[REPLAY] Marko Papic – Geopolitical Alpha at Clocktower Group (Capital Allocators, EP.161)

Marko Papic is the Chief Strategist at Clocktower Group, where he provides research on geopolitics, macroeconomics, and markets. Marko recently published Geopolitical Alpha: An Investment Framework for Predicting the Future, an imminently readable book with colorful examples of political analysis. Marko's approach is akin to Moneyball for politics, challenging the orthodoxy of how others traditionally make investment decisions. Our conversation covers Marko's upbringing, the flaws of most political analysis, and his constraints-based framework. We then turn to the obvious political topic at hand – next week's U. S. Presidential election. We discuss his views of different possible outcomes on the U. S. equity market, rates, tech stocks, China, private equity, ESG, Europe, and emerging markets. Learn More Follow Ted on Twitter at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com https://thepodcastconsultant.com/)

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:01Ted Seides?

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• 3:32Ted Seides?

  Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can keep up to date by visiting capitalallocatorspodcast.com.

• 3:59Ted Seides?

  My guest on today's show is Marko Popic, the chief strategist at Clock Tower Group, where he provides research on geopolitics, macroeconomics, and markets. Marko recently published Geopolitical Alpha: An Investment Framework for Predicting the Future, which is an imminently readable book with colorful examples of political analysis. Marko's approach is akin to Moneyball for politics, challenging the orthodoxy of how others traditionally make investment decisions. Our conversation covers Marko's upbringing, the flaws of most political analysis, and his constraints-based framework. We then turn to the obvious political topic at hand:

• 4:42Ted Seides?

  next week's US presidential election. We discuss his views of different possible outcomes on the US equity market, rates, tech stocks, China, private equity, ESG, Europe, and emerging markets. Please enjoy my conversation with Marko Papic.

• 5:04Speaker 01

  Marko, thanks so much for joining me. It's a real pleasure, Ted. It's great to be here.

• 5:08Ted Seides?

  Take me back to how you first got interested in studying economies and politics and markets.

• 5:17Speaker 01

  We can go way back, really way back. The first conversation I remember as a human being is my mom is giving me a bath and explaining to me why there's Iranian scuds flying over our heads.

• 5:31Ted Seides?

  And you were where? You grew up where?

• 5:32Speaker 01

  I didn't grow up here, but we spent basically like six months to a year in Baghdad. My dad was working there for like an SOE from Yugoslavia. And so I'm in a bathtub and I guess my mom has to explain to me why there's a war between Iran and Iraq. That's literally the first conversation I have as a human. And then I go back to Yugoslavia. I was going to be a football goalie, obviously. Why not? Lots of mileage. You can stay in Korea for a long time. Smart kid. And then we get hyperinflation. We get this last stage death throes of the country, of Yugoslavia. And I remember, I think I was seven years old or maybe eight. I go to my dad and I'm like, hey, to solve this inflation, why don't they just collapse everyone's salary?

• 6:13Speaker 01

  And then interrupt the cycle. He just looks at me. Yeah, that's what they probably will do. You know, I mean, so my background is pretty messed up. I've lived all over the place, Ted, and I think that's how I got into all this stuff.

• 6:27Ted Seides?

  So where is all over the place?

• 6:28Speaker 01

  I was in Baghdad for six to 12 months of Iraq when I was very, very young. That doesn't really count, but I grew up in Belgrade, Yugoslavia. And then in 94, as the country was really falling apart, my parents just said, look, we got to get out of here. And the only place we could think of was Jordan. We packed up two suitcases. And I remember you couldn't fly out of the country. The sanctions were so severe, we had to take a bus to Budapest and then fly from Budapest to Cyprus. And then my dad got his residency visas and we got to Jordan. And so I think I'm the one of only human beings ever to escape war by going to the Middle East. And then, you know, I spent three great years in Jordan. I went to an American school. I mean, honestly, it was incredible. Probably three best years of

• 7:10Speaker 01

  my childhood. And then finished up in Switzerland, three years in Switzerland, which was such a traumatic shift for a kid. And then I went to University of British Columbia in British Columbia, spent six years there, then Texas, and then Quebec, Canada for eight years. And now I'm in California. And out of all of that, I've actually lived in Canada the longest, 14 years.

• 7:30Ted Seides?

  You take all of that, very international experience, very different countries, cultures. How did you think about what you wanted to do when you came out of college?

• 7:38Speaker 01

  I didn't really have a good sense. I mean, I'm kind of like a typical immigrant kid from the third world. You're going to be an engineer, doctor, or lawyer. And I fall in love, to be honest with you, with my now wife. And so it kind of sideswipes me for a year. And so I'm like, ah, I'm going to become a professor, you know? Money doesn't matter. Like, I'm in love. I was in academia. I was doing a PhD at University of Texas, learned a lot there. And then we got a kid. And I'm like, oh, yeah, no, money does matter. And so I went to the private sector. And there, I was in Stratfor. So Stratfor is a geopolitical analysis firm, lucky for me, based in Austin. I just walked down the street, got in there, learned from some really great, great minds like George Friedman, Peter Zian.

• 8:24Speaker 01

  Learned a lot. I was hired to be the Europe analyst, which is like being completely irrelevant. This is like 2007, 2008. Nobody cares about Europe. Europe's fine. It's integrating. Okay, let's focus on Middle East and China and all these other things. And then boom, the euro area hits. First, actually, it was a Central and Eastern European crisis with the Swiss mortgages. And I suddenly find myself, in order to do my job, I gotta really understand macroeconomics and also finance at a very high level. And that was jarring to me because I just wasn't prepared for it. I had to like learn on the job. And I realized very quickly during that period in 2009, 2010, that there is a problem between these two communities.

• 9:06Speaker 01

  The finance professionals and political analysts, they don't talk to each other. They don't know each other's language. And I said to myself, wow, there's a market inefficiency that I'd like to resolve.

• 9:15Ted Seides?

  What were those two languages as you perceived them at the time?

