Podcast Transcript: James Aitken On Stock Vigilantes, Yield Curve Control and Inflation Paths

This is an edited transcript of our podcast episode with James Aitken, who gave his views on portfolio hedging, stock vigilantes, inflation, recent market volatility and much more. While we have tried to make the transcript as accurate as possible, if you do notice any errors, let me know by email.

James’ Background and Career Path

Bilal Hafeez (00:01:00):

And on this episode, I have the excellent James Aitken. He’s the founder and managing partner of Aitken Advisors, a research boutique for institutional investors, which he started in 2009. Before that, James worked for UBS, AIG, JPMorgan, where I overlapped with him, and Macquarie Bank.

Bilal Hafeez (00:04:11):

So, let’s perhaps start with your history. And I always like to start speaking to my guests around what’s their origin story. What did you study at university? And was it inevitable that you’ll enter into sort of, the finance world? I mean, where did it all start? And what were your early kind of inklings career wise?

James Aitken (00:04:31):

Well, I’d say zero inklings, but the exposure to finance if you will, started with my father, John, who’s still alive and well in Sydney at the age of 83. And Dad, in the early 1970s, was an accountant who set up the investment management business in a company called Perpetual Trustees. And he worked with a very great friend of his, the late Australian investor, Rob Maple-Brown. And frankly, how lucky were my brothers and I to have two mentors like that, who were just long term value investors. And it certainly sparked an interest.

But I have to say, I had no idea that I was going to end up in finance. I did not even study economics or commerce at school. Dad never forced us to pursue a career in finance or anything like that. But somehow, I ended up doing an economics degree at the University of Sydney. And I probably shouldn’t admit this in the public domain, but while I was very good at economic history and econometrics, I was absolutely hopeless at economics and could not make head or tail of it. Just couldn’t understand ISLM and all this kind of stuff. It just made absolute garbage to me, but I persevered.

And then towards the end of my fourth year, of what should have been three years, if you follow the drift – towards the end of that fourth year, I noticed an advertisement, which I’ve still got here in my library, from Macquarie Bank, and it said very cutely, “Ever had a yen to be a foreign exchange dealer?” I’m like, “Well, that sounds pretty promising.” Next thing I know, whilst I’m completing my final year at University of Sydney, I ended up as a trainee foreign exchange dealer at Macquarie Bank in Sydney, working for a mentor of mine, called Peter Taylor in January 1992, at the ripe old age of 21.

So, it all unfolded very rapidly. And I know people like to say they have the grand plans and everything else, but I just went with the flow. That was it. And look, for the sake of your listeners, I won’t take you through my whole lamentable sell-side and banking career, but there are a couple of very key points. The first was ending up at Chase Manhattan Sydney during the Asian crisis. And my client base was Japanese banks. There, I learned the power, importance, persistence and mechanics of Japanese yen flow and yen asset markets. And to this day, I still speak with some extraordinary nihonjin friends in Tokyo who have been in the markets for three decades. And every time I converse with them, I’m reminded that so little has changed in the way that Japanese institutional investors move money around, and groupthink the consensus. But that was an extraordinary experience. Chase Manhattan sent me to London in May 1999. Obviously, I’m still here. And this is where it gets interesting. And then we can talk about the other aspects later.

But Bilal, as they say in the classics, our eyes met across the JPMorgan Chase trading room, I thought, “Who’s that young man?”, and we got into a discussion about Greek repo or something, wasn’t it? And you were working with our great, great friend Alfonzo, who’s just an astonishing man, and a great friend to us both. And I thought, “this guy, he must be 35 years old.” And I’m not trying to age you or anything. But I think at the time you were in your early 20s. And you just were so calm and had such a presence, and you had the confidence, I remember, to go into meetings with people who’ve been around the track a few times, grizzled fund managers and hold your own.

And I’ll never forget that, I thought it was very, very impressive indeed. And it was a pleasure to work with you. And look, just to finish this point, as I think a lot of people know, in early 2002 I ended up at AIG Trading, which was taken over by AIG Financial Products. I had a front row seat at the circus, which became very useful when I went to UBS in late ’06. And I think people know the rest of the story beyond that. So I’ll stop there, for sake of space of time. But look, to be clear, there was no great plan to enter finance or economics as a profession. There was frankly no great plan to come to London, and even then I thought it would be two or three years. And here I am, the best part of gosh, 22 years long. And it’s been an amazing experience.

How to Balance the Micro and Macro Aspects of Markets and Give Good Investment Advice

Bilal Hafeez (00:08:31):

Yeah, it’s a fantastic kind of experience. And one of the things I always enjoy about our conversations, is that you have this amazing ability to go very micro, into kind of the nitty gritty of markets. But then at the same time, not stay in the weeds and get bogged down into the sort of the minutiae. You’re kind of very quickly able to kind of see the bigger picture. And perhaps it was your experience at AIG, UBS and the financial crisis, which kind of allowed you to kind of join all the dots. But that’s certainly something that I think you’re fairly unique, I would say, out of all the people I have in my various kind of connections and networks. It’s a fairly unique way of looking at things that you have.

James Aitken (00:09:10):

Well, it’s kind of you to say so, but to be very clear, I think it’s all out of necessity. And if I can go back a long way, working in 1993 and 1994, and even late 1992, at various stages on the night desk at Macquarie Bank in Sydney, because they had a 24-hour trading operation. And you’d learn about sterling going out of the ERM, ERM crises, the bond crack up in ’94, and you’d say “Gee whiz, well that’s interesting. I don’t know much about it, but it sounds like I need to find out”. And you’d start talking to people in money markets and stuff like that just to try and figure out what went on.

And then I think out of necessity, at AIG Financial Products, I had to learn. I had to learn about plumbing and everything else and then relate it into what was happening. And then of course, famously, at UBS from September 2006 onwards (I had no idea that UBS had the exposure to subprime that it turned out that they did) I’d be sitting people down and saying, “Look, here’s what I learned at AIG Financial Products. Here’s what’s happening with house prices. And you can go out there and short AVX and buy protection on various things, but here’s what it actually means for the entire financial system.”

So I’d say yes, but it was a function out of sheer necessity. And then, of course, when I set up my own business, or by the time I set up my own business, everyone knew me as the plumbing guy. And that’s great. But as we’ve seen, you can’t be the man with a hammer – you can’t go on and on and on about the same topic. I mean, eventually you’ll be right, but that’s of no use to anyone, and you have to evolve and adapt. I got very lucky with this attention to detail and the microstructure of markets because I thought, “Oh, gosh, here I am starting a business in April 2009, everything I’ve talked about has been hosed away by Central Bank activity and fiscal support, what the hell am I doing?” The clients were fantastic. They said, “Well, finally, we can pay you,” which was helpful.

And then at the end of November 2009, along came Greece, ironically. And I knew that back to front, because I’d seen every moving part of the Greek derivative exposure, the securitizations, the counterparty risk, and it was all across peripheral Europe. And you knew that if they tried to punish Greece, the whole show would be at risk, all of EMU would be in play. It was a combination of the, as you put it, the micro, the plumbing versus the macro implications.

But of course, more relevantly, over the past five years people go on and on and on about leverage ratios, balance sheets, collateral, collateral shortages. Oh, the endless garbage about cross currency basis swaps. I mean, if I had $10 for every time someone had asked me about cross currency basis swaps, I might have retired by now. But to be serious, just the colossal amount of misinformation on the plumbing. And really over the past five years, with the obvious exception of September 19, in repo, and of course, March 2020, and perhaps last week. When I have written about it, it’s been from the perspective of “Yes, I know everyone’s shouting about it. But this is why it doesn’t matter for you, and why you’re probably best advised to move on.” And look, again, you have to adapt, you have to be flexible.

And just to finish this point, Bilal, one of the best bits of feedback I’ve ever received from a client, a great mate, he said, “J.A., mate, never forget that everyone does the what, okay. There’s everyone who can describe what is happening, tell you what the headlines are. All right. So what, now what? What does it mean? How should I think about it? Why should I care? And should I do anything about it?”

