What If the Real Risk Isn’t Recession — But Reinvention? ft. Steven Bell

[00:00:00] Steven

Will it make America great again? Well, I thought America was pretty great before Donald Trump came in. The more dramatic impact is going to be AI.

The question is, will those people find jobs or will we end up with higher unemployment? And my guess is that in jurisdictions like the United States, you will find another job. There will still be jobs.

The question is, will you get the same pay? And probably not. But in some areas you’ll bid up and ultimately the rewards will be shared across society. But there will be winners and losers.

[00:00:42] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we’ll have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also, understand that there’s a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Here’s your host, veteran hedge fund manager Niels Kaastrup-Larsen.

[00:01:37] Niels

Welcome and welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle.

We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game changing issues and hopefully dig out nuances in their work through meaningful conversations.

Please enjoy today’s episode hosted by Alan Dunne.

[00:02:22] Alan

Thanks for that introduction, Niels. Today I’m delighted to be joined by Steven Bell. Steven has recently retired from The City after a long and distinguished career. He clocked up over five decades in the markets as an economist and money manager. He was most recently Chief Economist at Columbia Threadneedle Asset Management.

Earlier in his career he has been an Economic Advisor at the UK Treasury, Head of Global Markets Research and Chief Economist at Deutsche Bank’s Investment Bank, Head of Multi Asset at Morgan Grenfell, and also has been a successful global macro hedge fund manager. So, Steven, great to have you with us today. How are you?

[00:03:00] Steven

I’m very well, thank you.

[00:03:01] Alan

Good stuff. So, you’ve obviously transitioned, in your career, into retirement but you’re still being pretty active by the looks of things. Maybe, just to kick off, we always like to get a sense of our guest’s background in markets. How did you get interested and involved in economics and markets in the first place?

[00:03:20] Steven

I fell in love with economics at an early stage. I was 13 and struggling at a rather good school and I just started doing economics and loved it, fell in love and that hasn’t changed. And I was delighted to discover that I could go to good universities and study it, and then that I could get a career out of it. And it obviously led me into investing, and that’s really something I enjoy. I like analyzing things, and that’s been a constant source, and I’ll continue to do that.

[00:03:53] Alan

Yeah. And you’ve obviously worked in different roles but all kind of economic and markets related, you know. Any highlights as you look back over your career?

[00:04:02] Steven

Well, I started at the Treasury and the month I started was the peak of public private wages in the UK, never regained. I actually got paid more as a civil servant than anybody else graduating from the LSE which, by the way, has the highest paid graduates of any UK university. So those days are long gone. I wouldn’t recommend going to the Treasury for a high pay now.

And the good thing at the Treasury, as a junior economist, was to be involved in areas that were disasters because that’s where the policy goes. It’s not good to be Chancellor or a Senior Civil Servant. But I worked on foreign exchange when we were going to the IMF, cap in hand.

I worked on monetary policy when interest rates were raised by three percentage points on the basis of my money supply forecast, which was wrong by the way, but it was too low, not too high. We worked on fiscal policy rules, so it was a fantastic time – a mini university, but where the output was policy.

And then I moved to The City, to Morgan Grenfell, because it had a reputation for economics. And I stayed there as it became Deutsche Morgan Grenfell, Deutsche Bank Morgan Grenfell Asset Management.

I haven’t changed jobs more than a couple of times, but the company’s changed its name. And I ran a macro hedge fund successfully but, unfortunately, the firm I was working at closed. I moved to continue the strategy at a firm called F&C Asset Management which got taken over twice and was most recently Columbia Threadneedle Investments. So, that’s really been my career in a snapshot.

[00:05:39] Alan

Very good. Fascinating. So, obviously it goes back quite a number of decades.

I mean, from the perspective of today, it always feels like much has changed, but much is similar in markets. I mean, what’s your perspective has much changed in terms of the challenge of forecasting economics?

[00:05:59] Steven

I actually don’t think the challenge of forecasting has gotten any greater. I remember talking to the Deputy Chair actually of the FOMC If I could just drop a title, if not a name, Don Cohen it was. And he said I hate to write. He wrote the Minute. And he said, I don’t like saying, it’s particularly uncertain, it’ll be clear in a few months, because it’s always particularly uncertain.

What is clear though is we’ve had a collapse of a consensus in politics, notably in the United States, but also within Europe with the rise of right-wing parties and, of course, no more so than in the UK with Brexit and so forth. So, what used to be called the Washington Consensus has broken down. But there have always been enormous crises, and traumas, and so forth.

The one that really hit home to me was the equity crash in 1987, which many of the people listening to this weren’t even born in. But that was the first big stock market crash. And I remember nearly being lynched when I went into an equity meeting and said this was a healthy correction given that these people were, quite rightly, expecting to lose their job. But that was the first one since the Great Depression and subsequently we’ve had lots of them, so we have much more experience of that.

And the other thing about the United States is, the first time I went to Congress you couldn’t tell the difference between the Republicans and the Democrats. First of all, they’re nearly all men with silver hair and well dressed. Quite a contrast in British House of Commons where they’re also nearly all men but badly dressed.

And that schism between the Democrats and Republicans is quite dramatic and has effectively produced a breakdown in the legal consensus and all this sort of stuff. And that is quite an extraordinary development. But on the macro side, I don’t think the changes are necessarily as great that would influence investment.

[00:07:56] Alan

Okay. I mean, one theory on that that we heard, I think, in the last decade was around the longevity of the economic cycle and that, because we’ve oriented to a service economy, we shouldn’t expect so many recessions. Obviously, we had Covid, which came, I guess, as an exogenous factor, but do you think the economic cycle is longer, more stable now? Or it’s just that we went through a period there where we had a very long expansion? What are your thoughts?

[00:08:27] Steven

I think that maybe you’re right about services. Most of the volatility in GDP relates to inventory corrections. Demand goes down a bit, warehouses build up, and they bring the factory up and say, cut production. Orders go to zero for the inputs and you get a downturn. Well, obviously you don’t do that for hotels and restaurants in quite the same way. So, I think that’s really quite relevant.

More important, though, is that the great success of central bank independence, which may well be edging the wrong way, notably in the United States, has produced a credibility consistency of inflation management that was provided by the Bretton Woods system.

