Podcast Transcript: Jurrien Timmer on S&P to 8,000, Ukraine Fall-Out and Bitcoin Allocations

This is an edited transcript of our podcast episode with Jurrien Timmer, published 4 March 2022. He is the director of Global Macro at Fidelity Investments, one of the largest asset managers in the world. He is part of Fidelity’s Global Asset Allocation group, where he specialises in asset allocation and global macro strategy. He has held various other roles at Fidelity, including director of market research and technical research analyst. In the podcast we discuss, how the Russia/Ukraine conflict will impact markets, how to fit crypto into your portfolio, the importance of real assets like commodities and real estate, 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.

Introduction

Bilal Hafeez (00:01):

Welcome to Macro Hive Conversations with Bilal Hafeez. Macro Hive helps educate investors and provide investment insights for all markets from crypto to equities to bonds. For our latest views, visit macrohive.com.

The Russia-Ukraine conflict continues to dominate markets. The latest situation are the aggressive sanctions imposed on Russia. Sanctions on the Central Bank of Russia are almost unprecedented. We’ve never seen them in the case of a central bank member of the BIS. Markets have taken notice with a notable surge in oil prices. And we’ve been covering this in all its dimensions. We’ve written on what we think are the short and long-term consequences of the conflict. We’ve written explainers on complex topics, like what is SWIFT, and we’ve looked into whether Bitcoin will end up getting a boost, out of concern that holding dollars can be taken away from you at any point.

We’ve also held another special webinar with Russia expert, Dr. Samuel Ramani. You can either watch it on YouTube, or see our notes from his talk on the Macro Hive website. You’ll get access to all of this research and more as a member of Macro Hive. You’ll get access to our academic paper summaries, our podcast transcripts, and our member Slack Room, where you can interact with the Macro Hive research team and other members all hours of the day. In that way you can get full support to help you navigate your investments in these uncertain times. A membership to Macro Hive costs the same as a few weekly cappuccinos, so go to macrohive.com to sign up. And if you are a professional or institutional investor, we have a more high octane product that features all of my and the Macro Hive research team’s views, our model portfolio, trade ideas, machine learning models, and much, much more. Hit me up on Bloomberg or email me on [email protected], to find out more.

Now onto this episode’s guest, Jurrien Timmer. Jurrien is the director of global macro at Fidelity Investments. He is part of Fidelity’s global asset allocation group, where he specialises in asset allocation and global macro strategy. Fidelity is one of the largest asset managers in the world. Jurrien has been at Fidelity for 27 years, where he’s held various other roles within Fidelity, including director of market research, and technical research analyst. He’s also co-managed Fidelity’s Global Strategies Fund from 2007 to 2014. Before joining Fidelity in 1995, Jurrien was a vice president in the fixed income group at ABN AMRO in New York. He’s been in the financial industry since 1985. Now onto our podcast conversation. So welcome Jurrien, to this podcast. I’ve been looking forward to our conversation. I’ve followed your work over the years, and I’ve been looking forward to this conversation.

Jurrien Timmer (02:28):

Well, nice to be here. Thank you for having me on.

Bilal Hafeez (02:31):

Before we go into the meat of our conversation, I always like to ask my guests something about their origin story. So it would be good to learn something about where you studied, what you studied, was it inevitable that you’d end up in finance, and how you’ve ended up where you are today at Fidelity?

Jurrien Timmer (02:46):

That’s a good question. I was actually born and raised as a Dutch citizen on the Island of Aruba, so a slightly non-linear path to Boston.

Bilal Hafeez (02:55):

Aruba’s in the Caribbean, just near Venezuela.

Jurrien Timmer (02:56):

It’s one of the Dutch islands. And came here to the US to go to college. Got a finance degree, and ended up in finance, but almost by accident, because as a foreign national I needed a working permit to stay in the country. You got your F1 or something. You get a one year of practical training visa, but then it would be up for the employer to sponsor me for, I think it wasn’t an H1 visa back then. I’m not sure what it’s called these days. So I applied literally to every Dutch company in the United States, because I figured they would be more likely to do this than a non-Dutch company.

And I got almost hired by a Dutch bank called ABN AMRO, which is a shadow of its former glory these days. We have to thank the financial crisis for that. But they said, “We like you, but we don’t want to go through the trouble.” And then I called them back and said, “No, you got to do this. I’ll take care of it. I’ll pay for everything.” So I bluffed my way into literally the only job offer I got in the US. Obviously I had a job lined up in Holland. Not so much in Aruba because there’s only so much to do in finance there. So that was a good lesson for not taking no for an answer. And then I went to New York, went through a corporate banking training course, which was like watching paint dry, so I didn’t even start really in finance, was more in banking.

