Market Rotation: The guest highlights a major 2026 theme of rotation out of the U.S. into European and global equities, and from growth toward value and real assets.
AI Narrative Shift: AI moved from unbridled optimism to a nuanced view with clear winners and losers, pressuring software and some AI-linked names while questioning capex payoffs.
Key Mentions: AI infrastructure beneficiaries like Nvidia (NVDA) were cited as early winners, though the discussion underscores growing dispersion across tech and software.
Gold as Safe Asset: A sustained case for gold was discussed, driven by constrained supply, central bank purchases (e.g., China and Poland), and diversification away from U.S. dollar assets.
Emerging Markets: EM stands out with lower inflation than the U.S. and higher real yields, improving relative attractiveness versus U.S. assets and potentially redefining perceptions of safe assets.
Policy Regime Risk: Possible shifts toward fiscal dominance and changes at the Fed could alter liquidity, rates, and asset correlations, with implications for equity, bond, and commodity trends.
Strategy Implications: In a higher-uncertainty, regime-shifting environment, trend following and macro awareness are emphasized, with attention to changing correlations and causality across markets.
Transcript
Imagine [music] spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their [music] failures. Imagine no more. Welcome to Top Traders Unplugged, [music] the place where you can learn from the best hedge fund managers in the world, so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, [music] remember to keep two things in mind. All the discussion we will have about investment performance is about the past and past performance does not guarantee or even infer [music] anything about future performance. Also understand that there's a significant risk of financial loss with all [music] investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran [music] hedge fund manager Neil's Krup Larson. Welcome back to the latest edition of Top Traders Unplugged, where each week we take the pulse of the markets from the perspective of a rules-based investor. It's Alan Dunn here sitting in for Neil's joined by Mark this week. Mark, how are you? >> Not too bad. I was just in Chicago the last couple of days and it was 60° Fahrenheit, which for Chicago in February is quite unusual. >> Very nice. Well, I'm in Dublin. It's been raining non-stop for about I don't know at least two months it feels like. So, uh I'm off to uh Miami next week. Neils is already out there. Obviously, we've got big uh big uh I Connections hedge fund conference. So, a lot of people will be out there. So, if you're there, say hello. Uh but looking forward to that. And obviously uh yeah, hopefully we'll see um I'm no doubt we'll see some sunshine in in Miami. You would expect at this time of year. I'm going to say that there's so many hedge fund managers in in Miami, Florida this time of year. It's almost as though that uh who's minding to shop if everybody's down in Florida. >> That's right. Well, uh yeah, hopefully it'll be a good week. I'm sure it will. Uh lots of um lots of meetings and it'll be very busy. Um we always start off with what's on your radar. Anything out of out of the ordinary catching your attention at the moment? Well, everything seems to be out of the ordinary in the last month since the beginning of the year between all of the bubbles we've had, you know, the craziness and geopolitics. So, so where do we begin? Hard to say. [gasps] >> Fair enough. Well, we'll get to all of that in a minute. Um, I think it makes sense to cover off on performance uh before we get into u the main topics. Um so on the month um trend following and managed features continuing its recent uh good streak of performance month to date the sock gen CTA index up 1.1% um and the sock gen trend index slightly better at 1.15% and then year to date pretty much neck and neck both the sock gen CTA index and so trend index up 5.9% uh on the year so it's obviously been a good period this month obviously yeah We've seen a bit of a dip down in equities, but continuing to see some some decent moves on the commodity side, I would say. Obviously, gold higher on the month, and that's been a big trend in the softs, uh the likes of cocoa and coffee, uh trending to the downside, energy markets, uh starting to move up. Um and then elsewhere, obviously, currencies probably a bit more choppy and and US bonds obviously moving up trending in the last while. But obviously it's been good good period not just this month last month but for a few months. Mark um any thoughts on how performance has evolved more recently and the last few months? >> Well it's interesting is that I'd like to say that after January we may have hit at least in the metals and maybe some of the other markets what I'll call a peak bubble. And when you think about it is is that we had this the spike in gold and we and silver. We've had a little bit of reversal. What's really crazy is if you look at some of the softs, uh if you look at uh uh what happened to cocoa in the last year or so, we've gone from uh from a 12 handle down to four uh which is just and the same with coffee. It's it's just been a tremendous move. And this is what we see repeatedly that with a lot of bubbles is is that you could have a a blowoff top that you might have some correction and then sometimes that they'll just slowly you know just you know uh grind lower and this is where a lot of trend followers can make money on both sides of the market. market goes higher, you know, you you take on a little of that speculative uh uh fever on the upside, then if you can learn to get out at near the tops, then you can also play it on the other side. >> Absolutely. Yeah. And that's certainly the the case as you say with cocoa coffee and obviously crude oil in that big move up back in the 2000s as well was another example of of those kind of extreme moves. But um yeah, I mean it's interesting um you know mentioning bubble uh and and and I know you in your notes in preparation for today you're talking about peak bubble. I mean coming into here and over the last few months there's been a lot of talk about you know bubbles in the market and tech stock etc. And obviously a lot of the momentum has already come out of that. So are we are we is this a pose you think or are we in the midst of the initial deflating do you think? >> Well it's hard to say. uh because you have to go back to what causes bubbles in the first place. So, so you're you're going to need sort of the fuel which is excess money which I think we still have >> but you also need a narrative and a story associated with a bubble. What what we find with a lot of uh uh bubbles is is that it's it's for those assets that are very hard to value because if they're hard to value then you could be able to get stories or narratives that lead to extreme price moves. Now an interesting piece of research that studying it was talked about the uh retail habitat. So, so the these analysts have looked at retail investors and sort of said what seems to be their characteristics. So, one of their characteristics is is that they actually gravitate to hardto value stocks. So, so stocks and other assets that are hard to value then if they have an optimistic narrative then they could lead to sort of extremes. So, so that's what we sort of see with uh with a lot of uh you know tech stocks. If you don't know what how to discount the future cash flows from these firms that it's harder to value, you could be extremely optimistic and that leads to you know bubbles in the commodities markets. I think we're in a different situation is this is that uh people sometimes forget that a lot of commodities especially if it's uh not an annual crop this is is that that there supply constraints for mining for example supply constraints. So if you have some optimistic euphoria whether it be in silver or gold where are you going to get the supply is the supply is constrained so you could have these demand shocks and that's what we've seen with the uh with the gold market in the silver market is is that we're not going to see new supply and in fact we'll say to say some of the uh discount in and gold from the high is just related to the fact that there are fewer retail investors right now because of the Chinese lunar new year. >> Okay. Interesting. Well, as you say, you know, gravitating to her to value um markets certainly makes sense. The tech stocks, crypto, and obviously there's been a lot of retail participation in the gold market of late. Um I was looking at some data there uh from the World Gold Council and they were highlighting, you know, obviously central bank buying has been an important theme, but it's been less. it was less in 2025 than 2024 and certainly ETF flow was was very much the dominant driver in the latter part of the year. So that's very much consistent with you know much more retail participation and obviously as prices rise uh that that encourages new entrance into the market. So um I think that's definitely uh fair there. where the central bank issue is ve uh is very central to gold markets and we we'll talk about this a little bit later when we talk about the US dollar and US assets is a safe asset is that those countries that feel as though that there might be a potential risk of sanctions have been bigger buyers their central banks have been bigger buyers than other central banks. So we'll say China has been a big uh central bank buyer. Some of some of the other countries that we know that you know are worried about sanctions from the US have been bigger central bank buyers. Some are on the periphery of where there could be war like Poland has been a big buyer of of of uh gold. And so we'll sort of see that this is a serving as a as a quasi safe asset. So if you have uh foreign reserves or you have your excess reserves if you're a central bank say like well if I don't want to put in dollar where else can I put my money may end you say like well if I diversify I should put some in gold this is what we've seen has changed >> yeah no for sure and you're right I mean the data I looked at uh I think it had the national bank of Poland was the largest buyer in that um period and also a lot of the former Soviet uh countries is ending in Stan places that are hard to pronounce but [laughter] there not just as Beckistan but other places um like that so that's certainly consistent with what you're saying now interestingly you touched on narrative there which I think is quite interesting and obviously something that we're seeing in markets at the moment is a shift in the narrative around AI and you know if we went back you know 12 months maybe you know AI was seen as a positive influence you know it's going to change the world it was all positive of more more spending was a good thing. It was going to benefit the likes of Nvidia and uh all of those kind of uh chips and infrastructure providers. Obviously, that's shifted as we've come into this year. We've had the uh the SAS pop pop apocalypse. I struggle to get that one out, [laughter] the software selloff. And um and I suppose more generally, you know, that shift in the narrative to the fact that there, you know, clearly there will be winners and losers from this um AI revolution. That's one thing and then secondly obviously in terms of market reaction to earnings numbers and um you know the releases about the amount of uh capex spending uh around AI. So just curious to get your take on that shifting narrative. I mean what does that suggest to you in terms of is that you know symptomatic of of of more of the end of this move or just a different transition or different phase of of the move? Well, let's talk about what I mean by the word narrative. So, when we say the word narrative, often time we say, well, we think of it as a a story, which is true, but I think that narrative is is a is the use of storytelling when we don't have what we'll call countable risk. >> So, so let's say that there's a difference between risk and uncertainty. So, a risk is something that's measurable. I can count it. So that that would be our volatility. So if you say, well, what's the volatility market? You say, let's look at the VIX. Okay, it's something that's countable. I could even though that's a market expectation from the options market. So but then there's an uh uncertainty is that which is not countable. Okay, because I don't [clears throat] have any past events I could look to. So when I think of of uh AI and the AI revolution is is that since I this is new technology I don't have a way to actually measure the countable uh risk. So therefore I have I'm in the realm of uncountable which is uncertainty and there therefore I have to use narrative and then when I use the narrative I have to come up with a metaphor or story for what I think might happen in the future and in this particular case is is they say like well I have to discount sort of say the potential use of AI in in the future and we'll sort of say that AI is revolution a lot of our behavior. It's going to revolutionize a lot of businesses. It's going to increase productivity. But is the growth going to be what is embedded right now in expectations or is it going to be a little bit lower? Is it going to be a little bit higher? And because we can't sort of count that, that's where the narrative issue comes in is that you could have a very optimistic narrative and uh that uh and then discount the price with those uh values or it may be something in between uh you know a failure and and these overly optimistic forecasts. >> We've kind of fallen into more of a rangy markets particularly with respect to equities in the last while. I mean if you look at performance say over the last four four weeks or so bonds have actually gone up equities come down a little bit you know you had the the the the kind of the the the escalation of the runup in metals and then a correction currencies have been ranging so nothing um I suppose underneath maybe the big theme has been the rotation in markets is that is that probably fair to say >> no absolutely and I think this is where when we talk about what are the major themes in u uh in the marketplace we'll sort of say that uh rotation is probably