Ep689: Michael Howell – Liquidity Is the Main Driver of Asset Markets

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Quick take

BIO: Michael Howell is CEO of CrossBorder Capital, a London-based FCA-registered, independent research and investment company he founded in 1996.

STORY: Michael was once in a meeting with the governor of the Bank of Thailand, who told him they would cut interest rates the following week. Even though all possible data showed this would be a wrong move, Micahel believed him. The bank didn’t lower the rates; instead, it increased them.

LEARNING: Don’t listen to what people say, particularly central bankers; watch what they do. When participating in macro investing, understand where you are on the liquidity cycle and where investors are positioned.


“Don’t buy a market with a low PE because you think it’s cheap. It actually tells you a lot more about the liquidity background or about the investors’ positioning, which may be structural features of the markets.”

Michael Howell


Guest profile

Michael Howell is CEO of CrossBorder Capital, a London-based FCA-registered, independent research and investment company that he founded in 1996. The firm provides asset allocation and capital markets advice to institutional investors and manages US$1 billion of assets.

Worst investment ever

In the mid-1990s, when Michael was working at ING Barings, there was evidence of some economies beginning to overheat. Michael had a lot of discussions with central bankers, and one of those meetings in early 1995 was with the governor of the Bank of Thailand. Michael remembers the governor saying that the bank would cut interest rates. Michael assumed that the governor wanted to inform people, so it’s not a shock that interest rates will be cut.

In context, that was a crazy decision to make because Thailand was already overheating. The Chinese had previously overvalued the renminbi by about 30%, and the Japanese yen was beginning to strengthen significantly.

The governor wasn’t honest because the Bank of Thailand raised interest rates instead of cutting them. This taught Michael never to listen to what central bankers are saying. Instead, he now looks at the numbers and the underlying backdrop.

Lessons learned

  • When participating in macro investing, understand where you are on the liquidity cycle and where investors are positioned.
  • Equity markets are best valued against inflation, not against bonds.
  • From a global perspective, liquidity will likely be the primary driver of asset markets.
  • Big currency appreciations destroy earnings, and currency devaluations boost earnings.
  • PE multiples work very well at the individual stock level but certainly don’t work at the macro level.

Andrew’s takeaways

  • Don’t listen to what people say, particularly central bankers; watch what they do.
  • PE multiples are not a great measure when looking at the overall macro picture.

No.1 goal for the next 12 months

Michael’s number one goal for the next 12 months is to get more people to understand that liquidity is the key thing going forward.

Parting words


“Just watch the markets and understand what’s going on. Look at the data. Don’t read the central bankers’ lips; watch their hands.”

Michael Howell


Read full transcript

Andrew Stotz 00:02
Hello fellow risk takers and welcome to my worst investment ever stories of loss to keep you winning in our community. We know that to win an investing you must take risk but to win big, you've got to reduce it. Ladies and gentlemen, I'm on a mission to help 1 million people reduce risk in their lives to join me go to my worst investment ever.com and sign up for the free weekly become a better investor newsletter, where I share how to reduce risk and create grow and protect your wealth. Fellow risk takers this is your worst podcast host Andrew Stotz from a Stotz Academy, and I'm here with Michael Howell, Michael, are you ready to join the mission?

Michael Howell 00:38
Andrew? Absolutely. I'm pleased to be on board.

Andrew Stotz 00:41
I'm excited to learn from you. And I want to introduce you to the audience. Michael is CEO of cross border capital, a London base, FCA registered Independent research and investment company that he founded in 1996. The firm provides asset allocation and capital markets advice to institutional investors and manages a billion US dollars. Michael, just take a moment and tell us about the unique value that you are bringing to this wonderful world.

Michael Howell 01:10
Well, I think the starting point is going to be research where we're a research led firm, we believe fundamentally and understanding what drives markets ultimately. And that really comes down to two things supply and demand, like any market, and the major factor that is driving global asset markets in terms of that supply demand paradigm is the flow of liquidity in the world. And we do a deep dive on a weekly and a monthly basis to try and understand money flows around the world. Essentially, we're following the money. And that's key.

Andrew Stotz 01:49
Before we get into that, I'm just curious like to look at your background and the things that you've done over the years, to start kind of an independent research type of operation in 1996 was kind of way ahead of its time, when you think about what was going on at that time. As far as brokers were expanding around the world, I was working for a company called wi car, I was working for a company called Paragon in those days, I was working for Asia equity in those days in Asia, those were the brokers that we were you know, and we were providing free research. Why would you go to an independent research provider when you could get a free from a broker? And then many years later, the European Union and all of its wisdom came up with? What was that thing? Yeah, MiFID supposed to bring us, you know, a whole new world of protections and research and all that which seem to kind of collapse independent research. So I'm just curious, like, how did you get into independent research? And how did you stay and build a business out of that?