And I think it’s a great bit of advice, because as you and I have discussed from time to time, there’s an awful lot of people out there offering opinions on macro. Okay, that’s important. What do you do with it? And I think for someone in my role and someone in your role, we must never lose sight of that essential fact, right? Up into the point of saying, “Hey, look, if it’s unclear, I think you should do this.” Or equally confident to say, “I know everyone’s going on and on about X, Y, Z.” I think Brexit is the classic example of that. However, his valuations, his relative valuations, here’s what’s actually happening in Downing Street, here’s why you don’t take your Brexit advice from Twitter, here’s how to think about it. And just, be calm and sensible is often the right way forward.

The True Meaning of Macro – Which Embeds Both Right and Left Tail Risks

James Aitken (00:13:39):

And I’m sorry to keep going on. But there’s one other thing that I think is important to link in here. What actually is macro? What is it? Because I think as a result of 2008, understandably macro is defined as what is going wrong, or what could be going wrong. And yet, when you look back over the decades, the distribution of macro outcomes is symmetrical. It’s not asymmetrically, it’s not all left tail. It’s really, really important to think about the right tail of the macro risk distribution. And even now, I sense that a lot of people like, “Oh, gosh, here go bond yields, and they’re steepening, and they’re flattening, and there’s collateral shortages in bills and repos.” Yeah, okay. But so what? And we’re in this kind of, on the front edge, still, I think of this extraordinary inflationary boom. And it’s like people are still like, “What can go wrong?”

And yet you look at the largest profits that some of the greatest storied macro investors have made over the past, not the past 10 years or 20 years, but beyond that. It’s by understanding which part of the cycle we’re in and just absolutely letting it rip. And the final point I’d make is, when I set up my business, I never wanted to be narrowly defined in writing about macro. I write about whatever I want to write about, as long as I can understand it. And whether it be ESG, or climate, or bonds, or rates – it’s all linked. It’s all one great big tapestry that we’re trying to understand, and to be less wrong about, so that we survive whatever outcomes arise.

And look, it’s such an enormous intellectual challenge. And I think we’ve been spoiled. I know that sounds dreadfully cold phrase for the past 12 months. But at one level, macro investors have been spoiled, because there’s been so much to do. And the very last point is that you must think of macro in the broadest opportunity set. So not very narrow – not just equity indices, FX and bonds and REITs, and a little bit of EM for a dabble, but everything. Energy, commodities, grains, Chinese bonds, Japanese value stocks, Japanese banks, and equities in general, including single stocks. I think everything should be included in the broad macro opportunity set, which it was originally, when you go back to the 70s and 80s. And then the industry got more and more constrained, which I think is unfortunate. And now we’re in this extraordinary environment. And I think the stock vigilantes, Bilal, have been showing the bond vigilantes how to think about reflation. And perhaps that’s something we could talk about a bit later on.

How to View Recent Rates Market Volatility

Bilal Hafeez (00:16:30):

Yeah. And I mean, you’ve got lots of interesting points there. But maybe we can start with some of the recent rates volatility that we’ve seen, which has made a lot of people very nervous. And it seems like you’re saying that we shouldn’t get too worried about that. We’ve seen a number of these sorts of flash-crashy type dynamics before, but it doesn’t mean it’s the end of the reflation trade. So, I mean how would you interpret it? People were talking about the UST 7Y auction, where the tail is very wide, and the intraday ranges in 10Y and so on was super, super wide. Does this tell you the whole system’s going to crash? And so, there’s a lot of this sort of sensationalizing around it all.

James Aitken (00:17:11):

I think to be consistent, and this is great, because we’re going to make this practical and tangible, right? As opposed to just high level pontification, which is really important. And I’d say the best way to answer every sort of question like this is, it depends. I know a lot of people like to make assertions, but I try to start from, “Okay, how am I going to be less wrong?” And first and foremost, I need to be calm. And then second, okay, nothing is a given. It depends. And I don’t know if I can give your listeners a precise answer on what happened last week, or talk precisely in terms of how they should respond to it. But here’s how I think about it.

I’m surprised it took the bond market as long as it did to catch up with the reflationary narrative. I mean, if you look into the guts of global equity markets, they have been telling you, not just since November last year when the vaccines arrived, but since last August, September, that we were moving away from a disinflationary world into a somewhat different environment. The performance of different sectors against each other, told you that someone’s voting out there that the disinflationary danger is receding – not past, but receding. So that’s the first point.

The second point is, if one had simply gone short bonds the day the Georgia senate run-off was decided, you would have done pretty well. You would have insured a 10Y note future at say, the equivalent 95, 96 basis points, and it just kept grinding and grinding and grinding. And again, going back to the stock vigilantes, from whom I think we can learn so much. To see the ongoing rotation under the surface of global equity markets, I don’t just mean value as a concept. I mean, the rewriting of energy stocks, which I think has got a long way to go, the rotation away from hyper growth to other sectors, the way that mega cap tech stocks stopped going up, even though their earnings are getting better and better. And they’re going sideways. There was a whole bunch of interesting macro developments under the surface of global equities which were catching my eye.

To be clear, I’m surprised the bond market took as long to catch up as it did. Let’s face it, do we know anyone who does not think that we have six months or so of phenomenal nominal GDP growth, particularly in the United States? That’s a pretty strong consensus view. It would be surprising, don’t you think, if in an environment of the strongest nominal GDP growth that we’ve seen in many years, that nominal long term bond yields didn’t go up? And the central banks are trying to be very brave about this. And I have some sympathy with them. They’re trying to say in their own fashion that higher nominal bond yields are to be expected as the world reflates, but in brackets, high nominal bond yields are okay, just as long as they don’t go too quickly. So, what the central banks are all trying to tell us is, bear steepening thumbs up, bear flattening thumbs down.

So, what am I trying to say? In practical terms, and I sent this to my clients last Thursday night, when I was watching it. My hunch is, that last Thursday was a bit of a flush for a whole bunch of technical reasons. And that my very best guess would be that the bond market does not move much for a couple of months – we’ll sort of range trade. And let’s just use the 10Y note: my best guess is that the 10Y note might oscillate very boringly between 130 and 160.

That’s a complete guess. But the reason for that guess is that there’s a tightness in treasury repo right now, which makes it very, very difficult to hold a levered short Treasury position. That’s the first point. The second obvious point is that the carry and roll down in Treasuries is quite attractive. The third point is that Treasuries have become a useful hedge again, just when everyone’s become an expert on the death of risk parity. If I’ve got a 10Y Treasury, a levered hedge at 40 basis points, that’s not going to help. But on the other hand, a 10YT at 150 basis points is frankly, quite a useful portfolio hedge, not just for the risk parity crew, but for Japanese investors, and others around the world. And the lastly, my best guess is that despite the political pushback, the supplementary leverage ratio exemption will become permanent.

So, my best guess is that last Thursday was a flush, that the bond market, nominal long term bond yields head broadly higher over the next month, as long as nominal growth comes in hot. But I don’t think it’s anything to be afraid of. I think we’d be more worried if long term bond yields did not drift generally higher and what that might imply for our ability to create inflation and muddle through.

The Liquidity Squeeze Around the 7Y Treasury Auction

James Aitken (00:22:14):

And then there’s a related question. The microstructure of too many markets, has never been worse. And that should be no surprise when the cumulative impact of price crisis regulation was to make it so expensive to deploy a primary dealer balance sheet, due to capital leverage ratios. That unsurprisingly, shifted so much of the market making function across every electronic trading platform in every electronic trading market worldwide, to non-bank financial intermediaries and principal trading firms in particular.