the major theme for 2026. And so the rotation has been out of the US into European and in and global stocks, it's been out of, you know, US bonds to some degree or now when we say out of bonds, we want to be precise. There has been a lot of buying of of of US bonds even by foreign investors but at this particular time a lot of them are now hedging those bonds as opposed to unhedged and we see US pension funds flows moving from the US and to outside the United States and so that's where the rotation comes in. We're seeing the difference in let's say uh software companies have have fallen more real asset companies have gone up the sort of the AI stocks have have have fallen also bec and then we'll sort of say that there's been uh more you know uh buying across the diverse set of companies than what we saw in 2025 which where everything was more concentrated >> and I mean one of the interesting features has been if you look at it from more of a sectoral perspective, you know, you've seen maybe industrials and materials which would be kind of typically seen as cyclical sectors doing well and at the same time uh consumer staples doing well which would be typically more kind of um defensive stock. So I mean from that lens a bit of an inconsistency I guess we are seeing a rotation out of growth into value but I mean is it is there I suppose a coherent story around that narrative apart from okay you're I hear what you're saying about out of the US and Europe which is underpinned by a fairly obvious kind of story but the other rotations um what's driving those you think >> well it let's go back to some of the facts that we sort of see uh one is this is that and and I'm I I'll be leading the witness. This is it. What do you think of uh uh the US inflation relative to emerging market inflation? Which which do you think is is is higher or lower right now? >> Well, you wouldn't guess US, but but I'm guessing this is a a trick question. So yeah, that's a it's sort of a trick question, but I I found this very amazing that that if you look at a you know basket of em countries and then you look at their inflation, it's actually lower than US inflation even now. So obviously US inflation was peaking after the pandemic but what we'll sort of say that even now is is that US inflation at even at around 3% is you know our core inflation is higher than what we're seeing in emerging market countries. So this is a really big theme because what that means is is that uh em is much more attractive than the US you know just just from the inflation story. Okay. So that's going to cause cause a rotation. So if you see that kind of behavior going on, then you have to say, well, what's really going on? And and I think that the major theme that I see is this twofactor is is that we have this K-shaped economy uh where we have very difference between the real economy and then the asset economy in the US. And that's being played out in the behavior of assets such as stocks and bonds around the world. >> And I mean you talked on touch on the uh EM inflation versus US inflation. And I guess what one of the upshots of that is that real yields in in EM are higher and more attractive um that than in in the US. And I mean I suppose you know linked to this is I suppose historically the em had a premium because policy was less credible. You know central banks were less independent etc. Uh they weren't as rigidly pursuing inflation targeting but now everything is shifting. They're kind of more adhering to those uh inflation targets whereas credibility is maybe diminishing in the US. So I suppose is that relative attractiveness of of US versus EM shifting? >> Yes, I think the uh the there's the attractiveness is shifting and and and we'll just sort of say that part of this has to do with the uh uh major story of uncertainty. Now I follow pretty closely that you have trade uncertainty indices, we have uh geopolitical uncertainty, monetary uncertainty. Now some of those have peaked in the fall. So, and some of them have come down, but let's say trade uncertainty is still at very high levels. Overall uncertainty is high, although it's it's again it's it's come off its peak. But when there's more uncertainty in let's say a G7 country or in particular the US, that's going to have an impact on whether you know foreign investors or even US investors look at US as a safe asset. So, so that's on one level. And also, if there's more uncertainty, you'd say like, well, I'm going to need a premium to hold a risky asset in a high uncertain country versus a less uncertain country. And so, we're also seeing uh sort of flows going out there because you say like, well, maybe I could discount those cash flows better in other countries than the US right now. Just on this EM issue, I mean, is this a structural change, do you think, or are we just at a point in time where this is um a sweet spot for EM? And I'm I'm kind of thinking in terms of the overall regime that we're in at the moment. Obviously, it's, you know, it's it's a changed economic regime from what we were in in the 2010s, which was secular stagnation. Obviously, we we're in a higher nominal GDP environment or more inflation uncertainty. There's various features from an economic perspective, but we're also seeing this shift in the relative attractiveness of of EM debt versus say developed or particularly US debt. But is um I mean could could could em sovereigns be seen as the new safe assets really or mean once we get to the next crisis will all of this unravel? Well, uh, I'm spending more time thinking about, uh, the concept of a safe asset as a relative concept as opposed to an absolute concept. I think a lot of people when they think about a safe asset well they they've always viewed as the US dollar or or treasuries as a safe asset and then it was as absolute and I think now we have to think of uh uh safety as a relative concept is is that you could still be a safe asset the US treasury but it might be less safe than it was a year ago or two years ago. So consequently is is that if there's uh your relative safety has gone down even though on an absolute basis you're safe then that means that people are going to diversify more of their asset flows. Have have we seen a fundamental shift in in EM? Uh I'm that's probably not my area of expertise and I think that those are longer term structural changes, but we do see a situation is is that the relative safety or the view of the relative safety of US assets has fallen. >> Yeah, fair enough. I mean, it is something I've been thinking about. I mean, you do hear this comment sometimes, oh, bonds are not going to diversify equities anymore. Um, you know, look at the bond equity correlation, but it's very it's very definitive when you say it like that. Whereas I I don't think that's the case. I mean, there you can certainly envisage certain scenarios where we have crises, the Fed cuts rate aggressively and bonds rally while equities go down and bonds do diversify. So, you know, I would thinking more, as you say, like kind of less safe or less reliable as a diversifier, but not it's not yes or no. It's more less um less so than in the past. >> Well, this is the the key overall theme is this is you say like uh you know, obviously I'm trend follower, a strong believer in trend follower, but also global macro guy. And the reason why I I am a global macro person is because I think we go through regime changes or there there are different regimes that we might be in where relationships change through time and by being aware of we'll call it the you know regime changes or how all of our analysis is conditional then you might be able to get an edge and how you should form your portfolios or where you think that the opportunities might exist. No, I was going to start with a quote the uh you earlier you in our our podcast. This is at uh that was from Peter Lynch from Fidelity. This is is at that and I worked for uh Fidelity for a number of years but uh I don't believe this quote but I thought it was a great one. He said that if you spend 14 minutes on uh on macro then that's 12 minutes too long. So So I don't know if I actually believe that. I think you should use the whole 14 minutes or maybe more to spend time on macro. But I think that there is this view is that that you don't need to know what's going on in the global macroeconomy. And I'll I'll take the opposite point of view is is that we do need to do this. That has a big impact on uh all types of assets because most of our asset price relationships are conditional on the environment we live in. And >> yep. You know let's give a simple example. There was an interesting paper I was looking at was talking about stock beta and then if you just look at you know uh what is the beta for an individual stock or what is the beta for you know a given asset and once you break it down into you know you know different regimes whether we're in crisis non crisis recession non-recession is the concept of a beta for a uh individual stock is a fairly fluid one. This is that uh uh and I I remember one uh discussion I was having when I was at John Henry he said like what's the beta for the stock and I said well it's uh uh it's it's this but if we measure it differently we'll get a different beta he goes well what do you mean there's a different beta he said there should be what is the beta and I said like well there isn't a beta it's there are many betas because they they like his hands are you know thrown up in in uh uh in sort of frustration to say like I ask you a simple question can't you give me a simple answer and the answer is no that there are no simple answers now that could just be because I'm an economist and there's always on the other hand but in some senses is that a lot of our relationships that we see are conditional and that's why we have to spend a lot of time looking at different regimes looking at different environments because that's how we create an edge. >> Yeah. No, fair enough. I I Well, I agree with you. I mean, Peter Lynch was a bottomup uh stock picker. So, I mean, in terms of how he ran money, obviously hugely successfully, he wasn't a macro oriented as investor. But I think for the rest of us, if we're thinking about portfolio construction, certainly good to be cognizant of the macro picture and the regime changes. But just on the regime change, I mean, we always talk about it, you know, that there's a regime change underway and I think you can certainly paint that picture as I say with secular stagnation in the 2010s, delobization, all of that falling inflation, inflation targeting, etc. All of these things that have changed. Now, you could look at the equity market and you wouldn't really see much evidence of a regime shift. You know, it went up back then, it's still going up now. So, nothing there. But it is curious to think about what are the elements where we're seeing that change in in their regime. And so bond the bond equity correlation is is obviously one obvious example of that and we that was very much in 2022. I guess another one is is maybe the the the the US dollar, you know, going uh prior to liberation day, the dollar was kind of strong on on talk of tariffs and it was uh rising on on mount of interest rate differentials and and since then that relationship has been weaker and obviously you could say there's some kind of um negative uh premium or discount or whatever being applied to the dollar maybe for on the basis of credibility etc. And maybe gold is is the flip side of that. You know, historically you would have explained it in terms of real yields and and the uh and the dollar, but obviously it's been accelerating in the last kind of one to two years independent of those factors, you know, driven by central bank buying, ETF buying, etc. I mean, anything else you look at or any other signs that you say see that point to that that are evidence of that regime change, do you think? Well, we can think of uh regime change on a number of different levels is that so you can think of regime changes and use sort of techniques like sort of call like hidden markoff processes to just sort of say like well are we in a uh high valv regime or risk on risk off regime and I'm not saying that those are easier to forecast but we could sort of say that's very data dependent and >> so we do find is that for example is is that if we're in a higher risk regime or higher risk environment that that the behavior different uh strategies and tactics are different than if you're in a low volatility regime and we also do know and and in particular let's look at the VIX. This is what you find is is that the the VIX is a very skewed distribution. We do find this is that once it gets above like 25 and it's and it's moving higher. So it's above a certain threshold level and moving higher is that it's bad news for a lot of assets. So then if it gets to above, you know, around 40 or whatever, then we know it's sort of peaking and then we know it's going to come back the other way and that's good news to get back in. So u so there's a nice nonlinear relationship and we could use sort of like techniques to look at high versus low vol environments. So, so we could do that. There's also regimes when we think about the environment, you know, what type of monetary environment we are and what type of fiscal environment we we're in. So, uh so and we could think about uh you know uh the view of geopolitical if there's high level of uncertainty that's going to change the demand for safe assets. So there's we'll call it the you know priced driven regimes, there's policy structural regimes, there are sentiment regimes. So we can decompose these different types of impacts. And so uh in a uh in a simple podcast we can we can be flipped with our definitions. But when you you look underneath the surface is that you have to decompose this into a lot of different types of regimes and that that's where this is where you could be able to create your edge. So, so by you know sort of decomposing the kind of regimes that you're in. Now we do know for example the stock equity correlation regime which is usually negative is that inflation goes up that usually then that that that stock uh bond correlation is also going to go higher. So it's inflation dependent. So you can use sort