Podcast Summary
Foreign investors buying UK small caps at a premium: Foreign investors see value in undervalued UK small and mid caps, retail investors should follow and potentially benefit from these acquisitions
Foreign investors are buying up UK small and mid cap companies at a massive premium to the trading share price. This trend, which has been ongoing for some time, was recently highlighted by the acquisition of Hotel Chocolat by Mars, an American company. While some may view this as a loss for UK retail investors, others see it as a once-in-a-generation opportunity to benefit from the sale of undervalued companies. The podcast "The Big Take DC" encourages listeners to embrace this trend and not miss out on the potential gains. The podcast also emphasizes that global fund managers see value in these companies, and retail investors should follow their lead. The podcast hosts also shared a light-hearted moment about the joy of giving their children chocolate advent calendars from Hotel Chocolat, despite the premium price, before returning to the serious topic of investing.
A stable economic environment presents investment opportunities: Invest in discounted companies via investment trusts, but be aware of small bid-offer spreads. Stay informed of global challenges and potential election impacts.
Despite the uncertainties and fears that have arisen in the past, the current economic backdrop presents an arguably better and more stable environment than in previous years. This makes it an opportune time for investment, particularly in investment trusts, which offer discounted access to exceptionally cheap companies. However, it's important to be aware of the potential small bid-offer spreads in smaller investment trusts. Additionally, the global economy continues to face various challenges, such as political instability and the ongoing pandemic. Despite this, some experts believe that the American electorate is expecting a rematch of the 2020 election, and the consequences of the election results could significantly impact the markets. Overall, it's crucial for investors to stay informed and adapt to the ever-changing economic landscape.
Overlooking Important Economic Factors During Epoch of Ultra-Low Rates: The focus on inflation-driven interest rate hikes may cause us to overlook other crucial economic factors like capitalization rates, hurdle rates, and the price of risk, leading to misallocation of capital, financial system risks, and potential investment disappointments.
Learning from this conversation with Ed is that the current situation of rapidly rising interest rates, driven primarily by a focus on inflation, may be causing us to overlook other important economic factors. Ed, an expert on interest rates and author of "The Price of Time," argues that the functions of interest beyond inflation control, such as capitalization rates, hurdle rates, and the price of risk, were largely ignored during the era of ultra-low interest rates. This misallocation of capital led to significant risks in the financial system and distorted the price of time, creating an imbalance between present and future spending and investment. As a result, we may have overestimated future returns on investments, leading to potential disappointments. The ongoing process of adjusting to higher interest rates will continue to reveal the consequences of this misallocation.
Low interest rates and misallocation of capital in renewable energy and venture capital: Low interest rates have kept capital trapped in low-return businesses, creating 'zombie companies' while artificially inflating valuations in high-risk, high-growth venture capital investments. As interest rates rise, a shakeout is expected in both sectors.
The prolonged period of low interest rates has led to significant misallocation of capital across various sectors and industries, including renewable energy and venture capital. The low rates have kept capital trapped in businesses with low returns, creating "zombie companies." Meanwhile, the venture capital sector saw a massive influx of capital into high-risk, high-growth businesses with distant returns. The low rates artificially inflated valuations, leading to a potential for a significant correction. It's important to note that private equity and venture capital are not the same, and the low interest rates have played a significant role in their perceived superior performance. As interest rates rise, we can expect a shakeout in both the "zombie" companies and the venture capital sector.
Private Equity's Growth Driven by Financial Engineering and Low Interest Rates: Private equity thrived on financial engineering and low interest rates until the 2008 crisis. Post-crisis, they refinanced at low rates, but high valuations and large debt led to trouble. Critics argue for higher interest rates to correct misallocation, but getting out of overvalued assets and low future returns is a long process.
Private equity has been primarily driven by financial engineering and leveraging, with the industry thriving when interest rates are lower than the return on capital. This strategy worked well until the 2008 financial crisis, but the industry was able to refinance their portfolio companies at low rates afterward, leading to continued growth. However, private equity firms were doing deals at high valuations with large amounts of debt leading up to 2021, and some, like Apollo, pulled back. The industry as a whole carried on, and now faces trouble as the market price of assets like Blackstone Real Estate Investment Trust (BRID) has traded below declared asset value, and private investors were offered a 40% discount to net asset value to buy out. Critics argue that higher interest rates are necessary to correct capital misallocation and allocate capital correctly, but coming off an addiction to low interest rates and overvalued assets is a dangerous and lengthy process. The world we live in is one of overvalued assets, misallocated capital, and low future returns on investments, and getting out of this situation will be a long and fraught process.
Effects of higher interest rates take time to manifest: Higher interest rates can impact housing, corporate borrowing and create challenges for companies with debt obligations, while some may benefit from larger cash reserves.
