Gavekal Research founder Charles Gave shares his views on U.S. growth trajectory, potential rate cuts, budget deficit, and more.
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00:03 Thanks for tuning into WorldView.
00:13 I'm your host, Neeraj Shah.
00:15 Our guest today is arguably one of the most experienced
00:19 research professionals in the world at large.
00:23 He and his firm cover almost the entire spectrum
00:27 of the investable universe, both in geography
00:30 and in terms of asset classes as well possibly.
00:34 Charles Garve joins him right now from Garveckel Research
00:36 to talk about his worldview on almost all things investing.
00:40 Charles, so good having you.
00:41 Thanks so much for taking the time out.
00:43 And I hope all is well with you.
00:47 I was looking at your latest piece, which was published,
00:50 I think, on the 27th of February,
00:52 wherein you spoke about going back to the Vixel Theory
00:56 of how the US economy's position in the four quadrants
01:00 is shifting and what it could shift to over the course
01:03 of the next 12 months.
01:04 I would love to understand from you,
01:06 how do you look at the US economy's growth
01:10 and the resultant central banking action?
01:13 Because what the US will do will have far-reaching implications
01:17 on almost all geographies.
01:19 Yes, it usually does.
01:22 Let me put it this way.
01:24 Most people for the last 12 months
01:27 have been more or less expecting a recession any time in the US.
01:35 And it did not happen.
01:38 We were, in fact, in what we call in our jargon
01:43 a deflationary boom, which means economic activity accelerating
01:48 and inflation decelerating or falling.
01:52 And these are periods during which P/E ratios expand,
01:57 and we have usually very strong bull markets.
02:02 But due to a certain number of factors,
02:05 one of them being that interest rates are too low in the US,
02:10 we are probably moving from this deflationary boom, which
02:14 is heaven for the financial markets, to an inflationary
02:19 boom.
02:20 So contrarily to what most people are saying today,
02:25 I'm not worried at all about a recession in the US.
02:28 I'm worried much more about inflation accelerating.
02:33 And if inflation accelerates, as I
02:37 believe is very possible for a lot of reasons,
02:40 then what we will have, the central bank
02:42 will be forced to raise rates.
02:45 And it will be a much more difficult environment
02:48 for equities and bonds.
02:50 So you see the difference that I have with most people
02:53 is that most people seem to expect a decline in interest
02:59 rates engineered by the central banks in the US and elsewhere.
03:04 And as far as the US is concerned,
03:06 I expect the central bank to be forced to raise rates sooner
03:10 rather than later.
03:13 Is there a timeline mismatch?
03:14 Because I think the world looks at investing
03:17 in a very short-term way.
03:19 And maybe the belief is that 2024 could still
03:21 be a year wherein rate cuts could come in.
03:24 Are you in agreement there?
03:25 And do you believe this rate, this inflationary boom
03:28 and thereby subsequent rate rises,
03:30 is a factor of what will happen in 2025 and beyond?
03:34 No, it could happen.
03:36 It could happen any time for a very simple reason
03:40 is that, OK, that's a fundamental.
03:43 But as I have said, interest rates are too low.
03:45 And they are too low.
03:49 The short rates are too low.
03:52 The long rates are too low.
03:54 And the corporate bond rates are also too low.
03:57 So my view is that the market have anticipated
04:05 bigger and longer-lasting declines in inflation rate
04:08 to a certain extent for those of us
04:11 who have a little bit of memory.
04:13 This is what we had in '78 or '79, the South Bank
04:17 cut rates in the US.
04:19 And instead of having a normal recovery with falling
04:23 inflation, inflation took off.
04:25 And Mr. Volcker had to raise rates aggressively in '80
04:28 and in '81.
04:30 So I think the situation is very similar to the end
04:32 of the '70s.
04:34 The markets believe that inflation
04:36 is a temporary problem.
04:38 But let me put it this way.
04:40 There was a French economist called Roeff, very well known.
04:45 And he used to say that inflation
04:47 is subsidizing expenditures that have no return with money that
04:51 doesn't exist.
