Louis Gave (03:20):

That could take an hour and a half right there. It’s very nice to meet you. Look, I think right now things are obviously pretty challenging. We’ve just had three negative quarters for equities and three negative quarters for bonds. That’s a highly unusual combination. I think most people are licking wounds, and that’s even before you even go into what real estate is doing or what cryptos are doing. There’s basically been very, very few places to hide. And I think this reflects both some very important structural shifts in our economy from a deflationary world to an inflationary world itself. The result of a number of factors that maybe we’ll have time to get into. And some more cyclical stuff. Central banks tightening, economic growth slowing down in most major economies. Therefore, far more headwinds on earnings.

(04:10):

Now, I think before we get … It’d be very easy to get very despondent. It’d be very easy to paint a very bleak picture and to think, okay, things are going to be terrible. Maybe before we do, we should take a deep breath and remember that markets don’t go up in a straight line. They don’t go down in a straight line. At least in the near term, the potential, I think, for a rally, even if not a new bull market, but a rally is there. It’s pretty unusual that you get four negative quarters in a row for either equities and bonds, even more so. So the potential for if only just a bit of a breather.

(04:43):

And then you get to the question of what could be the catalyst for a change in the trend. And right now everybody’s focusing on the catalyst as the Fed pivot. It’s the big buzz word of the day. When does the Fed basically stop strangling the markets? I focus on a completely different part of the world. I spend most of my time looking at Asia, looking at China especially. And so for me, the potential catalyst is actually not a Fed pivot, but a Xi Jinping pivot. For two and a half years, China’s been on lockdown following crazy zero covid policies. The big question for me is, does this continue over the next 12 months? Does this start to shift? If obviously China was unleashed, then I think you’d probably see a rebound in growth in China and with that, a rebound in probably in a number of fairly beaten up assets. Who knows when this is going to happen? But the odds of it happening between right now, which is the party congress and Chinese New Year for me are not zero. And it’s not zero because there’s starting to be a big social cost to the zero covid.

(05:43):

To cut a long story short, I think Chinese people are sick of it. You saw that in the last two city lockdowns that you saw in Shenzhen and Chengdu. You basically had riots in the streets. I think the ability of the Chinese government to keep locking down their population is starting to wear thin. If you start to see the Chinese government back off, this could be positive news in a world where you’re really lacking, sorely lacking positive news. Maybe I’m clutching at straws, but trying to look for the silver lining to these dark clouds that are mounting overhead right now.

Rebecca Hotsko (06:15):

I want to dive deeper into your outlook on China in a little bit. I want to stay on the US economy first because we know we’re in a bear market and the rally, it might sustain, it might not. We’re down about 20% from the peak in the S&P 500. And some experts are still debating if we’re in a recession or not even though the data’s pretty clear we’ve contracted. But I guess I’m just wondering, do you think the market has already priced in a recession or has it not? And then if that data comes out, we could see further corrections.

Louis Gave (06:50):

I don’t think it has. Well, let’s put it this way. Let’s look at the market PE. I think the PE has definitely contracted. The P is probably about right. My fear is the E is not right. If there is a recession, the E is not right. If there is a recession, we have a whole other cycle of earnings downgrade to go through. And a cycle of earnings downgrade is another 20% lower in the market. And I think you’ve seen this spontaneously in different companies. Companies that have come out and announced disappointing earnings, whether you’re Federal Express, your Nike’s, your Ford Motors. They basically get dragged out and shot. And as the stock price goes down 15 to 20. In a recession, you get just a lot more of those. I think to answer your question directly, the market correction I think anticipates a slowdown. That’s the correction we’ve seen in the PE. The P is right. The big question, is the E right? And here my big fear is the big theme of 2023 will actually be earnings downgrades.

Rebecca Hotsko (07:52):

That’s really interesting. I think a lot of our listeners right now might be wondering, is this a good time to buy the dip? We often hear these are once in a lifetime opportunities to have these types of downturns. Or should we still be thinking this is a time to be defensive because 2023 could get worse?

Louis Gave (08:12):

I think bear markets are there for a reason. They’re not fun obviously. We all like bull markets better. They’re a lot more exciting. Bear markets are there for a reason. Big bear markets like the ones where … Because we are now in a big bear market. This is not a correction. Corrections, you buy the dip. Bear markets … What you do in a bear market is you wonder where is the next leadership going to come from? I think the tendency of most investors when they’re in a bear market is to hold onto the past cycle’s winners. To say, “Oh, you know what? I bought Peloton here, or I bought Zoom communications here, or I bought Facebook there and it’s going to come back because these are good companies and they’re going to come back over time.” But the reality is bear markets are there for a reason, and that’s to change leadership from one group of stock to the next.

(08:56):

So while you’re in a bear market, what you should actually be doing is thinking, “Okay, where is the next leadership going to come from?” And the best way to do that is to actually look at, while you’re going through the bear market, who is already outperforming? Who’s already starting to shine? And today I would say there’s really two asset classes that are starting to shine. The first asset class is energy. Pretty much anything linked to energy’s been outperforming. And the second asset class that’s been outperforming is emerging markets. Especially if you exclude China, which is such a big part of the emerging market benchmark. But if you look at your Brazil’s, your India’s, your Indonesia’s, your South Africa’s, your Mexico’s, all these markets are flat to up for the year, which is dumbfounding. In an environment of rising interest rates, of strong US dollar, that these markets are actually flat to up for the year goes against any historical precedence.