of third factors to give us some indication of what kind of environment we're in. And why do we want to look at that? Because if let's say that the stock bond correlation changes, well that has a big impact on what type of alternatives you want to buy is is that if the stock bond correlation is negative and highly negative and rates are, you know, reasonably, you know, high, let me put this way. is that I don't really need to buy alternative strategies. >> But when that correlation starts to go positive and rates are lower, they say like, well, that's a great time to own a lot of hedge fund strategies or other types of strategies. So that's a perfect example where we could use sort of regime analysis to help us build portfolios. how we look at and then from a you know we'll say a more micro basis is is that we know that when we build portfolios even based on trends the correlation relationships may have a big impact on the kind of risk exposures we have. So knowing the regime that we're in could help us you know on the margin change our our our tilts and our exposures to make sure that we're not overexposed to one sector versus another. >> [music] [music] >> One of the topics you touched on there was the kind of the the monetary regime and and I think you might have mentioned the fiscal [music] regime but but certainly we're into an era now where you know there is a lot more talk of possible fiscal dominance. I mean people have been thrown around the term fiscal dominance for a while now as if we're here already. We're not I don't think we are quite there yet, but it is obviously a risk because fiscal dominance is when um the debt and deficit levels are so great that they are dictating monetary policy. I know the pressure is on monetary policy at the moment, but but we're not quite there yet. But I mean, taking that angle, that lens, I mean, what would you say about the regime now versus where we were from a kind of a fiscal and monetary dominance perspective? >> Right. Well, I think that this is uh this issue of or at least trying to frame a lot of the discussion about Fed independence frame who is going to be the chairman of the Fed frame you know how so the the tussle between you know let's say the current US administration and the central bank you know has to be looked at through the idea of fiscal versus monetary dominance and so of course there's a political agenda going on here but I think sometimes is that we have to take ourselves away from the politics and look at the economics and try to say is is that what causes this the tension between the Fed and the Treasury Department and so we'll try to take out the administration we'll call it Fed versus Treasury and this is the issue of fiscal versus monetary dominance and in a monetary dominant environment we'll say the Fed could focus on or the central bank can focus on inflation employment regulation And the fiscal focus is just on financing. They say where can I minimize the cost of my debt. That's all I have to worry about. You'll say the Fed could do whatever they want. And in fact, the fiscal side or the Treasury could say, "Yeah, you could follow whatever you're doing because you're objective is full employment. We're just going to then try to pick on the curve where we want to issue our debt and we're going to finance our our our deficits which we don't think are going to be persistent and everybody's happy. Okay. If we have to go into a fiscal dominant situation, well then, you know, the government uh and we'll sort of say that even the central bank even if they're appointed for a long period of time, they're still authorized or they there's oversight by uh Congress. fiscal dominance says that debt is so high that central bank or we're going to put pressure on the central bank to use its powers to control interest rates and then buy up excess debt. You say like, well, is this abnormal? Is this should be shocking? Well, you look at World War II. You know, the the whole idea is is that the Fed kept interest rates low because we were financing huge deficits to pay for the war and then uh they you know they are actively buying you know treasuries. So so this is what happened in World War II post World War II and then we had the Treasury Fed Accord. the Treasury Fed accord said this is that well now that you know we're going to split the Fed and Treasury working in tandem to to lower the cost of financing because in in effect of doing that you raised inflation. Now we're going to allow them to sort of move in different directions. So now what's important here is there been another recent paper about uh debt and then they they talked about debt as a safe asset. So like well that's true except if we're having a war then if you buy debt and if you're in a war scenario because there's a lot of financing of wars and then there's usually inflation because of perhaps pent-up demand after the war ends is that you don't want to be a debt holder. And what these authors actually said is is that the pandemic had all the characteristics of a war. Okay, we had constraint demand. We had excess monetary policy. We sort of, you know, drove down interest rates. We had excess, you know, fiscal polices sort of sort of offset, you know, uh the the war on the pandemic. And so what happens when we came out of that is that well that's why we had a sort of inflation burst because of the excesses of fiscal policy. And so when you think about it, is this is that the excesses from that pandemic war is now we're still having that issue today because in some sense is that we should have said like well all of those spending was temporary. So we should have seen a big budget deficit increase now that the pandemic is over. We should have reversed all all of all of that. If you don't reverse that, well then you have have a problem. And this is where now you have the tussle between the monetary and the fiscal side. >> A lot to get into there. Yes. As you say, you've got this tussle. Um and as you rightly say, I mean it, you know, co was treated just like a war. I mean I mean that was the the the the kind of narrative at the time. And I think in the UK we actually there was actually direct buying of from the um bank of England of bonds issued by the Treasury whereas in the US it wasn't direct buying but it was all but in I mean the the the the um the Treasury issued more debt and and the Fed did more QE and uh um so they didn't buy finance it directly but effectively they did as you say we had a you know surge in deficits which haven't been addressed since then. Um I mean looking at the precedent of uh as you say the 1940s the justification at the time is obviously to try and keep debt financing costs down because you're in a war. It's also a form of financial repression of course as well isn't it? because obviously you you you you pin down long-term rates and you allow inflation to be higher. So bond holders experience negative returns and then ultimately in that scenario the Fed did flex its muscles again and demand its independence back and that's why you had this kind of standoff between the Fed and and the Treasury which ultimately resulted in the Treasury Fed Treasury accord and the Fed got its independence back. So this is all relevant in the current context because people are now saying you've got Kevin Wars and you've got Scott Bessant both uh linked via uh Stanley Ducken Miller interestingly enough but u they obviously already have spoken about a possible new accord but I mean they've spoken about it in some kind of positive light but I mean you know would that be should we interpret that as more financial repression or what do you think that might look like? Well, here's where the situation we're in right now is is that we'll sort of say that the tre current Treasury Department would love for the Fed to lower interest rates. So, because that lowers the cost of debt and then you could use that instead of paying off interest, >> you can use, you know, that money you to for other purposes is that it could be used for other other expenditures. >> Yeah. Uh so here so you have have the desire to do that and and you sort of say well if you can't default on your debt what's the easiest way to reduce the value of your nominal debt is that if you have inflation so so you have a treasury that would sort of say I'd like to have lower interest rate to lower my financing costs. I'd uh I really don't mind if let's say there's a little bit higher in uh inflation even though they'll never say this because that reduces the uh the real value of the debt. So uh and we'll sort of say then you have we'll call it this K-shaped economy. And if you look at you know some of the data on the employment side you can sort of say that I may want to be if I as a current administration I may want to run an economy hotter because I don't believe the data that I have and a perfect example is is that we just had in January the revisions for employment. The revision for employment said that there was probably a a million fewer jobs created because we changed the uh benchmark rating year before. We actually did a seasonal adjustment and we got like lower job produ uh production. So if you sort of said like look we didn't create a million uh jobs in the la last year or so is that the economy may not be doing as well as we expect on the on the one leg of the K. So you may want to say I want to run my economy hotter. Now you could also say that that these benchmark revisions was caused by demographics. And so if let's people are are moving out of the United States uh we call that euphemistically they're moving out of the United States. So you you're you and and you have less people in the workforce. Well then it may not matter as much. So we don't see the unemployment number going higher. But you'd say like there's this tussle between uh fiscal and monetary policy because we do have you know these competing interests. Now the interesting part and the reason how we get back to this recurring theme of always uncertainty is that wor said is that he never really liked QE in the excesses of what we had. So if some sense if he actually you know follows through on what his behavior is he's going to reduce the amount of uh of of treasuries on the Fed balance sheet that's reducing overall liquidity that's going to cause a major deleveraging which should have an impact on asset markets and at the same time is is that it's exactly what the TR treasury does not want them to do. They like the fact that the Fed has a large balance sheet and we'll say like look at the size of the financing is that again you know Allan I throw out these questions just to be provocative you you know you're going to uh it's not the obvious answer like how much debt do you think the US actually issued just last week? You just just take a guess half a trillion or something. So you're you're you're you're close, but you're still off by about $200 billion dollars. Say in one week the Treasury and now we had sort of like some you know quarterly refinancing with this is it and not all of this was new money. Some of this was rolled over but but we we did like a uh $700 billion of treasuries being auctioned in one week. Now that was between uh bills 2 years 10 years. So so it was along the entire curve. So but that's a huge amount of money. This is is that now the the world can absorb that kind of stuff. But if let's say that there was a change in people's you know buying habits for uh for treasuries you like that's a big number. And so and when you think about in one week >> you could do that then you look at the uh size of the balance sheet that's that's a pretty good portion of the entire Fed balance sheet. Now you again we have to look at what is the net new money uh and then what is this total demand from a number of different sources and you can cut you know sort of overnight repos. So, so there's ways to do this, but that's a big number and that that should give people a sense of, you know, what we're dealing with in terms of the size of the issues. >> Yeah. Well, as you say, the the demand is there for at the moment. Uh I mean, you could have to you'd have to look to see where it's coming from. Obviously, that's shifted over time. Maybe it's less foreign. I mean, and also they've they've talked about changing the the the SLR to make it more attractive for banks to hold it. So there there are things but but I mean coming back to Wars I mean his idea is is the smaller balance sheet but equally lower rates. Uh and then I guess the flip shot of all of the upshot of all of that would be uh maybe more TBL issuance to take advantage of lower short-term rates if that's how it played out. Um but but one thing I mean that we're missing in this we're talking about fiscal dominance and you know u so you know central banks are normally targeting inflation and now we're talking about no adjusting rates to to target you know to to to be cognizant of debt but of course that forgets about asset prices. you know, so if we had this scenario of um you know, the the the Fed, you know, being more cognizant of uh debt uh considerations and and lowering rates for for that reason as well. Not only could it be inflationary, but presumably, as you say, it it would run the economy hot and potentially fuel acid bubbles as well, which is um another part of the discussion from the '9s that that kind of is kind of getting lost in in the current debate, I think. >> Well, let's go back to what we started with. We always talk about regime changes. So, first, this is that this could be a regime change. This is that if we get a new Fed chairman because he might have a different view. Now, let me put this way. There could be a regime change because he has the view that is consistent with what he said he was uh is interested, which means is that we have a lower Fed balance sheet. We can say we could also have a regime change is that he's going to sort of follow more of what the Treasury Secretary would like and allow for fiscal dominance. That's a different regime change. So, so uh >> and the other third will will sort of say that if we just continue to follow the path of these large deficits in the US and probably the most interesting piece of research the last couple of years in the macro side hasn't got as much