Investing in the New World Order ft. Charles-Henry Monchau

[00:00:01] Charles

And these reports were, I think, eye openings and they should be taken with a lot of importance by European leaders that there needs to be a wake up call for kids – for the next generation. Something needs to happen because we are in a dangerous situation at this stage.

[00:00:20] Intro

Welcome to Top Traders Unplugged. In markets success doesn’t come from predicting what happens next, it comes from being prepared for what you can’t predict.

In each episode we go deep with some of the world’s most thoughtful minds in investing, economics, and beyond to understand how they think, how they prepare, and how they decide, and the experiences that shaped how they see the world. No noise, no short-cuts, just real conversations to help you think better and invest with confidence.

[00:00:53] Alan

Welcome back to Top Traders Unplugged. My name is Alan Dunne and today I’m delighted to be joined by Charles-Henry Monchau. Charles is CIO of Cyz, a Private bank in Geneva. Charles has had a long career in the markets. Before being at Cyz Private bank, he was at Rothschild EFG, Deutsche Bank, Lombard Odier, and BNP Paribas. So, an extensive career.

Charles, great to see you, great to have you on. How are you doing?

[00:01:18] Charles

Great, thank you so much for the invite, Alan, looking forward to the discussion.

[00:01:21] Alan

Absolutely, yeah. We’ve a lot to get into but we do always like to start by getting a sense of how people got interested and started in markets. I mentioned you’ve been around quite a while and worked in a lot of established and big houses. How did you get interested in markets and investing in the first place?

[00:01:38] Charles

I think it was pure coincidence internship at BNP Paribas. But I didn’t know exactly what I wanted to do. My only passion at the time was horse riding, something which is very popular in the islands. And so, I was, let’s say, just doing internship for the sake of it, and then I came across investment department and I told myself, wow, this is what I want to do.

It’s great to, let’s say, have a job where you need to be interested into what is going on in the world would be on the geopolitical side, macro sites and also try to make money out of it. And I like, I think, the fact that you can multitask. You need not only to be, let’s say, proficient in terms of financial research, understanding the markets and macro, but you also need to articulate that into something which is digestible by clients. You also need to manage people and be an asset for the firm you work with.

So, I think that’s quite mix and, as I always say to my kids, it’s first and foremost you need to do something you love in life because you spend a lot of hours at your job. And to me, I think investing is a kind of hobby. So, I’m lucky enough to have my job basically being my hobby. That’s the way I put it usually.

[00:03:12] Alan

Good stuff. Yeah. That’s a great characterization of working in the markets, I guess. I know you’ve just published your H2 outlook, and within that you talk about various structural themes. I think that’s a good jumping off point. And I mean, it is certainly one thing that we’ve been talking about a lot on the podcast is that we’re in a new macroeconomic regime. And I know you touch on this yourself, the kind of changed geopolitical and economic order. I mean, in your words, how would you describe that change in the order that we’re currently living in versus maybe where we were five or ten years ago?

[00:03:49] Charles

Yeah, so I think it’s… The question is not to say we live in, let’s say, a world which is better or worse when it comes to investing, you need to adapt to the new geopolitical landscape. And definitely we call it, let’s say, the East/West divide. We think that there are two superpowers which are US and China. They are in a kind of economic war, and they want to dominate on three very, let’s say, key points.

The first one is obviously AI. They know that AI is not only important in terms of technological and economic advantage, but also for defense, which is the other, let’s say, obsession we have is that in this world, which is much more uncertain, you need to also lead on defense.

And then when you want to lead on AI and you want to lead on defense, you also need to lead on electric power and having, let’s say, getting access to cheap sources of energy, cheap A to C prices, and also ample capacity in terms of electricity is key when you want to increase your output and your dominance on AI and defense.

So, I think these three themes are really the major priorities of these two superpowers. But not only if you get Japan, the new prime minister has that kind of agenda also in mind. Europe needs to catch up.

And if you think about these three themes from a global investment perspective, it also means that we live in the world, which is putting a lot of emphasis on what is called reshoring. So, making sure that because the war is uncertain is that you manufacture your chips, you manufacture your weapons, you have your manufacturing capabilities on your own soil or close to your soil, which is a very big difference compared to last decade where, with multilateralism, the key was to just decrease your costs. And now with the reshoring, this is also something which is inflationary. That’s point number one.

The other, let’s say, development we see is something which is called economic nationalism. So, who would have believed that the US will take some stake into some companies, like Intel for instance, but not only they want to take some stakes in SpaceX for instance. So that’s something we were used to with China, but not used to with the US. They’re also investing into rare earth, into commodities. So, all of these is they are, let’s say, some big things, but they are very easily implementable into a portfolio. If you follow the priorities of these superpowers, you are actually probably doing quite well.

