Transcript: Navigating the next super cycle

This is an audio transcript of the Unhedged podcast episode: ‘Navigating the next super cycle’

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Katie Martin
This stock market miracle that we’re witnessing in the US, is it for real? Are we getting a little bit overly focused on the short-term movements of a little handful of AI-related stocks, and how does this fit into the bigger picture? To do that, we’re gonna have to look back at history a bit and figure out what the meaningful forces here really are. Today on the show, the long view, the really long view. This is the Unhedged podcast from the Financial Times and Pushkin. I’m Katie Martin, the markets columnist here at the FT in London, and to answer these weighty questions, I have my usual sidekick, Ethan Wu, in New York. Ethan, hello.

Ethan Wu
Hey, Katie. It’s interesting to not be the host here for once.

Katie Martin
I know, I know. Just run with it. Run with it. But also, we’re doing this a little bit differently today, and I’ve got some serious brains in the room. Welcome to the Unhedged podcast, Peter Oppenheimer.

Peter Oppenheimer
Thank you, Katie.

Katie Martin
Peter is the chief global equity strategist and head of macro at Goldman Sachs, just up the road from here in London. And he’s also, because obviously he’s got a lot of spare time on his hands, the author of Any Happy Returns, which is a super deep dive on really long cycles in market and economy and the grand sweep of history. So, Peter, just to get us started, I mean, everyone talks about cycles. Why are cycles a useful way in and of themselves to think about long-term investment?

Peter Oppenheimer
Well, firstly, let me say thanks so much for having me today and to talk about this topic. I think cycles are important because you do get repeated patterns through history under really quite different circumstances. You know, if you look at economic cycles from growth/expansion and contraction/recession, these tend to repeat themselves in periods of high or low inflation and around them you get financial market cycles as well. And so there’s a great deal of reward from trying to understand where about you may be in a cycle and where a turning point may be close at hand. And it’s probably worth saying that, you know, if you look at economic cycles in terms of expansions and recessions, going back to the 1850s there have been about 35 of them in the US, as an example.

Katie Martin
Right. They’re nothing new. You can go back thousands of years and you see these patterns of mean inversion and cyclicality, right?

Peter Oppenheimer
There’s very, very good evidence of that over time. And interestingly, there’s about the same number of cycles that you get in financial markets. So if you look at equities, there’ve also been around 30, 35 of them over that period. Take the years since the second world war, there have been 13 recessions in the US and about the same number of bear markets in the equity market. So there’s obviously a connection between these things and understanding them is obviously a point of great focus for investors.

Ethan Wu
Peter, maybe I could ask just, one slightly critical question, which is, you know, the framework tends to be we’re in an early cycle, then we move to mid-cycle and then late cycle. And this is just obviously you progress from one stage to the other. But it feels to me like people talk about it in a looser way that you can actually move from late cycle to mid-cycle, for example. If you can move from late cycle to mid-cycle, how useful is this framework really, if you know what I mean?

Peter Oppenheimer
I think it’s a very fair criticism. And the truth is, like all things, it’s much easier to see in retrospect in the data — you know, where you are at any point in time — than in real time. It wasn’t long ago at all, you know, pretty much this time last year that most commentators were convinced that we were going into recession and therefore, it was end cycle. People were looking at inflation continuing to rise and alongside that interest rates. And here we are from late last year and certainly into the beginning of this year. Great confidence in actually a very, very different scenario, which puts you, as you say, in a different phase in the cycle. So I think understanding some of the factors that trigger these inflection points is extremely important, because you can rotate back into earlier parts of a cycle. They don’t always progress in quite the sort of uniform way that you would hope in an ideal world.

Katie Martin
I mean, one of the problems with investors, whether they are retail investors or professionals, is that they are humans. And humans are really fallible, right? We’re really bad at this stuff. We sort of assume that whatever the current situation is, it’s permanent. And we look for this kind of reversion back to something that we remember in the quite recent past. But one of the things that your book reminded me of is that like, the dominant sector in US stock markets for like 60 years from 1850 was transport, right? Railways and stuff, like, not a thing that people really care about.