Michael Howell 02:48
Okay, I think the short answer is that if you go back to the mid to late 1990s, what you were seeing was in that bull market, there was a tremendous appetite for stock investment. But there was already a lack of asset allocation advice. And people were effectively investing without context. And what we were trying to bring to the party was to say, look, we're, we got an expertise and understanding how markets work from a top down perspective. You can punt around in different investments, different stocks, but you really got to have that context, you got to understand where money is moving around the world. And the Federal Reserve is clearly important in this equation. The Bank of Japan then was particularly important in that picture, what, you know, what was happening in currency markets, all these things were major features. And if you go back to that period, in fact, very shortly after we started, there was the Asian financial crisis. And then we moved on to long term capital, the, the catastrophe there in 1998. And in actual fact, I mean, as an anecdote, we might my background was coming out of Salomon Brothers, the US investment bank, which many people may recall, was the world's biggest fixed income, trading house, and forex, Trader worldwide. And long term capital actually evolved out of Salomon Brothers, I come from Salomon Brothers, long term capital or clients of ours in the summer of 1998. I can remember in their offices in Greenwich in the US poring over a series of charts that we were putting forward to them saying, if you look at all these indexes, liquidity conditions are collapsing worldwide. And David Mullins who was an ex Chair of the Federal ex deputy chair of the Fed, was on their board and he was sitting around the table. And I saw them all looking pretty puzzled, not saying anything at all, and sort of scratching their heads and little I know the sort of degree of positioning they had in these markets. But the fact was, you were seeing this sort of common equation of liquidity falling around the world, not just in the Asian markets, but it was becoming a global phenomenon. And as we later saw it was an Asian crisis spilled over into Brazil into Russia, you know, run across the world.

Andrew Stotz 05:07
Yeah, it's interesting, because when I started in 93, as a sell side analyst, so I was covering a group of stocks. And, you know, for a lot of people at that time, we didn't think about those global issues that much. I mean, there were the Mad thematic things, and they were trends that were happening and stuff. But generally, you know, a lot of people look at stocks, and they think, okay, yeah, I like this one. I'd like that one. But then they miss the big picture. I'm just curious. Let's talk a little bit about what's happening. I mean, we saw an unprecedent amount of liquidity pumped into the system in the US. Now that's coming down. And you know, all kinds of crazy things are going on with interest rates. And all this. I'm just what is your update on the way you're looking at liquidity and flows these days around the world?

Michael Howell 05:52
Okay, well, the first thing to recall is that there is a liquidity cycle. And we've got a firt. The first question that any investor needs to ask is, where are we in that liquidity cycle. And what you've got to try and anticipate, to a large degree is what the cycle is going to look like maybe in six or 12 months time, because making money and investments is not looking today at what the environment is looking at what it's likely to be in coming months, financial markets or forward discounting mechanisms after all. And that's question number one. Our view is that we're, we've passed the trough of the liquidity cycle. Liquidity conditions are still very tight. There's no question about that. But the focus we have is very much on looking not on interest rates, interest rates are a very much misguided thing to look at, in many ways. They're not a measure of monetary tightness, or looseness, what you've got to actually look at is the flow of liquidity in the system. Now, I think the easiest way to try and explain what the issues really are here are that if you look at capital markets globally, with the huge amount of debt that is in the system, they have become not new financing vehicles, but refinancing vehicles. And that's an absolutely key point. So in other words, there's $350 trillion of debt in the world with an average maturity, around about five years now, simple math says, You've got to refinance their four $70 trillion of debt every year in capital markets, to refinance debt. without there being a refinancing crisis. You need liquidity? What liquidity is, is balance sheet capacity within the financial system, you need that capacity. If you don't get that capacity, you got to refinancing crisis. Now, that's what we've had many, many, many times. In the last 20 years or so, these things have been refinancing crises. What we're getting now is a refinancing crisis. Look at what's going on on the banks, many economists say, look, hey, look, there's a credit crunch. This isn't a credit crunch. This is a funding crunch. It's very different. And you can see that in the sense that the increase in interest rates has not hit the borrowers, it's actually hit the financial intermediaries, the banks, the lenders, they're the ones that are struggling. So this is all about funding. And so it ultimately comes back to the monetary authorities, the Federal Reserve Etal to put more liquidity into the system, which we can come back to. But I think what I want to do is to put this into context to say, look, if you pick up an economics textbook, or a finance textbook, what it says is that interest rates are really the thing that matters. Now, in a world where there's lots of capital expenditure, I'll come quietly and say, Okay, that's probably true, because you're comparing a return on capital with a cost of capital. And okay, if you get a green light, then you invest, that's fine. But that's not the world we're in anymore. We're not doing a lot of CapEx, we're doing a lot of debt refinancing. And in a world of debt refinancing, its balance sheet capacity, and all interest rates, capital markets globally, in terms of new capital raise, raise about $10 trillion a year, the refinancing pot is about 70. So for every $1, that's transacted in financial markets for new capital raise, there are seven in terms of refinancing. And that's why liquidity in a nutshell is so important to monitor. And that's why central banks have got to get a grip of this.

