so that you have these triple B or double B plus Italian bonds that have been issued but we now have these new Italian, German, French, Finnish Dutch super bonds that are at the European level that are triple-A that I’m willing to buy and invest in. I can use them as collateral for loans”. 

That’s a totally different story because now I know that Italy is staying within the eurozone and that the Germans have said that they’re willing to mutualize their debt with Italy, at least in part we have this debt mutualization and now I’m willing to say, “Yes, the euro is a project that is going to continue over the longer term.” 

That’s where the rubber hits the road because debt mutualization is a thorny political issue and until you get the debt mutualization, honestly, I don’t think the Euro becomes a greater reserve currency.

Stig Brodersen  39:53  
There was so much criticism and rightly so about the U.S. dollar and all the shortcomings that I can’t help but think we’ll try being Europe. Talking about a flawed currency and about so many limitations you’re setting for yourself whenever it comes to the currency. It’s just very interesting that you in many ways as an outsider looks at Europe and the currency system and the U.S. dollar and everything that’s going on.

Ed Harrison  40:25  
Stig because you’re in Denmark, you’re in a unique position. Just think about this. Denmark is essentially using the euro on some level. Your relationship to the euro is like the Dutch guilder’s relationship to the Deutsche Mark before the euro existed. 

They’re essentially the same in terms of how it works but you have not given up your monetary sovereignty. Why? That’s the question. Why would Denmark not give up monetary sovereignty to be into the euro? That’s the critical question. That is a problem with the euro as a reserve currency asset. 

If you have a country like Denmark which is a part of NATO (North Atlantic Treaty Organization) which is a part of the euro system which is a part of the EU and your monetary policy is shadowing the policy of the ECB (European Central Bank) but you’re not using the euro. That tells you right there that there’s something wrong with the euro. Let me just be provocative as they can say that until Denmark gets on the euro you know that the euro is not going to be a bigger part of the reserve currency status.

Stig Brodersen  41:35  
I love that you say that and try to single me out because I was just about to say before the British are part of the EU. Not necessarily giving up the poem but still, I think it’s such a good point. In the system, we have there are just so many exceptions because we are countries. Of course, you have a ton of exceptions in the U.S. because you all have stated but there are so many things that are still *Inaudible* on the federal level. It’s just such a different system here. 

You talked about the Nordic countries. We have the Danish currency, it’s pegged to the Euro within the band of 2.25% but it’s part of the euro. That’s effectively what it is but it’s not. Then you have Sweden, they’re a part of the EU but they have a floating currency. Then you have Norway and they’re not a part of the EU but still follow a lot of the trade agreements. They have a floating currency too. 

It’s just that you bring up such a good point. If you look at the numbers, 500 million people size bigger than the U.S. economy and you say, “Oh, there should be something right going on”. However, whenever you dig deep into what’s going on it’s just such a flawed system. On so many levels I can only agree with you.

Ed Harrison  42:51  
Ultimately what it boils down to is that you need a political and monetary union to reflect one another. It’s difficult to have a political union that is very different from what you do have from the monetary union. Until the two are coincident with one another, then you’re going to have problems.

Preston Pysh  43:15  
Ed, based on your comments for the dollar and the euro. How should investors think about that with their positioning?

Ed Harrison  43:23  
The progression of real interest rates over time is going to be an interesting factor. The U.S. curve has generally been steeper than the European curve. Potentially, you could make more money in U.S. dollar assets at the long end of the curve because the European Central Bank has shown that it’s willing to go negative.

The U.S. Central Bank has in the last 2 years shown that it’s willing to start jacking up interest rates even in the middle of a period where places like the ECB and the Reichsbank and so forth are having negative interest rates. This whole dollar demise period is overblown. In terms of the longer term, the U.S. dollar should hold up relatively well within the band that it’s been trading within over the longer term and that we’re near the bottom of that bed. 

When I think about the Euro and the U.S. dollar: the euro like 118, I don’t see it going up significantly more from here, over the medium term. When we talk about currencies, growth rates come into play, as well. I would say that with the U.S. growth rate most people are still of the opinion that U.S. growth, nominal growth, as well as real growth will be superior to European growth. 

Interestingly enough, if you look at the snapback from the COVID rally even though the United States has done demonstrably worse in terms of its effectiveness that was halting the disease. Its economy has done better than the European economy in terms of its growth rates both on the way down and on the way up. 

It may well be the case that over the medium term the United States continues to outperform in terms of growth, maybe it’s just because it’s a more dynamic economy. I’m not going to get into that. That’s almost a political issue but it should be helpful for the currency as well.

