GM84: What Everyone Saw, but No One Priced ft. Bob Elliott

Episode Transcript
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(00:06):
We are more likely than notmoving into a world where, you know,
foreign stocks, particularlyfrom a foreign equity investor's
perspective, are going to looka lot better. Meaning, their own
domestic markets are going tolook a lot better from their own
currency perspective than USassets, for an extended period of
time. And so that's anunderlying trend that I think is

(00:27):
an important one tacticallyand strategically to be thinking
about.
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your host, veteran hedge fundmanager Niels Kaastrup-Larsen.
Bob, welcome back to the show.It's been about a year since Cem
and I spoke with you, and Ithink it's fair to say that a few
things have happened sincethen. So,we're excited to have you
back. How have you been?

(01:39):
Thanks so much for having me.It's been a lively year. I feel like
we've been through kind ofevery regime you could imagine. Right?
You know, it’s been highlystimulative and then, you know, the
DOGE and extended regime, andthen run it hot and tariffs, I mean,
man, we just, every day it'ssomething new. Maybe global war is

(02:03):
coming.
You never know. You neverknow. BeforeI dive in. Hi to you,
Cem. How are you doing?
Doing well. Summer in Chicago,so, this is always a good time to
be alive.
Super. NowBob, when we hadyou on last year, you articulated
what I think was an importantmacro framework of the post Covid

(02:29):
era, that we were in an incomedriven expansion, not a credit boom.
And that simple idea reframedeverything - why higher rates weren't
breaking the system, whyspending stayed resilient, why the

(02:52):
Fed frankly looked a littlebit lost. But here's the thing, we're
one year on and whileconsumers are still spending, they're
leaning harder on credit.Profits,you could argue, are wobbling,
inflation refuses to behave,and we starting to see a quiet or
perhaps not so quiet emergenceof real fragility. And this is even
before we take into accountinternational relations. So, maybe
to start off, I wanted torevisit the idea of the income loop
and just ask the simplequestion, is it still running or
has that loop already cracked?
Yeah, I think the incomedriven expansion, in many ways, sits

(03:34):
underneath kind of everythingthat's going on. And a lot of what

(04:00):
we sort of look at on the dayto day basis is sort of the pressures

(04:34):
and the wiggles on that incomedriven expansion. Butlook, at a
big picture level, evenrelative to where we were last year,
you know, labor markets, like,the unemployment rate's basically
flat. Income growth continuesto run at about 5% to 6% nominal.
Spending growth is running atabout 5% to 6% nominal. Andwhile
there are sort of corners ofthe labor market that have clearly
softened, particularly for,you know, younger workers or those
who previously had lost theirjobs, you know, having a little bit
harder time finding a job, thebig picture story is the economy,
absent any of theseessentially these policy moves, we
would continue to be in sortof a traditional late cycle environment
where, unlike previous cycles,credit is still not a big part of
the story and where incomegrowth is a big part of the story.
Ithinkthe challenge here is,we've entered, with this new administration,
they're, essentially,exogenous efforts that are making
slower growth policy more ofthe norm ahead. And so, that is the
challenge. You sort of have afine economy, particularly if you
look backward looking,particularly sort of, let's say,
the fundamentals - theunderlying fundamentals are pretty
good. And at the same time,you've got this policy, almost by
choice, that could be creating disruption.
Yeah, actually I'm going tojump in here, Niels. I think the

(04:58):
other complicating factor is,you know, when you do a 90 day pause
on some really big thing liketariffs, it actually has the opposite
effect of pulling forwarddemand. So, not only can you not
see the effects, you kind ofmight be seeing the opposite effects,

(05:19):
and you would expect that. So,I think it's very muddy right now.
I think it's really, reallyhard to tease through the current
data and see through it in anyparticular way. Isthere anything
that you're looking at, Bob,on the data front that's telling
you, like, kind of threemonths forward how things might be
looking as opposed to kind ofwhere it is now?
Yeah, it's a good point. Andwe sort of had a pre-tariff set of

(06:05):
demand, like in things likeautos, that sort of pulled forward

(06:27):
demand and then now we'rehaving sort of a run of activity

(06:52):
ahead of the possibility thatthe pause rolls off. From a timely

(07:17):
perspective, given the incomegrowth dynamic, the labor market
continues to be one of thecore cornerstones of overall economic

(07:59):
conditions. Andof course wesee, you know, weekly data with continuing
and initial claims, which,particularly initial claims, are
short-term leading but thenbecome… In most cycles you want to
think about interest rates andcredit, and that's kind of the flow
through, and that leadsemployment. But in this income more
income driven expansion thoseemployment measures are actually
very critical because theyserve as the foundation of what's
likely to transpire in thecourse of the next, you know, three
to six months. And so, wehaven't really seen, you know, much
disruption. I'dsay what we'veseen is a very, very gradual deterioration,
that would be commensuratewith a gradual slowing of the economy,
that would be consistent witha late cycle type environment. But
nothing there is pointing to aproblem. Ithinkthe challenge is
that when you look on abackward looking basis, things are
mostly fine because of thedynamics that I described. But then
you have essentially thetariff shock which is, you know,
let's say at current rates15%, between 15% and 20% on effective
2024 imports, that's like a 2%of GDP tax hike. Nowif we were talking
about an immediate 2% of GDPtax hike, everyone would be looking
around and saying, yeah,growth is going to slow. Demand's
going to slow, growth's goingto slow, profits are going to slow.
Like, you know, that would bekind of obvious to people. Butinstead
I think some combination ofthe TACO belief, and a little bit
of misunderstanding about howthese things work, means that everyone's
sort of looking backwards andsaying, everything's going okay,
if anything a little bitbetter, and just kind of like missing
the fact that there's a wallahead of us that will eventually
affect the economy if thesetariffs stay in place.
Yeah, you can't help but feellike there's this uneasiness, right.

(08:22):
That you're kind of in thiseye of some storm. I think I'd add

(08:48):
to that with you have this newbudget that, in theory, will get

(09:13):
passed, that has also yet tohit markets. Andmy bigger issue,
I know everybody's kind offocusing on employment, and I agree,
you and I have agreed forquite some time secularly, this demand
side economy relative to thesupply side economy that we’ve been
running for the last 40 years,this income driven economy really
has changed the whole picture.But it primarily does it, in my opinion,
through the inflation picture- the long-term interest rate picture.
And so, I'd be curious to hearyour thoughts on where you see kind
of the other side of the stormas we get through here on inflation.
Obviously, backwards looking,inflation looks like it's cooling,
everything seems hunky dory.Growth is strong, inflation seems
to be cooling. Idon'tknow.I’d love to hear your thoughts on
that. If you're, again, anydata that you're looking at, and
particularly given kind of thesupply demand imbalance on the back
end of the curve. What you'reseeing back there vis a vis not just
inflation, but also what youthink is likely to happen in the
long run.
Yeah, I think the challengeright now in terms of inflation is,

