Investing in the Post-Modern Cycle with Peter Oppenheimer, Chief Global Equity Strategist for Goldman Sachs
Willy Walker: Welcome to another Walker Webcast. I'm actually back in the U.S. after doing the webcast last week from Dubai. And I don't know how many of you have seen the news over the last 24 hours, but Dubai is literally underwater after getting more rainfall in the last 48 hours than they've gotten, I think, in a quarter century. And so, as I've looked at pictures of planes trying to get out of the airport that's literally underwater, I feel very thankful that my son and I got out of Dubai over the weekend. Although that exit from Dubai was interrupted by the attacks on Israel, by Iran, and the airspace over Egypt being shut down. And so rather than flying to New York, we ended up flying directly to Los Angeles, up over the North Pole. And given Peter's geography background, you already in your own mind, you’ve got me going, due west out of Dubai then going due north up over Iran and Outer Mongolia as we went up over the North Pole, which was quite the route home.
Peter, let me first of all thank you for joining me.
Peter Oppenheimer: Thank you, Willy.
Willy Walker: And let me do a quick bio on you. And then, I'm going to dive in because I'm super excited to talk about the world we're living in today. And I think, more importantly, your perspective as a macro strategist, given your track record of, if you will, looking at cycles rather than looking at, if you will, blips and data points on a very short-term basis and your longer-term outlook for both, economic growth, in some instances recessions, and how we all ought to be making, sense of the world we live in today.
Peter Oppenheimer is Chief Global Equity Strategist and head of macro research in Europe within Global Investment Research at Goldman Sachs. Peter joined Goldman Sachs in 2002 as a European and global strategist and was named managing director in 2003 and a partner in 2006. He regularly appears in news outlets such as the Financial Times, CNBC, and Bloomberg as a financial strategist and expert on global markets. Prior to joining Goldman, Peter worked as managing director and chief investment strategist at HSBC and was previously head of European Strategy at James Capell. Peter is the author of two books, The Long Good Buy and Any Happy Returns.
He earned a BSC first class in geography from the London School of Economics. So, Peter, I got to start with getting a major in geography from the London School of Economics. Sounds to me to be a philosophy major at Harvard Medical School. How was it that you studied geography at LSc?
Peter Oppenheimer: I should say I'm just trying to think in my mind the route you took to get back to the US and map that in my mind, I should say that, actually, I did a BSc Econ, economics degree. But then moved to human geography or economic geography, which just interested me at the time, given there was a lot of focus at the time on the growth of emerging economies and the differences in opportunities given inequality. And I wanted to look at development economics. So it was very well aligned to economics, although obviously a different discipline, but certainly linked. And it's proved useful because I'm very interested in sort of multi-disciplinary kind of approaches and ways of thinking about things, particularly when it comes to social sciences.
Willy Walker: I know you typically bike into the office. Did you bike today? Did you work in a swim today, or is the swim still happening for you this evening?
Peter Oppenheimer: I don't know how you know that, Willy. But I did actually swim this morning. I was in the pool at 6 a.m. I did a mile. I like to swim, quite regularly, and I do cycle in to work normally. I didn't do it today, actually, because I had to go off and do some meetings before I got here. Look, I like to keep fit. It gives me some perspective and helps to keep my energy levels up, which is a crucial part of the focus you need to do this and so many other jobs today, I think.
Willy Walker: Let me ask you one other personal question before we dive into sort of the more mundane economic data that I'd love to hear your thoughts on. You've been at Goldman now for over 20 years, what's changed most either about Goldman Sachs or about investment banking over the past two decades?
Peter Oppenheimer: Firstly, I am very privileged to be here, it's an amazing institution and I've learned and benefited so much from being here and the people around me. It's grown, and the industry has grown tremendously over that period of time. And it's become more complex. I think all of that, probably we will get into this, is a function of many years, 20 years or more of falling interest rates and the cost of capital. And frankly, liquidity has increased. The depth, scale, and complexity of financial markets has grown tremendously over that period of time. The number of people we employ, the number of places that we reach and touch, and the different businesses we are in have become more diverse and more complex. But also a lot more interesting as a result of that. But I think we've all benefited in that sense from many years of falling interest rates and, indeed, from globalization, all of which have combined to really provide a very fertile environment in which financial services have contributed but also significantly benefited.
Willy Walker: Any differences between Goldman as a partnership versus Goldman as a public company?
Peter Oppenheimer: I actually got here when it was a public company. There is still a partnership. It's a really unique culture because, of course, being a public company, it isn't a partnership in the way that it was as a private company. But there's a very special network and camaraderie between and across the partners, as they call it here still at Goldman Sachs. There's a very strong culture of still that sense of ownership and entrepreneurism that comes from being a private partnership. And it's very much an emphasis on collaboration and working across divisions and across disciplines. And I think that I've learned a lot from that and benefited significantly from it. Of course, it is a very big public company. There is a sense still, a special grouping of partners the more senior people in the organization. I've been very lucky and privileged to be in that group.
Willy Walker: I opened the Wall Street Journal on Monday morning, and there were two headlines, Peter, that I read. The first one was inflation weakens demand for U.S. treasuries. And it was a big article about U.S. Treasury auctions and one that happened last week with very tepid interest in buying the ten-year bond. And the other one right next to it, was economic forecasters see good times ahead. And I said to myself, “Can those two headlines exist simultaneously?” And they obviously did because they were both in the Wall Street Journal on Monday. But explain to me how those two things can happen at the same time.