But then my boss at the time opened up a capital markets division about a year later and I joined, and actually worked on the bond desk. So my roots in our business is really from the bond side, which has served me very well, because you can’t understand anything that goes on, on our Bloomberg screens, if you don’t understand how the bond market works. So, that was a very good lesson. And then 10 years later, I got recruited by Fidelity to join their technical research team. So I was hired here as a technician by the then chairman himself, Mr. Johnson. He was my last interview out of probably 12, because nobody would come into the chart room without his blessing. So that was in 1995, and actually almost to the day, it was 27 years ago.

Bilal Hafeez (04:52):

So it sounds like as soon as you moved to the capital market side of the industry, you found your home, so to speak, you knew that was the area you wanted to remain in?

Jurrien Timmer (05:00):

Yes. That’s been my passion for really the last 36, 37 years. And as we know, even from the headlines these days, there’s never a dull moment, there’s always something to figure out. And I satisfied my creative outlets with charts, so that’s why I’m known as the chart person. And so that was a way to make something very left brain, a little bit more of a balance between left and right. So that served me well as well.

How the Russia-Ukraine conflict will impact markets and the importance of energy prices

Bilal Hafeez (05:25):

Okay. So let’s talk a bit about macro right now. Obviously we have to start with the terrible situation in Russia-Ukraine. I should probably timestamp this conversation as well, because things are moving so quickly, where we’re talking on Wednesday the 2nd of March. And so this podcast video might come out a few days after this. But leaving aside the political dimension and the moral and ethical dimension, in terms of the economic and market implications of this, how are you seeing the consequences of this?

Jurrien Timmer (05:50):

Obviously the humanitarian dimension aside, the question is always, what does it mean for the markets, right? I mean, that happened when we had Brexit, it happened when Russia took over Crimea back in 2014, it happened when we had tensions with Iran, with North Korea. So it’s certainly not the first time that this comes up, but this is always the tricky part, because we have to figure out whether something is systemic or not. And this is kind of like a black swan event, right? That the probability historically is probably very low, but the impact can be very high, and hopefully it doesn’t come to that part of the decision tree, where the impact does become high.

So, it’s certainly not nothing, because we already see the transmission mechanism with energy prices, right? Oil’s at 108. So clearly there is a systemic linkage to inflation, to energy, potentially energy shortage, and this comes on the heels of a period where the US went from almost complete energy independence a few years ago, when the US was pumping out 11 million barrels a day through the Shell fields. The pandemic put an end to that, or certainly reduced the output. Also, the ESG movement, of course. Also, just the intricacies of the energy sector itself, where energy companies have so often chased higher oil prices by basically pumping out more oil, or developing more resources, and then just as they come online, the oil price goes down. So there is also a certain capital discipline angle to why we’re not seeing a domestic increase in supply.

So, at this point, the clear transmission is in energy and of course energy is fungible, right? I mean, natural gas in Europe may not be the same natural gas here, but it’s still all the same idea. And of course this is happening right as the Fed is going to start its liftoff, and of course that has been the main focus of this cycle over the past three, four, five months or so, and I think it will continue to be. So it’s interesting what the markets are pricing in now in terms of whether the Fed will do as much as it was planning to or less. And clearly… Until yesterday actually, the bond market was complacent about all of the headlines. The 10-year yield went from 205 to 190, but the number of expected rate hikes didn’t really change that much. And then yesterday, all of a sudden the floor fell out, and the 10-year yield went to 169. It’s back up to 180 today. And the market unpriced at least one rate hike from the Fed.

Jurrien Timmer (08:17):

So those are the transmission mechanisms that we can point to that, again, beyond the humanitarian dimension, clearly affect markets. And generally speaking, when you have geopolitical uncertainty, investors want to get compensated through a higher-risk premium, right? And so what we know is that last year, the risk premium, at least in the stock market, but also in the bond market, was very, very low, right? Real yields were negative. They’re still negative, but they were becoming less negative, and then yesterday they became more negative again.

But the equity risk premium for the S&P was around three. The PE ratio was around 25, which was by my analysis about five points higher than it would have been if the Fed wasn’t so active with quantitative easing, and low rates, and forward guidance. And so a lot of that has now come out of the market, so that’s another transmission mechanism, where people just don’t want to pay high PEs when they don’t have a sense of clarity of where the market’s fundamentals are going, and earnings growth is one of them. It was 50% last year, it’s moderating now. It’s still very robust, but it’s expected to be about eight or 9% in 2022, so that’s again a different backdrop.