So, this is the kind of landscape, but it also leads to some sub themes which are very important from an asset allocation perspective. One of them is, for instance, the comeback of nominal growth. Everyone is looking at inflation as something which is negative, but actually, when you think about the comeback of inflation compared to the last decade, that means that nominal growth is higher than last decade.

And when you think about high nominal growth, high nominal GDP growth is good for equity markets, is good for real assets, is good for private equity, but is less good for bonds. So, when you think about strategic asset allocation, these new regimes need also to to impact your strategic asset allocation.

So, there are some big macro things, there are also some micro themes that we can talk about. But these big macro themes, they are already quite important when it comes to strategic asset allocation.

[00:08:07] Alan

Yeah. Now I know in your report you also talk about AI and the AI CapEx super cycle. And I mean, I fully agree with all you’re saying. It’s interesting how, if we look back over the course of the year to date, you might remember, I think it was February, we had the Citrini report and there was all this focus on AI and it was going to be really disinflationary. And then suddenly we had the war in Iran, and everybody kind of forgot about that, and focused back on supply shocks and higher inflation and those themes. So, you’ve got that kind of, I guess, contrast between those two structural themes.

So, I mean on the AI theme, obviously it’s currently pushing up, it’s an inflationary force, I guess, on the demand side. Do you see it, over time, being more inflationary or disinflationary or how do you think about its impact from a markets and asset allocation perspective?

[00:09:02] Charles

I think first we need to be very humble with any assumption. At the time we’re talking, there is a headline on the Wall Street Journal saying big firms are hiring again. You were mentioning the Citrini research report which was pointing out, let’s say, a massive destruction of jobs. Actually, we’re not seeing this.

And yes, the job market, for instance, in the US, has been going through a soft patch, but the latest numbers show that actually the job market is healing and there is still some, let’s say, job creation. So, one of the assumptions was that it will totally destroy many jobs, including for instance for the young people. It’s not happening. Actually, the unemployment rate for 18 to 24 years old in the US is going down. So, coming back to your question about is it inflationary or disinflationary? It depends what time horizon we’re talking about. Usually technology is disinflationary.

At this stage it’s very interesting to look at. If you look at the CPI basket, actually the technological components are currently having a higher contribution to inflation than all the components, which is something new. We have been used to, your TV is going to get cheaper over time, your laptop is going to get cheaper. Currently there is so much demand for AI components, for semiconductors, for memory chips, that it has an inflationary impact on prices of many goods. The iPhone prices are going up because memory chips are going up. Electricity prices are going up because there is high demand for computing.

So, for the time being, AI is inflationary. Is it going to be deflationary over time or disinflationary? Probably because if we look at history, technology has created productivity gains and usually leads to some, let’s say, disinflationary impact. But the timing, it’s very difficult to say how much it will be disinflationary.

I think that not only we need to talk about inflation impact, but also about the growth impact. I’m on the optimistic side. I tend to believe that AI is going to create massive opportunities down the road, lead to new businesses, new applications, new types of jobs. And this is why we call it a super cycle with some positive effects on growth and on the stock market because we haven’t seen, let’s say, all of the positive consequences at this stage. Is it going to, at some point, create some hiccups, some volatility in the market? Probably because all of the, let’s say, new cycle creates exaggeration, leads to greed and greed always ends up in tears. But we think that there is still some more upside to go on that side.

[00:12:23] Alan

Yeah. And is that based on you think that we’re still relatively early in this CapEx super cycle? Do you think this can go on for a number of years or do you think, I mean we’re now seeing with the reaction in some of the earnings that if Google or Meta report even greater CapEx that the market seems to be punishing those stocks at times. Do you think we’ll continue to see that very strong level of CapEx?

[00:12:48] Charles

Yeah, that was one of our theses at the start of the year saying the market is starting to get nervous about all of this spending. History always repeats itself, when you think about growth companies, when they want to win an economic war they all tend to overspend and at the end of the day there are only a few winners and usually the winners are not necessarily with those who spend.

The latest example is the dot com bubble. During the dot com bubble, if you remember these names, Genie Networks, Nortel, Alcatel and others, they were obsessed by fiber optics. So, they all massively invested into fiber optics. They invested so much into fiber optics that it created the supply gluts with a massive deflationary impact with fiber optics prices collapsing by 90%. And those who overinvested, they got massively punished by the markets.

And the winners were not those who were over invested, the winners were those who benefited from the fact that fiber optics suddenly got much cheaper. Who were they? The Internet companies, the new stars, the new Max 7. They benefited from that. But now that these Max 7 are overspending into AI infrastructure, they might be, at least for some of them, the future losers. And the future winners will be those who are going to benefit from all of these AI infrastructure spending.

So, we tend to believe that the cycle will repeat itself. And this is why we urge our clients, at the start of the year, to become much more selective when it comes to investing into the hyperscalers and to look also at the beneficiaries of AI. And by the way, the good news is that these beneficiaries, they are not necessarily just in technology, they are not necessarily just in the US. And this is, by the way, translating already in some numbers because if you look at the market currently, the market is broadening in terms of events.

