#20 -The Data Scientist

Chapters

00:02 – Demystifying Investing and Economics

06:41 – The Commodity Super Cycle

14:26 – Understanding the Capital Cycle

20:35 – Challenges with Economic Data

27:49 – Navigating a New Paradigm

33:47 – Shifts in Tech and Real Assets

42:43 – Merging for Margin Maintenance

48:07 – Bridging Experience and Data Science

Transcript

STEPHEN CLAPHAM: Hi, welcome to the Behind the Balance Sheet podcast where we meet leading investors and commentators and educate ourselves about the world of investing and the world. Our mission is to remove some of the mystique around investing and improve our understanding of what makes a successful investment or indeed an unsuccessful one. Our goal is to inform, educate and entertain.

DISCLAIMER: We hope you enjoy this and every episode behind the balance sheet and affiliates and podcast guests may own shares or have an economic interest in securities discussed in this podcast which is aired for your education and entertainment. Only nothing in this podcast should be construed as investment advice or relied upon for investment decisions. Always do your own research.

STEPHEN CLAPHAM: Tian Yang is a fascinating guest. He explains why chat GPT may be useful in solving accounting problems but it produces gibberish. When asked about investing, we talk about his work on the commodity super cycle, looking at rubber wheeling and fur.

STEPHEN CLAPHAM: He explains how he applies quantitative techniques to the capital cycle framework which was championed of course by Marathon Asset Management and featured by Edward Chancellor Tian explains how his work encompasses three different time frames. The long term for fundamentals, the 6 to 12 month business cycle and the shorter term trades.

STEPHEN CLAPHAM: Tian’s unusual for a Macro Analyst in that he understands the fundamentals but also what he calls, play the game, the tactical business of quarterly earnings and similar. We discussed the new environment which he calls the age of scarcity. Investors need to understand the implications of the end of the age of abundance, which rested on the availability of cheap labor, cheap commodities and cheap money.

STEPHEN CLAPHAM: All of this is changing, which means different equity allocations are necessary. His firm variant perception champions a combination of man and machine as outperforming man alone or machine alone. Tian talks about young people born after 1990 being more in tune with data science.

STEPHEN CLAPHAM: Look, we covered a lot of ground in this discussion.

STEPHEN CLAPHAM: I would recommend listening at normal speed. Don’t speed it up. I hope you enjoy it.

STEPHEN CLAPHAM: So, Tian, welcome to the podcast. It really pleased to have you here. I normally ask people, first of all, did you always want to be what you ended up as? But you’ve ended up as chief executive of a research boutique but really you’re an economist and an Analyst. Was that always what you wanted to do?

TIAN YANG: Kind of, I guess, I think when I got to university, so I, I read economics at Cambridge and I think when I first got there, my plan was to be a, a economics professor. I was interested in development.

TIAN YANG: At least that’s what my personal statement I said at the time and I think, throughout the course of time of university, the banks and all the hedge funds they come and they recruit, they have all these, you know, trading games, M and A games and end of the win a few of those games, actually when I was in 1st and 2nd years.

TIAN YANG: So that kind of pulled me into the system. And obviously over time, you know, you realize finance is a, you know, a very interesting industry. It’s kind of a, you know, the returns accumulate over time, right? Everything you learn compounds on each other and just learn more and more.

TIAN YANG: Sure your experience actually adds up, you never stop learning. So I think ultimately, that’s probably what kept me in, but it wasn’t quite the plan to start, but, you know, close enough and you, you were runner up in that competition.

STEPHEN CLAPHAM: What would Keynes advise if he were alive today?

STEPHEN CLAPHAM: I mean, what did you advise? I mean, the, the, I mean, that was 2009. It was quite a difficult time to be giving advice. Right.

TIAN YANG: Yeah, I mean, you’ve done your homework going from my linkedin that I forgot, I forgot it’s still on there. But yeah, gosh, let me think.

TIAN YANG: I think it was a slight copper answer because I remember quoting Keynes saying, you know, when the facts change, I change my mind and I felt like at the time not even, you know, as I was back then that, you know, everyone was so dogmatic in pursuing policy and that was important to knowledge kind of, you know, in the real world, the economy is a mechanical system.

TIAN YANG: So I remember thinking that it’s important to take elements of Keynes. You know what Milton Freeman said, what a lot of other people said. So I can’t remember exactly, but I think it was more targeted, fiscal was important. But you had to acknowledge that you had to shut it off. You can’t just effectively, you can’t do Q E forever. And obviously we’ve done Q E forever.

STEPHEN CLAPHAM: So yeah, we’ll get on to, we’ll get on to that.

STEPHEN CLAPHAM: But you did this wonderful piece that I really loved about the commodity Super cycle, which I think was something you were pushing maybe 12 or 18, 18 months ago.

STEPHEN CLAPHAM: And I really love this because you, you talked about the lessons from history, looking at whaling rubber and fur and rubber was a very familiar story to me because I spent a lot of time researching the plantation sector and visiting Malaysia.

STEPHEN CLAPHAM: And I also at one point visited Manaus, not for work but for pleasure. And Manaus was the center of the rubber production in the early 19 hundreds. And as the most magnificent opera, which is, you know, better than Milan.

STEPHEN CLAPHAM: But the what I thought was interesting about rubber is rubber actually coexisted with synthetic rubber because in the early part of the the the 20th century tire demand obviously was exploding.

STEPHEN CLAPHAM: The British stole rubber seeds from Brazil and planted the rubber in Malaysia, which is why Malaysia has got such a big plantation sector.

STEPHEN CLAPHAM: But when Japan occupied most of Asia in World War two, the Americans funded the development of of synthetic rubber.

STEPHEN CLAPHAM: And then of course, when you know the oil price supply shocks in the 19 seventies, synthetic rubber became more expensive. So its a very, very complicated cycle and you, you explained it very, very well.

STEPHEN CLAPHAM: But you also talked about whaling and fur. What did you learn from studying all these? And can you share some of the thoughts?

TIAN YANG: Yeah, so, so obviously there are things that are specific to each sector.