(09:55):
in many ways, the same, whichis like if nothing was going on,

(10:24):
we'd basically be seeing agradual cooling of inflation that

(10:46):
is still a little too high forthe Fed's mandate, but kind of okay,

(11:17):
stomachable by the Fed suchthat they can at least continue to

(11:44):
cut rates very gradually inresponse. And now we get, essentially,

(12:09):
a tariff shock. And,you know,we've seen dynamics like this happen
lots of times in the past,which is with VAT shocks, with VAT
hikes, and what the second andthird order effects of that are.
And, you know, consumers seethose things. They see even though
it's a tax, and if it was asales tax, you would think about
it like a little bitdifferently. They see it in the price
of the goods. And so, thenwhat ends up happening, you know,
they'll see the tariffs in theprice of the goods and so, then they
see higher inflation in termsof the things that they're buying.
The challenge is, if itdoesn't get paired with higher nominal
incomes, there's only onesolution which is that you have to
reduce real spending. There isno other solution to that problem.
Iguessyou could borrow more,but households aren't really likely
to extract a lot of value outof their houses and things like that.
That's kind of like the olddays. That's like 20 years ago you'd
lever up your house in thissort of scenario. It doesn't seem
like households want to dothat. So, basically it will lead
to lower real spending. And Ithink the question is, kind of, how
does that imbalance work? Howmuch does it get taken out of profits?
How much does it flow throughto prices? How much do those prices
then slow demand? That's kindof the question. Andyou know, there's
been lots of individual casestudies like the case study of the
washing machines and how theyflowed through to prices (washing
machine tariffs), but we'venever been like, you know what we
should do, like have aninstantaneous 20% tariff in the single
largest economy in the worldand let it ride and see what happens.
There's a lot of unknowns interms of how exactly this is going
to flow through to inflation. Ithinkthe real risk, the more strategic
risk, is that you get anotherbout of inflation. The Fed's a little
handcuffed. They're not reallygoing to tighten in response to incremental
inflation here. They might notease, but they're not really going
to tighten in response.Andso, you've got sort of a tricky
moment where you could sort ofre-embed some elevated inflation
expectations that are prettyundesirable and that could then go
over and influence long-termbond market expectations or maybe
the currency more thanlong-term bond expectations, currency
and gold more than bonds.
I think everybody's focused onthe recessionary effects of tariffs,

(12:32):
this idea that tariffs may beinflationary as a first order, but
as a second order, are theydeflationary? But in my opinion,

(13:09):
I think there are very fewpeople thinking about the potential
wage growth that may come fromit. That'skind of the whole point
of the tariffs, right? Thewhole point of the tariffs is to
bring jobs back and we'recutting immigration. But I hear very
few people talking about wagegrowth. That once again… By the way,
this has happened for fiveyears, that deflation might not be,
and recession might not be theactual result. That the actual result
might actually be ademand/push economy, which is what

(13:31):
we're doing. That's whatpopulism, protectionism does. So,I
think the one thing, again,that people aren't thinking about
is this could be inflationary.Not just from a secular kind of,
hey, we're taxing goods andprices of things go up. But even
on a secondary perspective, ifwe are cutting labor, that causes
a problem of cutting goods andwe need to create more goods here.
That's a problem as well interms of potentially creating demand,
more demand.
Can I ask both of you aquestion here? So, we seem to be

(13:56):
driven much more by narrativesthan by data compared to at least
when I started out my career.I kind of agree with what Cem says

(14:27):
that, you know, we shouldthink about, you know, the labor
force and what happens withimmigration. Butfrom a completely
outsider here across the pond,when I think about the new administration
in the US, and you think aboutwhat they said they were going to
do going into government, andthey started out doing some of that,
DOGE is kind of a goodexample. But it just seems to me
that a lot of that policy isjust going straight back to what
all governments do and that isborrow more money, lift the deficit,
et cetera, et cetera. So,I'mkind of thinking, and obviously I
have no idea whether that'sgoing to happen, but maybe we're
all just still believing thenarrative they gave us with immigration,
but in reality, it's just notreally going to happen. We're going
to see flashes of it on thenews, but in reality, the labor force
isn't really going to shrinkin the US.

(14:48):
Oh, I don't know about that. Imean, the labor force in the US,
labor force growth has gonefrom increasing at something like

(15:21):
2 million annualized pace tozero. That's a pretty huge adjustment
that we're seeing. Thechallenge with it is that it takes

(15:52):
time. There's no incrementallabor. Let's say, construction labor,
it's like it's a little hardto find someone, a little harder

(16:22):
to find someone, and a littleharder to find someone. Butif you
combine the fact that we wentfrom 3 million inbound immigration,
of which about 2/3 were in theworkforce, give or take, of that
incremental focus, there'salso children and people who are
not in the workforce, butabout 2/3 float into the workforce.
Combined with the fact of therescinding of various work visas.
So, most recently, I mean,just in the past week, the Supreme
Court upholding the rescissionof 500,000 work visas for immigrants
that are from certain LatinAmerican countries, you're talking
about a pretty big sucking outof the labor market dynamic. Thething
that has not really happenedis they haven't really deported anyone.
Like, I actually, I had achart recently where I just… They
had a big Splash. We deported70,000 people in our first hundred
days. And you're like, that'sa pace of like, basically the same
as the previousadministration. So,you know, okay,
like, good headline. Lots of,you know, patting ourselves on the
back that actually didn'tmatter. But the combination of things,
in terms of restrictingessentially the inbound flow with
some of this work visarecision is, you know, meaningful
in terms of this labor marketand we'll keep it tighter for longer
for sure and support wages, asCem's saying.
Yeah, Bob, I couldn't agreemore. Look, you know, we've pulled
off 2.4 million in supply oflabor and we're in an incredibly

(16:45):
inelastic tight labor market.That's fascinating, actually. People
are all focused on thetariffs. Will they, will they not?
But in the meantime, theimmigration thing, which was one
of the biggest things of theelection, and one of the things we
most worried about is tick,tick ticking along. And that is,
that's a big deal to thatinflationary push that we've been
talking about.

(17:08):
So just another thing beforewe move on, and I don't know where
you want to go with yourquestions, Cem, but debt seems to
be creeping back. I thinkpeople, from what I can tell, are
spending more on their creditcards, hitting sort of record highs.
I think there's risingdelinquencies as well. Are we going
towards some kind of maybehybrid regime? A little bit of both

(17:31):
and not one or the other?
Well, I think probably whatyou're seeing there, to some extent,

(17:55):
is a reflection of the K shapedynamic where there are the bottom

(18:19):
quartile of, I'd say,financially stressed folks. It isn't
necessarily consolidatedsolely amongst lower income cohorts.