• 9:18Speaker 01

  Finance professionals are trying to generate returns for their clients, for themselves. And so they need an answer on a certain time horizon. It cannot be like over the next 10 years, Mexico will do well. Like, well, no, I need to know where the peso is going like right now. So I think political analysis professionals don't understand the concept of price thin. They don't understand the concept of having a clear view that can be articulated in the markets. And you may have a very cogent, elegant, and parsimonious view on why Poland will do great over the next 20 years, but we gotta know right now. Is the entry point good? Is valuations there? That's what political analysis professionals don't really understand.

• 10:03Speaker 01

  And then on the financial side, there was the sense that politics cannot be systematically analyzed. So the only way that you can do it is to talk to some wise old hand in a smoke-filled room or at a cocktail party. And that those chatters will generate alpha because otherwise you can't do it. And I always found that very problematic. And thankfully, I have political science graduate experience. I mean, I was doing a PhD, I took a lot of courses and I understood that no, political science is not a science, I mean, obviously, but there are some systematic things about it that we can apply to finance. And what I also found very interesting is that investors had this really negative view of political analysis, like you cannot do that, you cannot forecast that.

• 10:46Speaker 01

  But they were making bets, sizable bets, in markets that themselves are inefficient and irrational and unpredictable. Because if economics and finance was predictable, if it was just a Newtonian exercise, then folks who have PhDs in finance would be billionaires and we all know that's not the case.

• 11:04Ted Seides?

  Things that you start writing about in your book that going forward, political analysis will really matter. Why is it the case that it should matter now when maybe it hadn't as much in the past?

• 11:19Speaker 01

  So that's really the key question, right? What's different now? I think politics, geopolitics, social issues have always mattered. So it's not so much that they matter now, but it didn't. It's more that they were tailwinds for investors. They were the wind in our sails from 1980 until 2010. You had these two really important mega trends. One was American hegemony. And so you could kind of ignore the geopolitical stuff like, you know, Azerbaijan, Armenia go to war in early 90s, much less of an issue than it is today. In early 90s, there's no chance of Turkey and Russia going to war because US calls

• 12:04Speaker 01

  them and says, hey, cool it. So that's the American hegemony part of it. The second one is there was a hegemony of an idea, which was the Washington consensus. And it's a catchall term. For everything from independent central banking to countercyclical fiscal policy, deregulation, privatization, free trade, all the good stuff that we think of when we think laissez faire. And why? Well, because Soviet Union collapsed. So if we were a left-wing socialist looking at demand-style Keynesian policies, you know, I mean, you lost. You lost literally and you lost figuratively and ideologically. And so I think that from 1980 onwards, there were these two tailwinds, and it allowed the investment community to become over-professionalized.

• 12:47Speaker 01

  Now, most investors will say it was Paul Volcker that did this, and I have a huge problem with that. There's no way that an academic, no matter how freakishly tall they may be, there's no way that they get to crush inflation by inducing a recession and high unemployment. And so this is like a fantasy of people in finance and economics that Paul Volcker did this because he was competent. He did what he did because he was the man for the time, and the time was the politics had swung against demand-style policies because they were so disastrous in the 70s. They brought inflation upon us. And so there was this political tailwind.

• 13:29Speaker 01

  The median voter in the US was okay with what Paul Volcker did. The median voter in the UK was okay with Margaret Thatcher did to the coal miners. There was this pendulum swing, and so we enjoyed this last 40 years of these tailwinds, the twin tailwinds. Obviously, for the last 10 years, I think they've been eroding, and I think with the pandemic now, we're in a different situation.

• 13:50Ted Seides?

  So if people need to start thinking more about this, you kind of mentioned that the idea of a guy in a smoke-filled room figuring it all out doesn't work. That's generally how a lot of investors have tried to figure out the geopolitical landscape. So first, like, what part of that is flawed if you do have access to the right people?

• 14:12Speaker 01

  Okay, so that's why, basically, I wrote this book. I want to empower investors, whether they're long-term or short-term investors. I want to empower them to be able to not so much do everything on their own, but also to have better conversations with folks in smoke-filled rooms. And so the first problem I have with that approach to political analysis, you know, relying on these key decision makers or former policymakers is that what's the statistical significance of that data point? How many people in how many smoke-filled rooms at how many cocktail parties are you going to have a conversation with in order to create a mosaic of intelligence to generate alpha? So the first issue is the statistical significance. Like you need to talk to a lot of these people.

• 14:56Speaker 01

  And that's what intelligence agencies do. They talk to sources and they spy on people, human intelligence, humans. That's how you get a mosaic, but we can't do that. We're in a private sector. We don't have the resources. The second problem, and I think that this is even more important, is that folks who are in the trenches, they will see the trees, not the forest. And so just because somebody was a deputy undersecretary of state for whatever, doesn't mean that they didn't understand the constraints and the macro environment in which their view rests. And the final issue is that a lot of these people are no longer getting the tap of information that they used to get in government.

• 15:36Speaker 01

  And so I think that it's very problematic to reach out and solely rely on that intelligence-driven model. I do encourage people to seek out experts and to seek out people who know, but quite often it's the technocrats. It's the academic who's been buried in an ivory tower for the past 30 years, looking at this one issue. It's quite often the boring contact that will give you insights, not someone with a name.

• 16:04Ted Seides?

  So what is the framework that you use when you are doing your strategy work to try to figure out the world?

• 16:10Speaker 01

  It comes down to what are we trying to do as investors? Geopolitics is just a sexy way of saying things that are not macroeconomics. It's like a broad spectrum of things, but really it's about what is the direction policymakers are going to take on monetary, fiscal policy, governance, regulatory affairs and stuff like that. So how do we do that? Well, you don't really care about what they want. That's the key. You don't try to get closer to the preferences of the policymakers because human preferences, yours, mine, preferences are optional.

• 16:45Speaker 01

  I may want to have a Bentley Coupe GT. But I can act on that preference or not, my life will be okay. And then they're subject to constraints. So in the case of the Bentley Coupe GT, one of the constraints is my wife will see the first monthly payment and then I'll have a choice. You know, I can return it or stay married. So preferences are really not the starting point of analysis because they're a derivative. They're subject to something else. And that's something else is constraints. Because unlike preferences, constraints are not optional. You do not have a choice to choose your constraints in life. And they're also not subject to preferences.