(09:51):

I think there’s a very strong message in both the outperformance of energy … Energy outperforming during an economic slowdown and in the emerging market outperformance. To me, it tells me that the next bull market will focus on those two. Maybe both or at least one of these two sectors. So in these two sectors, I want to buy the dip. When I see energy dipping, yep, I’ll buy that. But the reality is you’re wasting your time, and more importantly, you’re wasting your capital if you’re still hoping for the turnaround in Zoom, the turnaround in Facebook, the turnaround in Tesla. That ship has sailed. It’s gone. That was the previous bull market. The current bear market has marked the end of that bull market. Think about what the next bull market is going to be. It’s not going to be in the same place. It never is. Lightning never strikes twice in the same area.

Rebecca Hotsko (10:39):

That’s really interesting. I’ve heard that similar trend and perspective from a few guests now so it seems like it’s quite consistent among a lot of people. And so I’m just wondering about the energy piece. It has appreciated a lot over the past year. Right now would you say that it’s at an overvalued level and that yeah, investors should wait a little bit if it were to go down or that’s not important because it’s in this new cycle?

Louis Gave (11:07):

First it’s not important because it’s in this new cycle. But to your point, I think your listeners need to know that there’s fundamentally three ways to make money in financial markets. You can run some type of momentum trade. Things are going up so I buy it. And I think a lot of investors during the covid years, et cetera, became momentum investors. It’s like, “Oh, Zoom Communication is going up. I’ll buy that.” And it works. It can work for a very long time. Some people are very good at identifying trends and riding them. Today we’ve started a trend in energy so you have the positive momentum. Now you mentioned overvaluation. That’s the second way you can make money in financial markets, is you want to return to the mean trade. You buy things that are undervalued, buy things that are oversold, and you ride them until they become overvalued.

(11:52):

Now, I don’t think energy is overvalued. Not by a long shot. I look at things like the coal miners in the US for example, are trading at two, three times earnings. They’re buying back 10% of their shares a year. They’re far, far, far from being overvalued. Far, far, far from being … And same story with a lot of the oil companies. You’re based in Canada. If you look at some of the Canadian oil stocks … You take a Tormaline, you take a Suncor. These are not expensive stocks. These are actually cash flow generating machines. Now, historically … And this is what makes it for me energy particularly interesting in this cycle. Historically, your typical oil company CEO, when he gets money, the first thing he does is he goes drill a hole in the desert because otherwise he wouldn’t be an oil CEO. That’s what they do. Get money, drill holes.

(12:46):

Here, all of a sudden, your oil company CEO, nobody’s drilling, nobody’s doing any capital spending. And the reason he’s not drilling is because he’s got governments telling him, “In five years, I want you out of business.” So why is he going to do a big capital spending plan that comes due in three years? Why is he going to build a new refinery? Why is he going to build pipelines? He can’t even get environmental approval for it. So now he’s generating amazing cash flows and he really has no choice but to give these cash flows back to shareholders, either through special dividends or through share buybacks. Which brings me to the third way you make money. The third way you make money is by running some kind of carry trade. By basically having assets who always generate higher payments than whatever your cost of capital is.

(13:33):

What is very unique about energy and to some extent in emerging markets, but especially energy today, is that it ticks all three boxes. They’re positive momentum trades, they’re positive return to the mean trades, and they’re positive carry trades. It’s highly unusual to have assets that tick all three boxes. When you do, you have to back up the bus. So yes, I think we have started a new structural bull market for energy, a new structural bull market for emerging markets. And frankly, nobody’s participating yet. Very few institutions are in it because most of them can’t because of ESG constraints. Because they just got done divesting all their energy assets. So for them to turn around and now do it, I think to me it’s a trade that definitely has legs.

Rebecca Hotsko (14:17):

And then I guess on the emerging markets … So you mentioned a few of the countries that maybe are unexpectedly doing well during this time, minus China. So I’m just wondering, what do you think is the best way investors can get exposure to emerging markets? I know there’s a couple funds that I hold. IEMG and VWO. Those are two big emerging market ETFs, but they have China as a large allocation. So I think it’s hard for retail investors to get exposure to emerging markets and cherry pick certain sectors or markets. That usually comes with China being the top exposure.

Louis Gave (14:53):

If you’re going to buy a broad emerging market equity fund, you are going to end up with a lot of China just because it’s such a big part of the benchmark. Now you can buy individual country funds. You have ETFs for Brazil, ETFs for Korea, ETFs for India, ETFs for Singapore. So you can do that. Cherry pick by country. And you can either do it on momentum screens or valuation screens. That’s one option. When it comes to China … Look, China at this point, the equity market has been in a terrible bear market for the past three, four years. You have what I think are pretty world class companies like Alibaba or Tencent or JD, whatever, that are trading at very attractive evaluations, especially relative to similar companies in the western world. But it remains a policy driven market.

(15:42):

And deep down, the big problem with policy in China is that you can’t forecast. You can only adapt. And buying China through ETFs on that front is challenging. Who’s to say tomorrow morning, Xi Jinping wakes up and decides to go after Alibaba, and that’s your biggest holding. And nobody knows that until he does it. You could say, “Well, he’s already done that, so he is not going to do it again.” So maybe Alibaba is safe, but maybe Tencent isn’t. And look, I think my take on China at this stage is pretty simple. We’ve just started the party, the 20th party Congress, it’s going to go on for the next week. And there’s no real reason I think to jumpstart anything until we know more. And we’ll know a whole lot more in the next 10 days. Specifically, I think there’s three big questions that surround this party congress.

(16:30):

The first important question is what happens politically in China? Does Xi Jinping concentrate all political power around him? That’s option one. Which isn’t bullish at all for Chinese asset prices. Or does the Chinese communist party manage to bring Xi Jinping back somewhat towards what China used to be, which was management by committee before Xi Jinping arrived? It’s most likely that it will be one man rule more than management by committee, but there could be a positive surprise there.