In addition, you’ve got this arms race, to lay off risk by the millisecond. And you’ve got these risk engines providing liquidity, trying to understand where the next buy order or sell order is coming from, trying to pre hedge or provide liquidity for that. And they’ve got buy-side algorithms on the other side, which are more and more sophisticated. And some of them are trying to create mischief, frankly. And these market makers, these principal trading firms, and we know who they are, would say, “we’re more astute than our competitors, we got better risk systems, smarter machines this,” that and the other. Yeah, but they’ve all got kill switches. They’ve all got kill switches. And what we saw again, last Thursday night around the 7Y Note auction, is that for whatever reason, something happened that the machines didn’t like, and they turned off until it became clear that a two-way market had been restored. And I’m afraid we’re probably going to see more of that. And it is unsettling to see that, from a regulatory perspective, in a little under a year from when the treasury curve was not functioning at any price, which was the case in March 2020.

I mean, how can you have a financial system if the world’s risk-free curve is not functioning at any price, and we then have a mini re-run of it? That’s not good. And I’ll just finish by saying, I would love to give you and your listeners a precise microstructure explanation as to why all the market makers said, “I’m off, just I’m switching off”. I don’t know, other than they saw a pattern that they didn’t understand and felt that to protect their P&L, they should step back, because their objective is to get to 5:00 PM New York time every day with zero positions. That’s the game. I think it’s unsettling and it would amaze me if there’s not more investigation and inquiry. But would it be unkind to suggest that regulators don’t quite have a good handle on just how a modern financial system intermediates risk?

We know the risk is not in the banks anymore. But where is it? And how actually does it work? And I’ve had conversations over the past three days with important policy makers around the world who’ve been asking me, “Well, what do you think happened?” Now, of course, part of that’s just general market intelligence, chitchat. But they’re also saying, “we’ve tried to look into it, and we don’t know”. Oh, hold on a second, aren’t you the same guys that are trying to do yield curve control? There’s a bit of a dichotomy there, isn’t there? It’s strange and unsettling because we don’t know enough about how these risk engines work. And it’s also unsettling because we expect higher inflation to mean higher interest rate volatility. I mean, why wouldn’t it? Isn’t that going to put further pressure on bid-offer spreads and Treasuries and everything else?

Why Would Fed do Yield Curve Control?

Bilal Hafeez (00:25:55):

Yeah. And in terms of how central bank policy intersects with all of this, obviously since 2008, we’ve had continuous interventions like central bank QE, and now people are talking about some kind of twist-type operation. And it’s just endless. There’s always something going on. I mean, how do you interpret all of this? And is that one of the factors causing some of these issues at the micro level? I mean, is this something that is inflating valuations in markets? I mean, it’s like a Rorschach test, you can kind of take it however you want.

James Aitken (00:26:30):

Yeah, I think that’s well said, I think, look, I think for one particular sell-side firm to state or assert, over the weekend that the Fed has lost control of both ends of the treasury curve is just absolutely silly, right? I mean look, for structural/plumbing reasons that are well known – the draw-down of the Treasury general account (which, by the way, has attracted as much disinformation as anything to do with the plumbing over the past several years) and other structural issues, it’s going to get a bit sticky in the front end. There’s going to be some funny things happening with overnight repo, T-bills are going to trade negative etc. But the takeaway is, though, that if the Fed feels required to do so, they have the tools and capacity to deal with this messiness. And then, at the long end of the curve, I wonder if the clamor for “Oh, the Fed must do yield curve control” comes from a total misunderstanding of how the Fed’s thinking here, what the Fed’s trying to do. The Fed is trying to reflate and then inflate and then be responsible. They would consider it a sign of failure if bond yields did not rise. To some extent, they want higher bond yields.

I wonder whether a lot of the commentary about yield curve control comes from a desire for something to go wrong. It’s like, “Oh, it’s been a while since we had a good old-fashioned smash-up”. Central banks must do yield curve control. Okay, certain central banks are doing yield curve control – we know that. Some banks are so credible in “inverted commas” that the mere threat of yield curve control seems to work. I mean, Japan would be an example of that. It’s remarkable how few JGB’s the Bank of Japan’s actually had to buy over the recent past. So ironically, they’ve got credibility – it’s the threat that matters. But then Bilal, what’s the objective of yield curve control? What are they trying to do? Are they trying to prevent recovery or prevent premature pricing of rate hikes? And I fall into the camp that thinks that the objective of yield curve control, at least to begin with, is to ensure that the markets don’t price in premature hikes.

However, we want to define that because it’s a moving target. And the RBA is probably the leading example of that, although the RBA has the option to buy further out the curve if they wish. And that’s the way to think about it. So, to me, if the Fed was doing yield curve control, my best guess would be that it would be forced upon them in response to the growth ahead being so strong and the upswing in inflation being so strong that the STIR (short term interest rate) markets decide that the Fed’s promise that they’re not lifting off until 2024 is completely wrong, and they have to hike sooner. So, I can imagine the path to that scenario. And to be clear, this is not the scenario. It is a scenario. Again, it depends. The path to the Fed doing shorter dated yield term control – let’s say out to three years, similar to the RBA – would only happen if the market said, “you’re wrong.” And the market would only say to the Fed, “you’re wrong”, if the data ran white hot. So that’s the first point.

Now of course, that might be a bit sanguine. I would have to think that if the Fed did yield curve control anywhere, it would be a particularly bad time for the dollar. But I don’t know yet, I don’t know. If on the other hand, the Fed was much more aggressive in buying the long-end because auctions got a bit wobbly. Or heaven forbid, they had to buy the long-end, because the bond market was malfunctioning again, that would be another type of yield curve control altogether. And I think that would be a very bad scenario. Because the market would then become reliant on the Fed at the long end of the curve. It would serve, you would think, to exacerbate nascent inflationary tendencies or expectations. And again, I think it’d be a very negative day for the dollar. And let’s face it, there’s an awful lot of bonds to be sold. I think it’s a warning sign that last week’s 7Y auction had such a wobble.

And I think, just to be clear on a technical point, I’ve long thought and long told regulators that to include Treasuries and central bank reserves in the denominator of a supplementary leverage ratio was a step too far. I mean, how counterproductive is it when you’re running a reserve targeting regime like the Fed is, which requires ample reserves (I mean, have a look at September 2019), and then you’ve got a regulatory constraint which creates this feedback loop between an ample reserve regime and how private banks are trying to manage their balance sheet exposure and solve for a leverage ratio. So, to be clear, I thought the error of judgment was not the exemption, because I’m confident Jay Powell always thought it was a bad step. The mistake was actually going too far, to include Treasuries and reserves in that leverage ratio denominator. And I would think that after last week, well I hope after last week, there’s enough sensible people in Washington to say, “Look, if we do away with this exemption, if we rescind this exemption of Treasuries and reserves from the leverage ratio denominator, we might struggle to sell some of their bonds.” Right? But so, what do you want to do about it? And in brackets, how are you going to finance all your political aspirations (which are large, wild and growing) if you can’t roll over and refinance your Treasuries at an adequate price? Because right now, you’re getting auction congestion or secondary market congestion.

So, to come back to your original point, I appreciate that everyone’s pretty keyed up on yield curve control, if for no other reason than some countries are doing it. I mean, some jurisdictions are doing it. The ECB in their own haphazard way, are doing a form of your curve control without actually saying it is. And clearly, unlike other jurisdictions, the ECB bizarrely seems to think that higher nominal bond yields are a threat, as opposed to a sign of reflationary consequence, which is an unusual communication strategy. But look, yield curve control, I think, would be a last resort for the Fed. And I hope for a number of reasons that the Fed will never be required to use it. Because I think the circumstances in which yield curve control need to be deployed would be a very unhappy period for financial markets and financial market functioning in general. It would be a very unhappy period. So, I hope they can avoid it.

How Much Does the Fed Really Care About the S&P?

Bilal Hafeez (00:33:21):

And you talked about some of the reasons why people are looking at yield control. But one reason also is that, this jump in yields and rates volatility has coincided with equity markets being weak. So, there’s a narrative in the market that the reason stocks are higher is because we’ve had low yields. So, if yields go up, then stocks go down. And so, the Fed needs to come in to sort of target asset prices, keep financial conditions loose. How do you kind of think about that sort of narrative?