attention as uh John Cochran from the University of Chicago now at the Hoover Institute. So he's ris uh written about the fiscal theory of the price level and so he said like well if we really want to look at this shock to in inflation you know post pandemic we have to look at is it's a it's a fiscal theory of inflation. It's not a monetary theory. Now the two of them were working together but his view is is that you're going to get inflation because people are going to take your money out of uh uh you know going to start to buy real assets as opposed to you know uh debt assets if there's the expectation of permanent large deficits or we'll call it negative surpluses on the fiscal side. So that's going to lead to in inflation. And so uh so what are you going to do is is that you're going to put your money into real assets which we've seen in the gold. If we say that you're going to put it in other uh financial assets, we we're calling this sometimes a bubble because if let's say too much of it goes into one type of assets, but generally financial assets are being bit up because people don't uh you know sort of feel as though that uh you know they may have excess savings. They may not want to buy real assets or they purchase goods. So they they are bidding up financial assets. >> Yeah. I mean it's interesting because um if you go back to last summer, I think it was um Kevin Worsh gave an interview on CNBC. Um we he talked about all of this. He kind of talked about the Fed being slow to raise rates in 2001 2022 as being one of the I think it's the biggest macro forecasting mistake in 40 years. and he he talks about a need for regime change. So he at the Fed but but and he also um blamed he he he saw the Fed as being complicit in the the deficit expansions that we've seen because they've effectively financed it. And he had a definition for inflation of something like inflation happens when the government spends too much and lives too well or something like that which is consistent with the Cochran perspective. Yeah. consistent with this. So, let me put this way. >> It's possible this is that if uh you get the chairman Walsh of his comments over the last 10 years, you know, we'll sort of say the current administration may have no idea what they're really getting. If if if if they if he's the person that they choose and he follows through on what he says he's going to do, we're going to be in a very different monetary regime because we're going to have uh we're going to be cutting back our, you know, our the balance sheet. You could sort of say there's going to be a different view on how we're going to look at interest rates and we say that that may not be inconsistent with what the Treasury Secretary would like. This is so this is uh so when we talk about uncertainty and then we talk about okay why might you want to be a trend follower why do you follow certain strategies this is that I don't think people fully appreciate the amount of uncertainty they could have if let's say you just you know it's almost as though that uh at different times you like uh you you see people in government and you say like I'm surprised by what he did and if you said if I if you just read his speech speeches and you read what he said, you might have a pretty good idea and you would say like this is not what you were expecting. [laughter] >> Well, there is I mean there are different views in this. There is the the kind of the as you say that's a very literal reading of what he's saying, but he has also said that he believes in the um the disinflationary uh effects of AI and uh he sees scope for lower interest rates. So presumably he was emphasizing um those comments when he was doing these interviews at the White House. Um but there's also I mean have you seen those charts that show whether he was uh dovish or hawkish depending on whether it was you know Republicans or or Democrats in power. So so there is a suspicion that he might be a bit more political than than maybe uh than other uh central bankers. we'll say Wall Street and many uh you know voters actually sort of project what they would like to see on a candidate or on someone as opposed to what they see as reality and sometimes they actually then respond to what they think that you know their their constituents want. So yeah u >> so we'll just sort of say there is uncertainty here because we don't know what worsh we're going to get >> yes so u and uh I think that you often see this with supreme court justices is that that's not the current court but if you look historically is it that there are number of supreme court justices that have picked and there is assumed that he was going to behave a certain way and then we say like after he becomes the the justice his behavior is is seems to be significantly different than what they thought that they were getting. So this is the kind of uncertainty you have and so what we're saying be prepared for something that may be different than what you're reading about in the newspapers. >> Yeah, I mean that's fair enough. I mean from a I mean maybe moving it to more of a quant trading perspective. Obviously this is more qualitative but obviously as you say when you do get a regime shift you could get shifts in relationships that would be relevant. Um so how do you think about and obviously the Fed is at the heart of the financial system. So if there was a change in how the Fed is operating um you know whether it's a shifting towards less balance sheet more active in the interest rates or if it's fiscal dominance whatever it is you know that could have pretty widespread implications. So how do you think about that when you're maybe building uh um building models, >> right? Well, what what we one is is that that we've talked about that you want to try to sort of try to pick up regime changes. So so when we we know we have the technology to do that. So, so if we sort of see that uh using let's say the hidden markoff processes, we can be able to sort of say if asset prices start to delink or have a change in behavior like in volatility, we can pick that up and so we can adjust for that. Uh we also know is is that there there are break points in data sets. So, so we have technology to uh to what we call change point detection to sort of see if there's a change or break in a in a in in a time series. So, so now what we could have is now of course you're never going to pick a peak or a trough in a break point because it has to break before you actually then pick it up in the data. But that being said is is that if we're sort of aware that there's these structural changes, then we could be more sensitive to when we look at the data to see if there's a break point. So, so what does that mean is is that one of the things that you know um you know I've been uh work with with uh uh my my friends with uh you know firm we're involved in Zunthor is is that we're looking at uh you know the connections across markets. We think of it the markets as as a connected system. We think of it as a network. And so what we're trying to look for you what are the causal relationships between markets and then sort of say like how have network connections changed through time. And if we see that there are changes in in network connections and we're willing to accept or or adapt to these changes then it's more likely that we could get ahead of it. Now any type of trend following any type of quant model is always sort of looking into the past. Okay. So the question is how fast can we react to the past data or how can we sort of react to uh to these changes as they occur. One of the advantages of being having a macro view is is that when you start to see changes or we expect changes, we could then be more sensitive to say is there something going on in the data that we should be aware of and and we're a highlight. >> Yeah. So I mean is it a case that you would see a shift that is consistent with what you're expecting from a from a macro perspective? Is that it? >> One would hope that it's consistent what what we see in a macro perspective. But what we're finding is is is that and uh we'll sort of say that this is one of the key issues that we're seeing in economics in in general and especially in finance is the issue of trying to identify causality. So this is the number one issue in finance now and we'll sort of say that uh AIA had their uh labs had their causal discovery challenge where they sort of said like you could use different machine learning to look at sort of finding causal relationships. But the reason why this is so important is is that because we over the last couple of years what we have is what we call the factor zoo. uh that you know you look at enough data everybody's finding all these new risk premiums or risk factors in the data and then what you find out is that you find them in the training set or we find them in past history then we look at them in the future and they no longer exist. So they were sort of spurious causality or we are trying to find something that we overfitted or we found something that didn't really exist or it only existed temporarily and then it disappears. So now I said like well look if we're having this we'll call it the factor zoo we're finding also is that well what we find in the data sometimes doesn't persist through time. Well maybe we got to go back to square one and say let's look for what are the important causal agents. Let's look for causal factors and then make sure that see if our models are consistent with the actual data or can we find causal relationships that we need to rethink our models that this is going to improve the amount overall science for quanting. >> Interesting. Um I mean in the current context where is that relevant do you think or what are the ones you know >> we'll say where's uncertain would you say? Well, we'll say this is a work in progress because uh because we we'll sort of say that when we've uh analyzed uh some of the interesting work in machine learning right now is this is that uh uh >> they've they've done some uh some testing and some research where they said like well is it the number of features we look at that gives us value added or is it the complexity of our model? sort of linear versus nonlinear. And you know, the machine learning world says this is that well, you know, we want to add more complex, you know, sort of techniques to try to tease out relationships in data. And what the some of the research is now telling us is is that it's not the complexity of the technique that matters. it's the number of features that we have or it's the domain knowledge we have that actually adds more value so that you know we that if it's an arms raceer choosing you know more complex machine learning techniques we may not get as much value. So, so we talked about peak bubble. >> We'll sort of say that for different techniques there's a while is that everyone thinks that this is going to be the new holy grail and then in reality what we find out is is that it's a lot tougher to come up with a new new model solution than we thought. Another thing we find with machine learning is for example is is that machine learning is very good on stationary data. So uh and I'll use the analogy if uh if we're using machine learning to look at visual interpretations of can we find a picture of a dog. So so we show you know a 100,000 pictures of dogs is after a while it learns how to how to you know find a picture of a of a of a dog in a photo. Okay. Well, if the dog is changing through time, it's uh its characteristics are changing like a market, then we find that it's a lot harder to do this. And so, so a lot of the techniques that have in machine learning that have been very promising in different areas of science science, which has very stationary data, it's been very successful. when we apply these techniques when we're looking at time series data that seems to be more follow an adaptive markets hypothesis which is what Andy Low developed what we find and that we find that agents behavior changes through time we find machine learning is a lot harder to to sort of you know increase its predictive power so markets are complex they're non-stationary they go through regime changes which means means is is that the quest for finding the perfect model is ongoing and we still haven't solved it yet. >> Very good. So I mean it comes back to robustness, doesn't it? I mean obviously what you're suggesting is >> you can't overly optimize given the complex adaptive nature of the system. >> So and and when when you think about okay for your listeners and for a lot of modelers you say well should I tool up for machine learning? uh on the one hand the answer is absolutely you got to know what's going on in AI you have to know what's going on in machine learning at the same time is is that your benchmark standard should be more simpler models so uh so so I don't want to sound like I'm a uh you know talking out of both sides of my mouth but you say like I still believe in in trend following it still seems to say that it works especially in uncertain regimes especially when data is non-stationary at the same time as they say like well how do I always try to uh try to improve on that because so many people are already trend followers so many people are already using similar models so you're always trying to say like how can I look for some small improvements that's going to differentiate myself from everyone else and also give me a predictive edge >> the problem comes in is is that on margin it's sometimes hard to do that Now when we say it's hard to do is is that just when I think that you've solved it come up with a better model markets may change slightly and they go through periods of you know you know strong performance then you get delayed perform or fall in performance and it improves and that's even finding for momentum and trend following. There are periods uh that when it does really well then my period where where it it waines in performance and it goes back and this is what we've seen throughout history. So right now we've had a good uh performance and trend following you know will that persist well I could sort of say over the next five years I could still be a believer in momentum and trend following over the next five months. That's a little bit harder to say. [laughter] [gasps] >> Who knows? Well, we'll we'll we'll be here anyway to evaluate that over the next five months. So, we we we shall see. But, um yeah, thanks very much. Oh, thanks very much for your thoughts, Mark. Great to catch up and uh get your perspective on all of that. Um I'll be back again actually next week. I'll be back uh from Miami in time to record with Jim. So, if you have any questions, please get them into us. Uh but until then from all of us here on Top Traders Unplugged, stay tuned and we'll be back again with more content. 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AI Bubble Peak? | Systematic Investor | Ep.388