Peter Oppenheimer: Look, it's a great observation. I think it's a reflection actually of the multiple factors, and influences that impact financial markets at any given point. I think the way you close that circle is that stronger growth relative to what people were expecting a year or so ago when there were widespread expectations. The recession has meant that demand has been stronger, and inflation has held out more than perhaps people were expecting. And so, stronger growth means a bit more inflation, less scope for interest rates to fall as quickly as perhaps financial markets had been pricing just three months ago. And I guess another factor, which is also important, maybe we'll talk more about it in the conversation, is that the US, and certainly not the US alone, all major governments, are increasing their borrowing at a rapid rate, partly for structural reasons. The world around them is changing, and the obligations and requirements of government spending are shifting. And of course, as governments around the world need to borrow more, there's less demand for giving them or lending to them at any given rate. And just again, a bit of perspective here is incredible to think that just about three years ago, a quarter of all government debt around the world actually had a negative yield. In other words, investors at that stage, because interest rates were zero, were prepared to literally lend to governments knowing they were getting and get a negative return back if they held to maturity. That world has shifted dramatically in an environment of higher inflation and interest rates, really, since 2022. And I think what you're seeing at the moment is this tug of war really between sticky rate inflation, higher interest rates, higher cost of capital, but also somewhat better economic growth.
Willy Walker: We give the US Treasury a hard time, I would say, as it relates to not having gone and issued more debt when the cost of debt was so much lower and sort of managing their own exposure. Was there any government at a time, just as you pointed out, that literally people who were paying the government to take their money. There were negative yields on German debt. Was there any government that went and issued a ton of long-term fixed-rate debt and said, “We need to take advantage of this situation, and that therefore is not issuing to the degree that the United States and other major governments are issuing today.” Is there anybody who sort of managed their balance sheet better than what we are seemingly thinking the United States did?
Peter Oppenheimer: It is interesting, as you say, that the very few major governments, particularly in the developed world, did do that. Some did. I think Austria may have issued 100-year debt and some emerging economies did 50 or 100-year debt as well. So there certainly was some of that going on. But remember, in the context of the time, it's interesting that many governments, after the financial crisis, recognized that high debt was one of the problems that got us into difficulties, really focused on reducing government debt and spending. To the extent that you actually had significant cuts, particularly in Europe, in many government’s budgets, but that was counterbalanced by extraordinarily loose monetary conditions. In other words, interest rates went to zero or even, in many cases in Europe below zero. And you had this period of hyper monetization, of quantitative easing of central banks, literally printing money. So the orthodoxy at the time actually, was not to increase debt but to try and bring government debt levels down. Having taken on the burden of bailing out the failed banks and stabilizing economies in that deep recession in 2008 and ‘09. But to offset that with very loose monetary conditions, actually, what's interesting is that we're somewhat in the opposite end of the extreme as we move out of that period of zero interest rates into a period of somewhat tighter monetary policy. Central banks are looking to exit QE, or they've already started to do so. But at the same time, governments around the world are actually loosening fiscal policy and loosening those constraints on government spending. So it's a reflection again of how cycles tend to change. But also, you get structural changes in the realities of what governments and central banks are facing, which can cause quite different outcomes in terms of the policy mix.
Willy Walker: Talk about that for a minute. I'm jumping ahead on the conversation here, Peter. But we're on this monetary policy versus fiscal policy. And as you lay it out, we were in the modern cycle of 2010 to 2020, where monetary policy was really at the forefront, just as you just described. And now, in the post-modern era, as you talk about it, or the post-modern cycle, we're moving from monetary policy to fiscal policy. There are plenty of us in the United States who sit around and say, “Hold on a second.” With a government that seems to be spending money at an incredible rate, monetary policy still seems to be driving the bus, if you will, because we've got trillion-dollar deficits. And therefore the fiscal policy has to clean up for the lack of monetary constraint, if you will. And it seems to us as if it's actually monetary policy if it's driving the bus and the fiscal policy is trying to keep up with it. Why do you feel like actually the fiscal policy is now stepping in and taking the lead if you will, and monetary policy is taking a backseat?
Peter Oppenheimer: I think we need to differentiate here between the cycle and the sort of structural changes. And that's actually one of the key things I'm trying to pick up, in this book, Any Happy Returns, is really looking at the longer-term secular changes in which cycles unfold. Now, there is a cycle, early 2022, from record low-interest rate levels, supported by QE. We've begun to see central banks around the world raising interest rates because inflation finally started to pick up due to supply constraints after the pandemic. That was the cycle of rising inflation and interest rates, and it triggered a fear that we would get a recession. Those recessions actually didn't really materialize, fortunately, partly because there were excess savings in the household sector built up during the pandemic. And really importantly, corporations have healthy balance sheets. And so do banks remember, because of tightened regulation after the financial crisis, they were in a better position, really to absorb the shock or impact of rising inflation in rates. So we're now going into a period where investors are hoping that inflation is peaked. It's coming down, maybe not quite as quickly as was hoped a few months ago, but the direction is becoming more positive. Interest rates are going to come down. That's the cycle. But structurally, I think things are changing quite a lot. The context here really you have to go back to the early 1980s when that modern cycle that I described started. That was the peak of inflation and interest rates. After the big inflation shocks of the 1970s, if you look at the US or the UK, interest rates, and inflation, we're in the mid-teens. They started a journey then two significant disinflation, lower interest rates, which continued over the next 30 years or so. Also very important to say, by the way, that not only did interest rates and inflation come down over that long period, but you also had positive supply-side changes in economies. Remember, the policy shifts, in the Reagan and Thatcher administrations, deregulation, privatization, and tax reforms. You also then had, of course, the collapse of the Berlin Wall, the end of Soviet communism. And that brought down risk premia, uncertainty, and geopolitical tensions. And we started the modern era of globalization. So that's the supercycle that's really got us to where we are today. Now, as we move out of the period of super low interest rates, zero interest rates, or even negative, as we come out of the pandemic era, we're also finding that not only interest rates and the cost of capital probably need to rise because we've no longer got significant deflationary risks, but structurally a little bit more inflationary risks. But also governments are facing new realities that require more intervention. Some of it reflects the geopolitical tensions that are changing the requirements and the need now to spend more on defense. And people and governments believed likely just a few years ago. Also, the realities of the transition would perhaps talk more about things like decarbonization, which requires governments to offer more subsidies and tax breaks, which are increasing debt levels as well. So I think when you look at the structural changes, the revolving, we're starting to see a shift away from super cheap money and interest rates as the driver and support to growth. And we are starting to see an environment where government debt levels are rising and likely to continue to do so, for some time to come.
