This $52 Trillion Financial Time Bomb Is Set To Explode
Summary
AI and Passive Investing: The podcast discusses the impact of AI on passive investing, emphasizing how it could significantly affect the overall economy by altering investment behaviors and asset valuations.
Asset-Driven Economy: The US economy is described as being heavily reliant on asset prices rather than productivity or income, likened to a hot air balloon where asset prices drive economic demand.
Passive Investing Risks: Concerns are raised about the dominance of passive investing, where funds are allocated without regard to fundamentals, potentially leading to market instability and increased volatility.
Market Mechanics: The discussion highlights the potential dangers of a market with high passive investment, where a net outflow could lead to a rapid decline in stock prices due to lack of active management intervention.
Unemployment and Market Impact: The podcast suggests that a rise in unemployment, possibly driven by AI, could trigger a net outflow from passive investments, exacerbating economic downturns.
AI's Role in Employment: AI is identified as a potential catalyst for increasing unemployment rates, which could disrupt traditional investment flows and economic stability.
Investment Strategy and Risk Management: Listeners are advised to consider market mechanics and potential downside risks in their investment strategies, particularly in the context of passive investing and AI-driven economic changes.
Gold Investment: The podcast concludes with a discussion on investing in gold through Monetary Metals, which offers interest payments in gold, as a strategy to mitigate storage costs and diversify investment portfolios.
Transcript
Hello fellow Rebel Capitals. Hope you're well. So today I wanted to start discussing some of the incredible topics we went over last week when I was in St. Barts talking to some of the top minds in the hedge fund and macroeconomic space. And one of the consistent themes discussed, let's say, at this event was not just AI, not just AI's impact on the stock market, but AI's impact on passive investing and how that would impact the overall economy. So, I had a lunch discussion with two of probably the smartest people I know in finance and we you guys can probably guess who one of them was. And um we had it we talked for probably three hours on this exact topic. And when I was just kind of mentally taking notes, I wanted to make sure that this is one of the first things I discussed with the rebel capitalist audience. So, let's dive into this really quick here. First, I want to start off by going through a bit of a thought experiment. Now, one podcast that I listened to recently was a podcast, The Market Huddle. This was with Kevin Mure and CPY. And I'd highly suggest it if you get time. I think Patrick Sresno was off, but Cappy was talking about the experience that he's had with his father. And his father, like most Americans, has pretty much 100% of his net worth tied up in his house and the S&P 500. It's in an index fund and then, you know, maybe a small portion of it in CPY's hedge fund. And Copy was talking about over the last couple years or so, almost every single time he's called up his father and said, "Hey pops, what's going on, he's planning another trip to Europe and Cupy's like, this is really weird because although it's great, I'm happy for him. His income because he's retired now has declined. So I'm like, okay, Dad, where are you getting all this money?" And what's happening is it's just his stock portfolio. his stock portfolio in his house are going up to such a degree that he'll just take out a loan and it doesn't matter because the underlying value of the asset continues to go up and up and up. So even if he can't afford the payment, who cares? He just sells the house. So he's got just like a a virtual ATM machine with his house and his stock portfolio. So CPy's conclusion is something we talk about on this channel constantly. constantly and that's the idea. The US economy is pretty much propped up by asset prices where it should be the reverse. You guys know I always talk about that hot air balloon where the balloon should be the economy and the basket should be the S&P 500. So if the economy is doing better, well the S&P 500 should do better because that's corporate earnings and vice versa. If the economy is doing poorly, then you would expect asset prices S&P 500 to come down because that impacts the real businesses that make up the S&P 500. But as you guys know lately, it's almost the opposite over the last 10 years where if the economy is doing poorly, oh my goodness gracious. Well, that's great for assets. And now we have this reversal where the balloon is actually the asset prices and the basket is the real economy. And what I mean by that is wherever the basket is going, well, so goes the economy because so much of the aggregate demand in the real economy, just like the story of Cupy's dad, is a result of asset bubbles and just asset price. It's not a result of productivity. It's not a result of income. It's not a result of hard work. It's not a result of saving more than you spend. Or another way of saying that it's not a result of producing more than you consume or or business investment, capital spending, anything like this. It's just simply number go up. And because we've engineered number go up for so many years, then the economy has gone up with it. But obviously this is a house built on a foundation of sand. So, how has that number gone up? And just to illustrate my point here, we have the Buffett indicator, which is just simply the market cap of the stock market, the Wilshire 5000, relative to GDP, in other words, relative to the US economy. And so, it's just a bigger and bigger and bigger portion of the economy. In fact, you know what would be really, I should write this down, is to look at the economy, the overall economy through the lens of asset prices and government spending. So, I mean, let me know in the chat right now if government spending was reduced to the point where there's no longer a deficit and we get rid of all the fiscal and in addition to that asset prices just mean revert. So, I'm talking about the PE ratio and the price to income ratio in housing. If that just goes down by 40 50% which would be a reversion to the mean then what do you think would happen to the US economy? So you're stripping out asset prices or asset bubbles and you're stripping out all this obnoxious government spending. then obviously I think the majority of the people in the chat would agree you're going to see a serious serious decline to real GDP and you're likely going to see a massive recession if not something even worse. So I think that this is this is very easy to understand. We're all on the same page. So now let's go over to passive investing. Actually, you know, I'm sorry. Before we do that, let's go over to the S&P 500. And if you look at uh Mike Green's work as an example, you know that most of this move up, this is S&P 500 nominal chart. Most of this move up is a result of passive. And it's not just Mike Green. There's a lot of guys and gals who have done some great great great work on this. And a lot of the, let's just say, really smart people that I was hanging out with, I had the privilege of hanging out with last week, see it all the same way. I mean, this is they've got different opinions on a lot of different things, but uh this