(18:47):
It's just, you know, ifanything, actually the most financially
stressed are in the middleincome areas of the market. Andso,
I think what we're seeing isstress emerging as, essentially,
they are reaching their limitsaround what are the different levers
that they can pull in order tocontinue to keep up their consumption.
And you know, things like thestudent loan repayment or restart
is an example of the sorts ofcompiling stresses on those folks.
Now,if you go back and lookthrough time, often that would take
the form of starting to createsignificant credit stress in financial
institutions and then create acredit cutback. And that slowing
of credit from boom to slowingwould create a slowing of the economy.
The thing that's going onright now is we haven't had so much
of the debt boom part ofthings. And so, it means that as
those credit stresses emerge,their sort of second order effects

(19:09):
are less significant thanyou'd typically see in a traditional
cyclical environment. So,boththings can be true, which is we have
a mostly fine income drivenexpansion and there is a cohort of
people who are financiallystressed and you know, every week
that goes by, they becomeincrementally more stressed. Probably
not enough to bring down theoverall economy though.
Yeah, Bob, I think one thingyou highlight there, which I think

(19:34):
is so critical and has beenthe case really for the last five
years and is a secular trend,but I think is accelerating is, you

(19:59):
know, the top 10% of thedistribution here in the United States
now constitutes 40% of retaildemand. And we are now beginning

(20:20):
to institute policies that arepaired with AI. You know, the number
one cohort that's going to behurt there by AI's growth is that

(20:44):
cohort. Andwe're institutingpolicies now that are actually continuing,
through protectionism andpopulism, to help the bottom and
move that money from kind ofthat top 10%. Maybe money still flowing
to the top .1, but I thinkthat is an incredibly important dynamic
- this kind of K shape thatyou're talking about. Everybodyis
really thinking about thisstill two dimensionally, like the
last 40 years, that if theeconomy slows down then the long
end of the curve, the yields,will come down and inflation will
go to zero, etc. But I reallythink this dynamic of continuing
to send money to the bottom,send jobs to the bottom, and hollow
out that top 10% is going tobe a very, very big change from what
we've seen.
I think the challenge is, interms of the hollowing out, who actually
gets the hollowed out? Andit's probably, from my perspective,

(21:04):
as you look at the pressures,it's more the middle that's kind
of getting hollowed out andsort of distribution going to the
top and the bottom. Which iskind of interesting in the sense

(21:33):
of it aligns with thecoalition, let's say, of the current
administration, which is a bitof top and bottom coalition building
from an income perspective.Andso, I guess in that sense it
shouldn't be all thatsurprising. But it's going to create
a real stress point. Itcreates a stress point amongst a
cohort, a traditionally sortof stable cohort in the sort of longer-term
American prosperity sort ofperspective that probably is creating
stress or challenges from along-term growth perspective, but
in favor of sort of the verytop and the bottom amongst US income

(21:54):
cohorts.
Yeah. To add a little bit ofcolor to that, there is no middle
anymore, compared to where itused to be. And when you say middle,
what I'm actually seeing is,again, that top call it 1% down to
10%. Like it is top middle forme. It is top, realistically that
it’s coming from. It's justnot the tip-top - not where the majority
is. It's from this kind ofupper middle class. And it seems
like we're sending enoughmoney to the bottom. And we've seen
this kind of growth there,where demand and growth there is
pushing into a new lowermiddle class a bit more of that.
So,we're definitely changingthe demographic picture dramatically.
But it is very nuanced anddetails are making a big difference
in outcomes and inflation andI think that's really what's driving
the stagflationary.

(22:47):
Yeah, I mean part of thequestion, you know, strategically
is the US dynamism question. Abig cohort of the US dynamism, through

(23:21):
time (like if you look backover the post war period) has been
basically picking the best ofthe middle and giving them opportunity

(23:57):
to go to the top. Plus,frankly bringing in skilled immigrants
who come to our variouseducational institutions, and benefits,

(24:27):
and sticks around for avariety of reasons. Andso, part
of the question here, from along-term growth perspective standpoint
is, are you actuallymeaningfully reducing the potential
GDP growth of the economy, thesort of structural foundations of
what creates innovation andlong-term productivity gains of the
US economy both throughhollowing out the middle class, reducing
immigration, and, let's say,challenging our knowledge institutions?
And as a function of that,that'll have essentially negative
dividends. We'll have drags onUS economic conditions for a while
in favor of, essentially,income transfer to the bottom. And
in some ways AI is aproductivity enhancing activity but
it's less compoundedproductivity gains and more isolated
productivity gains. This maybe beneficial in a shorter-term time
frame, but if you look outover a longer-term time frame could
create challenges in terms ofoverall productivity growth. Which
kind of aligned, Cem, with,your sort of strategic slower growth,
higher inflationary dynamic.
Yeah, it's really these two… Imean, if you really like simplify,

(24:51):
simplify. There are two majorforces, right? I mean there's a bunch
of others, but one is thisprotectionism, like, really China/US.

(25:12):
If we're really going tocontinue to put a, a real lever between
the two or kind of divide thetwo, that will drive, by definition,

(25:37):
growth on the bottom. We willrepatriotize the bottom, the cheapest
goods of all, the cheapestproduction, the lowest end. And it's

(25:58):
not just China, but that's thebiggest part. Whileat the same time,
in theory, you would think,well, the growth of AI, it's so fast
and dramatic, it can replace,but it's replacing a completely different
sector as a completelydifferent section. So, we are getting
massive deflation in one partand massive inflation in another
part if you really think aboutit, if, assuming, I think we know
where AI is going, althoughthere are tons of policy changes
and things can slow it down,etc. But the one big question, I
guess this is where I wouldlead into for a question for you,
Bob, is where are we goingwith China? Because that is the biggest
question of all. And I thinkthat uncertainty, this TACO trade,
the uncertainty tied to whatis happening, where are we actually
going to end up is really thepart that's hardest to put your finger
on.
Yeah. I mean, where we go withChina is so emblematic of all the

(27:16):
different pressures that we'retalking about from a strategic perspective.

(28:05):
And I think the challenge hereis there's a lot of uncertainty.
Ithinkit sort of goes back,a little bit, to taking the new administration
kind of at its word in termsof what its priorities are. The joke
is, like, if you want tounderstand what the administration
was going to do, I basicallyjust take the campaign rhetoric that's
largely what they've pursued.It doesn't mean it's exclusively
what they've pursued. But, youknow, amongst immigration, tariffs,
you know, cutting the deficitwas never really a big story. If

(28:29):
you actually listen to thecampaign rhetoric, it was never kind
of like the big thing that wasfocused on. Itwas much more around,
you know, reshoring andrestricting immigration. And so,
when you go and you look atthe engage… I should say, and also
military toughness was a bigcampaign rhetoric story as well.
Andwhen you go and look atthe relationship with China through
that lens, essentially, let'scall it a strategic decoupling with
China. It hits on all thosedimensions in terms of helping support
the base, in terms ofonshoring, helping restrict immigration.
Chinese immigration hasn'treally been a big story, but, you
know, the US Is doing what itcan. Thereare still hundreds of
thousands of students, Chinesestudents from China, every year,
that we've basically nowdecided to kick out in one form or
another. So, that's astrategic decoupling. And then, from
a military perspective, youknow, basically figuring out ways
to ensure that our military isdisconnected from anything to do
with China, whether it's aboutrare earths and things like that,
or manufacturing. And so thatkind of decoupling, that is kind

