GM86: Everyone’s Watching the Fed. The Real Story’s Somewhere Else. ft. Louis Vincent-Gave

Episode Transcript
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(00:06):
It's like tequila shots.You've never known when you've had
enough until you've had toomuch. And government debt tends to

(00:35):
be the same story. Youfeelgood, you feel good, you feel good,
and then at some point you'rethrowing up in the bathroom. So yeah,
your point is, when do westart throwing up in the bathroom?
And the answer is I'm notquite sure. ButI know it's not a
great asset class to ownbecause at this pace, you know, it's
like you're seeing the guy atthe bar just pounding the tequila
shots and you know there'snothing good coming out of that.
You're not quite sure whenhe's going to hit the wall, but you
know that wall is there.
Imagine spending an hour withthe world's greatest traders. Imagine
learning from theirexperiences, their successes and

(00:58):
their failures. Imagine nomore. Welcome to Top Traders Unplugged,
the place where you can learnfrom the best hedge fund managers
in the world so you can takeyour manager due diligence or investment

(01:29):
career to the next level.Beforewe begin today's conversation,
remember to keep two things inmind. All the discussion we'll have
about investment performanceis about the past, and past performance
does not guarantee or eveninfer anything about future performance.
Also, understand that there'sa significant risk of financial loss
with all investmentstrategies, and you need to request
and understand the specificrisks from the investment manager
about their products beforeyou make investment decisions. Here's
your host veteran hedge fundmanager Niels Kaastrup-Larsen.
Welcome and welcome back toanother conversation in our series
of episodes that focuses onmarkets and investing from a global

(01:54):
macro perspective. This is aseries that I not only find incredibly
interesting as well asintellectually challenging, but also
very important given where weare in the global economy and the

(02:18):
geopolitical cycle. Wewant todig deep into the minds of some of
the most prominent experts tohelp us better understand what this
new global macro-driven worldmay look like. We want to explore
their perspectives on a hostof game changing issues and hopefully
dig out nuances in their workthrough meaningful conversations.
Pleaseenjoy today's episodehosted by Alan Dunne.
Thanks for the introduction,Niels. Today I'm delighted to be
joined by Louis Gave. Louishas been on the podcast a couple
of times before, so he needsno introduction. But for those who
haven't heard from Louisbefore, he's the founding partner
and Chief Executive Officer atGavekal. He's been in the markets

(02:41):
many years and is the authorof several books. Louis,great to
have you on how is home onyour side?
Things are good. I'm delightedto be back. Thanks for inviting me.
Not at all. And as I said, youwere on, I think it was October last
year and the summer theprevious year. So, if people want
to since check how your viewshave evolved or hear your full backstory,
they can listen to those episodes.

(03:02):
I hope I didn't say anythingtoo embarrassing back then. I can't
remember what I said.Hopefully it stood the test of time.
I had a quick look back. It isfunny how you kind of forget what
was topical at the time. Butyou did. I mean, to your credit,
you had a couple of very goodcalls. You were pretty confident.

(03:23):
You were confident that Trumpwould win. And was it the French
guy that you had the big beton the betting markets?
Yeah, that's right, the Frenchwhale. A lot of people asked me if
that was me and it wasn't.Just to be very clear, that was not
me. But yeah, I had quite anumber of clients ping me and saying,
hey dude, what are you doingputting such big numbers on the US

(03:46):
Presidential election?
Well, you seemed equallyconfident, at the time, and you were
right on that. And the otherpoint, the last couple of times you've
been on, you've beendefinitely in the ‘no recession camp’
on the view that such largedeficits in the US are not normally

(04:10):
associated with recessions.And obviously, the deficits have
not gotten any smaller in thelast couple of years, so they've
been getting bigger. Butwehave had some weak data out recently
which have kind of reignitedgoals for maybe a, a possible imminent
downturn. So maybe that's agood starting point. How, how are
you reading the data? Do yousee increased concerns on that front?
Yeah, look, I am increasinglyconcerned. I became a lot more concerned

(05:25):
with the tariffs, back inApril when these were announced.

(06:17):
And both Anatole, my businesspartner, Anatole Kaletsky at Gavekal,

(07:10):
and myself wrote a number ofpieces. Now, usually I start off

(08:13):
with the premise that whatmatters the most is the cost of capital

(09:21):
and the cost of energy.Thecost of capital is low enough,
and when capital is plentiful,and when energy prices are low enough,
and energy is plentiful,usually the economy just moves forward
because, you know, everyentrepreneur wakes up every morning
trying to figure out how tomake more money, how to produce more
with less, etc. And that'swhat drives our capitalist system
forward. Which again, unlessyou have the brakes of too high a
cost of Capital, too high acost of energy, that usually works.
Andthat was part of thereason I was sort of dubious on the
whole, oh, we're heading intorecession. Because in my career,
most of the recessions havebeen preceded by either a big increase
in the cost of capital,especially the cost of capital, I
would say, for the privatesector more for the government, i.e.
widening corporate spreads.And we didn't have that. And we also
had a cheap price of energy.So, I don't know, I felt pretty confident.
Butinherent in that belief isalso kind of the hope that entrepreneurs
wake up in the morning feelinggood about the future, wanting to
invest, wanting to move theball forward. And this is where the
tariff throws an interestingwrench because they add a lot of
uncertainty. Nowthe realityis most entrepreneurs just want certainty
in their lives. They want toknow what the tax rates are going
to be, they want to know whatthe regulations are going to be,
and then they get on with it.Now, of course, every entrepreneur
wants a lower tax rate, everyentrepreneur wants lower regulation.
Butby and large, you know,you're told the rules of the game,
and then you go out and playit, or not, or you decide, you know
what, I don't want to playthis game. I'm taking my ball and
going home. Mybig fear, whenthe tariffs hit, and I wrote it at
the time, was that when youlook at the construction sector in
the United States, you'redealing with a bunch of entrepreneurs
there who are still carryingthe scars of 2020 and ‘21. You know,
in 2020 and’ 21, you hadmassive supply chain dislocations,
you had bare shelves at HomeDepot, lumber prices spiking, etc.
And so, a lot of projects gotdelayed. A lot of project delays,
in the construction industry,means all of a sudden margins disappearing.
Andso my fear was that, giventhese scars from the 2020, 2021 experience,
a lot of the people in theconstruction industry (and I was
seeing this talking to people)would react to the tariffs by saying,
look, I don't know if in threemonths time I'll get the pipes, because
the pipes are made in China. Idon't know if I'll get electric wire,
that's made in China. Andtheproblem is if you don't get the electric
wire, then it postponeseverything, right? It's like, if
I can't get the electrician intoday, then I can't get the plumber
in the next day. And if Ican’t get the plumber then I'm not
going to get the drywall guyin. And so everywhere around me,
following the tariffs, I washearing of projects being put on

