The Global Order Is Cracking | Global Macro | Ep.86
Summary
Government Debt Concerns: The podcast discusses the unsustainable nature of government debt, likening it to excessive tequila consumption, where the negative consequences are inevitable but unpredictable.
US Recession Risks: There is growing concern about a potential US recession, driven by weak construction data and uncertainty from tariffs, despite traditionally low cost of capital and energy prices.
Tariffs and Economic Impact: Tariffs are creating uncertainty in the US economy, particularly affecting construction and consumer spending, with potential long-term inflationary effects.
Energy and Inflation Outlook: The podcast highlights the critical role of energy prices in determining inflation, with a bullish outlook on energy potentially leading to higher inflation if prices rise.
Federal Reserve and Monetary Policy: The discussion suggests the Federal Reserve is likely to cut interest rates, with potential implications for a weaker dollar and steeper yield curves, benefiting financials and emerging markets.
Emerging Markets Opportunity: A new bull market in emerging markets is anticipated, driven by a weaker dollar and potential rate cuts, offering significant investment opportunities in regions like Latin America.
China's Economic Strategy: China's shift towards exporting cars and other goods to emerging markets is noted, with implications for global trade dynamics and the use of Hong Kong dollars in international trade.
AI and Tech Investment Risks: The podcast raises concerns about the sustainability of current AI and tech investment levels, suggesting potential overvaluation and the risk of significant market corrections.
Transcript
[Music] It's like tequila shots. You've never known when you've had enough until you've had too much. And and government debt tends to be the same story. You feel good, you feel good, you feel good, and then at some point you're throwing up in in in the bathroom. So yeah, your point is when do we start throwing up in the bathroom? And the answer is I'm not quite sure, but I know it's not a great asset class to own because at this pace, you know, it's like you're seeing the guy at the bar just pounding the tequila shots and you know there's no there there's nothing good coming out of that. You're not quite sure when he's going to hit the wall, but you know that wall is there. >> Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their failures. Imagine no more. Welcome to Top Traders Unplugged, 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, 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 anything about future performance. Also understand that there's a significant risk of financial loss with all 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 hedge fund manager Neils Krop Len. Welcome or welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macrodriven world may look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today's episode hosted by Alan Dunn. [Music] Thanks for the introduction, Neils. Today I'm delighted to be joined by Louis Gav. Uh Louie has been on the podcast a couple of times before, so it needs no introduction, but for those who haven't heard from Louiesie before, he's the founding partner and chief executive officer at Gavocal. He's been the markets many years and the author of several books. Louie, great to have you on. How how is holding your side? >> Uh things are good. It's uh it's I'm delighted to be back. Thanks uh thanks for having inviting me. >> Not at all. No. And as I said, you were on I think it was October last year and the summer the previous year. So, if people want to sense check how your views have evolved or hear your full backstory, they can uh they can listen to to those episodes. But >> hope I didn't say anything too embarrassing back then. >> I can't remember I can't remember what I said. Hopefully hopefully it's stood the test of time. >> I had a quick look back. It is funny how you kind of forget what what was topical at the time, but you did I mean to your credit you had a couple of very good calls. You were uh pretty confident that you were confident that Trump would win. And uh so you and was it the French guy who had the big bet on on the p on the uh the betting markets? >> Yeah, that's right. The uh the the the French whale. A lot of people asked me if that was me and it wasn't just to be very clear. Uh that was not me. Uh but yeah, I had quite a number of clients ping me and saying, "Hey dude, what are you doing putting out such big numbers on on the US presidential election?" Well, you you seemed equally confident at the time and you were right on that. And and the other point, the last couple of times you've been on, you've been definitely in the no recession camp on the view that um such large deficits in the US are not normally associated with recessions. And obviously the deficits have not got any smaller in the last couple years, so they've been getting bigger. But we have had some weak data out recently which have kind of reignited calls for maybe a a possible imminent downturn. So maybe that's a good starting point. How are you reading the data? Uh do you see increased concerns on that front? >> Yeah. Um look, I am increasingly concerned. I became a lot more concerned when uh with the tariffs uh back uh back in April when when these were announced and both Anatol, my business partner, Anatol Kitki, the Cal and Gavcow and and myself wrote wrote a number of pieces. Now, usually, you know, I I start off with with the premise that what matters the most is the cost of capital and the cost of energy. Uh when the cost of capital is is low enough and when capital is plentiful and when energy prices are low enough and energy is plentiful, usually you know the economy just moves forward because you know every entrepreneur wakes up every morning trying to figure out how to make more money, how to produce more with less etc. And that's what drives our capitalist system forward which again unless you have the breaks of two higher cost of capital too high cost of energy that that usually works. uh and that was part of the reason I was sort of dubious on the whole oh we're heading into recession uh because in my my career most of the recession have been uh preceded by either massive price you know big increase in the cost of capital especially the cost of capital I would say for the private sector more for the government i.e widening corporate spreads and and we didn't have that and we also had a cheap price of energy. So I don't know I felt pretty I felt pretty confident but um but inherent in that belief is also kind of the hope that entrepreneurs wake up in the morning feeling good about the future wanting to invest wanting to uh to to move the ball forward. And this is where you know the tariff throws an interesting wrench. Um because they they add a lot of uncertainty. Now the reality is most entrepreneurs just want certainty in their lives. You know it's they they want to know what the tax rates are going to be. They want to know what the regulations are going to be and then they get on with it. Um now of course every entrepreneur wants a lower tax rate. Every entrepreneur wants lower regulation. But by and large, you deal with, you know, you're told the rules of the game and then you you go out and play it. Uh or not, or you decide, you know what, I don't want to play this game. I'm taking my ball and going home. My big fear when the tariffs hit and and I wrote it at the time was that uh when you look at the construction sector uh in the United States, you're dealing with a bunch of entrepreneurs there who are still carrying the scars of 2020 and 21. You know, in 2020 and 21, you had massive supply chain dislocations. You had bare shelves at Home Depot, lumber prices spiking, etc. And so, a lot of projects got delayed. A lot of projects and delays in the construction industry means all of a sudden margins disappearing. And so my fear was that given these scars from the 2020 2021 experience a lot of the people in the construction industry and I was seeing this talking to people would react to the tariffs by saying look I don't know if in 3 months time I'll get the pipes because the pipes are made in China I don't know if I'll get the electric wire that's made in China and and the problem is if you don't get the electric wire then it postcrones everything right it's like if I can't get the electrician in today then I can't get the plumber in the next day and if I can't get the plumber then I'm going to get the drywall guy in. Um and so everywhere around me following the the tariffs I was hearing of you know like projects being put on hold. Now the reason this matters now you could say well you know construction it's it's only like 3 or 4% of US GDP etc. But it's a huge employer. Uh it's a massive massive employer, which by the way, that's another uncertainty is, you know, am I going to, you know, there's there's a lot of illegal workers in the construction industry, especially in the whole southern belt of the United States and Florida and elsewhere where where construction has been absolutely booming for the past uh for the past decade or so. Whether you look at your Arizonas, your Neadas, your Texas, your uh your Florida, this is where most of the construction was happening. Um, so you're dealing with all of a sudden, if you're an entrepreneur, uncertainty of am I going to get the parts I need when I need them at what price and am I going to get the workers and at what price. Maybe it's just easier I hold back and and not do anything. And and I think what's interesting in the recent weak data that has come out is the extent to which it does seem to point towards weak construction. And again like the the PMI surveys that just came out yesterday uh were pointing like the it disappointed and it was all basically construction. So do I think we're going to have a US recession? It's it's a tough one because it's you know if you look at typical models cost of capital budget deficits cost of cost of oil you would say no. But so you almost have to make the argument that it's different this time. But if ever there's a time to make the argument that it's different this time, it probably is today where where policym in the US is very different than you know you and I have experienced through our careers. Uh so it's it's hard to have a strong level of conviction uh either way. But I am I am fearful that the odds of recession are going up. Yes, I'm not like banging banging my fist on the desk saying oh my god you know uh to your listeners watch out US recession coming etc. And I'm not doing this but I think we have to acknowledge that the odds are probably higher than we've seen uh since the start since the postcoid era. >> Okay. And you're seeing that very much being driven by the construction side obviously you know consumer spending has slowed as well. I mean are there other dynamics at play? Obviously with tariffs coming through it's going to be a hit to disposable income um in real terms. any other channels you see kind of confirming the the weakening economy scenario? >> Yeah, look, I I think all of these make sense, but again, for me, construction's a huge employer. Construction's also, you know, there there's a huge multiplier effect um in um AC across communities everywhere. So, I do worry about that. Yes, indeed, I think there is the squeeze on on US disposable incomes um and both from you know, inflation that is still there. I think I I can't remember the exact number, but I think inflation has been above the 2% mark of the Fed for something like 46 months in a row. Don't quote me on that exact number, but it's in that ballpark. It's essentially four years. The the bottom line is, yeah, there's, you know, you look at consumer being squeezed, you look at construction being highly uncertain, uh, and frankly even capital spending in general. Like if you look at the boom we've had in the US, it it rested on many things. One of them was of the recent years was capital spending and AI. Um now this this might continue. However, um what we're increasingly seeing is that the hoped for returns to the likes of Google and Microsoft and Apple etc. and um and Facebook and others uh you know the hope for returns aren't that great. So at some point you know does the AI like sort of rush ahead continue? We've had very very strong consumer spending which was partly linked to I think the wealth effect on um on houses on equities on crypto. Now granted you could say well equities are all-time highs crypto essentially at all-time highs. So maybe that continues uh but maybe the lower end guy does does get squeezed. And then you had construction that was like booming and I think that part is slowing really hard. >> Yeah. And I mean obviously when tariffs came along there were a huge uncertainty and that was a theme of Q1 Q2. I mean it was reasonable to say well businesses will postpone um spending decisions or investment decisions. We don't know what it's going to play out like. But now I suppose you could say it is increasingly apparent what it is playing out. It's kind of 15% or 20% in most cases. Okay. We haven't got a deal with China yet but the noises are positive. I mean, can you do you think as we get into Q3, Q4, we'll get to a point where there is certainty on the tariffs or be that they are are now here at at kind of elevated levels? >> Yeah, look, I think the this really the three countries that matter the most for the US is, you know, what the US trades the most with are Canada, Mexico, and uh and China. Uh now, um when it comes to Canada and Mexico, you know, to your point, just like Europe, just like pretty much everybody out there, you're going to be in the 15 to 20 range. Um and I don't think that's inconsequential. You know, that's that's a pretty high number. Somebody's going to have to pay for that. Now, I think that the premise that uh of the Trump administration is that either foreigners will pay or or corporates will will take the hit on their profit margins. Maybe maybe they turn out to be right, but if if the lower-end consumer is made to carry some of that bag, then uh you know that bag that bag's already pretty loaded. The the low consumer is pretty stretched in the US. So um so yeah so you that's and then you you indeed have the elephant in the room which is China which is right