James Aitken (00:33:50):

It’s an important point, because as we’ve all been trained for a decade, monetary policy in this day and age works by keeping financial conditions as loose as possible, lest it take you too long to get back to your inflation mandate. It’s not specified, but it’s obviously clear that [central banks] have viewed the way to create inflation is to keep financial conditions loose, which first and foremost means being mindful of any correction in equities. And look, I know a lot of people are cynical about it, but I’m afraid that’s just the way it is. That’s just the way it is. And I have a little bit of sympathy with central banks who think that they do need to keep financial conditions loose, because in many countries, they haven’t been able to meet their inflation targets for two and a half decades. Now, this magical mythical 2.0%, I mean, we can argue whether it’s the right number, but even the Fed in good times found it very, very difficult to get to 2.0%. Don’t whisper it, but maybe 2.0 is too high, Bilal, too high.

But anyway, look, you’re right about financial conditions more broadly and the FOMC’s reaction function. However, I would also say that what’s people don’t think about the recent market fit (let’s not forget Janet Yellen at Treasury, who, whatever one thinks of her policies, is a very brilliant, talented, collegiate lady) is that I don’t think the FOMC would mind too much if the heat came out of all those meme stocks. I don’t think they’d mind too much if the heat came out of leveraged loans. I don’t think they’d mind too much if credit spreads were somewhat wider. I don’t think they’d mind too much if the stock market came off somewhat – as long as the economic data continued to improve. Now, how do you calibrate “don’t mind too much”? I don’t know. But if the market assumes that this FOMC, in the context of an unfolding, but improving human catastrophe is going to jump in and bail out the first 5% to 10% setback in the S&P 500, I doubt that very much. I doubt it.

And I have to say, I think it’d be wonderful for the world if for any period of time, whether weeks or months, we can actually decouple financial markets and the real economy, even if it’s for a few weeks. It would be the most wonderful, wonderful thing. We have a Biden administration agenda that so far does not appear broadly friendly to finance. And as much as people say, “Gee whiz, the politics of providing a permanent exemption to the supplementary leverage ratio are quite tricky.” I’m not sure about that. Can you imagine how tricky the politics are, if the S&P is off just 10% from record highs? And all these stupid companies with zero earnings are getting de-rated, which is long overdue, and yet the economic data continues to come in really well. And we’re making progress and we’ve got another $1.9 trillion going out the door and then hotly followed by infrastructure and climate spending. I’d just be wary of the narrative that the Fed is obsessed with the S&P 500. And of course, your listeners would be wise enough to realize that the world’s most useless chart, which is the S&P 500 versus a balance sheet, is almost as useful for understanding how the Fed thinks as breakeven inflation is for providing a precise explanation of where inflation is going, right?

How to Hedge Your Portfolio

James Aitken (00:37:34):

There’s a bit of woolly thinking there. And there’s a related point, an important technical point, when we think about portfolios. Now, if one had been a little bit edgy going into February thinking, “Oh, geez, you know, everything’s a bit calm. And yet swaption volatility is on the move”, which it was, particularly in the belly – from six month to five years. There was really something was going on in the belly of the Treasury curve that gave us plenty of heads up if we’ve been paying attention. FX volatility is a bit low and there’s clearly rotation under the surface of global equity markets. I mean heck, when was the last time anyone felt comfortable buying Japanese banks? I mean, hello. And they’re all just going up, right? So, something’s changing out there. Oil is on the move.

Then I think, “Gee whiz, I can’t afford to be out of stocks, but I think I’ll hedge.” Oh gosh, implied vol and skews, way too high. But even if I’m hedging stocks and I get it right, I might not make any money because implied vol suffers. What’s left? Credit. Oof, broadly speaking for the first time in decades, US investment grade credit spreads are so compressed that the real return on US investment grade credit is negative. Now, we have to go back to the 70s for that. So, if you’re adding to US investment grade credit at current spreads, it’s a pretty big call.

On the other hand, the flip side is, you say, well, the cheapest portfolio hedge is credit. So, you start getting crafty. You pick up the phone to Boaz [Weinstein], who’s the great genius of all of them, I mean, truly brilliant. (And in brackets, I’ll just diplomatically suggest that. When I hear Bill Ackman speak, I hear Boaz’ voice. I’ll just leave it at that). But a serious point, you say to yourself, “I’m going to be very clever. I’m going to buy credit protection; I’m going to buy credit index protection as a portfolio hedge.” But hang on a minute, that doesn’t make any sense. It might work. And it will work because spreads will widen. But if you expect nominal GDP growth over the next six months to run white hot, it would be illogical to assume that credit defaults are going to go up a lot. It doesn’t make any sense. But spreads may widen, sure. In fact, if we’re going to have a recovery here and nominal bond yields are going to go up and interest rate volatility is eventually going to go up, mathematically, credit spreads are going to come out a bit. So, I think it’s a tricky time because some people argue about crypto. But it’s a tricky time to find portfolio hedges right now other than cash. But by golly, the timing of any decision to be out of these markets, amidst a rampaging bull market, it’s really, really hard to do.

James Aitken (00:40:18):

So therefore, what I am observing and seeing and talking about with clients, is the hedge is not, “let’s be cute and clever”, and hedging equity portfolio with rates vol or hedge credit with equity. I’ll do all this and end up with a portfolio of cross correlated hedges, which is nasty. But the hedge is to rotate within equities. And it’s so obvious, and yet we’re seeing it every day. And today’s the classic case of it. People are saying, “Wait a second, why do I own hyper growth stocks?” And I’m not talking about Amazon, by the way, Amazon’s a very special beast that everyone’s trying to extrapolate, right? But these hyper growth meme stocks trading on vapors, with impossible to beat base rates and earnings comps assuming they have any, in a world where discount rates are going up, makes no sense. So, might I be advised to rotate into quality growth, which is great businesses that have just been sitting there not moving at all, even though the earnings momentum is building, and they’ve got the classic ESG and EV credentials.

James Aitken (00:41:27):

And to make it practical for your listeners Bilal, I’ve been looking at BMW and Volkswagen for months, and it’s kind of like someone’s nailed them to €70 and €170 per share. And it’s like, I don’t get it. These guys have invested so much in EV and are great global brands. Okay, don’t talk to Volkswagen about diesel scandals, because it might not tick an ESG box, all that kind of crap. Doesn’t matter, great businesses. And then suddenly, in the past 24 hours, they’ve caught fire, and UBS has even upgraded Volkswagen, bless them, to €300 a share. But the point is, it’s very tempting to be some kind of macro professor and tell people that they should do this hedge or that hedge. And as you and I know, so well, the best hedge is the simplest hedge that’s right under your nose. It’s the one right under your nose. I’ll give you another topical example, practical example. The world’s best reflation currency has been Sterling, how about that? Simple vaccine related recovery trade at a time when UK equities on a blended relative basis are still as inexpensive as they’ve been in decades. Still, what are you going to do, right?

James Aitken (00:42:50):

And believe it or not, there are some great UK listed global brands. And I think that’s the key message I’m trying to impart to clients. And let’s share a little bit of a story, I don’t want to make it too dull or too macro. But I remember a few years back, a very impressive Tiger Cub (investor who has spun out of Julian Robertson’s Tiger Management) who I’ve been working with 15 years – a great friend and extraordinary investor. I won’t go too much into his portfolio, but it’s all sorts of assets, public and private, all around the world. And gosh, I have to say, and he knows this, that I’ve probably learned more from him than he’s learned from me. But there was one thing I helped him with a few years back.

He rang up and said, “Ah, man, I’ve just been at this amazing Goldman Sachs macro dinner with all these hedge funds. Wow, what’s a euro dollar future?” And I’m like, “Listen to me, stop right there. Have you heard Warren Buffett’s parable that ‘if you’ve been in a poker game for a while, and you still don’t know who the patsy is, you’re the patsy.’”? He’s like, “Yep”. I said, “Look, I looked at your last 13-F file and I know what’s in your portfolio, you have some of the greatest assets in the world in your portfolio. And you want to start dabbling in euro dollar futures?” The DV01 one that you’d have to run in your euro dollar position, or your mid curve options to make any difference to the portfolio you’re running today, is so huge that you would be the biggest player in the market, and dare I say the most naïve. And he’s just like, “Thanks.”