• 17:29Speaker 01

  The causality works the other way around. So would it be great to know the preferences of policymakers? Absolutely, I would love to. We're in the private sector. We don't work for intelligence agencies. We don't have a full mosaic. So given our own constraints of time and resources as investors, we need to focus on what's more diagnostic, which I think are material constraints.

• 17:50Ted Seides?

  Are there broad buckets of what these constraints fall into that you can then diagnose?

• 17:56Speaker 01

  Yeah, I think so. Basically, the most important constraint is political constraints to policymakers. Can you get something to Congress? Can you get something to legislation? Can you get something without being lynched by a mob? So those are the kind of things we should always start with. The second is economic, and these are like really macroeconomic constraints. Is your economy based on exports? Say Germany during the euro area crisis, highly export reliant economy. If they had abandoned the euro, the Deutschmark 2.0 would have appreciated 20, 30, 40, 50, 60 percent and then bye bye Germany. So hell yes, they're going to pay for Greek debt, like high conviction view. And then you have financial constraints. Bond yields go up.

• 18:41Speaker 01

  The bond market, super powerful. And then we have constitutional and legal constraints. And finally geopolitical constraints as well. So that's, I would say there's five buckets. Not all of them are as important as the other.

• 18:52Ted Seides?

  Let's turn to an example because part of the reason we're doing this and turn it around quickly is there's this US election coming up. And how are you thinking about the various things you do in the US economy, particularly in the US markets, through the lens of constraints on this upcoming election?

• 19:10Speaker 01

  The biggest constraint on the US policymakers right now is that the median voter is pissed.

• 19:18Speaker 01

  Okay, so that's where I would start. And that's because, you know, you had 10 years of really low growth. Real wages haven't really gone up for like 40 years. So you've got a lot of problems, you know? I mean, you can identify that through income inequality. You can talk about that this or that way. So why is this important? It's important because it means that going back to the Washington consensus and laissez faire, where we favor profits over, over wages, where we keep seeing profits expand at the cost of labor. I think is we've come to the end of the line of that. So what that means is that I see a mega trend in the US where the median voter is moving to the left on the economic spectrum. Irrespective of social, cultural issues, right?

• 20:02Speaker 01

  So like you can be a Republican, be conservative, but like you don't care about budget deficits anymore. That's what we're talking about. We're not really cool with tax cuts anymore. Now, a lot of people listening to this podcast obviously are cool with tax cuts. We're in a specific epistemic community. But I think the rank and file Republican voters, and you can see this through the polls, are becoming less and less concerned with these things. So the biggest constraint, I think, is on the kind of policies that are going to be affected over the next 12 to 18 months. And so if you're a long-term allocator of capital, should you be preparing yourself for the typical kind of return to austerity where Ricardian equivalence kicks in and we have a little bit of a headwind to growth because we start thinking about budget deficits?

• 20:47Speaker 01

  And my argument would be no. And so to me, this election is not between Donald Trump and Joe Biden. I think both of them are likely to pursue very similar policies. They keep fiscal thrust, the G in the GDP equation, at a much elevated level than the last cycle for sure. I think this is an election between pro-growth policies and anti-growth policies. What would the anti-growth policy look like? Well, I would have to admit it would kind of undermine my view of where we're headed. But it would be if Joe Biden was paired with a Republican Senate. And so to me, that's the big question. Do we get that? Because if Biden or Trump wins from a macro perspective, I think dollars going down. I think 10-year yields are going up. I think US equities are going to do well, but I think global equities are going to do better.

• 21:33Speaker 01

  Commodities are also going to do extremely well. I think there's a 70% probability subset of that. And I think either a Trump victory or a blue sweep deliver us that global asset allocation view. But there is this 1 in 3 probability that we actually have a little bit of a redux. That this kind of long-term view of the median voter doesn't pan out. Because Republicans in the Senate delay the articulation of this thesis by being tough on Biden when it comes to fiscal policy over the next 6 to 18 months.

• 22:03Ted Seides?

  So usually when we think about red victory, blue victory in the Oval Office, you do think of quite different outcomes for the economy. Why is it that you don't think there's going to be that much of a difference outside of the case where you have Biden victory with the Republican Senate?

• 22:19Speaker 01

  Because I think we're today in a world driven by fiscal policy. And I think it's all about fiscal. I think you should spend as little time as possible on monetary policy because we know where it is. We're at zero interest rates and we had the Jackson Hole consensus where the Fed told us what they were going to do. They were going to let inflation overshoot. So fiscal policy will move the markets. Now, look, if we want to talk about specific sectors, then I totally agree. Biden versus Trump then becomes very relevant. And also then we have to think about legislative constraints. Will Biden be able to pass legislation to affect these 5, 6 sectors? But to me, as a macro investor, I think what I'm always passionate about is the big picture.

• 23:03Speaker 01

  So the S and P 500, the 10-year, oil prices, the dollar, and the global asset allocation between US and emerging markets. And on that front, I think the two of them are quite similar.

• 23:13Ted Seides?

  And to go through those, you said S and P 500 over time, you think is higher?

• 23:18Speaker 01

  Yes, absolutely. I think we can easily be at 7,000 SPX by 2024.

• 23:24Ted Seides?

  The 10 year is an interesting one. There is this case that the reason the valuation of the S and P 500 is as high as it is is because rates are so low. We don't hear a lot of people say is, oh, but rates are going to go up and the S and P is going to go up. So how are you thinking about the relationship between the two?

• 23:40Speaker 01

  It depends why the 10 year goes up. If it's driven by higher growth expectations, then both can go up. Now, there is a limit. I think there is a rotation that would have to happen and it could be quite painful. So rotation out of the big tech sector that's obviously benefited from low rate environment for a very long time into more value sector. That that rotation is unlikely to be painless. But again, on the long-term trajectory, I think we've started a new cycle and I think it's going to be favorable for equities. Now, one thing I would say, though, there is a limit, though. And I think if you think about my view, which is that fiscal policy will continue to dominate. I think there will be a moment when the Fed will have to step in.

