Alec Cutler: it feels like the 1970s what should you buy? – MoneyWeek

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Merryn Somerset Webb: Hello, and welcome to the MoneyWeek Magazine podcast. I am Merryn Somerset Webb, editor-in-chief of the magazine. This podcast is being recorded on February 11th, 2020. With me today is Alec Cutler, who is director and manager of the Orbis Global Balanced Fund. Alec, thank you so much for joining us today.

Alex Cutler: No, thank you.

Merryn: Can we start perhaps by you just telling us a little bit about your fund so we know what it is that you do?

Alec: OK. So just for context, Orbis, Im not sure everyone knows who Orbis is, but we were founded in 1989, and we run 26 billion in sterling over eight strategies by 400 people in ten offices around the world. And Im fortunate enough to lead the multi-asset team and our flagship fund in the multi-asset team is a 3bn Global Balanced Fund.

And the Global Balanced Fund, as the name implies, can invest in equities, in bonds, but it can also use hedging on the equity side and invest in commodities. So a lot of flexibility to deal with all the environments that the markets can throw at us.

Merryn: And how has that worked out over the last couple of years?

Alec: It started out great and we rotated. We were actually a fairly growthy fund for the beginning, for the first few years. Its a ten-year-old fund now. And I rotated towards value and then deeper value and deeper value as it underperformed. So up until last year, we struggled, 2018-2019 and half of 20. And since the bottom of the Covid sell-off, which just happened to be the day the recession started and ended, weve done quite well. So we bounced back quite strongly.

Merryn: Excellent. So my guess is that youre moving into an environment that is really going to suit you at the moment. Now, were talking just as the latest CPI numbers have come out for the US. Quite shocking, and its beginning to look like no, it definitely looks like anyone who at any point over the last year said that inflation is transient was completely wrong. In fact, its beginning to feel a little bit 1970s out here.

Alec: Yes, I couldnt agree more. And I think its sending all the active managers scrambling to find notes from the 1970s and to call their mentors and find out if they know anything about the 1970s. Im fortunate enough to have lived through it. Im old enough.

I did try and Well, I thought about trying to track down my mentors but theyve all been deceased. So it wouldve been wonderful to be able to talk to Allan Gray and Anthony Hitschler, two people I respect greatly. But unfortunately both passed away. So when do you realise youre the old person in the firm? That was it.

Merryn: Yes. Well, its interesting, isnt it? There are so few people around, certainly working, who have experience of managing money or, in fact, doing anything in a heavily inflationary environment.

Alec: Yes. I was a teenager. I went to college in 1984. So it was pretty much my adolescence. And I remember it. I do remember it being a painful period. I do remember my father being out of work. I do remember him bringing home a coal stove that I then had to stoke every morning at 5:30, and four months later, had to try and clean the black soot off the entire inside of the house.

It was not a good time. Stocks went down. Bonds went down. And everything else went up in price. And the investors of today, as you point out, maybe one in 1,000 experienced that environment, and the vast majority of investors have only ever known a 20-year bull market punctuated by three-month sell-offs.

Merryn: Yes. And theres a feeling that most people expect some kind of reversion to what they consider to be the norm. Im hearing a lot of people thinking that this is only going to take a little while and then inflation will fall back down again and interest rates will stay low and the next decade will end up being a little bit like the last decade.

It reminds me of when I first when to Japan to work there in the early 1990s. And the bull market had fairly decisively ended. But nonetheless, most of the brokers still believed that that huge bull/bubble market was the norm and they expected it to return. They all said to me, youre here at just the right time. Its about to take off again. It never did, of course. But its interesting how long that idea that normal is what just happened. It carries on.

Alec: Yes. And its my favourite area of study in behavioural finance, is the anchoring theory, where people anchor at a certain point in time and they tend to anchor at a point in time thats either very fun or happy or a good memory, like a stock price peak, or very, very painful, like the bottom of a bear market when they got out. So that is certainly whats going on now.

And I talk a lot about the five stages of grieving right now because thats the process that pulls you away off that anchoring. You anchor on that wonderful feeling of markets that are going up 10-12% a year, and hey, I own the big mega cap growth tech names and theyre wonderful.

And you get a minor correction and another correction and youre in a state of denial because were always, this is how you get a rebound and buy the dip. And then you blow through the dip and you start to become angry. And youre starting to see investors lash out at their professional money managers whove been telling them to deny everything.