That’s an example of, and I fall in this trap a lot, of trying to be too clever. So, for me, it’s not trying to pick a top in equities. It’s just trying to understand how the world is evolving. And again, in macro, there’s two sides to the distribution. We’re on the front edge of a pretty powerful reflationary impulse, to put it bluntly, that may yet turn into inflation, which is something nobody’s had to think about for a long time.

And whether one believes in inflation or not, I’m not sure is the point. If you think the probability is rising, then I think it’s wise to think, “Hold on a second, I should scrub my portfolio here.” What’s a bit heroically priced? What are the YOY comps? Might I not be better off rotating into tangible stuff and away from some of the fully priced intangible stuff? And people go, “Oh, gosh, you’re so bearish.” No, it’s not that at all, it’s not that at all. It’s just that I’m trying to figure out how to stay in the game and keep up with the play.

But look, the serious point is that, it goes back to something I said earlier, the reason I’m running through this is because all I’m trying to do, every time I correspond with clients, or talk with clients is, I’m just trying to be less wrong. I’m just trying to be less wrong. And I think in a world that’s shouting at itself all day long, particularly on what’s increasingly becoming the sewer of financial Twitter. I wonder whether there’s an opportunity for guys like us and Juliette [Declerq] and others we know so well – the local crew. I wonder if there’s an opportunity just to be sensible, and calm, and proportionate, and to play the long game. Because if we can do all that, we’re going to be fine. No matter what happens, we’re going to be fine. So, I think the key message I’m trying to impart here is, that as much as my background obviously was in FX, and rates and credit and plumbing, you have to be well-aware of what’s happening, and what the stock vigilantes are telling you. Because in this day and age, there’s an awful lot of macro-economic information that can be extracted from rotations under the surface of global equities.

The Importance of Stock Vigilantes

James Aitken (00:47:03):

And to be very clear to your listeners, it’s not just, “Oh my gosh, something weird happened in Japan today in the TOPIX” or Hong Kong or Taiwan. This is happening everywhere. It’s happening in Australia. It’s happening in Japan. It’s happening in pan-Asian equities. It’s happening in Europe, it’s not just the US. And when you see those consistent patterns, and I am of course talking broadly about factor risk, which is so important and badly understood, or at least badly managed. And you see these consistent patterns where the most shorted value stocks are levitating. And the least shorted growth stocks are getting de-rated every day, that’s a powerful sign that something’s changing.

And actually, while it occurred, what I should do when we finish is send you the two charts, which are two Bloomberg things I’ve been eyeballing for six months. I think they can be quite useful for your listeners or on your site. Something pretty profound is happening under the surface of global equities. And to be clear, I’m not saying, “Oh, it tells us that x is a given”, maybe, maybe not. But it does tell us that something big is changing, right? Whether it be attitudes to rates or attitudes to reflation or inflation or earnings or global brands, or people moving away from the edgy stuff into safer assets. I don’t know. But it’s so interesting to see it happening around the world.

Bilal Hafeez (00:48:31):

I mean, I like your phrase, stock vigilante. There is an impression, especially if you come from a fixed income background, like ourselves I guess, that you kind of look down on equities. You kind of think that fixed income as the leading edge of markets and equities aren’t as sophisticated.

James Aitken (00:48:49):

I think you’ve put that extremely diplomatically. Are you suggesting that the median equity market participant doesn’t do macro very well? And they might not understand collateral and repo? How dare you?

Bilal Hafeez (00:49:00):

So, on the stock vigilante side, I mean, what you’re saying is that actually, now’s the time to listen to stock markets and…

James Aitken (00:49:10):

100%, and you’re dead right, mate. Because you and I were spoiled growing up in such interesting work environments, surrounded by immensely talented people who took the time to explain to you and I how things worked. And that’s so helpful when you’re developing your career. And look, you have to learn. You have to adapt. You can’t be the man with a hammer. And I think because of the events of the second half of 2007, in particular, when anyone with any remote understanding of credit and structured credit, knew the game was over by June 2007. And then over the next two months, the stock market ripped to a new high, right? Which is just nonsense.

And even February last year, it was clear that we were heading into a pandemic and the first two weeks of February last year, didn’t the stock market just rip? There’s a temptation to say, “Well, those people know nothing.” But to be fair, was the rip in the third quarter of ’07, was that active fundamental investors? Or was that machines? And the first two weeks of February 2020, maybe it was just mechanical asset allocation flows or whatever. And it’s something that I remind my clients frequently: no matter what our mandate, no matter what our experience, no matter how clever we are on micro or plumbing, or credit, or spreads or swap spreads, we can go down the list – no matter how well-versed we are, we must pay respect to our colleagues at the bottom of the capital structure.

The Investment Opportunity for Digital Infrastructure Companies

Bilal Hafeez (00:50:48):

Yeah, and I wanted to kind of just ask you something on, obviously, we are seeing this move away from some of these high-flying tech stocks and intangible markets and so on. At the same time, what the pandemic has done is, it’s accelerated the adoption of lots of different technologies. And so that feels like that’s something meaningful and something real, that’s going to change the structure of economies. So how do you kind of square the circle there that, on the one hand, this has happened these technological changes happening, but then on the other hand, let’s focus on energy and banks or whatever the other kind of the value side of things are?

James Aitken (00:51:25):

Yeah, you’re right. Yeah. And you’re dead right. Because you don’t want to just be flipping and flopping your portfolio, as a bottom-up equity investor based on evolving macro themes. First and foremost, any decision to pivot or tilt or rotate a well-invested equity portfolio has to start from the bottom-up, it has to start micro. And then you sort of think about the macro environment we’re entering, as opposed to the other way around. I don’t want some of the extraordinary long-only investors I’m lucky to work with, to be thinking too much about macro. That’s my job. That’s why they pay me. And nearly always, it’s like, “Oh, I heard this from Goldman, I heard this from Deutsche, I heard this from JPMorgan, what do you make of it?” And my answer, if I know them well enough is, “Look, I know everyone’s excited about it, just don’t worry about it.” It’s not material and this is why.

Now, you’re asking a key question. The way I think about technology is that the combination of COVID and very low discount rates has acted like a tractor beam to pull forward all these innovations from the future. And I’m open-minded about working from home versus working in an office because I’ve worked from home for 12 years, that doesn’t worry me. But I can fully understand how big businesses need that collegiate in-person environment to actually be at their best – I get that. The point is, I’m a tiny bit wary of this narrative that working from home is here to stay. But the fact that we have effective vaccines – that blew my mind. It blew my mind, because as best I can tell, we now have a plug-and-play response to pandemic. Wow. Now, that is phenomenal. In terms of ordering things online, take away dinners, meal kits, whatever. Maybe we view our relationship with restaurants differently and how we shop.

And most of all, it’s surprising just how low the penetration of e-commerce still is, at percentage of retail sales. And I know you’ve looked at the numbers, mate. But I mean, the UK is way out in front, (depending on if you factor in the COVID spike). But let’s say the UK e-commerce as a percentage of total UK retail sales is something like, I’m going to say 29%. France is 4%, right? The US is, I may get this wrong, I’m going to say 25% and obviously rising. We say to ourselves, “There is no way Amazon could get bigger. There is no way a Square [payment technology provider] could be more important. There’s no way that payment companies could grow further than they are.” Wrong! That to me is one of the most obvious macro or technology theme. The real issue when you’re thinking about payment companies, Amazons and all the others is the digital infrastructure required as we become more and more comfortable doing things in a digital way, whether it be doctor treatments or doctor engagements.