is this and probably AI and the unemployment rate is where most of the people completely agree. So you have this uh phenomenon where most of retail investors want to find a cheap way to just get a proxy for um you know the overall economy or they want basically they're deferring their retirement or they're subcontracting subcontracting out their thinking their investment to an index fund and they're just told over and over and over again just buy the dip, you know, buy and hold and just try to get as low of fees as possible. And this is going to allow you to retire to the point where you don't have to work as hard. You don't have to save as much. And you don't have to save as much. You have more disposable income. And this jacks the economy. This pumps the economy in um in u an environment where the economy is literally 70% consumption. So what happens here is and this is the key. Now, let's go over to this uh summary. This is paradox of passive investing. This was way back in 2017, but it definitely applies today. Let me go ahead and zoom in for you guys. So, the the key here, it's it's not just money going into the market. That that's that's not and people get confused. They're like, "Well, who cares if money is going into active uh management funds or passive? It doesn't matter because the money's going in." No, no, that you're you're missing the point. The key is the decision-making process. So, if a a dollar goes into a passive fund, there is no decision-making process on the fundamentals. So, right now, I'm sure most of you look at the fundamentals and you say, "This is insane." You know, I don't know what the the PE ratios, let's say 22, 25, something like that. You look at this and say, "They're wildly overpriced." You look at Nvidia, you look at um oh, what's the other one? Oh, the Mag 7. You You look at this and say, "Well, a lot of these don't make sense or none of them make sense." whatever conclusion you come to, but they're definitely not cheap when you look at the PE ratios. And so you kind of scratch your head and you're like, well, this can't last. You know, how did we get here to begin with? And the answer is because the majority of money going into the stock market, in fact, all the money on net going into the stock market has gone in without any discretion for fundamentals. They they don't that's not so it's not a question they're asking. It's just simply we don't care about the fundamentals. We don't care about the price. We don't care about how overvalued it is. We don't care about the valuation. We don't care about any of these things that used to matter. The only thing we care about is just if we get a dollar then we just have to buy at any price. So this is uh how they're describing it here. When stocks are being purchased without any thought to the underlying fundamentals of the company, this could create risk to how the market operates. Risk, this is an understatement. This is an understatement. So now let's look at this chart and just think this one through. Going back to 07, remember this is 2017. It's way worse now. Way worse. You have all this is on net. You have all the money going into passive and all this money coming out of active. So, let's just assume we had a pie chart of the total amount of money or capital that we could allocate to the market. The closer that pie chart gets to 100% passive, the closer we get to there being no decisionmaking at all. And so, let's just take it to an extreme so we understand the concept. If we have 100% passive investing, 100% and you have one more dollar come out than goes in, what happens? It it it it plummets. The S&P 500 would plummet because there would be there wouldn't Who's going to buy? And remember, I'm I'm saying if it's 100% and you have net selling, that means that they're selling. There's no discretion there. And there's no one that is going to say, "Oh my gosh, now all of a sudden it's cheap. I want to go ahead step in and buy." That would be the active managers because they're actually making decisions based on the fundamentals. But if there's no decision-making process in the entire market based on fundamentals, if you have net selling, you're going straight to zero. Now, I'm not saying that that's what would happen, but you would hit a a huge air pocket, and this would massively increase the volatility to the downside because you just don't have those active dollars that are going to step in and hit the bid when these things get cheap. Because remember, most of this that well, most of this that line you can see this is all retail investors. So, what's retail going to do? If you have net selling and they just see the market tank, you're going to get more selling. Selling selling begets more selling begets more selling and you just have kind of like this this doom loop where there's no active capital in there to step in. Now, of course, this is 100%. So, that's a thought experiment. We don't have that right now. But as you look at a pie chart and as we go from 50/50 to 75 passive, 25 active to 90% passive, 10% active, you get closer and closer to let's just say this risk, right? And so then you have to say, all right, if we do continue to get closer and closer to a potential air pocket and we hit that air pocket where we get we go, you know, over the span of I don't say it happens overnight, but over the span of whatever, 6 weeks, 6 months, something like that, you see the stock market go down by 40%. And let's remember that that that would just take us back to normal levels. Like a lot of people think that that's just impossible that we would need a GFC or like a survea sickness to go down 40% in the S&P 500. No, just look at the valuations. Like that would liter in fact we still might be overvalued in historic terms if the market goes down by 40%. I mean I don't have the number in front of me but I would not be surprised. Let's get back to this article. There's clearly a benefit of how low management costs that occur to those using passive strategies. However, at what point are the benefits of low management costs outweighed by the causitive effects of very large flows of capital being allocated with no reference to economic return? Is there a paradox of passive so that investors have low management costs but in aggregate their returns are at higher risk? That's really what we're talking about here. As more capital is invested with no thought behind what is being purchased or by the way what's being sold, there's a tipping point where the irrational behavior is no longer sustainable. And again, you're right there. It's no longer sustainable. But when that thing reverses, it's not like it slowly goes down. When that thing reverses, you get you get wet and wild slide or you get the wildly coyote moment. So here is just, you know, Warren Buffett says this all the time, but it's so true that value does not equal price. But in today's day and age of just wild speculation where the markets have literally turned into a casino, the only thing that matters is price. Price determines value in most people's mind. If the price goes up, well, it has to be valuable and then we just go ahead and buy more. I mean, this is the argument that you hear on social media all the time. where you're sitting there, you try to make an argument based on value, and then you just get the peanut gallery saying, "Oh, the price has gone up, therefore, you're wrong." Well, now, just because the price has gone up