And I suspect, if you flip over to the Federal Reserve and the central bankers, they were the lead cheerleaders. There was no inflation. Then it was transitory. Then it was, well be back to 2% by the end of 2022. That was Powell in December. And now he's, well be back to 2.4% at the end of 2022. And I suspect after this latest inflation reading, he might be talking about 2.6% by the end of 2022. So its a sort of cross this line and Ill kill you type denial.

The anger will come. If this is the real deal, the anger will come towards the Fed. And that will manifest itself in a complete lack of confidence. And as you know, inflation is a confidence game, so once you have a loss of confidence that anyone has control over inflation, then inflation just starts compounding and feeding on itself as people go into inflation behaviour. Buy today whats going to be more expensive tomorrow. Ask for a raise, which is why the Bank of England governor is telling people not to ask for a raise, as tone deaf as that sounds.

Merryn: Yes, I dont think anyone is listening.

Alec: Yes.

Merryn: And certainly, Ive told my readers not to listen. Why should they put up with losing real income every year? It might be better for the economy as a whole, but on an individual basis, why should you be the one who takes a hit?

Alec: Exactly. But what it tells you, more alarmingly than a tone deaf ivory tower attitude, is that if you listen to the central bankers, in order for them to maintain confidence, they say along the lines of, weve got this, dont worry, this isnt the 70s, we have a much better toolkit now. Powell is into toolkits. And if this, if trying to get people to not ask for a raise, is the toolkit, is the new toolkit, were in big trouble.

Merryn: Were in big trouble. OK, now Im getting the sense here, Alec, that you think we are in big trouble. How do you see the next few years panning out in terms of inflation?

Alec: I primarily studied the 70s period as an instructive tool to talk to the investors within Orbis not to use the last ten years as your model for the next ten years. So its really just to drag people off that past is prologue heuristic and to look at and think about periods in the past that might also share some characteristics with the environment were heading into. The 70s was a terrible, awful period. The 2000 TMT bubble crash, that was an awful environment for everyone but value investors, by the way.

Merryn: Oh, it wasnt an awful environment for everyone, was it? Because it was a slightly different time in that, for starters, not everybody was an investor at the time. Many more people are investors now, particularly in the UK, now we have an auto-enrolment system. And it was only really a small part of the market. It wasnt the same all-round crisis that affected lots of people. It was a bit different, wasnt it?

Alec: I think Im affected by my personal experience, where a neighbours father came over and knocked on the door. And he was an anaesthesiologist from New York. And he came to the door and he had some papers and he was crying.

Merryn: Aw.

Alec: And I said, whats going on? And he said, can I talk to you about my portfolio? And he showed me his portfolio and it was all the go-go stocks from the late 90s that had cracked 30%, 40%, 50%, 70%. And he said, I invested in the 70s. I vowed never to invest again. And all my doctor friends were making so much money in the late 90s that I had to get in. And I gave, Im not going to tell the name of the brokerage firm, my savings and its now down 70%.

So I think at least in the US, people really got into it at the end. And as you know, the market causes the most pain to the most people. And there was a lot of pain to go around, in the US at least.

Merryn: OK. Sorry. I shouldnt have made that interruption.

Alec: Thats OK.

Merryn: Were back to the 70s and what a bad time that was.

Alec: Yes, it was pretty awful. And studying it brought the analogies to today home very clearly. And I can best do that by talking about the Microsoft, Google, Amazon name of the day. Do you know what that was?

Merryn: Tell me.

Alec: Lowly IBM. So IBM went public in 1973, and it was And I remember my father talking about IBM and what a great company it was in the 70s. It came public at 40 times earnings in 1973. It was growing earnings at 60% a year.

Merryn: Wow.

Alec: And so came out at a massive premium. Sounds very familiar to some of the things weve seen recently. In fact, it came out at a discount to Amazon. But if you combine Microsoft, Amazon and Googles multiples, it would be about the same as IBM in 1973. For the next two years, it grew earnings at 60%. Cant get much better than that.

Merryn: No.

Alec: The stock price corrected by 50%, went down 50%, despite the fact that it was doing tremendously well. And if you think about it And by the way, it didnt eclipse its IPO price until ten years later.

Merryn: Wow.

Alec: In 1984. So the people that are saying today, well, all I need to do is own great growth companies with fantastic franchises that have very clear visibility of growth, I wont be hurt, no matter the valuation, so thats what Ill hold and just roll through it. You roll through it, you might be rolling through and waiting for ten years to get back to where you are today.