TIAN YANG: But if you do take a step back, I think it broadly fits in this idea of, you know, competition and the waves of competition from, you know, when too much capital gets invested and that, you know, there’s too much production which then deters future profitability and then when profitability goes down, competition falls, which obviously enables more kind of profits in the future.

TIAN YANG: So I think it’s kind of part of that cycle, but you have a structural element on top. And I think the key point is when you’re analyzing a lot of these base commodity sectors, it’s important to bear in mind that from a sector point of view, demand and supply is in elastic, right?

TIAN YANG: That’s kind of the key point. So just like we’re seeing with the kind of commodity super cycle with energy right now at a base fundamental level from civilization’s point of view, you need these things, right?

TIAN YANG: It’s in elastic, you know, you could do without Netflix, for example, but you know, we’re gonna need energy to heat our homes, right? This is the whole European kind of panic last year.

TIAN YANG: So I think that that’s kind of the key point that for a lot of these fundamental things, when there is an obvious replacement, the demand is an elastic and therefore when supply gets disrupted, you end up with very extreme prolonged cycles and it’s really those cycles that then drive technological innovation.

TIAN YANG: But even then there tends to be a lot of hyperbole about how industries, commodity industries die, right? Everyone likes to cite all the examples, you know, whaling or salt or these things that at one time, you know, ice at one time, these things are super valuable.

TIAN YANG: And now obviously they’re very cheap. But I think people underappreciate just the path and how you get there, there tends to be a this is the starting point, this is the end. So let’s just factor in this is how we end up.

TIAN YANG: But in practice for a lot of these industries, the more kind of linked to base level demand, they are, the longer and harder it is for these things to be displaced. So we just gave a lot of examples where even though you think of them as suddenly going extinct, it takes a while, right?

TIAN YANG: And usually it’s because alternative uses are found or often they can coexist. So rubber is like the particularly interesting one because even today, you still have kind of both, right, both synthetic and natural rubber, maintaining market share.

TIAN YANG: Similarly for fur, in theory, we have synthetic fur, why do you even need to, you know, go like grow animal, you know, and so that that’s still the case and even for whaling, you stop using it for oil, but you know, people still eat it and there’s all these other elements.

TIAN YANG: And so I think it’s just more understanding that in that long period of transition, the producers will also try to expand our markets, the technology will enable alternative uses and for something like fossil fuels in particular. And that was the point we were trying to make something as base level as fossil fuels. It’s such an efficient use of energy.

TIAN YANG: And we obviously we are aware of the problems of coal and oil, but it’s such an efficient use of energy from a physics point of view, just you know, such just energy density that it’s going to be very hard to replace. And I think, you know, we, we wrote that piece in response to what we felt like was like the very one sided view of the time, which was, oh yeah, all these things are going away.

TIAN YANG: Let’s just invest for the future. I remember there was a tweet by a obviously a very famous innovation, invest at the time about whaling oil.

TIAN YANG: And I remember that kind of set me off because having studied the history of whaling world, that’s actually factually wrong, but oil is not like whaling oil and that was kind of what motivated it originally. So so yeah, I think the general takeaway is really to think about how much energy energy density there is and how long the transition is going to take. And can you see the alternative uses?

TIAN YANG: And typically you need like a major catalyst event to really accelerate the technological disruption. You know, like you say it has to be really extreme, right? It’s like war, World War, these kind of things.

STEPHEN CLAPHAM: So if you enjoy this podcast, you’re bound to enjoy our free newsletter on substack. It’s a weekly email on interesting investing topics, visit behind the balance sheet dot com and hit the sign up button while you’re there, you might want to check out our brilliant online investor training school.

STEPHEN CLAPHAM: Hundreds of students have taken our flagship Analyst academy course which teaches you everything you need to become a serious equity investor.

STEPHEN CLAPHAM: And if you’re a professional investor, we run a forensic accounting course for institutional clients and soon a cohort based course for serious amateurs email us at info at behind the balance sheet dot com.

STEPHEN CLAPHAM: Yeah, you, you referred to the capital cycle and the investment in supply and all that. And I know that’s a big part of how you look at the, how you look at the world.

STEPHEN CLAPHAM: What what got you interested in the capital cycle framework? And can you talk a little bit about how you’ve adapted the original writings of Marathon Asset Management and particularly I like to talk about how you quantify it because you use three lenses Capex to assets, depreciation to assets and R O IC.

STEPHEN CLAPHAM: But let’s start by talking about how did you get into all this is? Do you think it’s just central to everything that or in a lot of sectors?

TIAN YANG: Yeah. Well, I think it’s central to every sector. It’s, it’s the fundamental way the world works.

TIAN YANG: So I I think, you know, our challenge when we’re investing come up with investment ideas has been, I think in finance, there’s a lot of theories and frameworks where it’s not clear, it’s axiomatically true. So, right, So like, you know, in maths, you have to have an Axion before you can derive proofs.

TIAN YANG: And you know, a lot of things, you know, say like technical analysis, right, every, you know, the assumption is everything is in the price, therefore look at the chart, but it’s not fundamentally axiomatically true. And I think there’s very few things we found about the real world that’s axiomatically true. And I think the capital cycle and the business cycle, basically a few, you know, core things you can rely on.

TIAN YANG: So when you think about investment, at least the way we think about it is there’s basically two concepts, right? One is the fundamentals, the axioms and the second is really playing the game. And I think there’s a lot of energy and time spent on playing the game, right? That’s where all the trading systems are.

TIAN YANG: That’s where all the flows and positioning and crowding and do devaluations being revered. Let’s forecast where the earnings going to be to us. A lot of that is kind of or earnings for the next quarter, right? That’s basically playing the game. But on the fundamental side, the the capital cycle is such an intuitive and core way that capitalism works, right?

TIAN YANG: The the basic idea is just competition when an industry has too much money going into it, then people over invests to chase market share. But that obviously crushes future profits. And so when future profits go down the return on invested capital goes down. So the money has to go somewhere else in search of profits.

TIAN YANG: And I think, you know, that’s basically the most fundamental way in which things work. And you know, we’re big fans of the of Marathon Asset Management of obviously, of, you know, the assistant subsequently set up other shops. I saw you had obviously Jeremy Hoskin on your podcast before.

