Peter Oppenheimer
4/11/2022
Goldman Sachs’s Chief Global Equity Strategist, Peter Oppenheimer, Discusses Macro and Markets

In this episode, we welcome Peter Oppenheimer from Goldman Sachs, to discuss the challenging investment landscape.

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transcript

Simon Brewer  00:08

Today, we're going to talk markets because this is a period which is challenging investors, raising questions about allocations, and prompting the kind of question parents get from their children at the back of the car, ''When will we be there?'' In this case, ''there'' being the end of the bear markets. And to give his perspectives, we have one of the world's most respected practitioners, Peter Oppenheimer, Chief Global Equity Strategist and Head of Macro Research in Europe for Goldman Sachs. So Peter, welcome to the Money Maze Podcast.

Peter Oppenheimer  03:01

Thank you so much, Simon. Good to be here.

Simon Brewer  03:04

In our little conversation just before we started, we actually discovered we were not just both at the LSE together, we were both there at the same period. Just for our own humility, we both found economics either in my case so hard or in your case so uninteresting that we switched topics, me to economic history and you to economics and geography. Well, there you go, you see. For all students out there listening, there is hope when things don't look great with your degree. Peter, we got a lot to discuss but before we dive into the topics, tell me what was the path from the LSE to chief strategist at Goldman Sachs?

Peter Oppenheimer  03:38

That was a very long and unexpected path really, because to your point, I didn't know what I wanted to do when I left university, but I did want to carry on doing research and found a job in an economics research department company called Greenwells, which was a broking firm, focusing on government bonds at the time. Then moved from there to the buyer side and various other roles along the way. But I've always been in research. I started my career in 1985, and the research career of that time has been quite an extraordinary period with many ups and downs and cycles, which of course, we're in another key one right now.

Simon Brewer  04:22

Great, which is why I thought it's so topical to have this conversation. I hope in the next period, we're going to talk about the macro backdrop, interest rates, equities, commodities and key asset allocation, thinking and decisions that will make a lot of our listeners here on the podcast that are important gatekeepers to pools of capital. And I know having listened to you and read your work, it was Harry Truman, the president, who said just give me a one-handed economist. I know you're going to be coming down on the side of active decisions and recommendations. Let's start with the global economy. We've got a slowdown courtesy of supply side shocks and belated tightening to combat inflation, and yet simultaneously, we've got these really low levels of unemployment. How are you thinking about this?

Peter Oppenheimer  05:08

You're right to point out that there are in some ways inconsistencies. We are facing an economic downturn. Most economies are either below trend. They've already slowed to below their average growth, the US being a good example, or probably they're on the brink of recession, the UK and the rest of Europe being a good example there. But it's a rather unusual downturn, partly because it's been triggered by rising inflation as a result of supply side shocks. Simon, you mentioned that. But also because it's a time when the labor markets are very strong, reflecting shifts in labor market participation since the pandemic. One of the other things that makes this downturn rather unusual, in some sense, more encouraging than we've seen in many previous downturns particularly around the financial crisis, is the private sector balance sheets are actually quite healthy. What do we mean by that? Well, actually, the aggregate level of debt in the corporate sector is relatively low. Banks have very healthy balance sheets, partly reflecting tougher regulation that was put in place after the financial crisis. And even though many households are facing a very difficult time in terms of real incomes being squeezed by higher energy and food costs, aggregate savings in households are reasonably good as well. So that means that while there may well be an economic downturn, it may not trigger the kind of negative spirals and vicious cycles that we've seen in some of the other downturns in the past. The bottom line is that we are going through a difficult cycle, weak economic growth, higher inflation, and that means higher interest rates and weaker asset markets.

Simon Brewer  07:02

So you dubbed it at the post-modern cycle, and at the core is inflation, which has leapt and might well prove very stubborn. It's the silent assassin of our purchasing powers. I just checked the numbers before we had this call and for the same purchasing power that £1 would have bought you in 2000, you now need £1.87. And that's going to be out of date very quickly. It really is a real issue. Talk about inflation and how you are calibrating it.