(17:00):

The second big question is what does the government do about the real estate market, which remains this huge overhang? Although in regards, everybody’s always asking questions about the Chinese real estate market and worried about it, et cetera. Meanwhile, real estate markets are struggling everywhere. It’s not like the Canadian real estate market is flying. And the UK real estate market is looking down right ugly. Why people keep focusing on China is interesting to me. But there’s same story in Australia, same story in New Zealand. Look most places, the real estate … It’ll be interesting to see how well the US real estate market does with a 7% mortgage rate. Anyway, cut a long story short, I think the real estate question is increasingly a global question, although on China we’ll probably have some answers in the coming weeks. And then the third big question of course, is the zero COVID. Does China stick with the zero COVID or do they get on with the rest of the world?

Rebecca Hotsko (17:54):

So just on those big tech names like Alibaba, Tencent, JD, you mentioned what we should listen for and pay attention to going forward. And I guess what in your view would be positive? Because they’re just trading so attractive right now. They’re very, very low. Alibaba’s below its IPO still, I believe. But I guess in your view, what would be that positive catalyst where it would signal those risks are behind us or there isn’t with the Chinese government?

Louis Gave (18:24):

One potential positive … Well, on the political side, on the first question, does Xi Jinping become dictator for life or are his powers constrained by the Chinese communist party? What I’m looking for is who gets appointed premier. Right now the premier is a gentleman called Li Keqiang who’s having to retire. He’s aged out. And Li Keqiang and Xi Jinping have clashed a fair amount. And so the big question is, does Li Keqiang now get replaced with a Xi Jinping crony? And if he does, then that’s basically game over. Xi Jinping controls all the levers of power. Or does he not get replaced by a Xi Jinping crony? Which would be, I think a signal of the party still has some say in decision making. That to me will be a big signpost. And I’m not going to forecast. There’s no point. I’d look stupid. It’s coming out in a week.

(19:12):

But more importantly, nobody can know what goes on inside the standing committee of the communist party. It’s very tightly held secrets. So we wait. I often like to say in China, you’re not paid … Especially in Chinese politics, you’re not paid to forecast, you’re paid to adapt. I think right now the market is priced in for Xi Jinping being emperor for life. So if you get anything that looks a bit different, then I think the markets will rally a good bit. Again, so the first question is who gets to be premier. The second thing will be whether there’s any announcements on covid. And if they are, what are they? Do they sound hawkish or do they sound fairly dovish?

(19:49):

On a positive sign here it looks like they might be easing up a little bit. I don’t know if you saw the October 1st holiday, which is their national holiday. There’s always a big parade on Tiananmen Square and none of the leadership were wearing masks. Neither were the policemen, et cetera. That was the first time in two and a half years, Xi Jinping was without a mask. And then of course he’s just started to travel abroad again, which is somewhat encouraging. And then finally Hong Kong is reopening, which could also be a sign that maybe they’re thinking of loosening, they’re trying it out in Hong Kong. See how that works and bringing it in. It’ll be interesting to see basically what happens on that front.

(20:25):

On the real estate side, I think the big challenge in China on the real estate side is that you’ve obviously had a lot of property developers go bust in the past 18 months or so. And this has absolutely crushed animal spirits. Because if you were a property developer and a guy buying an apartment, the way it works in China is I come into your office, you show me some nice drawings, I say, “This looks good. I’ll put 20% down.” And you say, “Okay, come back in 18 months. I’ll have your apartment ready.” But if you go bust in the process, then I lose my 20% through really no fault of my own. And so now what happens is because this has occurred too many times, people are just terrified at the thought of losing their 20%, which represents most people’s life savings because usually the last 70% of your mortgage.

(21:13):

This has led to a complete deep freeze of the real estate transactions. Nobody’s doing anything. Transaction numbers have absolutely collapsed. So what you need to do is do what we did in the western world where the banks failed in the 1930s to the government stepped in and said, “I’ll guarantee bank deposits.” To make sure that people didn’t take their money out of the bank. I think today the Chinese government needs to do an FDIC like insurance company. A government controlled insurance company that guarantees the deposits of people’s real estate purchases. And if you do that, then you have a chance of getting real estate going again. Because China has one thing going for it relative to the US or Canada or most places right now, is the fact that real estates are still pretty low. In fact, mortgage rates in China are about as low as they’ve ever been. So if you can just get animal spirits going again, then you have a chance of stabilizing real estate and perhaps getting it going again.

Rebecca Hotsko (22:08):

That was a really helpful outlook. I think there’s obviously lots of unknowns around that economy and that is your wheelhouse so that was really great hearing that from you. I want to use this as a segue now to talk about how we should position ourselves during this time. You recently published a book titled Avoiding the Punch: Investing in Uncertain Times. I really enjoyed reading it. It was all about how do you build a portfolio during this time of low interest rates, stretched valuations. And so I wanted to get into that a little bit with you today. In your book you mentioned there are six categories that make up a well-built portfolio. I was wondering if you could just walk us through those and explain some examples of assets that fall into those categories.

Louis Gave (22:56):

I guess the first concept I go through in the book actually is that you have to imagine your portfolio as you would a rugby team or an American football team. If you put an American football team together, everybody’s got a very specific job. You don’t expect everybody on your team to look like Tom Brady, nor do you expect everybody to look like an offensive lineman. And the same is true for … In the book I use a rugby team because I’m a rugby player myself, but it works just as well with American football. And given that your audience is probably North America I’m not going to use rugby terms with which they’re probably not too familiar. If you think of your portfolio as an American football team, you wouldn’t expect your quarterback to be the best tackler on the team. Nor would you expect an offensive lineman to run the 100 meters in 10.5 seconds. It’s great if he can, but that’s not what he’s being paid for.