Whether US stocks are still overvalued

Bilal Hafeez (09:25):

And you mentioned equity valuations. I mean in general, what’s your view on US equities? Because for years now, people have talked about overvaluations, we had the pandemic, tech stocks did even better it seemed, and now even through this Ukraine-Russia crisis, US equities have actually held up relatively well. It’s really European stocks that have taken the big hits. So what’s your overall sense on US stocks in particular?

Jurrien Timmer (09:47):

I think the market certainly looks a lot better now than it did six months or so ago. So again, I ran some math by looking at where the 10-year yield is trading… or was trading, this was last year that I did it… versus where it should have been based on inflation expectations. And last year, the yield was about 100 basis points lower than it should have been. And I at least, can point directly to the Feds’ balance sheet as the cause for that, what we call financial repression. So rates that get pushed lower than where they really should be based on inflation expectations. When you plug that rate into a discounted cash flow model, which I think is a great valuation tool… It’s a very difficult one, because there are so many variables in it, so it’s hard to isolate all these different variables, cash flows, pay-out ratios, risk premium, risk-free rate, et cetera.

But when you plug that into a DCF model, the actual risk-free rate versus what it should have been, it points to a difference in the intrinsic value of about five or six PE points. And again, this was about nine months ago when I did this. So at that point, you could actually clearly connect the dots from the Feds’ policy to equity valuation. And it was very popular in social media to say, “This is a fed-induced bubble,” and I wouldn’t call it a bubble, but the PE was five points higher than it should have been. Instead of at 20, it was at 25. That’s a 25% asset inflation, that in my view, was directly the result of these repressed rates. The good news is that as rates have risen, the 10-year went from 1% last year to 2% as of a few weeks ago, that has let the air out of that, don’t want to call it a bubble, but out of that acid inflation. And so the PE ratio for the S&P is down about 20, 25% from the highs, and that’s very healthy, because that PE was too high in the first place. And so the valuation side has gotten a much bigger correction so far during the last few weeks, than the price side, right? So the S&P 500 price as of last week Thursday, was down 15%, so that’s a pretty garden-variety correction. But the PE was down more than 20%. And as we always know, we tend to anchor ourselves to price, Bitcoin is at 45, or the S&P is at 4,000, or the 10-year yield’s at 2%. But it’s really the valuation that matters, and price is at the intersection of earnings and valuation.

And so to me, it comes down to, what is the growth going to be? And it looks like it’s going to be about eight, 9%, at least based on consensus estimates. And the PE has come down quite a bit. It may go down some more, because we’re just in that part of the cycle where multiples tend to come down, and especially if you add what hopefully won’t be, but what could be, a prolonged period of uncertainty, geopolitically speaking. So maybe the PE comes down some more, but then it’s just a question of how much of a buffer the earnings side, the E side of the PE provides, right? So if earnings go up 9% over the next 12 months, that’s a 9% buffer that the PE can fall by without knocking down price, so that’s how I think about that.

Bilal Hafeez (12:50):

I understand. So the reason the PE ratio has fallen more than per price, is because earnings have been more resilient or gone up even?

Jurrien Timmer (12:56):

Yeah. If there was no earnings growth, then the PE and the price would go down by the same amount.

Whether non-US stocks outperform

Bilal Hafeez (13:01):

And before this Russia-Ukraine conflict, there was this general view that US was less attractive and it was time to buy Europe or even China. China probably more, because of valuations in Europe because of the cyclical story. Do you have a view you on the relative geographical plays here?

Jurrien Timmer (13:16):

The valuation side outside the US is much more attractive, but part of that is the sector composition, right? So the US has a lot of large-cap growth. It has more of a new economy weighting, and Europe tends to have more of an old economy weighting, right? If you’re buying a Europe index or ETF or actively managed funds, it’s hard to get around the fact that there’s going to be a lot of banks in your portfolio, right? So that’s old economy versus new economy, and old economy tends to be more value, less growth, and that tends to trade at a discount. And so we’ve had this period that really started in 2014, where the mega cap growers, the FANG stocks… but it’s not just the FANGs, it’s broader than that… have dominated the US market at the expense of value and what we call quality, like utilities, staples, et cetera.

And by definition, when that happens, you see the same result between US and non-US, right? Because if this cohort of mega cap growers, these trillion dollar companies, are just stealing the show in the US, it’s going to be the same thing globally. And of course the other part of this is also the dollar. Currency translation is a very big part of allocating assets between the US and non-US regions, whether it’s EM or DM. And the dollar has been pretty strong. It’s not really an uptrend, but it certainly hasn’t been in a downtrend either, and I think one of the expectations was… and I’m guilty of that too… was during the pandemic, this period of just rapid liquidity impulse, both fiscally and monetarily, so this very big monetary inflation that we saw, you would think that would have been negative for the dollar and that therefore non-US markets would have benefited, and that did not happen.

