How central banks are setting the investment agenda...
TRANSCRIPT of an interview with Zephyr Management's Jim Awad by Hard Assets Investor's Mike Norman.
Mike Norman, Hard Assets Investor: Hello everybody, and welcome to HardAssetsInvestor.com. I'm Mike Norman, your host. My guest today is Jim Awad, managing director of Zephyr Management. Jim, thanks very much for coming on the show. It's great to see you, by the way.
Jim Awad, managing director, Zephyr Management: Old friend, it's my honor and pleasure to be with you.
Mike Norman: Thank you very much. I'm very happy to have you here, to get your perspective. You're a longtime Wall Street stock investor. I just want to talk to pick your brain a bit about the current environment, where we see sort of the backdrop is very uncertain, very scary, in a way. If you look at Europe, we have these rolling recessions. Here in the United States, growth is relatively slow. But yet we see equity prices pretty much all over the world just move on a very steady, upward trajectory. Is there some kind of a disconnect there? Or maybe you could make sense of it for us.
Jim Awad: Sure. The markets are doing better than the economies in almost every geography. And it really comes back to the central banks around the world. What they have done is taken away all the other investment options. They have made them unattractive. So people say, "OK, it's a zero interest rate environment. I can't get any yield in my money markets. I can't get any yield in bonds after taxes and inflation."
Well, the best place to go are US corporations that have fabulous balance sheets, that are highly profitable. Many of them have a global footprint, a dividend. If you get 3 percent dividend, 4 or 5 percent in growth, it's an 8 percent kind of return. And their balance sheets are better than the sovereign balance sheets.
So what they're doing is they're driving people into equities in the hope that that will create a wealth effect that will drag along the economies. And they're partially successful, but not entirely.
Mike Norman: Partially. We're seeing a wealth effect. But I'd say it's kind of bifurcated.
Jim Awad: Yes.
Mike Norman: The people at the top, we've seen a big bounce-back in their overall household net worth. But the lower percentages haven't really seen that. And there is a criticism that this is nothing more than an asset bubble. What the Fed is doing and other central banks, essentially, is inflating the stock market. Do you buy that?
Jim Awad: Well, I understand the case, and I can't say yet that it's not true. Only time will tell. What is a little bit scary is that they're creating a level of speculation in certain of the credit markets, certain of the financial markets, that's almost reminiscent of 2007, where you're having all these structured vehicles coming back. You're getting loans without covenants. You're getting takeover speculation. You're getting historical junk bond yields. You go over to Europe and look at the interest rates in Italy and Spain and Portugal, where they're all broke. And that unnerves one.
And how the central banks will ever unwind all this liquidity unnerves one. But in the immediate future, it looks like it's going to work in the short term, because you're getting 2 percent growth in the United States. You're getting somewhere around zero in Europe, which is much better than it could have been a few years ago.
Mike Norman: It's amazing that we say zero Dollars! Celebrating that, right?
Jim Awad: But it looked like it was going negative big time.
Mike Norman: It was negative for a long time, yes.
Jim Awad: Yes. You got 7 in China, 5 in India, and this can go on for a while. What you don't know are the long-term effects of it. Does it lead to inflation at some point? Does it lead to a currency war? Does it lead to loss of faith and paper currencies? We don't know that.
But what we do know is right now it's creating a sugar high in the financial markets. And you're right, in a real economy, the rich are getting richer, and the poor are struggling. And unless the real economy ratchets up from 2 percent growth to 4 percent growth, it's going to raise a whole lot of social issues as the rich get richer and the poor struggle.
Mike Norman: I agree. But the interesting thing is, also—and I guess this would be a counterargument to that asset inflating that we just were discussing—that corporate profits are at a record high. So something real is happening there. It's not just a nominal thing. We're seeing corporate profits at a record high.
Jim Awad: Well, it's in the capital sector. The capital sector is doing very well. But corporations are using that to pay dividends, to buy back stock, to do takeovers. The corporations are using that to help the capital sector, not to go out and hire, so what's happening is you're getting a historic shift from labor to the profit sector.
Mike Norman: Right. And we see that very clearly as labor's participation in GDP has shrunk to, I think, historically low levels. You mentioned something before about, at some point, perhaps investors losing confidence in paper money. Didn't we kind of see that, I guess, in the last several years, when you saw this big rush into gold, when people were touting it as an alternative currency? And yet gold has pulled back. So how do you sort of square that argument?