now at 50%. Now 50% essentially kills the trade. Now you know China unlike other countries hasn't come grubbling they've and quite the contrary they said okay we want to go down this path we can raise tariffs on you we uh we can block the export of rare earths we can block the export of magnets we can bring your entire auto and armaments and aerospace industry to its knees in about 3 months so you know fine that's you know you you want to play let's play uh let bring it on um and you know I think the perception in China is that of course this will hurt the Chinese economy but that China's ability to withstand pain is much greater than the US's ability to withstand pain that essentially you know if the GM factories are shut for 2 weeks um then Trump will be seen as a failure uh you know the whole make America great again American industrial renaissance etc doesn't work if Ford and GM can't get rare earths and and magnets to to make cars. So So China has played that card. Uh it's played it uh it's played it quite aggressively. Um which does probably open the door for for a deal uh at at some point. But it really seems like China's not rushing to get a deal. >> So I mean what what what is a likely deal would you say um given all of that? So if you look at right now China is at 50 20 of which is um the penalties for fentanyl now already the US is now going around saying oh you know there's been huge progress on fentel uh it's uh it's now it's now much much better. So so they can move pretty quickly from 50 down to 30. Um I mean the US can decide that unilaterally just say okay fennel you know China's done tremendous work there well done so we'll bring it back down. Um so they've given themselves this leeway with the fentanyl tariffs by the way tariffs that were also imposed on Mexico and Canada and the US said okay you know they're making progress so we're taking that off. So I and I suspect that's what will eventually happen. Now, you know, once you get down to the 30%, after that, it's like, hm, it's not obvious that uh it goes lower from here. >> Yeah. So, you think that it could settle somewhere around that kind of baseline? Um, which would obviously still still be significant. >> I think 15 to 20 on everyone and probably 30 on China is is I think where we we basically end up with with the occasional other country that may also be at 30 or 35. it >> to the question on um impact on inflation. Uh obviously it's a it pushes up the price level. We've seen a little bit of that in the most recent inflation data on the good side. I mean that's been offset by weakness I think in the services side. Do you think we'll see more? And then where do you stand on like will it be more persistent over time? Like Chris Waller seems very intent on the view that it's a one-off price impact and it's not going to lead to sustained inflation. Would you be as confident on that view? So I I hate to make like a Jesuit priest and answer your question with another question, but I think that the answer to your question depends a lot on uh what your outlook on energy is and what your outlook for the US labor forces because the reality is that goods, you know, within the US like goods inflation is is only a fraction. What what probably really matters is whether we start to see wages push higher. Now, historically, a huge catalyst for wages pushing higher is um is higher energy prices. Somehow, there's a psychological element to to energy prices. Perhaps because, you know, when we drive to work, we we see the gas price on on on the side of the road. Um perhaps because it's the one thing we we buy consistently and it's always the same thing. I fill up my car every week and I know I pay X to fill up my car and and so right now energy prices are low. Gasoline prices are low and so, you know, wages are still not really rising all that fast. Even with the immigration crackdown, um, even with the immigration crackdown, wages haven't been shooting up. Now, fast forward 6 or 12 months from now. If energy prices have moved up and at the same time, you've got a tight labor market because you've you've kicked off all the illegal immigrants, then you really have the recipe for I think an inflationary spiral where wages go up. At the same time, good prices are going up um and gasoline prices are going up and then the the the narrative the popular mood really starts to swing to oh my god there's so much inflation. Um so energy prices at this juncture are really really critical and I would say that if energy prices start to rise uh then probably President Trump's uh presidency start becoming starts to become very challenging. As long as energy prices stay low, basically the show more or less may manage to stay on the road. So, I hate hate to hate. Now, I happen to be a bull on energy. So, I happen to be an inflationista. Um, but I I willingly acknowledge that energy prices today are low. Um, and that we're going through an interesting time in in energy. Uh, because on the one hand, I think we've underinvested in carbon for for 10 years now. And the scope for oil and natural gas etc to go up is there. But at the same time you have the you know the biggest energy importer in the world namely China that has invested like absolute crazy in its ability to deliver electricity and to essentially fund its own transition uh transition from carbon-based energy to to electricity whether that electricity is produced by nuclear by solar by you know LG plants by hydro by coal based fire plants but the, you know, China now produces twice the amount of living electricity that the United States does. Um, so which is which is funny because the US is still supposed to be at least a third bigger as an economy, but when you look at electricity production, if you think that's probably a decent proxy for the size of a of an economy, China is now twice the size of of the United States. So all this to say, we're we're at an interesting point where, you know, the energy of the future is electricity. It's it's not gasoline. It's not diesel. The energy of the fuel is electricity. China is moving very rapidly in that direction. The rest of the world not as much. But meanwhile, we've also massively underinvested in carbon. So depending on where you fall on the energy question, I think will dictate how you fall on the inflation question. So I'm a bull on energy. I think energy prices move higher. I think inflation thus moves higher. >> And what's the bull? I mean I I get the underinvestment case in energy. Um obviously oil prices have been stuck here in a range for quite a while now and obviously we've had geopolitical events. We've had Iran strikes etc. And you know the view is always seems to be you get a spike it's a good opportunity to sell because the market's quite well supplied at the moment. So what changes on that front or what what are the risk factors do you think? Yeah, look, I think the main thing is it's uh it big energy bull markets are driven first are driven more often than not by demand. And so I think what what what changes what people underestimate is you know you could look at energy essentially you've got different billion dollar billion people markets. So China's a 1 billion person market like I'm rounding of course it's like 1.3 but let's just call it 1 billion. India's 1 billion. Africa will very soon be 1 billion. Um, and then the developed markets are essentially 1 billion and then everybody else is 1 billion. Um, if if I'm going to make it like very very simple simplistic. So Africa has been a huge net energy exporter. That probably changes in about 3 or 4 years as you know as between their population growth and their standard of living growth. So they they switch from being an exporter to an importer. you know, India continues to import more and more. Uh, so, you know, I think people focus on China because it's been the big story of the past three decades in energy and then they say, "Oh, look, China's energy needs are plateauing. They're importing less or they're importing as much. They're no longer growing." But it's it's missing the story that's occurring elsewhere in emerging markets. So, when you look at total oil demand, it's still growing by 1 million to 1.5 million barrels per day every year. you know ballpark. So for that given you know the fact that you know whales whales lose capacity over time to make that extra million and a half barrels you need to to continuously invent invest. Now today you could say yeah but you know what OPEC probably has 2 million surplus. Yeah. And that probably covers you for the next year. And then what? So then what you could say, well, you know, you got some coming out in Surinam and some coming out in um but here's here's a fun fact on the other side, you know, from nowhere 5 years ago, China is now the biggest car exporter in the world. Like that somebody something that nobody expected like China is now the biggest car exporter in the world. And 85% of the cars that China exports on any given month, 80 to 85% are ICE cars. like then the electric cars stay at home and the ICE cars go abroad. Um why? Because the cars go to emerging markets and when you live in Colombia, when you live in Indonesia, your electricity grid isn't going to support electric cars. Also, electric cars depreciate too fast for emerging market investors. Good thing about ICE cars is they last 20 years if you take care of them. So now all of a sudden what you have in Indonesia, in Vietnam, in Colombia, in Brazil, you have people who buy cars who never bought cars before because they're buying Chinese cars for less than $10,000 a car. So you have all of a sudden people driving ICE cars all across the global south that were not consuming gasoline up until 5 minutes ago. And I think that's that's the part that uh perhaps people are missing today is yes on the one hand OPEC's got this extra 2 million etc. But at the pace at which China is exporting cars, you're going to need gasoline, you're going to need more refineries. You know, nobody's building refineries. You're going to need more refineries etc. And so uh so yeah, I I do tend to think that the risk is is to the upside. >> That sounds like maybe a story for next year or thereafter and not necessarily for the next six months. you it's these things are always so hard to tell right uh what I do know is that today's equilibrium is unstable um now you're absolutely right that it could be stable for the next 6 months 12 months 18 months absolutely but I think that if there is a risk to our system today if there is a risk of the to global economic growth if there's a risk to you know we're now set on an easing stage for central banks everywhere around the world whether you know the Fed that's going to be easing the ECB that's easing saying, you know, em central banks everywhere easing, etc. If there's a risk to this whole environment, it is that oil prices spike. Now, granted, I take I take your point. It's like, yeah, but that's not going to happen in the next 6 months. Probably like 90% chance it doesn't happen in the next 6 months, but what if it does? What if in that 10% chance it does? Then it's going to obliterate your portfolio. So at the very least, you don't invest on the premise that this is going to happen, but you in you you buy protection for your portfolio in case it does. [Music] You mentioned easing likely for the Fed. I mean, is that do you think now we're the Fed the Fed's going to come under so much pressure that it will cut in September? And how much between now and the end of the year? >> Yeah, I think it cuts in September. I think it cuts in September unless um again I'm sounding like a Jesuit priest like hedging everywhere. Uh but there's two CPI prints between now and September. Unless you get two bad CPI prints. Uh and by bad I mean they CPI that surprises on the upside that it turns out to be much stronger than expected. Unless you get that I think you're getting the those job numbers we just had almost guaranteed that you're you're getting you're getting a cut in September. Now you know beyond that is it going to be 25 is it going to be 50 I think a lot of that will be driven by the data between now and then uh but you know recent PMI recent ISM I've looked softer like if all these things continue then yeah probably 50 >> okay and then that allows that allows uh you know the Fed to sort of at least get Donald Trump off their back a little bit. Speaking of which, the the big topic in in with respect to the Fed is what happens next. So, obviously it seems like Trump isn't going to fire Pal just yet, but obviously the window for putting a replacement in is is opening. Obviously, there's a spot for a new governor and then which may or may not be the person who becomes the chair. What's your thinking on this? Obviously, it's kind of two Kevins and Chris Waller are probably the three names. I know there's a fourth. I'm not sure if that's best to he who's now seem to be ruled out or if there is somebody else. But back to the betting markets there. They are the top three contenders. So >> I thought Trump wanted to appoint himself. >> Well, that was also muted at one point. Yeah. Not not impossible, but Yeah. Yeah. >> Yeah. >> I So, first I don't think he fires Powell. Uh I don't think he fires Powell because Powell at this at this stage he's set him up as the perfect scapegoat. you know, he's done these big tariffs, which may or may not work. It's a big gamble. Um, if it pushes the US into recession, he can turn around and say, "It's the Fed's fault. It's Pal's fault. I've told you all along, this guy's an incompetent, etc., etc." So, he said he set up Pal as the scapegoat. So, why would he want to get rid of him? Like, as soon as he get rid of gets rid of him and puts in the other guy, then he owns the economic situation. Uh, either guy or girl. He then he owns he owns the economic situation. So I think Powell essentially serves out his term because he serves a purpose now uh which is the being a scapegoat. Um beyond that who he picks uh I think at this stage the what really matters uh more is that you know it's been signal it's been telegraphed that the Fed from here on out will be easier will be following easier monetary policies and we'll be essentially pushing the US towards a weaker dollar. Um, and you know, I would say who cares about the personalities at the top. What what matters for us as investors is the the highest