The large growers, the stay-at-home stocks if you will, continued to dominate. I do think that, at least before these latest headlines, that emerging markets is a very attractive place to be, a little bit more so than developed markets, because emerging markets last year did very poorly, mostly because of China. As we all know, China instituted all of these regulatory moves that really curtailed the expansion of the economy. And so when you look at the MSCI EM Index, ex China or including China, they are totally different markets. And so our sense, or at least my sense, is that as China has now gone through all of that, and is stabilising and even stimulating the economy somewhat, EM is almost like a deep value play. And so I think this is a year where we see some rotation towards the value side financials, which are a play on higher rates of course, and energy, which are also a play on higher rates, but obviously a play on higher energy prices as well.

And I think EM, It’s not directly a part of that, but you can put it in the same style box almost. And also, because earnings growth in the US is now coming down, albeit from very high levels, the gap between earnings growth here and earnings growth there, I think will start to shrink. And ultimately, relative performance between regions is derived from relative earnings, and so I think the US will probably still out-earn EM, but the difference between the two growth rates is clearly narrowing here.

Whether equity value will outperform growth and the current parallels to the late 1960s

Bilal Hafeez (16:19):

And you mentioned value. And of course that’s been a big topic for asset allocators and investors over the last 10, 15 years. I mean, what’s your take on why value’s underperformed growth so much?

Jurrien Timmer (16:30):

I think it’s part of what we call the supercycle, or the secular trend. My theory on this… Because the market has been up, obviously since the financial crisis ended in ’09, but it’s been up about 15, 16% per year since that time. And so what’s that? 13, 14 years ago. That’s well above normal. Normal is around 10, 11%. And so in my view, this has been a secular bull market, which is a prolonged period of above average returns. And the driver of that secular bull market has been these large-cap growth companies that generate a lot of cash flow, a lot of free cash flow, and they are returning that cash flow in an unorthodox way. Normally a company would return shareholder cash via dividends, but in this cycle, really since ’09… it actually started in ’04 or so, but it really accelerated after the financial crisis… this excess cash that these companies don’t need, even after a CapEx and after buying other companies, they just have too much cash on the balance sheet, so rather than just sit on the cash, they have returned it indirectly via buybacks.

So share buybacks, financial engineering, M&A, a lot of that happens in that quadrant of the style box, if you will. And I think part of this is demographics. It’s ageing baby boomers here in the US, investors who are solving for income, and are unable to find it in the bond market, right? I mean, until a year ago we had one or half a percent 10-year yield. When you flip that yield upside down, you take a 1% yield and you flip it out, you get a PE ratio for bonds. And the PE ratio is 100 or 200. So it actually makes the stock market look cheap. So if you have these companies that generate consistent cash flow growth, buyback a lot of shares, they get rewarded for that. And I think part of that is just the demographic trend and the low level of interest rates. People solving for income and not finding it in the traditional vehicles, like the bond market, and therefore stretching out into the stock market, but going with the stocks or the companies that generate very consistent cash flows and return it to the shareholders.

The case for S&P500 at 8000!

Bilal Hafeez (18:43):

And I can see why value could outperform this year because of the reasons you mentioned, energy higher, interest rates higher. But on a five-year horizon, do you think this secular uptrend since ’09, would continue? This whole large-cap companies, they still will generate cash. Presumably they’ll still do buybacks. Will that mean that those growth style will end up outperforming in the long-run?

Jurrien Timmer (19:04):

My sense is that it will, and I’ve done a lot of work on what I called the nifty-50 stocks. That’s a term from the early 70s, when there were about 50 companies that investors… They only felt comfortable buying those companies, like Xerox, IBM, some of the old names.

Bilal Hafeez (19:21):

The Googles of the 70s.

Jurrien Timmer (19:22):

Yes, from 50 years ago. So, that was the nifty-50 back then. And then of course in the late 90s we had another version of it, with the Cisco, Dell, all these big tech companies, and that ended up in a bubble of course in 2000. So if we look at the nifty-50 today, Apple, Amazon, Google, companies like that, and not just tech companies, but healthcare, consumer companies as well, they have vastly outperformed the market, or let’s say the bottom 450, right? So it’s the top 50 versus the bottom 450. But that performance has been almost completely justified by relative earnings growth. So in 2000, and even in the early 70s, you had very big leadership in those stocks, but they were also much more expensive. And in 2000, the top 50 was twice as expensive as the bottom 450. I mean, really very, very large differences.