Peter Oppenheimer
That’s absolutely right. But of course that did reflect, you know, the dominant technology at the time and really, one of the areas that was driving growth in the economy. And it’s actually relevant even more recently because, you know, the US equity market, which is now roughly 30 per cent of the world’s stock market — you know, we’ve seen huge outperformance in the last 15 years relative to others. It was last at 30 per cent of the world stock market back in the early 1970s. But the biggest companies then were all car companies and oil companies, not technology companies.

Katie Martin
So we think that technology and, you know, more recently AI are like just the sort of normal steady state of dominance and that’s just not right.

Peter Oppenheimer
Yeah. And attitudes can change a lot. I mean, again, in the context of that more recent history, you know, by the late 1980s, the US was not actually the biggest stock market in the world. Japan was at this period of time. And in 1990, four of the biggest 10 stocks in the world were Japanese banks and six of the biggest 10 companies were Japanese.

Katie Martin
How did that work out? (Laughter)

Peter Oppenheimer
Exactly. In the current context, that seems sort of implausible, but of course at the time made a lot of sense. And so it’s very important to understand not just the cycle and the influence of things like inflation and interest rates on growth and assets but also some of the sort of secular changes within which these cycles unfold, which can really reflect a combination of complex factors, not just the economy and policy, but also geopolitics and technology, social attitudes. And these can really have a very big and dramatic impact on longer-term returns. But Katie, as you say, recency bias is a very strong psychological phenomenon. And people really forget. And it’s very difficult to really contextualise sometimes things that seem to be so important or urgent at a particular point in time.

Katie Martin
Yeah. The past is a different country and all that.

Ethan Wu
Well, speaking of the secular changes, Peter, I mean, I think when interest rates first rose in the US and across the world, there was a feeling well, maybe this is a temporary campaign to do inflation-fighting and, you know, it’s gonna come back down in the not-too-distant future. And now there seems to be more conviction that, you know, this new higher rates regime is perhaps here to stay. And you see that reflected in long yields across the world, that markets are pricing in rates being higher for longer. And that’s something that’s very much out of the cycle, right? If interest rates first rose to combat inflation but they stay higher because perhaps the economy is stronger and the economy can handle higher interest rates, that completely changes the regime for investors. And in the long run, it’s not one of these kind of cyclical changes that you’d associate with early/mid/late cycle, is it?

Peter Oppenheimer
No, I think that’s exactly right and emphasises the importance of these sort of structural changes. So you’ve got a cycle — you know, interest rates went up quite a lot from an extraordinarily low level over the last couple of years. And now markets are pricing interest rates to come down, although not quite as quickly as was hoped a couple of months ago. So that’s a cycle — interest rates rising and then falling. But the structural dynamics are really quite different because we need to see this in the context of what happened after the financial crisis in 2007 and 2008, when interest rates then moved down to really the zero lower bound. And even that was not sufficient to trigger a sustained recovery in economies. And we started to enter the period of QE, which has really dominated the environment, really, in the last decade or more. But that is . . . 

Katie Martin
So that period central banks were just buying every government bond they could find.

Peter Oppenheimer
Right. And that itself was a period that was historically pretty much unprecedented. But we’ve got very used to thinking about interest rates in that context. I mean, it’s worth remembering, you know, just three years ago, about a quarter of all government debt in the world had a negative yield. You know, that means that not so long ago, people were so used to these zero interest rates that investors were literally happy to lend money for a negative return, basically give money to governments with no return.

Katie Martin
Thank you very much for looking after me, former UK government.

Peter Oppenheimer
Yeah, whereas as Ethan, you quite rightly say, the environment has shifted. That’s no longer true. And people are demanding gradually, but probably persistently, higher returns for lending to governments, particularly as this new environment that we’re seeing is involving bigger and heavier levels of government debt. And pretty much all governments are borrowing more money together at the same time. And increasingly, that’s forcing longer-term interest rates to a higher level. So that’s an example, not just as the cycle, but as the structural shifts that we’re beginning to see.

Ethan Wu
Peter, let me ask you a question that, you know, I heard a lot in 2021, 2020, in the kind of throes of the easy money bull market. It’s that when the merry-go-round stops, when the Fed takes the punchbowl away, whatever metaphor you wanna use, you’re gonna see a great washout of companies in this kind of reset to higher interest rates. And, you know, you saw that to some extent in, you know, for example, unprofitable software companies. You obviously saw a couple of banks fail. But I think, at least my impression is that the washout from this secular structural interest rate change that you’re describing hasn’t been as dramatic as maybe some would have predicted a couple of years ago. I mean, is that your impression too?