(23:49):

And the same is true of a portfolio. So just like in an American football team, you need lots of different assets that do different things at different time. This is what you need in a well built portfolio. And I think the problem is you get in a bull market, people forget that. People forget that and they end up buying a lot of the same things. A portfolio that had a lot of Apple and a lot of Microsoft and a lot of Google and a lot of Facebook, it was just the same bet over and over again. It was just buying similar type companies that basically responded to the same kind of macro developments. It was almost as if you’re trying to put a team on the field with 11 Tom Brady’s. You’re never going to win a long game with 11 Tom Brady’s on the field. As great as Tom Brady might be, and perhaps the greatest quarterback that’s ever lived, a team with 11 Tom Brady’s ain’t getting you anywhere.

(24:39):

With that said, a well built portfolio, it’s built around six separate blocks. The first is your anti-fragile block. What is literally your offensive line. It’s there to protect everybody else. It’s there to protect your running backs. It’s there to protect your quarterback. Yeah, it’s there to protect everybody. Historically, your anti-fragile building blocks were government bonds. And the big challenge is that, and this is what I go through in the book, the offensive line, your government bonds, it’s like they went off on holiday weighing 350 pounds and they came back weighing 150 pounds. And that’s what government bonds became. Because they had such low yields that they couldn’t possibly do the job you would expect them to do. Now the good news is this might be in the process of getting solved. As yields rise bonds will get to valuations where once again, you can hope that they’re basically back to gaining weight right now. And so you might be able to pull them off the bench.

(25:40):

But just like a team manager, when he is got a player on the pitch who’s not doing his job, you’ve got to sub out. You got to say, “Okay, you’re not doing your job. Go sit on the bench. Maybe you can come back in later, but for now, I’m putting somebody else back in.” The big question of course today is who can you put in to replace your bonds? And here, I think there’s really two asset classes that this year have gotten the job done. The first is energy. We’ve talked about it. But energy is today negatively correlated to pretty much all the other asset classes. And the other is emerging market bonds that have done a halfway decent job, including Chinese government bonds that have actually held up remarkably well in spite of a lot of things. In spite of increasing tensions with the west and whatever else. So that’s your first building block. Anti-fragile. And today it’s the hardest one to match.

(26:30):

Your second building block is your defensives. It’s almost your second defensive curtain after the offensive linemen. It’s like, okay, if they go through, we have a second defensive line. So your defensives here, it’s mostly stocks, but stocks that have a higher beta. Sorry, a lower beta. Apologies. A lower beta. Think of things historically like utilities, healthcare, infrastructure, staples. Now, one point I would make today on this part of the portfolio is that the big shift that we have to think of is that we’ve gone from a deflationary environment to an inflationary environment. Now, in a deflationary environment, the government is your friend. In a deflationary environment, the government protects your margins. The government tells you, “Yes, yes. Build this power plant, build this water treatment plant, and I guarantee you’ll get at least 10% return or whatever else.” And you can price however you want and the government almost guarantees your margins.

(27:31):

In an inflationary environment, the government moves from being a friend to being an enemy. In an inflationary environment, the government is going to tell you, “Sorry buddy, you can’t increase your electricity price. You can’t increase the water price. You can’t increase the toll road because otherwise the voters are going to be too upset at me.” We’ve seen this in Europe where all the electricity companies in Europe are going bust because they’re being told by the government they can’t increase their prices. So in an inflationary environment, you want to own defensive companies that have as little to do with the government as possible. So I don’t think you want to own, for example, healthcare because the government can say, “Hey, you know what? If you price this too aggressively, I’m going to change your patents or whatever else.” But you can definitely own staples.

(28:19):

The government is never going to tell Proctor&Gamble, “Oh, you can’t raise the price of deodorants. Oh, you can’t raise the price of shampoo.” It’s never going to tell Nestle, “Oh, you can’t raise the price of a Kit Kat.” If Nestle wants to move the Kit Kat from $2 to $2.20 or shrink the size of the Kat Kat more likely from 200 grams to 150 grams, the government isn’t going to get involved. So that’s your second block. The defensives. And I would say there’s defensives for inflationary environment and defensives for deflationary environments. So you got to be careful which one you choose.

(28:52):

So I’m going from most defensive to most aggressive. Your third block is income. Now, having some high income producing assets in a portfolio is a very good way to stabilize returns over the long term, to reduce the volatility. And frankly to reduce your own … When things go really badly and you might be tempted to sell things right at the bottom, having income that’s coming in allows you to breathe. It’s more about mental health. The income portfolio is more about mental health than anything. And there’s many different ways to produce income. You can do it in the high yield space, you can do it in real estate, you can do it of course with high dividend yield paying stocks. Many ways to produce income. But for me the income bucket is first and foremost about mental health. About helping you to not panic at the bottom. Then you get to the growth part of the portfolios. And here there’s really two different types of companies. You have companies that grow through increases in price. Energy stocks are the perfect example. Exxon Mobil makes a whole lot of money when the oil price is at 85 bucks and a whole lot less when it’s at 55 bucks. And so the real variable for Exxon Mobil isn’t how much oil are they going to sell, it’s at what price are they going to sell it?

(30:10):

Now the problem is a lot of the price sensitive growth equities, they tell them control the price. So that becomes extremely macro driven. So that’s your fourth bucket. And then you have your growth volume price where basically the growth of the stocks depend more not on the price at which it’s going to sell, but at the volumes it’s going to sell here. Perfect example is Microsoft. What matters to Microsoft is perhaps not as much the price at which they sell their licenses, but the amounts of the numbers at which they’re going to sell them. Basically growth at price and growth at volume. Those are fourth and fifth.

