JORDAN ELISEO | The Big Picture

· Podcast Episodes
Jordan Eliseo Perth Mint

It's tough to make predictions, especially about the future. Jordan Eliseo and I polish the crystal ball to look at some of the bigger numbers (the macro) that will affect our portfolios (the micro). We've just experienced the fastest doubling off a stock market low ever recorded and in the first six months of this year more money has gone into equity markets than in the previous 20 years combined. Where are we headed from here? One of the major factors to look out for is inflation.

“It's funny because when we talk about inflation, we never talk about inflation in the share market or inflation in the property market or any of those things. We call it bull markets when they go up, right? But that is inflation by another name.”

We spoke about:

  • Macro-economics
  • Inflation - what is it and is it here to stay or just a passing concern
  • Commodity prices and how market forces can quickly adjust them
  • Why Jordan is still in equities while still feeling that returns will be flat for many years
  • Precious metals - not just gold and silver
  • Nassim Nicholas Taleb

 and his book - The Black Swan

THE BLACK SWAN | A great read

The Black Swan is a concept that will change the way you look at the world. Black Swans underlie almost everything, from the rise of religions, to events in our own lives. A Black Swan is a highly improbable event with three principle characteristics- it's unpredictable; carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random than it was. The astonishing success of Google was a black swan; so was 9/11. Nassim Nicholas Taleb reveals that we are hard-wired not to truly estimate risk, too vulnerable to the impulse to simplify, narrate, and categorize and not open enough to rewarding those who can imagine the 'impossible'. In this revelatory book, Taleb explains everything we know about what we don't know, and shows us how to face the world.

The Black Swan Nassim Nicholas Taleb

Gold Boom | 9 News Perth


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G'day and welcome back to Shares for Beginners. I'm Phil Muscatello. There are so many moving parts in economies and the numbers that eventually feed into the value of your portfolio. As a beginner investor, you don't need to know how all these forces operate. But it's nice to know a little bit about what's going on behind the headlines. Joining me today, I'm pleased to welcome back Jordan Eliseo from Perth Mint. G'day Jordan, how's it going?

Jordan (54s):

Yeah. Doing really well. Thanks Phil. Thanks for having me back on the podcast. Excited to be here.

Phil (59s):

Explain what you mean when you finance people are talking about macro. And because all of these things are highly time specific, we're recording today on Tuesday, August 10.

Jordan (1m 8s):

Yeah Phil, I suppose when we talk about macro or macro economics, we're typically talking about some of the big picture items that can impact the economy and investment markets and ultimately people's portfolio. So, you know, we're talking about things like, you know, the absolute level or the movement in interest rates or inflation, for example. Things like trends in employment or actual output. So, you know, where the GDP is rising or falling, you know. Other items that people would consider macro factors are things like movements in commodity prices, these days things like money supply growth and credit supply growth in the economy, other things as well, you know, things like trade balances for countries, whether or not their, you know, levels of exports versus imports and what it is that they're exporting and importing.

Jordan (2m 2s):

And I suppose also as well, things like movements in foreign exchange rates and the likes. So I guess, you know, all of those macro items and factors, they aren't necessarily something that are going to directly drive the performance of a particular share or company, although some are very directly correlated. So, you know, for example, if you know, the price of iron ore is going up, then it's probably going to be supportive of our major mining companies. Whereas when it's falling, it's obviously a bit of a headwind, but yeah, those macro factors are all things that impact the economy in any impact financial markets as a whole.

Phil (2m 39s):

Let's look at a specific example: the other day some job numbers came out in the United States and it had some pretty fast effects. Tell us about that.

Jordan (2m 48s):

Yeah. So I suppose, you know, in the United States, the main job report, there are a few different ones that are out there, but the main one the market tends to focus on is what we call nonfarm payrolls. And that's a, you know, a monthly time series that is published and it tends to be the number one indicator that the market looks at, or the investors look at to have a sense of, you know, how strong the economy is, at least from an employment perspective for Americans that are out either working or looking for work.

Phil (3m 18s):

So presumably higher job growth means a robust and strong economy.