04:54 To make a long story short, maybe the quantity of money
04:57 being printed is lower.
05:00 But the subsidizing of expenditures
05:02 that have no return--
05:03 for example, take the US budget deficit, which is immense
05:07 and getting bigger--
05:09 are going through the roof.
05:11 So you cannot keep subsidizing money
05:17 with money that doesn't exist, expenditures
05:21 that have no return.
05:22 Another way of what I'm trying to say
05:25 is that normally, in a good recovery like the one
05:28 we had in the last 12 months, I would
05:30 have expected the US budget deficit to go down.
05:34 It went up.
05:36 They are spending money as if it were going out of fashion.
05:39 [LAUGHTER]
05:42 Yeah, well, that's true.
05:43 Just following up on the comparison
05:47 that you did to the earlier era, Charles,
05:52 do you expect a Walker Shock-like phenomenon,
05:55 wherein the banks would have to raise it too fast
05:57 and kind of lead to a recessionary period as well?
06:03 Well, what I know is that now interest rates are sufficiently
06:09 low, according to the work that I do anyway,
06:11 for prices to start going up.
06:15 So we are moving from--
06:16 in the previous period, we had prices that were still
06:20 structurally going down.
06:21 Now they may structurally go up.
06:23 OK, if they structurally go up, the Federal Bank, the market
06:28 will have to accept the idea that the next move in interest
06:32 rate is not down, but up.
06:36 Yeah, yeah, yeah, OK.
06:38 So do you reckon that it could be a surprise at large
06:44 and that could trigger HITR to--
06:48 Oh, yes.
06:50 It could trigger a little bit of, let's say,
06:54 bad feeling in the market.
06:58 If interest rates go up, usually it's
07:01 very bad news for what is called long-duration assets,
07:06 long-government bonds, long bonds, and of course,
07:09 gross stocks.
07:10 And so if something like that happened,
07:13 since the markets, for example, in the US
07:16 have been driven by six or seven gross stocks,
07:19 it could have an inordinate impact on these guys.
07:23 But you see, something that I never do,
07:25 I try to understand where we are, where we might be moving,
07:30 but I never try to make any forecast,
07:33 because anybody who makes a forecast is looking
07:37 ridiculous pretty quickly.
07:39 Yeah, that's true.
07:40 I mean, maybe compressed cycles are making that too,
07:43 making people look like that too.
07:45 Just wondering, Charles, the investing implications
07:49 you laid out, what could happen to growth stocks, et cetera,
07:53 when the first up move of interest rates begin?
07:57 People spoke about how the decade at large
08:00 could be a year of higher for longer interest rates
08:03 than what you see in the previous decade.
08:05 And it would also have implications for multiples,
08:08 the P multiples that you assign almost, not just growth stocks,
08:11 but any stocks, the discounting factor, et cetera.
08:14 Is that a net negative for risk assets like equities?
08:18 Well, yes and no.
08:22 You see, to be perfectly simple, if you
08:28 try to explain the variations in P ratios, which
08:33 is your question, if I understand--
08:34 Yes.
08:36 You simply make a ratio between the S&P and the price of oil.
08:45 If the S&P goes up faster than the price of oil,
08:51 multiple expand.
08:53 If the S&P underperforms oil, multiple contract.
08:59 Why?
08:59 Because the economy is nothing but energy transformed.
09:04 So if the S&P goes up, it means that the economy is
09:08 transforming energy profitably.
09:11 If the S&P goes down versus oil, it
09:14 seems that the economy is not able to transform energy.
09:17 Energy, it's too expensive.
09:19 So right now, we are more or less
09:22 on the cusp between the two for the last year.
09:26 And the stock market--
09:27 or in two years, the stock market
09:29 has outperformed the S&P. And P ratios have expanded, sort of.
09:34 In the next-- the question is--
09:36 for the question on multiples is resting on only one thing.
09:40 It's oil.
09:42 If oil goes from 80 to 100, the P ratio will contract.
09:46 If oil stays where it is, probably not.