• 24:22Speaker 01

  But when I talk to sort of more short-term traders in the macro space, they hesitate to play the yield curve steepening or to be short duration because of expectation that that yield curve control has already kicked in. I don't think it has at 0.8. I don't think it will at one or one and a half. Maybe it's two. Maybe at some point the Fed steps in as it did in post-World War II era. That would be my view, but I think between now and that moment, you probably don't want to own long-dated bonds.

• 24:55Ted Seides?

  So you mentioned the tech stocks and that's obviously something that lots of people have their eyes on, that whole sector. As this election plays its way out, how do you think about that sector and particularly with the big stocks?

• 25:06Speaker 01

  I think there's a lot of headwinds. I don't want to be the one shorting triple Qs or something like that. I'm not smart enough to time it, but I do think there's a lot of headwinds to the sector. The trade war is a headwind. I think a lot of these big tech companies are still being priced in for a global TAM, which they will not get, and they won't get it not because China like bans them. But because I think every economic region, every major economy, has an incentive to impose non-tariff barriers to trade to the current incumbents. So that's the first thing that I think we need to start thinking about. Their TAM is not global. It's probably just the US and some other countries. And if that's the case, are we not already at the peak?

• 25:49Speaker 01

  The second issue is that obviously there's a stroke of pen risk with the incoming Biden administration. There seems to be this really interesting coalition in the US between diametrically opposed groups, both conservative and liberal, who have a problem with big tech for different reasons. And then finally, I think we're going to operate in an environment, given that we're starting a new economic cycle, where growth is going to surprise to the upside, thanks to fiscal policy. And then you don't need to and you don't want to own growth stocks when there's plenty of growth. You want to own them when there isn't. And so I think this has now become a consensus view. It's, in a way, probably why it's going to be wrong longer than right. And that's so timing it is very difficult. But I think after the

• 26:32Speaker 01

  election, it's going to be pretty clear that we're not going to have the austerity wave we had between 2010 and 2016. That would be my bet. And if that's the case, then you don't need to own growth stocks.

• 26:43Ted Seides?

  Do you have any view on the regulatory perspective in the tech sector?

• 26:46Speaker 01

  Yes, I mean, I do. I think there's so many different ways to go after these technology stocks. One is, of course, anti-monopoly. But there's also, especially the social media companies. So there could be revision of some of the rules that have allowed him to not be liable for things that are said on their platforms. And so I just think that we're going to enter a period where stroke of pen risk is very high. And I don't think it's going to cause a collapse in prices, but I think this may be the apex, and it's all downhill from here.

• 27:18Ted Seides?

  You mentioned the trade war. So what do you see playing out with US-China relations?

• 27:23Speaker 01

  My answer to that is going to be perhaps a little bit surprising, especially to those people who have been reading me when I was on the sell side. When I started at BCA Research in 2011, one of the first things I put my foot down was to say that all this focus on the Middle East was a mistake, that Middle East, as a source of geopolitical risk, would wane, and there was going to be a risk rotation to East Asia, because China and US were fundamentally on a collision course. Now I think that scenario has articulated itself. That forecast is done. We need to now think about what's the next step. And here, TED, I think, is the biggest source of potential geopolitical alpha for the next 10 years.

• 28:03Speaker 01

  I think that everybody in the investment community is using the analogy of the Cold War, when they try to think about the trade war. And so the analogy of the Cold War means that we're going to bifurcate global capitalism, and there's going to be Alibaba and Amazon like camps, like NATO and Warsaw Pact. I think there's a problem with this. There's several problems. First of all, it assumes that we live in a bipolar world. And this is important because political science research, especially formal modeling, game theory, show that a bipolar ordering of power, where there's only two countries that really matter, do produce bifurcated outcomes. Fine. But a multipolar ordering, where there's multiple countries,

• 28:46Speaker 01

  they kind of have an ability to pursue foreign policy and trade policy on their own, that's an ordering that doesn't produce bifurcation. In fact, enemies have to continue to trade with one another. Why? Fundamentally, it comes down to this. It's very difficult to keep your allies in check. So in a Cold War scenario, the US could tell Turkey or France or Italy what to do and what not to do. It was very simple. Like, you'd get a call from Washington DC, you would have to listen. Today, I'm not sure that's the case. Is France going to stop selling Airbus to China if we stop selling Boeing? I think the answer to that is definitively no. And so if that's the case, eventually, American policymakers realize this is a constraint. This is a huge constraint.

• 29:32Speaker 01

  That they cannot sever their economic relationship with China, because if they do, somebody else will pick up the benefits, the revenues. So that's the first major constraint. The second issue is just difference between Cold War and today. I mean, when you think of the Cold War and Soviet Union and the US, don't forget the starting conditions.

• 29:51Speaker 01

  Of this era. The starting conditions of this era where Europe was beset was completely destroyed. It was filled with millions of refugees. You had Japan, which had two nuclear weapons dropped on it. You had China, which was in the middle of its civil war. It didn't end until three years later. And then on top of that, you had India, which was completely irrelevant at the time, and a colony of another country. So when you put all of that together, US and Soviet Union emerged. It is so much more preponderance of power. So they could set the conditions for the Cold War. That's not where we are today. I mean, obviously, Japan and Europe are breathing deflationary economies and demographics, for sure, but they're not destroyed. Someone didn't drop nuclear weapons on them.

• 30:35Ted Seides?

  The implication of China's strength in a multipolar world that you're suggesting is that if US demand isn't there, someone else's will be. What does that mean for institutional investor who's thinking about the public or private investments in China?

• 30:55Speaker 01

  Look, right now, from what we understand at Clock Tower, the allocation to China is about 2% for real money allocators. And it's like 20, 25% of global economy. So I mean, the implication is that. What's interesting is that in this kind of a move away from laissez-faire economics, we're dropping our interest rates, we're using fiscal policy. China's kind of not doing that because the West learned from the last cycle that austerity was implemented too soon. The West learned from the last cycle that there's going to be political repercussions, rise of anti-establishment policymakers, for example, if you don't generate some sort of nominal GDP growth. I think China learned the opposite lesson. Did they overstimulate it? Did they cause collapse in productivity growth because they over-leveraged their system?