Jordan (3m 24s):

Yeah, pretty much. And also, you know, that then feeds into the idea that if job growth is rising pretty strongly you'd expect that that gives workers a better chance to agitate for pay rises. It tends to feed into expectations that inflation might be a little bit higher as well, because obviously if workers can get pay rises, they've got more money to go out and spend in the economy. And yeah, certainly the result that was released last week, as you say, we're talking Tuesday, August 10 was kind of better than the market expected. Yeah. That sort of drove a few markets, including gold, which is obviously my area of direct interest. It drove the gold price down a little bit and we saw it fall quite sharply again on Monday. So yesterday, so yeah, that's obviously one factor that investors keep an eye on.

Phil (4m 8s):

So why does it directly have an effect on the price of gold?

Jordan (4m 12s):

Well it won't always but in this case and what we saw with gold over the weekend and then into Monday, over the last little while we've seen the gold price sort of pull back in total, it's fallen about 20% in the last year. Now that sounds like a pretty big fall. It's important to contextualize that the price had risen 70% in the previous two years. So it kind of went up 70 and has now pulled back 20. Now there's been a few factors that have contributed to that correction in the price of gold. One has been the just absolute strength in share markets as a whole. So if you look at the S and P 500 in the United States, which is obviously the index of the, you know, the 500 leading stocks over there that has basically doubled in the last 16, 17 months since March of last year.

Jordan (5m 2s):

It's pretty much the fastest doubling of a stock market low that it's ever recorded. And what we've also seen in the first six or seven months of this year is pretty much record flows into equity markets. So I think there was a stat that was released from, don't hold me to this, but I'm pretty sure it was Bank of America Merrill Lynch, where they found that in the first six months of this year more money had gone into the equity market than in the previous 20 years combined. So that strengthened the equity market. The strength in flows into equities, that's been one of the factors that has held gold back. The fact that inflation whilst it's risen quite a bit in the short-term, doesn't look like it's rising in the long-term has also sort of held gold back a little bit.

Jordan (5m 48s):

And then I guess what happened on Friday with the employment numbers was, you know, in the very short term, kind of like a final nail in the coffin. So you saw, you know, employment numbers come out more strongly than the market was expecting. The market goes, you know, "Gee, you know, things are better than we expected". So the requirements to want to hold a safe haven asset like gold is minimized. And all of those factors, you know, sort of contributed to the sell off that we'd seen.

Phil (6m 14s):

And so, everyone sort of thought, "Ok, I don't need to doomsday prep with our bars of gold anymore. Let's get rid of them and get back into the stock market".

Jordan (6m 22s):

Yeah. Well, I mean, the thing is everyone's kind of already in the stock market. But yeah, in the very short term, that's kind of the way to see it. I mean, look, gold plays a lot more of a role than just the kind of doomsday holding. It actually tends to go up when the stock market's going up at least historically, but there are times like this and the last week has been a good example where yeah, you see a confluence of factors that make people say, "You know what, I'm going to dump my gold holdings". And that's exactly what we're seeing.

Phil (6m 50s):

So we've talked before on this podcast about inflation as being perhaps one of the biggest forces acting on share prices. What are you seeing with inflation at the moment, Jordan?

Jordan (6m 58s):

Yeah. So look, the last 12 months we've seen really much higher levels of inflation across the developed world. So if you look at the latest statistics that have been released. In Australia, you know, the official CPI number, which is, you know the, stands for the CPI is consumer price inflation, that's running at around 4% year on year right now. And over in the United States, the number is over 5% year on year. So pretty high figures on an annualized basis when you consider that central banks either directly or indirectly will communicate to the market that they would ideally like inflation to average closer to 2% over the long run or, you know, between two and three as a guide.

Jordan (7m 42s):

It's also important to remember that some of the big ticket items that are out there for people to spend money on aren't necessarily directly reflected in inflation statistics. So, you know, if you look at in the United States and again in Australia, over the last 12 months we've seen sort of soaring house prices. So, you know, up 10, 15%, sometimes more depending on which region you're talking about. Those things aren't always necessarily directly reflected in the inflation numbers. So yeah. Look, it's been a very strong 12 months for inflation. You know, that's in many ways, that some people would argue, it's a good thing because it, you know, it's devaluing the debt that households have. In other ways, it's very clearly a bad thing because it means your wages and savings and financial assets are losing their purchasing power.