Merryn: Thats interesting, and I still hear this all the time. It doesnt matter what the price is. As long as youve got a quality company, as long as its continuing to grow earnings, etc., youll be fine. But that is absolutely not what history tells us. History tells us, if you pay too much, however good the company, youre going to get hurt.

Alec: No, and of the top five names in 2000, the largest names in the US were Cisco, Intel, Microsoft, General Electric and Walmart. Of those names, the only one thats in the top five today is Microsoft. And in the medium term, between those two points in time, we were buying Microsoft at ten times earnings. We sold it far too early, and its a fantastic company. But to say that that cant happen again is kind of idiotic because it has happened twice. And this is just the type of environment that makes that happen.

Merryn: OK. So what do you think is going to drive the inflation that might bring us back to this 1970s scenario? We know that energy prices have been rising. We know that theres a supply chain crunch, etc. But all those things are possibly reversible. I keep being told that there are signs the supply chain is easing up already and it may be that energy prices stop here, in which case, they need to keep rising for inflation to keep rising, right? So what do you think is going to make inflation come in at these 7% numbers for more than a couple of months more?

Alec: Yes. Inflation is an amazing beast in that it doesnt matter what sparks it, its what comes next. It is does it compound? How is the PMM behaviour reacting to it? So in the 70s, the misnomer is that inflation was caused by the oil embargo in 1973/74, and then again in the Iranian Revolution in 1979. In studying it, inflation was ramping hard before the oil embargo, and prices of raw materials, in particular, but also wage inflation.

And so then you say, well, what caused that? And the cause of that And again, this is a strong parallel to today. The root cause of that was the US going off the Gold Standard. The Bretton Woods Agreement put tight guardrails on money supply. It really restricted what the central banks could do. And when Nixon pulled us off the Gold Standard in 1971, it allowed the Federal Reserve to crank up money supply. Cranking up money supply beyond those guardrails started inflation.

And thats something interesting today. We had a similar thing with quantitative easing and ZIRP [zero-interest-rate policy] and NIRP [negative-interest-rate policy] and all those crazy acronyms where, after the global financial crisis, people said, well, we have a lower limit here. We have a lower bound to how much you can stimulate with money creation.

And the central banks, as smart as they are, figured out a way to blow right through that level and do quantitative easing. And thats an experiment. And the references to the early 70s refer to experimentation. The parallels are incredible in this regard. But that caused inflation, a big increase in money supply, bigger than in any time in the past 20 years.

And then the oil embargo hit and you were off to the races. But then it compounds. And this is what I remember as a kid. I remember waiting in line on our assigned day to go to the gas station and get gas. And I remember the kid going out and changing the numbers on the gas price.

Merryn: Oh, you saw that?

Alec: Sure. And that just meant you wanted to get gas more.

Merryn: Yes.

Alec: Can I get a whole tank of gas instead of half of tank of gas that we were allowed. So that feeding frenzy is really what lights it up and makes it sustaining and very, very difficult to snuff out.

Merryn: And then, of course, that inflation drives everyone asking for more money. It drives the wage demands and it drives the union power as well because people want to collect together to give themselves more power when they see inflation rising. So inflation enhances union power, enhanced union power leads to higher wages, etc., and off we go.

Alec: Yes. And if you look at today, if you look at the elements today and say were those elements there in the early 70s, late 80s, a lot of those elements are there. Some elements are much, much worse.

Merryn: OK, whats worse?

Alec: The valuation levels, particularly in the US and the S&P and the Nasdaq are just much, much, much, much higher than they were in the early 70s. The debt loads, just night and day. The debt loads now, the government debt loads now are on par with the spike in World War Two. And we have not been in a war. Crazy low rates.

So the ten-year Treasury was yielding 4% at the end of the 60s. Its yielding now one It just popped up to 2% today, yesterday. Now its a bit below. But we were as low as 0.5 on the US ten-year and we were negative on the Bund until last week. Quantitative easing is a complete experiment that makes going off the Gold Standard look like childs play from a level of difficulty and trying to understand where this thing is going to go.

The wealth gap now is miles bigger than the wealth gap There wasnt much of a wealth gap at all, in fact, in the late 60s. Coming out of the war, everyone started the same and you didnt have this big gradient between the richest and everyone else, and labour was very strong. A third of workers were in unions in the 70s. 6% in the US, and I think its around 8% in the UK of workers are in unions today. But the popularity, the public sentiment around unions is as high as it was in the early 70s.