Willy Walker: When I hear you talk about a supercycle, Peter, it makes perfect sense looking back from 1980 to 2024, in the sense that fortunately, we're both old enough to remember the Reagan era and what happened. And what happened to interest rates from being up at 15% and then continuously going down? And if you look at the chart over that period of time, you sit there and say, that was a great time to be a floating rate debt borrower, and it was a great time to be an investor in the equity markets because as the cost of capital went to zero, there was really nowhere else to go other than into growth equities. And if you were in any macro play on the major equity markets, you did well during that period of time. As you look back, over that period of time, there were clearly moments where it was hard to have conviction on what you just said. 2001 World Trade Center goes down. We're in the midst of the dot.com blow-up, and it's very hard for you to sit there and say, we're in this supercycle and just, put money in equities and hang on. And rates are going to keep coming down, great financial crisis. How do you maintain discipline when you look at all of this from a supercycle and from various economic cycles? How do you, with the team at Goldman Sachs, sit there and say, “Okay, great. This is happening today. We just had Iran launch missiles at Israel and a lot of tension in the world. This could actually escalate. But we've got to look at the supercycle we're in from an economic standpoint and make bets that we hold on to.”
Peter Oppenheimer: Well look, Willy, I think that the reality is we all live in the here and now. And, of course, nobody knows for certain what's going to happen in the future. And they can look to the past to give some guide. But there's a tendency psychologically, I think, for two things to happen. First, for people to focus on what's urgent. Those are the here-and-now and near-term pressures. And the other thing is recency bias to adjust expectations to recent experience. So when you focus on what's urgent, you're not always focusing on what's most important. And it's often these secular developments that are beginning to unfold, that actually create the guide path for the more important structural developments that can affect the way that businesses operate and the way that investors can prosper. It's also the overemphasis on recent experience, which gets people often into trouble because they're not quick enough to adjust to new realities. For example, only a very short time ago, we lived in a world of pretty much zero interest rates, and the markets were pricing very high degrees of probability that the situation would just continue, and most people couldn't really envisage or understand what the implications of the high cost of capital would be because I literally haven't seen it for a generation. And equally, in the last couple of years of rising interest rates, all the focus has really been on the short term. Are we going to get a recession? if so, how deep, and how high would interest rates go? When would inflation peak? But not really a lot of emphasis on these bigger topics. How is the geopolitical landscape really changing and reshaping the dynamics of globalization, which hitherto has been uncontested in the last couple of decades, but is now beginning to fracture somewhat as we get a more regionalized trade model? What's happening in labor markets? Suddenly we have very tight labor markets and low unemployment. For years we've had excess labor, as globalization has provided ample labor supply in a globalized, integrated world. We also had excess energy supplies and commodity supplies that are now no longer really true as well. What does the world look like in an environment of high cost of capital? Also, as we begin to absorb two of the greatest shocks to hit economies for a very long time, the impact of newer technologies around AI and, at the same time, the move to decarbonization. So look, I don't say we have all the answers, but when I look with my team at developments around market pricing, what we try to do is look at what we think the market is pricing around these cyclical developments. Last year, for example, we didn't believe that there would be a recession even though the markets were pricing that. So we thought that was an opportunity. But we also really tried to keep coming back to what is structurally changing in the world around us. And what can that really mean for investors and for companies over a longer period of time? What's really happening that's important? Not so much what's happening that's urgent, and that's what we try to do. Of course, it doesn't mean to say you always get the right answers, but I think having that discipline, having that mindset, having that multidisciplinary approach, which, as I mentioned at the outset, I think is so important what we at least tried to do.
Willy Walker: There's a lot in that answer if you double-click on and go into there that you talked about as it relates to employment as it talks to, the reversal of globalization and regionalization, and things of that nature. Before we do that, the psychology behind investing. In your book, you write about there are four phases where you go from the optimism stage into the despair stage, into the hopes stage, into the growth stage. And you write that we're right now in an optimism stage. I guess my question to you would be, how long does the optimism last? And then, does optimism always get followed by despair?
Peter Oppenheimer: Yeah, it's a good question.
Willy Walker: Can you jump from optimism over to hope or into growth?
