In the last episode, Marcel and I spoke for over 1.5hrs about everything that happened in financial markets in 2022 and considered why we ended up in this inflationary environment and how that has affected investors in equities, bonds, commodities and property.
Here, we edited that podcast down to under 30 minutes and have provided a transcript below. Hopefully you find this helpful in understanding what’s happening in financial markets and geopolitics, especially now that we’ve seen a few bank collapses over the past month in 2023. Most importantly, how will this affect one of your biggest investments - your home?
Chris: Hi, my name is Chris Andersen and welcome to the Ando & Co Podcast. Today I'm sitting down with Marcel von Pfyffer, who is the managing director of Arminius Capital, and we met in finance in Brisbane in 2010. And really, for me, I hope that you're able to enjoy some of what I’m able to enjoy from being able to sit down with Marcel regularly. That is, that he's able to unpack what's happening in the global macro world, whether it be finance, politics or anything else along those lines. So, Marcel, to kick things off, what can you tell us about yourself?
Marcel: I was born in Australia to humble parents, my father was Swiss (that’s from Switzerland, not Sweden) both self-employed and incredibly hard working people. After entering the finance world post-university, I lasted a few years in Australia, then found myself working in New York and then London. I had the pleasure of working at, what the great Matt Taibbi, who wrote the Rolling Stone piece about the vampire squid wrapping its face around humanity described, was Goldman Sachs. I also had a little time in a place called Jersey in the Channel Islands, which was super cool. I then came back to Australia, met a girl who was Australian, got married, and had a couple of kids.
During that timeline, I quit an excellent paying job to start my own business while my wife was three months pregnant with our first child. But I'm still married, so let’s say it must have paid off! I then ended up in a fairly niche area in the funds management world, running a hedge fund, and also one that is not particularly well understood nor appreciated in this country – global macro. And so I moved back to Europe about six years ago. And now here I am in 2023, back in Australia now for about a year or so.
Chris: And as I mentioned earlier, one of the big benefits I find in being able to catch up with Marcel regularly is that I don't necessarily watch the news every day, but he does. And so if I ask a question, I know that he's already looked at all the news, unpacked all the data, and when he answers me in terms of what's going on in the world, I don't have to second guess it. And so, Marcel, before we dive into anything else, what's been going on in the world over the last twelve months that is impacting your world in financial markets?
Marcel: I would expect that the majority of the public would expect me to say the war in Ukraine, right? It's a terrible thing that's happened over in Europe, but to blame the machinations of what's impacted financial markets in 2022 solely and singularly on Putin and the Russians, I think is a critical point that many, many people have missed. There are those of us in the markets, along with myself, who have actually had a spectacular year with our returns, despite what’s happened in the market. MSCI World, which measures all equities in the world, fell -19% in 2022. Global bonds fell -14%. Our hedge fund made +21%.
The problem is that this – the post Ukraine invasion “inflation”, inflation which actually started well before the Russians went into the Ukraine - has been caused from what all the world governments and world central banks did post 26 March 2020. That – and I remember sitting at my dinner table in Geneva - was when Powell got on the TV and said, effectively, we're just going to open the dam gates again with the easing of monetary policy. To combat an air borne virus. So there are other things at play, and they all come back to why we've had such a great year. Ultimately, it all comes back to inflation. It comes back to the energy complex. So oil and natural gas. All of this is driven, literally, by the price of energy. When the economic environment changes, such as a change in a business phase or business cycle, you'll get all these reports from salesmen because for them it’s an opportunity to reach out to their clients to kick them into action to buy something or sell something,; stockbrokers, fund managers, real estate guys, your bank manager… they will say, “Oh, we think we're going into an inflationary period. So if we are right, the you are going to need to buy this.” But when the global economy moves into a new inflationary regime environment, the one thing, the single thing that I can tell you is immutable - what will always go up in value in an inflationary environment - are energy commodities. They will keep going up until the inflation either tips into a recessionary environment or a period of stagflation. As they say, the best solution for high oil prices is high oil prices. Of course, there is a mathematical economic equation which sort of says that level at which high oil negatively impacts the global economy around about $120 a barrel, in US dollars. The world can accommodate and absorb energy up to that price level.