Merryn: Oh, really?

Alec: Youve had this

Merryn: Thats interesting.

Alec: Youve had this huge shift. Yes. Youve had this huge shift. And I think it relates to the thing prior. The wealth gap is so high. And in particular, if you look at everything from the GFC through jaundiced eyes, it looks like everything the Fed has done, everything the government has done is to protect the wealthy. Its caused massive financial inflation, financial asset inflation, which the 99 dont really participate in though wed like them to, and its just made the rich richer and richer and richer.

Merryn: And it also protects the old. Thats one of the interesting things about this whole dynamic is obviously the old tend to be wealthier than the young. Theyve had more time to build the wealth. And a lot of the things that we have done with quantitative easing, etc., forcing up asset prices, has been to benefit the old to the detriment of the young. And, of course, thats something weve seen during the pandemic as well. Youve asked the young to give up everything to protect the old.

And I keep looking at this. I was thinking about this this morning. Its such a strange dynamic at a time when fertility rates have collapsed across the Western world and populations outside seven or eight core countries around Africa, etc. are going to start falling relatively soon. We have a falling number of young people, both relative to old people and also actually in many countries in absolute terms.

You would think that with that scarcity of the young, we would want to take care of them beautifully, we would want to look after them even better than wed want to look after our old. But you only have to look at things, the weird dynamics of making children wear masks when adults dont have to and focusing entirely on protecting the wealth of the old at the expense of the young to think, this is really bizarre.

Alec: Yes. We are living through an incredibly bizarre era. But I wouldnt say You have to differentiate the old. So the old that have financial assets, were protecting. The old that are on a fixed income

Merryn: We are not.

Alec: Have been getting hammered. Their cost of living increase has been nil, which is awful for them because the reality is their cost of living has been skyrocketing. The cost of living from a medicine standpoint, at least in the US, thats not as highly regulated as it is in the UK, but old people are really struggling with this low/no rate environment. So theyll at least get some benefit.

So the positive difference is supposed to be, if you listen to the central bank mouthpieces, that they have these great, new tools.. They all studied the 70s. I went back. In looking at literature, trying to find out and learn about the 70s, all the literature, all the academic literature is written by the people at the central bank. Thats what they did in grad school. So they know it really, really well. And I think its given them confidence, perhaps over-confidence, that theyre not going to make those same mistakes.

Merryn: OK. So what are they going to do?

Alec: I dont know. I dont know what they can do. They talk about new tools, but if new tools is represented by yelling at people and telling them not to ask for raises, were in big trouble. I think their new tools might just highlight to them sooner how screwed they are, pardon my language.

Merryn: Yes.

Alec: And how screwed we are. Because talk about sitting between a rock and a hard place. You want to fight inflation but you have a fragile economy. You fight inflation, you go into recession and people lose their jobs. And its very politically unattractive right now, just as it was in the early 70s, by the way.

Nixon was fairly famous for berating the Fed Chairman for not easing interest rates and increasing economic activity. It sounds very similar to the last President we had, and I wouldnt be surprised if Joe Biden, in his kinder, softer way, makes the same points. He desperately does not want a recession into the midterms.

Merryn: Yes. Interesting. Is it possible that central banks dont really have any tools at all to control inflation in that over the last 20 years or so, when theyve thought that it has been them controlling inflation and we hear about their targets and their special tools for doing this, etc., inflation has just been low anyway because of globalisation, because of the opening up of labour markets in Eastern Europe, China entering the world economy, etc. All these things kept inflation low automatically, regardless of what central banks did.

So theyve been bigging themselves up for something that was just happening. And now were moving into an environment where inflation is going to just happen because a lot of the dynamics, the big trends that have given us low inflation over the last 20-30 years are reversing. So it doesnt matter what they do. Its going to happen anyway.

Alec: Yes. Its a little bit And I dont want to be too flip because they can jawbone. But to me, its a little bit like yelling at the TV and thinking youre going to have an outcome on the football game.

Merryn: Thats very good. I like that. Im going to use that one. Im stealing that quote, definitely.

Alec: Youre welcome to have it. So I think theyre in big trouble. I think that when they did their academic papers, they didnt think that this would be the set-up. But its just very hard. And if youre ever going to listen to the very old people, the old people that still get asked to go on podcasts and TV, who want to talk about this, if you see what theyre talking about now, its this. They cant see how we get out of this alive, I guess alive referring to economic health and stability. And I think it might be a good time to listen to old people.