odds are that we're going to have a set of policies that almost guarantee steeper yield curves and a weaker dollar. And you know, so that that's what matters to us. and a steeper a steeper yield curve a weaker dollar that that usually means outperformance of financials which is what you're seeing in markets everywhere. It usually means outperformance of emerging markets which is what you're increasingly seeing. Um usually it means the outperformance of value against growth which we're not really seeing yet but um I I think we'll we'll we'll see you know probably further down the road. >> Plausible. I I mean the one thing I would say is like the likes of Kevin Worsh um has very distinct views on you know balance sheet normalization and and and you know being very critical of the Fed's approach around QE. So I mean if we saw him come in you know obviously he's in favor of rate cuts at the moment but he does seem to be a bit more of independently minded than maybe say Kevin. >> That is that is that's a very fair fair point. I'm a big believer and a big proponent. I always say that look, as money managers, we're paid to adapt, not to forecast. Um, so, uh, I I'll be dead honest with you. I'm not actually spending that much time thinking through all the various scenarios of, you know, once who gets it and what they do once they get it, etc. Because, uh, like once we know who it is, then then I'll start thinking, okay, so it's this guy, so it probably means this, this, and that. Um having having said that uh you know people change their minds, people evolve as well but uh so so it it's like it's like I fear that trying to anticipate the various guys moves is maybe too many chess moves ahead. You know I'm I I I played a fair amount of chess in in my youth and I was never very good because I could never I could never do more than sort of three moves ahead. like you know the really good guys got like six moves ahead. I could do about three moves ahead in my head and then I' I'd sort of lose it. And as an investor I try to do the same. I try not to be too many moves ahead because it it just the the the complications just get too big. >> Fair enough. Um I mean you did mention a weaker dollar and this has been a theme this year. Obviously the dollar has had I think it's like the worst start measure on a on a calendar year basis. At least it did going back a few weeks when the narrative was all about kind of outflows. The end of US exceptionalism obviously was one narrative which has kind of diminished a little bit as as the equity market has come back and then outflows from the US market. Um obviously some hedging pressures as well undermining the dollar. So putting all of that together and obviously you know in the background chatter about you know US reserve status under pressure as well. I mean I suppose that's the consensus view. Hard to disagree with it. What what do you think? >> Yeah, I think it's hard to disagree with it. I think we are seeing a paradigm shift in in the US dollar and and look perhaps the most important shift in in the US dollar. You know, if you were a French pension fund or a Korean insurance company for years, you bought US equities and you were long the US dollar and if ever there was a market accident and equities went down 10%. Typically your own currency went down five. So net net on your US equity position you would be down five. So it was yeah nobody likes being down five but it's not the end of the world. So the fact that for years and years the US dollar was this port in a storm, this uh this shelter in rough in rough seas um meant ma made US assets very attractive. It made the US dollar very attractive and sort of very reflexive move for foreign investors. And I think this was shattered this year. We saw it very well in April when you know the the the liberation day tariffs were announced. Instead of going up, the US dollar went down. In fact, for a period of about eight days, you had the bond market in the US, the equities, and the currency all falling at once. And if you've ever done the emerging markets, you recognize that pattern immediately. Uh you recognize that pattern, you're like, "Okay, I've seen this movie before. This is an EM crisis. I'm out of here." When you see those three things fall together, it's usually it's a it's it's a big warning bell. And you know, that's why I think Bessent and Lutnik had to intervene. and you know they they they talked the tariffs back and and and stabilized the markets. But the message was nonetheless sent that from now on when US equities falls so does the dollar. And therefore this makes US assets ju just this shift in correlations makes US assets a lot less attractive to to most institutional investors everywhere. So I think that's you know you got that of course you've got the greater uncertainty around politics. um and policies in the US. And politically, it's now no longer uh good to be seen being overweight the US. If you're running a public pension fund in Holland, uh or you're running a sovereign wealth fund in Singapore, like being massively overweight the US may not be the smart trade. Um so, so bottom line, I think the default mode amongst large institutional investors is now to bring money home. You know, for the default mode for 15 years was I invest in the US. Now the default mode is is bringing money home. But but the problem when you talk to pension funds in Germany or pension funds in Canada, they always tell you the same story is I want to bring money home but I don't have any assets to buy at home. Now this is where it gets interesting is if you look at the new chancellor in Germany, the new prime minister in Canada, new prime minister in Canada, you know, comes out of Goldman. I I tend to believe that you can get the guy out of Goldman, you're not going to get Goldman out of the guy. So, if you now have pension funds that come to CM and say, "Hey, uh, Prime Minister Carney, give us assets to buy." Uh, he's going to say, "All right, I know how to do this. Uh, let's build some infrastructure bonds. Let's, uh, IPO the airports. Let's build pipelines into British Columbia to sell the oil to to Asia and give all these Canadian pension funds that have hundreds of billions invested in the US opportunities to bring money home." And I don't want to pick on Mark Carney cuz you take the German chancellor, he used to be the CEO of Black Rockck for Europe for 6 years. So how hard is it for him to structure infrastructure bonds and call the head of every pension fund in Europe that he knows on a firstname basis? Probably not probably not very challenging. So I do think this trend is is starting where the marginal dollar instead of being invested back into the US is now increasingly going to be invested domestically. >> Makes sense, I guess. I mean the one thing that that it ignores is is the AI theme and and the mag seven haveve I've have have come back you know having been under pressure for a while. Um so if if investors want to play that theme that obviously the US still remains the obvious place to go to. I mean you mentioned that maybe some questions around the return on investment but you know at the same time recent results from you know u Meta were encouraging and and I think the likes of Microsoft and um a number of them were were announcing upgrades to their capex spend. So I mean for the moment it's it still seems to be raging on. Um is that not part of your your your the picture or your >> That's a massive part of the picture. uh that's a massive part of the picture because you're absolutely right to highlight it and that you've had an epic capital spending boom in the US where I actually recently wrote a piece on this where capex in the US over the past few years has gone from 9% of GDP to 11% of GDP and this 2% of GDP increase in capex by the way historically it tops out at around 11.5% like in 2000 it topped out 11 and a half% uh that extra 2% um has really gone to a handful of companies because that increase in capex uh some of it has been in data centers, some of it has been in you know building out new power plants although nowhere near enough and some of it has been most of it has been in AI you know it's it that 2% it's gone basically straight into Nvidia's bottom line exaggerating of course but don't don't send me data saying it's no it didn't all go into but it's gone into uh to Nvidia and yes to Microsoft and so so the question now becomes um you know you've had this huge increase in capex what do we get on the other side of it now do we get the productivity gains and do we get the profits that flow to these businesses that have essentially turned themselves you take a Facebook it's essentially turned itself from an extremely asset light business into an increasingly assetheavy business now again if the money flows in then happy days then the show stays on the And yes, people want to keep buying Facebook and they'll want to keep Nvidia, etc. If the the returns don't come through, if AI turns out to be very commoditized and if the the the profits on there or the productivity gains aren't what was hoped and expected, then the US really hits the wall really really really hard because right now what is keeping the show on the road to your point is this excitement around AI. uh take that away and all of a sudden things start to look pretty dire. >> And what's your thoughts on in the next downturn? I mean there is a view that because now of increased usage of AI, LLM, etc. that you know a lot of those entry level positions are not being filled and that in the next downturn we could see you know even more adoption and PE corporates trying to squeeze as much out of AI as they can and much higher unemployment. Is that too early to expect that or is that a risk factor on your radar? >> No, I think you have to worry about that. I mean, look, that that's the very lynch pin of the AI hope is the idea that we're going to get >> that's the productivity gain, isn't it? Yeah, >> it is. So, it's you you have to worry about it because either A this is so there's two options. Hey, this is going to be real and where, you know, all this to your point, the entry-level jobs in insurance companies and in banks and and in a lot of places are are going to disappear and so then you have to wonder, okay, so what does that mean for our societies? What does that mean for for jobs in general, etc. So, so that's your one path. Uh, and the the other path is, like I said, I think it it turns out to be a dud. uh nowhere near as uh as productive as as we'd hoped and we have a a hell of a stock market correction. It's it almost uh reminds me of that Woody Allen quote, right, about how you know you we've reached a fork in the road on on one side lies uh despair and uh and the other lies uh you know misery and that I hope we choose wisely. So I I don't want I don't want to sound depressing for for your listeners. Um, I tend to believe, and I may be wrong, uh, you know, but from my own playing with it, from I tend to believe that the level of hype on AI is off the charts. Um, and that there will be some productivity gains, sure, but it'll be nowhere near what uh what we're being told. uh and it won't be near enough to justify uh either the levels of capex that have been put into this thing or the levels of uh the valuations on on a lot of assets. I mean I look I'll give you just two examples right um if you go back to 2008 in 2008 the whole world from peak to trough lost 18 trillion in equity market cap right u so you had essentially 500 billion of losses on mortgage bonds that triggered 8 18 trillion of market cap equity losses it was a blood bath 18 trillion now yeah now okay keep that number in mind for just a second today if you look at Nvidia plus um plus crypto just those two assets Nvidia and crypto uh there today together it's more than an $8 trillion market cap right uh now crypto and Nvidia just two years ago crypto and Nvidia just two years ago were two trillion market cap so they've gained 6 trillion in market cap in two years now 6 trillion is a lot of money you know there's there's I think there's only two economies in the world that have more than a 6 trillion GDP, the China and the US. So 6 trillion is a huge amount of money and that's what that's what's been gained in just 2 years by those two asset classes. Now when you look at Nvidia and when you look at crypto, these are asset classes that every 3 to four years lose 75% of their assets. That's just what they do. I mean it's it doesn't mean they're bad. I'm not putting a value judgment on it. I'm just saying like look these are highly high these have asset classes that through history have had massive volatility and massive downside upside and downside volatility. Now you could say well this has changed now that that's over but let's imagine that it hasn't changed that you know at sometime in the near future we got a 75% wipeout on these guys that will be 6 trillion that will pop away like this. That's a third of the equity loss of 2008 in just two asset classes. Now imagine the the impact this will have then on on capital spending. This impact this will have on consumption. You know there'll be a lot less boats being sold uh and a lot less uh sports cars and whatever else. So um the for me this is now the the big risk in the market to be honest is we've reached a point where the hype on AI the the results really have to be pretty outstanding for to match the the level of hype that that was put in. You mentioned earlier about the period in in April with the dollar, bonds and equities selling off at the same time and you know it brought into I suppose focus the kind of maybe structural concerns about the the long end of the curve in the US that you mentioned the likelihood of steepening but we've had the big beautiful bill you know deficits are not getting any smaller they're getting larger um and on a kind of on a trend basis year on year we've just got used to kind of six seven 8% of GDP Um but we're not seeing a huge reaction from the bond market. Obviously yields went up to maybe four, five, 4.6% or back to four and a quarter now. You know, there was a view in the markets, do deficits matter? I mean, at what point do they matter? It's uh it's the old story, right? Uh it's like it's like tequila shots. You you've never known when you've had enough until you've had too much. And and government debt tends to be the same