doesn't mean that there's value, right? And that's what we're talking about here. And that's the difference. Uh, one of the main differences between active management and just let's just say retail piling in piling in at a cheaper and cheaper price making that pie chart go from 50 to 75 to 90 till you get to that point where there's this let's say tipping point I think that's a good way to say it where there's just not if you have a net outflow of passive due to demographics due to just people freaking out whatever whatever it is, there's no one there to hit the bid at any price and it just goes straight down. I like the conclusion here. They say, "While we understand and generally concur with desire to implement portfolios cheaply, investors should be cognizant of what they're buying. Is our view that flows into passive quasi passive vehicles are having a distortive effect on markets at the moment?" Well, basically saying that the reason why markets as far as the pees and these valuations are at nosebleleed levels is because of passive. Because if you had 100% active, there's no way there's no way that you would just have almost 100% of the S&P 500 in the in the mag seven or something like that. investors because why? Because in investments would be made not on price go up or just um indiscriminately investments would be made on the analysis of the underlying fundamentals. Okay. Uh paradox of passive investing could turn out to be an expensive mistake. Again, that that's definitely understating it. So, I think you guys get the concept and most people here would agree. The question that we had at this lunch that I'm going to dive into now is okay, I get it, but what's the tipping point or what would result or what is an event that would result on a net outflow from passive that would likely lead to that air pocket? straight down which would likely lead to a recession in the economy because I mean it's weird to say this but because asset prices are so vital uh to the aggregate demand in the US economy right now that if those asset prices go down it's almost impossible to avoid a recession. You say, "Oh, well, George, well, fiscal would come in. Fiscal would come in maybe." But then you're assuming that that fiscal is going to lead to STEMI checks. And I when I mean STEMI checks, I mean money going to the back pocket of the average Joe and Jane. And they're going to take that money and they're going to buy the dip. Maybe they will. Maybe they may, maybe they will, but maybe they won't. Uh let let's go back and remember, you know, this is a chart that I went over the other day that I think it's extremely important to realize. Uh let's see here. Let's um let's go back to this one. This is a chart that I went over the other day and I'll just quickly go over it here. Uh most people think that yeah, you're just going to buy the dip forever because that's how markets work and everyone knows that the market over time goes up and therefore it's not about timing the market, it's about time in the market. But if you actually look at history, you see this is complete and utter nonsense, especially when you adjust for inflation. So this is a chart 1930, let's say, to where are we here? 1930 to 1980. And you can see adjusted for inflation, the S&P 500 was flat, flat. And in fact, if you go back over the last 90 years, um, from 2020 to two, from 1930, excuse me, to 2020, you see that there's four decades, four decades where when you adjust for inflation, the S&P 500's down, and there's four decades where it's up and one where it's flat, little a little up, but basically flat. And so what we're saying here is it's a coin toss. So look at this. Why on earth weren't people buying the dip from 1930 to 1950? 20 years. 20 years where my guess there is it's it would be even down in nominal terms. Let's see here. So there's 1930 and let's stretch it out to 1950. Yeah. Yeah. So even in a nominal terms from 1930 to 1950 it's down. So look at this. Can you imagine that 31? So let's just say you know to make it more realistic numbers based on today that the S&P 500 was at 3100. 3,100 and over the next 20 years it goes from 3,100 down to 1,400 or 1,500. I mean, what do you think that does to the US economy? And then you have to ask yourself, why did this happen? Why did like why didn't people come in and buy the dip here? Like like why were they not buy and hold? Why why were they not just because of social media? No, of course not. because you get this massive downwardly move where everybody and their grandma gets wiped out. You combine that with a huge depression, unemployment rate goes up and everyone is has basically stock market PTSD. And this happens periodically just like it happens on the way up where people get conditioned to just buy the dip, buy the dip, buy the dip. You also get people conditioned to just sell, sell, sell, sell, sell sell and not even want to touch the stock market with a 10- foot pole because everyone knows that if you invest in the stock market, you'll always lose money. The narrative can change very, very quickly. I mean, you guys know that just being alive with the housing bubble. remember we went from it's impossible to not make money buying homes and that was from let's say 97 1997 all the way to 2006 or 2007 and then from 2006 to 2012 it was the complete opposite. I remember when I was buying housing in 2012 these rental properties everyone was telling me that I was crazy that I was insane that I was out of my mind. Why? Because they said well don't you know housing prices always go down. real estate always goes down because it had gone down the last six years. You see? So my my point there is maybe if we have a big stock market decline, the retail investor will come right back in and although there there'll be net outflows to passive there that would switch on a dime and there would be net inflows. But then you have to ask yourself where's that money coming from? Especially if we're in a recession where the unemployment rate is going up, right? So if the unemployment rate's going up, people have less disposable income to put into passive in the first place. And therefore, that would lead you to the conclusion that there's a higher probability that that net outflow would feed on itself, especially if you're in an economic decline. And again, it goes back to the unemployment rate, the unemployment rate or the labor market, let's say, the labor market. So when I was having this discussion with uh these two really really smart guys, a lot of fun. Uh it just really revolved around okay what would cause this whole cycle to reverse to where instead of having just these net inflows that have taken the stock market to these nosebleleed levels because of the indiscriminate buyer, right? going back uh oh I guess this is the chart here. So we'll just you know like this what would cause this to have a net outflow where we would see something like this and then what impact did that have on the economy? Well, the the well, you guys can guess. One of the guys I was talking to was Mike Green and he's done a lot of math on this and he said basically with his models if the unemployment rate assuming the labor mark the labor force participation stayed the same if the unemployment rate in the United States got above let's say five 6% that would And again, there's no certainties, only probabilities, but that would almost certainly lead to an environment where there's going to be