Small caps are outperforming large caps. Some sectors like healthcare and financials, who are big winners from AI productivity gains, are doing very well. And also, international markets are starting to do pretty well, as well, compared to the US. So, I think that’s the good part of AI story is that it’s creating, let’s say, more winners and this is helping the market to broaden, which is good news.

[00:15:36] Alan

Yeah, it’s interesting. I mean I was looking at that just there recently. As you say healthcare and financials are both leading at the moment, which is an unusual combination, I guess. Healthcare is more defensive and financials tend to be more cyclical, and obviously we’re in an environment where rates are going up. So, you think that’s AI is driving that and that these sectors are early adopters, is that fair to say?

[00:15:59] Charles

Not just AI, but it’s helping, I think about, let’s say, applications of AI into medtech into also biotech. You can shorten the testing cycle, the testing time of some new drugs on the pharma side. On financials, look at a company like JP Morgan which is investing a billion dollars a year into AI. They are multiplying the number of AI agents, and also creating some huge positivity gains thanks to AI. And this is helping their margins.

So, they are not just benefiting from this. I think that the M and A cycle is picking up, training is picking up, West management is doing well. The interest rate environment is also helping, but AI is definitely also helping. If you look at the net margins on the S&P 500, or other indices, it keeps moving up.

We tend to believe that some of, let’s say, the quality gains from AI are already translating into this. That being said, technology is also benefiting from this. I think if you look at cloud computing, revenue growth… cloud computing is one of the, let’s say, early beneficiaries of AI spending and it keeps moving higher, it’s re-accelerating.

When you look at these monsters like Alphabet or Amazon, their cloud business is growing at, let’s say, the rates of what you can see with startup, although they are monsters. So, you can see that, again, this AI super cycle is really, let’s say, spreading out in terms of tailwinds for stocks.

[00:17:53] Alan

Yeah, I mean it’s interesting because you’re talking about the previous instances, obviously the dot com boom bubble and burst, and then, as you say, with the railroads, etc., that history would say every time we’ve had this, the market’s got exuberant and we’ve had a correction. So, the question people are grappling with is, like, where are we?

I mean, listening to you, it seems like you think it’s broadening and that maybe the market then looks back to the past and keeps that in its mind somewhat, I guess. Do you think that? And you’re saying, well, the earnings are strong. Some people might argue we’re maybe in an earnings bubble as more of a price bubble this time. I mean, putting that all together, I mean, I’m sure your clients ask you a lot. I mean are we in a bubble? Are you worried? Should we be more defensive or do you think this has got a lot longer to play out?

[00:18:41] Charles

I think you hit the nail with the earnings bubbles, let’s say, narrative. I think the big difference with the dot com bubble is that dot com bubble was a price bubble. Earnings were not there. There were many dot com IPOs coming with companies with no revenues. This time, well, the earnings of Nvidia are growing faster than the stock price of Nvidia.

So, actually, these mega CapEx stocks, they’re cheaper now than they were at the start of the year. We are trading at, let’s say, the P of the NASDAQ 100 is, let’s say, below the 10-year average. So, it doesn’t look like a price bubble.

If you look at free cash flow, price to free cash flow, that’s another story. Because the thing is that, for these earnings to grow, there is a lot of spending coming in and this makes, let’s say, the free cash flow pretty bad. And here the price of free cash flow, that’s another story.

But I think that’s the key is that we are in the earnings bubble and the market will start to really freak out the day when earnings growth will start to decelerate. We don’t need to wait for earnings recession. The second derivative will be enough. If we see some deceleration of earnings growth, the market will probably start to become much more nervous.

So, as long as we have this earnings growth dynamic there and it’s, by the way, the earnings growth is being revised upward brutally in all regions. Not just in the US, but Japan emerging markets, Asia, even Europe. So, it’s very difficult to hold hands of these bull markets as long as your earnings are growing more than 20% in the US and also in other regions.

[00:20:44] Alan

Yeah, interesting. I mean, you talked on that kind of the capital requirements that this all requires. And you say, free cash flow at the hyperscalers has disappeared. We went from a period where we had a lot of buybacks and now, they are raising capital, debt, issuance, etc. And we’re seeing that, I guess, in the global fixed income markets where yields are higher now, the savings/investment balance has shifted.

I mean, how do you see the impact of that? Is that something that the markets can absorb? In the credit market the spreads still seem very tight. Is it a source of concern, this competition for capital we’re seeing now?

[00:21:27] Charles

You’re right Alan, your last point is very important. It all depends on the scale you’re using. If you take, let’s say, a chart with the CES or the hyperscalers, it looks parabolic but actually, if you look at the scale, it’s still very manageable because most of them, they trade with the same CDS than other investment grades. They are treated as investment grade by the market. Only some of them, like Oracle or CoreWeave, are getting closer to the CDS of high yields.