The problem is the Bretton Woods system is that when you got into trouble, you had to slash spending and all the rest of it, and that promoted more recessions. So, I think that the 2% inflation targeting has been a fantastic macro success.

And I give examples where, when I was at the Treasury, I say I worked at monetary policy when the Chancellor set interest rates. When I moved into The City, one of the key decisions you had to make on forecasting base rates was, is there a party political conference coming up?

You know, the Chancellor famously stitched up Neil Kinnock when he was on the train coming back from his party conference, when we joined the RM. Similarly, the probability of a base rate cut when the budget was happening was like five times any other period.

So, it’s become much more stable and predictable. It’s based on economics, not politics. So, that’s been good for the cycle. But at the end of the day, what matters for equity investment is the earnings cycle, not the economic cycle. And that is still subject to the same vagaries as it ever was.

[00:10:27] Alan

And obviously you say it’s as difficult or no easier, no more difficult on the economic side, I mean, you’ve obviously worn two hats. You’ve been an economist and a money manager. I mean, on the money management side, was it easier back in the day?

[00:10:43] Steven

Well, I’d say the following. When I first joined The City, I’d go along to our investor meeting and tell them, from the macro data, what was happening to retail sales and so forth. Well, that’s not happening.

I’d go along there, and they tell me on a Monday what the footfall was over the weekend. They can even tell me, you know, what particular buying, which region. So, the data from the stock market and from other sources is unbelievably high quality… well, unbelievably rapid.

Analyzing that data is quite a challenge. It’s quite interesting that during Covid we got all this data on open table reservations, Google searches, and so forth and they were fantastically useful when GDP was moving around 5%, up ¼, and 10% down, and all this sort of stuff. But now some information is guided from that.

The macro data has almost certainly deteriorated in quality, subject to structural change as people face to face interviews, and people are much less willing to answer a survey. You get a phone call, saying, hi, I’m from the government, I want to ask you about your wages. It’s going to go click.

So, there is a problem with the data, but ultimately, I think there are pluses and minuses on it. Research is a lot easier.

You know, we used to send students off to, what is now, the Office for National Statistics, and they’d get the press release, because there’d only be a headline on Reuters, and we’d have to read out paragraphs over the phone. Then we got mobile phones. So, information is much more available. But of course, investing, in many ways, is a zero sum game. You’ve just got to have an edge over your competitors in analyzing that data.

And obviously we already have systems where annual reports can be analyzed in seconds, and conclusions can be driven to drive immediate movements in stock prices. And all the AI stuff is very significant.

But for me the macro theme is very powerful indeed for the bond market, for the currency market – basically monetary policy – because all those economists largely (it’s not all, but largely economists) who are determining interest rates, all went to the same universities and read the same articles as I did and, effectively, are predicting what you would do if you were in their shoes. So, in the equity market it’s obviously much more company specific and it’s a different sort of skill set. But for the bond market, the FX market, and interest rates, I think it’s still macro driven.

[00:13:13] Alan

Yeah. And I mean it’s a changed environment now. We’ve got social media, and X, and all of this stuff. As you say, not only does information get disseminated very quickly, but there’s a momentum built around it or people kind of give their opinion very quickly. It seems to create, arguably, more hurting, more sentiment, more extreme reactions.

I mean, I’m thinking back to the last year, August of last year, when we had the Sahm rule got triggered, and the equity market dropped, and it felt very much like a crisis. People were calling for 75 basis points in cuts and emergency Fed meetings just on the back of a slightly weaker than expected non-farm payrolls number.

I mean, is that your perspective as well? Obviously, markets have always been volatile and emotional, but do you think that level of emotion and volatility or hysteria has increased over time?

[00:14:10] Steven

There’s no doubt that there were a number of financial markets that used to virtually shut down when things were bad. I mean Deutsche Bank, which I used to work for, dominated the bund market many years ago. And when bunds were weak, there’s just no trading. Prices would gradually sink. And I know traders who used to say, there’s only one Reuters screen in the whole of the Deutsche’s dealing desk. They’re not even realizing what’s going on. We’ll go short bunds and then bunds will fall.

That disjointedness is pretty much gone. It’s not completely gone but it’s a global world and people are looking at stuff. I would trade Korea in the middle of the night. I remember walking outside the golf course Hotel at 2 o’clock in the morning trading Korean equities. So, the ability to do these things may have changed but fundamentally what social media does, in a funny way, is you mentioned herding, it creates separate herds.

So, if you happen to listen to a podcast series, you know, the all-in podcast dominated by Trump supporting tech billionaires, you get a very different perspective than if you tune into one dominated by, you know, left leaning economists. So, you can avoid the consensus view if you stick to that media.

But when it comes to the financial markets dominated by Bloomberg and similar organs, and the Financial Times, Wall Street Journal, they’re all still very important, Reuters. But Bloomberg dominates as an analytical and news device and everybody’s watching and listening to very much the same thing.

So, I think that the herding, in a sense, for the investment community (the professional investment community) is no different. It’s just global where it was very much national before. It’s a much more integrated global market.

And I think the retail investor is the one where, particularly United States, the retail sector seems to have been buying the stock market when the institutional investor has been a bit more cautious. And they’ve driven the stock market higher and they’re communicating on these trading platforms in a way that they simply couldn’t. They would call up their stockbroker, back in the old days, and that’s a very different environment that you just need to take account of.

[00:16:46] Alan

Yeah, and from an economic perspective, you know, the question is always are there parallels with the past? But obviously, the Trump policies are very different. We haven’t seen this level of tariffs In, I guess, even the 50 years you’ve been in markets, I’m guessing.

I mean, have you seen anything like this? Is there anything to compare to the current administration’s approach to policy?

[00:17:09] Steven

Well, the first thing to note is that for the last 70 years tariffs have been coming down, And, far more important, before Trump, were non-tariff barriers. And they’ve been coming down. I mean there’s no higher tariff than a ban, right? That’s more than 100% tariff. It’s an infinite percent tariff.