Andrew Stotz 09:23
And that's where we're seeing in, let's take what's happening in the US. And right now, what we've seen is, you know, there's a lot of pressure on deposits and people are a little bit nervous, and they're moving money in the money market and other accounts, maybe you're seeing the banks having having to liquidate a little bit of their assets to get the funding needed to repay those depositors and the Feds helping them along by allowing them to pledge their treasury securities at basically par and kind of holding the losses there and allowing them not to realize them. Is that enough? Have? Or do we see that it just continues to be a liquidity crunch? Or what is your view on that?

Michael Howell 10:09
Well, as I said, we're at the low point of the liquidity cycle after central banks have tightened for, what, 15 months. And we're seeing the consequences of that. Bear in mind that financial markets are forward looking. So they're likely to feel the pain long before the real economies do. And in actual fact, financial markets tend to recover pretty much in the midst of recessions. In our view, the recession has probably already started, it's a number of months old. Many people don't realize that yet. But I think you can start to feel the pain. If you look at certain economic indicators. That's pretty clear. Financial markets are struggling, if you like right now, but they're starting to get some traction. And they're getting traction, because what we saw back in October of last year was the inflection in this global liquidity cycle. Now, the trigger for that was paradoxically, the British gilt crisis. The gilt edge crisis, as people may recall, was a situation that occurred when a new prime minister and Chancellor came into Britain and announced a mini budget, which was effectively shaking up the fiscal arithmetic in the UK, and the UK government bond market, the sovereign bond markets sold off. Now, that was a big shock, okay. It was a big shock for the UK insurance and, and pension industries. But it was also a wake up call for central banks globally, had that same event occurred in the US Treasury market, which is at the core of global financial markets, we would have had a financial crisis worldwide, probably on par with 2008. But it didn't happen, because with some alacrity, the US authorities mood. And if you look at what happened in the markets, around that time, you'll see that fed liquidity injections, which had been going down very aggressively, began to flatline. And actually, as of now, they're rising again. So that's creating more money in the money markets. And it's actually easing the strains. And what you saw was, if you recall it again at the time, Janet Yellen, US Treasury Secretary basically warned about how nervous she was about the US Treasury market. Bond volatility, if anyone is sort of wonkish enough to look at Bond volatility data, but there is an index called the move Index, which measures volatility across the Treasury yield curve, which is akin to the vix index for equities, that spiked dramatically. So that index is normally around about 80. On its on a measure, it went right up to 200. But it's starting to come down now quite significantly. And that is an indication that things are coming down. Now collateral. In other words, the value of this pristine collateral government debt is very important for credit creation in the world economy right now, ever since 2008. And actually, sometime before that, for us to sort of go under the window, there is very little interbank lending on trust, most of it now is collateralized lending. So you need a security of some value if you're going to get a loan of any form. And government or sovereign debt is really key to that. So if you start to see disruption in the sovereign debt markets, then you've got big warnings about liquidity, cratering, what we're seeing now is the government of sovereign bond markets are coming down. So what we've been saying to our clients is, look, don't worry about looking at the vix index, look at the move index, that's what we're really going to be what is important in terms of understanding your investments. That's where the risk lies. If the move index spikes and collateral values become undermined, then you're going to see a much much bigger liquidity squeeze than we're getting, at the moment that liquidity cycle is beginning to pick up. Partly because the Fed is inching in more liquidity for the reasons you said to help bail out various regional banks, SVB, etc. You're seeing as well, collateral values begin to improve, and volatility which will govern the haircuts. So that collateral coming right down. And then a third thing is that the People's Bank of China, which is the second most important central bank in the world, is been increasing its liquidity injections pretty significantly since around November of last year.

Andrew Stotz 14:35
And what's happening in the Eurodollar market these days, is there a squeeze there, or are we past that or what's your perception there?