(09:43):
hold. Now,the reason thismatters… now, you could say, well,
you know, construction, it'sonly like 3%, 4% of US GDP, etc.,
but it's a huge employer. It'sa massive, massive employer. Which,by
the way, that's anotheruncertainty is, you know, there are
a lot of illegal workers inthe construction industry, especially
in the whole southern belt ofthe United States, and Florida, and
elsewhere where constructionhas been absolutely booming for the
past decade or so. Whether youlook at your Arizonas, your Nevadas,
your Texas, your, yourFlorida, this is where most of the
construction was happening.Soyou're dealing with, all of a
sudden, if you're anentrepreneur, uncertainty of am I
going to get the parts I needwhen I need them, at what price,
and am I going to get theworkers and at what price? Maybe
it's just easier if I holdback and not do anything. AndI think
what's interesting in therecent weak data that has come out
is the extent to which it doesseem to point towards weak construction.
And again, the PMI surveysthat just came out yesterday, it
disappointed, and it was allbasically construction. So,do I
think we're going to have a USrecession? It's a tough one because,
you know, if you look attypical models, cost of capital,
budget deficits, cost of oil,you would say no. So, you almost
have to make the argument thatit's different this time. Butif
ever there's a time to makethe argument that it's different
this time, it probably istoday, where policymaking in the
US Is very different than youand I have experienced through our
careers. So, it's hard to havea strong level of conviction either
way. But I am fearful that theodds of recession are going up. Yes.
I'mnot banging my fist on thedesk saying, oh my God (to your listeners),
watch out, US is recessioncoming, etc. I'm not doing this,
but I think we have toacknowledge that the odds are probably
higher than we've seen sincethe post Covid era.
Okay. And you're seeing thatvery much being driven by the construction
side. Obviously, you know,consumer spending has slowed as well.
I mean, are there otherdynamics at play? Obviously, with
tariffs coming through, it'sgoing to be a hit to disposable income

(10:03):
in real terms. Any otherchannels you see are they kind of
confirming the weakeningeconomy scenario?
Yeah, look, I think all ofthese make sense, but again, for

(10:44):
me, construction is a hugeemployer. Construction is also, you

(11:12):
know, there's a hugemultiplier effect across communities

(11:34):
everywhere. So, I do worryabout that. Yes,indeed, I think
there is a squeeze on USdisposable incomes and both from,
you know, inflation that isstill there. I can't remember the
exact number, but I thinkinflation has been above the 2% mark
of the Fed for something like46 months in a row. Don't quote me
on that exact number, but it'sin that ballpark. It's essentially
4 years. Thebottom line is,yeah, you look at the consumer being
squeezed, you look atconstruction being highly uncertain.
And frankly, even capitalspending in general, if you look
at the boom we've had in theUS, it rested on many things. Oneof
them, of the recent years, wascapital spending in AI. Now, this
might continue. However, whatwe're increasingly seeing is that
the hoped for returns to thelikes of Google and Microsoft and
Apple, and Facebook, andothers, you know, the hopeful returns
on that are great. So, at somepoint does the AI sort of rush ahead
and continue? We'vehad very,very strong consumer spending which
was partly linked to, I think,the wealth effect on houses, on equities,
on crypto. Now granted, youcould say, well, equities are all
time highs, crypto isessentially at all time highs. So,
maybe that continues, butmaybe the lower end guy, does get
squeezed. And then you hadconstruction that was like booming.
And I think that part isslowing really hard.

(11:54):
Yeah, I mean, obviously whentariffs came along there was a huge
uncertainty. And that was thetheme of Q1, Q2. I mean, it was reasonable
to say, well, businesses willpostpone spending decisions or investment
decisions. We don't know whatit's going to play out like. But
now I suppose you could say itis increasingly apparent what is
playing out. It's kind of 15%or 20% in most cases. Okay, we haven't

(12:17):
got a deal with China yet. Butthe noises are positive. I mean,
do you think, as we get intoQ3, Q4, we'll get to a point where
there is certainty on thetariffs, albeit that they are now
here at kind of elevated levels?
Yeah, look, I think, really,the three countries that matter the

(12:51):
most for the US, and who theUS trades the most with are Canada,

(13:16):
Mexico and China. Now, when itcomes to Canada and Mexico, you know,

(13:39):
to your point, just likeEurope, just like pretty much everybody
out there, you're going to bein the 15% to 20% range. And I don't

(14:26):
think that's inconsequential.You know, that's a pretty high number.
Somebody's going to have topay for that. NowI think that the
premise of the Trumpadministration is that either foreigners
will pay, or corporates willtake the hit on their profit margins.
Maybe they turn out to beright, but if the lower end consumer
is made to carry some of thatbag, then that bag's already pretty

(14:55):
loaded. Thelower end consumeris pretty stretched in the US. So
yeah, so you've got that, andthen you, indeed, have the elephant
in the room, which is China,which is right now at 50%. Now 50%
essentially kills the trade.Now, you know, China (unlike other
countries) hasn't comegroveling. They'vequite the contrary,
they said, okay, you want togo down this path, we can raise tariffs
on you. We can block theexport of rare earth. We can block
the export of magnets. We canbring your entire auto, and armaments,
and aerospace industry to itsknees in about three months. So,
you know, fine, you want toplay, let's play. Bring it on. Andyou
know, I think the perceptionin China is that, of course, this
will hurt the Chinese economy,but that China's ability to withstand
pain is much greater than theUS's ability to withstand pain. That
essentially, you know, if theGM factories are shut for two weeks,
then Trump will be seen as afailure. You know, the whole ‘make
America great again’, Americanindustrial renaissance, etc., doesn't
work if Ford and GM can't getrare earths and, and magnets to make
cars. So,China has playedthat card. It's played it quite aggressively,
which does probably open thedoor for a deal, at some point. But
it really seems like China'snot rushing to get a deal.
So, I mean, what is a likelydeal, would you say, given all of
that?
So, if you look, right nowChina's at 50%, 20% of which is the