In the old days, before certain countries blew up pipelines of natural gas, the gas price was also somewhat correlated to the oil price. So you have this environment where inflation hits the world's growth level. Where the growth profile has been very healthy. Perhaps too healthy - and oil can keep going up in price up until about $140 barrel. Then it gets much more expensive, not in nominal terms but in real terms. What happened in early 2022 is that the cost of factors of production have increased because those industries have been starved of capital, as we've seen in Europe now with natural gas. The impact of the gas price on the manufacturing behemoth of Europe, which is Germany, is that they're now shutting manufacturing. So you have these domino effects from what is originally, was really, an inflation problem, in my demonstrably – given our profits from commodities – professional opinion. What these twits did in 2020 is a demon of their own design.
The central banks and the governments have literally created this inflation problem that we have now. So now you've got a situation where the west has forced Putin's hand because he can't transact in US dollars, and all commodities all over the world are traded in futures which are priced US dollars. So the takeaway is going to be the banding together of Russia, Saudi Arabia, probably Venezuela and of course, everyone's good friends, the Chinese. I'm yet to be convinced, and it is a very dark, deep rabbit hole to go down, to begin to surmise about the end of the US dollar. I have grave reservations that the US dollar can be replaced as easily as many people think it can be, let alone would like it to be. But what I can say is that the power of having the backing of your economy actually being energy, the price of energy in an inflationary environment is actually a powerful boon for that country.
In the same way that in Australia, they reap the rewards when the iron ore price is super high. Right? The companies do well, the governments do even better because they have all these royalties and taxes, which they do absolutely nothing to deserve or earn, but then BHP and Rio has a fantastic year for whatever reason (war, global growth) and everyone benefits.
But as I say, your listeners might expect me to say that inflation has come from the war in Ukraine. No. When you look at the data, it started well before a single Russian tank went into the Ukraine. It had already started. What it really is, has just been the natural conclusion of about two years of central bankers and governments around the world issuing so much debt it’s not funny and creating so much liquidity and et voila, you have 11% inflation in the UK and realistically at least 10% in the USA. You have household energy bills in the UK that are 700% higher than they were two years ago. Lowe expects inflation will hit 8% in Australia, the Yanks really got to around 10%. Their numbers are fungible. Again, that's a whole new interview. And this is what we have. We have an inflationary environment, and the Ukraine situation I don't think is going to be resolved anytime soon.
Chris: And so we look at everything that's been going on in the world and we've touched on it quite a bit. What can you walk us through over, let's say, the last twelve months? How has Australia fared when compared to other markets around the world?
Marcel: So from a capital markets perspective, the Australian stock market has done materially better than pretty much every other major exchange in the world apart from Argentina. Australia at the moment, I think, is down somewhere around negative three, negative 4% for the year compared to Europe and America.
The Nasdaq is down 29% for the year. Its main constituents are tech stocks. This is a very important point which I'll come back to. The S&P500 hasn't fared as bank badly as the Nasdaq, but it's still down and Europe at the moment is around 10%. So Australia, relatively speaking, hasn't fared as badly. Why is this? So, first of all, there's the why. And then the second point is, is it true? Australia does nothing, it effectively digs stuff up out of the ground and exports it to China... the Australians don't manufacture anything in this country anymore... not even a Holden. And again, I read the Labor Status Report from the ABS a couple of months ago and what's the best paid sector, of course, in Australia, by median weekly earnings, is the mining sector. Pretty much as anybody can attest to if they've had to do any refurbishments or maintenance on their house in the last two years. This is followed by the construction sector. So there we have, of course, a beautiful example of the old “Houses and Holes”, which is what drives the Australian economy. So fortunately for Australians, both of those two things fared pretty well through COVID over the past two years. The commodity sector, obviously, we export far too much of a proportion of total exports to one country, which is China. China, who as soon as the Australian government asked for an inquiry into where did COVID come from, slapped a ban of imports from Australia on wine, lobsters and coal. The coal ban didn’t last very long. These people are not our friends. From the construction perspective, of course, you've got two issues there. First of all, interest rates were brought into an insanely negative territory through COVID, making the cost of capital not quite free but basically free. But Chris, I do not need to explain this really any further to someone in your industry who watched housing prices go up 25% per annum for two years. So, that was completely fueled by the insane actions of the RBA.
