Dollars and Sense podcast

Mike Reed 00:05
Hello and welcome back to the RBC BlueBay podcast, Dollars and Sense. I am Mike Reed, head of Global Financial Institutions. Today I'm very pleased to be joined by Mike Bell, who is Head of Market Strategy and based in our London office. Mike is very well known and respected throughout the market, and for sharing his thoughts and views on global economies and markets. I would advise all our listeners to join his 30,000 followers on LinkedIn, where he regularly shares his insights and opinions.

Normally, on the Dollars and Sense podcast, I chat with the portfolio managers from one of the RBC BlueBay investment teams, where we focus on their area of expertise and the asset class they manage. But with Mike here today, we can go anywhere across the bond and equity spectrum. With so much going on, we could talk for hours, but we are going to try and condense this and highlight some of the opportunities and risks that we believe investors should be focusing on here and now. Mike, welcome. We have much to discuss.

Mike Bell 01:06
Hi, thanks for having me.

Mike Reed 01:08
We came into 2026 with the general consensus that central banks would continue the easing pattern from 2025 and carry on lowering overnight rates, but then the US and Iran went to war, pushing oil prices over USD100 a barrel. Inflationary fears resurfaced, causing longer-term interest rates to rise. But, over the last few months, despite elevated oil prices and the closure of the Straits of Hormuz, which has cut off vital supplies of not just oil but many other products, markets have first stabilised and then rebounded. Does this reflect a global economy that has been able to take this in its stride, or are markets just being too sanguine?

Mike Bell 01:51
Clearly, this is evolving day by day. Just this morning, it looked increasingly like we're getting a deal that at least is going to, in the near term, re-open Hormuz. Is it going to sustainably get rid of all of the problems? That seems like there's still meaningful risk that we're going to potentially see further disruptions in the future. There's a lot of question marks around how Israel are going to view this, how some of the other players in the region are.

Clearly, there's a desire from the US administration to try and move on from this, and the focus near term is just on getting Hormuz reopened. So, it looks like we're getting better news on that front. I think markets, until this happened, had been very sanguine and somewhat overconfident, because if Hormuz hadn't reopened and indeed doesn't go on to reopen fully, you were getting to the point where this was going to get ugly very, very quickly now. So, let's, fingers crossed, hope that actually Hormuz can sustainably reopen.

All the difficult negotiations that are going to have to happen now around the nuclear side of things and various other issues, that we can come to some kind of conclusion there. Ultimately, if Hormuz reopens and that starts to get the oil flowing, then that is a major positive relative to where we were just a few days ago, where that was looking like it was by no means a given. That said, even if Hormuz does fully reopen now and 60 days from now, the negotiations are fully concluded, and the oil keeps flowing, yes, we're seeing oil prices come down a bit, but we still think we're in a world where oil prices are unlikely to fall materially below USD80 a barrel.

I don't think you're going back to where you were pre this whole conflict kicking off in the first place. There's obviously been disruption to fertilizer supply, for example. So, I think you're still in a world where inflation is going to be higher than it would have been. The world is just not going to completely revert to how it was before this whole thing kicked off. That's not to take away from the fact that it really, really mattered whether Hormuz was going to open or not.

With it looking increasingly like we are at least going to have some period of time where they move towards reopening, assuming that actually happened this time around, we shouldn't try and pretend that's not a positive relative to the scenario where Hormuz remained shut because I think things were going to get ugly in the next couple of weeks if a deal hadn't been done.

Mike Reed 04:56
Basically, there's an element of scarring, but hopefully not fatally wounded in the tone of the global economy. Some room for it to rebound or be more positive into the second half or not be fatally wounded. I'd carry on on the war theme, I guess. As a result of the wars in Iran and Ukraine, and also combined with President Trump's tariff programs, we seem to have entered a new area of deglobalisation, with countries and companies looking to secure supply lines.

You mentioned the supply line issues that we've had in the Straits of Hormuz and also near-shore production. I guess, given this transition in outlook, what are likely to be the longer-term impacts on regions and the global economy?

