Transcript: The listeners have questions

This is an audio transcript of the Unhedged podcast episode: ‘The listeners have questions’

Katie Martin
Happy New Year. We’ve had a blast doing these podcasts over the past year and a half or so, and one of the best things about it is we get nice emails from listeners. Mostly nice.

Anyway, lately we’ve been asking you for your questions. What do you people want from us? Well, you delivered your questions. We got lots. And in today’s show, pre-recorded before we head off to eat, drink and be merry, we’re gonna answer as many as we can to kick off 2025.

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This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I’m Katie Martin, a markets columnist here at the FT in London, and I’m joined by the dynamic duo in New York from the Unhedged newsletter, first sea lord Rob Armstrong and able deckhand Aiden Reiter.

Robert Armstrong
Yeah, man.

Aiden Reiter
Ahoy.

Katie Martin
Ahoy. Here we go. Chaps, happy New Year.

Robert Armstrong
Happy New Year to you, Katie.

Aiden Reiter
Happy New Year.

Robert Armstrong
It’s gonna be a great year, Katie.

Katie Martin
It’s gonna be a biggie. Now, are you going-out-at-New Year people, or staying at home and getting-drunk-at-New Year, people?

Robert Armstrong
I drink at home on New Year’s and I’m generally asleep before the ball drops, as we say here in New York City. I find the whole thing rather a bore.

Aiden Reiter
I go out, but I get very cranky very fast.

Robert Armstrong
Yeah. I mean, it’s so crowded. In New York City, it’s like a mob scene and it’s not fun. You basically gotta barricade the door and stay home.

Katie Martin
What a curmudgeonly pair you are. Now, we got loads of questions in our mailbag and quite a few of them were about passive investing, which, as you all know, if you’ve heard me talking about passive investing before, is a really good way of starting an argument with a markets person. So I guess a lot of these questions sort of settle around the idea of is passive investment breaking markets? So we got a question — and I’m gonna pronounce people’s name wrong and I’m sorry in advance.

Robert Armstrong
It’s all part of the service.

Katie Martin
It’s all part of the show, boys and girls. A question from Phillip (inaudible), who asks: are investors missing opportunities outside of indices because of passive investment and are companies prioritising index inclusion over fundamentals. Interesting. Rob, why don’t you kick off by like, for the uninitiated, what is passive investment?

Robert Armstrong
So passive investing is investing through funds that own plus or minus the whole market or a slice of market. So you might have a fund that owns the whole S&P 500. You might have a fund that owns every publicly traded stock in America. You might have a fund that owns just the small ones or just the ones that are in industrials or healthcare or whatever. But it’s a way to get exposure to the market or market segments without picking individual securities.

And I would also say this is one of the great things in my view. I am strongly positive on passive investment. It is how I invest my own money and it is low-cost and it captures the first thing that investors should wanna capture, which is the general upward movement in equities over time, the beta in the market, the beta return. And so yay for passive investing, says Armstrong.

Katie Martin
Yay for passive investing. But Aiden, what kind of problems is this like throwing up? Like, is there an argument, as our correspondent, Phillip asks, that they are penalising companies outside of indices and actually investors are missing opportunities here?

Aiden Reiter
I think there’s definitely a very real rationale to his argument, right? So if you’re just buying all the stocks in an index or buying all the companies in the sector, A, if you’re having companies outside of that, as you said, then they’re not getting included, They’re not benefiting. And those could be, you know, the diamonds in the rough. That’s ideally what active investors are going to try to find. But if the rest of the market is not paying attention to that individual company, that could either be a good thing for them, right? They buy it and then theoretically, if they have success, later get into the index. And they owned it low and then it went and skyrocketed when it was later included. Or again, you know, they get trapped out of the money they otherwise would get. So I see it both ways.

I think at the end of the day, though, it’s probably a net good thing for people’s retirement portfolios and probably the market at large to have people investing in broad sectors. So, yes, there might be some losers, but for the most part, it’s probably a good thing.

Robert Armstrong
I’m probably gonna get this number wrong, Katie, but I think now it’s slightly over half in the US of assets that are in passive funds.

Aiden Reiter
And in 2023 it was like 15tn in passive and 14tn in active.

Robert Armstrong
Something like that. So the question is how many active investors do you need relative to the passive investors to keep the market honest? So when I buy my . . . 

Katie Martin
So how many stock pickers does the universe really need?

Robert Armstrong
Really need, because you want the prices to be efficient, right? You want somebody out there caring about individual stocks and what they’re worth and deciding some should be sold and others should be bought and valuing, you know, keeping the market efficient. And as far as I know, no one has proposed a proportion that is required. However, I have a guess, which is not very many. The market could become more passive than it is now before the prices all get kind of stupid.