(28:55):
of where we're going. Andfroma strategic perspective, what that
means is you're basicallyduplicating a lot. We went through
30 years, basically, where wecreated a global economy that was
really focused on creating themost efficient implementation of
all manufacturing productioneverywhere. And so, whoever could
do it the best, mostefficiently, most effectively, just
in time, all of that. Andnowimagine you've basically smashed
that whole system to one whichis a parallelization of supply chains,
production, isolation, etc.And that inevitably can create a
higher nominal growth support.You know, it certainly supports nominal
growth, but a lot of that islikely more through raising prices
relative to raising sort ofreal economic activity, which is
kind of, you know, it's notreally supported by this sort of
activity.
Yeah, I actually agree, Iagree that's where we're heading

(29:29):
now. There were some realquestions in January, though. Because

(29:53):
I think the bringing in ofElon Musk and kind of the more wealthy,

(30:26):
more traditional Republican,small government, kind of part of

(30:47):
the coalition, this timearound, like Trump 1.0 very much

(31:11):
was populism, protectionism.He was a vehicle of this. And to

(31:37):
be clear, since 1982, he'sbeen talking about this topic. So,this
is core to who Trump is,protectionism, bringing back jobs
to the US, not sendingeverything abroad. But this Trump
2.0 seemed like it would bepotentially very different. And if
you think about what they camein with, it was, DOGE. It was a lot
of supply side, the big taxcuts, lowering kind of spending writ
large. There was SNAP paymentsand Medicaid cuts. Meanwhile, there
was a general thought process,and Bessent was out there vocally
talking about it in January,like, we need to get the private
industry going again. Right.And I didn't think it would happen
as quickly, but there was areal question, which way are we going
to go here? Are we going totry and go back? Are we going to
maybe have a deal with China?And by the way, Elon also was kind
of pushing for a resolution ofsome of the tariff stuff. They were
kind of like willing to dealwith it. Butwhat we saw was, in
the first hundred days, adramatically big bad poll number
for Trump, like the worstsince the 1940s. And that resulted
in a complete kind of… And bythe way, there were, like, pitchforks
and fire, Molotov cocktails atTesla dealerships. And you put the
wealthiest man in the worldout in front, and you try and do
a supply side policy in apopulist protectionist time period.
And guess what? That was incomplete contradiction to who Trump's
base is. Andthey just cut thecord, pushed the lifeboat off to
sea and sent Elon kind of offon his own. And not surprisingly,
now Elon is kind of pushingback publicly against a lot of the
policy. I mean, they're tryingto play nice. But clearly this is
going in a much more Trump 1.0direction, to your point. And I think
that is important. Ithinkthat's actually critical because
there was some hope in a lotof things kind of going on in January,
February. And I think we areright back to where we were, if not
worse. Then again, my only bigquestion is what is going to happen
with China? If there's somebig deal with China that can change

(31:57):
everything.
Can I throw in acomment/question? So, you bring up
China. I don't know if any ofyou have come across the new book
that just came out like a weekor two ago called Apple in China.
Have you heard about that?
I have not, no.
Okay, definitely worth for youto check out. So, the author is a

(32:41):
journalist, Patrick is ajournalist. He spent a number of

(33:02):
years also, I think, in Asia.And essentially, he writes this book

(33:26):
where he basically completelysort of describes how Apple built

(33:46):
their supply chain and why itended up in China. Justto give you
a couple of stats and, andthen kind of maybe hear your response
or your thoughts about it. Sobased on Apple's own data now, in
order to do this, in order tobasically make their products as
great as they are, they had tosend thousands of the best engineers
from Apple to China. Soaccording to Apple data, from what
I can tell in the news, Appletrained 28 million Chinese people.
Thereare 3 million peopleworking in China for Apple, only
160,000 outside of China. Andaccording to him, the author Patrick
McGee, Apple simply cannotproduce, even if they wanted to,
they cannot produce outsideChina. Nobody has the skill to do
that. And you could almost goas far as (and I think he's kind
of alluding to) that you couldsay, well, actually, Tim Cook is
kind of pretty important inwhy China is more advanced than many
of the Western countries todayin the technology space, because
Apple trained them to be.So,my question is just, I mean,
again, we hear all thisrhetoric about, oh yeah, we're going
to bring jobs back to the USand all of that stuff. The question
is really, has anyone from thenew administration maybe thought
about can it really be done? Imean, it's one thing to say. The
narrative is great, but can itreally be done? I'm not so sure.

(34:07):
Well, I think that thechallenge is when you get down to
the details, it is a realchallenge. And I think it's easy

(34:36):
to talk about $5 trillion ofinvestment coming into the US from
various folks, and it's a lotharder to actually build the factories

(35:06):
and get the supply chainsover. And I think one of the challenges,
the biggest challenge on thatis that it's not like we've created

(35:36):
(for a lot of these areas),it's not like we've created smaller
scale, but nonetheless nascentcapabilities. So,like if you look
at something like steel andaluminum, you know, we do have some
steel manufacturing in theUnited States. And it doesn't mean
that we can meet all of ourdemand or whatever, but it does mean
that there are skilled peoplewho have worked in steel plants and,
theoretically, we could buildit, but it's going to take 25 years
to build up the fullmanufacturing capacity. Youknow,
or autos, there's plenty ofauto capability in terms of people
sitting in southeast Michiganwho have been doing this for a long
time, southeast Michigan andOntario, I should say. And so that's
certainly possible. But a lotof the other stuff is not… A lot
of the other manufacturing hasnot been in the US for 25 years.
The electronics, thefurniture, the toys, a lot of the
stuff that can seem trivialbut really is part of our sort of
day-to-day consumption andpart of the inputs to all of the
other things that happen -lots of made America things. Iliketo
joke about my, my kids’shampoo, you know, where, sure, the
shampoo is made in America,but the bottle is made in China.
And it's not like you couldtake delivery of the shampoo without
the bottle.

(35:57):
I think someone posted apicture of a Maga hat and it actually,
it said inside, made in China.
Right, exactly, exactly. So,that's one of the challenges is just
given that we're coming off ofthis 30 years of like just-in-time

(36:25):
creation, most efficientsupply chains possible, there's a
lot of elements, a lot ofdisruption that if we go down the
path of, let's call it, thestrategic embargo. Which I found

(36:54):
it interesting that evenBessent started saying embargo with
China. The impact of that isnot just on the imports. The impact
of that is much broader thanthat. And you know, we're not that

(37:26):
far away from that.We'reright on the cusp of strategic
embargo at 30% tariffs. Ifwe're much higher than that, it's
going to be really challengingand create magnified effects. Now,
I think the, the only savinggrace of this, from a macroeconomic
perspective, is, like we sawin April, if this starts to get meaningfully
priced in, it may start tocreate a response. Is that TACO?
Well, TACO, when equities areat all-time highs, is a very different
story than TACO in response to25% declines in equities. Andso,
you're probably going to needmore pain to roll back the behaviors,
to limit the impact on theeconomy, then at least, certainly,
where we are in terms of assetpricing right now.
Yeah, I mean, I think you haveto. The reality is if we choose to

(37:47):
prioritize median outcomes,it's painful. I mean this is not
going to happen. You're notgoing to fix 40 years of what we've

(38:12):
done in a year or two. Ithinkthe key is separating… You
know, we're actually doingsomething with a long-term view,
believe it or not, you know,for the first time in 40, 50 years.
And that takes short-termpain. At the end of the day the question
is, will they be able to dealwith the short-term pain? Because
politically they have to getreelected every two to four years.
And I think that's the bigquestion. And that's what these lags
of, you know, these delays,extensions, that's why TACO exists.
If you think about it, it'sthis short-term having to deal with
markets, having to deal withthe politics, which are very immediate
and short lived, while you'retrying to make big structural changes.
And I'm guessing that's likean on-again, off-again kind of trying
to manage what otherwise is avery difficult situation.