Merryn: Yes. And if we were to listen to those old people, what would they tell us to invest in?

Alec: Yes. So you can imagine that this is where everyone in our firm wants to get to. OK. So what? What do we do? What do we do to protect our clients? And I dont want to sound like a McKinsey consultant, but it does depend on the shape and nature of whats driving this.

So obviously, you referred to the Fed being a bystander, I think the thing where theyre most clearly a bystander is the commodity prices. The Federal Reserve cant pass an act that says go out and build more capacity, go out and drill for oil, go out and drill for natural gas, go build a copper mine. Thats not their remit.

The government can. The government could incent people to go drill for oil and gas. They have in the past. This government doesnt seem to want to, at least in the US. And in fact, no government in the world wants to. But energy would be the first place to look, in that if thats going to be the prime mover, the spark that causes this rolling inflation, then your safest place to be is in those that produce the inflating commodity that starts it and keeps it rolling.

Merryn: Yes, but youre talking about old fashioned energy. So were talking about oil and were probably, in particular, talking about gas, which everyone is gradually coming around to recognising is a major part of the energy transition.

Alec: Yes. Were almost exclusively invested in gas. So we have 15% of the portfolio in energy, and its very highly weighted towards gas because, as you say, gas was lumped in as part of the evil carbon emitter group. Lumping it in with coal is not fun for the gas guys. But it couldnt be farther from the truth.

The only way you get rid of coal It isnt with windmills that arent selling now because the price of steel and copper are too high, and it isnt going to be solar that only works for six hours a day. It has to be natural gas. So if you want to go get rid of coal, youve got to use a lot of natural gas. Its the transition fuel.

And we were able to buy into these names at very low valuations because the zeitgeist drove the valuations down so low and stopped production to the point where you could easily see supply-demand getting out of whack and you could easily see governments following the logic and saying, in the end, we need these. And youre seeing that in the EU. Youre seeing that in the UK. And youre seeing that in the US. And were welcoming it.

Merryn: Its amazing how quickly something stops being evil when you really need it, isnt it?

Alec: Yes. Cold will do that and the cost of electricity. And one thing Im seeing now thats pretty alarming is an echo of whats caused this. So why are we here? Why are natural gas prices and electricity prices so high? Because the zeitgeist, the ESG movement, which is fantastic, its all about participative and democratic capitalism, which I know youre a big advocate for

Merryn: Im very keen on, yes.

Alec: As am I. You have to understand how this stuff works. Otherwise, it wont work for long. Capitalism wont be sustainable if everyone doesnt participate. So its great to see this participation and all these ESG funds pop up. But because its rather new, its missed the target quite a bit, particularly on the global warming side.

And telling BP and Shell that they have to divest, they have to stop producing energy does two things. One, its not like its not going to get produced. When they leave When BP left Iraq, Sinopec comes right in. The Chinese and the Russians come right in and they help pump oil with abandon. And I dont know, if youre a better, whether you want to bet that BP is going to do a better job for the environment or a Chinese or Russian state-owned enterprise. But Ill be willing to bet anyone who listens to the podcast my standard bet, and Ill take BP and Shell.

But the other thing its caused is a reduction in the amount of natural gas being produced. And lo and behold, the windmills and solar and the battery unicorns really cant do it. You need baseload power that can come on and handle it. Thats natural gas, thats coal and thats nuclear. Nuclear has limited capacity. Coal is illegal, basically.

Merryn: Give or take, yes.

Alec: That leaves you with natural gas. And so at the same time the supply of natural gas went down because people forced it down, people power, including taking Shell to court in the Netherlands, so people cannot wipe their hands of this and say it wasnt us, it was us, to now go after those companies and say that theyre making super profits and its their fault because they didnt produce enough and were going to go after them and tax them more, well, what happens when you tax somebody more? You produce less, or you go elsewhere.

So if youre taxing me in the UK, Im not going to produce in the UK. There are plenty of places to go produce. Im going to go to the West Coast of Africa. Im going to go offshore Brazil. Im going to go offshore Guyana. Im going to go to the US and frAlec: in Texas. So were just going to keep the problem rolling.

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Alec Cutler: it feels like the 1970s what should you buy? - MoneyWeek