Summary
Transcript
Imagine [music] spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their [music] failures. Imagine no more. Welcome to Top Traders Unplugged, [music] the place where you can learn from the best hedge fund managers in the world, so you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, [music] remember to keep two things in mind. All the discussion we will have about investment performance is about the past and past performance does not guarantee or even infer [music] anything about future performance. Also understand that there's a significant risk of financial loss with all [music] investment strategies and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran [music] hedge fund manager Neil's Krup Larson. Welcome back to the latest edition of Top Traders Unplugged, where each week we take the pulse of the markets from the perspective of a rules-based investor. It's Alan Dunn here sitting in for Neil's joined by Mark this week. Mark, how are you? >> Not too bad. I was just in Chicago the last couple of days and it was 60° Fahrenheit, which for Chicago in February is quite unusual. >> Very nice. Well, I'm in Dublin. It's been raining non-stop for about I don't know at least two months it feels like. So, uh I'm off to uh Miami next week. Neils is already out there. Obviously, we've got big uh big uh I Connections hedge fund conference. So, a lot of people will be out there. So, if you're there, say hello. Uh but looking forward to that. And obviously uh yeah, hopefully we'll see um I'm no doubt we'll see some sunshine in in Miami. You would expect at this time of year. I'm going to say that there's so many hedge fund managers in in Miami, Florida this time of year. It's almost as though that uh who's minding to shop if everybody's down in Florida. >> That's right. Well, uh yeah, hopefully it'll be a good week. I'm sure it will. Uh lots of um lots of meetings and it'll be very busy. Um we always start off with what's on your radar. Anything out of out of the ordinary catching your attention at the moment? Well, everything seems to be out of the ordinary in the last month since the beginning of the year between all of the bubbles we've had, you know, the craziness and geopolitics. So, so where do we begin? Hard to say. [gasps] >> Fair enough. Well, we'll get to all of that in a minute. Um, I think it makes sense to cover off on performance uh before we get into u the main topics. Um so on the month um trend following and managed features continuing its recent uh good streak of performance month to date the sock gen CTA index up 1.1% um and the sock gen trend index slightly better at 1.15% and then year to date pretty much neck and neck both the sock gen CTA index and so trend index up 5.9% uh on the year so it's obviously been a good period this month obviously yeah We've seen a bit of a dip down in equities, but continuing to see some some decent moves on the commodity side, I would say. Obviously, gold higher on the month, and that's been a big trend in the softs, uh the likes of cocoa and coffee, uh trending to the downside, energy markets, uh starting to move up. Um and then elsewhere, obviously, currencies probably a bit more choppy and and US bonds obviously moving up trending in the last while. But obviously it's been good good period not just this month last month but for a few months. Mark um any thoughts on how performance has evolved more recently and the last few months? >> Well it's interesting is that I'd like to say that after January we may have hit at least in the metals and maybe some of the other markets what I'll call a peak bubble. And when you think about it is is that we had this the spike in gold and we and silver. We've had a little bit of reversal. What's really crazy is if you look at some of the softs, uh if you look at uh uh what happened to cocoa in the last year or so, we've gone from uh from a 12 handle down to four uh which is just and the same with coffee. It's it's just been a tremendous move. And this is what we see repeatedly that with a lot of bubbles is is that you could have a a blowoff top that you might have some correction and then sometimes that they'll just slowly you know just you know uh grind lower and this is where a lot of trend followers can make money on both sides of the market. market goes higher, you know, you you take on a little of that speculative uh uh fever on the upside, then if you can learn to get out at near the tops, then you can also play it on the other side. >> Absolutely. Yeah. And that's certainly the the case as you say with cocoa coffee and obviously crude oil in that big move up back in the 2000s as well was another example of of those kind of extreme moves. But um yeah, I mean it's interesting um you know mentioning bubble uh and and and I know you in your notes in preparation for today you're talking about peak bubble. I mean coming into here and over the last few months there's been a lot of talk about you know bubbles in the market and tech stock etc. And obviously a lot of the momentum has already come out of that. So are we are we is this a pose you think or are we in the midst of the initial deflating do you think? >> Well it's hard to say. uh because you have to go back to what causes bubbles in the first place. So, so you're you're going to need sort of the fuel which is excess money which I think we still have >> but you also need a narrative and a story associated with a bubble. What what we find with a lot of uh uh bubbles is is that it's it's for those assets that are very hard to value because if they're hard to value then you could be able to get stories or narratives that lead to extreme price moves. Now an interesting piece of research that studying it was talked about the uh retail habitat. So, so the these analysts have looked at retail investors and sort of said what seems to be their characteristics. So, one of their characteristics is is that they actually gravitate to hardto value stocks. So, so stocks and other assets that are hard to value then if they have an optimistic narrative then they could lead to sort of extremes. So, so that's what we sort of see with uh with a lot of uh you know tech stocks. If you don't know what how to discount the future cash flows from these firms that it's harder to value, you could be extremely optimistic and that leads to you know bubbles in the commodities markets. I think we're in a different situation is this is that uh people sometimes forget that a lot of commodities especially if it's uh not an annual crop this is is that that there supply constraints for mining for example supply constraints. So if you have some optimistic euphoria whether it be in silver or gold where are you going to get the supply is the supply is constrained so you could have these demand shocks and that's what we've seen with the uh with the gold market in the silver market is is that we're not going to see new supply and in fact we'll say to say some of the uh discount in and gold from the high is just related to the fact that there are fewer retail investors right now because of the Chinese lunar new year. >> Okay. Interesting. Well, as you say, you know, gravitating to her to value um markets certainly makes sense. The tech stocks, crypto, and obviously there's been a lot of retail participation in the gold market of late. Um I was looking at some data there uh from the World Gold Council and they were highlighting, you know, obviously central bank buying has been an important theme, but it's been less. it was less in 2025 than 2024 and certainly ETF flow was was very much the dominant driver in the latter part of the year. So that's very much consistent with you know much more retail participation and obviously as prices rise uh that that encourages new entrance into the market. So um I think that's definitely uh fair there. where the central bank issue is ve uh is very central to gold markets and we we'll talk about this a little bit later when we talk about the US dollar and US assets is a safe asset is that those countries that feel as though that there might be a potential risk of sanctions have been bigger buyers their central banks have been bigger buyers than other central banks. So we'll say China has been a big uh central bank buyer. Some of some of the other countries that we know that you know are worried about sanctions from the US have been bigger central bank buyers. Some are on the periphery of where there could be war like Poland has been a big buyer of of of uh gold. And so we'll sort of see that this is a serving as a as a quasi safe asset. So if you have uh foreign reserves or you have your excess reserves if you're a central bank say like well if I don't want to put in dollar where else can I put my money may end you say like well if I diversify I should put some in gold this is what we've seen has changed >> yeah no for sure and you're right I mean the data I looked at uh I think it had the national bank of Poland was the largest buyer in that um period and also a lot of the former Soviet uh countries is ending in Stan places that are hard to pronounce but [laughter] there not just as Beckistan but other places um like that so that's certainly consistent with what you're saying now interestingly you touched on narrative there which I think is quite interesting and obviously something that we're seeing in markets at the moment is a shift in the narrative around AI and you know if we went back you know 12 months maybe you know AI was seen as a positive influence you know it's going to change the world it was all positive of more more spending was a good thing. It was going to benefit the likes of Nvidia and uh all of those kind of uh chips and infrastructure providers. Obviously, that's shifted as we've come into this year. We've had the uh the SAS pop pop apocalypse. I struggle to get that one out, [laughter] the software selloff. And um and I suppose more generally, you know, that shift in the narrative to the fact that there, you know, clearly there will be winners and losers from this um AI revolution. That's one thing and then secondly obviously in terms of market reaction to earnings numbers and um you know the releases about the amount of uh capex spending uh around AI. So just curious to get your take on that shifting narrative. I mean what does that suggest to you in terms of is that you know symptomatic of of of more of the end of this move or just a different transition or different phase of of the move? Well, let's talk about what I mean by the word narrative. So, when we say the word narrative, often time we say, well, we think of it as a a story, which is true, but I think that narrative is is a is the use of storytelling when we don't have what we'll call countable risk. >> So, so let's say that there's a difference between risk and uncertainty. So, a risk is something that's measurable. I can count it. So that that would be our volatility. So if you say, well, what's the volatility market? You say, let's look at the VIX. Okay, it's something that's countable. I could even though that's a market expectation from the options market. So but then there's an uh uncertainty is that which is not countable. Okay, because I don't [clears throat] have any past events I could look to. So when I think of of uh AI and the AI revolution is is that since I this is new technology I don't have a way to actually measure the countable uh risk. So therefore I have I'm in the realm of uncountable which is uncertainty and there therefore I have to use narrative and then when I use the narrative I have to come up with a metaphor or story for what I think might happen in the future and in this particular case is is they say like well I have to discount sort of say the potential use of AI in in the future and we'll sort of say that AI is revolution a lot of our behavior. It's going to revolutionize a lot of businesses. It's going to increase productivity. But is the growth going to be what is embedded right now in expectations or is it going to be a little bit lower? Is it going to be a little bit higher? And because we can't sort of count that, that's where the narrative issue comes in is that you could have a very optimistic narrative and uh that uh and then discount the price with those uh values or it may be something in between uh you know a failure and and these overly optimistic forecasts. >> We've kind of fallen into more of a rangy markets particularly with respect to equities in the last while. I mean if you look at performance say over the last four four weeks or so bonds have actually gone up equities come down a little bit you know you had the the the the kind of the the the escalation of the runup in metals and then a correction currencies have been ranging so nothing um I suppose underneath maybe the big theme has been the rotation in markets is that is that probably fair to say >> no absolutely and I think this is where when we talk about what are the major themes in u uh in the marketplace we'll sort of say that uh rotation is probably the major theme for 2026. And so the rotation has been out of the US into European and in and global stocks, it's been out of, you know, US bonds to some degree or now when we say out of bonds, we want to be precise. There has been a lot of buying of of of US bonds even by foreign investors but at this particular time a lot of them are now hedging those bonds as opposed to unhedged and we see US pension funds flows moving from the US and to outside the United States and so that's where the rotation comes in. We're seeing the difference in let's say uh software companies have have fallen more real asset