Michael Howell 14:45
The Eurodollar markets are a lot less important than they used to be 10 years ago. Okay. I'm not going to say that unimportant, but I think you've got to distinguish very clearly between new credit flows. In other words, banking flows in the Eurodollar markets. which have been significantly curtailed? They're still large, but they've really haven't they haven't really grown substantially in the last decade. From the futures markets, the Eurodollar futures markets, which are huge in comparison, and much more reflect hedging activity in sovereign bond market, in other words, investors playing the yield curve. So I think you've got to draw that distinction. One is, in terms of the credit availability is the Euro traditional Eurodollar markets, that's kind of been eclipsed. Now, to a large extent by collateral pools. These tend to be more important than liquidity corrosion. But without any questions, looking at the Euro dollar, the traditional Eurodollar futures, which by the way, is itself going to be changing because Euro dollars are being old LIBOR is being shifted out of the equation for an alternative such as Sofer in the US, the traditional LIBOR is still a very important thing to look at.

Andrew Stotz 15:58
And just, maybe we can wrap it up by just looking at the dollar and how does it stand? You talked about Christine collateral, we know US Treasuries are the ultimate pristine collateral, you've also talked about the potential that we could be in a recession right now, like it's already happening, we've had 15 months of tightening, as you've said, and so one of the questions I mean, when we see things get panicky, people tend to rush to the dollar. And you know, then you've got this whole other side of people saying, oh, no, the vault, the dollar is going to fall apart. Because we're seeing BRICS and China and Russia coming together. I'm just curious what your thoughts are on that.

Michael Howell 16:35
Yeah, I should say, in fact, just to sort of finish the last point, maybe just in one, one sentence, I don't think there's going to be a banking crisis or credit crisis this year, policymakers are going to be too much onto this risk, for the simple reason that there was it would be a huge gift to China. Okay. They would point to this to reflect the instability of Western financial markets. And it would basically, you know, it would underscore what they're trying to do as an alternative financial system to the dollar, which leads us neatly onto what the outlook for the dollar? I think there are two things to say. One is the status of the dollar as the International means of settlement worldwide. That's more a qualitative or philosophical point. And the other is, what is the value of the dollar? What's the dollar going to do? Maybe in the near term? I think to on that latter point. First, our view is that very simply, if you look at 2022 last year, policy can be summarized very clearly as getting the federal reserve balance sheet down and getting the dollar up. This year is much more about getting the federal reserve balance sheet up and the dollar down. Okay, so that's what I think is going on. And the dollar is we think in a medium term bull market, but it will have a correction of about probably a further 10% this year. So from the peak of last year, you may be down 15% plus in terms of what the dollar is the dollars trade weighted value, so I think is effectively adjusting in the uptrend. Now part of the reason for thinking about an uptrend in the dollar is to understand the context of how the dollar acts as global means of settlement. And there's a lot of, let's say, I think mistaken analysis about what really drives global currencies. Many people have spoken about different alternatives like Bretton Woods, two, Bretton Woods three, whatever it may be, okay. Actually, reality is we're still in Bretton Woods one, okay. Things haven't changed. If you think of what really was Bretton Woods one Bretton Woods, one was putting the dollar as the centerpiece, the International Monetary System. It was having the World Bank and the IMF, lease payments, imbalances. Still both of those, all those silica thirdly, it was having the US military backstop the world trade system that still exists. Now, as an adjunct to that. You may have said well, okay, it was fixed exchange rates, and it was capital controls. But essentially, those weren't critical to the settlement. In time, it was always envisioned that you would see freedom of capital movement, and with freedom of capital movement, you ultimately had to have floating exchange rates. So let's not put floating exchange rates as the main driver here, the main drivers having the US Dollar as the centerpiece that means of settlement. Now, what does that really mean in essence, it doesn't mean simply denominating trade in US dollars. My analogy here would be to say well, okay, if we switched to pricing in yuan, Chinese yuan, it's a little bit like saying let's measure Fifth Avenue in kilometres, not miles. Would it be any longer? It's not this this the currency of denomination? And that makes no difference. You got a second level, which is important to understand, which is the payments mechanism. The payments mechanism, which would include trade credit is an important element. And that was actually how the US dollar became dominant right from 1915. Where in actual fact, if you look at the history of this, in just as World War One began in 1914, the US Dollar was traded in fewer centers than the Austro, Hungarian Pengo. Okay, put it in context, no one's probably heard of the pingo. But it was bigger than the dollar in 1914. In 1915, the British were unable to sustain their monetary system or their credit system internationally. And so they stopped British banks lending overseas, and American banks came in and started to give trade credit. Within three years, the dollar was the dominant currency in world Forex reserves. Okay, it was volatile. I mean, it went up and down after that, but that was really a statement to say, from nowhere, the dollar would become a big currency. And that was because of trade credit, that US banks were then moving into that market, barely China can move into that space. And that's, that's an issue one's got to one's got to think about. But it's the third element, which is by far and away the most important, which China can never achieve. And that is acting as banker to the world. And what that really means is that if the world economy wants to save, they can save in US financial markets. And if the world economy needs dollars, US banks can provide them with that funding. Okay. Now, what you need for that role as bankers of the world, a deep financial markets and liquid of transparent financial markets, and either a strong banking system that can effectively administer global credit, and words trusted? How many of those box ticks can you do in China? Not that many. And that's really the issue. are Chinese banks ever going to be international lenders? are Chinese financial markets going to offer the depth that international investors require? And therefore there may be hopes that the yuan can become a bigger currency, it will become a big currency, no question. But it's never going to shake the dollar in terms of this dominant role. Us is running a large trade deficit, that is not a signal of US industrial and competitiveness. It's a signal of the super competitiveness and efficiency of us finance. And the only way that you stop the dollar being the dominant currency is if US Finance trips up somehow.