09:50 Well, last question before we take that break, Charles.
09:53 And a lot of people consider oil to be a deep insider of what
09:58 global growth could look like.
09:59 The fact that despite all the disruptions,
10:02 if oil is steady at these $80 per barrel mark,
10:06 does it portend badly for growth?
10:08 And do stock markets follow that?
10:11 No, if oil stays at 80, we can probably--
10:14 we survive without too much difficulty.
10:17 But if it goes from 80 to 100, then we're in trouble.
10:22 OK.
10:22 Fair call.
10:23 You're not making forecasts, so I
10:24 want to ask you to make one, which is fine.
10:26 Now, you know--
10:28 But wait a second here.
10:29 I don't want to--
10:31 money management is not about finding the winners.
10:35 Money management is about finding the losers,
10:38 not to buy them.
10:39 So whatever is happening in the next 12 months,
10:43 I don't see how you're going to make any money on the bond
10:45 market in the OECD.
10:47 So what you should avoid is government bonds in the OECD.
10:51 The rest is literature.
10:52 You can keep shares.
10:53 You can buy gold.
10:54 You can do what you want.
10:55 But the main message I want to transfer
10:58 is don't buy government bonds in the OECD.
11:03 OK, don't buy--
11:03 Because they will lose it.
11:05 They will lose it all scenario.
11:07 OK, don't buy government bonds in OECD.
11:10 I believe you've spoken about how not to buy.
11:13 I mean, I was reading your other notes as well.
11:16 And you've laid it out very beautifully
11:18 for people who follow you that you would be buying put options
11:22 on both bonds and on stocks to protect against the move
11:25 into the next quadrant as well.
11:27 Yes.
11:28 OK.
11:29 That's very good idea.
11:32 If a problem starts, it will start in the bond market.
11:36 And it may-- so you buy puts on the bond market.
11:39 But it may, if it's big enough, have an impact on the stock
11:42 market.
11:43 You buy a fewer puts on the stock market.
11:46 That's the way to protect.
11:47 OK.
11:48 I want to give the viewers a teaser of what
11:50 will come in the next segment, Charles.
11:51 And I want to kind of just squeeze in a question
11:54 on emerging markets in India and how do you see them.
11:57 Because I remember a year ago when we spoke,
12:00 you'd come out with a fairly constructive piece
12:03 on how India has changed some of the things that it does well.
12:06 But I want to just first understand your view on EMs
12:09 before we take that break.
12:10 We'll talk about India in the next segment.
12:11 Absolutely.
12:12 But emerging markets, what's your view
12:13 in light of the view that you have around interest rates?
12:17 It will be a pleasure.
12:19 Yeah.
12:20 But will it be a pleasure for investors
12:21 into emerging markets, Charles?
12:23 Let me try to step back a second here.
12:31 The problem with the emerging markets in Asia,
12:34 but also in Latin America, up to very recently,
12:38 is that they always had their growth constrained
12:43 by their current accounts.
12:46 To put it bluntly, most of them are importing oil,
12:53 with a few exceptions.
12:56 And this oil had to be paid in dollars.
12:59 So you needed a current account surplus in dollars
13:02 to get the dollars to buy your oil.
13:05 And if the dollar went up, everybody
13:07 was killed in Asia or in Latin America.
13:12 In the last 18 months or two years,
13:14 before all the events in Ukraine, a lot of countries
13:18 can now buy their oil in their own currency, which
13:23 means that the exchange rate risk is now
13:26 borne by the fellows that are selling oil,
13:29 not by the fellows that are buying oil.
13:33 And so they can diversify that risk
13:36 by accepting payments in a lot of currencies.
13:39 So it means that suddenly, you have
13:43 broken the link that prevented you to grow,
13:46 as you should have in the past.
13:49 And that was the obligation to pay for all your oil
13:56 in dollars.
13:58 So what it means is that a new monetary system
14:02 is going to be emerged in the next 20 years or so that
14:06 will be not centered on the US dollar,
14:08 although the US dollar will remain very important,
14:11 but on bilateral relationships.