Jim Awad: Well, the thought was that all this money would lead to higher growth than what we're experiencing right now. And that that would ultimately lead to inflation, which would debase the debt, and that's how the US government could get out of all its debt. And people were turning to gold as a stored value, which is traditionally how you would have thought and what should have happened.
But what's happened is all this money printing has only gotten you to 2 percent growth. It's never accelerated to 4. Part of it is because they're only helping the capital sector. Part of it is the fact that you have restraint at the fiscal level around the world. Governments around the world are having to contract and pay down their debt and balance their books.
Mike Norman: Right.
Jim Awad: And so you're not getting the level of growth that would have given you the sustained appreciation of gold that you would have thought, after all this money printing. Doesn't mean it can't happen later. But the point is, central banks around the world have all this money. And they have to put it someplace. And they're basically saying, "At this point, gold can't absorb a lot of it." Whereas, therefore, the US Dollar is going to be OK. The Euro is going to be OK. And by default, gold doesn't do well, as well as history would have suggested it might have done.
Mike Norman: You're a very successful investor. You've been doing it for a long time. I think somewhat contrarian as well. When you look around sort of internationally, are there any particular regions or countries you like to focus on, or even through your investing here in companies in the US, is there an international sort of element to that?
Jim Awad: The United States right now is the least-ugly kid on the block. And we're doing better than most geographies. And so you want to have exposure to the US But also the highest secular growth is in certain emerging markets, where they are where we were in the 1950s. The middle class is growing.
Mike Norman: Like which ones?
Jim Awad: It emanates in China, but you're much better off investing in the geographies around China so you don't assume the China political risk, the China corruption risk. So you can go to Singapore and Hong Kong and find world-class companies that are serving the emerging middle class all over Asia, and find some terrific companies, and select mutual funds. But you have to worry about emerging market mutual funds, as many of them invest in commodity countries and countries that don't have good governance. So you really want to find a mutual fund and invest in emerging market middle class.
Then you go down to India; there's a lot going on in India. In fact, you could say the Indian model has better legs long term than China because it's got a democracy, and it's got better demographics and growth rates. In India, we like private equity more than public equity—that's where the inefficiency is.
And then, if you go through Latin America, interestingly, Mexico is coming around, in spite of all you read about the drug wars. Mexico looks like it's doing better. Colombia is doing better. Chile is doing better. Brazil is going to have a little bit of a tough time here short term. But it's doing well long term. And so some of the Latin markets, combined with non-China Asia and the US and private equity in India, I think, are the best geographies.
Mike Norman: Interesting. We recently saw a sort of pushback or a reaction to austerity, perhaps suggesting that it doesn't do what it claims to do. There was the paper by Carmen Reinhart and Ken Rogoff, when it was discovered that there were errors in that paper, where actually it produced a different result, possibly a growth result, as opposed to a contraction, which is what they claimed when you went over 90 percent. Do you see any chance that we're going to see a pullback in austerity? And if so, wouldn't that be bullish overall, and particularly for commodity prices?
Jim Awad: Well, if you had a pullback with austerity, coupled with long-term entitlement reform in both the United States and Europe, you then would have the chance of growing your way out and balancing the books by growth rather than through higher taxes in the various geographies. And that would include the United States and Europe. But just to delay austerity for the sake of pushing the pain off a little bit, without accompanying it with important entitlement reforms, I don't think would excite the financial markets.
But if they said, "OK, what we're going to do here is pull back on austerity short term, and really cut the growth in spending long term, in a meaningful way," I think that would unleash growth in ...
Mike Norman: Do you think that's going to happen?
Jim Awad: Not until the next set of elections. There's no political dynamic that are screaming for that yet. You could in the United States get a Ronald Reagan-type figure, who got us out of our last mess, to run on the basis of growth rather than contentious social issues. And in Europe, you're getting such populism against the austerity, you may have a pro-growth leader. But you don't see it yet. It's too early.
Mike Norman: Well, they keep getting elected saying they are pro-growth. But then, once they get in, they kind of kowtow to the austerity people.
Jim Awad: Right. And they also don't make the important entitlement reforms.
Mike Norman: Jim, it's great seeing you. Thanks very much for coming on the show; I really appreciate it.
Jim Awad: We'll do it again.
Mike Norman: All right, thank you. That's it for now, folks. This is Mike Norman saying see you next time.