Mike Bell 05:46
I published a piece recently called ‘Stop Being Shocked by Shocks’, where I basically made the point that we lived through a period where, broadly speaking, for investors, it was pretty easy because you had a disinflationary backdrop coming from globalisation that meant that goods prices were kept low; you had an enormous positive supply shock as the populations, first of Eastern Europe and the former USSR, and then China, came into the global capitalist workforce. So, that meant you had a massive expansion in the global capitalist labor supply. And because of globalisation, those goods were able to be exported from places like China into the developed world, and just kept goods inflation very low, and therefore inflation at the headline level was very comfortable and not something that central banks had to worry too much about. 

I think what we're seeing now is we're moving into a world where the demographics are becoming much less favourable. You're also seeing a shift away from a unipolar world where, for many decades, it was really the US was the only game in town. Now, you both have the rise of China, and you also have an American population who, the voters, they don't want to be involved in these foreign forever wars on an ongoing basis because of, obviously, Vietnam, but then Afghanistan and Iraq. They're just tired of that involvement.

I think the problem there is that when you have the Pax Americana that we've all grown up used to starting to retrench and showing, as we've seen in Iran recently, that while yes, they are willing to get involved in conflicts around the world and try and exert their power to get what they want, they're very, very reluctant to put troops on the ground. And when potential adversaries know that the Americans are cautious and, frankly, very unwilling to put troops on the ground, that influences their thought process about what they're willing to do.

They test boundaries and do things which, in a world where it was a given that if you did that, the Americans would just put 200,000 troops on the ground and go for regime change, would not have happened. In the world we inhabit now, where the Americans are much less keen to do that, I think it emboldens certain actors in other parts of the world that makes for a more difficult geopolitical backdrop, which along with the deglobalisation that's essentially coming from, again, a voter backlash against the fact that a lot of manufacturing jobs have been lost to China, but also, this national security lens saying that "Well, America needs to be able to not rely on China for key inputs for national security reasons," it just creates this world where a lot of the disinflationary forces that investors enjoyed since the ‘80s are becoming less prevalent, at least, and some of them actually going into reverse.

I think that what that creates is a backdrop where you get more frequent supply shocks, whether that's because of wars or disruptions to supply chains or tariffs, all of which just create these what seem like shocks, but they're not shocks. They're just a structural backdrop where you're going to get more frequent things, which mean that that low, stable inflation backdrop that we all got used to isn't as reliable anymore. 

The counter to that is you've got things like AI, which could end up near-term, it's being very inflationary. Medium-term, it could end up being very disinflationary because of its ability to boost productivity growth, but also the potential risk that it poses to jobs. I think you've got to think about all of that in aggregate.

Mike Reed 10:36
I'd like to come back to the AI theme at some point, but we've talked a bit about the macro, and I'd like to drill down a little bit to how investors can translate that into what they're doing in their portfolios here and now. 

I mentioned earlier that bond yields have risen this year, which seems to be attracting some investors with the highest yields available. Currently, inflation is a bit sticky. We have persistent global sovereign debt burdens. That remains a prevailing macro theme, has been for many years, and if anything, it's worsening.

There are obviously many different flavours of debt and credit products available to clients, including investment grade, higher yield, and emerging market funds, but where do you see the opportunities and the risks across this spectrum?

Mike Bell 11:31
I would actually encourage investors to not think of their equities and then their fixed income, but think about the portfolio as a whole and broadly think about what might work in a risk-off scenario, their defensive bucket within a portfolio, which is what investors have often historically thought of their fixed income allocation as, and then their risk bucket of a portfolio, which, again, historically investors think "Well, that's my equities," but I think that that's too simplistic a framework.