14:13 The problem that you have now in India
14:15 is that the Russians have too many rupees,
14:19 and they don't know what to do with it.
14:21 So what India has to do is pretty simple,
14:24 is build a kind of bond market in which the Russians will
14:30 be able to deploy their rupees for the--
14:34 and that would take interest rates lower
14:36 in India, which would be good news for the stock market.
14:40 So what we have now is find a certain number
14:44 of technical solutions for India, for example,
14:47 to pay for their oil in rupee.
14:49 And that is squarely in the hand of the Indian government.
14:54 They have to offer financial asset to the Russians
14:57 that the Russians would find interesting to own
15:00 for the long term.
15:02 So it requires a little bit of housecleaning,
15:06 but it's not very difficult.
15:08 OK.
15:08 Charles was talking about a few things
15:10 that the Indian government needs to do in order
15:13 to make it more attractive for foreigners to put in the Indian
15:15 bond markets.
15:16 He cited Russians, but I guess it's
15:17 true for some of the other economies as well,
15:20 with whom India can possibly engage in a rupee trade
15:24 for the crude imports that India does.
15:26 Now, Charles, I would love to understand--
15:29 you wrote about this back then, too.
15:32 Not everything in terms of that rupee trade or a non-dollar
15:37 trade has worked out.
15:38 But be that as it may, if we assume that over the long term
15:40 this is going to turn out to be true,
15:42 and let's assume Indian bond markets,
15:44 we are going to be included in the JP Morgan bond index,
15:47 the Bloomberg bond index, so the depth out there
15:49 increases, so on and so forth.
15:51 Does this all pave the way for better current account
15:56 dynamics for a large oil importing country like India?
16:00 And would foreign investors view that very positively?
16:05 Well, yes, foreign investors would view that positively.
16:08 And instead of-- let me put it this way.
16:11 India, for the last 40 years or so,
16:15 every time you were growing a little too fast,
16:18 your current account deficit moved into--
16:21 your current account moved into deficit,
16:23 and you had to slow down the economy, raise rates,
16:27 and basically it was a stop and go system.
16:30 Now, if suddenly your current account went into deficit
16:35 because energy imports went through the roof
16:38 and you had to pay them in dollars,
16:40 now if you can pay your current account
16:42 deficit with your own currency, then suddenly you
16:46 don't have to look at the current account deficit of India,
16:52 including energy.
16:53 You just have to look at the current account of India,
16:56 excluding energy.
16:58 And there you have first pretty large foreign exchange
17:01 reserves, and second, you are in equilibrium or in surplus.
17:06 So what I mean is that suddenly you
17:10 have to look to know when the Indian government is
17:13 going to tighten.
17:14 You have to look at the current account x energy.
17:18 And if it moves, as long as it is positive
17:22 and as long as inflation is subdued in India,
17:25 you have no problem.
17:27 And for inflation to be subdued in India,
17:30 the easiest thing to do is to allow a constant small
17:34 revaluation of the rupee against most currencies.
17:39 Like that, you will have a very subdued inflation.
17:42 So I have spoken previously about the US
17:46 being a deflationary boom.
17:49 If you have no massive monetary policy
17:52 mistake made in India in the next year or two,
17:55 India should enjoy a massive deflationary boom
18:00 for quite a while.
18:02 Your interest rates are still fairly high.
18:03 They're at 7 now.
18:05 So they could go easily to 5 or 4 over the long term,
18:09 especially foreigners are buying to build up position
18:12 in a country which has one of the few good demographics
18:16 in the world.
18:18 That's true.
18:19 Tell me, Charles, money flows into markets like India
18:25 not as much in an idiosyncratic fashion
18:28 as much as it is a part of an emerging market pocket,
18:32 if you will.
18:33 And emerging markets, per se, by virtue
18:35 of what China is going through or some other economies
18:37 are going through, are not quite giving returns.