Jordan (8m 28s):

The key thing for the market though right now is just trying to work out whether this is like a bit of a short-term bump to inflation off the back of COVID related issues or whether or not we're actually seeing the beginning of a transition to a higher inflation environment that might last for some years.

Phil (8m 47s):

That's a word we've been hearing a lot of lightly, "transitory". Whether inflation is going to be transitory: is it here today and gone tomorrow? So what's your view on that?

Jordan (8m 55s):

Look, I suppose there's a competing view. There's some logic to the argument that we are just in a bit of a short-term, I suppose short-term environment of higher than expected inflation or higher than normal inflation. And I suppose there's a couple of things that contribute to that. Firstly, there's what we might call the baseline effect. So let's use the United States, for example, whilst the overall inflation rate is above 5% year on year, part of that is because commodity prices crashed in the first quarter of 2020. So to give you an example here, whilst the overall inflation rate is running at about just over 5% in the United States, over the last year energy prices alone were up 25%.

Jordan (9m 38s):

Right and part of that's because they had, as I say, the baseline was we're starting off a low number because commodity prices crashed last year.

Phil (9m 46s):

So that's like, well they call it gasoline. Is that the major component in the energy they're talking about?

Jordan (9m 51s):

That's right. Things like that. Then you've also got this argument that part of the reason inflation is very high right now and why it might not last if these levels is issues around supply chains. So obviously when COVID kind of first spread around the world, I suppose in Q1 of last year and the lingering effects obviously lasted some time. You know, you had shutdowns all over the global economy. You know, the reopening has been, I suppose, staggered and you know, the economy is not something that you can easily just, you know, you can easily switch it off, you can't easily switch it back on though. And so you see, you know for want of a better term, bottlenecks built up in the global supply chain and that can be expressed through higher prices.

Jordan (10m 31s):

So to give you like one example that it's probably would resonate I think. If you look at the shipping costs for a 40-foot container to basically be put on a ship in Shanghai and sent over to Los Angeles, I think one of those containers is now costing something like $10,000 to secure. And that's up about 230% relative to a year ago. Now that's just one trade group. If we look, I think there was a statistic on the eight major trade routes around the world, the inflation rate over the last year has been closer to 300%. So I don't think we'll see those numbers stay at those levels. They'll probably peter back a little bit. Or at the very least we won't see another year of 300% inflation in those costs.

Jordan (11m 14s):

So, you know, whilst inflation's not going to go back to zero next year, there's a good case to be made that it's not going to stay at say five, five and a half percent in the United States. And certainly that is irrespective of what one's personal view is on these. The very clear direction from the market is the market does believe it's transitory. And one of the best ways to see that is to look at the gap between what CPI is now, so that current rate of inflation around the 5% mark, and what the market's expectations of what inflation will be 5 years and 10 years from now. And these are all numbers that can be tracked and that are published regularly. They're things that I look at, obviously, being in the gold space and being a financial markets commentator they're of interest to me and to our clients.

Jordan (12m 0s):

And to give you a guide there, the gap between current inflation and market's expectations of future inflation is around 3% right now. So you've got current at five expected around two, two and a bit that kind of gap we haven't seen in over 10 plus years now.

Phil (12m 18s):

What does that mean?

Jordan (12m 19s):

So basically the way of looking at this is the market has never been so sure that current rates of inflation are higher than what expected inflation will be in the future. The market has never been so sure in 10 years that the current number is far higher than what it will be going into the future. The market believes that inflation is transitory, whether that's right or wrong, or I suppose the degree to which it's right or wrong, time will tell. But that's one of the reasons why, you know, in particular if I make a quick segue back to gold, why gold has had a rough sort of six months. And a lot of people are scratching their heads because they're saying, "Well, hang on gold's an inflation hedge, inflation is going up. Why isn't gold going up?"