Today that’s not the case at all. Apple trades somewhere in the 20s as a PE, and is the most valuable company in the S&P 500. And so that to me makes this more sustainable. And also when you look at the percentage of the population that’s above 65, for instance, coming back to the demographics, that ratio is nowhere close to peaking. It’s well underway, but we probably have another five or so years to go. So my sense is that we have an interest rate scare, values outperforming, we obviously have a big inflation problem right now, real yields are negative. The Fed will try to normalise that, with an unknown outcome of course, but my sense is that eventually growth will resume the leadership.

And it’s interesting, when I look at the secular bull market periods, there’s only a handful of them, but the two best known ones were the 1980s and 90s, and the other one was the 1950s and 60s, after World War II. And both of those periods lasted 18 years, and produced a CAGR, or a compound annual growth rate, of 18% per year over that period. And this one, if it is a secular bull market, but I think that it is, started in ’09, so if we just extrapolate that, which is a dangerous game, because you have a sample size of two, but it suggests that we have another five years left, and that the S&P could be at 8,000 by then. And so when I think about which companies would drive that performance, I come back to the same players that have driven it since 2014.

Why 1970s parallels could be overstated

Bilal Hafeez (21:37):

And you mentioned nifty-50 from the 70s, many people are making parallels to the 1970s today. We have an elevated inflation, growth concerns, oil shocks, everything from the 70s appears to be with us today. I mean, what’s your thoughts on making parallels or comparison to the 70s?

Jurrien Timmer (21:53):

To me, the parallel is the second half of the 60s, and I’ve done a lot of work on that. There’s a lot of similarities. Again, when you overlay, the secular bull market started in ’09 with the same bull market that started in ’49, which is when that bull market began, we’re in the ’65, ’66 period, or ’64 period, and there’s a lot of similarities, of course, right? Social unrest back then, we had the same thing during the pandemic. Inflation crept higher, very, very slowly at first, right? The CPI was running at 2% in the early to mid-60s, and then you had a few cycles, and then all of a sudden 1970 rolls around, and you’re at 5% inflation. Again, we have that same creep going on right now.

The late 60s, the ’67, ’68 period, and I learned this from Mr. Johnson many years ago, because it’s not a well-documented period in market history, but the ’68 cycle, so there was a market peak in ’68, there was rampant speculation going on in growth companies. Any company that was involved with space exploration or technology, any company with the word ‘tronics’ in it. So there was tonnes of speculation. And part of it was because inflation started to creep higher, so investors… It was a value market back then, so investors were worried about losing their purchasing power, so there was a lot of venture capital. A lot of similarities with today. So I would put us more in the second half of the 60s than the 70s. The 70s was a whole different era, of course, but from other perspectives, there are similarities to the 70s, and also the 1940s, especially when it comes to what I call monetary inflation, right?

So when we think about inflation, we mostly think about prices, the CPI going up. But if monetary policy or fiscal policy, or the combination of the two, if there’s a rapid growth in the money supply, we call that monetary inflation. And that happened in the 40s, the World War II era, and it happened in the 70s, and so there are some parallels with those two periods. Especially the 1940s, because the 40s are interesting, because obviously the US was bombed at Pearl Harbour, and then the US mobilised to go to war in 1942. And the Fed was not yet independent back then. That happened in 1951, called the Treasury Fed Accord. But in the 40s, the fed was not independent. So it was actually tasked by the treasury department to absorb the increase in the debt load that was incurred by the US in order to mobilise for World War II.

And so the Fed begrudgingly did that. They increased their balance sheet tenfold from ’42 to ’46. They kept interest rates very, very low. The policy rate, which is now the fed funds rate, back then it was the discount rate, was kept at 1%. They put rate caps, yield caps on T-Bills of three-eighths of a percent, on long Treasury bonds at two and a half percent, and inflation was running at five, 6%. So you had a prolonged period of sharply negative real rates. That’s very, very similar to what we’ve seen since the pandemic, right? We had this, I don’t want to call it coordinated, but we had this two-pronged policy response, fiscal right? The Cares Act, the stimulus from a year ago, and then of course the monetary side to the Fed which increased its balance sheet, kept rates at zero, and kept forward guidance very low until last December. And so that double-barreled policy response, the only other time that I can point to where we saw something similar was in the 1940s. So I think by many accounts, that’s a very relevant analogue as well.

Bilal Hafeez (25:15):

And then what’s your view on inflation then? Obviously US inflation, the headline CPIs been running at around 7% or so. Most people expect inflation to start to head down over the course of this year towards three and a half, maybe four even, due to base effects and so on. But eventually people do expect it to go down towards two in a few years, rather than staying at five or six. I mean, where do you stand with the debate?