(15:18):
penalties for fentanyl. Now,already the US is now going around
saying oh, you know, there'sbeen huge progress on fentanyl. It's

(15:42):
now much, much better. So,they can move pretty quickly from
50% down to 30%. Imean,theUS can decide that unilaterally and
just say, okay, fentanyl,China's done tremendous work there,
well done. So, we'll bring itback down. So, they've given themselves
this leeway with the fentanyltariffs. By the way, tariffs were
also imposed on Mexico andCanada, and the US said okay, you
know, they're making progress,so we're taking that off. AndI suspect
that's what will eventuallyhappen. Now, you know, once you get
down to the 30%, after that,it's like, hmmm, it's not obvious
that it goes lower from here.
Yeah. So, you think that itcould settle somewhere around that

(16:02):
kind of baseline, which wouldobviously still be significant.
Yeah, 15% to 20% on everyoneand probably 30% on China is, I think,
where we basically end up,with the occasional other country
that may also be at 30% or 35%.
To the question on impact oninflation, obviously it pushes up

(16:22):
the price level. We've seen alittle bit of that in the most recent
inflation data, on the goodside. That being offset by weakness,
I think, in the services side.Do you think we'll see more, and
then where do you stand on,like, will it be more persistent

(16:47):
over time? ChrisWaller seemsvery intent on the view that it's
a one-off price impact andit's not going to lead to sustained
inflation. Would you be asconfident on that view?
I hate to make like a Jesuitpriest and answer your question with

(17:26):
another question, but I thinkthe answer to your question depends

(17:57):
a lot on what your outlook onenergy is and what your outlook for

(18:36):
the US labor force is. Becausethe reality is that goods within

(19:10):
the US, goods inflation, isonly a fraction. What probably really

(19:41):
matters is whether we start tosee wages push higher. Now, historically

(20:14):
a huge catalyst for wagespushing higher is higher energy prices.
Somehowthere's apsychological element to energy prices.
Perhaps this is because, youknow, when we drive to work we see
the gas price on the side ofthe road, perhaps because it's the
one thing we buy consistently,and it's always the same thing. I
fill up my car every week andI know I pay X to fill up my car.
Andso, right now energyprices are low. Gasoline prices are
low. And so, you know, wagesare still not really rising all that
fast, even with theimmigration crackdown. Even with
the immigration crackdown,wages haven't been shooting up. Nowfast
forward 6 or 12 months fromnow, if energy prices have moved
up, and at the same timeyou've got a tight labor market because
you've kicked off all theillegal immigrants, then you really
have the recipe for, I think,an inflationary spiral where wages
go up at the same time goodprices are going up and gasoline
prices are going up. And thenthe narrative, the popular mood really
starts to swing to, oh my God,there's so much inflation. So,energy
prices, at this juncture, arereally, really critical. And I would
say that if energy pricesstart to rise, then probably President
Trump's presidency starts tobecome very challenging. As long
as energy prices stay low,basically the show more or less may
manage to stay on the road.Now,I happen to be a bull on energy,
so I happen to be aninflationista. But I willingly acknowledge
that energy prices today arelow and that we're going through
an interesting time in energybecause, on the one hand, I think
we've underinvested in carbonfor 10 years now, and the scope for
oil and natural gas, etcetera, to go up is there. Butat
the same time, you have thebiggest energy importer in the world,
namely China, that hasinvested like absolute crazy in its
ability to deliver electricityand to essentially fund its own transition.
A transition from carbon-basedenergy to electricity. Whether that
electricity is produced bynuclear, by solar, by LNG plants,
by hydro, by coal-based fireplants. But China now produces twice
the amount of livingelectricity than the United States

(20:42):
does. Whichis funny becausethe US is still supposed to be at
least a third bigger as aneconomy. But when you look at electricity
production, and if you thinkthat's probably a decent proxy for
the size of an economy, Chinais now twice the size of the United
States. So,all this to saywe're at an interesting point where
the energy of the future iselectricity. It's not gasoline, it's
not diesel, the energy of thefuture is electricity. China is moving
very rapidly in thatdirection, the rest of the world,
not as much. But meanwhile,we've also massively underinvested
in carbon. So,depending onwhere you fall on the energy question,
I think, will dictate how youfall on the inflation question. So,
I'm a bull on energy. I thinkenergy prices move higher, I think
inflation thus moves higher.
And what's the bullishness? Imean, I get the underinvestment case
in energy. Obviously, oilprices have been stuck here in a
range for quite a while now.And obviously we've had geopolitical
events, we've had Iranstrikes, etc., and the view always
seems to be, get a spike, it'sa good opportunity to sell because

(21:04):
the market is quite wellsupplied at the moment. So, what
changes on that front or whatare the risk factors, do you think?
Yeah, look, I think the mainthing is big energy bull markets