And again, coming back to that, Australia is protected in its commodity exporting by the fact that China just will buy whatever we dig up out of the ground. So that's great when you've got a customer who will literally buy every single thing you have to sell. And it brought me a great deal of amusement in the first couple of months when COVID kicked off in 2020 when the Australian Prime Minister had temerity to suggest to China that we should have an investigation as to the origins of the Coronaviruses. And the Chinese promptly said, righto, we'll just stop buying coal from you. And that lasted, I think, about three or four weeks, and then they bought the coal again. So that's wonderful to have an almost infinite level of demand for something that you just have to dig up out of the ground.
The housing sector in this country is a phenomenon. Apart from Canada and New Zealand and Sweden, nothing else comes close to the appreciation of the Australian property market. Why is that so? Well apart from the cost of capital being quite cheap to people who can demonstrate that they can service the debt, which again is not a lot, providing a piece of the household salary hopefully comes from the mining sector. But then a combination of the RBA, the Government - APRA, who is the banking regulator and ASIC, I think that those four have planted the flag pretty firmly in terra firma in Australia and has said that the property sector won't be going down on our watch.
The only problem with that is that Australia represents about 2% of global capital markets. So from an investing perspective Australia is hardly on the radar. So when you've got big, big players in the States, as big players in Europe who need to deploy capital, they could come in and buy up a significant part of the stock market. So going back to what I said before about other numbers real inflation, the last inflation number that the ABS reported for twelve months to September I think was 7.3%. But if your stock market returns are down 4%, to get the real return, take your nominal return and subtract from that what the inflation level is, and that's your real return. Okay, so it's what you receive in your hand after inflation, and inflation is what we believe is a government caused tax: it is the end result of fiscal mismanagement. Okay, so the Australian stock market has lost 4%, and inflation is 7.3%. So in real terms, your average Aussie, you're actually getting negative 11% this year. If you've made 2% in a year where inflation has been 7.3%, you've still lost money in real terms.
Australia is doing ok, for the aforementioned reasons of being in the very advantageous position that we have a consumer to the north of us who will buy literally everything we can dig up out of the ground. And then the construction industry in this country benefits from the banking sector, which is effectively a protected species by two regulators, the government and the RBA.
Chris: So, Marcel, this is where you get the chance to tell us how you've been going in your global macro hedge fund.
We've had a pretty good year in the global macro hedge fund that we run that trades foreign exchange, commodities, bonds and equities. We did 21.6% for CY2022, and we took a moderately bearish position going into December because, quite frankly, again, the market is quite schizophrenic. The market is reactive to press conferences. We run a quant hedge fund. So, at our core, we run a couple of thousand econometric models per month to determine what we believe; or how the economic functions that we've written into the algorithms determine what we believe. They will identify what happened in November with Powell talking about maybe being ready to slow the pace of the rate rise in America going into 2023. When he said that, the market shot up 4 or 5% in some markets. As we said, in the space of seven or eight days now in the US, they're down three and a half percent. All that’s really happening is the market overreacting to what they perceive to be good news. Of course, the problem that we have now, eg. this whole money printing and quantitative easing stuff, was literally methadone that you give to a heroin addict.
So it's been a very challenging year for equities, because as bond yields go up, bonds, of course, are perceived to be a risk free investment and are supposed to react inversely. Although, that issue about real rates of returns can actually hit you even harder in bond land. The fact is that that way we invest in what we do is why in 2020, when markets fell 36%, we actually made money – a bit over 5%. And it is why this year, when the Nasdaq is down almost 30%, we are up over 20%.
Chris: And so, in all of this, we've heard that the Australian market has actually done pretty well. So, what's the value that you see in being global, rather than just invested here in Australia?
Marcel: The thing about being global? I mean, going outside Australia to get access to stocks, to sectors in an economy that we don't have here, that is the bottom line. We have no pharmaceutical sector, really. I mean, CSL is a huge player, but it's one stock. Also, we don't actually have a tech industry. And again, what is the stock market going back to after all this?
Warren Buffett, whose favorite metric for assessing valuation, be it over/under of a stock market, is the percentage of total stock market capitalization to the country's GDP. The proportion of that. So for that metric to work, you actually need comparators of an industry that's operating in your economy that then goes and lists on the exchange and, mate, that’s something Australians simply don't have. The ultimate argument for diversification is to achieve superior risk adjusted returns spreading your investment positions and to do that to get your money out of Australia you must go into sectors of a stock market that you literally can't buy in Australia.
Chris: And so, you mentioned commodities earlier, what are some of the key trades that you have really played out for you over the last twelve months?