Jordan (12m 59s):

The reality is the long-term inflation forecasts haven't been going up. You know, you don't buy gold because you're worried about inflation going up from one month to the next. You buy gold, or one of the reasons to buy gold as a strategic holding in your portfolio is you think, "You know what? We've got a bit of an inflation problem that's probably going to be there for 5 or 10 years and this is one of the best assets to hold as a hedge against that". The market, as I say, rightly or wrongly hasn't yet come to that view. And that's one of the contributors to why it's fallen in the last few months.

Phil (13m 29s):

Yeah, another interesting example, I was reading about that in terms of a transitory inflation. I mean, we've all heard the stories about timber prices in the United States. And has been all those jokes and memes going around like, you know, little bits of wood in the shape of coins because they've become so valuable. But what I have actually heard is that all it takes is for Canada to ramp up their timber production and suddenly the price of timber will drop and I'm not sure if that's happened. But am I hearing this right? Or am I saying this right?

Jordan (14m 0s):

Yeah look, lumber prices have definitely corrected in the last few months. So they had an extraordinary rally, which sort of coincided with the start of COVID and then obviously again, as the economy was sort of starting to thaw, I suppose, and particularly as interest rates came down and the fed was providing huge stimulus and support for the housing market, you saw this boom in house prices and demand for construction and all those things. And so obviously lumber feeds into that. But yeah, it's largely given up a lot of those gains now as indeed have quite a few commodities. Look, my view is whilst we're seeing a pretty healthy correction in commodities, it wouldn't surprise me to see commodities outperform over the next 10 years. Outperform share markets and financial assets.

Jordan (14m 42s):

And that's basically driven off the fact there, when COVID hit, commodity prices basically hit 100-year lows relative to financial assets. So I don't think that's a particularly outrageous call to make to say, "Logic'd suggest we're probably in for, on a relative basis, at least a better period for commodities. But it is interesting your point around, in this case lumber and Canada and the ability to increase supply, the market always finds balance eventually. So if there ever ends up being a shortage of a particular commodity, there's a great saying that, you know, the cure for high prices is high prices and the cure for low prices is low prices.

Jordan (15m 22s):

So if you see the commodity price boom, pretty much one of two things is going to happen. Either more supply is going to come on stream because it's economic to do so. Or if it's not possible to get more supply, the market will try and find an alternative input to use in place of that commodity. You know, whilst I've just shared my view on commodities for the next 5 to 10 years, if you look at the extreme long run for commodities, there doesn't tend to be much inflation in them at all in real terms because human beings are ultimately, you know, despite what we see in the news everyday, we're actually pretty smart and we find solutions to problems. And that's why commodity prices, as I say, over the extreme long run tend to just kind of hold their purchasing power.

Phil (16m 11s):

So you're still invested in the share market. What's your views for the short-term, long-term risks and, you know, being there and holding at this stage.

Jordan (16m 18s):

Yeah look, I think if I can be clear, in the short term I have very little confidence as to which way the market will go. Which might not be what people listening to a podcast on shares wanna hear.

Phil (16m 31s):

Nobody knows anything. We're going to talk about Nicholas Taleb later on. Yeah.

Jordan (16m 35s):

And I think if you're really that worried about where the share market will be three months from now, you're a trader rather than investor if that makes sense. And yet I own shares alongside gold and cash. They're the kind of the three main asset classes in my portfolio, when I say gold, gold and silver precious metals. However, if I'm being absolutely honest and just looking at the share market itself and my gut feel for where things will be say 5 to 10 years from now, I would be very surprised if the market is up in real terms. It might go up in nominal terms if enough inflation is created and people hold onto their shares. But in real terms, I think it's going to struggle to deliver much from here. And that's very simply a case of prices now are so extended relative to kind of historical norms that, you know, there's a lot of great companies and they're making good money and they're doing good things.