Peter Oppenheimer
Yeah, I think Ethan, that’s a very good point and a very important one to make. We’ve seen interest rates rise very rapidly from zero or even negative in many cases over the last couple of years but it hasn’t really triggered any systemic fallout. I think there are a couple of reasons for this. One of them is that although interest rates rose pretty quickly by historic standards, they’re still relatively low compared to longer-term history.

But the second point, probably more importantly, is that we entered this period of rising inflation with unusually healthy private sector balance sheets in many cases. So what do I mean by that? Well, you know, remember that as we entered rising inflation and interest rates in 2022, this came off the back of the pandemic and households were forced, if you like, to accumulate savings over that period because they just couldn’t spend money. And as a result of government policy, many cases they were supported through furlough schemes.

So household savings were pretty healthy. Broadly speaking, corporate balance sheets were quite strong going into this recent period of rising rates. And very importantly, I think, so were banks’ balance sheets. And that, of course, reflects the history of what happened after the financial crisis when regulation tightened to force banks to take on more capital and to de-lever. And that meant that they were in a relatively good position to absorb the shocks of rising interest rates in the more recent period. So none of these things have meant there’s been no impacts of rising inflation or interest rates, of course, but it has lessened the blow. And I think, again, that’s why it’s so important to understand the sort of context, rather than just assume a precisely consistent, repeated pattern as these cycles evolve.

Katie Martin
So you talk about in your book how we’re now in a postmodern cycle phase, right? So this is a kind of combination of a necessity to spend on the climate emergency and the emergence of deglobalisation after Covid and as a result of geopolitics, and as you mentioned, this kind of need for governments to just spend more like in general — you look at defence, you look at the green transition, all of this stuff. So what does that mean in terms of asset allocation now? What works and what doesn’t in that environment?

Peter Oppenheimer
Yeah. I think a higher cost of capital and a higher level of government debt means that over the longer run, we should get lower returns in risk assets like equities, credit, but also in government bonds and, and other related assets as well. What does that actually mean for asset allocation? I think it means that diversification becomes more important. And investors extending their time horizons is also going to become critical. And it’s interesting, this point about diversification, because, you know, over the long term in history, diversification has been a way of boosting risk-adjusted returns for investors. But actually, in the era of super-cheap money following the financial crisis, diversification didn’t really pay off. You know, if you were an equity investor, it turned out all you really wanted was US equities; for that matter, US technology. You wanted maybe a 60-40 benchmark between equities and bonds, but no other assets really enhance the risk-adjusted return. And I think with lower aggregate returns — really reflection of a higher cost of capital — being more diversified across assets, across geographies, and indeed across sort of styles and extending time horizons should pay off in my view.

Katie Martin
But that kind of implies that the market is wrong at the moment because it’s gone all in.

Peter Oppenheimer
It’s gone all in on risk and I think . . . 

Katie Martin
And it’s gone all in on AI creators, not on the ultimate AI beneficiary.

Peter Oppenheimer
Yeah. So I think there’s two interesting perspectives here. One of them, again, is the cycle, and the other one is the bet that people are making about long-term structural changes. So on the cycle I think it makes sense because what’s really happened since really last October, November is that investors have really centred in on this consensus that we’re gonna avoid a hard landing or a recession in most major economies, and that the scares about inflation are behind us, that inflation is gonna come down pretty quickly and alongside that, interest rates.

So the broader perspective here is that, look, you know, if you’re avoiding recession, company profits are gonna grow. And if inflation and interest rates come down, bond and equity markets should rise. And I think that does make sense. That being said, two important factors to take in mind. One of them is that most asset markets are pretty expensive now. Credit spreads are at record low levels, equity valuations are close to record highs, particularly in the US. You know bond markets are pretty fully valued as well. And that all should tell us that longer-term returns should be lower.

The second thing that’s happened is that a lot of those returns have been very concentrated in the small part of the market, particularly in equities, and especially so, Katie, as you say, in technology-related companies that don’t seem to be at the epicentre of the AI revolution. We do think that AI is gonna be one of the two really dominant factors that will reshape our economies over the next decade or two. That alongside decarbonisation. And we think it will provide some significant benefits, particularly in terms of improved productivity.