Peter Oppenheimer  07:33

You're quite right to mention that inflation is critical in many ways. In effect, it is a tax on people's savings, their ability to make purchases, and it's cumulative. So prices are increasing year by year. That means that the real purchasing power that you have over a period of time tends to be, of course, lower with higher inflation. The problem that we have now is twofold, I think. Firstly, inflation is picking up both as a result of demand still being relatively healthy because of the cumulative effect of purchases increasing after the pandemic. So people wanted to buy things and experience services which they could not do for such a long time during the pandemic. But also at the same time, something we haven't really seen since the 1970s, many of the inflationary problems that we're seeing at the moment are as a result of supply shocks, that means limited supply. Again, part of that has to do with the effects of the pandemic. Lots of things were shut down or simply were in the wrong places to match demand. That forced prices up. But also, we've got a real supply issue in terms of things like energy and labor.

Simon Brewer  08:54

And why wouldn't we have a situation where this inflation persists and the growth at very low levels also persists and it hangs around for a long time?

Peter Oppenheimer  09:05

That combination, a very difficult one of the weaker growth and higher inflation and interest rates often is described as stagflation, the worst of all possible combinations and something that was very much associated with the 1970s, which was a very difficult period, in particular for economic activity but also for financial assets, because higher inflation eroded the value of many financial assets and in real terms, they did very, very badly. So I think the context here is important. We're seeing inflation picking up at a period of lower economic growth. Also, it's not just inflation is rising. It's rising from extraordinarily low levels alongside debt. We're seeing interest rates rise from record low levels. If you go back just a little over a year, about a quarter of all government bonds, that is debt that governments issue, had a negative yield. People were actually paying for the privilege of lending money to governments and that's changed very radically. We've now got close to 4% yields on things like US 10-year treasuries. So it's the adjustment not just to higher levels of interest rates reflecting higher inflation but the speed of the change of prices and interest rates coming from these very low, historically record low levels, which is having quite a big impact on financial assets and risky assets, things like equities, which have adjusted downwards on the back of those higher rates.

Simon Brewer  10:50

I'm an old-fashioned investor. I've been appalled for the last few years at the central bank's reluctance to raise rates from these abnormal levels that you highlight. We've had the zero interest rate policies. It's caused misallocation of resources, punished savers. I think there's been a view that inflation from the central banks was yesterday's issue. You don't have to say it. I think it's been negligent and they're responsible. But I guess the question here now is, what next? And specifically, we're tightening, but what might force the Fed to stop tightening possibly prematurely?

Peter Oppenheimer  11:24

Well, I think, again, context here is really important. After the financial crisis in 2008 and 2009, the effect of the collapse in US real estate and credit markets around the world and the banking crisis and the many things that followed meant that interest rates had to fall to very low levels to try to stimulate demand again. And in the face of that crisis, central banks began an experiment really in what was called quantitative easing, printing money to try to stimulate demand further. That was the platform from which we're seeing this adjustment taking place today. Now, for a long time after the financial crisis, interest rates stayed at these record low levels around zero, in fact, in Europe, even negative policy rates, in order to try to prevent a deflationary shock, prevent inflation from actually being negative. And when the pandemic hit, the fear was that the stoppage of global economic activity as a result of trying to contain the pandemic would deepen that deflationary shock. So it was further stimulus, more money printing to offset that. And in this time, we also saw significant fiscal supports. Governments coming in to spend money to support, for example, the labor markets with furlough schemes and the like. And in the end, as we started to emerge from the pandemic, actually demand recovered pretty quickly, supply didn't recover as quickly, inflation started to rise. But for a long time, the central banks thought all of this would be very temporary. Remember, the Federal Reserve and others for quite a long period referred to this inflationary squeeze as transitory. It finally gave up the language of transitory, really the beginning of last year, and has gradually become more hawkish or more aggressive on its fight of inflation ever since. And that's been reflected in other central banks around the world in emerging economies across Europe and the UK, as well. I think what we've learned in the most recent period in the last couple of months or so is that that fight is taking on greater urgency. You're seeing the language of central banks shifting, where before, they were talking about really trying to balance growth while raising interest rates to try to achieve a so-called soft landing moderate growth without choking it off. Now, it seems like the priorities are shifting. They're worried enough about inflation becoming more entrenched and affecting people's expectations and wages and so on, that they're talking about an almost do-whatever-it-takes moment, that they're prepared to raise rates sufficiently to contain inflation even if that means that we'll see an economic downturn or a recession. And it's that evolution of the perception of central banks and how they're dealing with inflation that spooked investors because they're worried increasingly about the effects of this monetary tightening and the impacts on growth. But I think it's pretty clear now that central banks are really focusing on trying to contain and squeeze out inflation, even if it means that activity for a period of time was going to be much weaker. And that's really what markets have been adjusting to, particularly in the period since the summer.