a net outflow from passive. And why is that? Because most people are taking their paychecks and then a part of that paycheck is going right into a 401k and the majority of that is going straight into, you know, the S&P 500 index fund. And so if you reduce the size of people's paychecks, then there's going to be less inflow. And then on net balance when you combine that with people taking money out because value is price you know that's great on the way up where where or price equals value but on the way down then that just feeds on itself where now all of a sudden there's no value because the price is just simply going down. take my money out and on net balance that creates even more net selling and then that then you're just exacerbating the air pocket and then that what does that do then that makes the unemployment rate even higher because the US economy is so dependent on asset prices to begin with which reduces the amount of money that is there that's able to go into a passive index fund and then you're you're just basically getting into this this doom loop So we we know that a lot of this it's demographics, but the big big big catalyst here, the straw that breaks the camel's back based on Mike Green's models, unemployment rate, unemployment rate, unemployment rate, labor market. And if you think about it, that makes a lot of sense. That makes a lot of sense. So then you have to say, okay, what outside of a recession? That's duh. Everyone knows that. But outside of a recession, what could cause the unemployment rate to go up to that degree? And could we see something come along that would make the unemployment rate just almost go parabolic? I think you guys know the answer to this. It my view is absolutely unequivocally yes. And it's just it's right in front of our noses. It's AI. So, ironically, this move toward AI and you know, whether you like AI or not, the genie's out of the bottle. She ain't getting back in. And it's the future. Now, are the stocks overvalued and all these things? Yeah, but it's similar to the.com bust or blow up where you get ahead of yourself. You get over your skis, but you zoom out and that definitely was the future. And I think it's the something similar to uh with AI right now. And we see just the destruction of not just white collar jobs, but these white collar jobs that kids are expecting out of college that have all this student loan debt. They go out to the market. You know, you're a radiologist or something. I don't know what you'd have to study in uh in school to become a radiologist, but like that. You're looking for your job. You're expecting to make 150,000 a year. And that's what you need to make, by the way, to pay off your student loan debt or to even make these payments. And you got and there's no one hiring. Like, why on earth should I hire an entrylevel college student for a white collar job when a lot of those white collar jobs are are gone as of today, let alone, you know, where are they going to be tomorrow? So just looking at this, we've got this uh CEO from Anthropic. Um I mean he is predicting that the US unemployment rate and again this does not include a recession that due to all these entry- level white collar jobs just vanishing in the next 5 years. He's saying that could push the unemployment rate up to 10 to 20%. So don't take my word on it. 10 to 20%. uh this person venture capitalist I'm not sure Kaufu Lee uh is their prediction is AI could displace 50% of jobs by 2027 I I don't know if I'd go that far but I totally see how by 2030 that all us being equal the unemployment rate which is 4.2 right now goes up 10%. That seems totally totally totally realistic. So then that goes back to what Mike Green was saying. And if the let's say tipping point is the tipping point from going to this to this is 5% unemployment. What happens if AI takes the unemployment ve in very quick fashion straight up to 10%. Or even 8% for heaven's sakes. This is what I I think, you know, is this going to play out? No. I I don't know. I I guess that's the answer. I have no idea. But I I think everyone needs to be aware of this. You need to be aware of the market mechanics because that should absolutely unequivocally go into your risk management. And when you're looking at going long the stock, and I'm not saying don't go long. There could be a great argument for going long the stock market, but I think when most people go long the stock market, they simply focus on the reward. You know, what's the upside? And they completely completely ignore the downside. And even if they incorporate the what they believe is the downside risk, they are wildly naive when it comes to the real downside risks due to the mechanics of passive investing and when we could hit that tipping point. I mean, how many retail investors do you know like Cuppy's dad that are just 100% invest? You know, whatever they have in their 401k is just an S&P 500 index fund because that's what everyone tells him to do. Just dollar cost average. It's not about timing the market. It's about time in the market, right? How many people like that that just have a percentage of their paycheck every single week or month or whatever go into their 401k that goes into the S&P 500 index fund? How many people like that have a tail risk hedge? what their house. No, that's the exact same thing that that's that's effectively being long the S&P 500 because if the S&P 500 tanks, guess what's guess what's going to happen to the value of your house or vice versa. I mean, that's basically the same bet, right? We would call that just short volatility, your short volatility. So what happens if you get that you know four standard deviation event or not even that I mean just what happens if the unemployment rate goes up to 8% for heaven's sakes due to AI or the combination of AI recession the fact of the matter is these people the retail investor does not have that tail risk hedged excuse me they don't have that tail risk hedged and again I'm not saying don't be long the S&P 500 but just don't be long like an ostrich with your head buried in the sand where you're only where your investment strategy is just ignorance is bliss. That's most retail investors strategy from start to finish. It's just they they employ the ignorance is bliss portfolio. I'm saying don't do that. Don't do that. All right. It brings me over to today's sponsor, some great buddies of mine over at Monetary Metals. Uh I love gold, as you guys know. It's kind of the cornerstone of any portfolio that I set up, regardless of what the strategy is. And the the problem though that I was having is you've got high storage fees, especially when the price of gold goes up, which is what you want. Unfortunately, your storage fees goes up as well because your storage fees are based on the value of the gold you have and not the number of ounces. So, in looking for a solution, I stumbled across, you know, I it was right in front of my face, but my good buddies over at Monetary Metals, Keith Weiner's a a friend of mine, and they reached out. They wanted to sponsor the channel and I said, "Yeah, I mean, it sounds like a a great deal here because you don't have to pay those storage fees. They actually pay you an interest rate on the gold you have with them, and it's actually paid in gold, which is nice." So, how do they do this? Because a lot of people say, "Oh, this has got to be a Ponzi scheme or something like No, it's not. They just simply take