TIAN YANG: And yeah, and so what inspired us was so that was the capital book by our chancellor a few years back that you know, really collected together a lot of the insights. And essentially that was what motivated us to really try and quantify what’s going on. And so essentially what you’re trying to do is take a lot of balance sheet metrics to proxy for capital flows and, and competition.

STEPHEN CLAPHAM: This is an interesting idea because marathon themselves haven’t done that to my knowledge. And Jeremy Hosking and co I don’t think have tried to quantitatively apply the, the theory. They, they do it by observation. And obviously you can see the in the, you know, companies talking about closing down plant, then they start to get interested.

STEPHEN CLAPHAM: But this is, this is, I think quite new and quite innovative what you’ve done. So let, let’s just maybe talk about it. You, you look at Capex and R and D to assets.

STEPHEN CLAPHAM: This is just a way a proxy of understanding the the increase in capital expenditure, the increase in supply.

TIAN YANG: Yeah, so, so because the capital cycle is works over a very long term cycle, right? So, you know, we’re saying on average, say it takes three years to really have an impact. So, you know, a lot of the key elements of the balance sheet we’re looking at is you know, as you mentioned, is R and D assets depreciation amortization and so forth.

TIAN YANG: But it’s basically various proxies for essentially is the asset based growing or shrinking, which ultimately reflects if the company is investing, right, whether it’s new money being raised or whether it’s, you know, retained earnings being reinvested back in.

TIAN YANG: It’s a very, very simple way to proxy for overall is the asset based shrinking or growing? And then how much maintenance do you have to do to maintain the asset base? And you know, that’s probably the most intuitive definition of capital cycle most people are aware of, right?

TIAN YANG: And so, you know, what we try to do is aggregate up the dollar value for lots of industries where the competitive dynamics are aligned, you know, so obviously, you know, if you take all the tobacco companies and lump them together and locating aggregate, that gives you fairly good sense of kind of future profitability.

TIAN YANG: The challenge when you, when you look at the capital cycle initially is how do you filter out the losers or the value traps? And how do you keep in the secular winners, right? So a lot of class examples say like the semiconductor industry. So if you only look at money going into it, you would have said it was capital abundant. But obviously as a we’re in a major secular shift, like we should be plowing money into this, right?

TIAN YANG: Because there’s just been very high marginal returns like T S MC, like locks in that, right? They lock in that rate of return with their customers before they even do the deal. So I think what we found is that once you have the intuitive aspects of asset based depreciation and so forth, what you want is a marginal R IC component, obviously R IC defined properly.

TIAN YANG: Are you effectively operating R R IC, right? You know, get rid of some of the cash adjustment and so forth. But the key point is if you have a marginal R IC component, it allows you to be sensitive to when that shrinking asset base is suddenly starting to generate higher returns right at the first moment.

TIAN YANG: And that’s a way to at least help you with the a little bit with the timing for a lot of these long term, potentially secular winners or losers, right? Like shipping is a great example, right?

TIAN YANG: Like people actually piled into the sector, you know, in, in like 15 16 at the time because from a asset base or you know, over investments and investment point of view, it was looking like, you know, it was way over invested and people were exiting. But the point was actors act very irrationally in the industry.

TIAN YANG: You have a lot of families who own ships, obviously there in terms of ship building, a lot of Times it’s you know, national effective S O E s, right? So they have to maintain jobs. So by having that marginal R R IC component, you basically stay out until 2020 until profitability.

TIAN YANG: The first sign it turns and then all that underlying kind of, you know, capital cycle potential starts to be realized and the momentum picks back up. So I think that’s probably the slight extra edge you get from quantifying stuff, right? You know, the way we think about the world is this idea of, you know, man plus machine can be manual machine alone.

TIAN YANG: So we’re just essentially trying to use a lot of the quantitative techniques just to speed up our filtering down. So our model will tell us to not even spend time on say shipping and anything related to it until there’s a marginal shift.

STEPHEN CLAPHAM: So it’s very interesting, it’s very clever because as you point out the I mean, shipping is a good example of an industry where there’s a lot of capital outside the quoted sector.

STEPHEN CLAPHAM: So you can look at, you can look at the quod sector and you can see a lot of things happening, but you can’t actually see what’s happening in the Greek shipping companies. And so that’s a very clever, clever way of doing it.

STEPHEN CLAPHAM: Do you ever get caught out though? I mean, do you ever get like false signals where the returns start to improve and then fade away again? I suppose that must happen.

TIAN YANG: But yeah, yeah, for sure. So I think this comes back to time horizons. So, so that’s why when we try and think about investing, we explicitly target three time horizons and try to marry them together. So the capital cycle very much fits in what we call the structural bucket, right?

TIAN YANG: So that’s basically 2 to 3 year plus outlook. So that’s kind of the the the long term manor and then on a 6 to 12 months basis, you have the business cycle, right? So this is a lot more leading economic indicators, you know, growth, inflation, liquidity and so forth.

TIAN YANG: So you kind of lay it down on top and then you have the more tactical which is kind of, you know, the the trading signals valuations, you know, positioning and these kind of shorter term things that people tend to trade mean reversion around. And so if you marry the three together, it does a slightly better job of explaining when one model is not working.

TIAN YANG: So the classic example is capital cycle is it basically doesn’t even change month to month, right? Or even quarter to quarter, a lot of Times. So obviously, there’s Times when it’s going in your direction Times when it isn’t.

TIAN YANG: And a lot of Times the explanation is linked to the business cycle, the liquidity cycle in terms of asset price shift. So I think marrying the two is a bit more helpful. But in general though, when we’ve run the back test all the way back to like, you know, the late nineties like the alpha generation in terms of long short for capital cycle is insanely robust.

TIAN YANG: When you think the only input is balance sheet, it basically doesn’t change, right? The alpha generation is super consistent. Now, obviously, the drawdowns are quite, can be quite brutal, right?

TIAN YANG: Because obviously there’s no risk management if you just run it. But it’s amazingly consistent in terms of alpha and, and what you notice is basically as long as the business cycle doesn’t blow up, there’s no recession, it basically just works like on a rolling basis, you’re basically extracting alpha.