Simon Brewer  15:10

Let's say that it's the second half of the game and the pressure is on and that's why we're seeing the belated and more urgent action. We've got yields for the first time in a while. What do you want to do as an allocator of capital in the world of fixed income right now?

Peter Oppenheimer  15:25

We are for the first time, as you say, beginning to get to a point where there are a range of opportunities across asset classes. Within market circles, people often talked about TINA for a long time, there is no alternative to buying equities, because interest rates were zero or below or fixed income products were extremely expensive, and that squeezed investors into equities. Now people talk about TARA, there are alternatives to equities. And as you get interest rates rising, bond yields around 3.5%, 4%, index-linked or real yields rising to positive levels which we haven't seen for many, many years, it's starting to create a landscape of opportunities for investment, as well as risks. And we feel that greater diversification does make a lot of sense for investors as we move forward because there's a range of different types of asset classes which pulled together are likely to help moderate volatility in portfolios and generate reasonable returns. But I think in the near term, the rise in interest rates and bond yields that we've been seeing, and in particular, the rise in real yields, that means interest rates haven't taken into account inflation, means that the near term pressure on equity prices is still probably downwards. We think you need sort of three or four things to really establish a definitive base in an equity bear market and we haven't quite reached those yet. Typically, in a bear market around a recession, you would see equities falling about 30%. We've seen most major markets falling 20, maybe mid-20 percent. Valuations typically get to quite low levels at a point where equity markets trough and rebound. Secondly, while equities do start to recover while economic conditions are weak because investors start to anticipate recovery before it's actually apparent. It's not really until the rate of growth deterioration starts to slow when things look as if they're not deteriorating significantly further that you get this recovery coming through. And I would say thirdly, it's usually when interest rates peak and inflation peaks that equities start to recover. And when we take those conditions together, I think it's still a little bit early, bearing in mind that valuations in equity markets have come down a lot. But the US of course, the biggest equity market in the world, has only just really got back to average valuations having been well above average valuations for a very long time supported by very low interest rates, which have helped push valuations higher. So I think there's a little bit further to go in those adjustments before we get a sustained recovery in risk assets like equities.

Simon Brewer  18:44

I gave a talk at Imperial College recently and some of the data I used shows that in the last 96 years, we've had nine recessions and 73% of the largest US equity drawdowns of course happened with recessions. And you yourself I think have in commented in the 70s, the US PCE got to 12 times in the inflationary environment that we had then. Averages, of course, are deceptive because we trade a lot above them at times and below them at times. So why wouldn't this be a really much tougher, much more drawn out structural bear market that lasts and really isn't another 5 or 10% of the S&P? It's another 30 or 40%.