your gold and they lease it to jewelers who use it to hedge or it's just a a better business model for the jeweler and they're happy to pay a four, five, 6% interest rate paid in gold uh to have the ability to go ahead and lease that gold from monetary metals. And the benefit to you obviously is not only do you not have to pay those fees, but you are paid an interest rate paid in gold. So I said, you know, look guys, I've never taken on a sponsor, which you guys know I haven't. And so I was a little bit leery, but I said, I I'd be cool doing it because I really believe in the product, but I want to set up my own account first to see how this really works. So I set up my account with Monetary Metals. I've got maybe 45 uh $50,000 of gold in there right now. And it's it's I've had a great experience. I've had the account set up for probably four months or so. And um it's great. Whenever I have a question I had a question the other day if I could just take some of my gold and turn it into silver and if they could do that for me. And they said, "Yeah, absolutely. No problem. How much would you like to do?" I didn't do any because I wanted to take that purchasing power and move it over to the gold miners. But you have you got a lot of flexibility there. They're very customer serviceoriented. And if you want to learn more about the model, Josh will put a link to an explainer video in the description or just give them a call. I mean, just old school, right? Hopefully a lot of you can appreciate that. Just think about it. If you think it's going to be right for you or would potentially be right for you, just give them a call. Let's see. Here's their website and you can So, it's monetary-metals.com. You can do forward/gamon just to let them know that I I sent you. And then you just go to the bottom of their website and their phone number is right here. It's based out of uh Scottsdale. And so just give them a ring, tell them I sent you, ask any questions you want, see if it is potentially right for you. Because for a portion of my exposure to gold, this was definitely right for me. I've had a great experience and it's allowed me to instead of having to pay for that gold storage to actually get paid an interest rate that's in gold. So, the amount of my gold is just continually increasing. So, check them out, guys. Again, that's monetary-metals.com. And on that bombshell, as always, make sure you're standing up for freedom, liberty, free market capitalism. See you in the next video.
This $52 Trillion Financial Time Bomb Is Set To Explode
Summary
Transcript
Hello fellow Rebel Capitals. Hope you're well. So today I wanted to start discussing some of the incredible topics we went over last week when I was in St. Barts talking to some of the top minds in the hedge fund and macroeconomic space. And one of the consistent themes discussed, let's say, at this event was not just AI, not just AI's impact on the stock market, but AI's impact on passive investing and how that would impact the overall economy. So, I had a lunch discussion with two of probably the smartest people I know in finance and we you guys can probably guess who one of them was. And um we had it we talked for probably three hours on this exact topic. And when I was just kind of mentally taking notes, I wanted to make sure that this is one of the first things I discussed with the rebel capitalist audience. So, let's dive into this really quick here. First, I want to start off by going through a bit of a thought experiment. Now, one podcast that I listened to recently was a podcast, The Market Huddle. This was with Kevin Mure and CPY. And I'd highly suggest it if you get time. I think Patrick Sresno was off, but Cappy was talking about the experience that he's had with his father. And his father, like most Americans, has pretty much 100% of his net worth tied up in his house and the S&P 500. It's in an index fund and then, you know, maybe a small portion of it in CPY's hedge fund. And Copy was talking about over the last couple years or so, almost every single time he's called up his father and said, "Hey pops, what's going on, he's planning another trip to Europe and Cupy's like, this is really weird because although it's great, I'm happy for him. His income because he's retired now has declined. So I'm like, okay, Dad, where are you getting all this money?" And what's happening is it's just his stock portfolio. his stock portfolio in his house are going up to such a degree that he'll just take out a loan and it doesn't matter because the underlying value of the asset continues to go up and up and up. So even if he can't afford the payment, who cares? He just sells the house. So he's got just like a a virtual ATM machine with his house and his stock portfolio. So CPy's conclusion is something we talk about on this channel constantly. constantly and that's the idea. The US economy is pretty much propped up by asset prices where it should be the reverse. You guys know I always talk about that hot air balloon where the balloon should be the economy and the basket should be the S&P 500. So if the economy is doing better, well the S&P 500 should do better because that's corporate earnings and vice versa. If the economy is doing poorly, then you would expect asset prices S&P 500 to come down because that impacts the real businesses that make up the S&P 500. But as you guys know lately, it's almost the opposite over the last 10 years where if the economy is doing poorly, oh my goodness gracious. Well, that's great for assets. And now we have this reversal where the balloon is actually the asset prices and the basket is the real economy. And what I mean by that is wherever the basket is going, well, so goes the economy because so much of the aggregate demand in the real economy, just like the story of Cupy's dad, is a result of asset bubbles and just asset price. It's not a result of productivity. It's not a result of income. It's not a result of hard work. It's not a result of saving more than you spend. Or another way of saying that it's not a result of producing more than you consume or or business investment, capital spending, anything like this. It's just simply number go up. And because we've engineered number go up for so many years, then the economy has gone up with it. But obviously this is a house built on a foundation of sand. So, how has that number gone up? And just to illustrate my point here, we have the Buffett indicator, which is just simply the market cap of the stock market, the Wilshire 5000, relative to GDP, in other words, relative to the US economy. And so, it's just a bigger and bigger and bigger portion of the economy. In fact, you know what would be really, I should write this down, is to look at the economy, the overall economy through the lens of asset prices and government spending. So, I mean, let me know in the chat right now if government spending was reduced to the point where there's no longer a deficit and we get rid of all the fiscal and in addition to that asset prices just mean revert. So, I'm talking about the PE ratio and the price to income ratio in housing. If that just goes down by 40 50% which would be a reversion to the mean then what do you think would happen to the US economy? So you're stripping out asset prices or asset bubbles and you're stripping out all this obnoxious government spending. then obviously I think the majority of the people in the chat would agree you're going to