TIAN YANG: But when there’s a recession, it basically completely goes ha y you lose a lot of money. And I think it’s again very intuitive because if your capital scarce industry going into recession, you actually just go bankrupt, right?

TIAN YANG: You don’t even survive, you take a zero on equity and then some hedge funds who owns a senior debt comes in and takes equity, they write it up the next time and you don’t realize that, you know, that that future profit.

TIAN YANG: So I think the behavior is, is pretty good as well when you back test.

STEPHEN CLAPHAM: It’s fascinating actually. I mean, the longer term, the structural, the 23 year stuff is obviously where I tended to, to focus and then looking at the 6 to 12 month outlook just to make sure you’re getting your timing right.

STEPHEN CLAPHAM: Can, can you talk a little bit about what sort of leading indicators you use and, and how do you, how do you apply them?

TIAN YANG: Yeah. So again, going back to a bit what we discussed earlier in terms of this idea of axios, right? What is fundamentally true? And I think the the challenge with Macro, at least our challenge with Macro has been, again, there’s very few things that’s fundamentally true, right?

TIAN YANG: Like there’s no one model that’s going to give you the right coefficient to predict the point in time estimate for GDP or these things. The only thing we think is fundamentally true in how the economy operates is the sequencing.

TIAN YANG: So certain things have to happen before other things and it’s the sequencing you rely on and that’s basically what leading indicators all about. So very intuitive examples are things like, you know, building permits have to have a turning point before the construction activity, right?

TIAN YANG: Just like, and then it’s only when you construct the house, can you have changes in say, you know why goods are durable goods, right? You know, people move into the home and then they buy stuff. So in terms of the leading lags building permits will give you much more signal of where the future kind of things like durable goods like construction is going similarly in the labor market.

TIAN YANG: If you only look at temp workers, right, they should give you a much better sense of what’s actually going on on the margin versus the, the unemployment number. Right. Which is very, very lagging. Like unemployment is normally at the lowest point, you know, during the recession, right? Just because it companies take a long time before they decide to fire workers.

TIAN YANG: So I think it’s about applying that leading lagging concept to kind of every aspect of the economy thinking about what it’s truly sequentially leading. And then it’s essentially saying, ok, now I’ve seen the lead indicator turn, the coincident growth data hasn’t quite moved, but we know it’s going to move and it essentially shrinks down the window in which that constant growth series can move.

TIAN YANG: But obviously, it’s not exact science because, you know, the, the the transmission is different every time. But at least, I think it’s something that’s fundamentally true in how the world operates and therefore we can rely on it and it gives you some confidence, it narrows down your timing window.

STEPHEN CLAPHAM: No, absolutely. And, and it seems it always seem bizarre to me that people didn’t spend more time on things like the building. I mean, the building permit is a fantastic example and you would very, you know, I, I remember I used to look at this but I used to look at it at the raw data because the, the South side didn’t spend too much time worrying about it.

STEPHEN CLAPHAM: And I, well, hang on a second here. I’m being, you know, I’m, there’s somebody telling me what my road map should be and that’s what I want to worry about.

STEPHEN CLAPHAM: I mean, do you understand why these things haven’t been as popular? Perhaps with the bulk of the South side? I mean, is there any reason that you’ve focused in on this when others haven’t spent as much time?

TIAN YANG: Well, I wouldn’t say we’re the only ones, but for sure. I, I hear you that it’s, it’s a minority I think was, I think it’s like originals like Jeffrey Moore and like, you know, the conference board, you know, they’ve been looking at this stuff for a while.

TIAN YANG: I think the problem has been because the lead Times are somewhat variable and, and especially if your side, you know, incentives are to probably live in the short term, a lot of Times it might not be happening immediately. And sometimes, you know, it’ll just look, look like it’s not working right, basically into every recession, there’s always that this time is different.

TIAN YANG: The curve is no longer predicted, right? You can go back and look at reports every single time where into before 2008 before 2001, you know, right now everyone’s like, oh, the doesn’t matter, here’s why, you know, leading the case don’t work. So I think there’s probably an element of that where the lead Times take so long, people kind of, you know, lose confidence in it, for example.

TIAN YANG: And the other thing I would say is people probably don’t treat it as holistic a framework. There’s a lot of elements of and obviously we’re all subject to this, right? The bias is you have a view, you find data to justify it. So, you know, maybe people pick and choose they’re like, OK, I’m Barish or bullish, the I S M number just came out that fits my narrative.

TIAN YANG: Therefore, I’m going to talk about it because I have to talk about it. So I think just chopping out the leading data is I I haven’t seen that many cells that do that, but also you got to realize the data is heavily revised. So maybe you like the theory and you start using it, but in practice, you don’t realize the data goes through multiple, multiple revisions.

TIAN YANG: And in fact, the the real revision, quote unquote, real revision comes like a year later, right? When they do like annual revisits or, you know, whenever. So how do you cope with that?

STEPHEN CLAPHAM: Then?

TIAN YANG: I mean, that must really upset your process because, well, we we track the first release, so we track all the different revisions of the data. So that’s why you know, we’re recording this right after no farm payrolls, right? When I’m like, suddenly everyone’s narrative is all the labor market is great, but no payroll is like one of the worst series for revisions.

TIAN YANG: People don’t realize it gets revised up to 10 Times afterwards. And you can look at the revision patterns before in, in every historical recession where for the first month or two afterwards, the pattern is often gets revised up. So I revise even more positive or normal and then a year later it gets revised back down.

STEPHEN CLAPHAM: And do you know what that is? Why that would be? I mean?

TIAN YANG: So I think for, for series like employment one is, is based on surveys. So there’s a lot of statistical techniques that are going into the whole number. And you know, a lot of time the survey is coming in is lagging. And also you got to realize the people who compile statistics are just, you know, they’re trying to do their job, right?

TIAN YANG: They’re not if this wasn’t designed to help you time the market. So maybe it’s like two years later when the recession is consensus, then B R says its consensus, you notice the data suddenly they drop it by a million, right? The employment number is like, oh my historical data doesn’t quite fit the narrative anymore.