Peter Oppenheimer  19:22

To give it a bit of historical perspective, when we've looked at bear markets in equities over the last more than one century, what we've found is that not all bear markets are alike. They tend to have different depths and have different profiles of recovery. To simplify things, I think you can distinguish between three types of downturn, those that we call structural, those that are cyclical, and those that are event-driven. And what do we mean by this? Well, the structural ones are the worst type downturns. Typically, you would see equity markets fall about 60% from peak to trough. But these are in conditions where you've seen a major asset price bubble, usually in equity markets and real estate markets together, where you've had very significant debt levels building up or leverage building up in the private sector, lots of borrowing and debt in banks and households, for example. When that bubble bursts, you get a lot of forced selling, asset prices fall, and you get usually some kind of banking problem, which then creates quite a deep recession. Now, if you think about it historically, what happened in 1929 and 30 was an example of one of these structural downturns, and it was very problematic to get out of it. The same thing happened in Japan in the late 1980s. We had a huge bubble in the equity market and real estate market and then a huge collapse that followed with a banking crisis. And I think actually, the financial crisis globally in 2008 and 9 was another example. But these don't come along, fortunately, that often. We don't think we're in one of those types of downturn because we didn't see broad asset price bubbles in the way that we've seen in those previous examples. And as I said, bank's balance sheets are actually pretty strong now. You don't have the same kind of leverage that would likely trigger these systemic downturns. Now, the other type of downturn that I mentioned was an event-driven one. And as the name suggests, we're thinking here about the exogenous shocks that suddenly happen, unexpected things that can derail an economic cycle that would otherwise have been quite stable. Often, these are a function of things like wars or maybe a big commodity crisis. In a way, I think, Simon, the pandemic was an example of one of these events. It was a very unusual and extreme event. But typically what happens as a result of these shocks is the prices and equities adjust very quickly, usually down about 30%. But then because the broad underlying cycle is reasonably healthy economically, the recovery is pretty fast. And that happened actually during the pandemic as well, although of course, it was aided by that very aggressive policy easing that we talked about earlier. The third type of downturn, what we call cyclical are really these bear markets that are a function of economic cycles, usually lead to an economic expansion. You get some inflationary pressures building up. That forces the central bank to raise interest rates and that rise in interest rates triggers an expectation of an economic downturn and maybe falling profits. And it's that that really forces a bear market. Again, these bear markets usually do see falls typically of around 30%, sometimes a little less, sometimes a bit more. They don't tend to happen in a straight line, you tend to get falls and then rallies and falls again. There's some degree of volatility in these periods, just as we've seen actually, through the course of this year. Remember, in the summer, there was a rally in equities before they started to fall again. Usually, that takes place over a couple of years. And I would say we're probably in one of these cyclical downturns. I don't think it will be significantly deeper, partly because of these private sector balances that I mentioned being quite healthy. I think we should also recognize that while there's many things to worry about, and things do look quite alarming in many ways, we're also in an environment where governments are stepping in, a little as they did during the pandemic, to try to moderate some of the worst impacts of the pressures that we're seeing, particularly, for example, in terms of things like energy prices in Europe, which have shot up very sharply because of the dependency on gas from Russia. And in the UK and across Europe, you've seen governments capping those prices for households and that, again, won't prevent a downturn but may moderate the scale of what might have otherwise happened.

Simon Brewer  24:35

You wrote, and I liked the language, you said during bear markets, the extent of the fall can vary significantly beneath the surface of the index. So when we talk about what we refer to in the business as dispersion, but I'm particularly interested in opportunities, not all stocks are equal and indexes are made up of a number of different sectors and names. What are you most drawn towards in terms of where you would be allocating capital?