The effects of higher interest rates are not instantaneous and can take a long time to be fully felt, particularly in areas like housing and corporate borrowing. While some companies with large cash reserves may benefit, others with significant debt obligations could face severe challenges when it comes time to refinance. The complexity of the current economic landscape, with its long-term impacts of low interest rates, makes predicting a crisis or a decade-long slog towards recovery a challenging task. Harvard economist Jeremy Stein's observation that "interest rates get into all the cracks" serves as a reminder that the problems created by low interest rates have seeped into various corners of the economy, some of which may not be immediately apparent.
Unanticipated economic challenges: Despite general understanding, unexpected issues like UK pension funds' bond investments, regional banks' debt losses, excess reserves, and real estate concerns pose significant economic challenges, requiring ongoing vigilance and adaptability.
The current economic landscape is complex and uncertain, with various interconnected issues that even experienced analysts may not have fully anticipated. For instance, the UK pension funds' heavy investment in long-dated bonds at negative yields, which blew up in 2022, was unexpected. Similarly, the regional banks' losses from medium-term debt purchases were not immediately anticipated despite the general understanding that higher interest rates benefit banks. Additionally, the massive excess reserves held by banks worldwide, potential problems in China's real estate market, and lingering issues with residential real estate in places like the UK present significant concerns. The interconnected nature of these issues makes it challenging for any individual analyst to fully grasp the implications, emphasizing the need for ongoing vigilance and adaptability in the face of economic uncertainty.
Understanding the Complexities of the Current Economic Landscape: Central banks use interest rates to control inflation, but rising rates can have inflationary effects. Fiat currencies allow governments to inflate away unsustainable debt levels when faced with financial crises.
The current economic situation, including inflation, interest rates, and geopolitical events, is complex and evolving. Central banks use interest rates as a tool to control inflation, but it may not be the most reliable function. Rising interest rates can actually have an inflationary effect due to increased costs of doing business for individuals and businesses. The fiscal theory of the price level suggests that in a modern world of fiat currencies, governments do not go bankrupt but instead inflate away their debt when faced with unsustainable debt levels. The ongoing economic uncertainty calls for careful analysis and understanding of these interconnected factors. The Big Take DC team covers these stories in depth, providing valuable insights into the impact of money, politics, and economics on people and markets.
Low interest rates and government debt: Low interest rates make gov't debt more sustainable but encourage more borrowing. Rising debt costs challenge gov'ts to keep rates low, risking inflation.
The current environment of low interest rates has made government debt more sustainable but also encouraged politicians to accumulate more debt. Now, with the cost of debt financing almost doubling in the last year, governments are facing significant challenges in financing their debts, leading to an incentive to keep interest rates low to control inflation. This situation, as history has shown, could result in persistent inflation if there are premature celebrations of inflation being under control. The bullish outlook for equities in the context of financial repression, where interest rates remain below the rate of inflation, could provide some positive news despite market overvaluation. However, it's important to note that the potential for inflation to bounce back could lead to unexpected market volatility.
US vs International Markets: Different Returns on Equal Weighted Basis: The US market may not offer attractive returns in the medium term on an equal weighted basis, while international markets like the UK and Japan present more attractive valuations and opportunities for value unlocking through activism and consolidation.
The US market may not offer attractive returns in the medium term when looking at it on an equal weighted basis, as opposed to the market cap weighted basis that is commonly used. The speaker suggests that there are more attractive valuations in international markets, specifically mentioning the UK and Japan. In Japan, the speaker notes that there have been significant improvements in recent years, including the acceptance of activism and the potential for consolidation among companies. Despite the challenges of the past, such as high valuations and deflation, the speaker remains bullish on Japan and sees potential for value unlocking through activism and proper value investing.
Japan's Shift Towards Activism and Investing in Gold During Financial Repression: Japan's authorities are supporting activism, opening opportunities for potential returns. Chancellor prefers investing in gold during financial repression, with a reasonable chance for a gold bubble.
Key takeaway from this conversation between Meredith Somerset Webb and Edward Chancellor on Meryn Talks Money is that Japan is experiencing a shift towards activism with the support of authorities, opening up opportunities for potential returns. Additionally, Chancellor expressed a preference for investing in gold during financial repression, as there's a reasonable chance for a gold bubble. Overall, the discussion touched on the themes of investing in Japan and gold, and the potential impact of financial repression. Listeners are encouraged to make their own investment decisions and can find more information in John Steppach's daily newsletter, Money Distilled. The Big Take DC, hosted by Solea Mohsen, covers the intersection of money, politics, and power, and can be found on various podcast platforms.