Marcel: Worked out or gone badly? The bad stuff is actually easier to answer. The short answer here is really me telling you what risk management protocols we run models on about 1600, maybe 1700 individual stock models of companies in America, Europe, Japan and Australia. We run models of major currency pairs of which there are not too many and we model 18 commodities now for each of those positions and if something goes wrong, we have what we call gates in the systems. They will initiate stop loss protocol, which is a really fancy way of saying if it drops X percent - for most of our stuff the absolute kick out will be 10% - we are simply gone. We’re gone after the 10% level. The signal output says close the position you’re in, you try and get it out at VWAP, as you don't want to get taken out even further. Bite the bullet.
The price movement can be very volatile in commodities in particular. So commodities, foreign exchange are both very volatile asset classes. And of course, what's had the most fun in 2022? Natural gas. The earliest I could get out of the position ended up costing us -18% instead of losing only -10%. But in the in the pure commodity sleeve, that exposure was only 1/18. So we run 18 commodity positions in the commodity sleeve, that was one 18th of the whole sleeve. And that sleeve was about 30% of total exposure.
You asked me what went well. White Haven coal went really well. +314% well. Natural gas went well on the way up. Brent, West Texas went well on the way up. And in other commodities, we've had good wins on certain liquid markets.
Chris: So, just thinking about the normal way that you would usually invest, partially in equities, partially in bonds, can you walk us through how the bonds market went this year?
Marcel: I probably pay the most attention to American bonds, which are down around about 14%. The bond market is what is supposed to be your ballast. It is supposed to be your keel when markets go south. So you've had the double whammy this year of losing, -19% in your equities portfolio if you're lucky. And the old financial planning model of the old 60/40 equities/bonds allocation, which has stood most investors in good stead, to be fair, for about 30 or 40 years has lost -19% and -14% respectively.
Chris: And so, has there actually been some wisdom in holding property instead of bonds?
Marcel: Yeah, for sure. In most markets in the last couple of years, the capital appreciation of property as an asset class has gone up 20% to 25% if you were wise enough to buy property in certain pockets or capital cities. The thing about property, what saves people in property as opposed to what crucifies people in capital markets, is that the transaction costs to getting in and out of property are much higher. It is not an easy process.
For equities, any punk off the street can log into their comsec account and hit sell. When they see that BHP is down 10% and they get nervous they can sell. If you've got a house or an apartment it is a laborious process - I'm sure you don't mind me saying. So it is not something that you just do in 24 hours when you sell a property.
Chris: Well the other thing is getting a price correctly is not an easy thing either
Marcel: And the price in property is what the purchaser is willing to pay, and again, not everyone moves at the speed of 1000 gazelles. The beauty here with property is that it's pretty much a protected species in Australia but the fact that there are transaction costs like you've got to pay stamp duty and agent fees et cetera, it necessarily slows people down.
But as we said before, the problem with investing is the person doing the investment with property. It's almost like you've got this built-in gate that stops people doing something stupid. When you talk about property versus bonds this year, there's almost no comparison there.
Chris: So how do you see the next six to twelve months playing out? And what are some of the key variables that could change things?
Marcel: Stock markets, by their very nature, are filled with speculators who are making bets based on where they think supportive economic conditions are going to be twelve months hence. So the stock market is a forward looking mechanism. The real economy is what it is. So the condition, Lowe said himself - the esteemed RBA governor, said this week is that he expects inflation to be 8%. This is the same dude that told us a year and a half ago that “there was no inflation and there wouldn’t be any inflation, it’s all good, we don't need to raise rates problems until 2024”.
The whole wage increases vs CPI vs productivity, it's almost like some of these people have never actually studied a single piece of economics in their life. Providing the construction sector keeps doing what it's doing, providing China gets out of its sugar coated fantasy of zero covid, back into the production lines and needs to buy more coal and more iron ore, more copper off us, of Australia. So the outlook here, Chris, I would dare say that here there are more supportive economic conditions, than definitely in America and definitely in Europe. It's a relative world.
Chris: And if people have made it this far, and we’ve covered a lot of ground, how could they potentially invest you?
Marcel: Well, if they're listening to this, then they know you, so you can tell them where to go, but they can come to our website, which is Arminius Capital. www.arminiuscapital.com.au and the email contact is there info@arminiuscapital.com.au Otherwise, reach out to my dear friend Chris and he will put you in contact with me.