story. You feel good, you feel good, you feel good, and then at some point you're throwing up in in in the bathroom. So yeah, your point is when do we start throwing up in the bathroom? And the answer is I'm not quite sure, but I know it's not a great asset class to own because at this pace, you know, it's like you're seeing the guy at the bar just pounding the tequila shots and you know there's no there there's nothing good coming out of that. You're not quite sure when he's going to hit the wall, but you know that wall is there. Yeah. So I look at I do look at the fiscal situation across most of the OECD and the reality is you could say oh it's bad everywhere etc. But but there's really three countries that are that have really bad fiscal situations today. One of them is my own of France. The other is the UK and the third is the United States. These are really the three countries where when you look at the increase in debt you can start get getting worried. Uh now the UK and the US still control their central bank. So they have the option to monetize the debt to essentially take the pain through currency devaluation through currency devaluations and and a weaker currency. It's harder for France to do this because we're obviously part of the euro. And so you know if if you want to look for a debt crisis perhaps the the more obvious candidate at this juncture has to be has to be France where you have a very tenuous political situation. uh you know you you have a government that can't pass a budget that's coming back in September from holiday uh doesn't control parliament because parliament is divided a third a third or third and every one of those three groups hate the other two um you know where basically building coalitions is is impossible and then you could say well if France hits the wall then maybe that gives another um boost to US treasuries where foreign you know foreign investors say ah you know Europe it's it's screwed These guys can't fight their way out of a wet paper bag. I thought they had it together, but they don't. Um, by the way, I'm not saying this is going to happen, but I think that the risk of that is not zero. And then, you know, money comes back into US treasuries. So, you know, you can actually make a bull case for for US treasuries. Personally, I don't own any US treasuries. Um, I think the US dollar is a structurally weak currency from here on out. I personally have no interest in owning bonds in currencies that depreciate. I like to own bonds in currencies that appreciate. Currencies are bound to be strong. I have no interest in owning US treasuries. But you could see an argument where okay actually out of the three weak links in the system France is the weakest link and when it breaks they'll boost the US. >> And what's the scenario for you know French problem? Obviously in Europe we've had a lot of we've had easing from the ECB. So they've been you know much much more ahead of the curve I guess than the Fed has been. And obviously as you say in Germany we've had the debt break being loosened. So >> maybe it doesn't which is why I said I'm not sure I'm not sure we go this way. >> Shifting gears. I mean last time you were on was kind of I think October last year. It was not long after the big kind of China announcement. Um the stimulus at that point it was a kind of a big spike in the equity market. It's been kind of up and down since then but probably a little bit higher. So you know hasn't reversed but um you mentioned the kind of the the China now the exporter the largest exporter of cars in the world and that's been the Chinese strategy isn't it flood the world with its uh excess manufacturing capacity today I I guess countries like Indonesia as you say Brazil have been happy to absorb that excess capacity I mean where do you see China now in its process of coming out of that big deleveraging that it's been going through for the last number of Yeah. So, I'm not sure that it's been China's strategy to flood these other countries. I think China strategy is actually a bit different. The the way I conceptualize China is that China was humming along and in 2018 the US embargo on semiconductors was a massive shock to the system that when the US said no more high semiconductors to China, essentially the Chinese leaders panicked. They thought, okay, if they're blocking us from semiconductors today, tomorrow it could be auto parts, it could be tires, it could be chemical products, it could be anything. The US is trying to trip us up economically. We thus have to become self-sufficient and independent, resilient on every single supply chain. And so in 2018, essentially the government tells the banks, "Guys, normal loans to real estate, normal loans to the consumer, all the money has to go to industry." And so we we go through seven years of all the loans. Like if if you were an auto manufacturer, you'd get a loan. If you were a battery manufacturer, a chemical producer, like whatever, you were getting a loan. Uh if you wanted real estate, forget about it. Um, and so you see real estate loans absolutely collapse and you get a a epic real estate bust, unsurprisingly. Imagine if tomorrow the uh the Irish government told uh the banks, you're not allowed to lend to real estate anymore. What that would do to to the real estate market? Uh probably nothing good, especially if you know valuations were stretched to begin with. And then you also had fairly little consumption because you know you you lived through it in Ireland when people's real estate goes down you tighten the belt and it's not like you go out to the movies or the restaurant. So that was the story really of the past six seven years. And while this happened it did create all this excess capacity that that you talk about. Um and so now today China turns around and produces all these cars, all these tractors, these telecom switches, these railroads. Um and then indeed the question becomes okay where are we going to sell all this stuff? Now the obvious market would be obviously the developed markets but there there's protectionism against China. Um and frankly the Russia invasion of Ukraine and the fact that China has sided with Russia has has made all that part uh you know even more complicated uh and the western world is even less likely to do business with China. So then the only market becomes the this global south for lack of a better word. It becomes Latin America, Middle East, Southeast Asia, Central Asia. Um but all these countries are poor countries. So China's got to provide funding and this is where we are today is like okay China is now starting to export these cars these train systems etc. In what currency are we going to fund this? Uh and this is where it gets interesting is if you go back to 10 years ago 5 years ago all China talked about was funding its trade in its own currency in the remmbb uh and it talked about the offshore remn. And what China was saying was essentially look Indonesia we'll buy your coal for remmbb and if you don't want to keep the remn for you know whatever reasons that are yours you can come to Shanghai and exchange your remn for gold and now what they've realized is that the more they trade and the more they push out the remn the more people buy gold on the other side and so gold starts to go not yet but starts to move parabolic it starts to move up now the risk now if you're Chinese, if you're the Chinese central bank, if you're the PBOC, the risk is that gold really, really starts to shoot up because Chinese investors themselves first love gold. Secondly, love a momentum trade. They're like they're the biggest momentum investors. So, gold starts shooting up, then they all start buying gold. And the risk then is the gold goes absolutely bananas and then it crashes and you've wiped out an entire generation worth of savings and you uh and you've made people very angry in the process and you've you know destabilized social peace. So you will have witnessed perhaps that in the past sort of year there's been a big change of rhetoric from the POC. Um, and I've written a number of pieces on this, but the rhetoric is essentially the PVOC now comes out and says, you know what, China's unique cuz we have two currencies. We have the rem and we have the Hong Kong dollar. Now, we can use the remn to fund our internal trade and we can use the Hong Kong dollar to fund the external trade. Uh but of course if we're going to fund all this trade in Hong Kong dollar um then we're going to end up with a lot of excess liquidity in Hong Kong dollars. All this Hong Kong dollars that get created pushed out into the system eventually come back into Hong Kong into Hong Kong banks by Hong Kong assets. So I'm I I think we've started this cycle. You know last year the Chinese equity markets were actually the one market that outperformed the US equity markets. Uh this year again, Hong Kong is is massively outperforming. Um and and nobody cares. Uh nobody cares. You know, I look I look at China, you know, I when I look at any market, I look at it through five prisms. Um first I start with fundamentals. Does it make sense? You know, and I would say China today, they they put down more patents than any other country. They've gone from graduating a million university students a year to 13 million university students a year. They spent the past 20 or 30 years dramatically improving their infrastructure to the point where they now have the cheapest electricity costs in the world. Um they they have the cheapest transportation costs in the world. So the fundamentals actually make sense. Then I look at valuations, they're still very attractive. The momentum is now very solid. Then you look at investor positioning and uh you know nobody owns China because remember they're always about to invade Taiwan and all sorts of crazy stuff. And then finally, you look at policy support and this is where you've had the biggest shift in China is that up until a year and a half ago, the rhetoric from the Chinese government was push put all the money in building industry and now the rhetoric is we want asset prices to go up uh and we want to create a positive balance sheet effect uh partly to boost domestic consumption. So yeah, I think look, we've started an an equity bull market in China and frankly nobody's involved. So the the transmission mechanism in the the the Hong Kong dollars is are lent to kind of emerging markets who would then sell those back to back into the system in Hong Kong. So you got more liquidity in the system there that flows into the equity market and and basically you see the excess liquidity. One of the things that's been a head scratcher for many investors is the extent to which Hong Kong interest. So Hong Kong is pegged to the dollar for your listeners who don't know this. The Hong Kong dollar is pegged to the US uh dollar. So historically the the interest rates are roughly the same u because otherwise there's always an arbitrage opportunity right if I can borrow Hong Kong dollars that's pegged to the US dollar and now at periods of crisis what would usually happen when people worry oh my god the peg's going to break or whatever else at periods of crisis Hong Kong dollar interest rates would move far above US interest rates to essentially attract people back into the Hong Kong dollar um this is how the peg works all year long you would have seen that high ball rates are like way way below US interest rates not by little but by like 200 basis points which is frankly unprecedented um and is a testimony to all the excess liquidity that is now sort of flowing into the Hong Kong dollar and uh sort of broader world. Do the do the Hong Kong banks not just buy the dollars and is there an arbitrage there that they're that somebody has got on an huge scale? >> No, I think the the Hong Kong banks do uh do do it, but they've got so many so many deposits in in Hong Kong dollars coming coming in. They don't know what to do with the Hong Kong dollars. >> Yeah. Okay. Just conscious of time outside of Hong Kong. Well, which is not really emerging, I guess, but emerging markets more broadly. I mean you painted a positive picture from the perspective of you know an environment of you know a weaker dollar which would generally be positive for global liquidity and for EM. I mean from a more kind of structural growth perspective how do you see how has EM been playing out? Obviously the tariffs I guess are a headwind for certain countries um or not or how do you see that? Yeah, I think uh look to the extent that everybody's getting them, it sort of it sort of evens out. Uh it evens out now you've had some that have been punished more than others. Brazil is the obvious one now. I I happen to have been and remain a bull on Brazil. Um I I look and for that matter the whole broader Latin America uh spectrum you know today especially if you're a fixed income investor it's the one part of the world where you can easily anticipate 150 250 350 basis points of of interest rates uh drop uh over the next 18 months. Um, and you know, like today you can go out and buy a Brazilian tips giving you 7 12 8% real returns. You can go out and buy Brazilian bonds that going to give you 14% nominal at a time when inflation is roughly five 5 1/2. So the, you know, nowhere in the world has that level of real rates. And you know in in a weaker dollar world the local central banks will have their hands free to to cut interest rates much more aggressively. So I think there's there's tremendous trades to be had in Latin America. Um there's um yeah I think the Chinese equity market has started a bull market uh that few people are even noticing. So yeah there's there there's things to do out there. So is that your top top tip for the coming year months? I mean is that what your most high conviction view bullish em or what would you say? >> Oh yeah my look my highest conviction move believe by far is we we're starting a new bull market in emerging markets. >> Um a bull market that won't be derailed until we either get a new Fed tightening cycle which seems highly unlikely right now where you know we're going quite the opposite. uh or until we get much higher energy prices and and again as you pointed out right now things are stable. Uh it doesn't seem like a spike is the most likely scenario for the next 6 to9 months. So now I want to buy hedges against that spike because I'm super long in emerging markets and I do worry that they would get squeezed if energy prices shot up. Um, so I want to buy hedges against energy prices shooting up, but you know, to protect my EM positions, but EM is where you want to be. >> Good. So, well, great to have you back on again. I'm sure we we'll do it again maybe next year at some point and uh reassess all all of those calls. But, uh, yeah, for all of our listeners, um, obviously keep tuned uh, and make sure to follow Louis work at Gavacal uh, to get his insights over time. But from all of us here, thanks for tuning in and we'll be back soon with more content. Thanks so much, Alan. >> Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues to grow, please leave us an honest rating and review in iTunes. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged. [Music]