Jordan (17m 26s):

That's not the issue. It's just the price you've got to pay to be an owner of shares at today's levels is extremely high. If we look at the market as an aggregate, there'll obviously be great companies and individual success stories along the way. But the market as a whole is very expensive. And there's so many, I suppose, valuation metrics that people can use to look at the share market. But if I can maybe use my favour and using illustration to make my place, the metric that I really like to look at is what's called the price to sales ratio. And this is something that you can measure for in the United States, the S and P 500 as a whole. And very simply what we're measuring when we look at this is we say, "Okay, what is the price of a particular company or the market based on its current share price relative to the sales, the company, or the market is making as a whole?"

Jordan (18m 19s):

And back in 2009, you know the kind of GFC low, that ratio was sitting at 0.8. So that's another way of saying if the market as a whole was making $10 worth of sales, right, per share, you would have had to pay $8 to be an owner of that company, right? Because the sales are 10 you're paying 0.8, so you're paying $8. Here we are now, you know let's call it halfway through 2021, that ratio has now gone to 3.18. Right? So what that means is if the market was still making $10 worth of sales today, instead of paying $8 to be an owner of shares, you're having to pay $31 and 80 cents, right?

Jordan (19m 9s):

Now obviously the absolute level of sales changes and the profits that come off them change, you name it. But it's a very simple measuring ratio instead of paying $8 for that 10 bucks of sales, you're paying $31 and 80 to buy the market. You know, it's funny because when we talk about inflation, we never talk about inflation in the share market or inflation in the property market or any of those things. We call it bull markets when they go up, right? But that is inflation by another name. If I buy a stock today, I need to pay way more to be an owner of those shares, to buy a dollar's worth of sales relative to what I did 12 years ago. And as an inflation rate, it comes in at about 12 or 13% per annum over the last 13 years.

Jordan (19m 49s):

Now, if electricity prices have been going up 13% per annum or food prices have been going up 13% per annum or house prices have been going up 13% per annum for 12 years running, we would be considering it to be some kind of national emergency, right? Like there'd be major political ramifications and the like and we'd see it as a problem. But when we look at Wall Street or we look at share markets and we see rising prices, we kind of don't care why they're rising. We're just happy they rose. Right?

Phil (20m 16s):

Who needs a reason?

Jordan (20m 17s):

That's right. You know, we can ignore it but that doesn't mean it's going to ignore us in the long run. And so, yeah, there's no question. There's just been really quite colossal inflation in share markets in terms of the price people are having to pay to be owners and that's why my view on the next 10 years is one of really caution. But to your point, I still own shares, you know, the biggest managed fund investment I have has kind of equal money split between gold shares, fixed income assets and cash. So, you know, I'm cautious but I'm still an owner.

Phil (20m 50s):

Yep. I just wanted to remind listeners as well, because you had just referred to it briefly at the beginning of that, that precious metals are not just gold, are they?

Jordan (20m 58s):

That's right. So, I mean, look, you know, the four main precious metals, gold, silver platinum, and palladium. Although platinum and palladium whilst they are precious metals by nature, are more industrial metals by demand, but particularly palladium. Platinum's used in jewellery and the like as well. And so their pricing tends to be more correlated to the broader commodity cycle. Silver and gold, and obviously especially gold, are more seen as the kind of monetary safe haven metals. Again, whilst they're physically by nature, they're commodities gold in particular and silver to a degree are treated more as monetary metals rather than commodities in the sort of, I suppose, more widely understood sense.

Phil (21m 43s):

So let's talk about store of currency because Bitcoin seems to be taking some of that space as well. What are your thoughts here on Bitcoin?

Jordan (21m 51s):

Yeah, look, it's obviously had an incredible run over the last, I suppose let's call it 18 months. You know, it dropped to sort of $5,000 or thereabouts when COVID hit it. It then had a really frankly crazy run. Well done to anyone that was long Bitcoin. Basically went from, and this is US dollar terms, roughly 5 to roughly $60,000. Peaking around March, April this year. It then had a 50% correction and fell, actually traded below $30,000 US about a month, month and a half ago. And since then it's staged and other rallies now sitting just about $40,000. So, you know, perhaps that $30,000 mark or thereabouts was the low.