Andrew Stotz 22:41
And I mean, a lot of people would say that maybe the Chinese yuan is not going to be the replacement for the dollar. But if the US government keeps shooting itself in the foot through different things that they're doing, that it's just going to force countries to have to figure out another way, like bilateral trade without using the US dollar in the middle or something like that. Is it possible that the US dollar slides in its dominance because of that, or that doesn't make sense, either?

Michael Howell 23:11
In my view, it doesn't really make that much sense, either. I mean, I think the fact is that if you take I mean, let's take a large surplus economy like Saudi Arabia. Okay. If Saudi Arabia has got a surplus, where is it going to invest that surplus? Is it able to invest? Probably more to the point is it willing to invest all its money in Chinese financial instruments, I think highly unlikely. And so, you know, once you start to think about how this cooperate, then you start to realize that it's actually almost an impossible ask for China to rival the dollar in this way, not to say that it will never get there. But in the foreseeable future, I'm talking here decades, it's extremely unlikely. And there may well be a case for arguing that the dollar becomes more dominant in the near term than actually less dominant. And I think that goes back to the fiscal arithmetic and the point you made. And it's clearly it's important that the US needs to US Congress needs to think about some of the more futuristic themes here, such as digital currencies, such as you know, not imposing a debt ceiling or not, not, you know, not having the debt ceiling problem, let's say, every five or 10 years or whenever these things arise. These are issues which clearly mean a lot for international investors. But at the end of the day, the dollar was in a dominant position. And it's very, very difficult to shake that out. And that was something that was implanted in 1944, in the Bretton Woods Agreement.

Andrew Stotz 24:40
Well, that's a fascinating discussion, and definitely helps all of us think about this. I know, You've also written a book Capital wars, the rise of global liquidity, which is available on Amazon and I'm gonna have the link to that in the show notes. I think I've come over the years to really realize that flow of funds protect billion little markets like Thailand where I am, it can make a huge difference, it can be much more powerful than looking at the value of a particular individual stock as an example. So, for those people that want to learn more about it, that's definitely one place to go is to get into the book. And then also, you know, follow you everywhere you are is what would be the best place for people to, to follow you or learn more about what you're talking about.

Michael Howell 25:25
First thing, Andrew will be displayed a website, which is cross border capital.com. Yep, we've got a Twitter handle, which is cross border cap that I often tweet on. And there's also a LinkedIn site. So there's lots of opportunities or openings for people to connect.

Andrew Stotz 25:40
Now, after such an intelligent conversation, my listeners may ask themselves, how could a man such as this, make a mistake in investing, and now it's time to share your worst investment ever? And since no one goes into their worst investment thinking will be tell us a bit about the circumstances leading up to it, then tell us your story.