see a serious serious decline to real GDP and you're likely going to see a massive recession if not something even worse. So I think that this is this is very easy to understand. We're all on the same page. So now let's go over to passive investing. Actually, you know, I'm sorry. Before we do that, let's go over to the S&P 500. And if you look at uh Mike Green's work as an example, you know that most of this move up, this is S&P 500 nominal chart. Most of this move up is a result of passive. And it's not just Mike Green. There's a lot of guys and gals who have done some great great great work on this. And a lot of the, let's just say, really smart people that I was hanging out with, I had the privilege of hanging out with last week, see it all the same way. I mean, this is they've got different opinions on a lot of different things, but uh this is this and probably AI and the unemployment rate is where most of the people completely agree. So you have this uh phenomenon where most of retail investors want to find a cheap way to just get a proxy for um you know the overall economy or they want basically they're deferring their retirement or they're subcontracting subcontracting out their thinking their investment to an index fund and they're just told over and over and over again just buy the dip, you know, buy and hold and just try to get as low of fees as possible. And this is going to allow you to retire to the point where you don't have to work as hard. You don't have to save as much. And you don't have to save as much. You have more disposable income. And this jacks the economy. This pumps the economy in um in u an environment where the economy is literally 70% consumption. So what happens here is and this is the key. Now, let's go over to this uh summary. This is paradox of passive investing. This was way back in 2017, but it definitely applies today. Let me go ahead and zoom in for you guys. So, the the key here, it's it's not just money going into the market. That that's that's not and people get confused. They're like, "Well, who cares if money is going into active uh management funds or passive? It doesn't matter because the money's going in." No, no, that you're you're missing the point. The key is the decision-making process. So, if a a dollar goes into a passive fund, there is no decision-making process on the fundamentals. So, right now, I'm sure most of you look at the fundamentals and you say, "This is insane." You know, I don't know what the the PE ratios, let's say 22, 25, something like that. You look at this and say, "They're wildly overpriced." You look at Nvidia, you look at um oh, what's the other one? Oh, the Mag 7. You You look at this and say, "Well, a lot of these don't make sense or none of them make sense." whatever conclusion you come to, but they're definitely not cheap when you look at the PE ratios. And so you kind of scratch your head and you're like, well, this can't last. You know, how did we get here to begin with? And the answer is because the majority of money going into the stock market, in fact, all the money on net going into the stock market has gone in without any discretion for fundamentals. They they don't that's not so it's not a question they're asking. It's just simply we don't care about the fundamentals. We don't care about the price. We don't care about how overvalued it is. We don't care about the valuation. We don't care about any of these things that used to matter. The only thing we care about is just if we get a dollar then we just have to buy at any price. So this is uh how they're describing it here. When stocks are being purchased without any thought to the underlying fundamentals of the company, this could create risk to how the market operates. Risk, this is an understatement. This is an understatement. So now let's look at this chart and just think this one through. Going back to 07, remember this is 2017. It's way worse now. Way worse. You have all this is on net. You have all the money going into passive and all this money coming out of active. So, let's just assume we had a pie chart of the total amount of money or capital that we could allocate to the market. The closer that pie chart gets to 100% passive, the closer we get to there being no decisionmaking at all. And so, let's just take it to an extreme so we understand the concept. If we have 100% passive investing, 100% and you have one more dollar come out than goes in, what happens? It it it it plummets. The S&P 500 would plummet because there would be there wouldn't Who's going to buy? And remember, I'm I'm saying if it's 100% and you have net selling, that means that they're selling. There's no discretion there. And there's no one that is going to say, "Oh my gosh, now all of a sudden it's cheap. I want to go ahead step in and buy." That would be the active managers because they're actually making decisions based on the fundamentals. But if there's no decision-making process in the entire market based on fundamentals, if you have net selling, you're going straight to zero. Now, I'm not saying that that's what would happen, but you would hit a a huge air pocket, and this would massively increase the volatility to the downside because you just don't have those active dollars that are going to step in and hit the bid when these things get cheap. Because remember, most of this that well, most of this that line you can see this is all retail investors. So, what's retail going to do? If you have net selling and they just see the market tank, you're going to get more selling. Selling selling begets more selling begets more selling and you just have kind of like this this doom loop where there's no active capital in there to step in. Now, of course, this is 100%. So, that's a thought experiment. We don't have that right now. But as you look at a pie chart and as we go from 50/50 to 75 passive, 25 active to 90% passive, 10% active, you get closer and closer to let's just say this risk, right? And so then you have to say, all right, if we do continue to get closer and closer to a potential air pocket and we hit that air pocket where we get we go, you know, over the span of I don't say it happens overnight, but over the span of whatever, 6 weeks, 6 months, something like that, you see the stock market go down by 40%. And let's remember that that that would just take us back to normal levels. Like a lot of people think that that's just impossible that we would need a GFC or like a survea sickness to go down 40% in the S&P 500. No, just look at the valuations. Like that would liter in fact we still might be overvalued in historic terms if the market goes down by 40%. I mean I don't have the number in front of me but I would not be surprised. Let's get back to this article. There's clearly a benefit of how low management costs that occur to those using passive strategies. However, at what point are the benefits of low management costs outweighed by the causitive effects of very large flows of capital being allocated with no reference to economic return? Is there a paradox of passive so that investors have low management costs but in aggregate their returns are at higher risk? That's really what we're talking about here. As more capital is invested with no thought behind what is being purchased or by the way what's being sold, there's a tipping point where the irrational behavior is no longer sustainable. And again, you're right there. It's no longer sustainable. But