(21:37):
are driven more often than notby demand. And so, I think what changes,

(22:06):
what people underestimate isyou could look at energy as, essentially,

(22:29):
you've got different billionpeople markets. So, China's a 1 billion

(22:52):
person market (I'm rounding,of course), it's like 1.3, but let's

(23:15):
just call it 1 billion. Indiais 1 billion, Africa will very soon

(23:42):
be 1 billion, and then thedeveloped markets are essentially

(24:02):
1 billion, and then everybodyelse is 1 billion (if I'm going to

(24:30):
make it like very simplistic).So,Africa has been a huge net energy
exporter. That probablychanges in about three or four years,
between their populationgrowth and their standard of living
growth. So, they switch frombeing an exporter to an importer.
Youknow, India continues toimport more and more. So, I think
people focus on China becauseit's been the big story of the past
three decades in energy. Andthen they say, well, look, China's
energy needs are plateauing.They're importing less or they're
not importing as much. They'reno longer growing. But it's missing
the story that's occurringelsewhere in emerging markets. So,when
you look at total oil demand,it's still growing by 1 million to
1 and a half million barrelsper day every year, you know, ballpark.
So, for that, given the factthat wells lose capacity over time,
to make that extra million anda half barrels, you need to continuously
invest. Now, today you couldsay, yeah, but you know what? OPEC
probably has 2 millionsurplus. Yeah, and that probably
covers you for the next year.And then what? So, then what you
could say is, well, you know,you got some coming out in Suriname
and some coming out in…Buthere's a fun fact on the other
side. From nowhere - fiveyears ago, China is now the biggest
car exporter in the world.Something that nobody expected. China
is now the biggest carexporter in the world. And 85% of
the cars that China exports onany given month, 80% to 85%, are
ICE cars. The electric carsstay at home and the ICE cars go
abroad. Why? Because the carsgo to emerging markets. Andwhen
you live in Colombia, when youlive in Indonesia, your electricity
grid isn't going to supportelectric cars. Also, electric cars
depreciate too fast foremerging market investors. Good thing
about ICE cars is they last 20years, if you take care of them.
Sonow, all of a sudden, whatyou have in Indonesia, in Vietnam,
in Colombia, in Brazil, youhave people who buy cars who never
bought cars before becausethey're buying Chinese cars for less
than 10,000 US dollar a car.So, you have, all of a sudden, people
driving ICE cars all acrossthe global south that were not consuming
gasoline up until five minutesago. AndI think that's the part
that perhaps people aremissing today is yes, on the one
hand OPEX has this extra 2million etc., but at the pace at
which China is exporting cars,you're going to need gasoline, you're
going to need more refineries.Nobody's building refineries, you're
going to need more refineries,etc. And so yeah, I do tend to think
that the risk is to the upside.
That sounds like maybe a storyfor next year or thereafter and not
necessarily for the next six months.
These things are always sohard to tell. What I do know is that

(24:56):
today's equilibrium isunstable. Now, you're absolutely
right that it could be stablefor the next six months, 12 months,
18 months, absolutely. But Ithink that if there is a risk to

(25:18):
our system today, if there isa risk to global economic growth,
we're now set on an easingstage for central banks everywhere
around the world. Whether youknow, the Fed, that's going to be

(25:41):
easing, the ECB, that'seasing, EM, central banks everywhere,
easing, etc. Ifthere's a riskto this whole environment, it is
that oil prices spike. Nowgranted, I take your point. It's
like yeah, but that's notgoing to happen in next six months.
Probablythere’s like a 90%chance it doesn't happen in the next
six months. But what if itdoes? What if in that 10% chance
it does? Then it's going toobliterate your portfolio. So, at
the very least you don'tinvest on the premise that this is
going to happen, but you buyprotection for your portfolio in
case it does.
You mentioned easing is likelyfor the Fed. I mean, do you think,
now, the Fed's going to comeunder so much pressure that it will

(26:02):
cut in September, and how muchbetween now and the end of the year?
Yeah, I think it cuts inSeptember, I think it cuts in September
unless (again, I'm soundinglike a Jesuit priest, like hedging
everywhere)… There are two CPIprints between now and September,

(26:25):
unless you get two bad CPIprints. (And by bad, I mean the CPI
that surprises on the upside,that turns out to be much stronger
than expected), unless you getthat, I think those job numbers we

(26:46):
just had almost guaranteedthat you're getting cuts in September.
Now,you know, beyond that, isit going to be 25%, is it going to
be 50%? I think a lot of thatwill be driven by the data between
now and then. But, you know,recent PMI, recent ISM, have looked
softer. If all these thingscontinue, then, yeah, probably 50%.
Okay.
And then that allows the Fedto sort of at least get Donald Trump
off their backs a little bit.
Speaking of which, the bigtopic, in respect to the Fed, is

(27:09):
what happens next. Soobviously it seems like Trump isn't
going to fire Powell just yet,but obviously the window for putting
a replacement in is, isopening. Obviously, there's a spot

(27:30):
for a new governor, which mayor may not be the person who becomes
the chair. What's yourthinking on this? Obviouslyit's
kind of two Kevins and ChrisWaller are probably the three names.
I know there's a fourth. I'mnot sure if that's Bessent, he now
seems to be ruled out, or ifthere is somebody else. But back
to the betting markets,they're the top cthreeontenders.
I thought Trump wanted to happointimself.
That was also mooted at onepoint. Yeah, not impossible, but
yeah.
So first, I don't think hefires Powell. I don't think he fires

(28:02):
Powell because Powell at thisstage, he set him up as the perfect
scapegoat. He's done these bigtariffs which may or may not work.

(28:33):
It's a big gamble. If itpushes the US into recession, he
can turn around and say it'sthe Fed's fault, it's Powell's fault.

(29:02):
“I've told you all along, thisguy's an incompetent, etc., etc.”
So, he set up Powell as thescapegoat. So why would he want to

(29:33):
get rid of him? Assoon as hegets rid of him and puts in the other
guy, then he owns the economicsituation (either guy or girl), he
then owns the economicsituation. So, I think Powell essentially
serves out his term because heserves a purpose now, which is being
a scapegoat. Beyondthat, whohe picks, I think at this stage,
what really matters more isthat it's been signaled, it's been
telegraphed, that the Fed fromhere on out will be easier, will
be following easier monetarypolicies, and will be essentially
pushing the US towards aweaker dollar. And I would say, who
cares about the personalitiesat the top? Whatmatters for us as
investors is the highest oddsare that we're going to have a set
of policies that almostguarantee steeper yield curves and
a weaker dollar. So, that'swhat matters to us. And a steeper
yield curve, a weaker dollar,that usually means outperformance
of financials. Which is whatyou're seeing in markets everywhere.
It usually meansoutperformance of emerging markets,
which is what you'reincreasingly seeing. Usually, it
means the outperformance ofvalue against growth, which we're
not really seeing yet, but Ithink we'll see probably further
down the road.
Plausible. Theone thing Iwould say is the likes of Kevin Warsh
has very distinct views onbalance sheet normalization and has
been very critical of theFed's approach around QE. So, I mean,
if we saw him come in,obviously he's in favor of rate cuts