18:40 So how attractive could a--
18:41 albeit a large market, but how attractive
18:43 could a market like India be to foreign capital, which
18:46 is looking at emerging markets as a bucket,
18:48 even though India may be having these demographics
18:51 and these growth numbers?
18:54 OK, let me put it this way.
18:56 The way I look at India and China is pretty simple.
19:06 China doesn't need foreign capital.
19:10 They are an excess saving nation and always have been.
19:17 So I seldom buy equity in China, except when they are dirt cheap
19:23 as they are now, because they don't need my money.
19:28 India is almost always a nation that
19:36 doesn't have enough savings, probably also
19:38 because you are very young.
19:40 Makes sense.
19:42 So it's always a good idea to invest
19:46 in countries that have a deficit of savings in the equity market
19:51 because they will make it--
19:52 the market will be attracted for you
19:54 to send your capital to India.
19:57 So my inclination on a structural basis
20:04 would be in bonds in India, in China, and in equities in India.
20:12 But the problem is that the equities in India
20:14 are a bit expensive.
20:17 Always been, yeah.
20:19 And the bonds-- the equities in China are very cheap.
20:24 And the reverse is true for the bond market.
20:26 The bond market in China is a bit expensive.
20:30 And the bond market in India is a bit cheap.
20:34 So cyclically, I would probably recommend
20:39 to build a portfolio that would be Indian bonds and Chinese
20:42 equity.
20:43 But that would be out of a portfolio
20:45 that for the last few years would
20:47 have been Indian equities and Chinese bonds.
20:50 So I'm just trying to rebalance a little bit the portfolio here.
20:53 But what I'm saying is that India
20:55 will need capital for the next 10 years,
20:57 so easily, just to build their infrastructure.
21:01 And they will have to make that attractive for foreigners.
21:07 And why not buy equities there, structurally?
21:09 You see, the Indian market is expensive, OK?
21:14 But the profits are growing very strongly.
21:19 So if you do the P/E ratio when the growth rate,
21:23 India is kind of OK.
21:26 Yeah, true, true, true.
21:27 My final question, Charles, can Indian growth
21:30 sustain for the better part of the next few years
21:33 at a point of time when the world growth is
21:36 looking so uncertain?
21:36 China, Europe, you mentioned about the US high inflation
21:41 possibility and higher rates possibility,
21:43 so lower growth maybe.
21:45 The beauty of India, to a large extent,
21:48 that it never paid any attention to the rest of the world.
21:51 You have been always self-centered.
21:53 As a person of GDP, your exports and imports are minimal.
21:57 They are very slow.
21:59 You have so much potential in India
22:01 just by organizing your infrastructure, your roads.
22:07 And probably the biggest effort in India
22:09 will have to be made for things like nuclear energy.
22:13 So you have to find a way to finance
22:18 the development of your infrastructure.
22:21 And that will take at least 10 to 15 years in China.
22:25 It took more than 20.
22:27 So what happens in the rest of the world
22:29 should have very little impact on the Indian economy.
22:34 My belief is that the Indian economy is now
22:37 in the hands of the Indians.
22:39 And if they do correctly their long-term views,
22:44 organizing a bond market, monetizing
22:48 the savings in India and so on, to invest in infrastructure,
22:52 what happens in the rest of the world
22:54 will have no impact on the economy.
22:56 But it may have a temporary impact on the stock market.
23:00 Let's say you take a big thing in Wall Street or what have you.
23:04 Well, if you take a big thing in Wall Street,
23:05 I suspect the Indian stock market
23:07 will go down in sympathy.
23:11 But nothing to do with India.
23:13 OK.
23:15 Fair call.
23:15 Charles Gave, such a pleasure talking to you
23:17 and getting your insights.
23:19 We're out of time on the show.
23:20 Would have loved to talk more, but look forward
23:21 to talk to you more often.
23:23 And thanks for the wonderful, wonderful writing
23:25 that you and your team do on Gavikal Research.
23:29 Thank you so much.
23:30 The pleasure was entirely mine and ours.
23:32 And viewers, thanks for tuning into this very special episode
23:35 of WorldView.
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