Peter Oppenheimer  26:52

When we think about equity markets, what was very unusual, again, just to put things in perspective in relation to where we come from, what happened in the period after the financial crisis in the decade that followed was a very unusual style of equity returns. Generally, equity markets went up as did bond markets because interest rates fell, credit markets, private equity. Most financial assets saw valuations going up because of lower rates. Within equities, you got quite bifurcated returns. In other words, very big split. And the main way of describing that split, the difference between the winners and losers is broadly that things that were seen to be high growth did very well and things that were, if you like, very value orientated, lower value companies, more mature industries did very badly. Now there's two or three reasons why that happened. First of all, after the financial crisis, as I mentioned, because of the structural shock, economic growth was very weak for a long time. Inflation came down. That means nominal GDP, so GDP including inflation, was very weak. So investors were prepared to pay more for anything they were convinced could grow. And also the falls in interest rates towards zero had a bigger positive impact on the valuation of higher growth companies than slower growth companies. This is often referred to duration. There's a sensitivity of interest rates to longer growing companies, companies that are expected to grow fast well into the future. They disproportionately benefit from lower rates. But the other thing that happened in those years after the financial crisis is that waves of different shocks, falls in commodity prices, the sovereign debt crisis in Europe, the banking crisis in Europe, meant that many of these lower value, more mature industries became seen as value traps. They were cheap in valuation terms, but they were suffering very weak growth or no growth and perhaps having to cut dividends. So really, investors just migrated towards anything that was growing. I mention this context because what's happened over the course of this year is that as global interest rates have started to rise, that process is reversed to some extent. So growth companies have generally underperformed the more value orientated parts of the market. But in truth, that simple moniker of growth versus value, those simple labels, are not really very adequate or useful labels to be using anymore. Growth itself has split into two. You have what is seen as unprofitable growth companies, high tech, more speculative types of companies, which were seeing very high valuations up until about a year ago, having derated very sharply as interest rates and the cost of capital is increased. Whereas the more profitable mature growth companies and things like technology has done relatively well. And then we'd look at the more value orientated parts of the market. This is also split into two. There are the very cyclical or economically sensitive parts of that space which have done badly because people are worrying about falling profits as a function of potential recession, whereas those value areas that are closest to the sources of inflation, so things like energy stocks and mining and materials, who are able to pass on higher costs, they've actually done very well. So for us, what we've really been arguing through this year is to have a bit of a mixture between quality strong balance sheets, relatively defensive growth, and very low valued commodity-related parts of the market. And there you've had a bit of a balance and overall those strategies have worked quite well. I think as we move forward in time, I would be trying to focus on being much more agnostic to the factors, say growth versus value, and much more diversified both in geographical exposure and sector and style exposure. Because we think that as we go forward, even as we come out of this bear market and recessionary environment, interest rates won't trend downwards as they've done for many, many years. That means less opportunity for valuations to go up. It probably means lower returns, but it means much more idiosyncratic returns. That means more focused on actual companies and the quality of those companies and their ability to gain market share rather than just indexes rising as a function of lower rates. And I think that differentiation and diversification is going to become more important.

Simon Brewer  32:20

More opportunity for alpha, less simply beta.

Peter Oppenheimer  32:25

Yes, so active management, and alpha as it's often called relative to beta just being in an index is probably going to become more important.

Simon Brewer  32:34

You talked about geographical investing, which brings us nicely to FX. Dollar has been very strong. Back in 1971, the US Treasury Secretary John Connally quipped to the French authorities who were complaining about Nixon shutting the gold window, ''The dollar is our currency, but it's your problem.'' We have another epoch of strong dollar. Anybody with a memory knows that these things can be highly cyclical. I was interviewing in 1985, when sterling-dollar was 105. I remember the trader at Cargill said next stop is parity. In fact, next stop was 240. So let's just talk about currencies. Where do you think we go because there will be the next episode, the next chapter in the world of currencies? What are you thinking and what do you like?

Peter Oppenheimer  33:17

The dollar, as you say, has risen quite extraordinarily over the course of this year, pretty much against all currencies. So if you look at what's called the trade-weighted dollar, so the value of the dollar weighted by its trade exposure with all other currencies, that has gone up close to record high levels or at least the record highs that we saw back in the mid-1980s. There are a number of reasons for this. One of them is that in this very uncertain world that we're currently in both economically in relation to growth and inflation, but also geopolitically, there is a tendency to seek safe havens, and the dollar and its reserve currency status makes it quite a defensive currency to hold. So it tends to benefit relatively in periods of uncertainty. The other thing that we need to acknowledge is that the US Federal Reserve, the central bank, has been raising interest rates more quickly and more aggressively than many other central banks around the world. That means that there's quite a big interest rate differential between the US and other places. Interest rates are just simply higher there. And that means that global investors not only are seeking defensive places to invest, but also want to benefit from higher relative interest rates or yields available in the US and elsewhere. And that's really the central drivers of this dollar appreciation. Over the longer term, if these uncertainties moderate and as others central banks raise rates, the relative strength of the dollar should start to ease and we think that will be true for the next year and beyond. We don't see the dollar collapsing, we don't see very big movements in the dollar over that period of time. Over very long periods of time, there should be some relationship with what's called purchasing power parity, what's the relative price of buying similar things in different parts of the world. And on that basis, the dollar does look quite expensive, quite overvalued. It's just very cheap for people purchasing things in dollars in many other countries. And over time, that should start to adjust. So in the short term, I think Simon, probably the dollar remains pretty strong. We don't see very big weakness emerging over the next year or so. But over longer periods of time, we would expect to see some moderation in the dollar and some appreciation of these other currencies around the world on relative basis.