Ultimately, I think you want to be thinking about “Where am I taking risk across both equities and fixed income, and where am I looking for that diversification that's going to help me in a scenario where you get a recession, or you get an inflation shock that actually you're trying to protect against those risk assets performing badly?” And so, if you have that broad backdrop and a different way of thinking about it, then I'd say within the risk bucket, early on in an economic cycle where you have high unemployment, you have low equity valuations because you've just had a recession, you tend to want to overweight equities relative to things like high yield because you're going to get more upside on your equities.

Actually, when you're late in the economic cycle, where you have low unemployment, and particularly in markets where you have very high equity valuations, I think there's a compelling case to be made for owning, for example, high yield equities, where in the US you can get a yield of close to 7%.

Mike Reed 13:21
High yield bonds, you mean?

Mike Bell 13:22
High yield bonds, sorry. High yield bonds relative to perhaps European equities. You've got to ask yourself, well, in the good scenario where recessions are avoided, what's the return going to be over the next two or three years on European equities? Is it going to be more than 7% annualised? Maybe, but quite possibly not. If you can get that sort of return from high yield debt in the positive scenario, then that's worth considering, particularly given that in a scenario where you get risk-off, you get a recession.

Yes, of course, high yield will go down in value compared with, say, a government bond or investment grade bonds, but it'll probably go down a lot less than equities would. That's why I encourage investors to think not just about fixed income and equities but think about their risk bucket more broadly and how late in the economic cycle it makes sense, in my mind at least, to have some high yield exposure relative to equities. I actually think it makes sense to be overweight, say, US or global high yield, and underweight European equities at the moment is one view that I have. 

I also, when you talk about the risk bucket, think that emerging market debt looks attractive, again, relative to some equity exposures, and indeed, definitely over a long-term view, relative to some developed market government exposures. Because people talk about de-dollarisation and how the dollar is potentially going to weaken, having had a period where it was very, very strong, I actually think that when you look out over the next 10 years, yes, there's a good chance that the dollar weakens, but the key question is against what? Is it going to weaken against other highly indebted developed market nation currencies, where they also have weak fiscal positions, where debt-to-GDP is very high, and the politics is also challenging?

It's not clear to me that that is the case. The dollar could well end up devaluing, but against some of the emerging market currencies, where actually government debt-to-GDP ratios are much, much lower than they are in the West, where the politics…we always think of emerging markets as having risky politics, but you only need to look at here in the UK or indeed some of the risks in France, and we all know everything going on in the US. In fact, some of the emerging market politics seem to be shifting in a more market-friendly, more to the right way at the moment, particularly in some places in Latin America, in sharp contrast to what we're seeing in some of the developed market economies. 

I think if you take a 10-year view, I would want a decent allocation to emerging market debt relative to developed markets. One should be also thinking about that as relative to my equities. You get a high yield on this emerging market debt in the same way you do on high yield developed market debt.

And so, if I can get a nice return on my emerging market debt, I should be comparing that with what my expected return on, say, European equities is over the next two, three years, and then the drawdown in the scenario where you get a recession. I think, again, the risk versus potential return on emerging market debt relative to, say, something like European equities over the next two or three years looks quite attractive.

Then, if you shift and start thinking "Okay, well, what about the bit that most investors think of for their fixed income, which is the bit that's going to help me if the equities go down, because high yield debt and emerging market debt might outperform equities, but they're still probably going to go down in a big risk-off environment?" Well, then I would be thinking, actually, well, twofold. Some of the traditional fixed income, your high-quality investment grade, for example, is relatively defensive. If you get a disinflationary recession where central banks cut rates, both government bonds and IG credit are probably going to perform a lot better than your equities do, but also thinking "Well, I probably want some of what would have been a traditional fixed income allocation to be the kind of fixed income that can help me if we get these persistent supply shocks that we were talking about in this more uncertain, deglobalising world, no longer unilateral hegemon that reduces the risk of global conflicts.”

For that, frankly, you need fixed income that's not just long only, that's not just having to bet that rates come down. You need absolute return strategies that can bet on rising inflation expectations, take break-even exposures, that can go short treasuries rather than betting one way.