So, we ban imports of hormone treated beef, although they don’t clean their chickens with chlorine, apparently, whatever they clean them with… So that’s a ban. And there are all sorts of areas where you had exchange controls, capital controls, which basically, largely have gone. Within the European Union, the single market is a fantastic source of reduced non-tariff barriers.

And in the United States, in some ways, they had more internal barriers than the European Union. Now, of course, the European Union has lost one of its biggest members in the UK. We’ve left of course. And there are other moves going on there. But fundamentally, it is a massive break from the past, and no parallel with the Smoot-Hawley tariffs.

I also think that a lot of people are saying, well, why would anyone make a decision when they don’t know what the tariff’s going to be? I think it’s becoming fairly clear, up to a point I should say, what’s going to happen and that is that the baseline tariff is probably going to be 15%. I don’t think…

Who comes after Trump? I’m assuming he doesn’t change the Constitution to make him lifetime president. Even if it’s a Democrat, is he or she going to reverse these tariffs? I mean Biden didn’t, and all the vested interests that we’ll gain from the tariffs we’ll start complaining about them.

So, I think these tariffs are here to stay. I’m not sure that there’ll be much retaliation in terms of other people putting tariffs on. What you do have is an intense antipathy towards the US government which has shown up in things like a big decline in tourist numbers.

I’m going to have to watch the Augusta Masters, next year, without my wife who refuses to go to the United States. How long will that last? I don’t know. The snowbirds, the famous Canadian snowbirds who fly to Florida, they’re going to be 20% lower this year. Will that persist? I don’t know.

But these tariffs, I think it’s going to be 15%, not 10%. I think we’re going to have, still, 25% on autos, still penal tariffs on China, etc., etc. But the proportion of goods, the USMC, you know, NAFTA 2.0, that has a big exemption. So, I think there’ll be a high level of tariffs on goods, but, so far, not on services, where the US has a surplus. And a lot of the tariffs could be shifted if manufacturers shifted more to the service side.

It’s amazing that Japanese export prices of cars fell 20% in last three months and they’ve absorbed, effectively, all of the tariff increase. Auto parts have not fallen in price at all. So, if you buy your Toyota, made in Japan (assuming it is made in Japan) you’ll pay this tariff. But when you come to the service, and it needs replacements, they’ll be more expensive. There’ll be other methods that will be used, as well, to reduce the price of the goods. I mean, a maintenance contract, for example, is that subjected to a tariff? I don’t know. So, I would expect more of that.

Not, in various ways to attenuate it, but so far most of the tariffs have been absorbed by the exporter and the importer. I think that’s going to lead to further pass-through, but for now it’s been a margin hit. There have been some increases in prices, as we’ve seen in the CPI report this week, but they’re not dramatic. So, that is quite a radical change, and I don’t think it’s reversible.

It certainly increases uncertainty. It’s bad news for industrial CapEx, but there will be some onshoring in the United States. There will be benefits from import substitution. But effectively, I think the idea that these tariffs may be temporary, forget it.

[00:21:42] Alan

Yeah, so taking that as the baseline, then, that they’re here to stay at the levels you’ve mentioned. I mean, you talked about the example of the Japanese auto exporters and you referenced, obviously, we’re starting to see a little bit more of an impact this week in CPI. But still, you know, there are mixed views as to whether this will be something we’ll see with the lag. You know, it could be more into next year even, or not. I mean, so, from your perspective, what’s the economic impact going to be? How is it going to play out both on the growth and the inflation side?

[00:22:16] Steven

Well, one of the first things that any central banker will tell you is they look through one-off movements in prices. And although I’m saying tariffs are going to go up, they’re not going to go up beyond 15% to 30%. He’ll threaten them, no doubt, when he’s feeling in that mood. But I think that’s the number. And I think that the key element there is wage inflation.

And one of the interesting developments is that US wage inflation has fallen significantly and steadily and is already, arguably, at a level consistent with the 2% target. Bear in mind that applies to the CPI, to this personal consumers expenditure deflator. So, the CPI is about 2% and a bit. Wage inflation is 4%. The Atlanta Fed wage tracker came out as 4% and it’s sort of stabilized at that level. Productivity is nearly that nearly 2%. So that’s consistent.

So, as we get weaker data, and we could actually get the odd very low payroll number, unemployment is a different concept, obviously, from payrolls. And because of the dramatic decline in immigration (it was 4 million in one 12 month period and they could be in the labor market in the payroll figures), that’s fallen dramatically. So that could lead to a significant reduction.

So, I think wage inflation already would allow the Fed to ease. They don’t ease too much, or too quickly, while inflation is going up and inflation expectations are going up. But I think they will ease.

I’m much more confident, funnily enough, about Fed easing over the next year than the bank of England, who are going to cut rates next month. It’s a big mistake. The ECB are already on track to cut rates and they’re so low there’s not much further to go.

So, I think that’s, from the US economy point of view, when asked to make a distinction between the stock market and the economy, I think the US economy is actually going to be okay in 2026 after a wobbly time this year, and rates are coming down. The yield curve will steepen in response to that. But, actually, I think, in contrast to most of my bond market specialist friends, I actually think the long end of the US bond market is reasonably attractive – big steep curve there.

[00:24:38] Alan

Yeah, I mean, a couple of things on that. I mean, obviously you have the one-off impact of tariffs. I mean, from a bigger picture, longer term perspective, what seems to be the idea is that the US will re-industrialize. They want to have more manufacturing, so they want to produce lots of stuff which was previously manufactured overseas. But obviously, the labor market, as you say, is not growing the way it was and unemployment’s already at 4%.

So, I mean will there be an impact from that reorientation of the economy if they do start to see greater production? I mean to hire those workers, will you see kind of wages shooting up in some sectors and kind of relative value effects?

Okay, obviously economists will say to look through that to the broader price level. But do you expect to see meaningful economic impacts either from greater manufacturing in the UK or foreign companies relocating, or do you think people will just live with the 15% tariff?

[00:25:39] Steven

So, there will undoubtedly be more on-shoring and less offshoring. I think it’s very interesting the CHIPS act led to, you know, some semiconductor factories being built in the United States. They are shipping over Taiwanese families.

There’s a culture in Taiwan that you work in these foundries and you’re on call 24 hours a day. There’s a huge culture about it that is not the case anywhere else. So yes, they’ll be physically in the United States and they will employ some workers.