(29:54):
at the moment, but he doesseem to be a bit more independently
minded than maybe say, Kevin Hassett.
That's a very fair point. I'ma big believer and a big proponent.
I always say that, look, asmoney managers, we're paid to adapt,

(30:22):
not to forecast. So, I'll bedead honest with you. I'm not actually
spending that much timethinking through all the various
scenarios of, you know, oncewho gets it, and what they do once

(30:51):
they get it, etc. Because oncewe know who it is, then I'll start
thinking, okay, so, if it'sthis guy, so it probably means this,

(31:12):
this, and that. Havingsaidthat, people change their minds,
people evolve as well. So, Ifear that trying to anticipate the
various guys moves is maybetoo many chess moves ahead. I played
a fair amount of chess in myyouth, and I was never very good
because I could never do morethan sort of three moves ahead. You
know, the really good guyshave got like six moves ahead. I
could do about three movesahead, in my head, and then I'd sort
of lose it. And as aninvestor, I try to do the same. I
try not to be too many movesahead because the complications just
get too big.
Fair enough. You did mention aweaker dollar. And this has been
a theme this year. Obviously,the dollars had, I think, the worst

(31:36):
start measured on a calendaryear basis. At least it did going
back a few weeks. And thenarrative was all about kind of outflows.
Theend of US exceptionalism,obviously, was one narrative which
has kind of diminished alittle bit as the equity market has
come back, and then outflowsfrom the US market, and obviously
some hedging pressures aswell, undermining the dollar. So,
putting all of that together,and obviously in the background chatter
about US reserve status underpressure as well. I suppose that's
the consensus view. It’s hardto disagree with it. What do you

(31:57):
think?
Yeah, I think it's hard todisagree with it. I think we are

(32:25):
seeing a paradigm shift in theUS dollar. And look, perhaps the

(32:51):
most important shift in the USdollar… You know, if you were a French

(33:20):
pension fund or a Koreaninsurance company, for years you

(33:41):
bought US equities and youwere long the US dollar. And if ever

(34:08):
there was a market accidentand equities went down 10%, typically

(34:31):
your own currency went down5%. So, net/net, on your US equity

(34:56):
position, you would be down5%. So it was, yeah, nobody likes

(35:21):
being down 5%, but it's notthe end of the world. So,the fact
that for years and years theUS dollar was this port in the storm,
this shelter in rough seasmade US assets very attractive. It
made the US dollar veryattractive and sort of a very reflexive
move for foreign investors.And I think this was shattered this
year. Wesaw it very well inApril when the Liberation Day tariffs
were announced. Instead ofgoing up, the US dollar went down.
In fact, for a period of abouteight days, you had the bond market
in the US, the equities andthe currency all falling at once.
And if you've ever been downin emerging markets, you recognize
that pattern immediately.Yourecognize that pattern. You're
like, okay, I've seen thismovie before. This is an EM crisis,
I'm out of here. When you seethose three things fall together,
it's a big warning bell. Andthat's why I think Bessent and Lutnick
had to intervene, and theytalked the tariffs back and stabilized
the markets. But the messagewas nonetheless sent that from now
on, when US equities fall, sodoes the dollar. And therefore, this
makes US assets, just thisshift in correlations makes US assets
a lot less attractive to mostinstitutional investors everywhere.
So,I think you got that. Ofcourse, you've got the greater uncertainty
around politics and policiesin the US. And politically it's now
no longer good to be seenbeing overweight the US if you're
running a public pension fundin Holland, or you're running a sovereign
wealth fund in Singapore.Being massively overweight the US
may not be the smart trade.So, bottom line, I think the default
mode amongst largeinstitutional investors is now to
bring money home. Youknow,for the default mode for 15 years
was, I’ invest in the US’. Nowthe default mode is, is bringing
money home. But the problemwhen you talk to pension funds in
Germany, or pension funds inCanada, they always tell you the
same story, I want to bringmoney home, but I don't have any
assets to buy at home.Nowthis is where it gets interesting.
If you look at the newchancellor in Germany, at the new
Prime Minister in Canada, thenew prime minister in Canada comes
out of Goldman. I tend tobelieve that you can get the guy
out of Goldman, you're notgoing to get Goldman out of the guy.
So, if you now have pensionfunds that come to CM and say, hey
Prime Minister Carney, give USassets to buy, he's going to say
all right, I know how to dothis. Let's build some infrastructure
bonds. Let's IPO the airports.Let's build pipelines into British
Columbia to sell the oil toAsia, and give all these Canadian
pension funds, that havehundreds of billions invested in
the US, opportunities to bringmoney home. AndI don't want to pick
on Mark Carney because youtake the German chancellor, he used
to be the CEO of BlackRock forEurope for six years. So, how hard
is it for him to structureinfrastructure bonds and call the
head of every pension fund inEurope that he knows on a first name
basis? Probably not verychallenging. So,I do think this
trend is starting where themarginal dollar, instead of being
invested back into the US, isnow increasingly going to be invested
domestically.

(35:45):
It makes sense, I guess. Imean, the one thing that it ignores
is the AI theme, and the Mag 7have come back and haven't been under

(36:09):
pressure for a while. So, ifinvestors want to play that theme,
obviously the US still remainsthe obvious place to go to. Imean,you
mentioned there maybe somequestions around the return on investment
but at the same time recentresults from Meta were encouraging,
and I think some Microsoft,and a number of them were announcing
upgrades to their CapEx spend.So, I mean for the moment it still
seems to be raging on. Is thatnot part of the picture or you're
understanding?
That's a massive part of thepicture. That's a massive part of

(36:45):
the picture because you'reabsolutely right to highlight it
in that you've had an epiccapital spending boom in the US.