• 31:40Speaker 01

  So they're actually doing the opposite of what we are. And that's going to pull the yield. Higher. So the yield divergence between US and China is going to favor carry trades in China because they're adopting far less stimulative policies. I mean, they're still stimulating, don't get me wrong, but the central bank is kind of like moderately hawkish. They're cracking down on real estate and stuff like that. So you're going to have this yield advantage in China that I think is going to be very difficult to avoid if you're managing long-term capital.

• 32:10Ted Seides?

  As you flow through to some of the other major potential implications, the world over seems enamored with private equity right now. And there's a question of, in a Biden administration, really, what's the role of Elizabeth Warren?

• 32:23Speaker 01

  That's a great point. Well, I would suggest that everybody reads through some of her legislation that she's proposed. One of them was the Stop Wall Street Looting Act of 2019, where basically this proposal really focused on private equity. And in particular, it looks to make it much more difficult for private equity companies to sell the debt of portfolio companies. It's also looking to require PE firms to assume pension liabilities. And so it's going to make rollups and LBOs much more difficult. There's a good chance that legislators start looking into this. And I think that that's going to cause a shift in allocation to much more smaller players into private space,

• 33:05Speaker 01

  more VC investments and other more exotic strategies that don't rely on kind of rollups.

• 33:10Ted Seides?

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• 33:49Speaker 01

  This is not an offer to sell or investment advice. Investing involves risk, including the loss of capital.

• 33:55Ted Seides?

  And now, back to the show.

• 33:59Ted Seides?

  Yeah, interesting. The other big mega trend everyone's talking about these days is sustainability and ESG investing. How are you thinking about how that plays through this election?

• 34:09Speaker 01

  Well, I think it's very macro. I think it's very geopolitical, too. I think the election will obviously impact EV or green companies, which have been signaling through their rally that Biden's going to win. Obviously, there's going to be like an immediate impact after the election if Trump were to win. But I think that the longer term trend here, Ted, is towards more policy tailwinds for anything that has to do with sustainability, alternative energy. I mean, with China, Europe, Japan, everyone's on this. And so it's funny because, you know, you talk to some folks in finance community and some say, Marco, come on, this is like, okay, even if I believe in climate change or global warming, this is like an 80-year kind of a thing. How does this make an impact? And to me, it doesn't

• 34:52Speaker 01

  really matter. I don't have an answer to that question. I'm not a scientist, but I don't care. I try to get on these political trends and it's kind of to me like the moon landing. Let me tell you what I mean about this. When United States of America decided to send a man to the moon, that was one of the most wasteful, idiotic, and inefficient human endeavors in the history of mankind. Pause for effect. Okay. What? How can you say that? Well, because we never went back. When was the last time we were on the moon? Like 72 or something? Like, we never went back. We found nothing there. We wasted all this money to go somewhere and it was a complete waste of time. However, the ancillary technological

• 35:30Speaker 01

  innovation that has spilled out of that endeavor has been amazing. When I think of what's going on right now with climate change and sustainability, I think of it in the same way. Policy tailwinds are going to be so massive that I think investors have to start thinking about it. The technologies we're going to discover in trying to address these problems, whether it's food quantity and quality, whether it's obviously climate change, whether it's water availability, whether it's poverty, I think as a long-term investor, you just have to be behind that effort. Now, the problem I have, though, is that in the public markets, there's clearly this kind of rubber stamp of ESG that I think a lot of investors have already figured out is almost meaningless.

• 36:14Speaker 01

  Because you have these ESG indices that are like everybody but poor Exxon. So everybody fits into this bucket. And I don't see the value of that. I don't see an edge there. I think the edge is going to be in the private sector. And that's how investors just start thinking about that.

• 36:30Ted Seides?

  Marco, one of the things you do regularly in your writing is compare what you see as managers' view on markets around the world to your view and Clocktower's view. And I was wondering if we could take a quick tour around the world and what you're seeing managers are saying and what you're saying. And I'll just let you have at it and we'll go from there.

• 36:48Speaker 01

  Okay, cool. Well, I wish you had asked me this question like two months ago, though, because divergence was huge. So I think right now, unfortunately, the divergence is not that great. And that worries me a little bit. If we think today, I think most managers does agree that the blue wave would be very bullish for the market. But where I think there is a little bit of a divergence is that I think my view would be unique or differentiated is that I am worried about the Senate divergence. I think there's not enough written about that, that Senate could scuttle the plans. And that's why I think it's more prudent this time around to be a little bit more careful. Also, I think there is not that much enthusiasm for oil. I found even though managers are pretty bullish commodities, but on oil prices, you know,

• 37:31Speaker 01

  everybody kind of generally thinks that 45 to 50, maybe 55 is okay. I think there's a lot of upside potential in oil markets. And that's both because there's this risk, upside risk to oil prices of a Trump victory. Why? Because I think that what nobody's really talking about right now is Iran. Iran has patiently waited for this election, but I think they're running out of time and their economy has been really severely impacted by the sanctions. And so I think if Trump wins again, they see the writing on the wall and I don't think they're going to reach out by thinking of, oh, let's negotiate with the US. I think there's geopolitical potential risk in the Middle East, which is again interesting because everyone's focused on Asia and China, US.

• 38:15Speaker 01

  But I'm really worried what happens on that front. So I would say those are some of the differences between the macro universe and my views.

• 38:23Ted Seides?

  And one of the things we haven't touched upon is the ongoing negotiations with Brexit. So we'd love to hear what you're thinking about Europe in general and then particularly with the UK.

• 38:32Speaker 01

  Well, Europe in general, I think, is going to continue to integrate. And this is one of the most controversial views, and has been for a decade. I mean, as you read the book, you see that that was really a formative part of my career. Getting that call right for the last 10 years, I think it continues. I think Europe has enormous incentives to integrate. Because in this multipolar world, it's a world that demands economies of scale. And so, yes, state sovereignty matters, and yes, you'll lose some of it to Brussels. But you know what you're gonna lose? You're gonna lose a lot more of it to Beijing, or Moscow, or the US, if you don't integrate. So if you're sitting in Italy, and you're worried about losing some sovereignty to Brussels, hey, at least you have a say in it.