Peter Oppenheimer: You can, actually. And again, this is where the judgment really comes in. But to explain a little bit of a background here, my first book, which was called The Long Goodbye, was really about cycles and the inter-relationship between cycles in economies and cycles in markets. So very simply, these two things affect and influence each other. If you go back to, let's say, the 1850s, take the US, there have been about 35 economic cycles. That means expansions and recessions, and they've been pretty much the same number of cycles in the equity market, periods of strong returns and then bear markets. If you look, since the Second World War, there've been, I think, roughly 13 recessions in the US, about the same number of bear markets. So there's connectivity here. When you look at equities, they tend to anticipate they're influenced by, but they tend to anticipate those economic cycles. But each of those cycles, which on average, and it is only an average, have lasted around 6 or 7 years. You tend to get these separate phases. So the first part, if you like, of a cycle in the equity market is what we call a despair phase. That's a bear market. When prices fall nearly always in advance of or anticipating a recession, it forces profits to go down. So equity prices fall in advance of that. The first phase of the expansion cycle we call optimism. And that tends to be very explosive. It nearly always starts when you're in a recession when the news is really bad. When profits are depressed, something triggers the animal spirits usually, rate cuts, for example. And equity prices rise quickly in anticipation of the next recovery. And in that phase, you tend to get a lot of returns led by valuations going up. Because profits are still depressed, prices are rising. The valuations go up. The next phase, the longest phase we call the growth phase. That's usually associated with most of the expansion of the economic cycle. When companies make most of their profits and pay most of their dividends, they tend to get lower returns in the market then because some of it has already been pre-anticipated and paid for. But you nearly always get later in the economic cycle. Confidence builds up again and you tend to get valuations rising again. And that's the optimism phase, this belief that, actually, the cycle can keep going on. And I think we're probably in that because valuations of markets have been rising, particularly equities. Some of it, and we can talk perhaps more about this in detail, has been led by a particular group of companies, especially around technology and AI, broadly asset prices have been going up again. And I think we're beginning to see the sense that actually we've managed to avoid a recession. The cycle is going to continue to continue for a long time. Usually, that phase lasts a couple of years, and typically it'll be followed by a correction or a bear market again. It doesn't always have to. So we need to look very closely at the signals of the tensions between the cost of capital, interest rates, and growth expectations. Those are the things that really tend to drive the inflection points. But that describes how these cycles usually evolve and where we might most likely be right now.
Willy Walker: Take it from there, Peter, to when we do get a correction, you outlined in the book three distinct ways that we get corrections, if you will. There's the structural down market, there's the event-driven downturn, and then there's the cyclical downturn. Describe those three events. One of the things I thought was very interesting was the destruction of value if you will, is very different depending on whether it's a structural down market, an event-driven down market, or a cyclical downturn. So talk about those three things and what you predict will be the next one. Obviously, event-driven, we'd never know. But whether the next one will be structural or cyclical.
Peter Oppenheimer: That's a really great question and an important distinction because you do tend to get these repeated cycles. And they do usually end either with recessions or land on some downward adjustment in risk assets, and equities. The question is, to what degree? And, looking back at data over the last couple of hundred years, you can broadly generalize. So split these downturns into three buckets. As you say, those that are structural, those are cyclical, and those are ventures. And so what do we do? Let’s start with the cyclical ones because these are the most common. So these are literally the adjustments in equity prices that you get in those despair phases. Investors start to believe that there's a high prospect of a recession of profits falling, perhaps because of a period of rising interest rates. And you usually get an adjustment downwards in equity prices, usually lasting for six months a year, something like that. And the typical adjustment in those cyclical bear markets historically has been about 30%. But because it's about the cycle, and as interest rates start to come down and investors start to anticipate recovery, the losses tend to be relatively short-lived. And you get back to where you started, usually within 18 months or two years. The event-driven ones are very unpredictable because they're not really about the evolution of the typical cycles around economic and policy changes. They're usually just exogenous shocks that come out of nowhere. Often things like political events, wars, or shocks of some kind. Those tend to be similar falls in prices that say, on average, about 30%, but they tend to be much shorter. And you tend to get a recovery much more quickly because most of these shocks, not all of them, actually don't trigger a proper economic downturn. It's usually about an adjustment in risk appetite, which triggers as people get more uncertain, a derating, a lower valuation, and it's over relatively quickly. Now, the structural ones are the ones to really avoid. The fortunate thing historically is they're much less likely. And they do have some similar characteristics. These structural downturns are nearly always preceded by asset bubbles and very high valuations. Usually, extreme leverage that builds up in the private sector, particularly in the banking sector, usually associated with big rises and increased leverage in things like real estate. And, when the bubble bursts, for whatever reason, perhaps rising interest rates, it forces a vicious cycle of the private sector deleveraging, selling assets, hitting profits, causing deeper recessions, and much bigger falls in prices. Normally those types of downturns we've seen falls of about 60%. Some examples think about Japan and the boom in the 1980s. Remember, by 1990, people often forget Japan briefly was the biggest equity market in the world. There was a huge boom in real estate, land values, and in bank valuations. Three of the biggest ten stocks in the world in 1990 were Japanese banks. Six of the ten biggest stocks in the world were Japanese. There was a huge valuation bubble. Its burst led to a massive correction in equity prices. Then, a big collapse in the banking sector and the real estate sector, which took many years to unfold. In fact, we're only just now in the equity market, getting back to the levels we last saw in 1990. Another very good example of it was the financial crisis, very similar, with huge leverage in the private sector because of cheap debt, lots of leverage in the banking sector, and very high asset prices. When it burst, it created these structural vicious cycles, which led to significant secondary and tertiary effects, a big recession that resulted in very, very dramatic policy adjustments to offset the beginnings of zero interest rate policy. We saw equity prices around the world fall on average 60%, it took a very long time for them to recover. Fortunately, they're not too common. There are other examples in history. I don't think we're in that situation today.