companies have gone up the sort of the AI stocks have have have fallen also bec and then we'll sort of say that there's been uh more you know uh buying across the diverse set of companies than what we saw in 2025 which where everything was more concentrated >> and I mean one of the interesting features has been if you look at it from more of a sectoral perspective, you know, you've seen maybe industrials and materials which would be kind of typically seen as cyclical sectors doing well and at the same time uh consumer staples doing well which would be typically more kind of um defensive stock. So I mean from that lens a bit of an inconsistency I guess we are seeing a rotation out of growth into value but I mean is it is there I suppose a coherent story around that narrative apart from okay you're I hear what you're saying about out of the US and Europe which is underpinned by a fairly obvious kind of story but the other rotations um what's driving those you think >> well it let's go back to some of the facts that we sort of see uh one is this is that and and I'm I I'll be leading the witness. This is it. What do you think of uh uh the US inflation relative to emerging market inflation? Which which do you think is is is higher or lower right now? >> Well, you wouldn't guess US, but but I'm guessing this is a a trick question. So yeah, that's a it's sort of a trick question, but I I found this very amazing that that if you look at a you know basket of em countries and then you look at their inflation, it's actually lower than US inflation even now. So obviously US inflation was peaking after the pandemic but what we'll sort of say that even now is is that US inflation at even at around 3% is you know our core inflation is higher than what we're seeing in emerging market countries. So this is a really big theme because what that means is is that uh em is much more attractive than the US you know just just from the inflation story. Okay. So that's going to cause cause a rotation. So if you see that kind of behavior going on, then you have to say, well, what's really going on? And and I think that the major theme that I see is this twofactor is is that we have this K-shaped economy uh where we have very difference between the real economy and then the asset economy in the US. And that's being played out in the behavior of assets such as stocks and bonds around the world. >> And I mean you talked on touch on the uh EM inflation versus US inflation. And I guess what one of the upshots of that is that real yields in in EM are higher and more attractive um that than in in the US. And I mean I suppose you know linked to this is I suppose historically the em had a premium because policy was less credible. You know central banks were less independent etc. Uh they weren't as rigidly pursuing inflation targeting but now everything is shifting. They're kind of more adhering to those uh inflation targets whereas credibility is maybe diminishing in the US. So I suppose is that relative attractiveness of of US versus EM shifting? >> Yes, I think the uh the there's the attractiveness is shifting and and and we'll just sort of say that part of this has to do with the uh uh major story of uncertainty. Now I follow pretty closely that you have trade uncertainty indices, we have uh geopolitical uncertainty, monetary uncertainty. Now some of those have peaked in the fall. So, and some of them have come down, but let's say trade uncertainty is still at very high levels. Overall uncertainty is high, although it's it's again it's it's come off its peak. But when there's more uncertainty in let's say a G7 country or in particular the US, that's going to have an impact on whether you know foreign investors or even US investors look at US as a safe asset. So, so that's on one level. And also, if there's more uncertainty, you'd say like, well, I'm going to need a premium to hold a risky asset in a high uncertain country versus a less uncertain country. And so, we're also seeing uh sort of flows going out there because you say like, well, maybe I could discount those cash flows better in other countries than the US right now. Just on this EM issue, I mean, is this a structural change, do you think, or are we just at a point in time where this is um a sweet spot for EM? And I'm I'm kind of thinking in terms of the overall regime that we're in at the moment. Obviously, it's, you know, it's it's a changed economic regime from what we were in in the 2010s, which was secular stagnation. Obviously, we we're in a higher nominal GDP environment or more inflation uncertainty. There's various features from an economic perspective, but we're also seeing this shift in the relative attractiveness of of EM debt versus say developed or particularly US debt. But is um I mean could could could em sovereigns be seen as the new safe assets really or mean once we get to the next crisis will all of this unravel? Well, uh, I'm spending more time thinking about, uh, the concept of a safe asset as a relative concept as opposed to an absolute concept. I think a lot of people when they think about a safe asset well they they've always viewed as the US dollar or or treasuries as a safe asset and then it was as absolute and I think now we have to think of uh uh safety as a relative concept is is that you could still be a safe asset the US treasury but it might be less safe than it was a year ago or two years ago. So consequently is is that if there's uh your relative safety has gone down even though on an absolute basis you're safe then that means that people are going to diversify more of their asset flows. Have have we seen a fundamental shift in in EM? Uh I'm that's probably not my area of expertise and I think that those are longer term structural changes, but we do see a situation is is that the relative safety or the view of the relative safety of US assets has fallen. >> Yeah, fair enough. I mean, it is something I've been thinking about. I mean, you do hear this comment sometimes, oh, bonds are not going to diversify equities anymore. Um, you know, look at the bond equity correlation, but it's very it's very definitive when you say it like that. Whereas I I don't think that's the case. I mean, there you can certainly envisage certain scenarios where we have crises, the Fed cuts rate aggressively and bonds rally while equities go down and bonds do diversify. So, you know, I would thinking more, as you say, like kind of less safe or less reliable as a diversifier, but not it's not yes or no. It's more less um less so than in the past. >> Well, this is the the key overall theme is this is you say like uh you know, obviously I'm trend follower, a strong believer in trend follower, but also global macro guy. And the reason why I I am a global macro person is because I think we go through regime changes or there there are different regimes that we might be in where relationships change through time and by being aware of we'll call it the you know regime changes or how all of our analysis is conditional then you might be able to get an edge and how you should form your portfolios or where you think that the opportunities might exist. No, I was going to start with a quote the uh you earlier you in our our podcast. This is at uh that was from Peter Lynch from Fidelity. This is is at that and I worked for uh Fidelity for a number of years but uh I don't believe this quote but I thought it was a great one. He said that if you spend 14 minutes on uh on macro then that's 12 minutes too long. So So I don't know if I actually believe that. I think you should use the whole 14 minutes or maybe more to spend time on macro. But I think that there is this view is that that you don't need to know what's going on in the global macroeconomy. And I'll I'll take the opposite point of view is is that we do need to do this. That has a big impact on uh all types of assets because most of our asset price relationships are conditional on the environment we live in. And >> yep. You know let's give a simple example. There was an interesting paper I was looking at was talking about stock beta and then if you just look at you know uh what is the beta for an individual stock or what is the beta for you know a given asset and once you break it down into you know you know different regimes whether we're in crisis non crisis recession non-recession is the concept of a beta for a uh individual stock is a fairly fluid one. This is that uh uh and I I remember one uh discussion I was having when I was at John Henry he said like what's the beta for the stock and I said well it's uh uh it's it's this but if we measure it differently we'll get a different beta he goes well what do you mean there's a different beta he said there should be what is the beta and I said like well there isn't a beta it's there are many betas because they they like his hands are you know thrown up in in uh uh in sort of frustration to say like I ask you a simple question can't you give me a simple answer and the answer is no that there are no simple answers now that could just be because I'm an economist and there's always on the other hand but in some senses is that a lot of our relationships that we see are conditional and that's why we have to spend a lot of time looking at different regimes looking at different environments because that's how we create an edge. >> Yeah. No, fair enough. I I Well, I agree with you. I mean, Peter Lynch was a bottomup uh stock picker. So, I mean, in terms of how he ran money, obviously hugely successfully, he wasn't a macro oriented as investor. But I think for the rest of us, if we're thinking about portfolio construction, certainly good to be cognizant of the macro picture and the regime changes. But just on the regime change, I mean, we always talk about it, you know, that there's a regime change underway and I think you can certainly paint that picture as I say with secular stagnation in the 2010s, delobization, all of that falling inflation, inflation targeting, etc. All of these things that have changed. Now, you could look at the equity market and you wouldn't really see much evidence of a regime shift. You know, it went up back then, it's still going up now. So, nothing there. But it is curious to think about what are the elements where we're seeing that change in in their regime. And so bond the bond equity correlation is is obviously one obvious example of that and we that was very much in 2022. I guess another one is is maybe the the the the US dollar, you know, going uh prior to liberation day, the dollar was kind of strong on on talk of tariffs and it was uh rising on on mount of interest rate differentials and and since then that relationship has been weaker and obviously you could say there's some kind of um negative uh premium or discount or whatever being applied to the dollar maybe for on the basis of credibility etc. And maybe gold is is the flip side of that. You know, historically you would have explained it in terms of real yields and and the uh and the dollar, but obviously it's been accelerating in the last kind of one to two years independent of those factors, you know, driven by central bank buying, ETF buying, etc. I mean, anything else you look at or any other signs that you say see that point to that that are evidence of that regime change, do you think? Well, we can think of uh regime change on a number of different levels is that so you can think of regime changes and use sort of techniques like sort of call like hidden markoff processes to just sort of say like well are we in a uh high valv regime or risk on risk off regime and I'm not saying that those are easier to forecast but we could sort of say that's very data dependent and >> so we do find is that for example is is that if we're in a higher risk regime or higher risk environment that that the behavior different uh strategies and tactics are different than if you're in a low volatility regime and we also do know and and in particular let's look at the VIX. This is what you find is is that the the VIX is a very skewed distribution. We do find this is that once it gets above like 25 and it's and it's moving higher. So it's above a certain threshold level and moving higher is that it's bad news for a lot of assets. So then if it gets to above, you know, around 40 or whatever, then we know it's sort of peaking and then we know it's going to come back the other way and that's good news to get back in. So u so there's a nice nonlinear relationship and we could use sort of like techniques to look at high versus low vol environments. So, so we could do that. There's also regimes when we think about the environment, you know, what type of monetary environment we are and what type of fiscal environment we we're in. So, uh so and we could think about uh you know uh the view of geopolitical if there's high level of uncertainty that's going to change the demand for safe assets. So there's we'll call it the you know priced driven regimes, there's policy structural regimes, there are sentiment regimes. So we can decompose these different types of impacts. And so uh in a uh in a simple podcast we can we can be flipped with our definitions. But when you you look underneath the surface is that you have to decompose this into a lot of different types of regimes and that that's where this is where you could be able to create your edge. So, so by you know sort of decomposing the kind of regimes that you're in. Now we do know for example the stock equity correlation regime which is usually negative is that inflation goes up that usually then that that that stock uh bond correlation is also going to go higher. So it's inflation dependent. So you can use sort of third factors to give us some indication of what kind of environment we're in. And why do we want to look at that? Because if let's say that the stock bond correlation changes, well that has a big impact on what type of alternatives you want to buy is is that if the stock bond correlation is negative and highly negative and rates are, you know, reasonably, you know, high, let me put this way. is that I don't really need to buy alternative strategies. >> But when that correlation starts to go positive and rates are lower, they say like, well, that's a great time to own a lot of hedge fund strategies or