Stig Brodersen  45:37  
Fantastic. All right. Ed, I think every one of our listeners has been listening to you and for you to outline your investment thesis, to talk about the economy, and talk about currencies. I can only say “Wow, so many great Nuggets to take off from this interview”. Where can people learn more about you and Real Vision TV?

Ed Harrison  46:01  
2 different places. I wear 2 hats. I’ve been for the last, what is it now? For 12 years I’ve been writing at what was a blog which is now a newsletter called “Credit Write-Downs.” They can come and see my unfiltered view at creditwritedowns.com. Maybe every 10th, every 5th piece that I put out is free for the rest of behind the *Inaudible*. 

I’m on Real Vision. I do interviews with financial investors, financial analysts, hedge fund guys. I also do the Real Vision daily briefing which was talking about which is our video podcast that goes out on a weekday basis. I’m on that 2x to 3x a week. They can see me there. That’s also at realvision.com.

Stig Brodersen  46:49  
Fantastic. Ed, this has been such a pleasure and I can say now while I have you on record, we hope that you want to come on the show. It’s been an absolute pleasure. Thank you so much for coming on the show.

Ed Harrison  47:05  
Well, thank you for having me because I was gonna say the same thing. I hope that it was good enough because I’d love to come back. You ask the best questions. *Inaudible*.

Stig Brodersen  47:16  
Smooth and modest man. What can I say, Ed? Alright, guys. This part and time in the show, we’ll play a question from the audience. This week we picked a question from Jim.

Jim  47:27  
Hey Preston and Stig. It’s Jim calling from Calgary in Canada. I just read your last current market conditions, which ended up with, “When the facts change, I changed my mind.” “What do you do, sir?” that famous quote from Keynes. 

I’ve been thinking about the bond market and the fact that so many investors have a large allocation to bonds in their portfolio. As interest rates go down and as central banks manipulate markets, to me bonds are becoming less and less attractive. 

Knowing that the bond market is so much bigger than the stock market, is it possible that bond investors just start looking for something else? You get a rush of money out of bonds into other assets and maybe that’s stocks.

If that’s the case, we could start to see things like the Shiller P/E or P/E ratios, in general, going way beyond historic levels and a new normal becomes high P/E ratios. Just thought I would ask your opinion. I love the show.

Stig Brodersen  48:37  
Jim, I think this is such a wonderful question and it’s something that investors are considering right now. Bonds have been attractive for a long time since 1981 because you see interest rate drop and because of that returns have been great for long term bondholders. Today, as you pointed out, interest rates are really low. You might even be wondering why there are so many investors still holding bonds. 

Now, you do have many insurance companies and pension funds that have to do that because that’s simply how they’re regulated. That is due to a principle called “duration”. They simply have to ensure that they have enough funds where they can expect to meet a certain amount of claims. Another reason is that many investors like to have low volatility in the portfolio and fixed income instruments such as bonds are just a much better way of ensuring that than something like stocks. 

My response so far has been in so-called nominal numbers not in real numbers. In other words, you need to account for inflation. When people talk about double-digit returns on bonds in the 1970s, inflation was dubbed *Inaudible* too, so just because you might hold a say 50% return bond. 

If inflation was the same, yes, the bond would do better than the holding cost but your purchasing power didn’t change. You will be making 50% more and everything would be 15% more expensive. 

What I’m worried about right now and I think that’s also what you’re hinting at is: what happens if we account for inflation? Unless we enter a prolonged period of deflation bonds would likely not be as attractive in real returns compared to many other asset classes. When you asked whether we will see a new normal with a high Shiller PE, you can say that we’re already there to some extent. 

The CLP is very high right now. Part of that reason is that the Fed is printing so much money and keeping a 0% interest rate and that just drives up the price of stocks. Asset classes should not only be seen in the light of nominal numbers but rather investors look at what’s the opportunity. If you get 0% on your bonds, suddenly low to mid-single-digit return in equities might seem appealing. 

Whether or not it’s a new normal depends on how you define it because as we enter the next interest rate cycle, just to be completely upfront, I have no clue when and when that will happen. If you have higher interest rates then suddenly bonds and stocks change in value because stocks become less attractive and you can now get a higher return in bonds. 

Bonds also change value. If you are locked in long-term bonds at the current price level your bonds will drop in value as the interest rate goes up but it will on the other hand become more interesting to buy new bonds that are now paying a higher interest rate. 