The Global Order Is Cracking | Global Macro | Ep.86
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[Music] It's like tequila shots. You've never known when you've had enough until you've had too much. And and government debt tends to be the same story. You feel good, you feel good, you feel good, and then at some point you're throwing up in in in the bathroom. So yeah, your point is when do we start throwing up in the bathroom? And the answer is I'm not quite sure, but I know it's not a great asset class to own because at this pace, you know, it's like you're seeing the guy at the bar just pounding the tequila shots and you know there's no there there's nothing good coming out of that. You're not quite sure when he's going to hit the wall, but you know that wall is there. >> Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their failures. Imagine no more. Welcome to Top Traders Unplugged, 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, 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 anything about future performance. Also understand that there's a significant risk of financial loss with all 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 hedge fund manager Neils Krop Len. Welcome or welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macrodriven world may look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today's episode hosted by Alan Dunn. [Music] Thanks for the introduction, Neils. Today I'm delighted to be joined by Louis Gav. Uh Louie has been on the podcast a couple of times before, so it needs no introduction, but for those who haven't heard from Louiesie before, he's the founding partner and chief executive officer at Gavocal. He's been the markets many years and the author of several books. Louie, great to have you on. How how is holding your side? >> Uh things are good. It's uh it's I'm delighted to be back. Thanks uh thanks for having inviting me. >> Not at all. No. And as I said, you were on I think it was October last year and the summer the previous year. So, if people want to sense check how your views have evolved or hear your full backstory, they can uh they can listen to to those episodes. But >> hope I didn't say anything too embarrassing back then. >> I can't remember I can't remember what I said. Hopefully hopefully it's stood the test of time. >> I had a quick look back. It is funny how you kind of forget what what was topical at the time, but you did I mean to your credit you had a couple of very good calls. You were uh pretty confident that you were confident that Trump would win. And uh so you and was it the French guy who had the big bet on on the p on the uh the betting markets? >> Yeah, that's right. The uh the the the French whale. A lot of people asked me if that was me and it wasn't just to be very clear. Uh that was not me. Uh but yeah, I had quite a number of clients ping me and saying, "Hey dude, what are you doing putting out such big numbers on on the US presidential election?" Well, you you seemed equally confident at the time and you were right on that. And and the other point, the last couple of times you've been on, you've been definitely in the no recession camp on the view that um such large deficits in the US are not normally associated with recessions. And obviously the deficits have not got any smaller in the last couple years, so they've been getting bigger. But we have had some weak data out recently which have kind of reignited calls for maybe a a possible imminent downturn. So maybe that's a good starting point. How are you reading the data? Uh do you see increased concerns on that front? >> Yeah. Um look, I am increasingly concerned. I became a lot more concerned when uh with the tariffs uh back uh back in April when when these were announced and both Anatol, my business partner, Anatol Kitki, the Cal and Gavcow and and myself wrote wrote a number of pieces. Now, usually, you know, I I start off with with the premise that what matters the most is the cost of capital and the cost of energy. Uh when the cost of capital is is low enough and when capital is plentiful and when energy prices are low enough and energy is plentiful, usually you know the economy just moves forward because you know every entrepreneur wakes up every morning trying to figure out how to make more money, how to produce more with less etc. And that's what drives our capitalist system forward which again unless you have the breaks of two higher cost of capital too high cost of energy that that usually works. uh and that was part of the reason I was sort of dubious on the whole oh we're heading into recession uh because in my my career most of the recession have been uh preceded by either massive price you know big increase in the cost of capital especially the cost of capital I would say for the private sector more for the government i.e widening corporate spreads and and we didn't have that and we also had a cheap price of energy. So I don't know I felt pretty I felt pretty confident but um but inherent in that belief is also kind of the hope that entrepreneurs wake up in the morning feeling good about the future wanting to invest wanting to uh to to move the ball forward. And this is where you know the tariff throws an interesting wrench. Um because they they add a lot of uncertainty. Now the reality is most entrepreneurs just want certainty in their lives. You know it's they they want to know what the tax rates are going to be. They want to know what the regulations are going to be and then they get on with it. Um now of course every entrepreneur wants a lower tax rate. Every entrepreneur wants lower regulation. But by and large, you deal with, you know, you're told the rules of the game and then you you go out and play it. Uh or not, or you decide, you know what, I don't want to play this game. I'm taking my ball and going home. My big fear when the tariffs hit and and I wrote it at the time was that uh when you look at the construction sector uh in the United States, you're dealing with a bunch of entrepreneurs there who are still carrying the scars of 2020 and 21. You know, in 2020 and 21, you had massive supply chain dislocations. You had bare shelves at Home Depot, lumber prices spiking, etc. And so, a lot of projects got delayed. A lot of projects and delays in the construction industry means all of a sudden margins disappearing. And so my fear was that given these scars from the 2020 2021 experience a lot of the people in the construction industry and I was seeing this talking to people would react to the tariffs by saying look I don't know if in 3 months time I'll get the pipes because the pipes are made in China I don't know if I'll get the electric wire that's made in China and and the problem is if you don't get the electric wire then it postcrones everything right it's like if I can't get the electrician in today then I can't get the plumber in the next day and if I can't get the plumber then I'm going to get the drywall guy in. Um and so everywhere around me following the the tariffs I was hearing of you know like projects being put on hold. Now the reason this matters now you could say well you know construction it's it's only like 3 or 4% of US GDP etc. But it's a huge employer. Uh it's a massive massive employer, which by the way, that's another uncertainty is, you know, am I going to, you know, there's there's a lot of illegal workers in the construction industry, especially in the whole southern belt of the United States and Florida and elsewhere where where construction has been absolutely booming for the past uh for the past decade or so. Whether you look at your Arizonas, your Neadas, your Texas, your uh your Florida, this is where most of the construction was happening. Um, so you're dealing with all of a sudden, if you're an entrepreneur, uncertainty of am I going to get the parts I need when I need them at what price and am I going to get the workers and at what price. Maybe it's just easier I hold back and and not do anything. And and I think what's interesting in the recent weak data that has come out is the extent to which it does seem to point towards weak construction. And again like the the PMI surveys that just came out yesterday uh were pointing like the it disappointed and it was all basically construction. So do I think we're going to have a US recession? It's it's a tough one because it's you know if you look at typical models cost of capital budget deficits cost of cost of oil you would say no. But so you almost have to make the argument that it's different this time. But if ever there's a time to make the argument that it's different this time, it probably is today where where policym in the US is very different than you know you and I have experienced through our careers. Uh so it's it's hard to have a strong level of conviction uh either way. But I am I am fearful that the odds of recession are going up. Yes, I'm not like banging banging my fist on the desk saying oh my god you know uh to your listeners watch out US recession coming etc. And I'm not doing this but I think we have to acknowledge that the odds are probably higher than we've seen uh since the start since the postcoid era. >> Okay. And you're seeing that very much being driven by the construction side obviously you know consumer spending has slowed as well. I mean are there other dynamics at play? Obviously with tariffs coming through it's going to be a hit to disposable income um in real terms. any other channels you see kind of confirming the the weakening economy scenario? >> Yeah, look, I I think all of these make sense, but again, for me, construction's a huge employer. Construction's also, you know, there there's a huge multiplier effect um in um AC across communities everywhere. So, I do worry about that. Yes, indeed, I think there is the squeeze on on US disposable incomes um and both from you know, inflation that is still there. I think I I can't remember the exact number, but I think inflation has been above the 2% mark of the Fed for something like 46 months in a row. Don't quote me on that exact number, but it's in that ballpark. It's essentially four years. The the bottom line is, yeah, there's, you know, you look at consumer being squeezed, you look at construction being highly uncertain, uh, and frankly even capital spending in general. Like if you look at the boom we've had in the US, it it rested on many things. One of them was of the recent years was capital spending and AI. Um now this this might continue. However, um what we're increasingly seeing is that the hoped for returns to the likes of Google and Microsoft and Apple etc. and um and Facebook and others uh you know the hope for returns aren't that great. So at some point you know does the AI like sort of rush ahead continue? We've had very very strong consumer spending which was partly linked to I think the wealth effect on um on houses on equities on crypto. Now granted you could say well equities are all-time highs crypto essentially at all-time highs. So maybe that continues uh but maybe the lower end guy does does get squeezed. And then you had construction that was like booming and I think that part is slowing really hard. >> Yeah. And I mean obviously when tariffs came along there were a huge uncertainty and that was a theme of Q1 Q2. I mean it was reasonable to say well businesses will postpone um spending decisions or investment decisions. We don't know what it's going to play out like. But now I suppose you could say it is increasingly apparent what it is playing out. It's kind of 15% or 20% in most cases. Okay. We haven't got a deal with China yet but the noises are positive. I mean, can you do you think as we get into Q3, Q4, we'll get to a point where there is certainty on the tariffs or be that they are are now here at at kind of elevated levels? >> Yeah, look, I think the this really the three countries that matter the most for the US is, you know, what the US trades the most with are Canada, Mexico, and uh and China. Uh now, um when it comes to Canada and Mexico, you know, to your point, just like Europe, just like pretty much everybody out there, you're going to be in the 15 to 20 range. Um and I don't think that's inconsequential. You know, that's that's a pretty high number. Somebody's going to have to pay for that. Now, I think that the premise that uh of the Trump administration is that either foreigners will pay or or corporates will will take the hit on their profit margins. Maybe maybe they turn out to be right, but if if the lower-end consumer is made to carry some of that bag, then uh you know that bag that bag's already pretty loaded. The the low consumer is pretty stretched in the US. So um so yeah so you that's and then you you indeed have the elephant in the room which is China which is right now at 50%. Now 50% essentially kills the trade. Now you know China unlike other countries hasn't come grubbling they've and quite the contrary they said okay we want to go down this path we can raise tariffs on you we uh we can block the export of rare earths we can block the export of magnets we can bring your entire auto and armaments and aerospace industry to its knees in about 3 months so you know fine that's you know you you want to play let's play uh let bring it on um and you know I think the perception in China is that of course this will hurt the Chinese economy but that China's ability to withstand pain is much greater than the US's ability to withstand pain that essentially you know if the GM factories are shut for 2 weeks um then Trump will be seen as a failure uh you know the whole make America great