Katie Martin
So I was talking to a fund manager the other day who was saying that one of the problems that’s introduced into the system by passive investment is that say you’re an old-school stock picker, right, an active investor, and you find like a little company that’s a little diamond in the rough that not enough people are paying attention to. And you think I’m gonna buy this thing because I think it’s gonna go up and I think that some point, at a later date, the rest of the market is going to see the good qualities in this company that I can see now that other people can’t.

And the problem is that now that so much of the market is passive and it’s all tracking an index, it’s difficult to identify that next buyer, that next individual. So in a sense, it does make life difficult for the smaller companies that are outside of the big indices because passive eats active over time. And you know, just the weight of index-tracking investment does make life difficult for active investors. Now, in theory, it means that there should be more opportunities out there for investors who are clever enough to spot enough of these diamonds in the rough. But at a certain point, they do need someone else to sell to, right?

Aiden Reiter
If they got a diamond in the rough and then later on it gets included in one of these passive indices, that’s a huge return.

Robert Armstrong
And certainly when stocks enter the big indices, they get a big pop. Like it helps. It helps. You get up. You get a valuation premium for being in one of the main indices. There’s no question about that. And that we file under life is not fair.

Katie Martin
Yeah. So does that answer actually the second part of Phillip’s question, which is are companies prioritising index inclusion over fundamentals? Is our answer probably yes, but life’s not fair.

Robert Armstrong
But yeah, probably yes. But it’s hard to do. So to be included in the S&P 500, you have to have a certain amount of market capitalisation and a bunch of other requirements. So you can’t just will yourself into the index. You have to run the company well enough that you meet the demanding criteria that the indices propose. So I don’t know. I don’t know what it would look like to like, in some irresponsible bad management-y way, try to wheedle your way into an index. I don’t know if that’s really a thing.

Aiden Reiter
The roll-ups, maybe, but nobody . . . M&A is essentially frozen right now.

Robert Armstrong
Yeah. Perhaps by buying things.

Katie Martin
But one of the things about passive investment is that every now and then some clever clogs kind of raise their hand and say, well, you know, these things are going to break markets. They’re going to cause all sorts of trouble. You know, you wait and see. You know, as soon as you get a big shock to markets, these things are all gonna break. The evidence for that is pretty poor, I’ve got to say.

Robert Armstrong
But, you know, the next time we have a major market puke — and who knows when that will be — but when we do, that will happen in a market that is much more passive than the major market, last major market puke we had. Maybe call that 2008 or whatever.

Katie Martin
Well, 2020 was some pretty good puking.

Robert Armstrong
(Laughter) And there was an idea that the passive investors will exit the market in a disorderly way. And because they’re selling index products, everything will be sold at once. And this is bad. But on the other hand, my experience of these kinds of pukes is that everybody’s selling everything all at once anyway. That the whole point of one of these markets is that it’s indiscriminate selling and people are just getting rid of whatever they can. You know, so.

Katie Martin
Yeah. So plus ça change.

Robert Armstrong
So I’m not worried. Again, at the danger of repeating myself, passive good. Not worried about it.

Katie Martin
Yeah. Passive and chill, says Rob cheapskate Armstrong. So here’s a fun question from Richard Ivers, who is asking: What metrics or trends do we think are most under-appreciated by investors today? Hm. Intriguing question.

Robert Armstrong
Katie, you have to . . . We’ve been talking. You talk, you start. That’s such a hard question.

Katie Martin
Well, I think one of the things that is most under-appreciated is humans and human incentives. And by that, I mean, there’s a lot of movements that you get in markets and assets that come in and out of favour that hinge in quite a large part on what we call career risk for fund managers, right? So fund managers, you know, if you run a portfolio of money for a year, you don’t wanna get fired for doing something stupid, especially doing something that’s stupid and obvious that at some point it will go wrong. And so that prevents a lot of people from actually making investments that make a lot of sense sometimes and also it’s just quite an important factor over how . . . what investors do.

And also, I think there’s quite a lot of how fund managers are remunerated that actually is quite impactful to how markets move. So you will notice, right, it’s December. Markets are pretty quiet in general. A really big reason for that is that a lot of portfolio managers’ bonuses are decided based on their performance up to about the beginning of December. And after that point, what is the incentive to take on risky bets over the rest of that month?

Robert Armstrong
You know, it’s a fair point. I would only add one of the most important places for markets where you see career risk having an effect is moments like today when stocks are very, very richly valued, as they are in the United States. And it feels like we’re in a bubble because somebody who is running an active fund, it is almost impossible for that man or woman to say, actually, I think these valuations and these prices are scary. I would like to have a large allocation to cash in my fund. And they may think this would be the wise thing to do. But if they do it and there is not a big correction in the markets like the one they’re worried about, they are fired because they will have underperformed. So it’s like . . . 