Jordan (22m 32s):

Other corrective cycles in Bitcoin have same at lose closer to 80 percentage. So, you know, there are even people that I know of who are long-term Bitcoin bulls, but think it could drop to $15,000 in this cycle before it sort of properly bottoms again. I don't really have a view on that, I see it as something that could go either way. I've traded it before. I was very lucky to get out of it kind of near 60,000 US. There was no particular skill behind that at all, but there's a great saying that bull markets die on euphoria. And obviously the time that it went to 60,000 was, you know, Elon Musk was adding it to Tesla's balance sheet, there were Bitcoin ETFs being launched.

Jordan (23m 13s):

So, you know, I remember thinking about it going well, you know, at the time the world's richest guy or one of the world's richest guys is putting it onto his own balance sheet, talking it up, you name it that's about as euphoric a moment as you're going to see for any asset class. And so that was actually the catalyst for me to sell. I was just like, look, it could go higher, but geez can it going to really get much better than this? Now in the short-term that proved to be a good call. Although obviously, as I say, it's, it's been bouncing the last few months. Is it really stealing gold thunder though? I'm not sure that it is because most people that are buying gold buy because they want that long-term stable wealth-preserving asset in their portfolio. The thing that tends to counter balance equity market drawdowns and the like.

Jordan (23m 57s):

Bitcoin doesn't do any of those things, or at least it hasn't proved that it does those things over any given time period. When the market tends to sell off share markets, Bitcoin tends to sell off as well. So I don't really see it as being a kind of risk off safe haven hedge in a portfolio. I just see it as something that can go up a lot and make people spectacular sums of money. And look, that's attractive, right, to people. So to me, people aren't buying Bitcoin because they want to protect their wealth, they're buying Bitcoin because they want to very, very quickly add to their wealth. And there's nothing wrong with doing that but it's very clearly a distinct asset at this point in time. Again, how it evolves in the next 10 to 12 years, let's wait and see.

Jordan (24m 37s):

There's obviously people that, you know, think it's the future of money and the like and it's going to completely usurp gold and all sort of Fiat currency. Look, suffice to say, I think the odds of that happening are pretty low, but that doesn't mean it can't have some value at all.

Phil (24m 53s):

We talked about Bitcoin, but of course there's all the other kinds of cryptos as well. And Ethereum is quite interesting as well in that it's actually providing the technology for a lot of other transactions and ways of doing business. And is also much easier to use than Bitcoin as well. And that's something we've got to consider that maybe the effects of cryptocurrencies and the blockchain technology behind it might have a completely different effect to what we're expecting.

Jordan (25m 18s):

Oh, look a hundred percent. And I think it's, you know, it's interesting because yeah, the name now cryptocurrency as quite of the sort of broad banner over the sector, and look, there are people that can speak about the sector better than I can. But from what I do know, and from what I do read yeah, as I say, the term cryptocurrency is now almost maybe even misleading, right? In the sense that it's very diverse now what some of these things claim to do or are trying to do. It's a little bit like, you know, in some ways you could say shares, well, what does that mean? Okay. It's ownership of companies, but there are companies doing all kinds of different things. So, you know, one isn't necessarily going to be correlated to the other. I suppose the key differences though, is that, you know, with the share market, it is actually easy to buy broad exposure to all the main companies on the index.

Jordan (26m 8s):

And also you're able to do that in broadly speaking, a very safe and well-regulated environment. With crypto, you can't do that yet very easily. So yes, the use cases for crypto are very diverse and are growing. Is it easy to sort of allocate to a basket of cryptos in a, I suppose, a regulatorily sound way? Maybe not yet, although, you know, obviously the space is evolving and then there might be others that would say, actually you can do it very easily. Here's how. There's nothing that I've seen that even here in Australia, for example, you know, there aren't any crypto ETFs, for example, on the ASX. So, you know, it's not easy to go and just via your broking accounts, say, Hey, you know, I want to buy something that's got some exposure to Bitcoin or Bitcoin and Ethereum, for example.

Jordan (26m 52s):

Whereas, you know, if you want ownership of the equity market through an ETF, you can do it. If you want to buy gold through an ETF, you can do it. So, you know, other asset classes are far more established in that regard.