• 39:13Speaker 01

  Whereas the other potential alternatives, there's a lot more downside. So I think Europe will continue to integrate. I'm just not sure if that is enough of a catalyst to be bullish Europe. I am bullish the euro. I think that if you are bearish on the dollar for the next decade, you gotta be bullish in something. There's obviously gold, which I would be bullish on. But I think the euro is interesting. And no, this doesn't mean that it's a reserve currency argument at all. They're simply the other side of the ledger. On Brexit, I think it's interesting. Brexit negotiations with the EU and this phase four stimulus negotiations show the importance of the constraint framework. The reason you don't listen to policymakers is because they're selling their own book. And they're trying to beat their own chest, move the markets,

• 39:56Speaker 01

  and then get their opponents to do something. All we've heard for the last three months is how negotiations are done, they don't like each other, blah, blah, blah. And then, apparently, today, October 21st, there's a little bit of a breakthrough in negotiations. Look, I think the odds are that we do get some sort of deal. Likely a deal on a skeleton, that they'll then negotiate through 2021. But even if UK concludes a Canada-style FTA instead of an Australia-style, that's still a very hard Brexit. And even with a Canada-style FDA, what's interesting to me is that the UK will have one of the weakest economic relationships in all of Europe for a non-EU country.

• 40:39Speaker 01

  And so I think the consequences of even what people will hail as a successful conclusion to the negotiations, I think even the consequences of that would probably be negative for the UK economy.

• 40:48Ted Seides?

  And we haven't heard that much of late about emerging markets, other than their continued underperformance, maybe outside of some select tech sector in Asia. So what are you seeing in emerging markets?

• 41:01Speaker 01

  I'm bullish. And it's interesting because I've never been bullish in emerging markets since I joined financial industry, although I haven't been in the industry for that long. So it doesn't mean much. But from 2011 until this year, I've been very bearish. And I was greatly influenced by my colleagues at BCA Research, especially Arthur Bhuta Gayan, the EM strategist there, great mind, and he's been bearish for as long as I know him. So for good reasons. The emerging markets had a great decade between 2001 and 2011. And part of that was this industrialization of China play, where commodities obviously entered an epic bull market. And then there was a lot of misallocation of capital, very little governance reform. They kind of wasted that decade, didn't do much in terms of governance.

• 41:46Speaker 01

  And so when we got the great financial crisis, they didn't have the valuation reset that they really needed, in part because unfortunately for them, commodities stayed in a bull market for an extra three years after the recession for metals and another five, six years for oil. So there was never a reset in terms of their currency valuations and in terms of their overall valuations as markets and equities and so on. So you had a really terrible decade. Now, this pandemic has given that valuation reset, especially in terms of currencies. Currencies completely collapsed earlier this year. I think that's super positive. We're starting this new economic cycle with commodities at much lower levels, unlike in 2010, 2011. We're starting this commodity cycle with currencies in emerging markets at much lower

• 42:30Speaker 01

  level. And we're starting with pessimistic and bearish views. I talked to institutional investors who are thinking of closing their offices. Around emerging markets. And there's generally a really pessimistic view. I think that's really positive. And that's because I think people think this trade war between China and the US is somehow going to be negative for emerging markets. That rewiring of supply chains is going to be negative for emerging markets, and I think that's kind of silly. I think the rewiring of supply chains is growth positive. It's positive for commodities. You have to build new factories. You have to move stuff around. Look, at the end of the day, when China joined the global trading system, we had to rewire supply chains to welcome it.

• 43:13Speaker 01

  And so if now we're going to rewire away from it, there will be more opportunities for emerging markets, both because commodities, I think, will get a bid and because some emerging markets could fill the role of China a little bit, not too much. I think China can't really lose all of its opportunities, but there will be a little bit of a rewiring that will benefit some countries like Mexico, for example.

• 43:35Ted Seides?

  How does that thesis dovetail with your idea, very high level idea, that we've moved from a very globalized world to a de-globalized world? If the emerging market nations increasingly have to stand on their own because there isn't as much globalization, like, how do they manage through that?

• 43:52Speaker 01

  Well, it's not binary globalization to de-globalization. The way I would, I wouldn't characterize my view as a view that we will have de-globalization. I would say my view is that we had apex of globalization, and we won't reach it again. And because I don't think we're in a bipolar world, because I think we're in a multipolar world, I think there'll be these constraints on full de-globalization. So we'll have less globalization. And what that means is that economies of scale will matter. And so I think emerging markets that can achieve those economies of scale will be interesting for investors. I think Latin America is a good place. It has economies of scale, and what I mean by that is speaks two languages only.

• 44:33Speaker 01

  There are cultural commonalities across, and although they do depend on exports for current account balances and a lot of profits, especially in public markets, they are actually quite closed economies in terms of exports as a share of GDP. Also, I think that when you think about de-globalization, I think you have to think not just about commodity prices, but also how certain commodity supplies will be taken off of the global markets. And so what I mean by that is that we may not have a global market for X, Y, and Z, which will increase prices of those markets because consumers won't be able to source them on a global market. Rather, they'll have to source it on a more regional market, which will benefit producers

• 45:18Speaker 01

  as they'll be able to jack up prices. So just as a silly example, I mean, if China basically says on its own to Australia, "Look, we're not going to take your coking coal," and then turn to Mongolia and be like, "Okay, so we'll take yours." Mongolia could very well say, "Well, hmm, well, it's a little bit more pricier now." I think you could have that across a slew of different commodities that emerging markets export.

• 45:42Ted Seides?

  There are two parts of emerging markets we haven't really touched on: Africa and India. And I know in the book you wrote a fair amount about applying the constraints-based framework to your prognosis for India. Why don't you walk through some of your thoughts on India?

• 45:58Speaker 01

  I mean, it's really simple. I think India comes down to investment. This is an under-invested economy. And what China has showed is that you don't need necessarily FDI. You can also have very large SOEs, whose profits you kind of recycle back into the economy. So China is a great example of an economy that has both used its corporate sector and its household savings for a great amount of investment, and it's done brilliantly with that. India has just not done that. It hasn't created the conditions domestically, either through force or through incentives to be an investment-friendly economy. And I think until they do that, I am bearish on India.