other types of strategies. So that's a perfect example where we could use sort of regime analysis to help us build portfolios. how we look at and then from a you know we'll say a more micro basis is is that we know that when we build portfolios even based on trends the correlation relationships may have a big impact on the kind of risk exposures we have. So knowing the regime that we're in could help us you know on the margin change our our our tilts and our exposures to make sure that we're not overexposed to one sector versus another. >> [music] [music] >> One of the topics you touched on there was the kind of the the monetary regime and and I think you might have mentioned the fiscal [music] regime but but certainly we're into an era now where you know there is a lot more talk of possible fiscal dominance. I mean people have been thrown around the term fiscal dominance for a while now as if we're here already. We're not I don't think we are quite there yet, but it is obviously a risk because fiscal dominance is when um the debt and deficit levels are so great that they are dictating monetary policy. I know the pressure is on monetary policy at the moment, but but we're not quite there yet. But I mean, taking that angle, that lens, I mean, what would you say about the regime now versus where we were from a kind of a fiscal and monetary dominance perspective? >> Right. Well, I think that this is uh this issue of or at least trying to frame a lot of the discussion about Fed independence frame who is going to be the chairman of the Fed frame you know how so the the tussle between you know let's say the current US administration and the central bank you know has to be looked at through the idea of fiscal versus monetary dominance and so of course there's a political agenda going on here but I think sometimes is that we have to take ourselves away from the politics and look at the economics and try to say is is that what causes this the tension between the Fed and the Treasury Department and so we'll try to take out the administration we'll call it Fed versus Treasury and this is the issue of fiscal versus monetary dominance and in a monetary dominant environment we'll say the Fed could focus on or the central bank can focus on inflation employment regulation And the fiscal focus is just on financing. They say where can I minimize the cost of my debt. That's all I have to worry about. You'll say the Fed could do whatever they want. And in fact, the fiscal side or the Treasury could say, "Yeah, you could follow whatever you're doing because you're objective is full employment. We're just going to then try to pick on the curve where we want to issue our debt and we're going to finance our our our deficits which we don't think are going to be persistent and everybody's happy. Okay. If we have to go into a fiscal dominant situation, well then, you know, the government uh and we'll sort of say that even the central bank even if they're appointed for a long period of time, they're still authorized or they there's oversight by uh Congress. fiscal dominance says that debt is so high that central bank or we're going to put pressure on the central bank to use its powers to control interest rates and then buy up excess debt. You say like, well, is this abnormal? Is this should be shocking? Well, you look at World War II. You know, the the whole idea is is that the Fed kept interest rates low because we were financing huge deficits to pay for the war and then uh they you know they are actively buying you know treasuries. So so this is what happened in World War II post World War II and then we had the Treasury Fed Accord. the Treasury Fed accord said this is that well now that you know we're going to split the Fed and Treasury working in tandem to to lower the cost of financing because in in effect of doing that you raised inflation. Now we're going to allow them to sort of move in different directions. So now what's important here is there been another recent paper about uh debt and then they they talked about debt as a safe asset. So like well that's true except if we're having a war then if you buy debt and if you're in a war scenario because there's a lot of financing of wars and then there's usually inflation because of perhaps pent-up demand after the war ends is that you don't want to be a debt holder. And what these authors actually said is is that the pandemic had all the characteristics of a war. Okay, we had constraint demand. We had excess monetary policy. We sort of, you know, drove down interest rates. We had excess, you know, fiscal polices sort of sort of offset, you know, uh the the war on the pandemic. And so what happens when we came out of that is that well that's why we had a sort of inflation burst because of the excesses of fiscal policy. And so when you think about it, is this is that the excesses from that pandemic war is now we're still having that issue today because in some sense is that we should have said like well all of those spending was temporary. So we should have seen a big budget deficit increase now that the pandemic is over. We should have reversed all all of all of that. If you don't reverse that, well then you have have a problem. And this is where now you have the tussle between the monetary and the fiscal side. >> A lot to get into there. Yes. As you say, you've got this tussle. Um and as you rightly say, I mean it, you know, co was treated just like a war. I mean I mean that was the the the the kind of narrative at the time. And I think in the UK we actually there was actually direct buying of from the um bank of England of bonds issued by the Treasury whereas in the US it wasn't direct buying but it was all but in I mean the the the the um the Treasury issued more debt and and the Fed did more QE and uh um so they didn't buy finance it directly but effectively they did as you say we had a you know surge in deficits which haven't been addressed since then. Um I mean looking at the precedent of uh as you say the 1940s the justification at the time is obviously to try and keep debt financing costs down because you're in a war. It's also a form of financial repression of course as well isn't it? because obviously you you you you pin down long-term rates and you allow inflation to be higher. So bond holders experience negative returns and then ultimately in that scenario the Fed did flex its muscles again and demand its independence back and that's why you had this kind of standoff between the Fed and and the Treasury which ultimately resulted in the Treasury Fed Treasury accord and the Fed got its independence back. So this is all relevant in the current context because people are now saying you've got Kevin Wars and you've got Scott Bessant both uh linked via uh Stanley Ducken Miller interestingly enough but u they obviously already have spoken about a possible new accord but I mean they've spoken about it in some kind of positive light but I mean you know would that be should we interpret that as more financial repression or what do you think that might look like? Well, here's where the situation we're in right now is is that we'll sort of say that the tre current Treasury Department would love for the Fed to lower interest rates. So, because that lowers the cost of debt and then you could use that instead of paying off interest, >> you can use, you know, that money you to for other purposes is that it could be used for other other expenditures. >> Yeah. Uh so here so you have have the desire to do that and and you sort of say well if you can't default on your debt what's the easiest way to reduce the value of your nominal debt is that if you have inflation so so you have a treasury that would sort of say I'd like to have lower interest rate to lower my financing costs. I'd uh I really don't mind if let's say there's a little bit higher in uh inflation even though they'll never say this because that reduces the uh the real value of the debt. So uh and we'll sort of say then you have we'll call it this K-shaped economy. And if you look at you know some of the data on the employment side you can sort of say that I may want to be if I as a current administration I may want to run an economy hotter because I don't believe the data that I have and a perfect example is is that we just had in January the revisions for employment. The revision for employment said that there was probably a a million fewer jobs created because we changed the uh benchmark rating year before. We actually did a seasonal adjustment and we got like lower job produ uh production. So if you sort of said like look we didn't create a million uh jobs in the la last year or so is that the economy may not be doing as well as we expect on the on the one leg of the K. So you may want to say I want to run my economy hotter. Now you could also say that that these benchmark revisions was caused by demographics. And so if let's people are are moving out of the United States uh we call that euphemistically they're moving out of the United States. So you you're you and and you have less people in the workforce. Well then it may not matter as much. So we don't see the unemployment number going higher. But you'd say like there's this tussle between uh fiscal and monetary policy because we do have you know these competing interests. Now the interesting part and the reason how we get back to this recurring theme of always uncertainty is that wor said is that he never really liked QE in the excesses of what we had. So if some sense if he actually you know follows through on what his behavior is he's going to reduce the amount of uh of of treasuries on the Fed balance sheet that's reducing overall liquidity that's going to cause a major deleveraging which should have an impact on asset markets and at the same time is is that it's exactly what the TR treasury does not want them to do. They like the fact that the Fed has a large balance sheet and we'll say like look at the size of the financing is that again you know Allan I throw out these questions just to be provocative you you know you're going to uh it's not the obvious answer like how much debt do you think the US actually issued just last week? You just just take a guess half a trillion or something. So you're you're you're you're close, but you're still off by about $200 billion dollars. Say in one week the Treasury and now we had sort of like some you know quarterly refinancing with this is it and not all of this was new money. Some of this was rolled over but but we we did like a uh $700 billion of treasuries being auctioned in one week. Now that was between uh bills 2 years 10 years. So so it was along the entire curve. So but that's a huge amount of money. This is is that now the the world can absorb that kind of stuff. But if let's say that there was a change in people's you know buying habits for uh for treasuries you like that's a big number. And so and when you think about in one week >> you could do that then you look at the uh size of the balance sheet that's that's a pretty good portion of the entire Fed balance sheet. Now you again we have to look at what is the net new money uh and then what is this total demand from a number of different sources and you can cut you know sort of overnight repos. So, so there's ways to do this, but that's a big number and that that should give people a sense of, you know, what we're dealing with in terms of the size of the issues. >> Yeah. Well, as you say, the the demand is there for at the moment. Uh I mean, you could have to you'd have to look to see where it's coming from. Obviously, that's shifted over time. Maybe it's less foreign. I mean, and also they've they've talked about changing the the the SLR to make it more attractive for banks to hold it. So there there are things but but I mean coming back to Wars I mean his idea is is the smaller balance sheet but equally lower rates. Uh and then I guess the flip shot of all of the upshot of all of that would be uh maybe more TBL issuance to take advantage of lower short-term rates if that's how it played out. Um but but one thing I mean that we're missing in this we're talking about fiscal dominance and you know u so you know central banks are normally targeting inflation and now we're talking about no adjusting rates to to target you know to to to be cognizant of debt but of course that forgets about asset prices. you know, so if we had this scenario of um you know, the the the Fed, you know, being more cognizant of uh debt uh considerations and and lowering rates for for that reason as well. Not only could it be inflationary, but presumably, as you say, it it would run the economy hot and potentially fuel acid bubbles as well, which is um another part of the discussion from the '9s that that kind of is kind of getting lost in in the current debate, I think. >> Well, let's go back to what we started with. We always talk about regime changes. So, first, this is that this could be a regime change. This is that if we get a new Fed chairman because he might have a different view. Now, let me put this way. There could be a regime change because he has the view that is consistent with what he said he was uh is interested, which means is that we have a lower Fed balance sheet. We can say we could also have a regime change is that he's going to sort of follow more of what the Treasury Secretary would like and allow for fiscal dominance. That's a different regime change. So, so uh >> and the other third will will sort of say that if we just continue to follow the path of these large deficits in the US and probably the most interesting piece of research the last couple of years in the macro side hasn't got as much attention as uh John Cochran from the University of Chicago now at the Hoover Institute. So he's ris uh written about the fiscal theory of the price level and so he said like well if we really want to look at this shock to in inflation you know post pandemic we have to look at is it's a it's a fiscal theory of inflation. It's not a monetary theory. Now the two of them were working together but his view is is that you're going to get inflation because people are going to take your money out of uh uh you know going to start to buy real assets as opposed to you know uh debt assets if there's the expectation of