again American industrial renaissance etc doesn't work if Ford and GM can't get rare earths and and magnets to to make cars. So So China has played that card. Uh it's played it uh it's played it quite aggressively. Um which does probably open the door for for a deal uh at at some point. But it really seems like China's not rushing to get a deal. >> So I mean what what what is a likely deal would you say um given all of that? So if you look at right now China is at 50 20 of which is um the penalties for fentanyl now already the US is now going around saying oh you know there's been huge progress on fentel uh it's uh it's now it's now much much better. So so they can move pretty quickly from 50 down to 30. Um I mean the US can decide that unilaterally just say okay fennel you know China's done tremendous work there well done so we'll bring it back down. Um so they've given themselves this leeway with the fentanyl tariffs by the way tariffs that were also imposed on Mexico and Canada and the US said okay you know they're making progress so we're taking that off. So I and I suspect that's what will eventually happen. Now, you know, once you get down to the 30%, after that, it's like, hm, it's not obvious that uh it goes lower from here. >> Yeah. So, you think that it could settle somewhere around that kind of baseline? Um, which would obviously still still be significant. >> I think 15 to 20 on everyone and probably 30 on China is is I think where we we basically end up with with the occasional other country that may also be at 30 or 35. it >> to the question on um impact on inflation. Uh obviously it's a it pushes up the price level. We've seen a little bit of that in the most recent inflation data on the good side. I mean that's been offset by weakness I think in the services side. Do you think we'll see more? And then where do you stand on like will it be more persistent over time? Like Chris Waller seems very intent on the view that it's a one-off price impact and it's not going to lead to sustained inflation. Would you be as confident on that view? So I I hate to make like a Jesuit priest and answer your question with another question, but I think that the answer to your question depends a lot on uh what your outlook on energy is and what your outlook for the US labor forces because the reality is that goods, you know, within the US like goods inflation is is only a fraction. What what probably really matters is whether we start to see wages push higher. Now, historically, a huge catalyst for wages pushing higher is um is higher energy prices. Somehow, there's a psychological element to to energy prices. Perhaps because, you know, when we drive to work, we we see the gas price on on on the side of the road. Um perhaps because it's the one thing we we buy consistently and it's always the same thing. I fill up my car every week and I know I pay X to fill up my car and and so right now energy prices are low. Gasoline prices are low and so, you know, wages are still not really rising all that fast. Even with the immigration crackdown, um, even with the immigration crackdown, wages haven't been shooting up. Now, fast forward 6 or 12 months from now. If energy prices have moved up and at the same time, you've got a tight labor market because you've you've kicked off all the illegal immigrants, then you really have the recipe for I think an inflationary spiral where wages go up. At the same time, good prices are going up um and gasoline prices are going up and then the the the narrative the popular mood really starts to swing to oh my god there's so much inflation. Um so energy prices at this juncture are really really critical and I would say that if energy prices start to rise uh then probably President Trump's uh presidency start becoming starts to become very challenging. As long as energy prices stay low, basically the show more or less may manage to stay on the road. So, I hate hate to hate. Now, I happen to be a bull on energy. So, I happen to be an inflationista. Um, but I I willingly acknowledge that energy prices today are low. Um, and that we're going through an interesting time in in energy. Uh, because on the one hand, I think we've underinvested in carbon for for 10 years now. And the scope for oil and natural gas etc to go up is there. But at the same time you have the you know the biggest energy importer in the world namely China that has invested like absolute crazy in its ability to deliver electricity and to essentially fund its own transition uh transition from carbon-based energy to to electricity whether that electricity is produced by nuclear by solar by you know LG plants by hydro by coal based fire plants but the, you know, China now produces twice the amount of living electricity that the United States does. Um, so which is which is funny because the US is still supposed to be at least a third bigger as an economy, but when you look at electricity production, if you think that's probably a decent proxy for the size of a of an economy, China is now twice the size of of the United States. So all this to say, we're we're at an interesting point where, you know, the energy of the future is electricity. It's it's not gasoline. It's not diesel. The energy of the fuel is electricity. China is moving very rapidly in that direction. The rest of the world not as much. But meanwhile, we've also massively underinvested in carbon. So depending on where you fall on the energy question, I think will dictate how you fall on the inflation question. So I'm a bull on energy. I think energy prices move higher. I think inflation thus moves higher. >> And what's the bull? I mean I I get the underinvestment case in energy. Um obviously oil prices have been stuck here in a range for quite a while now and obviously we've had geopolitical events. We've had Iran strikes etc. And you know the view is always seems to be you get a spike it's a good opportunity to sell because the market's quite well supplied at the moment. So what changes on that front or what what are the risk factors do you think? Yeah, look, I think the main thing is it's uh it big energy bull markets are driven first are driven more often than not by demand. And so I think what what what changes what people underestimate is you know you could look at energy essentially you've got different billion dollar billion people markets. So China's a 1 billion person market like I'm rounding of course it's like 1.3 but let's just call it 1 billion. India's 1 billion. Africa will very soon be 1 billion. Um, and then the developed markets are essentially 1 billion and then everybody else is 1 billion. Um, if if I'm going to make it like very very simple simplistic. So Africa has been a huge net energy exporter. That probably changes in about 3 or 4 years as you know as between their population growth and their standard of living growth. So they they switch from being an exporter to an importer. you know, India continues to import more and more. Uh, so, you know, I think people focus on China because it's been the big story of the past three decades in energy and then they say, "Oh, look, China's energy needs are plateauing. They're importing less or they're importing as much. They're no longer growing." But it's it's missing the story that's occurring elsewhere in emerging markets. So, when you look at total oil demand, it's still growing by 1 million to 1.5 million barrels per day every year. you know ballpark. So for that given you know the fact that you know whales whales lose capacity over time to make that extra million and a half barrels you need to to continuously invent invest. Now today you could say yeah but you know what OPEC probably has 2 million surplus. Yeah. And that probably covers you for the next year. And then what? So then what you could say, well, you know, you got some coming out in Surinam and some coming out in um but here's here's a fun fact on the other side, you know, from nowhere 5 years ago, China is now the biggest car exporter in the world. Like that somebody something that nobody expected like China is now the biggest car exporter in the world. And 85% of the cars that China exports on any given month, 80 to 85% are ICE cars. like then the electric cars stay at home and the ICE cars go abroad. Um why? Because the cars go to emerging markets and when you live in Colombia, when you live in Indonesia, your electricity grid isn't going to support electric cars. Also, electric cars depreciate too fast for emerging market investors. Good thing about ICE cars is they last 20 years if you take care of them. So now all of a sudden what you have in Indonesia, in Vietnam, in Colombia, in Brazil, you have people who buy cars who never bought cars before because they're buying Chinese cars for less than $10,000 a car. So you have all of a sudden people driving ICE cars all across the global south that were not consuming gasoline up until 5 minutes ago. And I think that's that's the part that uh perhaps people are missing today is yes on the one hand OPEC's got this extra 2 million etc. But at the pace at which China is exporting cars, you're going to need gasoline, you're going to need more refineries. You know, nobody's building refineries. You're going to need more refineries etc. And so uh so yeah, I I do tend to think that the risk is is to the upside. >> That sounds like maybe a story for next year or thereafter and not necessarily for the next six months. you it's these things are always so hard to tell right uh what I do know is that today's equilibrium is unstable um now you're absolutely right that it could be stable for the next 6 months 12 months 18 months absolutely but I think that if there is a risk to our system today if there is a risk of the to global economic growth if there's a risk to you know we're now set on an easing stage for central banks everywhere around the world whether you know the Fed that's going to be easing the ECB that's easing saying, you know, em central banks everywhere easing, etc. If there's a risk to this whole environment, it is that oil prices spike. Now, granted, I take I take your point. It's like, yeah, but that's not going to happen in the next 6 months. Probably like 90% chance it doesn't happen in the next 6 months, but what if it does? What if in that 10% chance it does? Then it's going to obliterate your portfolio. So at the very least, you don't invest on the premise that this is going to happen, but you in you you buy protection for your portfolio in case it does. [Music] You mentioned easing likely for the Fed. I mean, is that do you think now we're the Fed the Fed's going to come under so much pressure that it will cut in September? And how much between now and the end of the year? >> Yeah, I think it cuts in September. I think it cuts in September unless um again I'm sounding like a Jesuit priest like hedging everywhere. Uh but there's two CPI prints between now and September. Unless you get two bad CPI prints. Uh and by bad I mean they CPI that surprises on the upside that it turns out to be much stronger than expected. Unless you get that I think you're getting the those job numbers we just had almost guaranteed that you're you're getting you're getting a cut in September. Now you know beyond that is it going to be 25 is it going to be 50 I think a lot of that will be driven by the data between now and then uh but you know recent PMI recent ISM I've looked softer like if all these things continue then yeah probably 50 >> okay and then that allows that allows uh you know the Fed to sort of at least get Donald Trump off their back a little bit. Speaking of which, the the big topic in in with respect to the Fed is what happens next. So, obviously it seems like Trump isn't going to fire Pal just yet, but obviously the window for putting a replacement in is is opening. Obviously, there's a spot for a new governor and then which may or may not be the person who becomes the chair. What's your thinking on this? Obviously, it's kind of two Kevins and Chris Waller are probably the three names. I know there's a fourth. I'm not sure if that's best to he who's now seem to be ruled out or if there is somebody else. But back to the betting markets there. They are the top three contenders. So >> I thought Trump wanted to appoint himself. >> Well, that was also muted at one point. Yeah. Not not impossible, but Yeah. Yeah. >> Yeah. >> I So, first I don't think he fires Powell. Uh I don't think he fires Powell because Powell at this at this stage he's set him up as the perfect scapegoat. you know, he's done these big tariffs, which may or may not work. It's a big gamble. Um, if it pushes the US into recession, he can turn around and say, "It's the Fed's fault. It's Pal's fault. I've told you all along, this guy's an incompetent, etc., etc." So, he said he set up Pal as the scapegoat. So, why would he want to get rid of him? Like, as soon as he get rid of gets rid of him and puts in the other guy, then he owns the economic situation. Uh, either guy or girl. He then he owns he owns the economic situation. So I think Powell essentially serves out his term because he serves a purpose now uh which is the being a scapegoat. Um beyond that who he picks uh I think at this stage the what really matters uh more is that you know it's been signal it's been telegraphed that the Fed from here on out will be easier will be following easier monetary policies and we'll be essentially pushing the US towards a weaker dollar. Um, and you know, I would say who cares about the personalities at the top. What what matters for us as investors is the the highest odds are that we're going to have a set of policies that almost guarantee steeper yield curves and a weaker dollar. And you know, so that that's what matters to us. and a steeper a steeper yield curve a weaker dollar that that usually means outperformance of financials which is what you're seeing in markets everywhere. It usually means outperformance of emerging markets which is what you're increasingly seeing. Um usually it means the outperformance of value against growth which we're not really seeing yet but um I I think we'll we'll we'll see you know probably further down the road. >> Plausible. I I mean the one thing I would say is like the likes of Kevin Worsh um has very distinct views on you know balance sheet normalization and and and you know being very critical of the Fed's approach around QE. So I