I mean construction of these things definitely employs workers, most of whom, by the way, are of South American origin, Mexican and South American origin. So, there will be shifting. Will it make America great again? Well, I thought America was pretty great before Donald Trump came in.

You know, there’s a very high income per capita. The more dramatic impact is going to be AI. I mean, for heaven’s sake, you can’t have a sentence, a paragraph without mentioning it. But it is a dramatic innovation.

Actually, when ChatGPT first came about, just before our company banned it in the office, I asked them to write a report on financial markets. Now it had to be a bit out of date because I think it was only trained up to 2022. It was very good. It wouldn’t be very difficult to get macro reports written. I mean best-selling authors… I reckon you could write an Ian Fleming book with artificial intelligence. So, that’s a productivity improvement. But the speed of that improvement could be rather greater.

I always point out to people, some of whom can remember who are nearly as old as me, that you used to go to the bank once a week and stand in a queue, write out a cheque that was given to somebody over a counter who counted out your 30 pounds and then the check was physically processed. And all that employment, thousands of jobs have gone. And they aren’t unemployed, they’re doing other things.

The pace of AI, which has already affected graduate recruitments, accounting firms, is really quite dramatic and I think we will see big changes in wages. I mean programming, for example, your bog standard programmer is almost obsolete, but your senior programmer, who’s what used to be called system design, systems analyst, they are worth a lot more and they’re more productive in the same way as lawyers have become more productive because they can just use Word to rewrite the same contract by changing the company name.

I know a friend of mine got a draft prospectus and they hadn’t removed the undo facility and he saw the same fund with a different name when he clicked undo a few times. So, that’s in productivity improvement. The question is, will those people find jobs or will we end up with higher unemployment?

And my guess is that in jurisdictions like the United States, you will find another job. There will still be jobs. The question is, will you get the same pay? And probably not. But in some areas you’ll bid up pay and ultimately the rewards will be shared across society. But there will be winners and losers.

[00:28:56] Alan

I’m going back to seeing inflation questions. I know the official line from the Fed is that, I think, in the most recent minutes, I mean, a number of the FOMC members are concerned about inflation being more long lasting.

Obviously, you’ve got a camp like Chris Waller, who is very much in the one-off adjustments kind of camp. But I mean, for the rest of the committee, what do you think they’re looking at in terms of that risk of more prolonged impact?

[00:29:23] Steven

Well, bear in mind that interest rates have come down a long way and, when you try and measure financial conditions, you don’t know how tight monetary policy is until maybe five years later. And even then, it’s a bit uncertain, but it’s a lot less tight than it was. There’s a positive real interest rate, that’s for sure.

But it’s not the case that the stock market’s collapsing. It’s surveys like the Small Business Survey, the NFIB, are showing credit’s not a problem. So, there isn’t a suggestion that monetary policy is really tight. The risk of the one-off rises in inflation being embedded in inflation expectations are worth thinking about, but I think they’re modest.

And because we’ve got this pressure on margins in the United States, you will have further downward pressure on wages. And although the price level people will be saying, well, that’s a real wage cut, it’s lower than inflation.

I think wage inflation is already at the right level. I think rates will come down and they’ll be precipitated probably by a weak payroll report, some weak data.

Trump threatening to sack J. Powell is just bad for morale, bad for credibility. By the way, Reagan did this. Well, Reagan didn’t do it explicitly, but members of his administration did when Paul Volcker was in charge. And the rates were a lot, lot more volatile and high in those days, but he resisted it.

But such is the power, the perceived power and willingness to just break the rules of Trump that it’s a lot of pressure on Jay Powell, who loses his job anyway. He’s not going to be reappointed as chair, I think his governor terms a bit longer, but he’ll stand down.

The interview process for the candidates would be quite interesting. What’s your view about the right level of interest rates, Mr. X or Mrs. Y? Oh, I think they should be 3% lower. Then that’s going to be a dovish Fed Chair. And I think that also lines into the weaker dollar series scenario because every time they get an ability to influence the Fed, it will be to a dovish direction.

In addition, my previous firm, Columbia Threadneedle, a guy there, Gary Smith, wrote a terrific article. He’s an expert on foreign exchange and banks. And he was saying, 10-10-10 there’ll be a 10% shift out of the dollar, into 10 different currencies, over 10 years. And that was before Trump was elected. Well, that’s going to happen, I think.

So, the dollar with lower rates in the US, a shift in central bank reserves, who are huge players in the FX market, that will weaken the dollar as well in the United States. And any credibility issues related to the central bank will just make people, oh, we’ll sell the dollar.

[00:32:16] Alan

Okay. You mentioned being optimistic on the outlook for the long end of the US curve, given the kind of backdrop of expected Fed tightening. I mean, the other aspect that the market has been talking about, although we haven’t had a big reaction, obviously the big beautiful bill and then the ever rising deficits. I mean, you’ve been in markets a long time. If you go back to the ‘90s to talk about the bond vigilantes back then, but the debt was only 40% back then. The deficits were maybe 4%. Now deficits are 100% and debt is 100% and deficits are 7% or 8%. I mean, do deficits matter or not? Or does that not worry you about being a bull at the end of the curve?

[00:32:56] Steven

Okay. When I was at the Treasury and monetary policy had basically failed, We were going to switch to a debt strategy and I was asked to come up with good macroeconomic arguments. And second only to the Netherlands, we have the longest history of government debt. It’s been all over the place – 350% of GDP, 0%, 150%, 250%, 0%. It’s been all over the place. And, ignoring wars and the immediate aftermath, I looked at the relationship between the level of debt and the level of growth and inflation over the next five years – no link at all. The correlation was zero.

So, what deficits mean is that the government is absorbing a huge share of resources, pushing inflation higher via aggregate demand. But, you know, that’s the increase in the deficit.

So, my view is that whilst debt… The only fiscal discipline, in recent years, has been the German Constitutional Court and even they have been rode back a bit with the new rules. So, I think, effectively, there’s more and more debt. Japan’s going to be issuing more debt in the new election.