TIAN YANG: So, you know, there’s so many assumptions that go into these models and so it’s very sensitive to just small parameter changes.

TIAN YANG: Right. Because the employment I say, like today it’s 100 and 50 million. Right. Right. That’s the magnitude. And we’re worrying about like a 200 K change. As, as, you know, the markets worried 200 K is suddenly, is like a big deal.

TIAN YANG: So, you know, I think that these are all the elements that’s probably going to why, you know, you might think something is leading and then the first release comes out, you’re like, oh, wait, you know, I’m gonna, I’m gonna react to this and it doesn’t work for you.

STEPHEN CLAPHAM: But you don’t realize, you know, that that’s the, and of course, as you said, you’ve got to play the game because if everybody else is looking at that number, then you’ve got to, you’ve got to worry about it even though, you know, even though, you know, it’s wrong, it’s funny, isn’t it?

STEPHEN CLAPHAM: Because the United States has got a data set that is far, far superior to any anywhere else in the world, but even its data set isn’t that good concurrently.

TIAN YANG: Yeah, I, I mean, the data is doing what it’s supposed to be doing. I think as investors, you probably have to realize that, you know, that the statistics, people didn’t come up with this to specifically help you invest in time in the market, right? They’re trying to, there’s lots of uses for the data. It’s doing what it’s supposed to be doing just like the GDP now.

TIAN YANG: Numbers, right? Like again, this feels a bit like when it suits people’s narrative, they bullish or bad, they point at the data. But the data is always behave like this. It’s just, it’s just who’s bothered to read the methodology and like, look at how it behaves, right? That, that feels more like what the issue seems to be.

STEPHEN CLAPHAM: And of course, that doesn’t make for a very sexy research note, the methodology.

STEPHEN CLAPHAM: You talked a bit earlier about sequencing. And I think that’s very, very interesting because you’ve written quite a lot about bear market bottoms. And, you know, we had Russell Napier on, on the podcast with Jeremy Hoskin. When we did that capital cycle, we talked about financial repression, but he also wrote that book, Anatomy Of, of the Bottom.

STEPHEN CLAPHAM: You were talking about funds going out of business and the comeback of fallen angel investors like value investors today. I mean, David Einhorn obviously is up 36% and he’s been coming to London to raise capital. But what I think is quite funny is that Cathy Wood is still getting inflows in spite of, I mean, horrendous performance. You know, it’s conceivable that as we’re talking, we’re talking in early February 2023.

STEPHEN CLAPHAM: I mean, it is conceivable. We’ve ended the Bear market and both David and Cathy are going to make money from here. But that seems a very implausible scenario.

STEPHEN CLAPHAM: But what I think is very difficult about today is history doesn’t seem to be very relevant because we’re at a very odd juncture in history. The circumstances of today are very different from the way they’ve been in the last 40 years.

STEPHEN CLAPHAM: And, and you know, you can look at periods like post World War to in terms of government debt or the 19 seventies in terms of inflation and energy. But how do you think about this because you’re very historically, data precedent driven. How do you think about we’re in a, a new paradigm or a new mode? How do you, how do you work out what’s going to happen?

TIAN YANG: Yeah. Well, that’s a, that’s a big question. Well, first of all, shout out to Russell. Nay, I think he’s also got this series of libraries, the library mistakes I’ve actually visited. So, you know, that, that also tells you a bit about history, right? And you can see in real time all the kind of errors people make.

TIAN YANG: But yeah, so I think it, first of all, I don’t know if you read our, note on what we call the age of scarcity. So that kind of sets out our kind of 5 to 10 year view right now where our heart we’re going from, you know, decades of cheap money, cheap labor, cheap commodities and all three are basically now going to be in reverse for the next decade, right?

TIAN YANG: So you can have more expensive commodities, more expensive labor and more expensive financing. So I think that’s a fundamental regime shift in the investing environment. So all these assumptions were going to mean revert back to whatever that average or median is over the past 10 years. But we don’t think that’s going to happen. Right. So, first of that’s the kind of very structural overlay.

STEPHEN CLAPHAM: Ok. So let’s stop there. What, what, what does that mean?

STEPHEN CLAPHAM: I mean, I, I completely get what you’re saying. So we’re not gonna have, we’ve had 40 years of falling rates and that stopped. So that’s a bit, I mean, that’s been the thing for me and we’ve had cheap labor. So what how does that affect the investing landscape?

TIAN YANG: So, well, this is linked to a little bit like my understanding, Russell Napier is view on some, some things as well, right? Where at heart, it means your equilibrium level of rates is gonna be higher for bon yields are gonna be your equilibrium level where inflation is gonna be, is gonna be higher. You know, sector leadership is going to be different.

TIAN YANG: You know, we’ve been very fortunate to live in a decade where tech startups, consumer tech startups raise financing, give you free stuff, right? Using cheap capital, right? A lot of these business models are probably going away, it’s not going to be as sustainable, it’s going to be harder to finance innovation. You saw a Facebook Stock Tank and then they said, ok, we’re going to stop the stuff in rallies, right?

TIAN YANG: So I think it’s just, it just puts up, putting up to your point, putting up the cost of capital is one piece, but also your input costs is going higher, right? Because the commodity super cycle, that’s where the capital cycle comes back if we are under invested in the base needs of society for so long.

TIAN YANG: But unless we suddenly get all these, you know, nuclear fusion breakthroughs, whatever all the you know, battery tech breakthroughs, it’s going to take a while. And so input costs are going higher, obviously, you know, more militant labor, right? You see strikes, picking up a lot of these, obviously, you know, we we living here in the UK, right? It’s like every week, right?

TIAN YANG: You know, there’s gonna be a strike. And so, you know, these are very fundamental shifts, right? Like you have a shift in monetary and fiscal policy coordination, right? Like it’s only in the age of abundance that you can get independent central banks, right? In the age of scar, the central bank is going to listen to the big daddy, right? Which the government tells you what to do.

STEPHEN CLAPHAM: And so the government is going to tell us, oh, they tell us to do, but what this means then is that margins are going to go down in the long term margins structure there all time high returns structure there and all time high.