mean if we saw him come in you know obviously he's in favor of rate cuts at the moment but he does seem to be a bit more of independently minded than maybe say Kevin. >> That is that is that's a very fair fair point. I'm a big believer and a big proponent. I always say that look, as money managers, we're paid to adapt, not to forecast. Um, so, uh, I I'll be dead honest with you. I'm not actually spending that much time thinking through all the various scenarios of, you know, once who gets it and what they do once they get it, etc. Because, uh, like once we know who it is, then then I'll start thinking, okay, so it's this guy, so it probably means this, this, and that. Um having having said that uh you know people change their minds, people evolve as well but uh so so it it's like it's like I fear that trying to anticipate the various guys moves is maybe too many chess moves ahead. You know I'm I I I played a fair amount of chess in in my youth and I was never very good because I could never I could never do more than sort of three moves ahead. like you know the really good guys got like six moves ahead. I could do about three moves ahead in my head and then I' I'd sort of lose it. And as an investor I try to do the same. I try not to be too many moves ahead because it it just the the the complications just get too big. >> Fair enough. Um I mean you did mention a weaker dollar and this has been a theme this year. Obviously the dollar has had I think it's like the worst start measure on a on a calendar year basis. At least it did going back a few weeks when the narrative was all about kind of outflows. The end of US exceptionalism obviously was one narrative which has kind of diminished a little bit as as the equity market has come back and then outflows from the US market. Um obviously some hedging pressures as well undermining the dollar. So putting all of that together and obviously you know in the background chatter about you know US reserve status under pressure as well. I mean I suppose that's the consensus view. Hard to disagree with it. What what do you think? >> Yeah, I think it's hard to disagree with it. I think we are seeing a paradigm shift in in the US dollar and and look perhaps the most important shift in in the US dollar. You know, if you were a French pension fund or a Korean insurance company for years, you bought US equities and you were long the US dollar and if ever there was a market accident and equities went down 10%. Typically your own currency went down five. So net net on your US equity position you would be down five. So it was yeah nobody likes being down five but it's not the end of the world. So the fact that for years and years the US dollar was this port in a storm, this uh this shelter in rough in rough seas um meant ma made US assets very attractive. It made the US dollar very attractive and sort of very reflexive move for foreign investors. And I think this was shattered this year. We saw it very well in April when you know the the the liberation day tariffs were announced. Instead of going up, the US dollar went down. In fact, for a period of about eight days, you had the bond market in the US, the equities, and the currency all falling at once. And if you've ever done the emerging markets, you recognize that pattern immediately. Uh you recognize that pattern, you're like, "Okay, I've seen this movie before. This is an EM crisis. I'm out of here." When you see those three things fall together, it's usually it's a it's it's a big warning bell. And you know, that's why I think Bessent and Lutnik had to intervene. and you know they they they talked the tariffs back and and and stabilized the markets. But the message was nonetheless sent that from now on when US equities falls so does the dollar. And therefore this makes US assets ju just this shift in correlations makes US assets a lot less attractive to to most institutional investors everywhere. So I think that's you know you got that of course you've got the greater uncertainty around politics. um and policies in the US. And politically, it's now no longer uh good to be seen being overweight the US. If you're running a public pension fund in Holland, uh or you're running a sovereign wealth fund in Singapore, like being massively overweight the US may not be the smart trade. Um so, so bottom line, I think the default mode amongst large institutional investors is now to bring money home. You know, for the default mode for 15 years was I invest in the US. Now the default mode is is bringing money home. But but the problem when you talk to pension funds in Germany or pension funds in Canada, they always tell you the same story is I want to bring money home but I don't have any assets to buy at home. Now this is where it gets interesting is if you look at the new chancellor in Germany, the new prime minister in Canada, new prime minister in Canada, you know, comes out of Goldman. I I tend to believe that you can get the guy out of Goldman, you're not going to get Goldman out of the guy. So, if you now have pension funds that come to CM and say, "Hey, uh, Prime Minister Carney, give us assets to buy." Uh, he's going to say, "All right, I know how to do this. Uh, let's build some infrastructure bonds. Let's, uh, IPO the airports. Let's build pipelines into British Columbia to sell the oil to to Asia and give all these Canadian pension funds that have hundreds of billions invested in the US opportunities to bring money home." And I don't want to pick on Mark Carney cuz you take the German chancellor, he used to be the CEO of Black Rockck for Europe for 6 years. So how hard is it for him to structure infrastructure bonds and call the head of every pension fund in Europe that he knows on a firstname basis? Probably not probably not very challenging. So I do think this trend is is starting where the marginal dollar instead of being invested back into the US is now increasingly going to be invested domestically. >> Makes sense, I guess. I mean the one thing that that it ignores is is the AI theme and and the mag seven haveve I've have have come back you know having been under pressure for a while. Um so if if investors want to play that theme that obviously the US still remains the obvious place to go to. I mean you mentioned that maybe some questions around the return on investment but you know at the same time recent results from you know u Meta were encouraging and and I think the likes of Microsoft and um a number of them were were announcing upgrades to their capex spend. So I mean for the moment it's it still seems to be raging on. Um is that not part of your your your the picture or your >> That's a massive part of the picture. uh that's a massive part of the picture because you're absolutely right to highlight it and that you've had an epic capital spending boom in the US where I actually recently wrote a piece on this where capex in the US over the past few years has gone from 9% of GDP to 11% of GDP and this 2% of GDP increase in capex by the way historically it tops out at around 11.5% like in 2000 it topped out 11 and a half% uh that extra 2% um has really gone to a handful of companies because that increase in capex uh some of it has been in data centers, some of it has been in you know building out new power plants although nowhere near enough and some of it has been most of it has been in AI you know it's it that 2% it's gone basically straight into Nvidia's bottom line exaggerating of course but don't don't send me data saying it's no it didn't all go into but it's gone into uh to Nvidia and yes to Microsoft and so so the question now becomes um you know you've had this huge increase in capex what do we get on the other side of it now do we get the productivity gains and do we get the profits that flow to these businesses that have essentially turned themselves you take a Facebook it's essentially turned itself from an extremely asset light business into an increasingly assetheavy business now again if the money flows in then happy days then the show stays on the And yes, people want to keep buying Facebook and they'll want to keep Nvidia, etc. If the the returns don't come through, if AI turns out to be very commoditized and if the the the profits on there or the productivity gains aren't what was hoped and expected, then the US really hits the wall really really really hard because right now what is keeping the show on the road to your point is this excitement around AI. uh take that away and all of a sudden things start to look pretty dire. >> And what's your thoughts on in the next downturn? I mean there is a view that because now of increased usage of AI, LLM, etc. that you know a lot of those entry level positions are not being filled and that in the next downturn we could see you know even more adoption and PE corporates trying to squeeze as much out of AI as they can and much higher unemployment. Is that too early to expect that or is that a risk factor on your radar? >> No, I think you have to worry about that. I mean, look, that that's the very lynch pin of the AI hope is the idea that we're going to get >> that's the productivity gain, isn't it? Yeah, >> it is. So, it's you you have to worry about it because either A this is so there's two options. Hey, this is going to be real and where, you know, all this to your point, the entry-level jobs in insurance companies and in banks and and in a lot of places are are going to disappear and so then you have to wonder, okay, so what does that mean for our societies? What does that mean for for jobs in general, etc. So, so that's your one path. Uh, and the the other path is, like I said, I think it it turns out to be a dud. uh nowhere near as uh as productive as as we'd hoped and we have a a hell of a stock market correction. It's it almost uh reminds me of that Woody Allen quote, right, about how you know you we've reached a fork in the road on on one side lies uh despair and uh and the other lies uh you know misery and that I hope we choose wisely. So I I don't want I don't want to sound depressing for for your listeners. Um, I tend to believe, and I may be wrong, uh, you know, but from my own playing with it, from I tend to believe that the level of hype on AI is off the charts. Um, and that there will be some productivity gains, sure, but it'll be nowhere near what uh what we're being told. uh and it won't be near enough to justify uh either the levels of capex that have been put into this thing or the levels of uh the valuations on on a lot of assets. I mean I look I'll give you just two examples right um if you go back to 2008 in 2008 the whole world from peak to trough lost 18 trillion in equity market cap right u so you had essentially 500 billion of losses on mortgage bonds that triggered 8 18 trillion of market cap equity losses it was a blood bath 18 trillion now yeah now okay keep that number in mind for just a second today if you look at Nvidia plus um plus crypto just those two assets Nvidia and crypto uh there today together it's more than an $8 trillion market cap right uh now crypto and Nvidia just two years ago crypto and Nvidia just two years ago were two trillion market cap so they've gained 6 trillion in market cap in two years now 6 trillion is a lot of money you know there's there's I think there's only two economies in the world that have more than a 6 trillion GDP, the China and the US. So 6 trillion is a huge amount of money and that's what that's what's been gained in just 2 years by those two asset classes. Now when you look at Nvidia and when you look at crypto, these are asset classes that every 3 to four years lose 75% of their assets. That's just what they do. I mean it's it doesn't mean they're bad. I'm not putting a value judgment on it. I'm just saying like look these are highly high these have asset classes that through history have had massive volatility and massive downside upside and downside volatility. Now you could say well this has changed now that that's over but let's imagine that it hasn't changed that you know at sometime in the near future we got a 75% wipeout on these guys that will be 6 trillion that will pop away like this. That's a third of the equity loss of 2008 in just two asset classes. Now imagine the the impact this will have then on on capital spending. This impact this will have on consumption. You know there'll be a lot less boats being sold uh and a lot less uh sports cars and whatever else. So um the for me this is now the the big risk in the market to be honest is we've reached a point where the hype on AI the the results really have to be pretty outstanding for to match the the level of hype that that was put in. You mentioned earlier about the period in in April with the dollar, bonds and equities selling off at the same time and you know it brought into I suppose focus the kind of maybe structural concerns about the the long end of the curve in the US that you mentioned the likelihood of steepening but we've had the big beautiful bill you know deficits are not getting any smaller they're getting larger um and on a kind of on a trend basis year on year we've just got used to kind of six seven 8% of GDP Um but we're not seeing a huge reaction from the bond market. Obviously yields went up to maybe four, five, 4.6% or back to four and a quarter now. You know, there was a view in the markets, do deficits matter? I mean, at what point do they matter? It's uh it's the old story, right? Uh it's like it's like tequila shots. You you've never known when you've had enough until you've had too much. And and government debt tends to be the same story. You feel good, you feel good, you feel good, and then at some point you're throwing up in in in the bathroom. So yeah, your point is when do we start throwing up in the bathroom? And the answer is I'm not quite sure, but I know it's not a great asset class to own because at this pace, you know, it's like you're seeing the guy at the bar just pounding the tequila shots and you know there's no there there's nothing good coming out of that. You're not quite sure when he's going to hit the wall, but you know that wall is there. Yeah. So I look at I do look at the fiscal situation across most of the OECD and the reality is you could say oh it's bad everywhere etc. But but there's really three countries that are that have really bad fiscal situations today. One of them is my own of France. The other is the UK