The fiscal rules, under Rachel Reeves, well, they’ll be observed in the breach more than anything else. So, there’s a lot of debt. And I think, if you’re going to invest in fixed income, you want to try something other than govies, you know, swaps, credit, supras, all of those will be attractive alternatives. But I don’t buy this analysis that says the old bond equity correlation is broken down.

This comes back to another point which is, equities are expensive, but they typically go up when they’re expensive, in the near term. In the longer term they go down. Well, hang on a second, how can that be? And our answer is, when you get a recession expensive equities fall further. So, the way to protect against that is to make sure you have a reasonable bond portfolio if you’re an institutional investor. But be careful about holding too many govies.

And one asset that I think is particularly attractive, partly because of its great name, is catastrophe bonds. I mean, no one could be accused of miss selling an investment called catastrophe bonds, and they offer a terrific spread. They’re cash based, not bond based. You don’t get duration. And they’re a very attractive investment. And there’s been huge issuance. And, of course, insurance companies are under pressure to mitigate these rising risks. But I think they’re a very good source of diversification because they’re basically uncorrelated with your other assets.

So, portfolio construction, your strategic asset allocation is the single biggest decision you make. It dominates your returns. And I, actually, quite like equities, I quite like bonds, and I quite like catastrophe bonds and gold, which we’ll talk about another time. You can’t be overweight everything unless you are leveraged.

So, what are you going to be, underweight? And I think you should be overweight equities, but don’t sell all your bonds.

And within your bond portfolio, I think one of the things to remember is, although I’ve spent my career doing this, the duration call (which is all about bond yields going up and down), that’s very hard. If you’re really good, you might have an information ratio of 0.3. Focus much more on the spread trade, the relative value trade, the yield curve trade, cross market and all that sort of stuff. The gilt trade, so, South African gilts versus UK gilts, that’s an instinct trade.

All of those aspects mean that an actively managed bond portfolio can add value. It’s a more difficult search in the equity market. I’ve worked with people, particularly those I’ve worked with recently, that I would definitely think have talent at adding value, but don’t go passive in bonds would be my advice, basically.

[00:36:53] Alan

We might come back to the asset allocation maybe from the big picture perspective again in a little bit. But I mean, you talked about the Fed independence being under threat and, obviously, people draw the parallels. You would have been in the markets, you talked about Reagan and his cohorts, but most would point to the 1970s and Arthur Burns. And then I think Bill Miller came in as Fed Chair as well for a while. It does look like a distinct possibility that we will have a more dovish Fed Chair.

Now, some people will say, well, it doesn’t matter that much, obviously there’s a whole committee, but presumably the Fed Chair will be still very influential. So, how messy do you think this will get, over time, with a kind of a more politically sensitive Fed Chair?

[00:37:43] Steven

So, I think there’s two things here. First of all, there’s the correct academic intellectual argument about whether 2% target is the right number. And I think, if they were making the decision again, knowing what we know now, the economics community would go for 3%.

Why was two chosen? Well, it’s close enough to zero to call it price stability, but it’s far enough above zero that rates are not going to go into the effective lower bound and deflation territory. And that’s something that was expected to happen maybe once or twice a century. Well, it’s happened twice this century.

So, we need more breathing space to aggressively cut interest rates when the next mega shock turns up. And 2% is not enough. However, nobody, no central bank is going to change it to 3%, because if you change it to 3%, why not 4%, why not 5%? So, you lose all that credibility.

So, what I think is actually happening is they are effectively targeting something above 2%. To coin the Bundesbank and early days ECB phrase, close to but above 2%. And nowhere more so than the bank of England, who have had only one month, in the last four years, where inflation has been below target. And they are forecasting inflation to go down to 2% in two years time. It’s 2027, by the way, when it’s going to happen.

Well, they’ve been doing that consistently, and they have to, because if they don’t expect inflation to go down to 2%, they have to raise rates. So, it’s a complete nonsense. And I think the bank of England is seriously at risk of losing credibility. They certainly, I think, are under pressure to support the government’s fiscal rules.

And bear in mind, it’s not like the bank of England is independent. The governor’s appointed by the government, and actually, the bank of England members would struggle to be appointed under serious Treasury opposition. And the external members are effectively appointed as well. So, although it’s independent, it’s not totally… No central bank’s totally independent from the legislature.

So anyway, what I’m trying to say is that the Bank of England is pursuing a target, by revealed preference, of more like 3%. The Fed, which was flirting with this idea of averaging inflation after years of under 2%, is actually going to implement that with, you know, cutting rates when inflation risks… It’s all about risk management, where inflation is more likely to be a bit above 2% than a bit below.

So, I think we should really be looking at 1% above target in the UK, 50 basis points above target in the US, and maybe a little bit above target in Europe. Bear in mind that Europe has been cutting rates when they’ve raised their inflation forecast on a consistent basis.

[00:40:43] Alan

Now, obviously that’s a fair point. And I mean, coming back to the idea of the Fed Chair being under political persuasion, and Trump has already said rates should be 3% lower. So, we’re not talking about a 25 basis points cut here.

I mean, do you think whoever comes in, have you any thoughts on who that might be? Do you think we could see something more radical and more coordination between fiscal and monetary than we’ve seen in recent years?

[00:41:13] Steven

Well, let’s imagine that we did get a three percentage point cut out of the FOMC. Imagine they said, oh, sorry, we agree with Trump, he’s wonderful. Rates would fall at the front end, there’d be a steepening yield curve, growth would pick up, inflation would pick up, and we’d end up with not minus 1.5% real, but minus 3%, 4%, 5% real. I mean, we’ve seen that happen.

He could appoint Erdogan as Central Bank Governor (from Turkey) who believes high interest rates cause inflation, and he’s, you know, had 100% inflation. So, I think we understand what would happen.

[00:41:51] Alan

I guess the question is, how likely is that, do you think?

[00:41:54] Steven

Well, you know, I’d like to come back as the bond market said Carville, didn’t he?

[00:41:58] Alan

Exactly, yes.

[00:42:00] Steven

So the bond market vigilantes, I feel that, you know, they’ve hung up their holsters, retired to their sheep farms, but they will come back. And they did come back for a while and Scott Bessent, who is the guy who understands these things, you know, they did cause some retrenchment by the government.