Can you imagine Bilal, the benefits to the long-suffering NHS, if it turns out that nearly 75% of doctor appointments are unnecessary? And it goes on and on. So, I’m not sure how to answer your important question in a sensible way. Other than thinking that, if I can find a way to partner my savings with the companies that are going to be building out all the essential digital infrastructure in every direction. Amazon at the right price, Adyen in Europe at the right price (though the right price might be a long way from where we are now, I don’t know). These are the companies that are going to provide the backbone of everything we’ll do for the next several decades. So, it’s a tricky one, isn’t it? Because if you’ve owned Amazon for 10 years, you don’t care. If you’ve owned Amazon for 12 months, you do. If you’ve owned Adyen since the IPO, you’re drinking Cristal every night or having a good old time. But if you bought it in the last year…

So, it’s really a valuation judgment call. In practical terms, for Adyen, to use an obvious payment example here in Europe, it’s a question of whether they can meet their year-on-year comps, which are very stretched. Maybe they can’t, I don’t know. But the idea that one could be short an Apple, long in cash, or a more volatile investment like PagSeguro in Brazil (phenomenal company if you can stomach the volatility). And eventually people will realize there are great technology businesses in South Africa. One thing that’s been on my mind for a long time, and this is maybe a separate podcast, because it’s such an enormous topic, is China’s DCEP (digital wallet) project – it’s a huge topic. And investment in Alibaba. Wouldn’t it be wonderful if India listed their equivalent of Alibaba, right? Imagine that.

Because it would give the world an option, should the infrastructure of the Indian financial system be able to absorb the flow. So, I think about that a lot and as you can tell, my response is not terribly sophisticated. But I’m just drawing up a list and it’s a bit like the BMW and Volkswagen examples. So boring and so obvious but I feel I can understand it and I feel like I can articulate the why to my clients without looking like even more of an idiot. That’s the challenge for you and I and our listeners is, how can I play the long game by partnering my savings with these essential businesses at the right price? And to put it in strategic terms, if the bond market gets out of control this year, because right volatility goes up several deltas, and a whole bunch of these payment companies and others get shaken down or de-rated 20%, what are you gonna do? You’ve got to buy.

The Different Channels of Inflation

Bilal Hafeez (00:57:37):

And on the inflation point. Yeah, one thing I always kind of think about with inflation is, I can kind of see there’s all sorts of base effects and we could see some inflation this year or even next year. But then I kind of look at say China, Japan, your area which kind of make up a significant part of the world economy and the picture there doesn’t look that inflationary. So how much of an inflation regime are we really in right now?

James Aitken (00:58:04):

It’s so tricky. To set the scene I know people are inclined to make, and I don’t mean you, but I know people are inclined to make brave assertions. For example, M2 is up X% year on year, here’s an inflation chart [on the relationship between M2 and inflation] and therefore inflation must go up. I find that absolutely useless. Look, we will get higher inflation but how much higher, I don’t know. I really don’t. But for the benefit of listeners, here’s how I think about it. At the most basic level, and thinking through the eyes of central banks (let’s take the Fed, because it’s the obvious one) – if you expect core PCE to go up and stay up and accelerate… If, let’s say through September and the fourth quarter of this year, core PCE in the United States will remain above 2.3%, 2.4%, you are implicitly saying that, given they are the two biggest components of US core PCE, that housing is going to roof it and healthcare costs are going to surge.

Now I know it’s more complicated than that. But that is the essence of the argument. So, in other words if you think core PCE, which is the Fed’s beloved measurement, is going to surge all the way into 2022, you implicitly have a really strong view that they’re going to create another housing bubble and that healthcare costs are really going to stay up. Well, it’s hard to create a housing bubble when you’ve got much tighter regulatory constraints than a decade ago and the bond yields are rising. That’s a tricky one, so that’s the first point. And the second point is, I very much doubt that a Biden administration and the politics would conspire to drive healthcare costs up. Because that would create a riot in democratic caucuses. So, my base case is, yeah core PCE up but I’m not sure whether that’s sustained or not. But then, that leads me to my other point: it’s not all about core PCE.

Inflation is a story of inflation expectations. If enough people decide inflation is going up, it’s going to go up, right? It’s a psychological thing. And unsurprisingly, when we look across the surveys, we start with the University of Michigan. And we look at the latest data on one-year-ahead inflation expectation – University of Michigan has it at 3.3% and it’s up smartly. I look at the same thing in the Philly Fed business surveys, Atlanta Fed surveys, they’re all pointing in the same direction for one-year-ahead inflation expectations. Good. What has not moved so far is longer-run inflation expectations. So, the University of Michigan has 5 to 10-year-ahead inflation expectations (Lord knows how the respondents can even determine it) up a little bit. But is basically looks like an ECG graph of a very sick patient.

Bilal Hafeez (01:00:57):

Yeah, it hasn’t really moved up in a meaningful way. Yeah, yeah.

James Aitken (01:00:59):

Yeah, yeah probably the wrong metaphor at this particular moment. But it’s not much movement there. And I think that’s something we have to watch. But there’s something else related to inflation expectations that’s on my mind because inflation can happen slowly and then suddenly. That’s the lesson of the 60s and early 70s. Normally, it takes an awfully long time to get inflation expectations up. But as we’ve seen of late, memes, memes stock investing, crypto memes, Elon Musk, the great P.T. Barnum of our age. You can create memes and you can create crowd sourced convexity, as I like to call it, in pretty much anything you want, certainly in stocks. And it would be no surprise to you or your listeners, that foreign state actors are having so much fun getting involved in this, on Reddit boards, on Twitter, the bots. Why is Bitcoin Twitter so vile? Because most of it is bots. It’s some guy out there in a suburb of Beijing or Kiev on a keyboard just like, “I can’t believe they’re letting me do this, creating strife.” The point being, how long is it before people hit upon a shitcoin meme for the dollar? “Oh, the dollar is a piece of crap”, #shitcoin I can see that.

And how easy would it be if inflation does start to perk up, for people to exacerbate that by steering people’s attention on social media towards price rises across all sorts of things? Maybe it’s become much easier to influence inflation expectations in 2021 than it might have been between 1966 and 1973. Now I don’t know but I’m wondering about the macro implications or the spillovers of all this meme stock stuff. Classically, this is groupthink on steroids. But who knows how it could ultimately influence expectations of economic outcomes? And you may recall, Robert Schiller wrote a book in 2019, called Narrative Economics. I think that’s a very good one to read. Now look, there’s another component, the final component, which is wages. So, core PCE – meh not sure how high it can go, inflation expectations possibly easy to manipulate or snowball – but don’t know yet.

The Unexpected Impact of US Fiscal Policy on Wages

James Aitken (01:03:34):

But wages is where this gets super interesting. Now let’s use a metaphor here, which is Australia. Going into this COVID mess, wage growth in Australia was anemic and already of concern to the RBA. The Australian economy is doing better earlier than the Australian authorities thought, which is good news. But the wage growth is still anemic, even though Australia is coming back online, a bit earlier than other parts of the world. And the underemployment rate in Australia, unsurprisingly, is still very high. And I want to keep that in mind, because Australia is not the same as China, it’s not the same as India it’s not the same as Europe, it’s not the same as the UK, right? Because in the US in particular, they’re still going forward in fiscal policy. While other jurisdictions, they’re sort of trying to dial it down a bit, manage fiscal expectations, as we saw here with Rishi Sunak yesterday, or at least attempg to. But look, here’s the thing, if we pay people not to work, they won’t, right?

That’s the number one problem in the United States, because the combined generosity of federal and state unemployment insurance means still, that tens of millions of Americans are earning more from staying at home than they did in their previous jobs. And if you look at the $1.9 trillion Biden fiscal plan, it looks like they’re going to give them even more money to stay at home. That’s not the textbook way of getting people back to work, unless employers decide to bid up for labor, which is something we’ve not seen for many decades. I mean it’s been a long, long time since labor had any pricing or bargaining power vis-à-vis capital. You’d have to go back to the 70s. The point is that it is a given that we will see some pretty substantial wage rises in key sectors required to get the economy reopened, okay?