(38:39):
The basic path here is youeither have to accept a significant

(39:06):
amount of pain, which, ingeneral, western democracies are

(39:27):
not particularly good at doingthat outside sort of proactively,

(39:49):
in wartime maybe, butproactively, that is not a particularly

(40:12):
well-traveled path. Orwhatyou have to do is create enough stimulative
effect that offsets the painpart of the equation through either
running large deficits,transfer payments, cushioning the
challenges, running easiermonetary policy than would be appropriate
given inflationary conditionsor economic conditions – basically,
do a bunch of offsets. Andyouknow, and this isn’t black and white.
It's not like terrible pain ordumping money into the streets to
offset what's going on. But Ithink probably what we're seeing
is a path that has a bit ofelements of both of those things.
Which is that there is someelement of pain that's going to occur
as we engage in, to someextent, some strategic decoupling
that exists relative to therest of the world, and then at the
same time some amount of, youknow, easy money policies that will
offset that. Andthatcombination of things, it's interesting,
it's like not particularlygood for stocks, it's not particularly
good for bonds, but it ispretty good for gold and bad for
the dollar.
And actually, it's really goodfor the economy broadly. Like, demand
and the rebuilding the middleclass. The economy by the way, does
not have to be weak. This ideathat the stock market is somehow
tied to the strength of theeconomy. I think that part is going

(40:35):
to break people's minds, thatthey don't necessarily have to be.
I think we could get reallystrong, above trend economic growth
like the ‘60s and ‘70s, butwith really, really poor equity market
returns.
The sort of link between thosetwo points which you're making there

(40:57):
is that there's no reason whyprofit margins necessarily have to
be pushing to all-time highs.You can have a circumstance where,
you know, if we have somemoderation of profit margins, said

(41:18):
definitely, part of the tax(and I describe it as a tax on the
economy, not a tax necessarilyon individuals, but a tax on the
economy), part of the way thatthat can flow through is you can

(41:44):
just have reduced profitmargins. And reduced profit margins
are obviously not good forstocks and not good for companies.
But that reduced profit margincan flow through and be beneficial

(42:05):
to individuals, and wages, andtheir spending. Andso, that's a
way in which this can playout, which is not great real returns
for stocks, not great profitmargins pushing higher essentially
transfer payments, whatever,transferring the capital to the lower
income cohorts who have higherwage growth and the outcomes that
you're saying. And so thatthat's a combination that can exist.
Thechallenge, I think formost investors, is that is a pretty
(just in the same way it wasin the late ‘60s and early ‘70s),
that is an awful outcome formost financial market investors because
basically no one's preparedfor that at all.
This is a perfect segue to,actually, I think another big, important

(42:36):
conversation that you and Iactually had a lot in common on and

(42:59):
think a lot about. I know withyour unlimited funds you do think

(43:23):
about this a lot. But mostpeople think (I'm just going to reiterate

(43:46):
this idea) that if we havestrong economic growth… If you ask

(44:08):
your average person whatdrives the outcome for equities?
It’s, well, if the economy isstrong, stocks will do well. But

(44:46):
the reality is, in real terms,from ‘68 to ’82 (the last time we

(45:11):
saw interest rates go bottomleft to top right), we saw, in real

(45:34):
terms, 2.5% GDP growth - inreal terms, above inflation, with
a lot of inflation. So,nominally it was very high. That

(46:14):
is significantly higher thanwe've seen in the last 40 years.
Thatis 0.75%, you know,almost a percent higher than the
1.7% or so we've seen in realterms for the last 40 years. But
in the last 40 years we'veseen about 10% real, annual growth
in the equity market. And in‘68 to ‘82, we saw negative 4%, actually,
in real terms - over negative4% per year. So, dramatically different
outcomes. Andthe reason, asyou highlighted, is because labor
was getting a larger share ofthe earnings. Profit margins, which
sat at a record for the time,in 1968, collapsed into 1982. That's
one. Two, the divisor, thediscount rate forced multiples, at
23 pe in 1968, to 4.5. Why?Because in 1982, with a 20% 10-year
bond, you needed a 21%, 22%earnings yield of the S&P to invest
in the S&P. It's that simple.Andso, this idea that the divisor
was a much more mathematicallypowerful effect on equity values
than the 0.75% or 1% economicgrowth per year is mathematically,
it's clear, it's, it'sobvious, not to mention the profit
margin compression. So,Ithink we could, like we were talking
about, if you see a strongeconomic growth scenario where it
is a demand/push economy,where you are pushing money to the
bottom and rebuilding kind ofyour own economy, at the end of the
day, that is going to have tomake demand, first of all, for stocks
go down dramatically. And thatdiscount rate is going to ultimately
weigh. And it does with a lag.As we know with the CAPE. InShiller's
CAPE, you know, interest rateswork with a long and variable lag.
Why does that lag exist?Because 1968 - a similar thing. Here's
a similar thing. Everybodygoes in and gets debt in 2020, 2021.
And that lasts. That debt,that cash lasts for five years, seven
years - that's the averagetime period. But eventually people
have to come back and get thatliquidity from the market at a much
higher rate. Andthat's whenthe rebalance happens between stocks
and bonds. So, I see thiswhole thing playing out that we've
been talking about for fiveyears. But I really think the economy
will continue to be muchstronger than people expect. I think
this is because we are sendingmoney to demand, to the velocity
of one people. The people whotake all the money they get and spend
it. And we're taking it awayfrom the velocity zero people. The
people at the top. 0.1% or, or1% or 2%, who spend maybe 10% of
the money. I think that is ahuge, huge deal and a very different
outcome. Butthe reason thisis important, now to kind of get
off my soapbox and go back toyou, Bob, is if that is the case
(and we've seen periods likethis, not just the ‘60s and ‘70s),
investing 60/40 is a disaster.The Sharpe ratio of 60/40, for the
last 40 years, has been about1. Butif you take that period out
of it, you know what theSharpe ratio is of 60/40 in the last
125 years? 0.3.