So, as long as they are not blowing out, in terms of spreads, it’s okay. The market obviously wants to get remunerated for the risk and this is why you see a bit of spreads widening on the credit side of these hyperscalers. But it remains manageable. They are still able to raise equity, they are still able to raise capital.

My only concern is that, for the markets, we have shifted from a context where there was negative net equity issuance during years, there was no IPO, there is very little new equity issuance, and these hyperscalers, they had so much free cash flows and little CapEx requirements, so, they were buying back their shares. So, the number of stocks available for investors was actually going down. So, demand, strong demand for stocks, lower supply, so, the price of the market was going up.

Now we are shifting into a new regime where they don’t have money anymore to buy back stocks because they need to invest into CapEx. They still to issue new stocks, new shares, and then we start to see the early innings of the, let’s say, the usual ends of a bubble when you start to see a lot of IPOs coming.

So, for the time being, it’s spectacular but it’s not outrageous. SpaceX, Anthropic will come, OpenAI will come, but the real issue is when this wave of IPOs will start to accelerate. And then when you start to have the crowding out effects of too much supply of stocks coming, maybe at a time when the market will start to, let’s say, become more demanding in terms of, let’s say, the price they pay for stocks, it will also need to be put into the context of potentially higher yields.

What do you do as an investor if you can get 4% or 5% risk free, and you see a market which is starting to become more expensive? Maybe you don’t think, that’s the kind of, let’s say, regime where things will start to become a bit more difficult for investors. I don’t think we are there yet, but you can see that things are moving and it’s normal. That’s the cycle. Every cycle looks the same.

[00:24:36] Alan

Yeah, well as you say, yields are moving up around the world and obviously on the sovereign debt side as well. And another one of your themes is the kind of rising sovereign debt and fiscal dominance. And I mean, as you say, we talked about that world where there was a lot of capital around and yields were negative and now we’re in a world where capital is more scarce.

So, from a kind of an asset allocation perspective, I guess, you mentioned bonds being less attractive in a higher nominal growth environment but at the same time yields are higher. How do you kind of think about that from an asset allocation when you can’t… bonds, in theory, are investable but maybe they’re less attractive from a diversifying perspective.

[00:25:22] Charles

Yeah, so, you summarized the two key points, that there’s higher nominal growth and also higher debt to GDP. So, higher nominal growth means that the coupon is being heated partly by inflation (It’s not great in terms of rewards). And then in terms of risk, every bubble and with overleverage; this time the overleverage is not with the consumer, is still not with the corporates, it’s with governments. So, this is where we are kind of nervous, also, with all of the leverage by government.

So, for these two reasons, so not great rewards on a real basis for these government bonds plus the risk of overleverage, we decided, a few years ago, to decrease quite aggressively the allocation to sovereign bonds into our multi asset portfolios. What we did is that, and one of the reasons, also, is that the correlation between bonds and equities has been going up.

So, when you have an asset, which is bonds, which has a higher risk and higher correlation with equities, that means that within, let’s say, a 60/40 portfolio, the high value has decreased. So, if you want to maintain the same kind of return to risk ratio, you need to decrease your asset allocation to sovereign bonds, and then you increase your allocation to equities, and you find new diversifiers. What are the new diversifiers – hedge funds, investment grade bonds (we prefer investment grade bonds to sovereign bonds), and also gold and commodities.

So, this is how we shifted our strategies as allocation. We still have some sovereign bonds, but we find them, let’s say, much less useful than before.

[00:27:28] Alan

Makes sense. I mean, as you mentioned it, it’s probably a good time to talk about it. Gold has obviously been very interesting. Had a huge run up last year into January and now we’ve seen a big drawdown, about a 30% drawdown or so. It’s kind of bobbing along, about $4,000 where we’re recording at the end of July. I mean, it’s interesting because people often think about gold as a safe haven asset, as a stable asset, but, you know, in reality it’s quite volatile. It’s probably more volatile than equity indices. When you’re positioning gold for clients, do you see it as a debasement trade? Is it store value or just a diversifier or how do you kind of position it so people can withstand that kind of volatility?

[00:28:12] Charles

Yeah, the three of them, I think these three features are correct over time. You mentioned before this theme about, let’s say, the fiscal dominance and rising around debt. I think that most of the, let’s say, G7 countries, they have no other choice than, let’s say, kind of debasing their money. So, if you want to protect yourself against money debasements, either you spend today, or you invest into risk assets, or you invest into store values. And gold is a store value.

And if you look over time, the performance of gold against any fiat currency, including the Swiss, have been very strong. And we think that this will continue. But it doesn’t mean that gold is not volatile. The perfect asset which has high expected return, being de correlated, and being low in volatility, does not exist. Yeah, it existed at some point. It was called Malofil. But we knew, afterwards, that indeed it was impossible. So gold is indeed volatile.