and the third is the United States. These are really the three countries where when you look at the increase in debt you can start get getting worried. Uh now the UK and the US still control their central bank. So they have the option to monetize the debt to essentially take the pain through currency devaluation through currency devaluations and and a weaker currency. It's harder for France to do this because we're obviously part of the euro. And so you know if if you want to look for a debt crisis perhaps the the more obvious candidate at this juncture has to be has to be France where you have a very tenuous political situation. uh you know you you have a government that can't pass a budget that's coming back in September from holiday uh doesn't control parliament because parliament is divided a third a third or third and every one of those three groups hate the other two um you know where basically building coalitions is is impossible and then you could say well if France hits the wall then maybe that gives another um boost to US treasuries where foreign you know foreign investors say ah you know Europe it's it's screwed These guys can't fight their way out of a wet paper bag. I thought they had it together, but they don't. Um, by the way, I'm not saying this is going to happen, but I think that the risk of that is not zero. And then, you know, money comes back into US treasuries. So, you know, you can actually make a bull case for for US treasuries. Personally, I don't own any US treasuries. Um, I think the US dollar is a structurally weak currency from here on out. I personally have no interest in owning bonds in currencies that depreciate. I like to own bonds in currencies that appreciate. Currencies are bound to be strong. I have no interest in owning US treasuries. But you could see an argument where okay actually out of the three weak links in the system France is the weakest link and when it breaks they'll boost the US. >> And what's the scenario for you know French problem? Obviously in Europe we've had a lot of we've had easing from the ECB. So they've been you know much much more ahead of the curve I guess than the Fed has been. And obviously as you say in Germany we've had the debt break being loosened. So >> maybe it doesn't which is why I said I'm not sure I'm not sure we go this way. >> Shifting gears. I mean last time you were on was kind of I think October last year. It was not long after the big kind of China announcement. Um the stimulus at that point it was a kind of a big spike in the equity market. It's been kind of up and down since then but probably a little bit higher. So you know hasn't reversed but um you mentioned the kind of the the China now the exporter the largest exporter of cars in the world and that's been the Chinese strategy isn't it flood the world with its uh excess manufacturing capacity today I I guess countries like Indonesia as you say Brazil have been happy to absorb that excess capacity I mean where do you see China now in its process of coming out of that big deleveraging that it's been going through for the last number of Yeah. So, I'm not sure that it's been China's strategy to flood these other countries. I think China strategy is actually a bit different. The the way I conceptualize China is that China was humming along and in 2018 the US embargo on semiconductors was a massive shock to the system that when the US said no more high semiconductors to China, essentially the Chinese leaders panicked. They thought, okay, if they're blocking us from semiconductors today, tomorrow it could be auto parts, it could be tires, it could be chemical products, it could be anything. The US is trying to trip us up economically. We thus have to become self-sufficient and independent, resilient on every single supply chain. And so in 2018, essentially the government tells the banks, "Guys, normal loans to real estate, normal loans to the consumer, all the money has to go to industry." And so we we go through seven years of all the loans. Like if if you were an auto manufacturer, you'd get a loan. If you were a battery manufacturer, a chemical producer, like whatever, you were getting a loan. Uh if you wanted real estate, forget about it. Um, and so you see real estate loans absolutely collapse and you get a a epic real estate bust, unsurprisingly. Imagine if tomorrow the uh the Irish government told uh the banks, you're not allowed to lend to real estate anymore. What that would do to to the real estate market? Uh probably nothing good, especially if you know valuations were stretched to begin with. And then you also had fairly little consumption because you know you you lived through it in Ireland when people's real estate goes down you tighten the belt and it's not like you go out to the movies or the restaurant. So that was the story really of the past six seven years. And while this happened it did create all this excess capacity that that you talk about. Um and so now today China turns around and produces all these cars, all these tractors, these telecom switches, these railroads. Um and then indeed the question becomes okay where are we going to sell all this stuff? Now the obvious market would be obviously the developed markets but there there's protectionism against China. Um and frankly the Russia invasion of Ukraine and the fact that China has sided with Russia has has made all that part uh you know even more complicated uh and the western world is even less likely to do business with China. So then the only market becomes the this global south for lack of a better word. It becomes Latin America, Middle East, Southeast Asia, Central Asia. Um but all these countries are poor countries. So China's got to provide funding and this is where we are today is like okay China is now starting to export these cars these train systems etc. In what currency are we going to fund this? Uh and this is where it gets interesting is if you go back to 10 years ago 5 years ago all China talked about was funding its trade in its own currency in the remmbb uh and it talked about the offshore remn. And what China was saying was essentially look Indonesia we'll buy your coal for remmbb and if you don't want to keep the remn for you know whatever reasons that are yours you can come to Shanghai and exchange your remn for gold and now what they've realized is that the more they trade and the more they push out the remn the more people buy gold on the other side and so gold starts to go not yet but starts to move parabolic it starts to move up now the risk now if you're Chinese, if you're the Chinese central bank, if you're the PBOC, the risk is that gold really, really starts to shoot up because Chinese investors themselves first love gold. Secondly, love a momentum trade. They're like they're the biggest momentum investors. So, gold starts shooting up, then they all start buying gold. And the risk then is the gold goes absolutely bananas and then it crashes and you've wiped out an entire generation worth of savings and you uh and you've made people very angry in the process and you've you know destabilized social peace. So you will have witnessed perhaps that in the past sort of year there's been a big change of rhetoric from the POC. Um, and I've written a number of pieces on this, but the rhetoric is essentially the PVOC now comes out and says, you know what, China's unique cuz we have two currencies. We have the rem and we have the Hong Kong dollar. Now, we can use the remn to fund our internal trade and we can use the Hong Kong dollar to fund the external trade. Uh but of course if we're going to fund all this trade in Hong Kong dollar um then we're going to end up with a lot of excess liquidity in Hong Kong dollars. All this Hong Kong dollars that get created pushed out into the system eventually come back into Hong Kong into Hong Kong banks by Hong Kong assets. So I'm I I think we've started this cycle. You know last year the Chinese equity markets were actually the one market that outperformed the US equity markets. Uh this year again, Hong Kong is is massively outperforming. Um and and nobody cares. Uh nobody cares. You know, I look I look at China, you know, I when I look at any market, I look at it through five prisms. Um first I start with fundamentals. Does it make sense? You know, and I would say China today, they they put down more patents than any other country. They've gone from graduating a million university students a year to 13 million university students a year. They spent the past 20 or 30 years dramatically improving their infrastructure to the point where they now have the cheapest electricity costs in the world. Um they they have the cheapest transportation costs in the world. So the fundamentals actually make sense. Then I look at valuations, they're still very attractive. The momentum is now very solid. Then you look at investor positioning and uh you know nobody owns China because remember they're always about to invade Taiwan and all sorts of crazy stuff. And then finally, you look at policy support and this is where you've had the biggest shift in China is that up until a year and a half ago, the rhetoric from the Chinese government was push put all the money in building industry and now the rhetoric is we want asset prices to go up uh and we want to create a positive balance sheet effect uh partly to boost domestic consumption. So yeah, I think look, we've started an an equity bull market in China and frankly nobody's involved. So the the transmission mechanism in the the the Hong Kong dollars is are lent to kind of emerging markets who would then sell those back to back into the system in Hong Kong. So you got more liquidity in the system there that flows into the equity market and and basically you see the excess liquidity. One of the things that's been a head scratcher for many investors is the extent to which Hong Kong interest. So Hong Kong is pegged to the dollar for your listeners who don't know this. The Hong Kong dollar is pegged to the US uh dollar. So historically the the interest rates are roughly the same u because otherwise there's always an arbitrage opportunity right if I can borrow Hong Kong dollars that's pegged to the US dollar and now at periods of crisis what would usually happen when people worry oh my god the peg's going to break or whatever else at periods of crisis Hong Kong dollar interest rates would move far above US interest rates to essentially attract people back into the Hong Kong dollar um this is how the peg works all year long you would have seen that high ball rates are like way way below US interest rates not by little but by like 200 basis points which is frankly unprecedented um and is a testimony to all the excess liquidity that is now sort of flowing into the Hong Kong dollar and uh sort of broader world. Do the do the Hong Kong banks not just buy the dollars and is there an arbitrage there that they're that somebody has got on an huge scale? >> No, I think the the Hong Kong banks do uh do do it, but they've got so many so many deposits in in Hong Kong dollars coming coming in. They don't know what to do with the Hong Kong dollars. >> Yeah. Okay. Just conscious of time outside of Hong Kong. Well, which is not really emerging, I guess, but emerging markets more broadly. I mean you painted a positive picture from the perspective of you know an environment of you know a weaker dollar which would generally be positive for global liquidity and for EM. I mean from a more kind of structural growth perspective how do you see how has EM been playing out? Obviously the tariffs I guess are a headwind for certain countries um or not or how do you see that? Yeah, I think uh look to the extent that everybody's getting them, it sort of it sort of evens out. Uh it evens out now you've had some that have been punished more than others. Brazil is the obvious one now. I I happen to have been and remain a bull on Brazil. Um I I look and for that matter the whole broader Latin America uh spectrum you know today especially if you're a fixed income investor it's the one part of the world where you can easily anticipate 150 250 350 basis points of of interest rates uh drop uh over the next 18 months. Um, and you know, like today you can go out and buy a Brazilian tips giving you 7 12 8% real returns. You can go out and buy Brazilian bonds that going to give you 14% nominal at a time when inflation is roughly five 5 1/2. So the, you know, nowhere in the world has that level of real rates. And you know in in a weaker dollar world the local central banks will have their hands free to to cut interest rates much more aggressively. So I think there's there's tremendous trades to be had in Latin America. Um there's um yeah I think the Chinese equity market has started a bull market uh that few people are even noticing. So yeah there's there there's things to do out there. So is that your top top tip for the coming year months? I mean is that what your most high conviction view bullish em or what would you say? >> Oh yeah my look my highest conviction move believe by far is we we're starting a new bull market in emerging markets. >> Um a bull market that won't be derailed until we either get a new Fed tightening cycle which seems highly unlikely right now where you know we're going quite the opposite. uh or until we get much higher energy prices and and again as you pointed out right now things are stable. Uh it doesn't seem like a spike is the most likely scenario for the next 6 to9 months. So now I want to buy hedges against that spike because I'm super long in emerging markets and I do worry that they would get squeezed if energy prices shot up. Um, so I want to buy hedges against energy prices shooting up, but you know, to protect my EM positions, but EM is where you want to be. >> Good. So, well, great to have you back on again. I'm sure we we'll do it again maybe next year at some point and uh reassess all all of those calls. But, uh, yeah, for all of our listeners, um, obviously keep tuned uh, and make sure to follow Louis work at Gavacal uh, to get his insights over time. But from all of us here, thanks for tuning in and we'll be back soon with more content. Thanks so much, Alan. >> Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you. And to ensure our show continues to grow, please leave us an honest rating and review in iTunes. 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