It is inevitable that in essential sectors, that some companies will have to bid up for workers because per the Fed’s beige book last night (it was very interesting – there was commentary about business costs and hiring that you haven’t seen for a long time) about how hiring costs are going up already. So, you say to yourself, it would be unusual not to see some pretty substantial wage increases in the third quarter. How that breaks down by sector and demographic, I’m not sure. But it’d be a highly unusual combination for policy makers and investors if you had core PCE stuck (this is a guess) at 2.4%, long-run inflation expectations rising in a way we hadn’t seen in decades, supply chain bottlenecks which are a given as well, and month-on-month wage growth that we haven’t seen in many, many, many years.

In other words, do we inadvertently discover that the Phillips curve is alive and that long-run equilibrium NAIRU post-COVID actually, shockingly turns out to be higher? Now I don’t know, I really don’t know. All of that is pure theory to be tested when the economic evidence emerges. But if you and I are having this conversation, I’m sure all your listeners are thinking about these topics and every asset allocator in the world is thinking about these trade-offs. And dare I say, it goes back to our earlier discussion which is, “Do I get all clever and I hedge and I go out there and whack every bid in bonds or whatever? Or, do I just say to myself, ‘Gee whiz, I think this is going to get a bit hot. I think we’re going to get for some period of time higher realized inflation, don’t know if it’s a permanent change or not, but can’t just sit there and wait for the event. I have to just start ducking and weaving a bit today.’”

And look, I wish I could be much more assertive and precise on inflation outcomes, Bilal, but I’m afraid I just don’t know. For what it’s worth my client base is split between frankly, “don’t care” because life goes on and we’ll find a way to muddle through or “it’s going to run hot”. There are no disinflation-esters, if you will. It’s like, no, no this is either gonna run way too hot or muddle through this. That’s it.

James’s Productivity Hacks and Books

Bilal Hafeez (01:08:09):

Now we’ve covered so many topics and I’d love to talk about more topics, but I’m cognizant of the time I’ve taken of you. So I’m going to kind of wrap up our conversation with some of the personal questions I always like to ask. Now you’re one of the most well read people I know and not just well read, but also you always talk about stuff that no one else is talking about. You mention a book or an article or this or that, that I haven’t seen anyone else talk about. So I kind of want to know what’s your process, where do you find all this stuff? How do you manage your kind of your research in flows or the inputs to you?

James Aitken (01:08:45):

I’m glad you ask because I think the common thread across all the greatest, most successful, long-lived investors I work with, is their absolute obsession with process. And I know you talk about that a fair bit which is wonderful. And I won’t name him but we have, or had, a leading example of that for a long time in Wimbledon Village. I mean a truly, truly phenomenal trader, who was obsessed with process. And boy, did that work out for him. And I’m not saying he’s the only one but he’s the obvious one, right? And I thought, I’ve been lucky because I’ve always liked reading and it goes back. Why do I read so widely? And the answer is because I have to, I have to. And it goes back to working through the night at Macquarie Bank in Sydney on an Aussie dollar-focused trading desk listening to all those brokers links coming in from all around the world. Like the famous Lasser Marshalls Dollar-Mark A Desk, which would mean nothing to anyone under the age of 50, right? That was the epicenter of global currency markets. And you’d hear these huge flows and they were talking about economic data with their mates.

And I thought well I know nothing about that, I know nothing about the Spanish peseta, I’m going to have to learn. And then I’d do a briefing note – I was in my early 20s and I’d have to write up a note for my colleagues who were coming to work during the day, explaining what had happened. And they loved it. And then Notes from a Small Island, which is my calling card, my publication, actually started 25 years ago in Sydney. And then during the Asian crisis, I was trying to explain to my colleagues in Chase Manhattan FX around the world, about what was happening in Asian markets, what flows we’ve seen and why it mattered. So, you had to be able to synthesize all these different points of information and importantly leave out everything that wasn’t. So, it’s out of necessity and I’m very lucky that I’ve always liked to read.

And you asked me just to set the scene about some of the earliest books I read and how they impacted me. And one of my absolute favorites, which was a present on my ninth birthday from my parents, was The Adventures of Sherlock Holmes. I just love it to this day. I just love it. And the deductive logic, the heuristics, I find myself often re-reading that because it’s just so damn good. It’s so damn good and there’s a book behind me written by that remarkable woman Maria Konnikova written a few years back, she’s written a couple of books now, but this one was written a few years back, How to Think Like Sherlock Holmes. Oh, it’s wonderful, it’s so wonderful. There’s such application for investing. So, I was fortunate that I always liked reading from a young age. But my reading really accelerated when I started in the business, right?

Actually, there was another really important step and you’ll appreciate this I think as much as anyone. I was rejected, as you know, after couple rounds of the merger with JPMorgan Chase and I ended up at AIG trading in early 2002, and you think, as you do when you’re 31, “Oh gosh, I really know a lot about the world.” And I started working with two very remarkable men. One was Bernard Connelly who’s a very, very dear friend and brilliant man and the second was Sir Allan Walters. Sir Allan had this remarkable ability, and he was in his mid-70s then and he’d been worn down by Parkinson’s, but any time a pretty young lady appeared on the AIG trading floor, miraculously Sir Allan would emerge from his office. And I don’t know how he did it, but he’d walk past with a cheeky grin on and I just thought, “God love him”. His Parkinson’s has slowed him right down, but there you go.

But the point is, seriously, they were both brilliant men and I’d go into meetings with them and they’d start referring to these books or these economists or this or that. And I’m like, I don’t know anything. Seriously, I don’t know anything. I’ve got to start reading what these guys are talking about. So, my reading went up a notch and then when I started the business 12 years ago, my reading went up a lot, why? Because I had to, because I had to. If I’m going to do the right job by my clients and be of value to them, that’s the key thing, be of value to them, I need to read widely.

Bilal Hafeez (01:13:04):

And do you have, I’d like to get into the weeds here because I admire this about you. I mean do you set aside a certain time during the day when you do your reading? And then secondly, where do you find this stuff to read?

James Aitken (01:13:18):

This will sound strange for someone who’s allegedly a macro strategist. But I took a subscription several years ago to the Times Literary Supplement, and I love it. Oh my gosh, there is so much diverse stuff in there. I obviously have recommendations for my clients, I speak to policy makers, I read research, academic research, it just depends. In terms of a reading routine, I’m very fortunate because when I get into a book, nothing else matters. Nothing else matters. I give every book 100 pages, which is completely arbitrary. And if I’m not getting it after 100 pages, I just set it aside and I recycle it, right? Or resell it or give it to charity, because life’s too short to read bad books. But then there’s other books that I just pick up, and I’m so into it. And I’ll just stop and I’ll read that book, from cover to cover on a given day. I try to do the bulk of my reading in the morning, ideally, before I even look at email.

So, to go back into first principles for me, I start every day with a Bloomberg screen and prices. Because prices are how you and I are judged. Or as one guy I love in Chicago puts it, “We’re all judged by the hard right edge of the screen.” I love that, right? We’re not judged by what has happened. We’re judged by what’s next. And I just think that’s a great metaphor for thinking about risk in general, the hard right edge of the chart. And I look at price first, I think on price. And to be frank, most days, you go through all the Bloomberg worksheets, you look at all the price alerts that you might have got through the night, things about where they are. Nothing really out of line. Although more recently, there’s quite a lot of things in motion. So, Bilal, it’s like, Okay, got a feel for markets, I’m not going to go into email, because I’m going to end up in a rabbit hole for two hours. And it’s a bit of a risk. Because even if markets are not moving, I might have some correspondence from clients. And obviously, that’s important.