I think one of the reasons also for the pullback is twofold. One, there was a lot of speculation at the end of last year. So, that means that some retail investors, momentum players entered the trade on a leverage basis. And when the momentum started to fade, they had to get out. And this kind of, let’s say, nurtured the pullback, the drawdown. And then the other reason is that gold has become… Since the invasion of Ukraine by Russia, many emerging market countries, when they saw that Russia… the US, their treasury being confiscated. And also, with all of the, let’s say, reservations they have with US geopolitics and also the situation of the dollar. Many emerging markets decided to shift some of their reserve from US treasuries to gold. So, gold is effectively their largest reserve asset.

And then these emerging market countries, when they suddenly saw oil picking up once the Iran war started, many of these emerging markets, they are net oil importers. So, they had to find some dollars, and when you need to find some dollars you sell your reserves. And I think this participated, also, to the drawdown of gold, that the market knew that some emerging markets were at least slowing down their purchases of gold, if not even selling some gold because they had to find some money somewhere.

So, this is the pitfall of being a reserve asset is that your reserve assets, when you need to tap into your reserve assets, you become a source of funds. And this is what happened with gold.

[00:31:37] Alan

I mean the other thing that just kind of changed or seemed to disappear was the whole debasement theme. Obviously, we heard a lot about it. There was a lot of, as you say, the fiscal arithmetic looks very negative. At the same time we had talk of maybe Fed independence being under threat and the concern maybe somebody like Kevin Hassett might come in, who would be very close to the administration. With Warsh being appointed, that seems to have contributed to that, a little bit of comfort coming in about the Fed.

Obviously we had one press conference we’re just recording today with the Fed kicking off. What do you think about Kevin Warsh? What do you expect? Obviously, he’s changed the communication style. What else do you expect or what do you think the Warsh Fed is going to look like?

[00:32:26] Charles

Every year we write a report called the 10 Surprises for the year, and usually you write it in November of the previous year. And one of our 10 surprises, well, one of them was, US invade Venezuela. So, I think it happens. We didn’t find the Iran war surprise. This one we missed. But another one that was part of the surprise was, at the time he was not, let’s say, the favorite, there was another Kevin. But the surprise we wrote about the Fed was Kevin Warsh is picked as the new Fed chair and the markets love him.

Why? Because the markets were prepared so much for a Fed chair that will be just, let’s say, a White House, basically, speaker that they are the market is probably surprised by his first speeches that he wants to tackle inflation, that he seems, let’s say, more hawkish than many thought at some point. And I think that he’s very, let’s say, smart. He’s very smart in the way that he knows that the Fed cannot lose credibility.

So, I think he needs to show that the Fed is indeed independent. He’s reminding also the markets that the FOMC is a committee. The chair is here to manage the committee and that this committee, for the timing being, he doesn’t have a majority and he needs also to build his own credibility with the committee. So, I think the markets now think that there is someone at the top of the Fed will not let inflation run too hot. And this is why I think the shifts in Fed rates expectations has been pretty spectacular. At the start of the year the market was expecting two rate cuts and now the market expects potentially two rate hikes. So, that’s 1% shift, in a matter of months, partly explained by the fact that oil is picking up but also validated by the fact that the Fed chair is not the dove that many thought.

That being said the fiscal dominance theme will stay. He will have to cope with the fact that there is just too much debt in the US and that all of this debt being rolled out cannot be rolled out if the interest rate which is too high. So, he will have to find ways. There is no choice, no other choice for him.

[00:35:29] Alan

And I mean do you think we will see that kind of more? I mean he’s talked tough, he talked about price stability. The market has interpreted him as being a bit more hawkish. But at the same time, obviously, we have midterms coming into view in November. Do you think we can see higher rates and that can be managed given everything that came before in terms of pressure for lower rates?

[00:35:57] Charles

Well, there are many variables in the same time just not just the midterms, where will be the oil prices? Will oil prices stay too high, too long? The job market… we just saw the unemployment claims at a 40 year low. So, if we don’t see wages pickup, is okay, but if we see wages starting to pick up again there will be an issue.

So, I think it’s not just the midterms, they will have to take into account the geopolitical context but there is a wall of maturity coming due and they need to find ways to manage that. So, I think that they don’t just have, let’s say, the rates tool. We have seen the treasury doing a lot of, let’s say, maintenance on the curve. The Fed balance sheet has been increasing by more than US$200 billion since the start of the year. We can see also that it starts to tweak the issuance more the front hands, and then when the issue with the front hands they are buying the long hands.

So, they are trying to cap, let’s say, the rise of bond yields which is not easy because, again, there are oil prices going up and feeding through other commodities and thus good prices.

[00:37:21] Alan

So as you say there’s rising issuance. The Treasury has been taking more actions to manage the various maturities. We’ve seen that as a feature for a period of time now. There’s been some suggestion we might see even a Fed/Treasury accord. What are your thoughts on that?