Simon Brewer  36:02

Let's just shine the spotlight on the UK for a minute or two. Money Maze Podcast is now listened to in over 90 countries and nearly half of our listeners are outside of the UK. So they're looking at a currency has come down a long way, a lot of assets that are cheaper than they were, a lot of noise around recent actions. UK equities are deep historically, there is competition from yields that there wasn't. But there's also the typical market reaction, which is the UK is a lost cause, let's move on. How are you weighing up that risk reward in the UK?

Peter Oppenheimer  36:35

Depends on again, what you're looking at. The UK is facing a difficult combination of circumstances. It's not unique in this sense, but it is facing particularly challenging circumstances because it has a very strong labor market. That's good. Unemployment is very low. But that means wages are rising and inflation is rising. But also because it's very exposed to gas and the problems with very high gas prices across Europe, people are facing a squeeze in real incomes and economic activities weakening. So you have this real challenge, which is true across many European countries, which puts it in a very difficult position. Most recently, of course, there's been the added challenge that the government's new policy has been to add a fiscal stimulus through tax cuts to this cocktail of issues, which is seems to be at odds with the Bank of England's attempt to slow the economy to contain inflation. And it's that juxtaposition between those two things that's caused market concern in the very recent past. Having said that, I think it's important to say that the equity market in the UK, the main index, the FTSE 100 Index, is not really very reflective of the UK economy anyway. About 75% of the revenues of UK FTSE 100 companies come from outside of the UK. It's one of the most global indices in the world. In fact, about 50% of the dividends of UK FTSE 100 companies are paid in dollars. So as sterling has weakened, the value of those dividends when translated in sterling have actually gone up. So I think those are important points to mention. Actually, the equity market is quite cheap. It trades at around PE, a price earnings ratio of about nine times. That's much, much cheaper than say the US. Part of this also reflects the fact that the UK index is skewed towards lower value industries. It has a lot of exposure to things like energy, oil companies, mining companies, and others like that. But for that reason, surprisingly perhaps, even with these economic challenges, the UK equity market being one of the best performing globally this year. Local currency terms, it's down around 5%, as we speak through the year. That's much less than, for example, the S&P in the US down around 20%, and similarly across the rest of Europe. The UK's market has been quite attractive, we've liked it. But it's quite specific to the drivers of that particular stock market rather than the economy. Worth noting is that the more domestically exposed parts of the UK market have suffered much more because they are more geared to the economy and our domestic basket of companies in the UK is down quite sharply, around 40% this year, which is very similar to very domestically exposed parts of other markets like the DAX in Germany as well. So I think it really depends on where you're looking and what you're looking at. The rise in interest rates that we're seeing in the UK, the sell off in the bond market, that means higher yields have started to come through the bond market, has meant that you're getting some quite attractive yields in the bond market in index-linked or inflation-adjusted bonds in the UK as well. So I think there are selectively some quite interesting assets and I think many companies in the UK will be attractive potential buying opportunities for foreign companies as well.

Simon Brewer  40:26

And PE firms and we're seeing that already. Let's just move across the channel. Talking about Europe, Philipp Freise runs KKR's European private equity business, talking about the very tantalizing array of opportunities they're seeing at a private company level, notwithstanding this eurosclerosis and clearly unresolved. How do you think we should think about the thorny issues that Europe is challenged by?