(30:47):

And the last bucket, which you don’t really need actually … I do it because it fits well with my own temperament. It’s the contrarian bucket. It’s markets are manic depressives. And every now and then markets will just throw up some assets. It might be a given company because they’re disgusted with the management. It might be a given country because of poor leadership in that country. It might be a commodity. It might be whatever. But sometimes it can’t be given away cheap enough. Just like the market wants absolutely nothing to do with it. Now granted, sometimes it’s for very good reason, which is why I said you don’t need the contrarian bucket. It’s a bucket where you can easily break your teeth. Having said that, it’s also one where you can have really outsized returns. And it’s also one where when you get it right, it is so exciting. It is just so much fun.

(31:40):

Those are for me, the six buckets. And I think whenever I buy an asset, I try to be very clear in my own head, okay, where in my own portfolio out of these six buckets is this asset going into, number one. And number two, is it a return to the mean trade, is it a momentum trade or is it a carry trade? And what’s important when you buy things is you know why you buy them. You want to make sure as you make your grid of your six boxes and your three reasons why you buy them, that you don’t end up too skewed one way in into just one part. If you put this on an Excel, you want to be a little bit everywhere. Otherwise it means that you have a team with 11 Tom Brady’s, which might work great for a little bit. But 11 Brady’s is never going to win you the Super Bowl.

Rebecca Hotsko (32:26):

That was super helpful. Thanks for going into all that detail on the different buckets and everything. That was really great. I want to also talk to you about your four quadrant framework that you talk about in the book. And you’ve already touched on it today by talking about the inflationary versus deflationary environments. So for our listeners, can you just explain what the four quadrant framework is and how it can be used to inform investment decisions?

Louis Gave (32:54):

Absolutely. I would tell your listeners to grab a pen and paper and do an X axis and a Y axis. On your X axis you put growth, and on your Y axis you put inflation. And growth and inflation are basically your two drivers of earnings. If you’re driving earnings, you’re somewhat driving returns. Now the drivers of earnings, and they’re the drivers of interest rates. The more growth and the more inflation you have, the higher the interest rates are going to be. And of course the lower the growth and the lower the inflation, the lower the interest rates. Now most asset prices are a stream of future earnings discounted by an interest rate in which you tack on a risk premium. The four quadrants framework, basically focusing on the interaction with growth with inflation, gives you a picture of both the stream of future earnings and the interest rates on which it’s going to be discounted.

(33:47):

It doesn’t tell you anything about the risk premium, but it’s already two out of the three parts you need for your equation. In that interaction between growth and inflation, you start off, if you go at the very top left bottom, you start off with the deflationary bust. Falling inflation, falling growth. This is the 1930s in the US. This is 2008, 2009 crisis. This is Japan following their 1990 real estate bust. Most of Asia in 1997 during the Asian crisis. During that period, during periods where growth is falling and inflation is falling, really the only thing you want to own are this world’s safest government bonds. So typically US treasuries. And these are grim economic times. Like I said, the 1930s in the US or Canada. It’s really not fun. Now, let’s move one over to the right, where now all of a sudden you have falling inflation, but rising economic growth. This is is a disinflationary boom or deflationary boom, however you want to call it.

(34:44):

And this is actually the natural state of capitalism. This is when people are left unhindered, this is where capitalism ends up. Why? Because when you think of it, most businessmen, every morning they show up at work, they try to do more with less. They want to produce more stuff with fewer workers, fewer inputs, fewer … They try to play with their machines so that they can produce more. So the natural state of capitalism is always to produce more with less, which brings you naturally to a deflationary boom. And a deflationary boom is extremely positive for growth stocks. Especially the growth volume stocks I was describing earlier. The ones that don’t depend on price, but depends on volume. That’s when those boom. And that’s really what we’ve had for most of the past 30 years. We’ve had some interruptions of course during that time, but most of the past 30 years in North America, we were in a deflationary boom.

(35:40):

Now let’s go one above. The inflationary boom where I think we’ve been more or less up until recently, and now we’re starting to move towards the inflationary bust. But first the inflationary boom. Inflationary boom is you’ve got strong growth, strong inflation. Typically commodities during that time are absolutely booming. So you want to be long commodities. You want to be long commodity currencies like the Canadian dollar, like the Australian dollar. You want to be long emerging markets because emerging markets tend to be more inefficient producer. During inflationary booms, there’s not enough to go around. So your more inefficient producers actually get re-rated because all of a sudden they stand a chance.

(36:18):

So the inflationary boom is, yeah, it’s usually pretty good for commodities, emerging markets, that kind of thing. And then finally you get to the inflationary bust, which is also pretty bad news. You get falling economic growth with rising inflation. Another name for it, of course is stagflation. Now of course, that’s the fear today on everybody’s mind. And during that time, you basically need to be in cash and the safest currencies or in gold. That’s the four quadrant framework.

Rebecca Hotsko (36:49):

That was great. Thanks for going over that with us. You mentioned gold there. We haven’t touched on that yet. Some investors might be wondering why gold hasn’t performed that well or maybe as well as expected. Can you talk a little bit about your outlook for gold?