But if history tells us anything, it’s very unlikely that the dominant companies today are the only companies that eventually end up profiting or growing as a result of changing technologies. In fact, others are likely to leapfrog them and become faster growing. You know, companies that can utilise these dramatic technologies outside of the technology sector itself may be big beneficiaries. And at the moment, the market is not really focusing on them as much. You know, take things like healthcare, for example, you know, an industry that could be very disrupted in a positive way from the use of large language models and other AI technologies. You know, these stocks, generally speaking, have lagged behind the companies that are really spending the money on the principal investment to begin with.

Katie Martin
So all in all, markets and investors are thinking a little bit wrong about how this sort of grand sweep of transformation really kind of crystallises over the long term.

Peter Oppenheimer
I think so. That being said, I would argue that we’re not really in a sort of bubble territory, because when you look at technologies in the past — and it was true of major transformations: you know, the canal revolution, the railway revolution and of course the tech bubble that we saw in the late 1990s. These ended with massive speculative bubbles which ended up reversing in very dramatic fashion. I would argue we’re not in that situation, at least not currently. And the reason for saying this is that if you look at the valuation of the really dominant technology companies, they are not really at the sort of valuations that we’ve typically seen in bubbles in the past. The balance sheets and profitability of these dominant technology companies are extremely strong today compared to the more speculative position that many of the leading companies had in previous bubbles. But despite all of that, I still think that we will see a broadening out of market returns. And the other faster growing companies will come along both in the tech space and there’ll be some big beneficiaries outside of technology as well, which comes back to the point, really, of diversification.

Katie Martin
Yeah. History doesn’t repeat but it rhymes. It’s well worth bearing that in mind.

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We’re gonna have to leave it there. We’ll be back in a minute with Long/Short.

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Right now it’s time for Long/Short, that part of the show where we go long a thing we love, short a thing we hate. So what are you long or short of? It can be anything.

Peter Oppenheimer
I am long healthcare companies because I think they’ll be a big beneficiary of changes in technology, AI and cost-cutting.

Katie Martin
Yeah. Who needs doctors when you’ve got computers? (Peter laughs) That makes a lot of sense. Ethan, what you got?

Ethan Wu
Tesla! Man, I’m short Tesla. You know, people have long argued about whether Tesla is in a bubble. Aswath Damodoran has written for years that the valuation is completely unjustifiable. And it feels now that sales are slowing down. They just reported a 9 per cent drop in first-quarter vehicle sales. The stock is starting to lose some steam. It’s fallen double digits in the past couple of months. And it comes down to earnings. They’ve not shown earnings. The market’s getting more competitive. There’s a price-cutting war going on in EVs. I mean, it seems like tough times for Tesla. And maybe the argument about whether it’s a bubble or not, maybe the kind of actual result of that was just shifted forward a few years from when everyone was arguing about it in the mid-2010s.

Katie Martin
Yeah. It’s kind of, show me the numbers Elon. And then the market’s like, no, not those numbers. We don’t like them very much.

Ethan Wu
Pretty much.

Katie Martin
So I’m gonna be short private members’ clubs. If you read British newspapers you will know that the UK is having one of its periodic moral panics about men-only private members’ clubs. And to be clear, I think that is valid. But I just don’t like any of them whether they’ve got women in them or not. I always feel like a total fish out of water in private members’ clubs. I don’t like them. They’re a no from me. I’m gonna be short.

Ethan Wu
Peter, are you part of any private members’ clubs?

Peter Oppenheimer
I’m not, no. I think . . . Was it Groucho Marx who said I wouldn’t be a member of any club that would accept me, or something like that. But no, I’m not.

Katie Martin
Let’s start our own.

Ethan Wu
You are now part of the FT Unhedged club. Yeah.

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Peter Oppenheimer
Oh, thank you. I feel honoured.

Katie Martin
Velvet rope stuff right there. Peter, thank you so much for trudging all the way from Goldman Sachs towers up the road.

Peter Oppenheimer
It’s been a pleasure. Thank you so much.

Katie Martin
It’s been really nice to have you. Ethan, nice to chat to you, as always.

Ethan Wu
Absolutely.

Katie Martin
We’ll be back soon. Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler. FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Katie Martin. Thanks for listening.

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