Jurrien Timmer (25:36):

I agree with, I think, the general impression, that just from a base effect alone… And we see clear evidence that supply chain bottlenecks are starting to get resolved. The number of ships waiting to be offloaded at the port of Los Angeles is way down. Tanker shipping rates from Shanghai to LA or New York are moderately down. So I think it’s very likely that the year-over-year change in the CPI will moderate towards, let’s say, three to 4%. So it’s interesting, because there are clearly structural disinflationary trends, the demographics being one of them, right? If you just look at the 10-year annualised growth rate in the labour force, it’s a spitting image of the 10-year yield over the past 50 years. And that labour force is barely growing.

Or if you look at the dependency ratio of people at working age versus not working age, we’re going in the same direction as Japan, with about a 10 to 15-year lag. And you look at Japan, right? I mean, rates are very, very low. Inflation is very low. Then you add to that technological disruption, digitisation, et cetera. So there are powerful, deflationary underpinnings that I think will keep rates low, and will keep inflation low over time, but there are offsetting forces now that really weren’t there a few years ago, and one of them is of course, a very tight labour market, a workforce that is feeling more empowered to work on their terms rather than the employer’s terms, and we see that everywhere. And housing, right? You look at the real estate market. The CPI accounts for real estate costs to owners equivalent rent, which is just a survey of homeowners. But my understanding is that the actual growth in rent costs are much higher.

So you have these two structural forces that I think will keep inflation higher than where it otherwise should be, and so maybe that’s going to be over the next five years, three instead of two. And then the question is, what does the fed do about that, right? So we’re actually not that far from a fork in the road for the fed, where if the yield curve continues to flatten, the 2/10 curve, it’s at about 35 basis points today, it was about 150 basis points a few months ago, so that’s flattening pretty rapidly. If at some point the Fed sees the curve invert, and that’s not a prediction, but we have to think about the possibility, what will the Fed do, right? Will it choose to tolerate higher than desired inflation, or will it sacrifice essentially the economic expansion in order to push inflation down? My sense is, and again going back to the 1940s as the analogue, is that Fed will have no choice but to accept higher inflation.

And if you think about it, debt to GDP is running well north of 100%. It’s one of the easiest ways to reduce your debt burden, is just to inflate your way out through negative real rates. And so that’s the side that I would be betting on. It may not be a straight line from here to there, but I think ultimately, my sense is that we’re going to remain in a period of very low real rates, if not ongoing negative real rates. And that has a lot of implications for asset allocation, in terms of choosing real assets over nominal assets.

The importance of real assets like commodities and real estate

Bilal Hafeez (28:36):

Understood. And in terms of real assets, I mean, do you have any preferences which assets… Obviously equities is an obvious one. When you say real assets, do you have particular ones?

Jurrien Timmer (28:45):

I think real estate of course, is one. That’s a real asset. It can generate an income, and it tends to be a good inflation hedge. Equities. I mean, let’s not forget that equities, generally speaking, are an excellent inflation hedge. I mean, in periods of extreme inflation, like the 1970s, you see a significant valuation derating, because the PE ratio’s inversely correlated to the inflation rate. But if we go from two to three on a long-term basis, I don’t think that’s really going to make a big difference for equity valuation. And companies that can pass on their increased costs, obviously will win, and companies that are on the other side of that will not. And companies that generate a yield, whether it’s a dividend yield or combination of dividend and buyback… I look at the market on a total cash yield basis, by also including buybacks.

So again, I think those companies will be the winners. And the stock market, as we know, the magic of long-term equity investing, is the compounding of returns. And this is why historically, if you go back 50, 100, 200 years, basically nothing else comes close. And so I think equities in my view will remain the anchor in any portfolio. Then you get to bonds. That’s a harder value proposition to make, because the nominal yield is 1.8. Inflation, I don’t think it’s going to stay at seven and a half, but let’s say it goes to three, you still have pretty substantially negative real yields. And if you buy bonds and you hold them to maturity, the return you get is the yield that you’re paying for the bonds, right? Or that you’re receiving at the bonds.

So if you hold a 10-year yield to maturity, you’re going to get a 1.8% return, and if in 10 years inflation has averaged, let’s say 3%, or even 2%, you’re going to get a negative real return. So the only reason to own bonds in my view, is for their diversification effects. And it’s interesting, last week bond yields barely moved, even though we had these very disturbing headlines, because the bond market concluded at that time that the Fed would stay on its course no matter what would happen. But that’s changed this week. So all of a sudden the 40 side of a 60/40 portfolio is again doing its job… Again, it wasn’t really doing it last week.

Beyond that, I think we have to look at other real assets, right? So commodities, they’re obviously on the moon right now. They’re doing very well. The problem with commodities is that they have a very high volatility, and historically over a very, very long-term, let’s say, going back 50, 100 years, you will earn the inflation rate out of commodities, but you’re paying a massive volatility for it, so you’re getting a very low Sharpe ratio. So as a strategic anchor in a portfolio, it’s hard to make the case for commodities on a sustained basis, but they do have periods where they do extremely well, and right now is one of those periods.