Katie Martin
So if you’re gonna do something stupid, at least make sure everyone else is doing it, too. So you could . . . So this time next year when you’re talking to your boss, you can say, look, I know. I know I bought US stocks and they were already looking really expensive, but everyone else did it too. No one could possibly have known that this would go wrong.

Robert Armstrong
So the lemming effect is very important. I agree with you.

Aiden Reiter
Are there any actual indicators you guys look at like in the market, stock prices or currencies that you think are under-appreciated by investors or that are helpful to you as you write columns?

Robert Armstrong
Well, one thing I think about a lot that I think — and anybody who reads Unhedged will have heard me rattle on about this at tiresome length — is I think US federal deficits are very good for the stock market, that when the federal government borrows a lot of money and pushes it into the economy, unsurprisingly, that makes stocks go up. So I think people don’t appreciate how beneficial the wild fiscal binge the US has been on is for stocks and how potentially hazardous it is for stocks and other risk assets if the government gets religion about balanced budgets and austerities. I would consider that a major risk to the stock market.

And most people you talk to think it’s the other way, where if the government is careful and thoughtful about deficits and watches every penny, that’s kind of good for business, as if America was like this giant household where if it saves carefully, there will be prosperity. But alas, no, it is the exact opposite, I would argue. So I think that is something that investors should probably think about more than they do.

Aiden Reiter
I’ve rattled on about emerging markets in the past, but I find them interesting. They’re very good at picking up things that are not going well in the US, right? So if rates are high or inflation is heating up in the US, the first place you’ll see that is in emerging market currencies or emerging market debt. So I think they are not actually underrated by the market. I think the market is looking at them. I just find them interesting to follow.

Robert Armstrong
And because they’ve had bad returns like the last five or 10 years, people tend not to follow them. But I am old enough to remember — now there is a phrase I find myself saying more often than I would like to say. I am old enough to remember when in like the early 2000s when people were like, why would you ever own anything but emerging markets? That’s where the growth is, etc, etc. And now it’s literally the opposite. You mention emerging market stocks to people and they laugh in your face.

Aiden Reiter
I think also emerging market currencies are a really good indicator of things that might be going wrong. In modern portfolios you have everything balanced. It’s a complicated weight balance act and if you see a huge sell-off of the Brazilian real or the Japanese yen, it means something’s not going well on the other side of that portfolio. And we saw that play out this July.

Robert Armstrong
We sure did. Good point.

Katie Martin
Yeah. OK, look, we’ve got to crack on with another question. If US stocks are in a bubble, what can you do about it? How can you protect your portfolio? And on a related note, question here from Andy Foote. What might be the catalyst for Europe to catch up? Because I guess the question here is like if US stocks are in a bubble, right, you accept that as a premise, one of the things that is seen as like the potential catalyst for that bubble popping is another outbreak of inflation in the States. The problem with that is if that happens, that’s no good for bonds. So the bond bit of your portfolio is not going to save you. And people have got super-short memories, but that’s what went very much belly up in 2022 when everyone lost money on everything and it was absolutely brutal.

Robert Armstrong
It is awful when stocks and bonds are correlated and you have a rout. That is just the baddest of bad. All bad things.

Katie Martin
No good. Very, very bad. No good thing happening. So, OK. So if we think that US stocks are in a bubble . . . 

Robert Armstrong
Well, one thing that’s nice about this moment right now, and I’m speaking because I’ve done a bit of this in my own portfolio, is you can hold a bit more cash now or cash-like things, very short-term things. And the thing that’s nice about those is that for the first time in a long time, those are for real returns. So, you know, you can get a 2, 2.5, 3 per cent inflation-adjusted return on cash. So I think it makes a lot of sense if you’re worried, if you’re highly exposed to US stocks, which my portfolio is, and you’re worried about the downside, which I am, increase your allocation to cash. You get a little something. And if the bad thing does happen, you have some firepower to buy the US stocks back when they get cheap.

But there’s always the tax problem, right? The problem for like an individual investor is you sell stocks, even stocks you’ve held for over a year, you’re taking a 15 per cent hit right off the bat for your capital gains taxes. So you have to think, do I really think it’s gonna be worse than 15 per cent? That’s gotta be, you know, a 10 per cent correction. If you sold ahead of a 10 per cent correction, you’ve lost money, right? But to the tax man. Of course, you have to always pay tax eventually. You know, it’s a matter of just when you wanna pay them and etc. But it’s an issue you’ve got to think about.

So traditionally, one would say that’s why you have 30 per cent of your portfolio in bonds. But you just made the point, Katie, and I think it’s really important, that we just had an inflationary incident. This is stagflation, is what we’re talking about. That kind of thing can happen again. And you can have bonds and stocks become correlated when there is inflation. And that means your stocks could fall and the bonds could fall at the same time. And the difference with cash is it is not sensitive to rates in the same way that a normal bond portfolio would be.