(46:34):
Yeah, which is what you'dexpect strategically for two assets
with a 0.25 Sharpe ratio and amodest positive correlation. That's
what the portfolio should look like.
Right. The problem is it'svery disjointed. During periods like
the last 30, 40 years thenegative correlation of the bond
and stock part of yourportfolio, which has been relatively

(46:55):
consistent, completely doesn'tjust break down and go to zero. It
goes positive. They becomepositively correlated. And that's
because they're both subjectto that discount rate. And so we
go through decades, and thishappens again and again throughout
history where stocks and bondsdon't work. Everybodyassumes passive
investing is this newtechnology, this new innovation -
that's the way to invest.Well, no, it's not. The reason it
became popular in the late‘80s was because interest rates went
from the top left to thebottom right and they continued for
40 years. Passive investing isnot a new idea. We've had indexing
for almost 150 years. It's thesame thing. Whydidn't anybody index
invest consistently passively,even though we knew that was a thing
until about 40 years ago? Imean, think about it, right? It's
pretty obvious it didn't work.Andso, what happens when it stops
working? Yet, now everybodyjust does that. That's a lot of pain.
And that's where you and Icome into this, right? That's why
alternatives andnon-correlated assets are so critical.
Youknow, we're callingalternatives, like private equity
and private credit, which arejust leveraged versions with no mark
to market of the assets -stocks and bonds themselves. What
we need is trulynon-correlated assets. AndI'll get
off the soap box, but I'd lovefor you to talk a little bit about
what you're trying to dothere, how you're trying to make
that more accessible and getinto some of the ways you do this.
Because the real challenge isthat some of these strategies are,
A, not scalable, and, B,that's the problem with 60/40, like
that's scalable. Thesealternatives cannot be. So, how do
you make them scalable and howdo you make them more accessible
to people?

(48:44):
Yeah, yeah. Well, I think it,it all started… I totally agree with

(49:33):
you in terms of the need tobuild better portfolios and, in particular,

(50:22):
build better portfolios thatcan withstand a wider range of different

(51:03):
macroeconomic outcomes thanbasically peak disinflationary growth

(51:29):
that we've seen over thecourse of the last 40 years. Andso,
I think one of the interestingthings is, if you take a step back
and you just look at what arethe strategies, what are the return
streams that are the mostdiversifying to a 60/40 portfolio?
What you basically see isprivate equity, private credit, and
venture capital, which havebeen all the focus of the alternatives

(51:57):
world, are basically useless.Youknow, it's like if you want venture
capital type returns, like, golever up stocks. Like, it's fine.
You can get that return streamfor one basis point. Or private equity,
certainly, you can get thateffective return stream for a basis
point. The things that aretruly diversifying are… There are
basically three things thatare diversifying to a 60/40 portfolio,
meaningfully diversifying.Oneis gold, which nobody owns and
is about as cheap and easy adiversifier as you can get. So, if
you take nothing away fromthis, you should go out and allocate
some money to gold. Twoisdiversified commodities, which there's
now lots of ways in which youcan gain access to diversified commodities,
I mean, like, industrial oil,copper, etc., those are actually
strategically beneficial andthen tactically very interesting
if you just think about howthe world is pricing in nominal economic
conditions right now.Basically, extractive commodities
are weak at a time when stocksare very, very high. So even if you
believe the economy will begreat, why wouldn't you be buying
extractive commodities sincethey're so cheap relative to, essentially,
equities, on a global basis?Andthen the third is alpha strategies,
diversified alpha strategiesand particular macro diversified
alpha strategies. And I thinkthat's very important because the
ability to bring to bear longand short (and short being an important
component), long and shortpositions and flexibility is really
important. The key issue isyou have to be able to do that at
a much lower fee point.Because if you pay people 2 and 20,
you basically eat away… allthe alpha's gone. The manager takes
away all the alpha. Andso,having sat in the seat, taking the
alpha, it's a pretty goodbusiness if you could take all the
alpha for yourself in thefees. But if you can get access.
And this is really what we'refocused on is how do we create access
to these alpha strategieswithout all the fees, without all
the negative tax implicationsand things like that? Becauseif
you get access to those, thoseare essentially the most compelling
diversifiers that you can havein your portfolio. So, if you just
took your 60/40 and you andyou shifted, and you put in gold,
diversified commodities, anddiversified alpha, at a low cost
(particularly macrostrategies), you can meaningfully
improve the quality of theperformance of your portfolio from
a reliability standpoint.Relative to 60/40, even in pretty
good 60/40 times, which isimportant to recognize.
Yeah, I mean at Kai Wealthwhere instead of a 60/40, we really

(53:20):
are focused on kind of 30%non-correlated. When we talk about

(54:19):
alternatives, you know,similar to you, it truly is alpha

(55:13):
strategies, non-correlatedstrategies. Youknow, the current
portfolio, for most endowmentsand foundations, is not just 60/40,
it's worse. Because a lot ofthem have 60% to 70% exposure in
privates, which is leveragedequity, leveraged credit, with no
liquidity, with, you know, 5,10-year lockups and 2 and 20 fees.
They'rebasically paying forleverage and they're kind of saying,
well, that volatility numberthat defines a Sharpe ratio doesn't
exist because we don't see it.And that's been the case, by the
way, for 40 years. That worksgreat in an environment where you
don't have a drawdown inequity performance that lasts longer
than four years. Because ifyou have a 10-year lockup, then you
never see that volatility.Whathappens when that drawdown is
10, 15, 20 years and yourlevered equity is at 2 and 20? I
think there's a lot of painthat could happen in private equity
and private credit. I thinkit's something that, again, will
happen. It'll be a slow motiontrain wreck and then eventually accelerate
because it'll be a function ofa drawdown in a mark to market that
will actually be experiencedby investors because it'll last longer
than a decade. Andso, I thinkthat's the big story, is what is
an alternative and, and how dowe get access to that at scale? And
you know, there's a lot ofalpha strategies. There's global
macro, as you mentioned, but Ican name merger arbitrage, convertible
arbitrage, managed futures,trend following, distress debt event
driven, commodity focused,long/short equity, long/short credit.
I mean we could go on, there'slike a hundred. And I think most
of these are foreign words toyour average investor and I don't
think they will be in three,four, five years. Ithinkalso, importantly
(this is my hobby horse), butderivatives, you know, options are
a huge, huge game changer herebecause not only do they allow you
to take access tonon-correlated bets, not just up/down,
they allow you to get capitalefficiency. And as interest rates
go higher, capital efficiencybecomes paramount. This idea of stacking
yield, getting that T-billrate, and then being able to, on
top of that, stack anon-correlated yield. You don't need
much alpha to start making areally good looking kind of non-correlated
strategy. You can get it atscale too, if you can stack. And
I think that's an importantconcept that I think very, very few
people know and understandnow. ButI think, you know, that's
1% of the market or 0.5% ofthe market, which has doubled and
tripled the last severalyears. That's going to double, double,
double again. And I was justat an equity derivatives conference,
and there were twice as manypeople there than last year. And
structured products, by theway, have gone from 500 billion issuance
a year to 1.5 trillion inthree years. I think that is a world
that is just ripe forexplosion in terms of just demand,
and it's becoming more andmore efficient. I think we're really
hitting a tipping point there.

(55:50):
Yeah, I think the challengefor a lot of folks, when they're
looking at this though, is howdo you pick your manager? That's
the big pickle. If you talk tothe advisor on the street, the guy
in Dubuque who's trying tobuild his portfolios. And so, from
our perspective, a big part ofwhat we've been trying to do is remove

(56:15):
the single manageridiosyncrasy. Nothingagainst what
you're doing, Cem.
I agree with that, but. No,no, to be clear, I completely agree.
But this idea, diversificationis the chief.
Exactly, exactly, and, inparticular, what you see when it
comes to alpha strategies is,if you just take, as you say, that
universe, there's a bunch ofdifferent ways you can generate alpha.
And if you look at all thosedifferent managers, they basically

(56:39):
all generate alpha. Andparticularly if you bring the fees
down, they definitely generateconsistent alpha over time.
Absolutely.
As a group, as a cohort, andit makes sense. Look, you've got
the smartest minds in financeall trying to figure out how to beat
markets. Like, yes, theyshould generate alpha over time.