So I think some kind of inflation hedge, whether it’s commodities or TIPS, and of course gold and maybe crypto, Bitcoin, I think all makes sense. And I think the value prop for gold… Gold was kind of left behind by Bitcoin the last two years, and all of a sudden gold has woken up as it should have done. And I think if the bond market is correct that after this Fed cycle real yields will remain at negative levels, then gold will be a very good hedge against that. And I would put Bitcoin in the same category. So I think, there are times, for instance the 1940s, where you could just be all equities, because the bond market was repressed by the Fed, so you got a 2% return on your long bonds in a 5% inflation world. And bonds were not negatively correlated to stocks at that point. So there was no reason to own any bonds in the 1940s. They wouldn’t insure you against a loss on the equity side.

We also had price controls back then, so even the commodities didn’t do that well. So it was really just equities, especially small caps and value. Then there are other periods where just a straight up 60/40 does wonders. The last 20 years is one of those periods, where that’s all you needed, because both the 60 and the 40 were in structural bull markets. I think today and going forward, a much more diversified portfolio, I think makes sense, and that would include inflation hedges, and metals and maybe crypto as well.

How to fit crypto into your portfolio and the difference between Bitcoin and the rest

Bilal Hafeez (32:46):

And you’ve mentioned Bitcoin and crypto a few times. I mean, what do you see as the case or crypto, because even to this day, many institutional investors, sophisticated investors, are sceptical of crypto. But it’s becoming more established, it seems. I mean, what’s your view on the case for crypto as part of your portfolio?

Jurrien Timmer (33:01):

So I would categorise it in two different ways. There’s Bitcoin, which is totally separate from the rest of crypto, because it’s more decentralised, it’s more scarce. It’s also clunkier. It’s harder to scale. And so to me, Bitcoin is basically digital gold, but it’s a unique digital gold because gold has scarcity, of course. That’s why it’s a precious metal. But gold does not have a network dimension, right? It doesn’t have this exponentially growing adoption curve, which Bitcoin does have. So Bitcoin is extremely unique in that sense, maybe the most unique asset class I’ve ever seen, because you have both the scarcity and you have this growing S curve effect, and that makes it a very potent asset. So I would put Bitcoin on the bond side of a 60/40, because to me, if you’re going to lose purchasing power by owning bonds, but you want to own them because they are a diversifier against equity risk, so how do you fix that? You want to own the bonds, but you also want to own a little gold and a little Bitcoin.

And you don’t need a lot of Bitcoin, because its return, its Sharpe ratio, is about the same ironically as a 60/40 index, but obviously the numerator and the denominator of that Sharpe ratio are off the charts. So, that’s where I would Bitcoin. And I think the institutional adoption has slowed. I think the retail adoption is pretty advanced, and would become more so if there was an easy vehicle, like an ETF, for investors to buy. But I think institutions are waiting to solve for the regulatory risk. And I think if Bitcoin does get more regulated, it will actually be a good thing, because it will legitimise the asset class.

And I think institutions are waiting for volatility to go down, which I don’t think will happen, because I think volatility is a feature and not a bug of how Bitcoin works. Because when you look at a commodity like oil, if the demand for oil goes way up, someone will pump some more oil, and you’ll get a supply response. That by definition is not possible with Bitcoin. So therefore, changes in demand, up or down, are completely translated into price, because you don’t have the supply response. So, that’s the view on Bitcoin. And then the rest of crypto, whether it’s Ethereum or all the blockchain stuff that happens aside from Bitcoin, I think that’s more of a venture asset. It’s more of a tech stock type of thing. And I would put that way on the other side of a 60/40, in the aggressive growth part of that benchmark.

Bilal Hafeez (35:18):

I think it’s a great way of describing this actually. It’s the first time I’ve actually heard somebody describe it in those exact terms, so appreciate those insights. I think let’s move on now to some personal questions, which I like to ask all of my guests. One is, what’s the best investment advice you’ve ever received from anyone?

Jurrien Timmer (35:31):

I think looking at the long-term… And again, I would put Mr. Johnson as a very important mentor in my career. He hired me 27 years ago, and for many, many, many years, we would spend hours per week in the chart room, and he would just go from chart to chart. We’d have these huge charts from floor to ceiling, 20, 30 feet wide, and he would just draw his finger across the chart and say, “Well, the last time this happened was then,” and I’d learned to really appreciate the visual communication of charts, while at the same time also realising that at Fidelity, most portfolio managers, who are my constituency if you will, speak more of a fundamental language than a technical language, right?