Peter Oppenheimer  40:55

There are lots of challenges and again, most countries at the moment are facing challenges, perhaps, to varying degrees and in slightly different ways. The rest of Europe, like the UK, is faced with a problem of spiraling energy costs at the moment, particularly because of the war in Ukraine and the effect on European gas and energy prices. That's pushing inflation up, even in Germany, which has been historically very low inflation anchor, if you like. You're seeing inflation of over 10% at the moment and that's like what we're seeing in the UK, forcing the central bank, the ECB, to raise interest rates. But it's been slow to do that particularly relative to, say, the Federal Reserve in the US. They need to get interest rates higher. The problem is that this is happening at a time of weakness in the economy heading into a recession. It's also difficult because it's pushing up the cost of interest for countries within Europe that have a lot of debt, Italy being a notable example. Therefore, it's creating some tension in terms of the priorities and the obligations the central bank has to contain inflation on the one hand but maintain financial stability on the other. There are lots of things that Europe can and is trying to do, and transitioning its mix of energy, which is not going to happen immediately, but it certainly was already an important focus even before the war because of its commitment to net zero carbon over the next couple of decades or so is now taking on renewed urgency because of the security issues and the urgent need to find alternative energy supplies. So I think that's really going to be the central focus of Europe over the course of next year. In the long run, I think it will be successful. It is building up renewable infrastructure, alternative energy supplies. That could of course in time generate jobs and growth as well. But I don't think we should be naive as to the difficulty of doing this and indeed the cost as well.

Simon Brewer  43:09

As we move towards some conclusions, you've talked about this energy transition. Underpinning that are some key commodities like copper, Goldman had a very good podcast on why the underlying bullish case for copper when we get through this cyclical downturn is as bullish as it is. How do you think about owning commodities and institutional asset allocation? And what are the commodities you would want to wait?

Peter Oppenheimer  43:35

I would say two things about this. One of them is that in the context of asset allocation, commodities can be quite interesting because they're often referred to as relatively uncorrelated assets. What do we mean by that? We mean that they can often move in the opposite direction to other financial assets, unlike other financial assets like equities, which are really about anticipating the future. And that really drives expectations for the future to really drive current prices. In commodities, it's just a balance between current demand and supply. And in periods of higher inflation, which means higher interest rates, which typically would be a negative for government bond markets and equities, commodities often thrive. So in that sense, they offer very good diversification. They are what's described as real assets, a real physical thing, which again, in a period of rising inflation can be quite valuable. But the second thing I would say is that, in our view, we're in a circular supercycle for many commodities because you've had long periods of underinvestment in commodity infrastructure and exploration because for a long time, particularly after the financial crisis, weak global demand meant low commodity prices. There wasn't really an incentive to invest. And also, what we're seeing is a low commitment to investing in a lot of commodity areas because of the move towards energy transition, the move towards a net zero carbon. And that means that many investors haven't wanted to put their money into traditional energy and commodity supplies. But it is a complex mix. Of course, moving to net carbon is absolutely essential for the planet and for the future of jobs and energy security. You don't get there without also investing in some of these transition materials and commodities. And to your point, Simon, you mentioned copper. If we're going to move towards net zero, and that means that our economies are going to increasingly electrify, rely more on electricity as a generator, everything from cars to heating, you can't do that without having more copper. And copper means mining copper to extract that material to facilitate that transition. So it's a very complex balance of priorities here. Generally speaking, we think that we're still in for quite a long period of relatively high prices in commodities as this energy transition unfolds.

Simon Brewer  46:20

When we release this episode, we'll release the link to what I said was a very good podcast. We also have a curated channel on the podcast and we had Brian Menell who runs a company called TechMet and at they're at the very core of developing these specialist metals that people are interested in. It is extraordinary just how, I think his words are there's a war been going on for 20 years that the West didn't know they had to fight as the Chinese have increasingly got a stranglehold on so many of these key metals, and it's absolutely terrific. You and I have the same vintage. I was listening to a song, you will remember Ian Dury and The Blockheads. It was ‘Reasons to be Cheerful’. Peter, what are the reasons to be cheerful as we look out?