when that thing reverses, it's not like it slowly goes down. When that thing reverses, you get you get wet and wild slide or you get the wildly coyote moment. So here is just, you know, Warren Buffett says this all the time, but it's so true that value does not equal price. But in today's day and age of just wild speculation where the markets have literally turned into a casino, the only thing that matters is price. Price determines value in most people's mind. If the price goes up, well, it has to be valuable and then we just go ahead and buy more. I mean, this is the argument that you hear on social media all the time. where you're sitting there, you try to make an argument based on value, and then you just get the peanut gallery saying, "Oh, the price has gone up, therefore, you're wrong." Well, now, just because the price has gone up doesn't mean that there's value, right? And that's what we're talking about here. And that's the difference. Uh, one of the main differences between active management and just let's just say retail piling in piling in at a cheaper and cheaper price making that pie chart go from 50 to 75 to 90 till you get to that point where there's this let's say tipping point I think that's a good way to say it where there's just not if you have a net outflow of passive due to demographics due to just people freaking out whatever whatever it is, there's no one there to hit the bid at any price and it just goes straight down. I like the conclusion here. They say, "While we understand and generally concur with desire to implement portfolios cheaply, investors should be cognizant of what they're buying. Is our view that flows into passive quasi passive vehicles are having a distortive effect on markets at the moment?" Well, basically saying that the reason why markets as far as the pees and these valuations are at nosebleleed levels is because of passive. Because if you had 100% active, there's no way there's no way that you would just have almost 100% of the S&P 500 in the in the mag seven or something like that. investors because why? Because in investments would be made not on price go up or just um indiscriminately investments would be made on the analysis of the underlying fundamentals. Okay. Uh paradox of passive investing could turn out to be an expensive mistake. Again, that that's definitely understating it. So, I think you guys get the concept and most people here would agree. The question that we had at this lunch that I'm going to dive into now is okay, I get it, but what's the tipping point or what would result or what is an event that would result on a net outflow from passive that would likely lead to that air pocket? straight down which would likely lead to a recession in the economy because I mean it's weird to say this but because asset prices are so vital uh to the aggregate demand in the US economy right now that if those asset prices go down it's almost impossible to avoid a recession. You say, "Oh, well, George, well, fiscal would come in. Fiscal would come in maybe." But then you're assuming that that fiscal is going to lead to STEMI checks. And I when I mean STEMI checks, I mean money going to the back pocket of the average Joe and Jane. And they're going to take that money and they're going to buy the dip. Maybe they will. Maybe they may, maybe they will, but maybe they won't. Uh let let's go back and remember, you know, this is a chart that I went over the other day that I think it's extremely important to realize. Uh let's see here. Let's um let's go back to this one. This is a chart that I went over the other day and I'll just quickly go over it here. Uh most people think that yeah, you're just going to buy the dip forever because that's how markets work and everyone knows that the market over time goes up and therefore it's not about timing the market, it's about time in the market. But if you actually look at history, you see this is complete and utter nonsense, especially when you adjust for inflation. So this is a chart 1930, let's say, to where are we here? 1930 to 1980. And you can see adjusted for inflation, the S&P 500 was flat, flat. And in fact, if you go back over the last 90 years, um, from 2020 to two, from 1930, excuse me, to 2020, you see that there's four decades, four decades where when you adjust for inflation, the S&P 500's down, and there's four decades where it's up and one where it's flat, little a little up, but basically flat. And so what we're saying here is it's a coin toss. So look at this. Why on earth weren't people buying the dip from 1930 to 1950? 20 years. 20 years where my guess there is it's it would be even down in nominal terms. Let's see here. So there's 1930 and let's stretch it out to 1950. Yeah. Yeah. So even in a nominal terms from 1930 to 1950 it's down. So look at this. Can you imagine that 31? So let's just say you know to make it more realistic numbers based on today that the S&P 500 was at 3100. 3,100 and over the next 20 years it goes from 3,100 down to 1,400 or 1,500. I mean, what do you think that does to the US economy? And then you have to ask yourself, why did this happen? Why did like why didn't people come in and buy the dip here? Like like why were they not buy and hold? Why why were they not just because of social media? No, of course not. because you get this massive downwardly move where everybody and their grandma gets wiped out. You combine that with a huge depression, unemployment rate goes up and everyone is has basically stock market PTSD. And this happens periodically just like it happens on the way up where people get conditioned to just buy the dip, buy the dip, buy the dip. You also get people conditioned to just sell, sell, sell, sell, sell sell and not even want to touch the stock market with a 10- foot pole because everyone knows that if you invest in the stock market, you'll always lose money. The narrative can change very, very quickly. I mean, you guys know that just being alive with the housing bubble. remember we went from it's impossible to not make money buying homes and that was from let's say 97 1997 all the way to 2006 or 2007 and then from 2006 to 2012 it was the complete opposite. I remember when I was buying housing in 2012 these rental properties everyone was telling me that I was crazy that I was insane that I was out of my mind. Why? Because they said well don't you know housing prices always go down. real estate always goes down because it had gone down the last six years. You see? So my my point there is maybe if we have a big stock market decline, the retail investor will come right back in and although there there'll be net outflows to passive there that would switch on a dime and there would be net inflows. But then you have to ask yourself where's that money coming from? Especially if we're in a recession where the unemployment rate is going up, right? So if the unemployment rate's going up, people have less disposable income to put into passive in the first place. And therefore, that would lead you to the conclusion that there's a higher probability that that net outflow would feed on itself, especially if you're in an economic decline. And again, it goes back to the unemployment rate, the unemployment rate or the labor market, let's say, the labor market. So when I was having this discussion with uh these two really really smart guys, a lot of fun. Uh it just really revolved around okay what would cause this whole cycle to