(37:14):
I actually, recently, wrote apiece on this, where CapEx in the
US, over the past few years,has gone from 9% of GDP to 11% of

(37:51):
GDP. And this 2% of GDPincrease in CapEx, by the way, historically
it tops out at around 11.50%.Like, in 2000 it topped out at 11.50%.
Thatextra 2% has really goneto a handful of companies because
that increase in Capex, someof it has been in data centers, some
of it has been in building outnew power plants (although nowhere
near enough). And most of ithas been in AI. Youknow, it's that
2%. It's gone basicallystraight into Nvidia's bottom line.
Exaggerating of course, butdon't send me data saying, no, it
didn't all go into that. Butit's gone into Nvidia and, yes, to
Microsoft. And so, thequestion now becomes, you know, you've
had this huge increase inCapEx, what do we get on the other

(38:22):
side of it? Now,do we get theproductivity gains and do we get
the profits that flow to thesebusinesses that have essentially
turned themselves? you take aFacebook, it's essentially turned
itself from an extremely assetlight business into an increasingly
asset heavy business. Nowagain, if the money flows in, then
happy days, then the showstays on the road. And yes, people
want to keep buying Facebookand they'll want to keep Nvidia,
etc. Ifthe returns don't comethrough, if AI turns out to be very
commoditized, and if theprofits on there or the productivity
gains aren't what was hopedand expected, then the US really
hits the wall really, really,really hard. Because right now what
is keeping the show on theroad, to your point, is this excitement
around AI. Take that away andall of a sudden things start to look
pretty dire.
And what's your thoughts on inthe next downturn? I mean there is
a view that, because now ofincreased usage of AI, LLM, etc.,
that a lot of those entrylevel positions are not being filled
and that in the next downturnwe could see even more adoption and

(38:45):
corporates trying to squeezeas much out of AI as they can and
much higher unemployment. Isthat too early to expect that or
is that a risk factor on your radar?
No, I think you have to worryabout that. I mean look, that's the
very lynchpin of the AI hopeis the idea that we’re going to get
productivity gain.
That's the productivity gain,isn't it?

(39:06):
Yeah, it is. So, you have toworry about it because either, A

(39:43):
this is… So, there are twooptions, A, this is going to be real

(40:23):
and where all this (to yourpoint) the entry level jobs in insurance

(41:00):
companies and in banks and ina lot of places are going to disappear.

(41:39):
And so, then you have towonder, okay, so, what does that

(42:14):
mean for our societies? Whatdoes that mean for jobs in general,

(42:48):
etc. So, that's your one path.Andthe other path is, like I said,
I think it turns out to be adud. It’s nowhere near as productive
as we'd hoped and we have ahell of a stock market correction.
It almost reminds me of thatWoody Allen quote about how we've
reached a fork in the road, onone side lies despair and on the
other lies misery, and that Ihope we choose wisely. So, I don't
want to sound depressing foryour listeners. Itendto believe,
and I may be wrong, but frommy own playing with it, I tend to
believe that the level of hypeon AI is off the charts, and that
there will be someproductivity gains, sure, but it'll
be nowhere near what we'rebeing told, and it won't be near
enough to justify either thelevels of CapEx that have been put
into this thing, or the levelsof the valuations on a lot of assets.
Imeanlook, I'll give youjust two examples. If you go back
to 2008, in 2008 the wholeworld, from peak to trough, lost
$18 trillion in equity marketcap. So, you had essentially $500
billion of losses on mortgagebonds that triggered $18 trillion
of market cap equity losses.It was a bloodbath - $18 trillion.
Now,okay, keep that number inmind for just a second. Today, if
you look at Nvidia pluscrypto, just those two assets - Nvidia
and crypto, there, today,together it's more than an $8 trillion
market cap. Now, crypto andNvidia just two years ago, crypto
and Nvidia just two years agowere $2 trillion market cap. So,
they've gained $6 trillion inmarket cap in two years. Now, $6
trillion is a lot of money. Ithinkthere are only two economies
in the world that have morethan a $6 trillion GDP, China and
the U.S. So, $6 trillion is ahuge amount of money. And that's
what's been gained in just twoyears by those two asset classes.
Nowwhen you look at Nvidiaand when you look at crypto, these
are asset classes that everythree to four years lose 75% of their
assets. That's just what theydo. It doesn't mean they're bad.
I'm not putting a valuejudgment on it. I'm just saying,
like, look, these are assetclasses that, through history, have
had massive volatility, andmassive upside and downside volatility.
Now,you could say, well thishas changed now, that's over. But
let's imagine that it hasn'tchanged, that at some time in the
near future we got a 75%wipeout on these guys. That will
be $6 trillion that will popaway like this. That's a third of
the equity loss of 2008 injust two asset classes. Nowimagine
the impact this will have,then, on capital spending; the impact
this will have on consumption.You know, there'll be a lot less
boats being sold and a lotless sports cars and whatever else.
So, for me, this is now thebig risk in the market, to be honest.
We've reached a point wherethe hype on AI the results really
have to be pretty outstandingto match the level of hype that that
was put in.
You mentioned earlier aboutthe period in April with the dollar

(43:15):
bonds and equity selling offat the same time. And you know, it
brought into, I suppose, focusthe kind of maybe structural concerns
about the long end of thecurve in the US that you mentioned,

(43:45):
the likelihood of steepening.Butwe've had the Big Beautiful Bill.
Deficits are not getting anysmaller, they're getting larger.
And on a trend basis, year onyear, we've just got used to kind
of 6%, 7%, 8% of GDP. Butwe're not seeing a huge reaction
from the bond market.Obviously yields went up to maybe
4%, 5%, 4.6%, and are back to4.25% now. There was a view in the
markets of, do deficitsmatter? At what point do they matter?
It's the old story, right?It's like tequila shots. You've never