Peter Oppenheimer  47:00

It's a favorite song, as for you, it seems. There are reasons to be cheerful. I think that we have to recognize that the world is changing economically and in many ways geopolitically, and that means different styles of investment. I do think we're moving into an era where the cost of capital is going to be higher and that should only be expected given that we had this artificial period of very low cost of capital after the financial crisis. That doesn't mean lower returns. But the shifts in geopolitics and the moves towards decarbonization are also going to mean less globalization and a bit more regionalization. That means more production and more localization of products, everything from food to chip manufacturing, batteries, and many other production processes, which will create its opportunities as well as costs. And also, I think it's worth saying that although the inflationary shock that we're seeing is coming from higher energy costs, higher labor costs, there will be opportunities here as well, because I think that will incentivize companies to invest in becoming more efficient by spending money on energy efficiency, by investing in machines, and artificial intelligence and things that help to become more productive in terms of the use of people. Those things over time, they will boost productivity. Remember, we've been a long period of high technology innovation, but not much productivity growth. These things could actually spur our productivity growth. Finally, we're moving from a very virtual era, a near and very much dominated by the digital revolution, which has brought many advances and benefits but has largely been at the cost of physical infrastructure. In many countries, physical infrastructure has deteriorated, it has aged. But as governments shift their priorities and there's more demand for increasing spending on defense and also decarbonization, this is going to be very costly but will also require actual physical infrastructure to be built to really retool economies to be fit for the 21st century. And while there is a cost to that, there are also likely to be benefits, both environmentally and also in terms of jobs, innovation, new products, and new growth opportunities. And it's those sorts of things that I think will create some interesting returns for investors as well.

Simon Brewer  49:39

You've been very generous with your time. I'm conscious I've got to let you go. We always ask our guests a couple of general questions. So I'm going to ask you these. What's your favorite or most important daily habit?

Peter Oppenheimer  49:49

Swimming. I don't do it daily, but I do it as much as I can. I really like that and I cycle every day. I like that very much.

Simon Brewer  49:57

What would you tell a 20-year-old Peter Oppenheimer

Peter Oppenheimer  50:00

I would say be optimistic and be patient. To use a bit of a hackneyed phrase, it's a marathon, not a sprint, everything that you can do to try and learn and even the failures are really opportunities to strengthen and develop and grow. So don't take the hits and the failures too hard because they will strengthen you and provide a platform for development as you move on. Think of it as a marathon. Develop, grow, learn, and hopefully, you will find that any knocks are temporary. Be optimistic and stick with what you're doing.

Simon Brewer  50:35

That's very good advice. I'm going to sum up three particular things I've taken from this conversation from you. For stock investors, more alpha, that means stock selection is going to play a more important role for investors, number one. Number two, we are in a supercycle for commodities and that's creating a range of opportunities as well. And number three, reduce globalization means more localization of production, and one needs to factor that into one's thinking as investors as well. Lots more in there, but Peter, I'm going to let you go. Thank you so much indeed for your time today.

Peter Oppenheimer  51:07

Thank you, Simon.

All content on the Money Maze Podcast is for your general information and use only and is not intended to address your particular requirements. In particular, the content does not constitute any form of advice, recommendation, representation, endorsement or arrangement and is not intended to be relied upon by users in making any specific investment or other decisions. Guests and presenters may have positions in any of the investments discussed.

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In this episode, we welcome Peter Oppenheimer from Goldman Sachs, to discuss the challenging investment landscape.

He starts with an overview of economic growth before unpicking the inflation debate, reviewing rates and the emergence of opportunities in fixed income, before discussing equity markets.

He explains why active equity management is back, why value versus growth discussions are too simplified and the likely character of this bear market.

Finally Peter discusses the commodity supercycle, localisation of production and to quote Ian Dury, “reasons to be cheerful” in the medium term!

Peter Oppenheimer

Peter is chief global equity strategist and head of Macro Research in Europe. He is a member of the Global Investment Research Client and Business Standards Committee and the Structured Research Products Group. Peter joined Goldman Sachs in 2002 as European and global strategist and was named managing director in 2003 and partner in 2006. Prior to joining the firm, Peter worked as managing director and chief investment strategist at HSBC and was previously head of European strategy at James Capel.

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