Daniel Lacalle's face-to-face Keynote Lecture

Lessons and opportunities from an increasingly volatile financial market

On 25 May 2022, the Rafael del Pino Foundation organised the Master Conference "Lessons and opportunities in an increasingly volatile financial market" given by Daniel Lacalle on the occasion of the publication of his latest book "Make your money grow. My experience with the best investors in the world" published by Ediciones Deusto.

Daniel Lacalle is an economist, international advisor and Chief Economist at Tressis. He holds a PhD in Economics, a degree in Business Administration from the University of Madrid, a CIIA (Certified International Investment Analyst), a postgraduate degree from IESE (University of Navarra) and a Master's degree in Economic Research. His career in portfolio management and investment began at the hedge fund Citadel, in the United States and London, and continued at Ecofin Limited, covering equities, fixed income, private equity and commodities, and later at PIMCO. He has been voted for five consecutive years in the Top 3 best managers in the Extel Survey, the Thomson Reuters ranking, in the general, oil and power categories. Prior to his time as a manager, he worked as a financial analyst at ABN Amro (now RBS), and held various responsibilities at Repsol and Enagas, where he received the award for best IPO (IR Awards 2002). Daniel Lacalle writes regularly for El Español and is a regular contributor to La Sexta, CNBC, CNN, Epoch Times, Hedgeye, Mises, The Commentator and The Wall Street Journal. He is also a lecturer at the Instituto de Empresa, UNED, OMMA and IEB. He has also written the books Nosotros, los mercados, Viaje a la libertad económica, La madre de todas las batallas, Acabemos con el paro, La Pizarra de Daniel Lacalle, La Gran Trampa and Libertad o Igualdad, all of them published by Deusto and bestsellers both in their original Spanish edition and in their translations into English and Portuguese.


On 25 May 2022, the Rafael del Pino Foundation organised the conference "Lessons and opportunities of an increasingly volatile financial market" by Daniel Lacalle, chief economist of Tressis.

Lacalle indicated that, at the moment, there is great uncertainty in the financial markets, concerned about the current situation. However, we have lived through much more convulsive times than now. We think that there is more uncertainty because for more than two decades we have been accustomed to monetary laughing gas, which amuses but does not cure.

Central banks have pursued expansionary monetary policy, which is what has produced budget deficits and public debt. It was thought that this expansionary monetary policy was going to be limited in time, to give governments room to make the necessary structural reforms. Instead, this policy has become an excuse for not doing them and we have reached a situation of concern because interest rates are going to rise at 0%. We call it uncertainty because we are not used to volatility.

Expansionary monetary policy also removes tolerance for volatility. It gives us a false sense of security. Central banks massively increase their balance sheets by buying government bonds, and mortgage securities also in the case of the US. Bonds are the least risky asset. Central banks make it more expensive by taking it out of the market, thus forcing you to take more risk for less return.

They also create a perverse incentive. When people see the stock market falling, they say they will have to stop monetary policy normalisation. Central bank governors are worried because the risk taken by the market increases every time the central bank governor gives a message. Alarm bells go off when bonds go down, stocks go down, cryptocurrencies go down, inflation goes up and the dollar's suction effect is generated.

The European Central Bank cannot play the Federal Reserve when you do not have the reserve currency of the world, the financial balance of the United States, the legal certainty of the United States, nor its credit history. You cannot play at it because, in the short term, it looks very attractive, but then, when you find yourself in the circumstances we are in now, you find yourself between a rock and a hard place. The European Central Bank right now has a very serious dilemma. On the one hand, if it raises rates to 0%, it fears that stock markets will collapse, that risky assets will collapse and, therefore, a feeling of risk and instability will be generated. But if it does not do so, or does not do so much faster, inflation in the Eurozone has appeared and is not easily controllable.

Why is inflation appearing now? We have spent years hearing that printing money, increasing the money supply, does not cause inflation. But while the money supply was increasing, prices were rising uncontrollably, for example real estate prices, prices and valuations of unlisted risky assets. Company valuations were rising uncontrollably. This is asset inflation and there has been a lot of it. But there has also been the other kind of inflation, the kind we all suffer from. Food prices before 2018 were already at record highs. The price of non-replicable goods, such as healthcare or education, kept rising, particularly in the United States. They were going up by more than 10% or 12% than the CPI inflation indicators were going up because CPI is not inflation. The CPI is a measure of inflation based on a basket that a statistical agency generates in which it more or less assumes goods and services that it assumes we consume every day. That is not inflation. Inflation is the loss of purchasing power of the currency, which is the only thing that makes all prices go up.