Louis Gave (37:06):

Look, there’s no doubt that I think the performance of gold this year is disappointing. I think if most people had been told a year and a half ago we’d be on the verge of World War III, potential nuclear war with 8.5% US inflation rate, they wouldn’t have expected gold to be down. But here we are now. The first point one could make of course, is we’ve had an environment, a very, very strong US dollar. So gold has done fine in pretty much every currency except the US dollar. If you’re Canadian, gold is roughly flat for the year. If you’re European, if you’re Japanese, it’s up a lot. If you’re European, gold has done its job for you. If your Japanese gold has done its job for you. It really hasn’t done its job if you’re American. Now, for me, the main explanation for this is that we now live in a world where most of the physical demand for gold comes from emerging markets.

(37:59):

You have roughly 30% that comes from China, roughly a big third that comes from the Indian subcontinent, probably about 15% that comes from the Middle East, about 10% that comes from Russia. So most of the physical gold demand is emerging market related. And so one of the points I’ve made a lot to over the past really 20 years, is that we should now see gold as a proxy for emerging markets. When emerging markets do well, as they did from 2001 to 2011, the gold booms because every guy getting richer in Jakarta or Bangkok or Beijing or Lahore or wherever else, he’ll take his savings and he’ll put it into gold. By the same token, when your average businessman, your small businessman in Delhi, or in Colombo or in Yangon struggles, then he’s going to sell his gold, which is how he keeps his savings. He’s going to sell his gold to make ends meet.

(38:54):

Now today, we know that you have actually, as it turns out, two of the economies in the Indian subcontinent that are literally imploding before our eyes. Sri Lanka being one of them, Pakistan being the other. And as these economies implode, I think what you’re seeing is people there are having to fire sale their gold. The bottom line is … I’m a bull on emerging markets as I’ve mentioned earlier. I think as it becomes clearer that emerging markets are coming out of this current crisis ahead, as we start a new bull market in emerging markets we’ll probably start a bull market on gold as well. For me, it’s one and the same. But at the end of the day, gold is more or less a way … It’s become a low beta play on emerging markets. I think there’s more exciting things to own than gold, but I know that a lot of people find emerging markets a little too exciting so gold is not a bad halfway house.

Rebecca Hotsko (39:48):

Okay. And then I’m interested to talk about deflation because in your last chapter of your book, you talk about where will deflation come from? There’s a debate among people if we’re going to be heading towards a deflationary environment eventually. Right now, obviously inflation is still running hot and hotter than expected with the new September data just released. So I’m just wondering how you think about that deflation piece. Do you think that’s coming and will we move into that kind of cycle?

Louis Gave (40:20):

I’ve been an inflationista for a while. I remain it. I think behind today’s inflation rate, you have a number of factors. The crazy fiscal and monetary policies that we followed in recent years is definitely a big one. But for me, the biggest factor is deglobalization. I think the major deflationary force of the past 20 years was our ability to basically go to China and benefit from China’s structural excess capital spending and their excess of workers. Now that excess of workers in China has now disappeared. China demographically now looks horrible. China last year lost four million workers. By the end of this decade, they’ll be losing 10 million workers a year. The ability to in essence turn to China and say, “Look, I want you to produce this at a very low price,” and China’s ability to say, “Yes, I can give you first world infrastructure and first world workers.” Because they were first world workers at third world prices. All that has been blown out of the water. That’s finished.

(41:20):

And not only is it finished, but we’re actually making it worse. As we speak the US has told China and all the countries around the world, nobody’s allowed to sell semiconductors to China anymore, which is going to wreck new havoc and supply chain. But if you’re China and you think, “Okay, the US is coming after me economically,” now if you’re the Chinese government, you have to be telling all your auto manufacturers, “Guys, the US is after us. So forget semiconductors. Just make sure you don’t use anything from the US.” So let’s use chemical products as an example. You have about $3,000 worth of chemical products in a car. Well, right now, if I’m a Chinese auto manufacturer and I was getting this from DuPont or Dow Chemical, I’m now either looking for a local replacement or I’m going to buy it from BASF or whoever.

(42:06):

Now, the reason I was buying it from DuPont or Dow Chemical was either that it was better or that it was cheaper. Either way, it helped me get a better product at a better price. But now with this latest thing from the US if I’m a Chinese producer, I’ve got to basically cut back all my product importing from the US. Not just semiconductors, everything. Because if tomorrow the US decides no more chemical products for China, then my whole business is going to implode. So I got to prepare for it now before it happens. The rise, I would say, of geopolitical protectionism … Because that’s what it is. Or what I’ve called in my books, the age of weaponization. Where everybody weaponizes their one comparative advantage to try to trip up the next guy. All this points to lower productivity. And lower productivity means lower growth at higher prices. No. I think we are now heading to a much structural higher rate of inflation. Unfortunately, but it’s the case.

Rebecca Hotsko (43:06):

And then I guess everything with energy prices as well, with OPEC cutting supply, prices were going down for a little bit, but it’s definitely not the case anymore. So we can probably expect energy prices to be at least in near term and maybe long term pushed for inflation as well.

Louis Gave (43:23):

I think so. I very much think so. You have, as you pointed out, energy prices came back down I think thanks to two things. First, you have the Chinese lockdown and then you had the US strategic petroleum reserves. I think most people, myself included, I’ll put my hand up to this one. I was very much hoping that post the Chinese Olympics in January, we’d see China reopening. And instead we got the Shanghai lockdown, which came very hard. Two hard months of lockdown in Shanghai, which came as quite a shock to everyone.

(43:59):

So you had the Chinese lockdown, which probably took about a million and a half barrels out of global oil demand. And right at the same time, the US turned around and said, “Look, we’re going to release strategic petroleum reserves, we’re going to release roughly 800,000 barrels per day.” So it increased supply, lower demand. Obviously you’ve got constrained prices. But will we still have these two factors in three months time? Well, we definitely won’t have any more strategic petroleum reserves releases because you can’t release it forever. In three months time, the US won’t have oil to release. So that’ll be that. If at that point China comes back onto the system and says, “Yep, I’ll have another million and a half barrels per day, please,” where will that million and a half barrel per day come from? I don’t know.