Willy Walker: Do you think that the cycle we're in right now as it relates to rising rates? You mentioned real estate. We are in a cycle right now where we have rising interest rates. You predict that rates will start to come down as inflation comes down. But do higher rates pose a risk that something like commercial real estate starts to tip, and therefore, you get yourself into a structural downturn rather than a cyclical one?
Peter Oppenheimer: It is possible, but I think unlikely. And here's the positives. I think the reason it's unlikely is twofold. Interest rates have risen from all-time record lows. We have histories of interest rates going back hundreds of years, and they've never reached the lows we were seeing before 2022 and after the pandemic. So they rose from these extraordinarily low levels. Inflation has gone up, but it hasn't really spiraled out of control in the way that we've seen, for example, in the 1970s. So there's a limit, I think to how far interest rates rise. But importantly, and this is one of the reasons why we didn't think there would be a recession in the last year or so as interest rates went up, is that we actually entered this period of rising interest rates with unusually healthy private sector balance sheets, very different from what happened, in the years before the financial crisis. This time around, partly because of the effects of the pandemic and government support and furlough schemes, household sectors were in a relatively good position. They had excess savings. After all, we were all at home for long periods of time, unable to consume in a typical way. So we're building up excess savings. Secondly, unlike 2010, it was certainly before the financial crisis. Corporate sector balance sheets, in aggregate, have been quite healthy. And very importantly, banks' balance sheets have been very strong. And that's partly because of regulation that came into being after the financial crisis. Remember, banks had to take on much more capital as a buffer against potential, repeated crises. So I think that the private sector leverage was much more modest going into this period of rising interest rates. Yes, there have been problems, and there are issues, of course, particularly in the US, in commercial real estate. And there have been issues, of course, around some of the regional banks that have particularly high exposure. But in aggregate, the financial system is much more sound. Meaning that it doesn't prevent problems or issues from arising. It just means that the ability to offset those and moderate the impacts of them is much greater. So, of course, if interest rates need to rise again significantly for some reason that is not yet being anticipated, that could cause much greater problems. But I think the probability of that is not very high.
Willy Walker: Right now your Goldman is looking at what, a 397 ten-year by the end of the year, I think is what I read.
Peter Oppenheimer: Yeah, it's roughly around 4%. I think long-term interest rates, a broad message, would be they are pretty much going to be around this level. So they're not going to come down.
Willy Walker: In my business, Peter, there's a big difference between a 4.62 ten-year and a 4% ten-year. One of the things that, honestly, I think is quite interesting is that it's the volatility of rates that has been so challenging for our clients. If you said to our clients today, the cost of capital for a ten-year bond is going to be 4.50 for the next two years. They could start transacting off of a 4.50 10-year. And they sit there and say, that's my cost of capital, and there's going to be a spread on top of it. And that's my borrowing cost. What's ended up happening is we keep getting these head fakes where you're at a 3.86, and everyone says, “Oh, the Fed's going to start cutting, and we're going to get a rally off of here” and be like, “Oh, I think for that.” And then all of a sudden, it balloons up to 4.62, and they say, “Oops, I should have done it at 3.86. Now that I am at a 4.62, I'm going to wait.”
Peter Oppenheimer: Totally. Right. And I think, again, this is a very good example of the difference between the urgent and the important, between the cyclical and the structural factors. A year ago, we were seeing rising interest rates, and there was very little confidence about where inflation and interest rates would peak. And so everything that was indebted, everything was very dependent on the cost of capital was seeing valuation, derating. By the end of last year, not very long ago, as inflation looked as if it was peaking, people got very confident that interest rates would come down and come down very quickly. Just at the beginning of this year, take the US; the markets were pricing the probability of seven rate cuts by the Fed this year. Now we're back to pricing just two. So that's the cycle changing the noise about, how far, the timing and when. But structurally, I think and this is the important thing, I think, assume that the cost of capital is not going to be trending downwards as it really did for the majority of the last 20 or 25 years. And there's a good reason for this. First of all, government debt levels are rising. And that means long-term interest rates, which affect the cost of capital, are not likely to be trending back down towards zero again anytime soon. Some of these, the de-globalization patterns that we've been describing, just mean more costs. Tariffs are going up in trade terms, and that's going to be higher costs as well. So inflation might come down cyclically, but structurally it's probably not going to be trending much lower. The cost of capital is going to be higher. Also, remember another important component of the cost of capital is risk premium. And we are in a much more uncertain, unpredictable world. And all of those things, I think we don't know exactly where it's going to settle out. Nobody does. But I think we should be assuming that the cost of capital is not going to be consistently trending downwards in the way that we've been seeing in at least the last one or two decades. Business models and investment valuations need to adjust, I think to that structural shift.
Willy Walker: Explain that comment, Peter, of we're in a more uncertain world. Aren’t we always in an uncertain world in the sense that why is the risk premium up now than ten years ago in the sense that it was a scary world ten years ago? Why has the risk premium gone up now?