(57:03):
The challenge is that any onemanager, it's like, huh, what's going
to happen with that onemanager? They might be down 30, they
might be up 30. It looksrandom when you pick one manager.
But from our perspective, whatyou can do is you can index alpha.

(57:26):
Now that alpha indexationtotally changes the game because
you get that managerdiversification which allows you
to get a more consistentbenefit, more consistent drawing
on that wisdom of the crowd.Andif you could do that at low cost
and higher target return, thatis a combination that can be very,
very compelling for a lot ofportfolios and, frankly, hasn't really
existed until you could put itinto an ETF wrapper.
Yeah, this is a criticalpoint. If anybody's listening, this

(58:13):
is so critical. People thinkthat these big Millennium, Citadel.

(58:45):
0.72, Valley ASNI returns, forthe last 25 years are because these

(59:23):
guys are geniuses. It'sactually way simpler. And the fear

(59:54):
about hedge funds isoverstated. Whatis happening at
a multi strategy hedge fund isthis idea of diversification that
is at the core of the successof this true diversification. Not
like diversifying stocks butnot diversifying... truly non-correlated
distribution of returns.Ifyou take 50 different strategies
that are truly non-correlatedfrom each other and don't own an
asset so they're not exposedto the same thing, at the end of
the day you can have a bunchof 10% yielding strategies, or 9%
yielding strategies that maynot be that exciting. That have maybe
a 1% Sharpe which sound prettygood but, like we aren't hitting
a home run. They could have a15% to 20% drawdown each. Andif
you looked at each manager ontheir own you'd be like, that's good
but meh, I've been getting12.5% in the S&P. Why bother? But
this amazing thing happenswhen you put 50 together. You still
make 10% but your Sharpe goesto 2% or 2.5%. Nothing changed except
you just put them together.That is diversification. That is
true diversification. Not justtaking 500 stocks in the S&P. That
is diversification of totalincome stream, total risk. That’s
the alchemy of risk. That iswhat's happening at the hedge fund
level. And I think that's thecritical point. And to your point,
the hedge funds are capturingtoo much of a large share. This is
due for democratization.Butthe key points here that make
it challenging for an ETF, andthese are the things that we need
to find solutions for, or aretrying to, is getting the leverage
and getting the capitalefficiency that these hedge funds
do. Because it's all doneinternal. All the strategies are
done internal. It'sverydifferent to have a fund of funds
relative to a multi strategyhedge fund because the multi strategy
hedge fund, at the end of theday, only probably deploys 60% of
the capital because they'reall in house, and gets embedded leverage.
So that 10% yielding strategyall of a sudden yields 15%, 20% still
at that 2, 2.5 Sharpe. Andthat drawdown which went down to
five, rnaybe you take it to7.5, 8, which is fine. It's the leverage
that's critical because a lotof these strategies aren't scalable.
And if you can get capitalefficiency and leverage (and that's
the key to deploying this),providing that leverage internally,
at scale, for these strategiesis important because you can get
a lot of great Sharpe ratios.But getting the returns, the actual
total returns is hard, andgetting them scalable. And I think
that's a critical point here,and I think that's the real thing,
I think a lot of us are tryingto solve for.

(01:00:55):
So, I have a question for you,Bob, and free to jump in here Cem,

(01:01:26):
as well, because I've beenquietly listening, but very intently,

(01:01:46):
to this conversation becauseyou've kind of moved into my territory,

(01:02:09):
and what I've been spendingthe last 35 years working on, and

(01:02:33):
that is exactly uncorrelatedor non-correlated strategies. Andas
Bob rightly pointed out, oryou Cem, trend following is certainly
one, perhaps ‘the one’ whenyou look at that. So, one of the
things we do at the shop thatI work with is we have a chart where
we look at the pre-crisis, so2002 to 2007 period. We look at the
actual crisis, ‘07 to ’09, andwe look from ‘09 to now. Andwhen
I look at the correlation, forexample take global Macro from the
official databases, itactually has positive correlation
throughout any of the threeperiods between somewhere 25% to
60% plus correlated to the S&Pfrom ‘09 to 2024. Okay, so my question
is just sort of more anunderstanding of it because of course
I agree with what you say,that that's the magic. How do we
do that? And of course, I havemy strong opinions about replication
in general, but that's fine.Butmy question is, within the replication
world that you operate in,Bob, how do you get the non-correlation,
say for example from GlobalMacro when the underlying strategies
appear to be pretty correlatedor somewhat correlated, let's call
it that, to the S&P 500 if weare, as you both seem to agree on,
heading into a period wheresay equity returns will be much weaker
than perhaps we've gotten usedto. How do we bridge that gap?
Well, I'd say the first thingis, if you look at macro over the

(01:02:54):
course of the last 15 years,in the post GFC period, I'm not quite
sure what data you're looking at.
I'm using the BarklayHedge database.
Yeah, which, if you look at aholistic look at macro in particular,

(01:03:27):
and there are some reasons whythe BarclayHedge index is a little

(01:03:48):
more tilted, a little betterfor your equity long/short managers
than it is for your macrocoverage. You see correlations that

(01:04:25):
are in the 0.3 type rangewhich is pretty good because anything

(01:04:47):
moving up into the right isgoing to have modest positive correlation

(01:05:08):
during the stock market boom,which we've seen in the past 15 years.
Ithinkyou could also see,through that time frame, some of
the defensive benefits ofsomething like macro where you've
got, you know, very, verystrong performance, in 2022, offsetting
the performance of both stocksand bonds during that period because
of the flexibility to be ableto go long and particularly short
during those environments andwhere those managers have done particularly

(01:05:29):
well. Andso, I think, youknow, if you look at it over a variety
of different time frames,those macro strategies are quite
beneficial to a portfolio bothfrom a correlation standpoint but
also from a risk standpoint.One of the things I like to talk
about a lot, when it comes tothings like macro strategies, is
the asset managers. Whatthey're particularly good at is helping
contain downside risk which,when you think about a return consistency
perspective, that's reallybeneficial. And so, you have modest
correlation, good protectionon the downside, and defensive properties.
Andthat's, you know, I liketo describe it a little bit like
an all-weather alpha which islike… You know, one of the challenges
with trend following is it'sdefensive. And it's good that it
exhibits defensive propertiesbut it also has long periods of poor
performance, or mediocreperformance maybe is the better way
to describe it, which makes itchallenging for a lot of investors
to hold in their portfolio.Whereas,if you have something like
macro, you have theflexibility to move beyond just trends
and look at other elementsdriving the returns. And so, you
can get some of thosedefensive properties with the sort
of good returns, also duringgood times, that make it a strategy
that's a little more reliablein terms of being able to stick with
it in investor portfolios.
And when you do yourreplication, do you replicate an
index per se?
Yeah, I mean what we dofunctionally is look at all the different