I eyeball the client correspondence and I set it aside until the afternoon. So, I want the morning to be for prices, to be for reading, to be for thinking and ideally, the workout of the day, right? And unsurprisingly, the more disciplined I am, the earlier I awake, the more I get done without fail. Easier said than done, when you’ve got weeks like last week, that’s fine. So, there’s no hard and fast process for reading. But I try to do the bulk of it in the morning, and unfailingly I read myself to sleep. I have at least two books on the go all the time. I should also add there’s a blend of hard copy and Kindle, mainly hard copy, although I don’t mind Kindle at all. I think the way you can highlight stuff and share it with people is actually really, really good. The way you can annotate and search for keywords across your Kindle I think is great. I should do more of it. Why do I read so much and why do I read so widely? It’s because I have to. And that’s important to ensure that my clients continue to value my input.

And here’s the key. On an average day, every single reader, and every one of my clients probably receives 1,000 plus emails. It could be compliance, it could be marketing, it could be another diversity and inclusivity training exercise, don’t get me started. It could be sell-side research, it could be whatever, right? The point being, the people that you and I are working with and have worked with, are massively time constrained individuals. On a good day, if they’re lucky, and it’s actually harder if you’re working from home, especially if you got a small family and homeschooling, on a good day if an investor can get an hour to herself or himself distraction free, just to think, they’re doing really well. And as much as I’ve long believed that I’m trying to educate and inform people about what I think is happening in the world and how they should think about it. In practical terms, I’m trying to solve a massive time constraint that they all face and therefore no flowery language.

I know we’ve talked for a long time, but this is just to share the idea. No flowery language, no word salads, say what’s on your mind. Explain why it’s on your mind. Tell your clients why it’s important. Tell them how to think about it. Tell them while it matters, and then tell them again so they’re in no doubt, right? And you have to do that. And some people say, “Oh J.A. you’ve been hammering x, y and z.” I’m like, “Good, I just want to make sure that you understand where I’m coming from.” So, to me, there’s a whole flywheel of reading and thinking and synthesizing information. And at the epicenter of that flywheel is how to be less wrong. That’s the epicenter of the flywheel. And it’s a constant battle as it should be, because the world changes and evolves. And again, I’m very lucky, we’re both very lucky to work with extraordinary people around the world. I mean, brilliant, brilliant investors, who have found a way to thrive through thick and thin, are generous with their time and their support both financial and psychological and helpful, just friends, in other words.

And what a privilege it is to work for them all. But I’m under no illusions as to how time constrained and how distracted they too often are. It’s really hard. And I hope that my clients going forward are able to take a day a week at home, or in the local cafe with their headphones in or to find a niche where they can just sit and think and be still in a world that is shouting at itself all day long, right?

Bilal Hafeez (01:19:02):

Yeah.

James Aitken (01:19:03):

And I think, a bit of self-interest afoot, but I think that’s where you and I can provide some help.

Bilal Hafeez (01:19:10):

Yeah. And then on books, just last question. You mentioned Sherlock Holmes books, which sounds great. Are there any other books that have stood out for you maybe recently, or that have really influenced you over the years?

James Aitken (01:19:23):

My problem is that there’s so many of them. I really wish I could be precise. But look, there’s the obvious finance books that I think people are well aware of. I mean, the Jack Swagger books got me so fired up about finance in the early 1990s. His Market Wizards has some wonderful, wonderful stuff. I’m just going to throw a couple out. There’s another book by Donald McKenzie, published in 2006 called, An Engine, not a Camera. Absolutely brilliant book. I think too many of the books that people hype about finance are not that useful. The recent book on Renaissance Technologies was remarkably light on insight, which may have been the whole point. I’m not sure why people were terribly excited by that. But look, if you gave me a week or so, I’d be happy to put together a list and share it with you. And then you can put it out.

Bilal Hafeez (01:20:26):

Yeah then I’ll blast it out, yeah that’d be great, I’d really appreciate that.

James Aitken (01:20:26):

But I’ll just say for the sake of time, mate. I connected several years ago with an extraordinary man in Ottawa called Shane Parrish of the Farnam Street blog. I’ve learned a lot from Shane and with Shane. And I think the way he curates, as he put it, the best of what everyone else has already figured out, is absolutely superb. It’s a brilliant, brilliant idea. And look, I don’t know what I’m going to read next. I have a very large unread library of books, as you might call it, an anti-library. From time to time, you stare up at the shelf and think, there’s about 196 books there waiting for me, but that actually keeps you humble. Because you think, “Man, I’ve got so much to learn.” I’ve got to learn. And to this day, even this week, I’m like, how could I not know about that? How could I not know about him? How can I not know about that event? or How could I have not thought about that market perspective? I mean, I guarantee that every time, well I know this, every time I publish something, I’m like, “Ah, dang, I thought about, I forgot that. I meant to mention that.” Or a client will come back and say, “James, did you mean to write…” I’m like, “Oh man, that’s the dumbest thing I’ve ever write…” And that’s part of the challenge.

But look, here I am 12 years on, it’s been an extraordinary and fortunate experience. Like you, I’m just a guy who loves what he does. And is fortunate to have some phenomenal supporters from all around the world, most of whom are completely anonymous, and certainly not on financial Twitter. And look, if I can keep a quarter of a step ahead of them all I’m doing immensely well. But realistically, if I’m half a step behind, that’s probably not too bad.

Bilal Hafeez (01:22:10):

And in terms of I mean, I think your work is exceptional and I would kind of urge people to really follow your work and subscribe to your service and everything. So, at the same time I know you’re a quite private person, it’s actually quite hard to get hold of you. But how can people get in touch with you to kind of get access to your work?

James Aitken (01:22:31):

It’s very kind of you to mention that, and I appreciate it. And I just want to be clear to set the scene because my business is very different. And there’s never been any marketing and it’s always been word of mouth. And it’s always been a premium service. And it’s been a premium service in the eyes of my largest clients, most of whom I’ve been working with for over a decade. That’s the market clearing price of it, the market clearing price of my input is high. I just don’t want to give anyone any false expectations. If you want people to jump up and shout and point at lines on charts and yell at them again and again, you can get that, that’s not what I do. I publish once a week or thereabouts if I think there’s something to say. And if there’s nothing to say, I don’t publish, it’s quite simple.

I should have also mentioned I send out booklets every year to my clients to thank them for their support. And so far, Bilal, over the past 12 years, I’ve sent out 2,650 books to clients on various topics. And yeah, I mean, it’s just to encourage them to read. And it seems like I’ve started a few corporate libraries, which is great. But look, that warning aside, my client base pays me handsomely for which I’m very, very grateful indeed. And it tends to be institutional clients with large research budgets. But look, if people would like to track me down and have a bit of a chat about how I may support them, then I’d be pleased to engage in that discussion.

I think the simplest way is just to send me an email, which is [email protected]. it should be strictly speaking, it should be E-R-S, but I don’t know what I got wrong when I set up the business. But yeah, [email protected] And we’d love to have a discussion to see how we might work together. And look, the very final point is, not wishing to jump too far ahead, I don’t actually do free trials in the interest of protecting my existing clients and our collective intellectual property. There are no free trials. But look, let’s see what happens.

Bilal Hafeez (01:24:48):

Yeah, no it’s good that you’ve kind of contextualized your work. I mean, a large chunk of our audience actually are people at institutions. So hopefully, there should be some people in the audience that kind of meet those criteria.

James Aitken (01:25:00):

We’ll see how we go, but I’m just grateful for you to make that suggestion. So, thanks to you, brother.

Bilal Hafeez (01:25:04):

Well, on that note, I mean, it was fantastic speaking to you. I mean, we’ve gone over kind of my usual one-hour mark, I think. We could easily speak for a few more hours, and which basically tells me that we have to have a follow up podcast at some point. But it’s been great chatting to you.

James Aitken (01:25:20):

Likewise, mate, it’s good to see you and I look forward to catching up in person and well done. Because, look, I know I said at the top, but what people see is your output, but they don’t see the input. And again, you should be really proud of yourself, brother because I’ve had a vast number of people approach me over the past dozen years, saying “Oh, how do I do this?” And very, very, very few have the courage to follow through and you have. So well played and more power to you

Bilal Hafeez (01:25:49):

Yeah, that’s great. Thank you very much, James.

James Aitken (01:25:51):

Good on you, mate.