STEPHEN CLAPHAM: So they they’ve got a decline, right?

TIAN YANG: Well, again how far away you are from the base layer of commodity needs will determine that, right? Like pricing power now is gonna be, well, guess what if I’m a, you know, if I’m any of the energy guys, right? Un obviously, unless the government specific tax, you know, windfall tax me or whatever, like people gonna pay what I ask. Right.

TIAN YANG: But yeah, I’m not gonna pay Netflix 4 99 to renew my subscription. Maybe they got offer me 1 99. I still won’t do it right. Like this is the difference, we got to pay our bills, we got to, you know, buy our food, right? We’re gonna, you know, fertilize it, right? There’s a shortage, we got to pay for that.

TIAN YANG: So I think it’s more there’s a shift in where the pricing power is gonna be and what and clearly when financing needs go down, you actually have to live off your positive cash flow, right to reinvest. So therefore, margins will actually matter again.

TIAN YANG: Whereas obviously when you can raise free money, it’s all about market share and you don’t need them, you don’t need to actually even generate your own cash flow or you just, you know, raise money to grow. So yeah, I think that that’s like a very fundamental shift in where the market leadership is going to be.

TIAN YANG: But also I think it affects the policy regime, right? So therefore, you know, obviously you mentioned financial repression, these kind of things, right? You know, something I like, I, I half jokingly talk about is is kind of the ification of policy where the West just keeps adopting China, China’s policy with you years later, right?

TIAN YANG: Even like China locked down first and we for some reason just locked down here before switching. Well in China, like credit is very state driven, right? You know, policy banks drive it and that’s obviously what we’re seeing a lot more in the West, right, especially in Europe, right?

TIAN YANG: When the government backstops and gives credit guarantees for loans, that’s the government allocating credit, right? And it distorts private sector lending incentive. So a lot of these things have been happening already and that’s usually what you see in a more kind of yeah, in a regime where I don’t want to say quite say the stock inflation, right?

TIAN YANG: Because you need a recession while inflation is high and we’re not quite there. But that’s basically the trend, right? Higher levels of inflation are changing what kind of business model is going to do well in the next decade.

TIAN YANG: Yeah, and obviously it’s probably good for gold, it’s probably bad phenomenal bonds. And if you’re going to be in equities, you better be in the, in the good in the inequities with the pricing power.

STEPHEN CLAPHAM: And we’ve seen a lot of this and in fact, we talked quite a lot on the, on the podcast, one of the earlier podcast I did Pete Davis from Lands was saying, well, you know, I just don’t believe that Facebook and Google are going to be the leaders in the, in the next decade. And that was in September of 2021.

STEPHEN CLAPHAM: So quite near the, quite near the peak and it was quite controversial at the time. It’s funny you, you don’t, it’s only when you look back and you, you say, well, that was, he, he said something that was very right and very clear and quite obvious, but people didn’t listen and didn’t, didn’t believe it.

STEPHEN CLAPHAM: But I think that’s now the tech leadership, it’s not gone away. I mean, I think people do still believe in it because obviously we had this big rally in, in January.

STEPHEN CLAPHAM: But I think a lot of people understand that tech isn’t going to lead in this decade and it’s much more likely to be energy.

STEPHEN CLAPHAM: Are there any sort of second tier effects that you, that you’re looking at that? You know, other areas that we, we should be thinking about that are knock ons from that. I mean, obviously if you’ve got the leadership going away from tech, then tech is a big consumer of tech.

STEPHEN CLAPHAM: So there’s all the a product, all the services that feed into that will suffer. But are there any other sort of second tier effects that you’re thinking about and you’re studying?

TIAN YANG: So I think again, going back to not missing the secular shift and, and confusing with the cyclical essentially what you’ve, what I, I, I mean, the one line summary will be, we’ve invested too much in software and not enough hardware.

TIAN YANG: Right. So, but obviously hardware is extremely unsexy. You know, I have friends who do hardware startups. Right. And then they just can’t raise money. But guess what if you want to do any of this electrification stuff?

TIAN YANG: You might need a better battery charging technology, right? You might need a bad wireless charging, whatever it is. So I think that’s going to be the big shift like we still need technology, right? This technology is secular, right? It’s not like the, you know, there’s all these right is a secular thing, but there’s big cycles on top.

TIAN YANG: So I think there’s going to be increasing focus on tech, hardware, manufacturing, tech and all these things. So I think it’s just the format of this is going to shift. So it’s more moving away from, as you say, purely two guys sat in a garage somewhere, you know, buy, you know, buy aws right to a thing.

TIAN YANG: And you’re going to actually need some innovation in, you know, material science, you know, in energy and you know, all these things can you can you talk a little bit about real state because you’re constructive on real estate.

STEPHEN CLAPHAM: And obviously it’s been very difficult with the rise in, in in bond yields so far. I mean, my simple perspective in this is they aren’t making Bond Street anymore. You know, there’s only one Bond Street. And so if you’ve got the right asset, it’s, it’s going to be highly valuable in, in 20 years and there’s a very good inflation protection, but obviously there’s this yield compression component to it.

STEPHEN CLAPHAM: What do you think about real estate? How do you look at it?

TIAN YANG: Yeah. Yeah, I mean, well, I would agree with you again. Going back to the time horizon issue, right? Clearly on the structural point of view. Yeah, it’s going to be inflation hedge. It has to be in scarce supply, right? To precisely to your point.

TIAN YANG: It has to be, you know, location, location, location. So yeah, I think that’s fairly obvious. I think on a slightly more cyclical viewpoint, this is where we were only constructive on it in the sense of playing the game.

TIAN YANG: So basically from I think for the US where the demographic picture is slightly better, there is a need ultimately to build housing. So like a very simple indicator you can look at is just housing starts versus the population or housing starts versus the stock of total homes available, right?

TIAN YANG: So basically after the G F C crisis, this being at a much lower level versus history. So today there’s a lot less empty homes that were previously, the housing stock is much, much older, right?