[00:37:39] Charles

We can see first that the Fed balance sheet is being managed. There is at least some maintenance with the Fed balance sheet having been increased by more than US$200 billion since the start of the year. It sounds a bit crazy when you have inflation picking up, the spreads being all-time tight and the market all-time high. But the Fed balance sheet is still, let’s say, being increased. One of the reasons for that is that they need to manage, indeed, the treasury markets.

And I think that the job has been pretty decent because, despite the fact that we have oil prices at elevated level and an economy which is doing reasonably well, the 10-year is still nicely below the 5%. So that’s okay. But they definitely will have to face some key issues with all of these rollouts coming. There is a wall of maturity coming and they need to keep the costs as low as possible. We are in a regime where the interest expense bill in the US is now larger than the defense budget.

So, the cost of money is becoming an issue. But they have some tools with the Fed balance sheet. The Treasury Department also has something which is called stablecoins. Stablecoins is cryptocurrency which are specked to a fiat currency and 99% of them are pegged to the dollar. Each time you buy a stable coin, the stable coin invests into US treasury bills.

So, that’s one way for them, if stablecoins start to be used worldwide, to find a new source of buyers for the treasury. So, they need to have a plan. They seem to have a long-term plan to keep, let’s say, their bills being covered by buyers of US treasuries but it’s becoming very difficult to manage, and at some point the market might ask for, let’s say, more reward to buy this debt.

[00:39:47] Alan

I mean just shifting gears a little bit. I mean at the start you talked about the kind of the East/West divide, and we’ve talked a lot more probably on the Western side. But obviously China has been going through its own transition. It had its property boom and bust, and now it’s obviously investing heavily in AI, and we’ve seen its own domestic chip players posting massive gains yesterday.

China is still going through this policy of industrial led growth. They’re trying to export EVs, etc., it gets pushed back in certain parts of the world. I mean, how do you see the Chinese economic outlook evolving and how does that impact your asset allocation thought?

[00:40:36] Charles

Well, China on tech, on innovation is obviously the number one, number two player. You mentioned automobiles. We can see, in electric vehicles, that they’re also starting to eat the lunch of the Europeans with BYD, for instance, seeing massive share increase, including in Europe and really doing well on a worldwide basis. On robotics, definitely, they seem to be ahead of the crowds. And when it comes to AI there is currently this tug-of-war between the, let’s say, the US way, which is more, let’s say, closed system, and then the open weight ecosystem of China AI. So, I think they are doing really well on that side.

They are still in transition when it comes to economic growth. They want to be more domestic consumption oriented, and this is not being achieved from, let’s say, in two days. It’s going to take some time. You mentioned the real estate bubble. It sees something which is probably making, let’s say, the shift into domestic consumption more difficult. We know from history that these real estate bubbles, when they burst, they have long lasting effects. And this is why, also, they start to focus again on the stock markets.

A few years ago there were some anti capitalistic, let’s say, measures being taken by government. But they understand that having a strong local equity market is also good for the consumer. They probably learned the lesson from the US. And we saw last week, by the way, that they started to intervene to support their own equity market. They want a strong equity market because they know that ultimately this will benefit also the consumer and also give access to capital to all of these companies which start to expand in terms of innovation and which are competing on a worldwide basis.

So, we think that there is a bright future for China, including on innovation. We have some allocation to Chinese tech newcomers. But we know that China is quite volatile and that is not because you have a large share of GDP, that you have a large share of the world’s market cap. So, it remains a smaller allocation into accounts. But we want to have some exposure because they are very promising companies over there.

[00:43:24] Alan

And I mean, with something like that, obviously, when you’re looking at big thematic ideas like Chinese chips or Chinese innovation, etc. I mean, how do you assess the structural trends, which seems obvious, versus say valuation considerations, say, in that idea and some of the other big ideas that you have in your report?

[00:43:48] Charles

Well, there is one thing we didn’t touch base on is that when it comes to themes or asset allocation, you’ll remember in the previous, let’s say, the old way, it was all about, okay, how much I allocate to US, to Europe, emerging markets. Now, at the time we’re speaking, the weight of technology in the MSCI emerging markets is larger than the US. That means that before you always say, okay, I have exposure to technology through my US stocks, I want to create diversifications, so why not adding emerging markets? Because they are more sensitive to financials, to, let’s say, cyclical value resources, sectors like this.

This is not the case anymore, and we can see how it is developing now is that when you have memory chips tanking in Korea in the morning, in the afternoon, Nasdaq, there are some ripple effects. So, we can see that correlation between markets is starting to increase because of tech. So, when you want to have exposure to various themes, you need not only to think in terms of countries, but also into other aspects.

So, it is becoming quite interesting. And the way we tackle that is say, look, it’s a world which is so much led by AI. Let’s map the world’s stock universe by thinking in an AI way. So, when we look at this, we say, okay, who are the winners, who are the losers of AI?