reverse to where instead of having just these net inflows that have taken the stock market to these nosebleleed levels because of the indiscriminate buyer, right? going back uh oh I guess this is the chart here. So we'll just you know like this what would cause this to have a net outflow where we would see something like this and then what impact did that have on the economy? Well, the the well, you guys can guess. One of the guys I was talking to was Mike Green and he's done a lot of math on this and he said basically with his models if the unemployment rate assuming the labor mark the labor force participation stayed the same if the unemployment rate in the United States got above let's say five 6% that would And again, there's no certainties, only probabilities, but that would almost certainly lead to an environment where there's going to be a net outflow from passive. And why is that? Because most people are taking their paychecks and then a part of that paycheck is going right into a 401k and the majority of that is going straight into, you know, the S&P 500 index fund. And so if you reduce the size of people's paychecks, then there's going to be less inflow. And then on net balance when you combine that with people taking money out because value is price you know that's great on the way up where where or price equals value but on the way down then that just feeds on itself where now all of a sudden there's no value because the price is just simply going down. take my money out and on net balance that creates even more net selling and then that then you're just exacerbating the air pocket and then that what does that do then that makes the unemployment rate even higher because the US economy is so dependent on asset prices to begin with which reduces the amount of money that is there that's able to go into a passive index fund and then you're you're just basically getting into this this doom loop So we we know that a lot of this it's demographics, but the big big big catalyst here, the straw that breaks the camel's back based on Mike Green's models, unemployment rate, unemployment rate, unemployment rate, labor market. And if you think about it, that makes a lot of sense. That makes a lot of sense. So then you have to say, okay, what outside of a recession? That's duh. Everyone knows that. But outside of a recession, what could cause the unemployment rate to go up to that degree? And could we see something come along that would make the unemployment rate just almost go parabolic? I think you guys know the answer to this. It my view is absolutely unequivocally yes. And it's just it's right in front of our noses. It's AI. So, ironically, this move toward AI and you know, whether you like AI or not, the genie's out of the bottle. She ain't getting back in. And it's the future. Now, are the stocks overvalued and all these things? Yeah, but it's similar to the.com bust or blow up where you get ahead of yourself. You get over your skis, but you zoom out and that definitely was the future. And I think it's the something similar to uh with AI right now. And we see just the destruction of not just white collar jobs, but these white collar jobs that kids are expecting out of college that have all this student loan debt. They go out to the market. You know, you're a radiologist or something. I don't know what you'd have to study in uh in school to become a radiologist, but like that. You're looking for your job. You're expecting to make 150,000 a year. And that's what you need to make, by the way, to pay off your student loan debt or to even make these payments. And you got and there's no one hiring. Like, why on earth should I hire an entrylevel college student for a white collar job when a lot of those white collar jobs are are gone as of today, let alone, you know, where are they going to be tomorrow? So just looking at this, we've got this uh CEO from Anthropic. Um I mean he is predicting that the US unemployment rate and again this does not include a recession that due to all these entry- level white collar jobs just vanishing in the next 5 years. He's saying that could push the unemployment rate up to 10 to 20%. So don't take my word on it. 10 to 20%. uh this person venture capitalist I'm not sure Kaufu Lee uh is their prediction is AI could displace 50% of jobs by 2027 I I don't know if I'd go that far but I totally see how by 2030 that all us being equal the unemployment rate which is 4.2 right now goes up 10%. That seems totally totally totally realistic. So then that goes back to what Mike Green was saying. And if the let's say tipping point is the tipping point from going to this to this is 5% unemployment. What happens if AI takes the unemployment ve in very quick fashion straight up to 10%. Or even 8% for heaven's sakes. This is what I I think, you know, is this going to play out? No. I I don't know. I I guess that's the answer. I have no idea. But I I think everyone needs to be aware of this. You need to be aware of the market mechanics because that should absolutely unequivocally go into your risk management. And when you're looking at going long the stock, and I'm not saying don't go long. There could be a great argument for going long the stock market, but I think when most people go long the stock market, they simply focus on the reward. You know, what's the upside? And they completely completely ignore the downside. And even if they incorporate the what they believe is the downside risk, they are wildly naive when it comes to the real downside risks due to the mechanics of passive investing and when we could hit that tipping point. I mean, how many retail investors do you know like Cuppy's dad that are just 100% invest? You know, whatever they have in their 401k is just an S&P 500 index fund because that's what everyone tells him to do. Just dollar cost average. It's not about timing the market. It's about time in the market, right? How many people like that that just have a percentage of their paycheck every single week or month or whatever go into their 401k that goes into the S&P 500 index fund? How many people like that have a tail risk hedge? what their house. No, that's the exact same thing that that's that's effectively being long the S&P 500 because if the S&P 500 tanks, guess what's guess what's going to happen to the value of your house or vice versa. I mean, that's basically the same bet, right? We would call that just short volatility, your short volatility. So what happens if you get that you know four standard deviation event or not even that I mean just what happens if the unemployment rate goes up to 8% for heaven's sakes due to AI or the combination of AI recession the fact of the matter is these people the retail investor does not have that tail risk hedged excuse me they don't have that tail risk hedged and again I'm not saying don't be long the S&P 500 but just don't be long like an ostrich with your head buried in the sand where you're only where your investment strategy is just ignorance is bliss. That's most retail investors strategy from start to finish. It's just they they employ the ignorance is bliss portfolio. I'm saying don't do that. Don't do that. All right. It brings me over to today's sponsor, some great buddies of mine over at Monetary Metals. Uh I love gold, as you guys know. It's kind of the cornerstone of any portfolio that I set up, regardless of what the strategy is. 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