Mike Reed 18:37
That's an interesting point. I want to talk to that as well. First of all, I want to be stereotyped here, and I'm going to talk about some equity markets as well. I know you've talked about it quite a lot already. If you look at one of the big drivers of performance this year, it has been the AI theme, particularly in the US and in some of the Southeast Asian markets. This has been, as I said, led by a lot of the US mega-cap stocks, Nvidia, Alphabet, Meta. Those are the people who either produce the hardware that enables AI, such as Nvidia, or who are leading the race to develop generative AI models. There's a lot of cash following that. 

Should investors be looking beyond these sectors and these big stocks? There's an old maxim in markets that stems from the California gold rush, where the reliable wealth generators, we talked about medium-term generation, were not those companies who gambled on finding gold, but were the merchants who supplied the essential tools and equipment.

I'm saying which sectors could be the pick-and-shovel suppliers of today that could benefit indirectly from the AI boom? And I guess, obviously, where’s going to suffer because surely not everyone's going to be a winner out of this?

Mike Bell 19:57
I think that's such a big question. The way I think about it is, I totally understand this notion that rather than trying to pick which AI company is going to be the winner, you go for the chip companies that are providing the picks and shovels that are needed for all of them. Then, in some way, investors think "Well, that's diversifying my risk away from betting on one particular company. Is it going to be Company X or Company Y that is the one that really wins in AI?"

I think the problem there is that when you look back through history, you see that, yes, during that buildout phase, the providers of the so-called picks and shovels, the semiconductors in this scenario, and some of the memory chips etc do very, very well. But it doesn't mean you can't get a bubble in the picks and shovels stocks. You very much can. That is the risk. In fact, when you look at markets at the moment, the real ramp-up in performance has been coming in precisely those picks-and-shovel-type stocks. It's the memory providers, it's the semiconductor plays.

And so I think investors need to think about diversifying, not just in terms of "I'm going to make sure I own picks and shovels rather than the specific AI provider," but thinking about the fact that if you take the tech sector, the communication services sector, which is basically made up of two big tech stocks, and add in the large stock that sits in the consumer retail sector that is essentially a tech stock that provides a lot of cloud computing as well, and you add those together to give you a TMT equivalent weighting, you go back to 2000, and that as a percentage of the S&P500, peaked at about 43%.

When I looked at it about a week ago, it was at 53%. The market has just become hugely concentrated in what I would call broad tech. I think the biggest risk to almost every investment portfolio in the world at the moment is if that big broad tech exposure starts to perform badly. I think investors need to be thinking about…because everyone is invested in this, and there's trillions and trillions of dollars. If everyone tries to get out of that trade at the same time, it could look very, very ugly.

I think investors want to have exposures both within their equities and in their portfolios more broadly that are going to hold up in a scenario where actually everyone is trying to get out of that. 

I'm not saying it happens in the next three, six months, or even in the next year, but at some point, there is a meaningful risk that tech performs less well than it has in the broad sense, and that you're not going to be saved by being in the picks and shovels stocks as opposed to the AI producers.

You need to be in absolute return strategies that are able to hedge that risk out, whether that's within fixed income or broader, whether it's just having some traditional IG corporate bonds that are going to provide you a diversifier in that scenario where tech is hit. And actually, high yield is another interesting one. The US equity market is hugely, hugely concentrated in tech. High yield has actually very moderate exposure to tech and is giving you a pretty decent all-in yield.

I would think about making sure that my portfolio isn't just an enormous bet on tech. The problem is, if you buy an exposure to global or US equities, you almost can't avoid that at the moment.

Mike Reed 24:15
I think you're getting an element of that in emerging market equities as well. Interesting, you mentioned alternative-type funds as opposed to long only-type funds. That is a theme that investors, given the levels of volatility, are often being encouraged to diversify into. 

On the flip side, I've read multiple reports of private debt firms restricting investor redemptions and also private equity funds, which were the golden child of the market for many, many years, now struggling to actually sell their assets and return capital. The term ‘alternatives’ covers a multitude of products. Where should investors be looking now if they really wish to find uncorrelated returns?