Phil (27m 3s):

So Jordan, I've got a question here and I didn't actually flag this with you beforehand. This is just more that I've noticed that you've referred to this book or you seem to know about this book in posts on Twitter. And it's "The Black Swan" by Nassim Nicholas Taleb. Is that correct? Have you read that book?

Jordan (27m 19s):

I've read parts of it. Yeah. And obviously, you know, Taleb's work, I suppose, in as much as people expect black swans to be bad for markets and that's probably good for gold, I suppose. I'm okay with it. Yeah.

Phil (27m 30s):

Yeah. Well, black swans is just the idea that there's an event that's going to happen that's so far out of left field that no one could have been expecting it, but as he says, it can be a positive and it can be negative as well. And he's got some really interesting ways of looking at things.

Jordan (27m 45s):

Yeah, absolutely. I couldn't agree more. It's quite interesting because obviously when COVID hit, everyone kind of looked at that and went "Well, that's kind of your ultimate black swan", right? Whereas Taleb himself is kind of on the record, you know, he's actually quite annoyed that people can say COVID is a black swan because actually anyone that's studied their history should know that not only can pandemics happen, but that they will happen. Right? But whilst I sympathize with his point, I also sympathize with the point that actually now COVID is a black swan because you know, saying something can happen is also kind of meaningless if you have no idea about when it's going to happen. Which to be fair, with COVID I don't think many people could have predicted that it was going to hit in 2020 and it was going to have the impact that it has.

Jordan (28m 29s):

So whilst I think his work is very interesting and the points that he made are very relevant for investors. I sort of also sympathize with those that perhaps don't see black swans as rigidly defined as he might. Maybe that's the black swan for him: that not everyone's going to agree with his definition of black swans. But yeah, look, I think it's, you know, it's an important thing for investors to sort of keep in mind when they're looking at their portfolio is to kind of go, well, what am I not protected against? And maybe it's not a black swan, because again, by Taleb's definition, you can't even foresee what that would be. Right? But there are plenty of things you can foresee that would happen. So, you know, a stock market crash is one, right? They happen. We know they happened.

Jordan (29m 10s):

They've happened three times in the last 20 years. Higher inflation, again, to move from Taleb to Donald Rumsfeld, that's a known known that those things can happen and do happen in markets. And indeed you could say they happen in exactly the kind of environments we're heading towards or are largely in now. So it doesn't mean it will happen. But those to me are two things that investors should look at and go, "Well, all right. If I was in my portfolio, is it going to hold up well, if there's another major market crash? Is it going to hold up well if there's a period of it, doesn't have to be hyperinflation or stagflation like some people hypothesise, but what if we do just enter a period where inflation averages 4% per annum for the next 10 weeks, right?

Jordan (29m 52s):

And where, like what has happened for the last 20 years, the inflation in the essentials in life is running it two to three times overall inflation, right? So you might have 4% overall, but your healthcare, your utilities, you name it, they're running it sixes or sevens. That's going to be a major problem for people that have still got money in fixed income assets, people who still got money in term deposits and the like. The purchasing power of that money is going to lose 50, 60% across the course of a decade.

Phil (30m 21s):

So are you saying that even though you're getting higher interest on your, the money that you've got invested, just in like safe assets, like even just cash, it's still going to be eroded as if it was a high inflation? Is that what you're saying?

Jordan (30m 34s):

If interest rates go up to try and counter that higher inflation, then it might not be so bad. And indeed there's a big argument that some people will put out there that cash is actually one of the better assets you can hold in a high inflation environment because interest rates would go up. And as interest rates go up, probably equity markets go down or at least stagnate. And if your rates go up well then that offsets the inflation. The challenge though, or the thing for an investor to consider now, is we are in an environment where we just have these gargantuan when debt to GDP ratios now, right? So the question is, can interest rates go up if inflation rises or does that cause a whole heap of other problems that central banks and policy makers would arguably quite rightly look to avoid?