All prices do not go up at the same time by chance. You can have one price or two prices going up because of a geopolitical issue, because of a financial risk, because of a disruption of supply chains. But if two or three prices go up for those reasons, for the same amount of money, the other prices don't go up; they go down. In fact, the velocity of money would go down because the quantity of money plus the velocity of money would generate a reduction in all other prices. The price of everything, or almost everything, can only go up if the quantity of money is much higher than the demand for money, which is what happened in 2020.

In 2020 we had the Covid-19 crisis. Faced with an economic crisis by closing the economy by decree, it is decided to take massive demand measures, i.e. massively increase the amount of money, massively financing current public spending. The moment you reopen the economy it works exactly like a funnel when you are closing the smallest part. This is the problem that happened in 2020 and is now more difficult to get out of because inflation is cumulative and, moreover, has different factors that move as the amount of money is withdrawn. Now we have to raise interest rates and reduce the quantity of money. However, public spending stays the same. If you have massively increased it, financed it with newly created currency and kept it in the midst of an inflationary process, when you control inflation you are doing so by taking the private sector with you. In other words, you get into a crisis, you create the risk of deflation.

The idea that you have to fight deflation is a danger in generating perverse incentives which are to spend too much, to drive the economy into imbalances and then, when you overshoot, to tell the private sector that it has been very bad because it wants to consume.

The big problem we face in financial markets, therefore, is that you have to pay attention to fundamentals and there is nothing more fundamental than the quantity of money and the cost of money. You have to pay a lot of attention to it because when you go into a period where the tolerance for volatility is very low and you introduce the idea that the central bank is going to bail you out when the problems come, what happens when the correction comes that everybody says they were waiting to buy is that the correction comes and they don't buy. This happens because, because you are so scared of volatility, you assume that relatively standard volatility at historical levels is an unacceptable problem.

Also because something else is happening. Everything seems cheap because it is going up, and everything seems expensive because it is going down. This depends on the maturity period of our investment, how long we intend to stay, what we are buying, what we are buying it for and our capacity to increase a position as the price relatively does not rise or fall. We have to adapt to an environment in which we are getting used to the fact that the free bar of liquidity introduced by the central bank will no longer be the same. This is the perverse incentive that central banks had introduced whereby, when unemployment rose, the stock market rose because it was assumed that, given this bad economic data, they were going to inject more liquidity and lower interest rates much further.

This is how a view has been formed in which two generations of market participants are only used to demand mechanisms, i.e. injections of money and lowering of rates, and we should get used to the opposite because the incentives to leave economies worse off in the medium and long term would be lower. We should get used to the opposite because the incentives to leave economies worse off in the medium and long term would be lower. How are you going to reduce public debt if you lower interest rates and increase liquidity? There is no concept of massively buying time by incentivising borrowing to reduce indebtedness. It doesn't exist, it can't happen.

And, most importantly, what we are now seeing as a debacle is a very good thing. Asset valuations are moderating. The bubble of everything had been generated, where everything was monstrously expensive. The central bank makes the bond monstrously expensive during periods of crisis and growth. Then the valuations of everything go up and a bubble of everything is created. So what we are seeing now is very good. And if we don't see it in the same way as in other periods of high volatility, we are going to miss the opportunities that are being generated over the long term. Some assets are still very expensive, but others are starting to look really interesting. In periods of high volatility, the market consensus generates a series of siren songs that make you look to the present and backwards, when you should be looking outwards and into the future.

The key thing at the moment is that in the coming years we are going to find ourselves in an environment of lower growth, lower productivity, lower real wages and it is going to be more difficult to manage the inflationary monster. The problem is not to be led all the time by the market situation to think that the things that are happening are either extremely good or extremely bad. When we analyse the economy, we always make three mistakes. The first is called presentism, which is exaggerating what is happening now. The second is nostalgia for a supposedly better past. And the third is dystopia, when everyone says that the world is going to end because the market is going down. That is why central banks pay so much attention to markets, because the perception of wealth disappears and the dystopian perception that the world is going to end is generated. But it is neither the one nor the other. When there was no volatility, everybody knew that Netflix was very expensive, that cryptocurrencies were very expensive. Everybody knew that, but nobody was short.