Peter Oppenheimer: Look, it's a very good point. And it's easy to dismiss these things when you've got to the other side of them. But we had the bursting of the technology bubble shortly after that, the terrible events of 9/11. We had lots of other shocks, including the pandemic, the war in Ukraine, and other things that are evolving. Actually, while each of those shocks caused adjustment and asset prices because we were seeing a disinflationary environment where interest rates could continue to fall, at least to some degree, it was offsetting the effect of that. Now, I think we are living in a more uncertain world because it's not just that we have, sadly, the reality of conflicts and wars that were not predicted or expected in the near recent past. But we're in a world where the rules of the game are changing in a way that leads to more unpredictable outcomes. We've lived in a world really in the last few decades which was dominated by the postwar economic and institutional architecture. The establishment after the Second World War of the World Bank, the IMF, and the General Agreement with Tariffs and Trade, the rule-based architecture that was created, sponsored, and developed by the United States. Now, lots of these things still exist, but they are being questioned and pushed back on. The uninterrupted period of globalization that really accelerated after the collapse of the Berlin Wall and the end of the Soviet bloc when we had the Eastern European countries integrated into the Western European economies, then India joined the WTO (World Trade Organization) in the mid-90s, and then of course, China by 2001. We were living in a world that had shocks, certainly, but the broader economic and geopolitical architecture was really not being challenged, I think, in the way that we're seeing today. I would also note living in an unpredictable world because of the dual shocks of rapidly changing technologies like AI. And these could be positive shocks. I think eventually they will. And the effects of climate change and decarbonization, when you throw that together with a less predictable world trading system, greater geopolitical tensions, more government intervention, and more trade tariffs, for example, I think there has to be some effect on the cost of capital because of the less predictable, rules-based order compared to what we've generally lived in over the last couple of decades.
Willy Walker: When I hear you talk through the global order and what caused it to, if you will, the risk premium to come down. You ended your description of all the various things that got us to what you would say was a very safe world in 2001, with China going into the WTO. 2001 was also when the World Trade Center came down. I actually look back on that and wonder whether Osama Bin Laden and what he tried to do on 9/11 is actually having…. As you look back over the last 20 years, whether he actually is winning and I know that is a wildly controversial thing to say, but my point is that he wanted to break apart the world's global order from the expansion of globalism, the expansion of capitalism. And you have to look at the last two decades, and all the things that you've just talked about have happened subsequently. And there's plenty in there of the United States going to war in Afghanistan and Iraq and everything that the United States did to try and “prosecute the war on terror.” But it's just interesting to me to hear you talk about, here we are in 24 with a higher risk premium based off of the splintering of the global economic order. Which is all exactly right. But I just thought that 2001 date, you put out there as far as China going into WTO, also happened to coincide with 9/11 and what Osama Bin Laden was trying to do to arrest the development of globalization and capitalism.
Peter Oppenheimer: Look, it's a good point. And that was an extraordinary shock. But it didn't really displace the integration of the global economy at that stage. Of course. In fact, since China joined the WTO, we have had this extraordinary growth in the Chinese economy, which I think it increased something like 15-fold over the subsequent, 20 years. And had a big impact on the global economy. It was a virtuous cycle because you were getting economic growth and increased demand. Still, you were getting the provision of cheaper inputs and components that were benefiting Western companies as well. So there was, at least economically, a very virtuous circle. Now, look, I'm optimistic about the long-term prospects of capital allocation and growth. And I think actually, AI will prove to be a solid positive for the global economy as it boosts productivity. But we are beginning to see conflicting interests, not just geopolitically but economically, which is reshaping the confidence that you can have in that very integrated model, at least for now.
Willy Walker: As we think about supercycles, one of the things you've pointed out is that we're going into a supercycle for commodities. Talk for a moment, Peter, first of all, about the fact that in the modern cycle, you could go and put your money into one of the major indices, the US, S&P 500, and you could do extremely well because there really wasn't anywhere else to make money other than in equities. And the US had the best growth stocks. And all anyone wanted was growth value was out, bonds were out, commodities were out, and currency was out. The only place to go was there. And if you put money into the markets and equities, you did exceedingly well. One of the things that you talk about in the post-modern era is the fact that AU can make money in other investments, but that also it's going to be harder to find returns and that people need to be very focused on not just a general strategy, but a more specific strategy. Talk for a moment about why you think we're coming into a commodity supercycle.
Peter Oppenheimer: Yeah. Just as a precursor to that. Look, the fantastic, outsized returns that have been enjoyed in equities, particularly US equities, in the last 10 or 15 years were based on fundamentals. The U. economy has been more successful than others. US corporate profits, in aggregate, have grown a lot more than others. But there has definitely been the tailwind, of course, of ever lower cost of capital in interest rates. And that's boosted the present value of what we call long-duration assets, assets with growth expected to pay off far into the future. But that's not going to be repeated in the same way. But we also have to recognize that valuations do tell us something about future returns, and the valuations of US equities are high. You've got PE ratios well above 20. So right at the top of their long-term range doesn't mean to say that they're going to be bad. But I think you're going to need to lengthen time horizons as an investor in equities and be more diversified to get this as a good risk-adjusted return. The interesting thing about commodities is that for long periods, particularly after the financial crisis, excess supplies of commodities. Because there was lots of investment in the decade that preceded it. Then we had the shale revolution, which created new sources of energy in the US, and the US ultimately then became a net exporter of oil. So there were excess supplies of commodities. People didn't want to invest in them. And then the moves gradually towards ESG investing and the prospects of decarbonization meant that the rates of return on capital were quite low. Certainly, relative to the sorts of rates of return on capital that you were able to get in growth equity. So the consequence of all of this is that you've had years now of underinvestment in commodity exploration, storage, and transportation. And so the returns available there are going up. And actually, there's an interesting symbiosis here as well because the interesting thing about AI and the prospects of higher growth emanating from these technologies is that, really, to fulfill the potential of AI, you need huge amounts of electricity. Decarbonization is all about re-electrifying our economies based on cleaner and more renewable resources. So these two things are going to move alongside each other. But again, to electrify everything. Guess what. You need huge amounts of copper. And there's been very little investment in copper mines. And these supplies are very tight. So we are again structurally in an inflection point into a secular environment, which does require actually, not just the evolution of a very virtual technology-driven world. We actually need to rebuild stuff again, physical infrastructure, new energy supplies, new energy distribution and storage, and transmission mechanisms. And all of this is going to cost a lot of money, and it's going to require some very physical assets build as well. And I think the returns in some of these areas will be very good.