So I think one of the things that I learned early on, is you don’t have to choose, right? You have a lot of technicians who think fundamentals are stupid, because it’s already in the price anyway, so you just have to look at the chart. And then you have a lot of fundamentalists, who think technical analysis is voodoo, and that you need something more robust than that. And so over the decades have blended the two, and I think that’s on the advice of many people that I speak to at Fidelity and outside Fidelity. And I think that was a very good lesson. And to always look at the context, right? You have to make decisions in real time as an investor, and the context always matters. So you need to have some view, some thesis of where we are in the big picture. May be a wrong view, it may be the right view, but it’s impossible to interpret the minutia of what’s happening in the markets without having that sense.

Bilal Hafeez (36:57):

Okay. And then the other question I wanted to ask was, do you have any productivity hacks, or how do you manage all of this information overload that we all face?

Jurrien Timmer (37:05):

Less is more. And it’s funny, I learned this the hard way, because… I guess this was maybe 10, 15 years ago, I was actually co-managing a global strategies fund, that unfortunately was launched right at the end of 2007, right into the teeth of the financial crisis. And we did okay, but it never got traction, because it was just an impossible cycle to be trying to make the case for a new asset allocation fund, et cetera. But that was a period where obviously there were… You were almost afraid to wake up in the morning and look at your screen, because God only knows what had happened overnight. And it’s not unlike today. It’s like, “Oof, I hope I didn’t miss anything really bad in terms of the headlines today.” But I got so immersed in the short-term signals. Screen is flashing green. Now it’s flashing red. It’s very counterproductive.

And then over the past 10 years or so, I’ve done a lot of TV, like CNBC, Bloomberg, and I would consume all the shows back in the day, five, 10 years ago, and today I don’t watch any of the shows. I still go on them, but I don’t watch any of them. And so I think too much signal can be counterproductive, and so I think my advice would be, something I’ve learned and that has really helped with my sanity, is just, don’t overconsume the information. You have to know what’s worth consuming and what’s not worth consuming, but it’s easier to keep your zen if you’re not constantly bombarded with green and red flashing numbers on your screen.

Books that influenced Jurrien

Going to Pieces Without Falling Apart (Epstein) and The Art of Loving (Fromm)

Bilal Hafeez (38:32):

That’s great advice there. And finally, what books have influenced you the most?

Jurrien Timmer (38:36):

The books that I read that are of the most value to me, are not business or finance books. They are personal growth books. Because I think I’ve got the left side of my brain covered, it’s the right side, the balance, where I’m really focused on. That’s why I do a lot of cooking, I do a lot of cycling, so I can think. I make a lot of charts, because to me those are a creative expression as well, while still hopefully showing something that actually means something. So there’s a lot of books out there. I’m spacing out on the name, but it’s, How To Fall Apart Without Breaking Into Pieces. That’s one. There’s a book from the 50s, The Art of Loving, by Eric Fromm. And to me, I’ve been doing this 37 years, I obviously read a lot of market stuff from my Bloomberg and then other… The Economist, and Wall Street research, Fidelity research, but if I have some time to read a book, it’s going to be a right brain book, not a finance book.

Bilal Hafeez (39:29):

No, that’s excellent. Well said there. And if listeners and viewers wanted to follow you, how do people follow your views and your commentaries?

Jurrien Timmer (39:36):

The easiest way is just to follow me on Twitter. It’s @TimmerFidelity, is my Twitter handle, which I just surpassed 100,000 followers about a week ago, so that was a nice milestone. And then on LinkedIn. It’s the same content, just search for my name. On LinkedIn we don’t post quite as much as on Twitter, because it’s just a different type of platform. But those two, and I publish reports. It’s called the Viewpoints series, so that comes out every couple of weeks. There are ways to get it, and you don’t necessarily have to be a Fidelity client. It helps of course.

Bilal Hafeez (40:09):

Okay. I’ll include the Twitter handles, LinkedIn, and Viewpoint links on the show notes so people can access it in that way. Well with that, I just wanted to give a big thanks. I learned a lot in our conversation, and good luck with your views for the rest of this year.

Jurrien Timmer (40:21):

Well, thank you very much for having me, and hopefully the markets will settle down soon.

Bilal Hafeez (40:25):

I hope so, too. Great. Thanks a lot. Thanks for listening to the episode. Please subscribe to the podcast show on Apple, Spotify. Or wherever you listen to the podcast, leave a five-star rating and a nice comment, and let other people know about the show. We’d be really grateful. And finally, sign up to become a member of Macro Hive at macrohive.com. We’ll be back soon, so tune in then.

Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)