(44:51):
known when you've had enoughuntil you've had too much. And government

(45:58):
debt tends to be the samestory. Youfeel good, you feel good,
you feel good, and then atsome point you're throwing up in
the bathroom. So, yeah, yourpoint is, when do we start throwing
up in the bathroom? And theanswer is I'm not quite sure. ButI
know it's not a great assetclass to own because at this pace,
you know, it's like you'reseeing the guy at the bar just pounding
the tequila shots and youknow, there's nothing good coming
out of that. You're not quitesure when he's going to hit the wall,
but you know that wall isthere. So,I do look at the fiscal
situation across most of theOECD, and the reality is you could
say, oh, it's bad everywhere,etc. But there's really three countries
that have really bad fiscalsituations today. One of them is
my own of France, the other isthe UK, and the third is the United
States. These are really thethree countries where, when you look
at the increase in debt, youcan start getting worried. Now,the
UK and the US still controltheir central banks, so they have
the option to monetize thedebt, to essentially take the pain
through currency devaluation,through currency devaluations and
a weaker currency. It's harderfor France to do this because we're

(46:20):
obviously part of the euro.Andso, if you want to look for a
debt crisis, perhaps the moreobvious candidates, at this juncture,
has to be France, where youhave a very tenuous political situation.
You have a government thatcan't pass a budget, that's coming
back in September fromholiday, doesn't control parliament
because parliament is divideda third, a third, a third. And every
one of those three groups hatethe other two, where, basically,
building coalitions isimpossible. Andthen you could say,
well, if France hits the wall,then maybe that gives another boost
to US treasuries, whereforeign investors say, ah, Europe,
it's screwed. These guys can'tfight their way out of a wet paper
bag. I thought they had ittogether, but they don't. Bythe
way, I'm not saying this isgoing to happen, but I think that
the risk of that is not zero.And then money comes back into US
treasuries. So, you canactually make a bull case for US
treasuries. Personally, Idon't own any US treasuries. I think
the US dollar is astructurally weak currency from here
on out. I personally have noInterest in owning bonds and currencies
that depreciate. Iliketo ownbonds and currencies that appreciate
- currencies are bound to bestrong. I have no interest in owning
US treasuries. But you couldsee an argument where, okay, actually,
out of the three weak links inthe system, France is the weakest
link and when it breaks, it’llboost the US.
And what's the scenario for aFrench problem? Obviously, in Europe

(46:41):
we've had easing from the ECB.So, they've been much, much more
ahead of the curve, I guess,than the Fed has been. Obviously,
as you say, in Germany we'vehad a debt break being loosened.
Maybe it doesn't, which is whyI said I'm not sure we go this way.
Shifting gears. I mean, lasttime you were on was, I think, October

(47:07):
last year. It was not longafter the big kind of China announcement,
still stimulus at that point.It was a kind of a big spike in the
equity market. It's been kindof up and down since then, but probably

(47:30):
a little bit higher. So, youknow, hasn't reversed. But you mentioned
the kind of the China Nettieexporter, the largest exporter of
cars in the world. Andthat'sbeen the Chinese strategy, isn't
it? Flood the world with itsexcess manufacturing capacity. To
date, I guess countries likeIndonesia, as you say, Brazil, have
been happy to absorb thatexcess capacity. I mean, where do
you see China now in itsprocess of coming out of that big
deleveraging that it's beengoing through for the last number
of years?
Yeah, so I'm not sure thatit's been China's strategy to flood

(48:58):
these other countries. I thinkChina's strategy is actually a bit

(50:03):
different. The way Iconceptualize China is that China

(50:57):
was humming along and in 2018,the US embargo on semiconductors

(52:02):
was a massive shock to thesystem. When the US said no more

(53:20):
high-end semiconductors toChina, essentially the Chinese leaders

(54:08):
panicked. Theythought, okay,if they're blocking us from semiconductors
today, tomorrow it could beauto parts, it could be tires, it
could be chemical products, itcould be anything. The US is trying
to trip us up economically. Wethus have to become self-sufficient
and independent, resilient onevery single supply chain. Andso,
in 2018, essentially thegovernment tells the banks, guys,
no more loans to real estate,no more loans to the consumer, all
the money has to go toindustry. And so, we go through seven
years of all the loans… If youwere an auto manufacturer, you'd
get a loan. If you were abattery manufacturer, a chemical
producer, like whatever, youwere getting a loan if you wanted
it. But real estate, forgetabout it. And so, you see, real estate
loans absolutely collapse, andyou get a, epic real estate bust,
unsurprisingly. Imagineiftomorrow the Irish government told
the banks, you're not allowedto lend to real estate anymore, what
that would do to the realestate market. It would probably
be nothing good, especially ifvaluations were stretched to begin
with. Andthen you also hadfairly little consumption. You lived
through it, in Ireland, whenpeople's real estate goes down, you
tighten the belt. And it's notlike you go out to the movies or
the restaurant. Sothat wasthe story, really, of the past six,
seven years. And while thishappened, it did create all this
excess capacity that you talkabout. And so, now, today, China
turns around and produces allthese cars, all these tractors, these
telecom switches, theserailroads. And then indeed, the question
becomes, okay, where are wegoing to sell all this stuff? Now,the
obvious market would be,obviously the developed markets,
but there’s this protectionismagainst China. And frankly, the Russia
invasion of Ukraine, and thefact that China has sided with Russia,
has made all that part evenmore complicated. And the Western
world is even less likely todo business with China. So,then
the only market becomes thisglobal south, for lack of a better
word. It becomes LatinAmerica, Middle East, Southeast Asia,
Central Asia. Butall thesecountries are poor countries, so
China's got to providefunding. And this is where we are
today is like, okay, China isnow starting to export these cars,
these train systems, etc. Inwhat currency are we going to fund
this? Andthis is where itgets interesting is if you go back
to 10 years ago, five yearsago, all China talked about was funding
its trade in its own currency,in the renminbi. And it talked about
the offshore renminbi. Andwhat China was saying was essentially,
look, Indonesia, we'll buyyour coal for renminbi. Andif you
don't want to keep therenminbi for, you know, whatever
reasons that are yours, youcan come to Shanghai and exchange
your renminbi for gold. Andnow what they've realized is that
the more they trade and themore they push out the renminbi,
the more people buy gold onthe other side. Andso gold starts
to go, not yet, but starts tomove parabolic. It starts to move
up. The risk, now, if you'reChinese, if you're the Chinese central
bank, if you're the PBOC, therisk is that gold really, really
starts to shoot up becauseChinese investors themselves first
love gold, secondly love amomentum trade. They're the biggest
momentum investors. So, ifgold starts shooting up, then they
all start buying gold. Andtherisk, then, is that gold goes absolutely
bananas, and then it crashes,and you've wiped out an entire generation
worth of savings, and you'vemade people very angry in the process,
and you've destabilized socialpeace. So,you will have witnessed,
perhaps, that in the past sortof year there's been a big change
of rhetoric from the PBOC, andI've written a number of pieces on
this. But the rhetoric is,essentially, the PBOC now comes out
and says, you know what?China's unique because we have two
currencies. We have therenminbi and we have the Hong Kong
dollar. Now, we can use therenminbi to fund our internal trade,
and we can use the Hong Kongdollar to fund the external trade.
Butof course, if we're goingto fund all this trade in Hong Kong
dollar, then we're going toend up with a lot of excess liquidity
in Hong Kong dollars. Allthese Hong Kong dollars that get
created, pushed out into thesystem, eventually come back into
Hong Kong, into Hong Kongbanks, buy Hong Kong assets. So,I
think we've started thiscycle. Last year, the Chinese equity
markets were actually the onemarket that outperformed the US equity
market. This year, again, HongKong is massively outperforming,
and nobody cares. Nobodycares. I look at China.. WhenI look
at any market, I look at itthrough five prisms. First, I start
with fundamentals. Does itmake sense? And I would say China
today, they put down morepatents than any other country. They've
gone from graduating a millionuniversity students a year to 13
million university students ayear. They'vespent the past 20 or
30 years dramaticallyimproving their infrastructure to
the point where they now havethe cheapest electricity costs in
the world. They have thecheapest transportation costs in
the world. So, thefundamentals actually make sense.
ThenI look at valuations.They're still very attractive. The
momentum is now very solid.Then you look at investor positioning,
and nobody owns China because,remember, they're always about to
invade Taiwan and all sorts ofcrazy stuff. Andthen finally you
look at policy support, andthis is where you've had the biggest
shift in China is that upuntil a year and a half ago, the
rhetoric from the Chinesegovernment was put all the money
in building industry. And nowthe rhetoric is we want asset prices
to go up and we want to createa positive balance sheet effect partly
to boost domestic consumption.So yeah, I think, look, we've started
an equity bull market in Chinaand frankly nobody's involved.
So, the transmission mechanismand the Hong Kong dollars are lent
to kind of emerging marketswho then sell those back into the
system in Hong Kong. So,you’ve got more liquidity in the
system there that flows intothe equity market.