Willy Walker: Let's talk about currencies for a second. The dollar has obviously been extremely strong, somewhat counterintuitive, if you will, Peter, in the sense that the U.S. Treasury rate certainly wouldn't tell you the dollar has been really strong. But clearly, the U.S. raising rates faster than anybody else made it so that investing in the U.S. and actually buying our treasuries was something that was extremely attractive to others, particularly someone like Japan, who has kept their rates so, so low.
Peter Oppenheimer: Yes.
Willy Walker: We benefit from being the reserve currency of the world. What's your outlook for the dollar if you will have a secular standpoint in the longer term as it relates? If the euro had continued to grow, I thought that there was an opportunity that the euro could actually be a competitor reserve currency of the world if it continued to grow. I think the euro is taking a very big backseat. If you look at the amount of Yen outstanding versus dollars, it's not even a raise so is the dollar. Do we in the United States have the lock and the privilege of having the reserve currency that allows us to continue to issue U.S. government debt at a ridiculous rate for seemingly forever? Or do we have to be careful that we actually lose that perch?
Peter Oppenheimer: I think it's very unlikely that there's any realistic challenge to the dollar's reserve currency status. And, for the foreseeable future. There is a bit of diversification away from the dollar in central banks' reserves right now. And that's one of the reasons we're seeing rising gold prices, because some central banks around the world are trying to find an alternative to the dollar in their reserves, and gold is one of them. But, privilege, yes, luck, yes. But based on skill as well. The US is not only the reserve currency, but it's the most dynamic economy in the world, with some of the most extraordinary growth companies. And therefore, it's able to attract foreign investment because people want to get access to these assets. So I think it's not just luck and privilege. It's also based on hard work and skill and comparative advantages. But look, I think the dollar cyclically has benefited from all that you say as well, higher interest rates there than in other parts of the world. Also, uncertainties we've been in a world that has faced a series of shocks. And when that happens, you tend to find that dollar benefits. It benefits relative to other currencies in periods of uncertainty. It's not the only currency that does. The Swiss franc would be another good example, of course, but I think this will continue for some time. Of course, the counterbalance to this is the idea of relative valuation, like every other asset, What is the value telling us? And economists like to look at things like purchasing power parity, as they call it, what is the price of buying a cup of coffee in New York relative to London, Madrid, Tokyo, and so on. When you look at these comparisons, they do suggest that the dollar is pretty overvalued. And so, under more normalized risk conditions and shocks and everything else aside, over the very long term, you would expect to see some normalization, some moderation. I think the dollar on a trade-weighted basis. But I don't think there's any immediate threat to the US as the core reserve currency.
Willy Walker: You talk about relative value, Peter. Just a quick one. I think you mentioned the US market trading at 21 times earnings. And I think you have GDP growth for the US at about 2.7% in 2024. The eurozone you have growing at 0.7% in 2024. But they're trading at 11 PE. Which one of those on a relative value basis do you like better?
Peter Oppenheimer: You even got have slightly higher growth and now forecasts in the US of roughly 3%.
Willy Walker: Oh really.
Peter Oppenheimer: Yeah. But you make a very good point. There are big differences. The US is still outgrowing other economies in the world. And there are good reasons why the US stock market has got higher valuations than other stock markets like Europe. Some of this is because the US has outgrown Europe and other regions in terms of underlying profit growth. In the decade after the financial crisis, roughly speaking, S&P earnings doubled, whereas, over the whole period, earnings in the Stocks600, 600 biggest companies in Europe went up about 5%. So that justified a higher valuation in the US than in Europe. But a couple of things that are important to emphasize. One of them is that European companies, of course, make a claim global growth. Many of the biggest companies in Europe may be headquartered there but are selling lots of their products to the US or other regions. So they're not really wholly determined by the domestic economic conditions in the region where they're headquartered. And if you look at comparable companies in the same sector, auto companies in Europe compared to the US or financials or industrials or many other industries, the valuation gaps are the biggest state they've been really going back to the 1990s. These gaps have gotten very big. And actually, the fundamentals are now the gaps are not as big. If you look at expected consensus, profit growth sector by sector, region by region. So I think there is a valuation gap, an advantage. And we have actually been arguing that investors should diversify a little bit more geographically. That's not a negative statement about the US, but the US stock market is 50% of the world or so. Here are some very good quality companies are much cheaper in other regions and places like Japan and Europe. And we've been recommending a bit more exposure to them. Because often, those valuation gaps are not fully justified based on their fundamentals. And that's part also of the diversification strategies that we've been suggesting in the last several months.