permanent large deficits or we'll call it negative surpluses on the fiscal side. So that's going to lead to in inflation. And so uh so what are you going to do is is that you're going to put your money into real assets which we've seen in the gold. If we say that you're going to put it in other uh financial assets, we we're calling this sometimes a bubble because if let's say too much of it goes into one type of assets, but generally financial assets are being bit up because people don't uh you know sort of feel as though that uh you know they may have excess savings. They may not want to buy real assets or they purchase goods. So they they are bidding up financial assets. >> Yeah. I mean it's interesting because um if you go back to last summer, I think it was um Kevin Worsh gave an interview on CNBC. Um we he talked about all of this. He kind of talked about the Fed being slow to raise rates in 2001 2022 as being one of the I think it's the biggest macro forecasting mistake in 40 years. and he he talks about a need for regime change. So he at the Fed but but and he also um blamed he he he saw the Fed as being complicit in the the deficit expansions that we've seen because they've effectively financed it. And he had a definition for inflation of something like inflation happens when the government spends too much and lives too well or something like that which is consistent with the Cochran perspective. Yeah. consistent with this. So, let me put this way. >> It's possible this is that if uh you get the chairman Walsh of his comments over the last 10 years, you know, we'll sort of say the current administration may have no idea what they're really getting. If if if if they if he's the person that they choose and he follows through on what he says he's going to do, we're going to be in a very different monetary regime because we're going to have uh we're going to be cutting back our, you know, our the balance sheet. You could sort of say there's going to be a different view on how we're going to look at interest rates and we say that that may not be inconsistent with what the Treasury Secretary would like. This is so this is uh so when we talk about uncertainty and then we talk about okay why might you want to be a trend follower why do you follow certain strategies this is that I don't think people fully appreciate the amount of uncertainty they could have if let's say you just you know it's almost as though that uh at different times you like uh you you see people in government and you say like I'm surprised by what he did and if you said if I if you just read his speech speeches and you read what he said, you might have a pretty good idea and you would say like this is not what you were expecting. [laughter] >> Well, there is I mean there are different views in this. There is the the kind of the as you say that's a very literal reading of what he's saying, but he has also said that he believes in the um the disinflationary uh effects of AI and uh he sees scope for lower interest rates. So presumably he was emphasizing um those comments when he was doing these interviews at the White House. Um but there's also I mean have you seen those charts that show whether he was uh dovish or hawkish depending on whether it was you know Republicans or or Democrats in power. So so there is a suspicion that he might be a bit more political than than maybe uh than other uh central bankers. we'll say Wall Street and many uh you know voters actually sort of project what they would like to see on a candidate or on someone as opposed to what they see as reality and sometimes they actually then respond to what they think that you know their their constituents want. So yeah u >> so we'll just sort of say there is uncertainty here because we don't know what worsh we're going to get >> yes so u and uh I think that you often see this with supreme court justices is that that's not the current court but if you look historically is it that there are number of supreme court justices that have picked and there is assumed that he was going to behave a certain way and then we say like after he becomes the the justice his behavior is is seems to be significantly different than what they thought that they were getting. So this is the kind of uncertainty you have and so what we're saying be prepared for something that may be different than what you're reading about in the newspapers. >> Yeah, I mean that's fair enough. I mean from a I mean maybe moving it to more of a quant trading perspective. Obviously this is more qualitative but obviously as you say when you do get a regime shift you could get shifts in relationships that would be relevant. Um so how do you think about and obviously the Fed is at the heart of the financial system. So if there was a change in how the Fed is operating um you know whether it's a shifting towards less balance sheet more active in the interest rates or if it's fiscal dominance whatever it is you know that could have pretty widespread implications. So how do you think about that when you're maybe building uh um building models, >> right? Well, what what we one is is that that we've talked about that you want to try to sort of try to pick up regime changes. So so when we we know we have the technology to do that. So, so if we sort of see that uh using let's say the hidden markoff processes, we can be able to sort of say if asset prices start to delink or have a change in behavior like in volatility, we can pick that up and so we can adjust for that. Uh we also know is is that there there are break points in data sets. So, so we have technology to uh to what we call change point detection to sort of see if there's a change or break in a in a in in a time series. So, so now what we could have is now of course you're never going to pick a peak or a trough in a break point because it has to break before you actually then pick it up in the data. But that being said is is that if we're sort of aware that there's these structural changes, then we could be more sensitive to when we look at the data to see if there's a break point. So, so what does that mean is is that one of the things that you know um you know I've been uh work with with uh uh my my friends with uh you know firm we're involved in Zunthor is is that we're looking at uh you know the connections across markets. We think of it the markets as as a connected system. We think of it as a network. And so what we're trying to look for you what are the causal relationships between markets and then sort of say like how have network connections changed through time. And if we see that there are changes in in network connections and we're willing to accept or or adapt to these changes then it's more likely that we could get ahead of it. Now any type of trend following any type of quant model is always sort of looking into the past. Okay. So the question is how fast can we react to the past data or how can we sort of react to uh to these changes as they occur. One of the advantages of being having a macro view is is that when you start to see changes or we expect changes, we could then be more sensitive to say is there something going on in the data that we should be aware of and and we're a highlight. >> Yeah. So I mean is it a case that you would see a shift that is consistent with what you're expecting from a from a macro perspective? Is that it? >> One would hope that it's consistent what what we see in a macro perspective. But what we're finding is is is that and uh we'll sort of say that this is one of the key issues that we're seeing in economics in in general and especially in finance is the issue of trying to identify causality. So this is the number one issue in finance now and we'll sort of say that uh AIA had their uh labs had their causal discovery challenge where they sort of said like you could use different machine learning to look at sort of finding causal relationships. But the reason why this is so important is is that because we over the last couple of years what we have is what we call the factor zoo. uh that you know you look at enough data everybody's finding all these new risk premiums or risk factors in the data and then what you find out is that you find them in the training set or we find them in past history then we look at them in the future and they no longer exist. So they were sort of spurious causality or we are trying to find something that we overfitted or we found something that didn't really exist or it only existed temporarily and then it disappears. So now I said like well look if we're having this we'll call it the factor zoo we're finding also is that well what we find in the data sometimes doesn't persist through time. Well maybe we got to go back to square one and say let's look for what are the important causal agents. Let's look for causal factors and then make sure that see if our models are consistent with the actual data or can we find causal relationships that we need to rethink our models that this is going to improve the amount overall science for quanting. >> Interesting. Um I mean in the current context where is that relevant do you think or what are the ones you know >> we'll say where's uncertain would you say? Well, we'll say this is a work in progress because uh because we we'll sort of say that when we've uh analyzed uh some of the interesting work in machine learning right now is this is that uh uh >> they've they've done some uh some testing and some research where they said like well is it the number of features we look at that gives us value added or is it the complexity of our model? sort of linear versus nonlinear. And you know, the machine learning world says this is that well, you know, we want to add more complex, you know, sort of techniques to try to tease out relationships in data. And what the some of the research is now telling us is is that it's not the complexity of the technique that matters. it's the number of features that we have or it's the domain knowledge we have that actually adds more value so that you know we that if it's an arms raceer choosing you know more complex machine learning techniques we may not get as much value. So, so we talked about peak bubble. >> We'll sort of say that for different techniques there's a while is that everyone thinks that this is going to be the new holy grail and then in reality what we find out is is that it's a lot tougher to come up with a new new model solution than we thought. Another thing we find with machine learning is for example is is that machine learning is very good on stationary data. So uh and I'll use the analogy if uh if we're using machine learning to look at visual interpretations of can we find a picture of a dog. So so we show you know a 100,000 pictures of dogs is after a while it learns how to how to you know find a picture of a of a of a dog in a photo. Okay. Well, if the dog is changing through time, it's uh its characteristics are changing like a market, then we find that it's a lot harder to do this. And so, so a lot of the techniques that have in machine learning that have been very promising in different areas of science science, which has very stationary data, it's been very successful. when we apply these techniques when we're looking at time series data that seems to be more follow an adaptive markets hypothesis which is what Andy Low developed what we find and that we find that agents behavior changes through time we find machine learning is a lot harder to to sort of you know increase its predictive power so markets are complex they're non-stationary they go through regime changes which means means is is that the quest for finding the perfect model is ongoing and we still haven't solved it yet. >> Very good. So I mean it comes back to robustness, doesn't it? I mean obviously what you're suggesting is >> you can't overly optimize given the complex adaptive nature of the system. >> So and and when when you think about okay for your listeners and for a lot of modelers you say well should I tool up for machine learning? uh on the one hand the answer is absolutely you got to know what's going on in AI you have to know what's going on in machine learning at the same time is is that your benchmark standard should be more simpler models so uh so so I don't want to sound like I'm a uh you know talking out of both sides of my mouth but you say like I still believe in in trend following it still seems to say that it works especially in uncertain regimes especially when data is non-stationary at the same time as they say like well how do I always try to uh try to improve on that because so many people are already trend followers so many people are already using similar models so you're always trying to say like how can I look for some small improvements that's going to differentiate myself from everyone else and also give me a predictive edge >> the problem comes in is is that on margin it's sometimes hard to do that Now when we say it's hard to do is is that just when I think that you've solved it come up with a better model markets may change slightly and they go through periods of you know you know strong performance then you get delayed perform or fall in performance and it improves and that's even finding for momentum and trend following. There are periods uh that when it does really well then my period where where it it waines in performance and it goes back and this is what we've seen throughout history. So right now we've had a good uh performance and trend following you know will that persist well I could sort of say over the next five years I could still be a believer in momentum and trend following over the next five months. That's a little bit harder to say. [laughter] [gasps] >> Who knows? Well, we'll we'll we'll be here anyway to evaluate that over the next five months. So, we we we shall see. But, um yeah, thanks very much. Oh, thanks very much for your thoughts, Mark. Great to catch up and uh get your perspective on all of that. Um I'll be back again actually next week. I'll be back uh from Miami in time to record with Jim. So, if you have any questions, please get them into us. Uh but until then from all of us here on Top Traders Unplugged, stay tuned and we'll be back again with more content. 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