And of course, the funding cost of treasuries is dependent directly on treasury yields. And, whilst there’ll be a rally in the front end, there’d clearly be a steepening. I think it could be a bear steepening or a pivot, basically a pivot, but a steepening and high yields. And that will be a discipline. If he does that, it would be very disruptive. It would be bad news for the stock market, and I think they row back from it quite quickly.

[00:42:49] Alan

Yeah, I was going to ask that about the impact on the stock market, because I think we naturally kind of expect these things, because they’re opposed to what standard economic theory would tell you to do, would be negative. But in the short term, could the stock market benefit on the kind of a euphoria trade of that Trump is going to prime the economy with lower rates and, obviously, he’s already got a large deficit.

[00:43:15] Steven

Well, I wouldn’t buy the stock market on that news. If someone secretly revealed to me they’re going to sell… I mean, I might find a stock I might buy but I’d certainly sell the dollar of course. No, I think sell the bond market.

So, he threatens these things. I don’t know, I can’t really predict Trump very well but he seems to threaten X, and if he does half X he says, well that’s half what I said before. So, I don’t think anyone seriously thinks…

I mean the regional bank presidents, many of whom are more Republican, I don’t know how many of them are mega MAGA types, but they are able to vote against FOMC moves, and Bernanke’s rules that he kind of semi invented, which said only one regional bank president can dissent or something like that. I think the consensus would be so strongly against that, but you know, we’ll see.

[00:44:18] Alan

Any thoughts on who’s the most likely replacement for Powell?

[00:44:23] Steven

No. I was interviewed by the BBC’s Chief Economics Editor about whether Volker would be reappointed. I said yes. And after he walked out the door, because he came to my office to do it, the thing came across Reuters, Volker resigns, Greenspan appointed. And he came back in to ask me about Greenspan. I was very complimentary about Greenspan and all my reasons why Volker was going to be retained were edited out into appreciations of his career.

So, my forecasting success in this area is minus one. So, I would leave it to other people to come up with.

[00:45:13] Alan

Well, you mentioned Greenspan and obviously there are some parallels now between now and the late ‘90s. Obviously, you had Greenspan’s new paradigm productivity boom and now we’re in the midst of AI, as you say. I mean productivity growth, as you say, is 2%. So, it was very weak. Now it’s bounced back. So, it hasn’t been exceptionally high.

I mean there is a view out there that we could be in a productivity boom for the next few years driven by AI as well as some of the productivity initiatives we’ve already had. It sounds like you’re optimistic on the impact of AI. Do you think it’ll be that transformative in the near term?

[00:45:54] Steven

Yes, I think so. I think that there’s huge scope for productivity gains in the service sector. I mean just the job that we do, you know, if you’re writing a research piece, analyzing stuff, it’s, you know, type it into Google, do it. I used to have to walk around libraries getting academic articles and you know, go to bookshops, and ring people up, and so forth.

I mean it’s already happened a lot, and that will continue. A lot of it isn’t in the statistics, by the way. You know, your iPhone consists of a map, a torch, a radio, a broadcasting device. These really don’t get reflected in GDP, the price you pay for your iPhone, or any services it uses. But a lot of those benefits aren’t captured but are there and enable productivity growth in other areas.

Few people turn up to the wrong restaurant like they used to do, in the old days. I certainly experienced that. But I think in terms of the service sector productive, there are massive gains, and there are massive potential gains, in the NHS, for example. I’m a big fan of the NHS app.

I had the experience of my mother and mother-in-law being in hospital trying to get a blood sample, which was very difficult for elderly people. Well, if it’s on the app, they’d only get the blood sample. My mother-in-law was admitted to a hospital. She was discharged from the same hospital in the morning. It took them two hours to get a blood test.

So, whilst they’re not quoted companies, there is scope for public sector productivity, very significant scope. So, I think that I do… To some extent, this is the continuation of a trend that’s been going for many, many years.

When I joined The City there were no personal computers and our IT department was actually the biggest division in the Merchant Bank. And I bought the first Apple PC, it was the first Apple PC in the building and that improved our productivity. So, that growth is enormous.

Technology in the City has improved productivity massively, but headcount’s actually gone up because international financial services are a very strong growth area. But a point I’m trying to make is that it has been a tech driven growth in productivity.

The speed with which AI can be disseminated, you know, you download DeepSeq or ChatGPT, 100 million can do it in a day. And the issue of implementing that is quite complicated and is taking longer even than people forecasted, you know, a few months ago. But it will be big.

It’s bigger, faster than previous innovations because of the nature of the change, but more service sector orientated and, ultimately, more powerful. Very, very powerful indeed, I do think so.

[00:48:47] Alan

And obviously, the market impact, to date, has been on the infrastructure spend in relation to this. So Nvidia has benefited from the spending on their chips. The second order impact presumably then is the service sector will see larger margins because they can cut costs, is that it?

[00:49:05] Steven

Yes, yes, basically.

[00:49:07] Alan

Presumably that won’t be evident in the data in kind of a one to two year, but it might be evident over kind of a four to five year time horizon.

[00:49:13] Steven

It will build. It will build.

[00:49:16] Alan

Just taking that view, I mean, obviously, we’ve got a number of different, you know, currents at the moment. There’s AI, as you mentioned. There’s rising yields, as I mentioned. And there’s also this breakdown in the Washington consensus, the end of the neoliberal era.

So, I mean, one of the things, if you look back through your career in the markets, markets go through regimes. You had the ‘70s that were inflationary, prior to that was a lot of fiscal demand management, ‘80s, ‘90s, disinflation, 20s, the first decade was a lost decade and 2010s secular stagnation. Now we’ve moved into a new regime which has taken shape., higher interest rates, more volatile.

I mean, if you were to try and paint out a picture for the next 10 years, if you could, that might inform asset allocation. Big picture, do you think it’ll be stronger growth driven by AI or what would be the defining feature, more volatile interest rates because of deficits? What would your guess be?

[00:50:15] Steven

So, I think that’s a very good question. First of all, the end of the disinflation era.