• 46:42Speaker 01

  But I think that with Modi's second term, there are some good things going on. I think the first term, there was more rhetoric and headlines that were positive than actual things. Well, we really need two things. India needs new labor laws and property, in particular, real estate laws. That's what needs to be done so that it encourages investment in manufacturing and encourages relocation of some factories. And that is already happening on some scale, but we need to see a lot more of that. So I am looking very much into whether the government in India pursues those two reforms.

• 47:15Ted Seides?

  Why do you think it hasn't happened yet?

• 47:16Speaker 01

  I think because it's politically painful. I think that's where the constraint comes in. And the constraint is that India is a very low-income country still, and it's very difficult to do away with labor protections and very difficult to have land reform in a country like that. China has managed to do it for obvious reason. I mean, China didn't really have to worry about the median voter in the seventies and eighties when it did most of the important stuff. I think China now does have constraints. Middle class is a huge portion of its economy. People say it's not a democracy, but there's other ways to voice your displeasure. And I think China is very cognizant of that. So China has its constraints. For India, the usual answer to your question is, I think, still applicable,

• 48:01Speaker 01

  which is that they democratize before they advance economically. And this is something that Samuel Huntington wrote about in the 1960s. This idea that democracy should come after you've managed to grow. Now, I don't want to put too much on that because I don't think that's necessarily the case. I think India might be able to overcome it soon. It just might take a little bit longer.

• 48:22Ted Seides?

  And how about Africa?

• 48:23Speaker 01

  Well, I think Africa is interesting. You know, some of the best years for Africa were during the Cold War. And by the way, Latin America too, my own country that I grew up in that doesn't exist anymore. We all used to suck at the teat of the Cold War geopolitical competition. It was great. It was gravy. You know, like, oh, we need a new bridge. Maybe we'll go communist. Oh, thank you very much, America. Thank you for that bridge. You know what? We also need a new port. Maybe we'll become capitalist. So this is a dance that a lot of countries did very well. And I think that Africa gets a chance to play this dance again. So let me give you an example. I spoke recently with a large institutional investor, and they were very concerned about Chinese loans to African countries.

• 49:07Speaker 01

  The Belt and Road. And one of the things they said was, well, the more borrowing one has done, a country has done with China, the less likely we are to invest in there. And I said, why? I don't understand the logic. Well, you know, they have to repay. And my point was like, look, if you go back to the Cold War and see what happened, I mean, these countries didn't get invaded for debts. They got a blank check. And I think we saw what happened in Zambia, which was an interesting macro story. They basically said, look, we're going to default on Chinese borrowing, on Chinese loans. I don't see China preparing itself to invade them. In fact, it may very well lead to more favorable loans. And so I think that this great power competition between China and the US and potentially

• 49:51Speaker 01

  other countries mixed in creates a really interesting environment for frontier markets like Africa, maybe some of the less developed countries in Latin America and Asia as well. Because they can play all sides together. And I think investors should start actually taking a look at them very closely.

• 50:06Ted Seides?

  So Marco, you make a point in your book to state that you are a strategist, that you will express opinions, but you are not the guy who's making the call in the markets. You leave that to the managers. What have you seen in the many managers that you speak to that differentiates the ones who are good at that from the ones who aren't as much?

• 50:31Speaker 01

  Yeah, I have an immediate answer to that question. To complete and utter indifference, like, I mean, to the elegance of their view, to the parsimony of their theory, to the ideological alignment of their ideas. It's just pure focus on alpha. And you say that, it sounds, of course, but no, that's tough. Okay, fine, I'm not ideologically biased. Yeah, but are you biased towards the elegance of your view? So you're a short duration because of this beautiful fiscal view that you have, but then it doesn't work out because Biden has to deal with a Republican Senate. Are you willing to pivot? And so... That's why I think some of the best managers are not necessarily people who went to the best

• 51:15Speaker 01

  schools, or not necessarily people who are the best educated in terms of like the length of their education. They're all extremely smart, but they're promiscuous intellectually. Because they put as primal performance over intellectual prowess, being kind of like rewarded for their elegance of their thinking. And so, yeah, I think that's what it comes down to.

• 51:39Ted Seides?

  Well, Mark, I want to turn to some closing questions. So, let's start with what's your favorite hobby or activity outside of work and family?

• 51:47Speaker 01

  I think it's pretty clear after you read my book. Very much basketball. So, there's a section where I use some math to show constraints. And my example is this lack of fighting in the NBA. So, I would say, yeah, basketball. Watch it. I used to coach it, played it, tore my ACL this year while playing it. So, there's nothing more that I enjoyed in basketball.

• 52:08Ted Seides?

  I'm going to save for our premium members. I'll have you tell the story of what that mathematical model was for fighting in the NBA. But until then, what's your most important daily habit?

• 52:17Speaker 01

  I think drinking a cup of coffee. I'm sorry, it's nothing better than that, but I get a little healthier. But if I don't have my coffee in the morning, I'm useless.

• 52:27Ted Seides?

  All right. What's your biggest pet peeve?

• 52:29Speaker 01

  I think my biggest pet peeve, and this happens a lot in these podcasts, and you know, when I do something on YouTube or something, people hear me say something. Say I said Biden's gonna win. And then they just assume my answer on a whole slew of other points. I can't stand that. I really cannot stand that. I have a very low beta between my views. Like, they do not correlate in any way. I wish we all would give each other more time to hear our views out and to understand where we're coming from. Because then we would understand that they're, they're unique. They're not all the same.

• 53:04Ted Seides?

  What teaching from your parents has most stayed with you?

• 53:06Speaker 01

  My dad grew up in Yugoslavia. He was in corporate affairs and business. And he taught me a lot of things. I think my ability to kind of analyze things comes from my dad. And one of the things he always used to say, it's all Hollywood. But with like a thick Serbian accent, it's all Hollywood, it's all Hollywood. And I love that because you have to kind of like understand there's theater going on. You know, like UK, EU negotiations, you asked me about like, yeah, it's all Hollywood. So that's the first. The second is, I think I have a chip on my shoulders because of my upbringing and because of just where I'm from and everywhere. I've always been an outsider, a foreigner, an immigrant since I was 12. And I think my parents encouraged that. And I think I was good.