Mike Bell 25:08
I think that is the key point. Not all alternatives are there to provide uncorrelated returns. If what you're looking for is juiced-up risk, then that's a different conversation. I think when you're late in the economic cycle, as we are today, in other words, unemployment is low, it's been a long time since you had a recession, and equity valuations are high, and spreads are tight, so risk assets are broadly pretty fully valued, whether they're publicly or privately held investments, then I think what you want is you want at least some of your portfolio in strategies which aren't just long only exposures to these asset classes where valuations are rich.

Shifting out of public equity into unlisted private equity, where valuations are also very rich, or out of public credit into private credit, where again, valuations are rich and as you say, there's lots of people trying to redeem and obviously the liquidity doesn't allow them to do that, isn't giving you what you want, or at least it's not giving you that diversification. And so I think I totally get why, if it's early in the economic cycle, it's 2009, let's say, and the irony of this is that in 2009, when you just had a big recession, and the stock market had gone down 50%, everyone wanted to buy these absolute return vehicles because of what had just happened.

The time to buy those hedge fund-type strategies or targeted absolute return liquid alts is before that big sell-off in equity markets, before the recession. Of course, what happens is that everyone wanted that in 2009, when actually what you wanted to be doing was buying equities because you've just had a big sell-off, you wanted to be piling into high yield debt and emerging markets where spreads were very, very wide.

I think at this point in the cycle where valuations are tight across equities and credit, and I'm not saying you're going to get a recession in the US at least in the next 6, 12 months, but eventually a recession is going to come along as they always do and when unemployment is low, that risk is historically higher than when you've just had a recession and unemployment is high. That is the point in the cycle where you want to have the kind of alternative that can use hedges, and obviously, hedge funds are pleasing a name.

Just being able to not have to only bet one way, being able to put a hedge on, being able to just dial that beta down when you think the risk is building, having that toolkit becomes more useful when valuations are stretched and you're late in the economic cycle than when, frankly, a buy-and-hold long only approach works just fine. 

I think that is what everyone forgets, and this is why people keep getting burnt by it, is that you want to own these strategies precisely when they've massively underperformed equities over the last 10 or 15 years. And because equity returns come in long cycles, what you tend to see is a decade or more of very, very strong returns and then quite a long period, often a decade, where you get actually very weak returns, which include a big bear market at some point. 

We've just had a 15-year phenomenal rally in equities, particularly in the US. We don't know exactly how much longer that goes on, but chances are, at some point, you're going to go into a period where you get a bear market, and you're going to want the kind of absolute return strategy that can hedge that risk out.

Whether that's in fixed income hedge funds or macro hedge funds, the kind of strategy that, looking back and saying “What strategies were able to protect when bond yields went up sharply in 2022, when equities went down sharply in 2008, what kind of strategies protected?” It was often those absolute return fixed income strategies, the macro strategies, that can provide that genuine buffer against the risk-off environment, particularly in this world of more frequent supply shocks against a scenario where you can envisage a world where both government bonds and equities get hit at the same time.

Mike Reed 30:09
I guess when you're looking at alternatives, they're not all born equal. Make sure you're looking for absolute return at this point in time, rather than just an alternative asset class. Oh look, Mike, there's a lot for us to think about there today, and thank you very much for joining me. It's been a pleasure having you on the show, sharing your insights. I hope we have you back soon.

Mike Bell 30:30
Thanks very much for having me. Look forward to speaking to you soon.

Mike Reed 30:33
Many thanks for listening to the show. If you've enjoyed it, please like and subscribe on your podcast platform of choice. We will be back soon with another edition of the podcast. I'm sure with so much going on in both the global economy and markets, we will have lots to talk about. If you wish to listen to any of the previous editions of the podcast, they're available on our website, www.rbcbluebay.com, or can be found on Apple, Spotify, or Google. Thank you once again for joining us today. Good luck and goodbye.