There’s a great book by Charles Goodhart and Pradhan, I think his name is, that really caught this very well. A lot of people in the bond market, in particular, have only experienced falling interest rates until recently, and they’re anchoring on lower rates. So, I think rates will, not too dissimilar from current levels, as I say, I think US rates come down a bit.

Inflation targeting means that inflation is probably going to be a little bit above 2%, as opposed to 2% or below, which is what it has been. That’s not a big change. And I don’t think the volatility is going to be dramatically increased.

I do think, if and when we get the next recession, and I don’t see a recession in the next year in the US or anywhere else, then I think because equities are expensive in most cases, the equity market will struggle. And that’s why bonds are still an important part of your portfolio.

So, by the way, I do this podcast on LinkedIn, and I’ve criticized the government for lifestyling forcing private investors, wealth managers, to put their clients largely into bonds. And I think that is a mistake.

But I’m talking about the more institutional portfolios, where I do think you need bonds as a hedge against the recession. But I would not characterize for financial markets, for the next five years as a burst of volatility. I don’t see that at all.

We’ve certainly had, particularly for individual stocks, a surge in volatility because of Trump, and not much else. But I think that overall, I think you mentioned economic cycle. I think the economic cycles are tending to be smoother, shorter, longer.

And I think that’s the outlook from my point of view. I think equities will outperform. I’m not sure they’ll do 5% or 6% on average, more than bonds, quite frankly. But I think they will outperform. And I think that that is a theme that we will see.

Productivity growth fell in OECD countries every decade after 1950. And I think that may be slightly reversing. The boom in productivity in the dot com period was largely about computers and a little bit more. So, we may have an end to the fall in productivity growth and a slight rise but we’re not going to go back to 4% productivity growth in the developed economies. It’s more like an extra 50 basis points, which is still a massive change.

[00:52:55] Alan

Now, obviously, equities are already expensive, at least in the US the S&P 500 PE is whatever, 22, 23, something like that I think. So, is that just the scenario? Equities do fine, they stay expensive but do fine. And then we see you get opportunities?

I mean overseas there’s a lot of talk about that we haven’t talked… I mean you have touched on a bearish view on the dollar. So, I guess is that the way to play this is non-US equities?

[00:53:25] Steven

No, I think that first of all, for example if you buy the FTSE, you know, most of those earnings are in dollars. So, you think you’re hedged because it’s quoted in sterling, but you’re not. And equities, in many ways, are also hedged. But I think that I am bearish with the dollar going down further. So is everybody else. It’s not going to be the thing that’s going to make your year, selling the dollar.

I think that the question of the US… It’s interesting that there’s a silly process in the US where analysts have optimistic expectations for earnings that they cut just before the reporting season, allowing companies to beat earnings on a consistent basis even when earnings are constant. Now at the beginning of the year there is normally a 5% to 10% bias. Adjusting for that, there hasn’t been a reduction in US earnings relative to the norm if you can follow that gobbledygook. However, within that there’s been virtually no reduction in the tech earnings, the Mag 7, and a big reduction in the rest.

So, what you’ve got is an increased margin squeeze on the 493 and small cap which is a big feature of the declining pressures on inflation, by the way, and that reflects the enormous competition in that area. So, the tech theme I think is alive and well. Pick your tech company properly. I mean I’m not a stock picker and the guys at my previous firm are extremely good at this and I just used to follow what they say. But anyway, generally speaking that theme I think is intact.

I think US exceptionalism is still intact and I don’t think I’d want to be underweight US equities simply because I’m a bit cautious about the dollar. A lot of these companies have a lot of overseas earnings. I think it’s 30% for the S&P and more for some of these tech companies. So that would be my theme.

I mean, what happened? A lot of European investors pulled their money from the US and stuck it in Europe. Well, if you take $100 million out of the US stock market, it doesn’t really matter. Put it in the STOXX 50, it’s actually a much bigger percentage. And I think that pushed European equities up to quite high levels.

So, I don’t think there’s a regime change where you should underweight the US. I personally still quite like the US, particularly the tech sector. And there are lots of costs.

One theme that I think is interesting is electricity prices should fall in Europe and the UK relative to the United States over the next few years. And that’s actually priced into the futures market. I’m not sure it’s priced into other forms, but that would be my theme. Volatility from the US, political uncertainty, but from macroeconomic terms, somewhat higher inflation, wobbly growth in the US. 2026, I think, will be a good year for US growth and Europe will continue to muddle through as it normally does.

[00:56:34] Alan

Well, you touched on the consensus bearish view on the dollar. So, I’m curious how you’ve navigated that through your career as an economist and money manager. Because obviously not all economists are very good at the markets. They’re good at describing the economic situation but then ask them to trade and it becomes a different scenario. You’ve obviously done both successfully.

[00:56:56] Steven

Yeah, good question. So, my investment philosophy was to look for value where markets sentiment is stretched and news flow is turning. Now I said value is a very poor predictor of equity markets, so I would never use that for the aggregate equity position. And basically, I’d go long or short at extremes. And I was more confident in buying equities when they were in a bear market.

I did go long equities in early 2009, driven by the fact that, I mean, I was bearish. Because earnings expectations, after Lehman went bust, were plus 25% in Q1 2009. It was clearly bonkers. And by the time we got to March, they were minus 25% and that was too low. And there were other things, TARP, and the rate cut, the Fed move, and all the rest of it. But anyway, so, that was a cheap market by my valuation metrics.

But in terms of the dollar and currencies, you don’t want to be too extreme when you agree with everybody. So, what you want to do is find that contrarian approach. Most of my investors had portfolios in CTAs and that’s a trend following system.

So, we were the opposite of that. We were a good diversifier. And the one thing, when you’re an active trader, the key challenge is actually not picking winners, it’s dealing with your losers. And the biggest lesson that I learned, running my hedge fund, was to change the way I did my stop losses. I’ve never been a fan of trailing stop losses.

Trailing stop losses basically make you a trend follower. And that’s great, that’s fine, people make money out of it. But that’s not me. I’m a fundamental investor. And we had these hard stops that were cliff edge. And we blasted through some stops on some occasions, notably with libel issues. So, what we changed it to was a dynamic de-gearing. So, we had a stop loss and when we got to maybe minus 1.5% on the trade, we’d halve the risk limit. And then when we got to 1.75, we’d halve it again. And what that meant was we never broke through two.