The important thing is not to fall into dystopia. When have the great opportunities to create wealth and wealth in the medium and long term been generated? In 2008, in 2011, in 2001. The era of monetary laughing gas has eliminated the idea of looking for opportunities in bear markets, when they have been around all our lives.

The other thing that is very important to understand is that when we look at the economy and fall into presentism, nostalgia and dystopia we also have the problem of not seeing that what is changing in the world is changing much faster, but not for the worse. As bad as things are going, we got through a pandemic without supply shortages and without famine thanks to business. We are two and a bit months into the war and the PMI indices of purchasing managers are still expanding. What are they telling us? That it is neither that bad, nor that good. But the mistake is always to think it's great.

Which brings us to why consensus should be ignored. Consensus is the aggregation of a lot of people's opinions about a particular piece of data without including any of the things that those same people think might be trends of change. So you don't look at the rate of change. So you have to avoid the siren songs and realise that the market, when it has been at its best, has been when we didn't have the monetary laughing gas, which makes you laugh, but doesn't cure. And we have already realised that it does not cure, that it generates perverse incentives.

So, since central banks are not going to disappear, we will have to continue to pay attention to the fundamentals, which are, first, the quantity of money and the price of money; second, the rate of change of trends; third, the opportunities that are generated in things that are not changing. For example, the technological progress that we have seen in the last few years has not only not changed, it is moving much faster. Inflation is at seven-something percent. If technology is monstrously and wonderfully disinflationary, what would inflation be like without technology.

It is in that environment that we have to realise the dangers and where the greatest risks are. Where the biggest risks are is not where everyone perceives the biggest risks to be. Bubbles never occur in assets where we all think there is a lot of risk. Bubbles can only occur by definition in assets where we think there is no risk. The real estate bubble is not created because people are stupid and decide to take a lot of real estate risk, but because they know or think that it is the least risky asset, that it normally does not go down and that the last thing you stop paying is your mortgage, which is not true because the last thing you stop paying is your electricity.

What happened in the tech bubble of the 1990s? Has technology disappeared? No. Everything Enron did is still being done. In fact, much more is being done. Everything that WorldCom did is being done now. The fact that the valuation of a company goes down does not mean that the underlying, its technology, be it solar, be it a disruptive technology, is going to disappear, but the opposite. What is it that has made solar panels cost 80% less than they did in the middle of the bubble? That there was a bubble. Bubbles are usually very good at destroying the inflationary spiral generated by excess money and low interest rates when they burst and the technology is not lost. The same thing is happening right now.

Therefore, in investment, one should never confuse an underlying asset with a listed company, a sovereign bond with a risk-free asset, high returns with low risk. There is no such thing as a high return with low risk.

Whether we like it or not we are going to have negative real interest rates for a long time to come, because of all these perverse incentives. It is absolutely key that we take advantage of volatile environments to look for the things that are going to give us the best returns in the medium and long term. You have to know what your investment horizon is. Things that go up a lot don't always go up. Things that go up a lot don't always go up. There is a period of maturity and a moment in the life of everything.

We must learn from our mistakes. In our country it seems that no one has ever made a mistake, which gives the impression that everything is relatively easy and profitable. We have to learn from those mistakes and constructively, what goes right and what goes wrong. It is very difficult to know exactly what is the peak of the market and what is the valley. Therefore, as it is very complicated, we have to be aware that every moment generates opportunities. It is very important not to exaggerate the value and growth forms of investing as if they were mantras that solve everything. It depends on our maturity period and what we are going to see over the next few years.

The second and more important lesson is that what doesn't work, doesn't work. The next stimulus plan, whatever it is called, is not going to work. Demographics and monetary policy are much more important and generate much more stagnation.

It is absolutely key that we realise that, when we have made a mistake in something, we have to get it out of the way and look for any other opportunity, there are millions in the market. In other words, you have to let go of the dead weights, which is what does the most damage to an investor's portfolio every day. We must learn from our mistakes, put ourselves in a more realistic environment and never believe that two and two add up to twenty-two.

The Rafael del Pino Foundation is not responsible for the comments, opinions or statements made by the people who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their sole responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio González, are the result of the debates held at the meeting held for this purpose at the Foundation and are the responsibility of the authors.

The Rafael del Pino Foundation is not responsible for any comments, opinions or statements made by third parties. In this respect, the FRP is not obliged to monitor the views expressed by such third parties who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their own responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio J. González, are the result of the discussions that took place during the conference organised for this purpose at the Foundation and are the sole responsibility of its authors.