Rebecca Hotsko (44:40):

I also want to talk to you … This will be the last question for today about China de-dollarizing their economy. I’ve heard you talk about this before and I was hoping that you could explain what this means and maybe what implications this could have for US and global markets.

Louis Gave (45:00):

Absolutely. Look, I think if you’re China … I always like to tell my clients, you shouldn’t criticize Xi Jinping until we’ve walked a mile in his shoes. It’s the old Steve Martin quote, “You don’t criticize anyone before you walked a mile in their shoes because, like this, when you do your mile away and you have their shoes.” When we look at Xi Jinping, for him from where he’s sitting, the US is out to get him. The US is cutting all of the semiconductor access to China, keep making threatening noise. You got US officials visiting Taiwan, which is against the status quo that has been established for 50 years. He feels they’re out to get me. Now that he feels this, he thinks, “Okay, how so how are they going to do it?” Well, there’s three ways the US can trip up China. The first is indeed by banning semiconductors. Well, they’ve already done that. I don’t have much choice. I got to spend a fortune building my own semiconductor industry. So be it. I just don’t have a choice. So that’s number one.

(45:57):

Number two, the second thing that Xi Jinping can do … Sorry, the US can do to China is they can cut me off energy. But here this is getting hard for them to do because China’s doing long-term deals with Russia, doing long term deal with Kazakhstan. China has now become the world’s leader in solar industry. It’s rapidly building a lot of nuclear power plants. On the energy front they’re trying to basically cut themselves off ocean imported energy because of course, the US controls the oceans. Or at least reduce the dependency on the amount of ocean imported energy. But then where China’s greatest weakness is, of course, is on the energy front. Sorry, on the currency front. The fact that most of China’s foreign trade is still denominated in US dollars. And that the US does have a track record of tripping up its enemies by weaponizing the US dollar. The US did this against Venezuela. The US did this against Iran. The US is now doing it, of course, against Russia. The US turns around and says, “Well, look, the US dollar is our currency and we don’t like you, so you’re not allowed to use it anymore. And anybody who uses the US dollar with you will fall under US sanctions.”

(47:05):

So if you’re China, you now have to de-dollarize your economy as quickly as you possibly can. And that means trying to convince most of your trade partners to switch from using the US dollar to anything else. But of course, preferably the renminbi, since China controls the renminbi. Now, China’s been trying to do this for 10 years with very limited success up until the Ukraine war. I think the Ukraine war actually changes the equation somewhat in that at least now you have Russia. Russia that always was a little bit reluctant on trading in renminbi. But now because Russia itself has been kicked off the US and Euro systems, Russia has no choice but to embrace the renminbi, right? It’s beggars can’t be choosers kind of thing.

(47:50):

And so now all of a sudden you have the world’s largest commodity exporter, namely Russia, trading with the world’s largest commodity importer, namely China. A trade, all of which used to happen in US dollars now happening in renminbi. Now, this is I think, quite a big game changer because that trade will never go back to being in US dollars. If you look at it this way, before, when China wanted to buy a billion dollars worth of iron ore or copper or coal or whatever else from Russia, it first needed to go to the US and earn a billion dollars. So it first needed to go out and sell a bunch of … I don’t know, bicycles or plastic toys or shoes, or you name it. Earn a billion dollars. Then it could take that billion dollar to Russia and say, “Please give me a billion dollars worth of iron ore.” Now all of a sudden Russia says, “No need to do this. Just print a billion renminbi in your basement and send it over to us.”

(48:43):

So this is a huge, huge improvement for China. And as a result, Russian-Chinese trade is actually booming. A few years ago, China was buying about four billion a month of commodities from Russia. Now it’s about 12 billion a month. And it’s probably going to keep growing. It also allows now China to turn to people like BHP. BHP is the one of the world’s largest mining companies there, and the biggest iron ore minor. So they turn to BHP and they say, “Hey, BHP, we used to trade in US dollars, but I like your stuff a lot. Your iron ore is terrific. It’s much better than this Russian crap I buy. But Russia, they accept renminbi. So unless you two start too accept renminbi I’m going to do more with Russia and less with you.”

(49:24):

And so a few weeks ago we saw BHP announce for the first time RMB deal. RMB for iron ore deal, which was a first in the market. And now that BHP accepts RMB for iron ore China won’t let them go back. In fact, what’s going to happen is they’re going to turn to Rio Tinto and Vale, the other two big iron ore miners and say, “Hey guys, if you don’t accept renminbi as well, we’re going to do more with Russia and more with BHP and less with you.” So I think China, the Ukraine war has been … Obviously it’s a humanitarian disaster and you never have to … Nobody wins in a war. But if anybody wins out of this war, for me, it’s China because it’s allowed them to shift the needle in their de-dollarization strategy what I think is a fairly meaningful way.

Rebecca Hotsko (50:12):

And I guess just quickly then, can you explain what impact that has for the US dollar then? Obviously that’ll cause it to depreciate, but how soon could we see that happen?

Louis Gave (50:26):

Let me tell you a personal experience. Back in 2008, 2009, I set up a fund with a friend of mine called Mark Hart. And our view was pretty simple. Europe was cruising for a bruising. That the way that euro constructed made no sense. And that pretty soon countries like Greece and Italy and Portugal that were all borrowing at the same rate of Germany, would no longer be able to, and then you’d see a blowout in European spreads. So we went out and we bought a bunch of credit default swaps in Greece and Italy, et cetera. And one of the other bets we made was to say, okay, as Europe economically hits the wall, the euro will go down. So we bought a bunch of puts on the euro. Okay. So we had the credit default swaps, and those did great. As Europe started to hit the wall, you saw spreads on Greece, explode. You saw spreads on Italy explode. And so these were re-rated massively and we made lots of money there.