TIAN YANG: You have a ton of homes built in the fifties and sixties and I think people tend to just only look at household formation versus housing stocks without realizing a lot of buildings get demolished. Right. You have to do maintenance. And so I think structurally there is a need to build more homes in the US. That’s kind of the secular story.

TIAN YANG: However, home building businesses are basically just a pass through business. Right. They take whatever costs and pass through. But I think there are probably operating efficiencies to some of the better operators, right? If you can knock out a cheaper home and over time, you’ll, you’ll, you’ll do better.

TIAN YANG: So I think it’s more they got so bummed out because of the rising rates that you will get to the point where your pricing already discounting quite a strong recession, all the flow crowd in the case, it shows like, you know, everybody is basically sold out. So then you are like, ok, if, if you can find players that are on two level, they’ll probably survive. You got to hold something.

TIAN YANG: You can’t just hold the basket energy names, right? We got to find something else that’s somewhere aligned with the core view. So I think that’s where some of these names came in. So in Latin America as well, home bill is potentially interesting, but it’s, it’s a question where you can take home the geopolitical risk.

TIAN YANG: People have been going to the Latin America demographic trade for ages, right? And if you know how many years ago looking at all cost mcdonald’s of of Latin America, you’re like, this is a no brainer, right? Great demographics, all these things and you know, performance is terrible for years.

TIAN YANG: So, but yeah, at I think it’s more structurally, either it’s a real asset play, it holds inflation value or fundamentally, there are certain regions of the world where demographics a bit better where you will need to build more homes. And ultimately, if there’s financial repression, real rates are going to be negative.

TIAN YANG: So it will make sense for people to to go to get the mortgage to buy their homes, the mortgage will be given to you by the bank which is backed by the government. So like that makes sense and then people want it to go up. So I think that’s probably more the secular point, but for sure, in the short term, it’s a pass through industry, right? You got to be a bit careful who’s kind of, you know, the cowboy operators.

STEPHEN CLAPHAM: And also I think the the other point is the companies that have bought land effectively because the David Einhorn was talking about, he’s, I think he’s the chairman of Green Brick and but they were making acquisitions during COVID and including acquisitions of distressed companies.

STEPHEN CLAPHAM: So they’ve built up quite a big land bank in Texas. So, you know, he’s very well, obviously he’s a big holder of it. So he’s obviously very bullish on it. I it’s quite an interesting start.

STEPHEN CLAPHAM: The other thing that you’ve been talking about is sort of the age of abundance and profits and cash flows are sexy again, less on the dash for growth. But you, you said you see more merger activity now as companies look to maintain margins by consolidating the supply chain.

STEPHEN CLAPHAM: I wondered why you were talking about that. Do you think there’s been too much horizontal mergers? I know, obviously, we both know Jonathan Tepper and he wrote that great book with a, with a colleague about the consolidation and particularly in the United States. Do you think it’s just gone too far?

TIAN YANG: Well, I don’t think it’s, that’s a viewpoint on whether it’s gone too far. I think the point was, it’s another confirmatory piece of anecdotal evidence you want to see for the age of scarcity thesis, right? Which is when margin pressures become more persistent.

TIAN YANG: The historical observed pattern is that how do you preserve profit margins? Well, if you don’t have as much pricing powers, all these companies think they do, then one way is to consolidate the the vertically.

STEPHEN CLAPHAM: So I think why vertically rather than horizontally?

TIAN YANG: Because obviously, you essentially cut out the layers of profit margin from your suppliers, right, the downstream. So you basically put it all together. So at aggregate level, it looks a little bit better. In theory, there’s more bargaining power, right?

TIAN YANG: When you, when you consolidate as well So that’s generally what you observe. It’s not, again, in practice, it might not happen because sometimes you have to pay a premium and, you know, it’s hard to kind of operate assets as efficiently. But that’s kind of the theory people go for.

TIAN YANG: So I think this is more, not a media story, but again, for the next 5 to 10 years, you should expect that to happen a lot more. So that’s why if you’re like a upstream, you know, tech hardware, all these things, you make something important to the world, you’re more likely to also have that get out of jail.

TIAN YANG: You know, there’ll be like a strategic choir that comes in as well, right? You can value it on those kind of things. I think that’s, that’s more the angle where we’re going for that.

STEPHEN CLAPHAM: That’s very, very interesting one. Thing I want to ask you’re the youngest person I’ve had on the, on the podcast. I got a bad thing. Like I think that’s a good, I think it’s a good thing because I think, you know, cognitive diversity.

STEPHEN CLAPHAM: But I just, I just wondered if, if youth was an advantage because I really believe and, or I have believed over the, you know, my investing lifetime that we’re in cycles and that the experience of the past cycles really helped.

STEPHEN CLAPHAM: And, you know, you make the mistakes the first time, you make mistakes the second time and hopefully you don’t make them the third time, you know, you, you, your exposure, your risk appetite gets diminished. But because we’re in this kind of new environment where the old roles kind of get chucked out.

STEPHEN CLAPHAM: I wondered if you thought that there was an advantage in being younger and that you, you weren’t relying on your experience, you had to do everything from first principles and that actually gave you a help.

TIAN YANG: Well, I, I think doing things from first principles for sure helps. But you know, we’re, we’re like strong students in economic history, financial market history, we’re very aware of the is this Schwarzman or someone had to quote, there’s no, there’s no like what is it? No courageous and old investors or something?

TIAN YANG: Yeah.

TIAN YANG: Yeah, that’s the one. No old and bold investors, right? So I think we’re very aware of what we don’t know. So that’s why, you know, we spend so much time, you know, obviously we mentioned multiple examples looking at economic history.

TIAN YANG: But because because we’ve, you know, this is like, you know, post 1990 right, people born after 1990 we probably more, you know, in line with some of the more leading edge of data science and some of those techniques. So the way I see is we can have a nice niche where we take a lot of those insights from economic history, from interacting with very experienced investors.

TIAN YANG: You know, like yourself listen to your podcast, reading your book plug plug and then and then trying to take some of the data science techniques and then trying to, you know, do something you know, like with the capital cycle, right, I don’t think we need to necessarily reinvent the will come up with brand new insights and make the mistakes.