Willy Walker: I think I've heard you say that 70% of the revenues of the FTSE 100 come from outside of the UK, and 50% of their dividends are paid in dollars. So, if you're looking at these global companies that are being, if you will, to some degree pulled down just because they sit on the FTSE rather than on the Nasdaq or the NYSE, I see that there's an ARB that exists there to sit there and say, I'm going to get great earnings on a company that is fully globalized and competing on a global basis and is actually more dollar-denominated than I would think. They just happened to be on the wrong exchange.
Peter Oppenheimer: Exactly. One of the things we've started to be seeing as a form of arbitrate trading, that those gaps is that some European and UK companies have actually relisted in the US and enjoyed a valuation increase. Some of the companies in Europe where the valuations are lower, the companies themselves are the biggest buyers of their own equity. They're buying bulk stock at a very high rate. And some are even going private. So, in the end, valuation gaps can create an opportunity for investors who want to take a long-term view. And I think there are some of these opportunities outside of the US at the moment.
Willy Walker: Could you say the same thing about the Nikkei? The reason why the Nikkei has had such a big run is because those companies on the Nikkei are similarly global companies.
Peter Oppenheimer: Yeah, many of you will know that a very high proportion of companies in Japan traded below book value. Now this represents many years of economic stagnation. Deflation risks are very bad for equity and also very low rates of return on capital and low margins. But two things are happening in Japan. And this again, is why the secular shifts are so important to really focus on. One of them is that for the first time since the 1980s, the deflationary risks are moderating, and you're getting some inflation. So nominal GDP, so it's real GDP plus inflation, which companies are really making a claim on. And that's what drives their revenues is finally growing, and company profits are finally growing. It also happens that lots of Japanese companies are now really working on improving their rates of return on capital and margins, really focusing more on shareholder value. And that combination is creating a revaluation in the market. And I think we referenced just earlier in our conversation Willy that it's interesting that for the first time since 1989, 1990, the topics are back to those previous peak levels that we were seeing very briefly in the Japanese market was actually bigger than the US market.
Willy Walker: It only took him 34 years.
Peter Oppenheimer: Yep.
Willy Walker: It's unbelievable. You think about 34 years to get back to where they were in.’90. It's quite stunning.
Peter, one final one. And then we've got to wrap. Just because you've been incredibly generous with your time. And I loved this conversation.
As you look at the post-modern era. And the various things that you've highlighted on this call of an aging demographic, of a reversal of globalization more towards regionalization as you talk about decarbonization. All of those and a higher interest rate environment. What's either the biggest opportunity or the biggest risk that you see that investors ought to be thinking about? Is there one thing that you sit there and say there's just a massive opportunity there, or there's a big risk there that people are not seeing?
Peter Oppenheimer: I think if I were to take the risk, first of all. And then let's leave on an optimistic note, I think it does really come down to what we've been describing about structural shifts in government debt because of aging populations, unfunded liabilities, more defense spending, higher tariffs and subsidies, and so on. Higher debt levels ultimately may mean that long-term interest rates possibly have to go up, and that will affect the cost of capital and have its impact on everything. And there is a risk we wake up and just find that the price at which people are prepared to lend to governments just, the returns that they expect go up. That means higher rates. So that's a big risk. Probably one of the biggest outsize risks.
Now in the opportunities, despite the headwinds and the structural shifts that we've described in this conversation, I do think there are reasons to be very optimistic. I think the combination of AI and decarbonization ultimately could prove to be very positive for growth and, indeed, for investors. Both have their issues and problems. But AI is likely to boost productivity. And that means over the long run, higher real incomes and more economic growth despite aging populations. And in the long run, there's a huge cost to achieving it. But once we do, if we can really transition our economies to a decarbonized model, we end up not just with a more sustainable planet and healthier conditions for people, but an environment where the marginal cost of energy falls to zero, which we've never really had in history. And that could be a huge long-term opportunity as well. So I think it's a nexus of these two things, despite many of the headwinds, which are certainly there that investor opportunities create lots of really interesting investor opportunities.
Willy Walker: I have to say, having been in New Delhi last week, Peter, and seeing just the oppressive air pollution; the pollution index when I got off the plane in New Delhi was 180, and someone turned to me and said, “you should be here when it's 300.” And then the rain that we've seen in Dubai, given these much more significant weather events that we're seeing, just makes me sit there and say, “As much as decarbonization is going to cost us a huge amount.” And Peter Linneman, who I had on the webcast last week, did an analysis as it relates to the actual cost. I think you mentioned in a webcast– I listened to it for you– that there are estimations that by mid-century, it will cost us $100 trillion to get to decarbonization goals, that we have. $100 trillion, not $1 trillion, $100 trillion. And at the same time, you just look at the collision course that we're on and you sort of say, we got to start doing something about it. So I know you, and I could spend another hour on that topic, and we don't have that time, but I appreciate the opportunities that sit out there that you're pointing out as it relates to a decarbonized world.
Peter Oppenheimer: Thank you.
Willy Walker: Thank you. Peter. It's been a delight. Thanks for all you write. Thanks for all your insights. Thanks for all you do at Goldman Sachs to guide investors' investments. Also, I would put forth, if you will, a longer-term outlook and not just the monthly or daily or even annual look of I got to be here today because the world is moving on me in such a quick fashion. So, thanks very much, and I appreciate your time.
Peter Oppenheimer: Thank you, Willy, it's been a pleasure. And thanks to everyone for listening. I really appreciate it.
Willy Walker: Take care. Have a great day.
Peter Oppenheimer: Thank you. Bye bye.