Going back to what you said before, what do you do as a retail investor? If you’re looking to compound your purchasing power, you do have a leg up compared to  pension funds insurance companies because you do not need to hold long-term bonds. 

If you have less volatility in your portfolio you can buy short-term bonds that won’t drop in value if you see an increase in interest rates. If you do think that the interest rate stays long for a long time you might consider looking into stocks instead. If you’re worried about inflation you might also include a gold component. 

Jim, I know I covered it a lot of ground here and it is a tricky question that you ask because it’s very important to say. Based on what’s happening today, bonds are not attractive. However, you do need to factor in what’s going to happen in the future and that determines the value of the bonds and the decision that you make today. 

You might have heard the quote that it’s very difficult to predict especially about the future if I can even add to that. It’s even harder to predict what’s going to happen with the interest rate.

Preston Pysh  52:42  
Jim, from my vantage point, the question you’re asking is: how can I continue to measure something whenever a ruler doesn’t exist anymore? Because for all these years, that’s how we’ve looked at the fixed income market. Particularly the 10-year treasury because that was always your ruler as to how you measure your returns above that risk-free rate. 

If the risk-free rate is 0, how in the world can I measure anything? And the expectation that I have moving forward on a global scale I think central bankers are going to try to implement this MMT (Modern Money Theory) where they’re going to try to take rates negative. 

The question for me becomes: are they able to do that? For how long are they able to do that if they can do it at all? For that, and I think that’s what Stig’s getting at is: How in the world can you possibly answer that question? Because it’s never been done before. This is implementing negative interest rates across people like “Hey, give me some money, and I’ll guarantee you that I give you back less.” That’s never been done before. 

Does that mean it can’t be done? Probably not. Who knows at this point? I do know one thing if they go down that path, they’ve got to get rid of the hard currency that you have in your wallet. What people are going to be incentivized to do is to go take out as much of that at the bank as possible and put it in a safety deposit box because you’ll get a higher return than if you do it digitally with your checking account. We’re not there yet. 

However, all trends indicate that that’s where they’re trying to move things. The reason they’re trying to move it there is that they can’t allow interest rates to go up because of the fiscal spending that’s happening not just in the U.S., but all over the world. How do you deal with this as an investor? What it comes down to is you need sound money. You need something that can’t be debased. 

What you’re seeing in the stock market right now is that there are people that are bidding the value of certain companies. Companies that can protect their enduring competitive advantage even in a depressing scenario. Those companies are just bidding at levels that don’t even make sense. Historically speaking based on the earnings that the companies have created, everyone in the market’s minds is exploding right now. 

How is this possible? Why is this happening? It’s happening because people are treating that stock that equity as if it’s sound money. An important consideration to have is you need to own something that doesn’t have counterparty risk when you think about the debt that has counterparty risk. When you think about equity, it does not. Unless you’re playing in the derivatives market, right? If you own the stock that does not have the counterparty risk. 

If the company decides that the base or to create more shares of stock sounds like what you’re seeing with Tesla that’s a whole different story that has, I guess you could argue that has a counterparty risk because decision-makers are debasing the stock but you need to find something that has sound footing that is profitable, that is going to perform well in a depression deflationary environment. 

You’re seeing a lot of that in the tech stocks. That’s why they’re running. Does that mean they’re going to continue to run? I have no idea. I would suggest using some type of momentum strategy on those types of companies to protect your downside risk. 

I don’t know how else the person can navigate this crazy central banking induced volatility environment that we’re dealing with other than treating it from that perspective because we’ve pretty much taken the ruler, snapped that across our leg, and thrown it in the trash can which is your risk-free rate. 

That’s the best I can do for you. I would tell you to try to get smart on momentum strategies and then focus on those companies that are going to continue to perform in a depression-like scenario that has earnings so that they don’t debase their stock, or dilute their stock. Those are the ones that I’d be looking at. 

All right, Jim. For asking such a great question, we’re going to give you a free subscription to our TIP finance tool and this is on our site at The Investor’s Podcast website. Anyone that wants to find this can go to Google and just search TIP finance. 

The good news for you, Jim is we have a momentum tool on our website that will assist you on those types of companies to understand where the momentum stops and also when *Inaudible* has a positive momentum trend. 

It’s all there on the site and we’re excited to give that to you for free. Anybody else wants to get a question played on the show go to asktheinvestors.com, and if you get your question played on the show, you get a free subscription to TIP Finance.

Stig Brodersen  57:33  
That was all the Preston I have for this week’s interview here on The Investor’s Podcast. We’ll see each other again next week.

Outro 57:41  
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