The winners, you can still find some of them in the pick-and-shovels, so, the AI infrastructure. But you need to be very selective because, as we discussed earlier, some of them are just investing too much and they will not get, let’s say, good reward investment. So, the winners can still be in AI infrastructure, but you need to be selective.

Number two in the winners are companies across sectors, across countries which are benefiting from AI predictability gains, as we discussed before. Ad number three is what is called the halo effects for heavy assets, low obsolescence. Any sectors which cannot be disrupted by AI. So, think about the whole economy. Think about businesses with economic moats which are strong enough to, let’s say, not be distracted by AI. Interestingly, in this halo effect theme you have many stocks which are actually trading at the interesting PE because they didn’t benefit from the initial, let’s say, rush into the AI theme. So, these are the three kind of winners.

And then in the losers you have, as mentioned before, the infrastructure CapEx spenders who are not going to see the benefits of all of this spending. So, you need to avoid them. And the other category of losers is businesses which are getting disrupted by AI and which are losing the edge, their competitiveness, because of AI. Think about, look at what is taking place in India currently. The Indian market is currently struggling. Not because the economy is doing bad, because it was based on IT outsourcing and some of these IT outsourcing stocks are getting hammered. Or think about software in the US.

So, I think this is why, on a thematic basis, it’s now more important to think about winners and losers coming from this AI super cycle than just, let’s say, the geographical asset allocation. Because the geographical allocation is more something of the past.

[00:47:57] Alan

Okay, interesting. And I mean outside of the AI winners and losers, what are the other big kind of structural themes that you think are critical to kind of be cognizant of and kind of position for?

[00:48:11] Charles

Well one which is quite interesting is the commodity super cycle, I think. So, oil is volatile and is currently, let’s say, benefiting from a world premium. But besides oil you have many commodities which are benefiting from a supply/demand imbalance. So, think about uranium. There is a big push to invest in nuclear and currently there is just not enough uranium supply to meet the demand. So, uranium is a long-term thing that we like. We also like copper. Copper is facing the same kind of, let’s say, imbalance. Rare earth is part of this. And we also see gold and silver as also benefiting from this dynamic of supply/demand imbalance. So, that’s I think an interesting theme. And we also like biotech because biotech is probably going to benefit from the fact that, well, there is the AI effect as mentioned before.

But also, the big pharma are currently facing like a patent cliff. Some of their, let’s say, blockbuster drugs are seeing their patent expiring so they need new drugs and maybe they are, well, for most of them they haven’t, let’s say, invested enough into new R&D. So, they need immediate fixing. And one of the ways to do that is either to partner with some biotech or buy them. And we are, I think, seeing an interesting dynamic on that side. So, this is another theme.

And defense is also one theme that we like for bad reasons. I would say that the world is becoming more uncertain and so many countries need to catch up in their defense spending. And also, one thing that we like is more than SW&ME cast will be in Europe or in the US, this is a segment of the market which has been lagging and again we are seeing improvement in terms of margin, in terms of revenue growth dynamics and we find some very interesting stories over there.

[00:50:32] Alan

I mean you talked about defense and spending and that that’s obviously a feature in Europe now, in Germany in particular. They’ve obviously taken a big change there. I mean, Europe, the view has always been Europe has lagged in terms of the technology side. It hasn’t developed the big unicorns, hyperscalers like in the US. Obviously, we’re seeing a shift obviously on the defense and investment spending in Europe. What’s your sense on from a macro perspective and from a thematic perspective, how are you viewing the outlook in Europe?

[00:51:09] Charles

Interesting point you mentioned is about, let’s say, Europe lagging in innovation. And it’s true that if we just look at the stock markets, if you think about, let’s say, the Internet bubble.

[00:51:21] Alan

Yeah.

[00:51:22] Charles

Europe was full of leaders. Nokia, Ericsson, Alcatel, France Telecom, Deutsche Telekom, British Telecom. It was full of, let’s say, national champions, European champions. And this is not the case anymore. We have ASML, we have estimate micro, but for the rest is very disappointing. And here, if you dig a little bit into this, Europe has been very bad in terms of monetizing innovation because actually many of, let’s say, the brightest ideas came from Europe.

Many of the top researchers came from Europe but then they were stolen by the US because the US is very good at monetizing any idea coming from the rest of the world. So, there is, we know that in these more uncertain worlds, the East/West divide we mentioned before, that Europe needs to find their place. And maybe there is one big thing which is called sovereignty. Well, you need to be sovereign in terms of defense, but probably also you need to be sovereign in terms of robotics, in terms of AI.

We are so dependent on the US when you think about it in Europe. The whole day we spend it on the Apple device, we need the Amazon or Microsoft server, we need Alphabet, Google, on everything… the dependency… and then on social media, we’re on LinkedIn, we’re on Facebook, Instagram. The dependency we have with the US is terrible. If they pull the plug, we are done.