Michael Howell 26:00
Okay, well, I think that there is a list of a long list of mistakes that I could cite. But I think, you know, one of the interesting things I think, to maybe kick off with so look, one of the things that I've often learned in markets is whether it's a tip, there's a tab, okay? Meaning that I've never made money out of tips. And it's really difficult to do that consistently. And the reason for that is that tips don't have context. And what you need to do is to think of investments, not speculations. But if you think you've investments, you've got to start thinking about the context, and really getting the macro call right. Now, if I think of the biggest errors that I've made, it's basically those areas, it's ignoring that macro. And I can give you actually, one I can give you two, I can give you several, one, for example, was in actual fact, in Thailand. And we used to do a lot of when I was a bearings, we used to go around, obviously, we're big in the region, in the night or late 1980s 1990s. And going around the central banks was an important thing to understand, particularly, as you recall, with large capital flows, we knew the way into and out of markets. And you're beginning to see, even around the mid 1990s, evidence of some of these economies actually beginning to overheat. And there being a problem. Now, we had a lot of discussions with central bankers. And one of those meetings, I think it was in early 1995. With was the governor of the Bank of Thailand. And I remember him saying to me, sort of almost sort of secretly, but sort of quite candidly, you know, our upcoming interest rate decision next week, you know, we're going to cut interest rates for working. That's an interesting point, maybe he what he wants me to do is to actually, you know, use this information and try and, you know, try and let people know, so it's not a shock that interest rates are going to be cut. Okay. Now, actually, in context, that was a crazy decision to make, okay, for the simple reason that China was, I'm sorry, the time was already overheating. The Chinese had previously devalued the renminbi by I think, if I recall, you may remember better than me by about 30% or so the previous year, in some of the previous year. So you're looking at a big shake up going on Asian currencies. And what's more, you were starting seeing the Japanese yen begin to strengthen quite significantly. So the idea of cutting interest rates was actually a red rag to the time Bart and the Thai baht should be forming. What was the reality? The reality was that, you know, obviously, I've been taken us a monkey here. And the Bank of Thailand raised interest rates at the next meeting, they didn't cut them, and the bond strengthened. So you know, this is a very good example of saying, Never listen to what central bankers are saying, okay. Look at the numbers. Look at what the underlying backdrop is. Don't listen to the gossip, where there's a tip, there's a tap, you've got to look at context. Now I can go on and say these macro themes are very important to understand. Another example is to think about ignoring currencies. And think of the huge gyrations and I've already cited the Japanese yen but think of what the Japanese yen did in 1990. At the time of the bubble, the yen currency was 150 yen dollar. And some of your listeners may recall the history of why the Yen has its value, and it goes back to you. I may be telling you a story you already know. But when the Yen was first floated after World War Two, or first first reinstated after World War Two The US administration was thinking about what exchange rate do we start with, because this economy has been devastated by the war. And so somebody pointed out to the US administration, that the word yen in Japanese means circle with our 360 degrees in a circle. So there were 360 yen to the dollar. So for a long time, the Yen was 360, to the dollar. And through the 1980s, as the Japanese economic miracle really unfolded, the yen got stronger and stronger. And basically, it appreciated. And it got to about 150. In 1990, at the time of the bubble, actually, the reality is, it should have got even stronger. And then you look at what happened by 1995, the yen got to 80. So it effectively doubled again in value. So you can see these effects have absolutely dramatic effects on economies and financial markets, think how much they squeeze Japanese profits think what they do to the Japanese bond market. And underlying inflation, these things matter hugely by I think it was a then again, if you go from the 1995, low of around 80. By year 2000, I think you were back at 150. Again, for yen dollar. So these are whopping great movements in currencies, which really needs to be thought about. And one of the things that I've often seen, you know, being in markets for a long time is analysts are always about 12 months behind in understanding the effect on earnings of currency swings, big currency, appreciations, destroy earnings, and currency devaluations Boost Earnings. So I think that's another example of saying, you know, these are good examples. And then if I finish on this point, in terms of worst investments, and that comes down to, again, looking at Japan, and maybe eurozone, or the European markets, in the context of a macro call on equity markets, and that's looking at P E multiples. Now, P multiples work very well at the individual stock level, but they certainly don't work at the macro level. And that's very important for people to understand. And realize, it took me a number of years to realize that, but it's absolutely invaluable advice. Don't buy a market with a low p mold, because you think it's cheap, because that has that tells you a lot more about the liquidity background, or about the positioning investors, which may be structural features of the markets. And let me give you examples. In 1980, the P E multiple on the Japanese market was 20 times earnings, okay? At the same time, in the US, the P multiple was nine times by the end of the 1980s. Which market have performed the best Japan by a long way. Now in actual fact, Japan was then sitting on a multiple of 40 times. And the US market equivalent, I think was low teens might be 1213 times. Okay, so the US had been rated Sure, but nothing like as much as Japan and Japan saw a big earnings kicker. And then you get the sort of the perennial issue about Europe. Okay, so many American investors look at the European markets and say, Hey, P multiples are lower, we're going to invest in Europe, because it's a much cheaper market. We're value investors. If you're a value investor, look at the stocks don't look at the markets. And any five year period you take from 1980 onwards, the P E multiple of the European markets has been below that a Wall Street. But Wall Street has massively outperformed over that pretty much entire period. And you can even look more recently and say, you know, look at year 2000. The year 2000. The P multiple on the US market was about 1415 times. Europe was about what 1011 times by 2020. The US multiple had gone up to 35 times. So big outperformance valuations are always P e is at the macro level absolutely mean nothing. And what drives Pease as we show in the book Capital Wars is liquidity and positioning and how you make money in the long term and of equity markets is to understand the positioning of investors. What you want to do is to buy when effectively people are out of the markets when they got very very low equity exposure relative to the norm and you want to be selling when they got very high equity exposure exposure. Where they are right now just for you know a heads up is really globally that around neutral levels in terms of normal benchmarks, okay, but where they are significantly underweighted is in the Chinese Mark. gets relative norms. And in some of the Asian markets, which have been I've obviously got to China spillover effect. And that's where you've seen the biggest anomalies.