TIAN YANG: But hopefully, we can take a lot of those other insights and then try and quantify or apply some more leading edge techniques to it. And in a way that’s probably only been and enable in the past decade, right? I I have to imagine even when I was initially growing up, you literally had to go to the library and physically get a book out, right to read. That wasn’t this information was widely available.

TIAN YANG: So maybe that’s what enables you to be maybe a bit more effective this time around where you don’t have to make all the same mistakes.

STEPHEN CLAPHAM: You can rapidly accumulate the information I was explaining to somebody the other day, you know, I love doing these talks to universities and it was at the, at L S E actually a couple of weeks ago, but I was talking to some a youngster about, you know, getting into, into the industry and now explaining that at one of the firms that I worked at, we had a library and he, he sort of looked at me, why did you have a library and, and explained to us all you might own?

STEPHEN CLAPHAM: You, you might be following a company that makes a takeover of another company and, you know, there might not be an Analyst following that stock. So we used to have the accounts, the physical accounts of every company quoted in the London Stock Exchange.

STEPHEN CLAPHAM: So that if that happened, you would just go to the library and pick out the accounts because there wasn’t an internet that you could access.

STEPHEN CLAPHAM: And the, you know, the, the, the sort of the wheels were going around, I could see him thinking about this, couldn’t conceive of the idea that the world wasn’t on your, on your desk, on your screen.

STEPHEN CLAPHAM: And of course, there has been a marvelous, marvelous change. And, but listen, thank you so much for coming in and, and talking about your, your views. And I normally ask people when we finish, to recommend a book and you’re a great reader, I think.

STEPHEN CLAPHAM: So, what books would you recommend to somebody who wants to follow your footsteps and become a strategist economist? I’m not sure how to describe variant perception. You’re quite an unusual firm, right?

TIAN YANG: Well, yeah, I mean, we think of ourselves more like full stack investors, right? We’re trying to, I mean, this is, I guess this is somewhat linked to your question as well where in terms of career advice I remember getting is, you know, essentially capitalism is only going to reward two things. You’re either the very best of something or you have a unique mix.

TIAN YANG: Now, it’s pretty hard to be lebron James and you know, break the all time scoring record, right? So it’s usually easier to be unique and to unique means you say have 80% everything. So, you know, we do, we do bottom up, we do Macro, you know, we try to look at how to trade fixed income, how to trade all, but maybe just 80%.

TIAN YANG: But if you just have, if you eventually broaden out enough to cover all of it, you have a somewhat unique mix and perspective and that can also be valuable and help with, you know, investment decisions really. So I think that’s probably the, you know, how I would describe our firm, how I’ve tried to go about my, my path so far and in a way that’s probably linked to the books I would recommend, right?

TIAN YANG: When people ask me, usually the first book I always think about is The Volatility Machine by Michael Pettis who I actually met before as well. I just think at least for me personally, that was like the game changer.

TIAN YANG: It was one of the first books I read that wasn’t very academic in nature, that wasn’t just a very theoretical about this is fractional reserve banking or this is how technical analysis works. It was very practical in terms of how the real world works. You know, how do things propagate through balance sheets at Macro and micro level to drive asset prices.

STEPHEN CLAPHAM: I think Michael Pettis is the China expert.

TIAN YANG: Yes. Although he started off as a LA time credit trader.

STEPHEN CLAPHAM: I know that, I mean, I have met him and he, I mean, he’s amazing in China a lot of things.

TIAN YANG: So yeah, so that was like something that really, really was like a catalyst for me to really think about the world differently. So I would say that’s the first I think for newer people, any of Joe Greenblatt’s kind of, you know, classics and stuff like, you know, the Magic formula or I think it’s called like the little book that Yeah.

TIAN YANG: Yeah, that’s the one. Yeah, I think it’s also the one how you can be a stock market genius. I mean, some of the examples obviously by now quite old but still, you know, very useful as a guy.

TIAN YANG: So I think those were some of the things that really helpful to start again trying to bridge that gap between doing things in practice having a framework versus just, you know, whatever you hear. I mean, in a way this is a problem as well. Going back to a little bit to what we were saying before, there’s just too much information on the internet as well. So how do you filter down? Right?

TIAN YANG: This is why Chat G BT might work really well if you have a question on accounting, but you ask Chat GP T A question now about finance or it’s being trained on all those articles like this is how you make a million bucks in the next 30 days. Right? Here’s the top 10 crypto strategies or whatever.

TIAN YANG: This is some random seeking alpha article. So it’s trained on that. So you ask him investing question, it just gives you gibberish, right? So in a way going back to experience and books and all these, you’re trying to filter down the initial information you you train your own brain on and then hopefully that that means it’s improved, improved kind of outcome.

TIAN YANG: So yeah, so any of the green black books are pretty good. I think obviously we mentioned capital returns. So again, that’s obviously edited by a chancellor from all the marathon letter. So again, extremely thoughtful and and useful practical book.

TIAN YANG: So yeah, you got us through. Yeah.

STEPHEN CLAPHAM: Thank you so much. Tell the listeners where they can find you.

TIAN YANG: Yeah, well, I mean variant perception, hopefully, you know, it it’s fairly memorable word, variant perception dot com. If you want to get a sense of what our company does, we’re, as I say, full stack institutional service provider. So we provide research, we can provide tools and data or, you know, advice on kind of investing or you know, as well.

STEPHEN CLAPHAM: So listen, it was really great talking to you. Thank you so much for coming on and I’m really glad we could do this.

TIAN YANG: Like I said, you know, we’ve been in touch for a while and you know, a big fan of the work you’re doing, especially with a lot of the forensic accounting stuff. Big shout out to your Netflix piece as well. So yeah, I’m really glad we could do this. Thanks a lot.

STEPHEN CLAPHAM: Tian is the youngest guest we’ve had in the podcast, but he is razor sharp, super smart and a keen student of economic and financial market history. He made the point that the generation born after 1990 are more in tune with data science can take first principles, insights and learnings and apply quantitative techniques to them.

STEPHEN CLAPHAM: I agree that youth can be more effective today who couldn’t. After listening to Tian I came away with a lot of food for thought and I hope you did too.