So, I think there needs to be some kind of wakeup call in Europe, that Europe does have a huge talent, there are a lot of ideas, bright people, great education systems, and we need to recover from that side because otherwise we’re going to end up being just an open air museum. Good for tourism but not good for business.

I think Mario Draghi wrote about that on two occasions, and his reports were, I think eye opening, were very genuine, and they should be taken with a lot of importance by European leaders that there needs to be a wakeup call for kids, for the next generation. Something needs to happen because we are in a dangerous situation at this stage.

[00:54:01] Alan

Yeah, I mean, you talk about the kind of the return of nominal growth and, I mean, we’ve seen it to some extent, I guess, in Europe, but still Europe is lagging on that side too. Is that something, I mean, do you think we will see that changing? I mean we had the German announcement about the greater defense and infrastructure spending, but the impression is it hasn’t really kicked in yet. I mean, growth is still quite sluggish in Europe. Do you see that kind of any sign of a transformation there or is it just still waiting for more dramatic policy to come through?

[00:54:37] Charles

I think that’s Europe is also facing the issue of too much regulation. We are obsessed with regulation, and also, we are obsessed with taxes. So, high regulation plus high taxes is preventing probably a lot of innovation and business opportunities to take place.

There is also one thing, where Europe needs to make a choice is that at the time where the US is becoming fiscally irresponsible, where China is also increasing debts, Europe, for the time being, is more on the fiscal responsibility side, which is probably good, let’s say, from, let’s say, ideological points, but which is probably capping investments. So, what I mentioned in the start, that China and the US, they are spending a lot into AI, their AI infrastructure. They are subsidizing, by the way, all of these investments. Remember the chips hacks and the Binance. The chips hack was basically your ASML or estimates if you build your manufacturer in the US, get some US money, and Europe is not doing that.

Defense is the same in that if Europe wants to become, let’s say, a defense champion, they need to invest into their own manufacturing capabilities. And for the time being it’s probably coming from Germany is that we are cap in terms of fiscal spending. Here, in Switzerland, we are very responsible in terms of fiscal spending but we try to cope with that by going into higher value added industries; very precise, let’s say, industries to being able to maintain our edge.

So, that could be, let’s say, one lesson for Europe in trying to really become even better into the higher value added, let’s say, part of the industry and innovation. But I think some spending needs to take place also to kind of boost that nominal growth, as you mentioned before.

[00:56:57] Alan

Very good. Just conscious of time. I mean obviously we’ve talked about the kind of structural themes and the kind of thematic ideas. I mean outside of AI which has obvious risks, with the CapEx cycle, are there any other areas of risk that you were, in your mind, or kind of themes that you’re thinking about that could be challenges for markets looking ahead.

[00:57:23] Charles

But to connect the dots, we talk a lot about sovereign debts, that we have seen this in the UK for instance, we’re very close to… the UK was very close to seeing the pension system imploding because of gilts – suddenly started to go to the roof, and I think will it be in France, would it be in the US, it could be in Japan it could be a debt crisis, at some point, where the market suddenly asks for, let’s say, much higher bond yields before investing into sovereign debt and that will probably burst the bubble. When you have bonds is going up, It means that at some point some money is shifting from the equity markets to the debt markets. So, I think that’s one of the key risks is definitely, let’s say, sovereign debts.

[00:58:23] Alan

Good stuff. Before we wrap up, we always like to just ask guests their perspective. You’ve been in the markets for a long time and had a long career. So, for people looking to get invested, or get interested in investing and develop a career, any advice or things you’ve read or things you’ve done or just in general, how would you answer that for people?

[00:58:44] Charles

So, you mean in terms from a career perspective?

[00:58:47] Alan

From a career perspective, yeah, developing a career as an investor.

[00:58:51] Charles

I think that, well, investing is something you never stop learning. It’s really an area where you need to build your investment knowledge. And I think the most important thing is to do something you love. So, don’t go into finance just for the sake of making money. Go into finance because you like it. And if you love fixed income, stay in fixed income. If what you like is equities, go into equities. If you prefer to talk about investment rather than dig into research, go into sales. You need to go into a place where first you think you are good at, but also that you love. Because if you do something you love, usually you do well. I think that’s the simplest advice I will give.

[00:59:45] Alan

Makes sense. Simple and makes sense. Well, great. Well, listen, I appreciate you coming on Top Traders Unplugged, and I know you post on LinkedIn quite a bit so people can follow you there, I guess. Probably the best place to keep track of what you’re saying. Lots of funny pictures about the World Cup as well. So it’s not all about economics and markets. But Charles, thanks a lot for coming on.

[01:00:11] Charles

Thank you.

[01:00:13] Alan

Yeah, really appreciate it. And from all of us here at Top Traders Unplugged, we’ll be back soon with more content and we’ll speak to you soon.

[01:00:23] Ending

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