Andrew Stotz 35:13
So let me maybe I'll just kind of go through what you talking about that the first one is, you know, be careful about listening to what people say, particularly central bankers watch what they do. It reminds me of when I started everyday lives. Yeah, exactly. Yeah, when I started as an analyst in 93, I was a bank analyst. So I was, you know, following the Thai bank sector as it went into its boom, you know, in its final boom, let's say before, then went bust and then read capitalize. So I learned a lot in my first 10 years of that, but I, you know, young analysts nowadays, they go to the companies to get so much information. And they asked me what I said, I, I swear, for the first 10 years as an analyst, I pretty much almost never went to the company. Because I thought, either they're going to mislead me, because they don't know what they're talking about. Or they're going to just mislead me by lying to me. And I just saw many cases where, you know, that was the case. And there was a, there was a report in Thailand called the new Khoon Commission, which was set up to investigate the collapse of the Thai baht. And one of the findings of the commission was that the Bank of Thailand had misled the public by not disclosing the forward positions, you know, and what was happening. So they were able to show that they had foreign foreign foreign US dollar foreign reserves about 40 billion US dollars, when in fact, that that had already been broken down by March of two of 1997, that have already come down about 6 billion, but they didn't disclose it in a in a way that the market could understand it. So it was only insiders hedge funds, other people that were figuring it out, and then they pushed them to the wall. So that's a great lesson. Listen, you know, don't believe what people are saying, watch what they're doing. The second one is ignoring currencies. And that's an important one, because a lot of people are investing globally nowadays. And you can get all your stock calls, right, and you know, all kinds of things, right, you get the currency wrong, and you're wiped out, as you've explained about Japan. The other third part that you've talked about is that multiples and valuation measures can be distorted, and they're oftentimes distorted on a macro level, because of liquidity positioning. Also, you know, you can say interest rates potentially can be distorting to P e multiples. So what you're telling us is, you know, pay attention to P e multiples, maybe on a company level, but PE multiples are not such a great measure when you're looking at the overall macro picture. And those are some of the things that you said, Is there anything else you would add to that?

Michael Howell 37:53
Not really, I think that, you know, the, it's really a question in terms of macro investing, of understanding where you are on the liquidity cycle. And where investors are position? Are they already discounting that or investing for that or not? And you know, at the moment, you've got this, I mean, you've actually got a clamor in markets right now to predict bad news in a way that I've never seen before. Okay. And that's an unusual feature. But when he tells you Well, I mean, that, you know, what we're what we've been told by economists the whole time, is that we're about to go into a deep recession. And there is an eagerness to sort of outbid the your competitor by saying, it's going to be a deeper and deeper recession. Now, I think there's a number of features which are distorting many of the indicators, which are saying that bad things look a lot worse than they really are. But what you see is evidence from corporations, particularly the recent run of results in the US, which actually seem to give a much better tenor to what's happening to the economy seems to be more robust. But economists that you know, they're unremitting in the sense, they say, oh, it's gonna get worse. It's always next next quarter, whatever. So they keep pushing their recession forecasts out, and but they're getting deeper and deeper. And I think that that's not really the issue right now. The issue in markets, curiously, is not the business cycle. Because I think the markets, probably investors are already there, they understand that things are gonna get tougher. What's really important to understand is, first of all the liquidity cycle. And as I said earlier on, policy makers don't want to create a banking crisis right now it's in no one's interest. In actual fact, it will be a disaster if this happened. So they're going to do all they can to prevent banks failing. That means more liquidity being put into the system. So I think that's, you know, that's an important thing and the other factor above always look at inflation. Inflation in my experience has been a huge, huge negative for financial market investment. Whenever you get inflation picking Up, financial markets do badly. And that's true not just in the period since the 1980s, when inflation has generally been going down with a few blips, it's also true in the 1970s, there was a big, big move out of financial assets in the 70s. With a raging inflation, people moved into real assets. This bull market that we've experienced since 1980, has got a lot to do with falling inflation, equity markets are best valued against inflation, not against bonds. If we're in a situation where inflation, even temporarily tumbles at the back end of this year, down towards where central banks have been targeting, I think equity markets will see a big rewriting. That may be a temporary one, if inflation picks up again, but I think that's coming. And if you look around the world Paci, the bad news in the UK, of course, we've got still over 10% inflation. But the UK is a very inflation sensitive economy. If you look around the world, generally, Asia is an extremely good example. But look at the latest numbers coming out of Brazil further evidence that inflation is coming down quite significantly. And I think you can say, okay, maybe it's a bit sticky. But the reality is, the direction of change is down, by the back end of this year, the Fed may even be able to hit or even beat its 2% target.