(01:05:53):
indices because each one… Imean we could spend a lot of time
down in the weeds about thenuances of all the indices and probably

(01:06:19):
you and I would enjoy thatconversation. But probably the listeners
are not that interested in theweeds of hedge fund index construction.
Butfunctionally what we do iswe look at all the different sources
of different hedge fundperformance information and we basically
use all of them as inputs, inpart, because each index has its
own idiosyncrasies. And youdon't want to get too reliant either
from a performance informationperspective or, frankly, from a business
perspective on any oneparticular index because it can be,
you know, any one index can bea little wonky or incomplete in terms
of its coverage. So, we lookat all of them and average them together

(01:06:41):
in various ways.
And Niels, I would add to yourcorrelation comment, you know, beta

(01:07:08):
is not systemic to these hedgefund alpha strategies. I think the

(01:07:32):
reason that you see thepositive alpha is quite simply because

(01:07:55):
everybody's been kind ofcheating, right? Likein the sense,
hedge funds have to competewith stocks and bonds and when stocks
and bonds, for 40 years, havebeen in a 12.5% annualized rate,
they're providingnon-correlation at their core and
they don't need to have beta,but they prefer to have some beta
in order to at least compete.Andso, my view is, whether it's
macro, global macro, orequities, all the models, everything's
subject to recency bias and soeverything is kind of pushed to be
a bit more correlated. And Ithink that if you start to see that's
not as important, I thinkthose betas can easily be brought
down, and will. Nottomention, I think the alpha and edge
becomes more non-correlated ina world where you have more disjointed…
particularly with globalmacro, where you had more kind of
things happening across,globally. Things become less correlated
cross country which meansthere's more non-correlated alpha.
And I think that's animportant point.
I agree with that, and ofcourse you're right. I mean, all

(01:08:28):
of us have had to compete withsome very strong equity markets,

(01:08:49):
and so on, and so forth, andthere should be hopefully more of

(01:09:11):
a difference, so to speak, ina world that becomes more challenging,

(01:09:32):
for sure. Sincewe're comingup to the hour point, or so, I want
to give you, of course, Bob, achance to take us in a direction
that we didn't take you orCem, if there's anything else you
want to bring up. I mean,there's so many. My list of questions
is much longer than what we'vetouched on, from Japan to debt. Andby
the way, we're recordingtoday, on the 2nd of June. Over here
in Europe, especially forthose of us who were in the markets
when we had the financialcrisis and the bond crisis some years
ago, every time politicianswere out saying something like, oh,
we're never going to devalue,we're never going to break the old
European monetary system thatexisted and broke in 1992. Every
time they said that, you kindof felt they're saying that because
it's probably not going tohold. So,I couldn't help notice
that Bessent, today, came outsaying, oh, the US Is never going
to default. Thought it waskind of an interesting comment all-of-a-sudden.
Anythingyou want to leave uswith, Bob?
Well, I think the only thing,sort of going back to the macro,

(01:10:12):
the more sort of strategicmacro perspective, that we didn't

(01:10:40):
really touch on too much iswe've talked a lot about economic

(01:11:14):
decoupling, but the thing thatwe haven't really talked about is

(01:11:45):
financial decoupling. And Ithink that's a really important sort

(01:12:13):
of underlying theme that isreally, you know, this is just getting

(01:12:46):
started. Forthe last 20years, basically, the US has absorbed
the vast majority of capital,global financial investment. And
part of the reason why thatwas, was because the US, 25 years
ago, was really driven byreserve accumulation. Although that
hasn't really been a story inthe post GFC period. It really has
been about how, you know,essentially the US was the most attractive
place for capital. Andas wecreate barriers, as we do strategic
decoupling globally, I thinkthere's a lot of portfolio managers
that are looking at thesituation and saying, why am I so
radically overweight USassets? European, big institutional
allocators have fundedsomething like 30% of the incremental
demand of US stocks over thecourse of the last 10 or 15 years.
That is a lot. That is a hugeflow coming from those allocators.
Andprices are reflectingthat, meaning weak prices elsewhere
in the world and very highprices in the United States, or weak
currencies in the rest of theworld and a dollar which has sold
off, like in any strategicsense, that is not that far off from
secular highs. Andso, I thinkthis is the sort of thing we've all
talked about becoming enamoredwith 60/40, you've also become enamored
with US stocks outperformingeverything else in the rest of the
world. And, you know, thesesorts of things take a long time
to change. Ifyou've sat in aEuropean pension fund investment
committee, you know that it isslow moving, let's say. But once
the ball gets rolling, it cango on for a long period of time.
And so, you know, we couldeasily have a circumstance where
that unwinding is detrimentalto the dollar and beneficial for
foreign stocks for the firsttime in 15 or 20 years. And really,
a totally different seculardynamic than what we've seen in the
post GFC period. Andit'ssomething that I think, you know,
people kind of were like, oh,look at those German defense stocks
going up a lot. And then we'relike, ah, that was a flash in the
pan. Forget that. Andunderlying it, you know, who knows,
tactically might wiggle up orwiggle down. But we are more likely
than not moving into a worldwhere foreign stocks, particularly
from a foreign equityinvestor's perspective, are going
to look a lot better. Meaning,their own domestic markets are going
to look a lot better fromtheir own currency perspective than
US assets, for an extendedperiod of time. And so that's an
underlying trend that I thinkis an important one tactically and
strategically to be thinkingabout as well.
Yeah, And I thinkparticularly, I mean, one thing that
people aren't talking abouttoo just is that the new budget has

(01:13:11):
a significant amount ofremittance taxes on foreign investment.
I mean, if you're trying toencourage foreign investment, that's
probably not the way to dothat. AndI think there are also,
you know, things in therewhere we can pull levers in the US
to punish certain entities.And so, if you're going to start
manipulating and changing kindof the rules of engagement with international
investment, and close yourborders in some ways, that can cause
some major shifts inpsychology among international investors.

(01:13:37):
I just got a warning sayingthat Bob's microphone has been disconnected.

(01:14:02):
So, he simply cannot give usany more of the wisdom. But I think

(01:14:32):
it's a good time to wrap up.Andactually, both of your points
right here, I think are verygood in terms of why, as you both
agree. Things like globalmacro, or diversifying trend following,
whatever it may be, but thingsthat have a big playing field, a
big sandbox, could be really,really important in the future for
sure. So,as Bob, you cannotsay anything. I want to thank you
from both of us for anothertremendous conversation. We got around
a lot of subjects. We couldhave continued on many more. We stayed
away from those we had agreedon initially not to go to. So, I
think we did pretty well.Andyeah, I look forward to having
you back in the future becauseof course it's a very global macro
driven world we're in. So,from Cem and me, thanks ever so much
for listening. We look forwardto being back with you next week
as we continue our globalmacro series. And in the meantime,
take care of yourself and takecare of each other.
Thanks for listening to TopTraders Unplugged. If you feel you
learned something of valuefrom today's episode, the best way

(01:14:53):
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(01:15:14):
on Top Traders Unplugged.

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