More importantly, it cleared your mind because if you put a trade on, because you like it, and it goes wrong, you lose confidence, you’re unhappy. But maybe the reasons are just as great. You cannot detach yourself from that misery and depression of getting it wrong. And everybody gets it wrong, even the best. So, this dynamic de-gearing is the single biggest risk management gain that I learned.

And of course, what you must always remember about risk management, the number one rule is to make sure you quantify your risk. The number two rule is don’t believe any of those numbers because they’re based on, you know, matrices of correlations that are not stable. Never mind the diagonal vol, the off diagonals are not so… So, but you must quantify it. But you must be careful thinking that tells you everything. So that’d be my single biggest rule.

I used to trade futures, not only equities, bonds and FX. And I went through phases where I made all my money in in rates, nothing in FX, and then I ended up making all my money in FX. And I used to make steady earnings in equities with a quant model, and then that stopped working. So, there’s no such thing, in my opinion, of a totally discretionary investor who doesn’t look at anything quant.

[01:00:34] Alan

Yes.

[01:00:35] Steven

Similarly, there’s no such thing as a machine does at all. Somebody designs the machine, turns it off, changes the machine. So, there’s always a spectrum. And I think one of the key judgments you’ve got to make, I think it may be Johnny Cash, ‘know when to fold them, know when to hold them’. I don’t know about this, ‘don’t count your money while sitting at the table’ or whatever that was. But anyway, that’s an important feature. You’ve just got to know when you’re wrong and you should get out, or whether they’re wrong and you shouldn’t. And it’s true about a quant model as much as anything else.

[01:01:08] Alan

Pretty good. Well conscious, we’re coming up in time. Now, I was going to ask you about advice for money managers, but it sounds like you’ve already given us some very good advice there. But I do want to get your thoughts and advice for people coming into the markets, either early stage investors, or economists. Reflecting on your career, you know, what has been influential? What would you suggest to people to do or to read if they want to get better at macro?

[01:01:34] Steven

So, I find the quality of macro research output is staggering. I mean I used to publish research and people would tell me you can’t talk about the natural rate of unemployment, the Sahm rule. I mean, the idea that I could actually put that in a headline. So, the educational level of the market has gone up. And the quality of stuff from Goldman Sachs, Pantheon Macro… Just two people that I read quite a lot… Deutsche Bank. I mean, the quality of input is amazing. Of course, everyone’s got that access to that.

So, your skill is in finding the nugget that’s interesting and you’ve just got to look for it. And for me it’s got to fit into a theme of macroeconomics that I understand and there are bits that I just don’t understand.

I mean technical analysis, chartism, call it what you will, is important intraday but I don’t see the mechanism and I’ve got experience and evidence that it doesn’t work. So, I don’t bother with that at all. And that’s a resource gain because you don’t have to spend all your time looking at these 20 year charts and, I don’t know, triple… head and shoulders, or whatever. So, I think that’s something that’s, that’s quite important.

The capitulation trade, which when I was running my hedge fund, there’s a guy, Lawrence Staden, whose real specialty was the capitulation trade. I could never do that. It was one month where I lost 6% in the month and he, sitting just across the room, made 8%, and we were trading the same universe. I mean, I couldn’t get that. But that is something where everybody’s the same way around and some trigger is going to produce forced selling.

I mean, I got it during the global financial crisis. Not that I anticipated the breakdown of the financial system, but I just thought things were getting worse incrementally. And again, I was privileged to get all sorts of information during the Covid crisis. There was a conference call, actually my colleague was on, where the chief medical advisor to the Wellcome Trust said 40% of the world’s going to get Covid. I said, well sell everything then. And that made us negative.

And then Dame Sarah Gilbert, as she now is, said, my vaccine might not work, but one of them will. And I thought, wow, you get people being optimistic about their own research area or product. But she was saying the competitor might work. So, I was bullish about vaccines and thought the whole idea… So, you’ve got to be flexible and nimble.

In terms of promoting your career, choose the best university. It’s not necessarily something that I think is necessary. I recruit people from all universities. But to get past the application sifting process, much of which is done by the way by machines and not by the people, even when people do it, that are going to actually hire you, you’ve got to have a good university and a good degree and techniques are important. People used to say reading and writing and arithmetic are what you need in order to learn other stuff. Well, it’s true, but more in the technical sense.

In terms of choosing the right firm, you want to go for a big successful firm, even if they fire you, you’ll get another good job. And choose your boss carefully, and be in a sector that’s expanding. It’s pretty obvious really.

I’m not very good at telling you which of the sectors that expand anymore. One of the problems with The City is that there used to be always new entrants or new markets. The Japanese came in, the Americans came in, the Europeans came in, there was derivatives, emerging markets, all the rest of it. I’m not really sure what the growth is, quite frankly, on a five year view. But in terms of your career, think very carefully about the fact that different parts of the same firm are very different.

So, for example, if you go into, I don’t know, fixed income fund management at Columbia Threadneedle, it’ll be quite similar to the same job in Schroders and more different than doing equities. So, it’s kind of different. And in investment banking, trading and sales, totally different client relationships, very different.

So, get something that suits your skill set and your personality is undoubtedly the right thing to do.

[01:05:51] Alan

Very good. Well, you, I know you’ve retired formally, but if people want to follow you, I think you are still posting videos on LinkedIn, is that right?

[01:06:01] Steven

Yes, I do. I’m quite interested how many people ask to follow me and how many hits I still get, rather more than I did before. But yeah, I do most of my stuff on LinkedIn. I still get lots of people contacting me for advice and I’m going to do some seminars later in the year with a firm, Room 501. So, I’m still as interested. And as long as people are interested in hearing from me, then I’ll keep going.

[01:06:30] Alan

Good stuff. Well, great to have you on Steven.

It’s been fascinating to get your perspective on five decades in markets and, and everything you’ve learned and all of that quality advice. So, yeah, stay tuned. Obviously, feel free to follow Steven’s content on LinkedIn. And for all of our guests and listeners here on Top Traders Unplugged, stay tuned and we’ll be back soon with more content.

[01:06:55] Ending

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