(51:25):

And then the Euro puts, we lost our shirt on. The euro went from 120 2010 to 150 in 2011. Even as Europe was falling apart. It was obvious that the Europe was collapsing. At the time, I talked about it with my dad, and my dad had run a macro fund in the ’90s, and he said, “That’s nothing. You think you’ve got pain, try being short Japan in the ’90s.” For those listeners who don’t know, Japan had a huge bubble. Probably the most historical bubble of all bubbles in the 1980s. You actually had a shop in Ginza that sold for over a million US dollars a square foot. So that’s how big a bubble it was. So it was the bubble to end all bubbles.

(52:07):

And then when it imploded in 1990, it was pretty obvious that Japan would have a lost decade. It’d be terrible. So a lot of people, including my dad, shorted Nikkei and shorted the yin. And the Nikkei part went great. The market lost 50% and then kept falling. So that part was great. And the yen went from 160 to 85, which means it went up because the yen is inverted. The yen actually went up as it went from 160 to 85. Now, the reason I highlight this, is that when you have a bubble and a bubble blows up, which is what we had in Europe, which is what we had in Japan, it leaves financial companies with big holes. And whether your pension funds, your insurance companies, your corporates themselves, they have big holes in their balance sheets, big holes in their income statements, and they need to plug them.

(53:04):

And the fastest and easiest way to plug them is to sell foreign assets and repatriate capital. And so often what you can see after a bubble implosion is the currency go up. And it can go up quite strongly because there’s nobody to take the other side. Nobody is taking the other side. While the economy is slowing following the bubble implosion, nobody’s pushing capital outside. Everybody’s bringing it back. So everybody’s on the same side of the trade. The reason I highlight this is we’ve just had an epic bubble implosion in the US. We’re still in the middle of it. A fixed income bubble, a crypto bubble, a real estate bubble, a equity market bubble. It was an everything bubble. You’ve got to believe that when you look at the 15, 16 trillion of capital destruction that you’ve had in the United States, a lot of that is sitting on the books of insurance companies, of pension funds.

(53:53):

And so I think what they’re doing right now is repatriating capital. Repatriating capital to plug the holes. And this explains the parabolic move in the US dollar. Now these things, when they get started, they can continue for quite a while. So I’m not inclined to try to top dig this. Having said that, if you ask me for a structural view over the next four or five years, not the next three months, then yes, this de-dollarization of global trade away from the US dollar is extremely bearish the US dollar. Because once it happens, it’s not coming back. And of course the biggest comparative advantage of the US is the fact that everybody else uses the US dollar to fund most of their trade. The fact that when China buys lumber from Canada or coal from Canada or oil from Canada, that it’s priced in US dollars. Why does it need to be priced in US dollars? It’s like having a menage a trois. It’s like why can’t it be just either in Canadian dollars or renminbi? But of course the fact that it’s in US dollars allows the US to … It’s the exorbitant privilege. It allows the US to live far above its means for a very long time. And when that ends, then I would say the cost of living adjustment in the US will be quite drastic. I do think US policy makers are playing with fire.

Rebecca Hotsko (55:09):

Thank you so much for sharing all those insights with us. That was so great. I know that I learned a lot from this conversation. Before I let you go, can you let our listeners know where they can learn more about you, your work, and then everything that you do?

Louis Gave (55:24):

Sure. I’m not really on social media, so I apologize for that. We publish research mostly for institutional investors and we do that out of our website, gavekal.com. G-A-V-E-K-A-L.com. We also have a free news. So you mentioned that you’ve already interviewed my colleague and very close friend, David Hay. David runs the private wealth arm of Gavekal called Evergreen Gavekal. Evergreen Gavekal does publish a bunch of free newsletters that retakes sometimes some of the stuff we publish at Gavekal.

(55:55):

I myself, I try to publish a book every 18 months or so if only to clear my mind about what I’m really thinking. I find it a cathartic exercise in terms of structuring my thoughts. Those books are always available for sale on our website. After a few years you can download them for free, the e-version. Otherwise they’re like 15 or 20 bucks. And I did publish one not that long ago called Avoiding the Punch. I haven’t started working on the new one yet. Taking it easy for a little bit. Another thing we do … We also have an institutional money management arm. We manage different, mostly invest money in Asia. We have Asian Equities fund, Chinese … A fixed income fund. We do manage one Asian government Bond ETF. For anybody who’s interested in exposure to Asian government bonds, the ticker is AGOV. A-G-O-V. And if people want to reach out to me, I’m louis@gavekal.com.

Rebecca Hotsko (56:51):

Awesome. Thank you so much again for taking the time to chat with us today.

Louis Gave (56:55):

My pleasure.

Rebecca Hotsko (56:57):

All right. I hope you enjoyed today’s episode. Make sure to subscribe to the show on your favorite podcast app so that you never miss a new episode. And if you’ve been enjoying the podcast, I’d really appreciate it if you left us a rating or review. This really helps support us and is the best way to help new people discover the show. And if you haven’t already, be sure to check out our website, theinvestorspodcast.com. There’s a ton of useful educational resources on there as well as our TIP finance tool, which is a great tool to help you manage your own stock portfolio. And with that, I will see you again next time.

Outro (57:34):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by the Investor’s Podcast Network. Every Wednesday we teach you about Bitcoin and every Saturday we study billionaires and the financial markets. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.