• 53:48Ted Seides?

  All right, last one on this set. What life lesson have you learned that you wish you knew a lot earlier in life?

• 53:53Speaker 01

  I think to be an optimist. I come from a very pessimistic place. And I think one of the problems with that is that you will not have confidence in your vision. And so you will settle a lot. And I think one of the greatest things about coming here, joining Clock Tower Group especially is my partner and boss, Steve Drogba, he's a true Californian and he's very optimistic. So when he came to me and said, Marco, you should write a book, here's why, here's how, I've written a great book. Like, I was like, nah, who's gonna read my book? That's crazy. That's insane. Why would I do that? I got all this other stuff. And I'm smart enough to know that I'm not naturally an optimist. And so

• 54:34Speaker 01

  I seek out people who are optimistic to surround myself with, so I can kind of cover for my deficiency.

• 54:40Ted Seides?

  Marco, thanks so much.

• 54:42Speaker 01

  It's a real pleasure, Ted. This was great. Thank you.

• 54:45Ted Seides?

  All right, we're gonna keep going a little bit for our premium members. And we're gonna start right here on the NBA. So why don't you go ahead and, and talk about that analysis about fighting in the NBA and constraints?

• 54:55Speaker 01

  Oh, my God, yeah. So I asked one of my closest friends, he's a professor of quantum physics, Dan Green, at UC San Diego. And we basically grew up together in Vancouver during our college years. And I said to him, hey, listen, man, I need to put some math into this book. And he was like, why? Well, because it looks cool. Formulas look just cool. And one of the things that we have a bond between each other is basketball. So I have to admit, it's, it's his example. But he wrote it because he knows how absolutely psychotic I am about the NBA. The example is that in the NBA, you no longer have any fights.

• 55:29Speaker 01

  And one of the constraints to fighting is teammates. So teammates hold the players back. And so what you see is that when there are no teammates to hold players back, when, for example, someone goes for a layup on a breakup and they get fouled really hard, you don't see them get as aggressive. They're kind of waiting, waiting for everyone to come from the other side. And then they're like, hey, what'd you do? And then that constraint prevents fighting. And of course, Dan, and I have to give it to him. I mean, you know, everybody knows I didn't write this formula, but he made a very elegant equation. And I welcome everyone to read that section because it's awesome.

• 56:06Ted Seides?

  So do you think that the players never wanted to fight? And that's why they're doing it? Or is there something else driving that behavior?

• 56:13Speaker 01

  I think the real constraints, rather than their teammates, the real constraint to fighting is really the fines. For fun, I listen to really good podcasts like Bill Simmons has a great podcast on this. And he discussed this all the time. The fines just got huge. In the eighties, the fines were small, whatever. So, you know, Kurt Rambis gets clotheslined and all the good stuff that we saw in the eighties, Shaq and Charles. Now, the constraint to fighting is really monetary. It's a serious one. So what you're going to do is you're going to wait for your teammates to show up so that you can hold me back.

• 56:46Ted Seides?

  Marco, what advice do you give people early in their career?

• 56:49Speaker 01

  I've thought about that a lot. So when I said that basketball is my passion, it really came from coaching. I wasn't that great at playing, but I really think I could have been a basketball coach. And one of the things that I always thought about is that if you're not very good at something, just find a niche, you know? So if you want to be on the court, set picks really hard. And I would say the same thing for people starting their career. Just if you're in a firm, don't necessarily try to replicate what the successful people in that firm are doing because they're doing it.

• 57:20Speaker 01

  And they're successful. Rather, find something that the firm is missing. And I was very lucky at Stratfor, you know, 2007, when I joined the firm, nobody cared about Europe, as I said. And I said, look, I'm going to own this. I know everyone's focused in the Middle East, Iraq, things going on in East Asia, but I'm going to own Europe and I'm going to crush it. And then at BCA Research, obviously, I owned the geopolitical analysis from an investment perspective and so on and so on. And I think that's really important. When you are just starting your career, make sure that the enterprise you work for becomes addicted to you and what you provide.

• 57:57Ted Seides?

  So you talk to a lot of money managers and I'm curious, outside of just your views and how you're thinking about markets, what do they come and talk to you about when they're asking for advice?

• 58:07Speaker 01

  I think developing talent is probably one of them. Aside from markets and things like that, I think it's developing talent and growing businesses. How do you grow talent? How do you articulate a vision in a way that will appeal to the institutional investor community? So that's something that I speak to them a lot about.

• 58:27Ted Seides?

  What's your favorite book or thing that you read online?

• 58:30Speaker 01

  So my favorite book, which would be, I think, applicable to everyone, is Why Nations Fail. And you know, I don't say that just because it's applicable to everyone here, but I think what Asimoglu and Robinson do is really powerful and it's a really, really good book. And it really tries to distill like a thousand years of history of successful countries down to really one thing, setting up institutions that will allow successful people to fail. It's like enshrining creative destruction. That's what I got from it. And I think it's one of the best books, especially if you start thinking about long-term investments and where you want to put your money, like in emerging markets and so on.

• 59:14Ted Seides?

  What's the biggest mistake you've made and what did you learn from it?

• 59:17Speaker 01

  Definitely putting my job in front of my family for the last 10 years. So, great, I got a book out of it, but not a good idea. And I think we all need to find a better way to balance things out, I think. So yeah, that's what I would say. I mean, in my acknowledgements, I said, I have nothing to thank my children for, but I just want to apologize to them for the last decade.

• 59:40Ted Seides?

  Okay, Marco, again, thank you so, so much. Really enjoyed it.

• 59:43Speaker 01

  Thank you so much, that's a real pleasure.

• 59:46Ted Seides?

  Thanks for listening to this episode. I hope you found a nugget or two to take away and apply in your investing and your life. If you liked what you heard, please tell a friend and maybe even write a review on iTunes. You'll help others discover the show and I thank you for it. Have a good one and see you next time.