Jordan (31m 17s):

You know, and if your answer to that is yes, actually they'll just have to let inflation go higher and they won't respond what they would in an environment where debt ratios were much lower. Well then you go, okay. So I might be sitting on cash here for 10 years, you know, paying zero or next to zero in nominal terms like it is now. And maybe over that 10 year period, overall inflation, as I say, is averaging three to four. Inflation in the must haves in life might be averaging four to five. That's a pretty profound problem for investors to consider. And indeed I'd argue, that's one of the reasons why equity markets have been so well-supported for the last few years because investors are saying, "Well, at least if I keep my money in the share market, I hope that it'll rise and sort of give me a bit of inflationary protection.

Jordan (32m 2s):

More importantly, I hope the dividends that I get a far higher than what I'd get with my money in the bank account. And those dividends are what can pay for my, you know, my living expenses and the likes". So yeah, I think it's a bit of a segue away from pure black swans. But by definition, if a black Swan is something you can't predict, well you almost can't prepare for it then, right? Whereas things like higher inflation, things like, you know, a period where, you know, maybe it's 10 years where rates stay below zero in real terms or another major stock market crash, those are the things investors can credibly foresee happening and can credibly protect themselves against if they choose them.

Phil (32m 39s):

And correct me if I'm wrong, but the reason the central banks won't be lifting up interest rates is because suddenly all these people have got huge loans on their homes won't be able to afford to pay them. And suddenly you're going to have a housing crash. Is that correct? Is that one of the ways they're looking at things?

Jordan (32m 52s):

Yeah, I would argue there's at least three elements to it. And that is, that is probably the one that will resonate most closely with people listening to this podcast. Or let's just say households more generally. Because for them they have mortgage debt. Right? And so that's the thing that they see and feel and they fret over in terms of, you know, what interest rate they're paying and the potential for that to go higher. So yeah, that's clearly one problem that could come in if interest rates were to rise more significantly. The other problem would be, well I'd say this is the least important potentially, but the actual just hit to public finances as well. So governments themselves have record higher debt levels now. And so if interest rates rise, the rate that they are going to need to pay on their borrowings will go up.

Jordan (33m 34s):

Although again, given current, you know, governments through their central banks can create their own currency. There are many that argue that's kind of just an academic problem. The third area though, where it will cause a problem is actually with corporates as well, Phil. So, you know, obviously businesses borrow money. You know, a lot of corporates are sitting on a lot of cash, but they're also sitting on pretty much record levels of debt right now. And one of the really interesting things that I think is worth keeping an eye on is this concept of what we call zombie companies. And zombie companies are effectively, they're still alive today and they're still functioning, but the amount of money that they are making in their operations isn't even enough to service the interest on the loans that they have.

Jordan (34m 14s):

Now, the number of zombie companies in developed markets depends which market we're talking about, but I think it's gone from something like 5% to 15% of all companies in the last let's call it 10 to 20 years. Now that's quite interesting because rates have just gone down and down and down. So you would think that actually there wouldn't be many companies struggling at all to service their debt. But actually the exact opposite has happened. As rates have gone down, more and more companies have become reliant on just being able to increase their borrowings. And they're really struggling to service them even though rates are low. So if we see rates rise, you know, you could see three challenges really for the economy and for financial markets: businesses will suffer, governments will take a little bit of a heat as well or provide a bit of a challenge there and then as you alluded to at the start, households will also feel the burden.

Jordan (35m 4s):

And that's why I suppose there's a school of thought out there and one that I'm definitely sympathetic to. Which is that actually, even if inflation does prove to be more sustained than some might hope, there's actually probably very little scope for rates to rise or certainly to normalise. That's a challenge for investors as we move through the next few years.

Phil (35m 24s):

Jordan Eliseo, as always, great to hear your pessimistic optimism. Thanks for joining me today.

Jordan (35m 30s):

My pleasure, Phil. Always enjoy chat.

Shares for Beginners is for information and educational purposes only. It isn’t financial advice, and you shouldn’t buy or sell any investments based on what you’ve heard here. Any opinion or commentary is the view of the speaker only not Shares for Beginners. This podcast doesn’t replace professional advice regarding your personal financial needs, circumstances or current situation