Katie Martin
So on the second point of the question from Andy, like what is the catalyst for Europe to potentially catch up? Now I’ve been banging this drum for a little while. I think people are too nervous about Europe right now. So, you know, stuff that can go right for Europe include, right, currently, France is a mess. It got itself into a mess. It can get itself out of a mess again. Germany’s got some elections coming up where it might decide that actually it’s not so allergic to, you know, to tax and spend as it normally is. Maybe it could get a bit looser with the fiscal purse strings, which should, all things being equal, be good for German growth.

China could get better rather than worse and that’d be good for demand of European goods. But also you do have this possibility of something going right rather than wrong in Ukraine. So I think there’s a bunch of upside risks for European stocks there that are not currently very well priced. And I think just the America first, American exceptionalism agenda is so overwhelming that actually a lot of the kind of counterpoints from Europe are just getting totally obliterated.

Robert Armstrong
The best time to own any asset is not at dawn when the sun comes up. It’s one minute after midnight, meaning everything looks perfectly awful in every way. And then it goes to almost everything is perfectly awful. It’s just the tiniest spark appears somewhere on the horizon. And that’s when you see the biggest move in any asset class, is when you go from completely dark to almost completely dark.

Aiden Reiter
You heard it here first: buy France.

Robert Armstrong
(Laughter) Buy France.

Katie Martin
So if you do feel like the US is in a bubble for whatever reason — maybe there’s an inflation shock coming, maybe there’s a growth shock coming, maybe you think there’s some sort of tech AI crap-out coming — there are alternatives, right? You know, we’re not kind of here to give you, like, investment advice at all, but depending on what type of shock — it might be bonds, it might be cash. But mate, there are other places in the world than the US. Not sure if you guys are aware.

Robert Armstrong
And regimes change.

Katie Martin
Regimes change. Markets flip around.

Robert Armstrong
We’re in a very US-y investment regime. We don’t know when it’s gonna stop. It’s been great to be owning US assets, big-cap stocks especially, but things change.

Aiden Reiter
And as the last three weeks have shown, regimes, like government regimes, change very fast. And that can change the market too.

Katie Martin
Hell, yeah, that is a whole thing.

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I would love to do more questions from readers but we are absolutely bang out of time so we are gonna be back in a second with Long/Short.

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OK, it’s time for Long/Short, that part of the show where we go long a thing we love or short a thing we hate. But just to be annoying, I’m gonna make you guys do it differently and ask, what are your New Year’s resolutions? You haven’t even thought of this.

Robert Armstrong
I have one. No, I 100 per cent have one.

Katie Martin
Go on.

Robert Armstrong
I’m gonna try to concentrate in the new year. I feel like I have incredibly bad internet, social media, father of teenagers, New Yorker scatterbrain. And I just wanna every day take a little time to just try to focus on whatever it is I’m doing, whether it’s walking down the street or making a cup of coffee or writing an Unhedged column or doing a podcast. I wanna try to pay some attention to my life before it ends.

Katie Martin
Just don’t start talking about being present in the moment and wellness. Otherwise we cannot be friends.

Robert Armstrong
No, no, I never I will never stoop to using that kind of language. But you know, it’s as simple as just trying to concentrate a little bit in 2025.

Katie Martin
Aiden, how are you going to be a better person in 2025?

Aiden Reiter
Well, now I’m gonna hit Rob on the head all year with various, you know, psychological and New Wave meditation. My goal, my resolution or one of my resolutions for 2025 is to read more female authors. I am very often in the dead man trap, where I read a lot of old dead men and what they have written. I just did a big Philip Roth binge. I just bought Proust. But I’m just gonna try to read actual female authors and expand my mind from these old dead white men.

Katie Martin
I can help you out with that. I went through a phase where like I did an entire summer where I didn’t read like any men. I didn’t even do it on purpose. And yeah, ladies write books, too. It’s a good point. So even though this is my question that I posed and I sprung it on you, I don’t really have a New Year’s resolution of my own, but I am gonna do my usual very, very boring thing, which is dry January. No booze in January. Been plenty of booze in December, do not need more booze in January. So I’m gonna be very, very boring.

Robert Armstrong
Sober up, Katie.

Katie Martin
Yeah, I’ll be very boring in January. And yes, I can use that to interrupt your wellness when we speak later in the year. (Robert laughs)

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Guys, it’s been a blast. We’re gonna have an excellent 2025. I can feel it in my bones.

Robert Armstrong
Hooray!

Katie Martin
Listeners, tune in. We’ll be back in your ears pretty soon.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler.

FT premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer.

I’m Katie Martin. Thanks for listening.

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