Andrew Stotz 41:21
Wow. And that's something I do monthly reflect inflation report. And I talk about it here on the podcast, and then I have downloads so people can download that data. But what I said is US inflation, I think could be down at three to 4% by the end of this year. And that, as you're saying is relatively positive for equity markets. And if we get some teetering banks or some other liquidity issues, you could see some reversal in policy from the Fed or some other way of making sure that they've got liquidity injected into the system. And all of a sudden, the equity markets perform much better than people had thought is that that's what you're thinking?

Michael Howell 42:02
Exactly, exactly correct. And if you look at what's going on right now, in terms of stock markets, they seem to be defying the bears, they're trying to sort of claw their way higher. And I think you can see that with some of the longer duration investments, things like technology, for example, they're moving up, they're beating people's expectations in terms of what the market should do. Defying gravity in the words of many people. But actually, what this is really telling us is that liquidity is coming back, and maybe inflation is coming down. And that's because these are what in bonds speaker called long duration investments. These are the things that should do well in that environment.

Andrew Stotz 42:42
All right. Last question. What is your number one goal for the next 12 months?

Michael Howell 42:48
In investment terms?

Andrew Stotz 42:50
Well, I guess any anything investment or in your own life, personal.

Michael Howell 42:55
I think the main goal probably and let's do a bit of a joint one is basically to get more people understanding, but liquidity is the key thing going forward. And liquidity is likely from a global perspective, to be the main driver of asset markets in the future. Now, one of the reasons to start to say that is that what we're looking at in the US right now, is that the Federal Reserve is bailing out the banks, what the Federal Reserve is going to have to do in the next 10 years is bailout the government. But the US happens to be the cleanest shirt in the global laundry here. Okay. Other countries are far, far, far worse. So that's part of the reason I think the dollar will do well. But ultimately, there's a huge amount of liquidity coming. So if you believe that QE is dead, forget it. It's not coming back. It's coming back big time. And investors have got to start to adjust their asset allocation methodologies to take this into account.

Andrew Stotz 43:55
So that's a great, you know, great way to wrap up, because I know you talked about that the market is a discounting mechanism, and it's looking into the future. And in order to make money, you've got to look further ahead. I think a lot of people are stuck in Okay, fed tightening. Okay, there's a little bit of a crisis, but we're about to go into a recession, it's going to be a disaster, that type of thing. But if you look six months ahead, basically, you can see, yep, we probably have some loosening, that's going to happen. And we have other factors that could potentially lead us into a situation with inflation down with potential QE coming back that, in fact, in equity markets actually do pretty well by the end of this year. And that's not something I think people are that comfortable with right now.

Michael Howell 44:37
I think that's right. I think, you know, one of the things I think too, you know, to say is to refer to security analysis, the book written by Ben Graham, the DOJ on the value investors, and what does it say you probably got several editions and you're on your shelves. There we are. There it is. We are security analysis. There we are latest edition or whatever.

Andrew Stotz 45:00
You know, few and I got that when I was head of Research at wi car in 1995.

Michael Howell 45:05
Wow, wow. In that book, you'll find a quote. And that quote says that in the long term, the markets are weighing machines. Okay? But in the near term markets or voting machines, the votes are money. And that's the important question.

Andrew Stotz 45:28
Well, listeners there you have it another story of loss, but so much more to keep you winning. Remember, I'm on a mission to help 1 million people reduce risk in their lives. If you've not yet joined that mission, just go to my worst investment ever.com and join my free weekly becoming better investor newsletter to reduce risk in your life. As we conclude, Michael, I want to thank you again for joining our mission and on behalf of a Stotz Academy I hereby award you alumni status for turning your worst investment ever into your best teaching moment. Do you have any parting words for the audience?

Michael Howell 45:59
No, just watch the markets. You know. That's the key thing to do understand what's going on. Look at the data. Don't read central bankers lips wash their hands.

Andrew Stotz 46:11
Yeah, exactly what a great ending. And that's a wrap on another great story to help us create, grow and protect our wealth fellow risk takers. Let's celebrate that today. We added one more person to our mission to help 1 million people reduce risk in their lives. This is your worst podcast host Andrew Stotz saying. I'll see you on the upside.


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About the show & host, Andrew Stotz

Welcome to My Worst Investment Ever podcast hosted by Your Worst Podcast Host, Andrew Stotz, where you will hear stories of loss to keep you winning. In our community, we know that to win in investing you must take the risk, but to win big, you’ve got to reduce it.

Your Worst Podcast Host, Andrew Stotz, Ph.D., CFA, is also the CEO of A. Stotz Investment Research and A. Stotz Academy, which helps people create, grow, measure, and protect their wealth.

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