(54:29):
You see this excess liquidity,but one of the things that's been
a head scratcher for manyinvestors is the extent of Hong Kong
interest rates. So, Hong Kongis pegged to the US dollar, for your

(54:59):
listeners who don't know this,the Hong Kong dollar is pegged to
the US dollar. So,historically the interest rates are
roughly the same becauseotherwise there's always an arbitrage

(55:23):
opportunity. If I can borrowHong Kong dollars that's pegged to
the US dollar. Now,if there’sa crisis, what would usually happen,
people worry, oh my God, thepeg's going to break or whatever
else. So, in periods ofcrises, Hong Kong dollar interest
rates would move far above USinterest rates to essentially attract
people back into the Hong Kongdollar. This is how the peg works.
Allyear long you would haveseen that highball rates are way,
way below US interest rates,not by a little, but by 200 basis
points, which is franklyunprecedented and is a testimony
to all the success liquiditythat is now sort of flowing into
the Hong Kong dollar in sortof a broader world.
Do the Hong Kong banks, notjust buy the dollars, and is there
an arbitrage there thatsomebody has got on a huge scale?
No, I think the Hong Kongbanks do it, but they've have so

(55:47):
many deposits in Hong Kongdollars coming in they don't know
what to do with the Hong Kong dollars.
Okay. Just conscious of time,outside of Hong Kong. Well, which
is not really emerging, Iguess, but emerging markets more
broadly. I mean, you painted apositive picture from the perspective
of an environment of a weakerdollar, which would generally be

(56:08):
positive for global liquidityand for EM. I mean, from a more kind
of structural growthperspective how has EM been playing
out? Obviously, the tariffs, Iguess, are a headwind for certain
countries or not. Or how doyou see that?
Yeah, I think, to the extentthat everybody's getting them, it
sort of evens out.

(56:29):
It evens out.
Now, you've had some that havebeen punished more than others. Brazil's
the obvious one now. I happento have been and remain a bull on
Brazil. I look, and for thatmatter the whole broader Latin America

(56:55):
spectrum today, especially ifyou're a fixed income investor, it's
the one part of the worldwhere you can easily anticipate 150,
250, 350 basis points ofinterest rates drop over the next

(57:18):
18 months. And today you cango out and buy a Brazilian TIPS giving
you 7.5%, 8% real returns. Youcan go out and buy Brazilian bonds
that are going to give you 14%nominal at a time when inflation

(57:45):
is roughly 5%, 5.50%. So,youknow, nowhere in the world has that
level of real rates. And youknow, in a weaker dollar world the
local central banks will havetheir hands free to cut interest
rates much more aggressively.So, I think there's tremendous trades
to be had in Latin America.There's,yeah, I think the Chinese
equity market has started abull market that few people are even
noticing. So, yeah, there'sthings to do out there.
So, is that your top tip forthe coming year or months? I mean,
is that what your most highconviction view on bullish EM or
what would you say?
Oh yeah, look my highestconviction move, I believe by far,
is we're starting a new bullmarket in emerging markets. A bull

(58:09):
market that won't be deraileduntil we either get a new Fed tightening
cycle, which seems highlyunlikely right now (we’re going quite
the opposite), or until we getmuch higher energy prices. And again,

(58:30):
as you pointed out, right nowthings are stable. It doesn't seem
like a spike is the mostlikely scenario for the next six
to nine months. So,now I wantto buy hedges against that spike
because I'm super longemerging markets and I do worry that
they would get squeezed ifenergy prices shot up. So, I want
to buy hedges against energyprices shooting up to protect my
EM positions. But EM is whereyou want to be.
Good. Great to have you backon again. I'm sure we'll do it again,

(58:58):
maybe next year at some point,and reassess all of those calls.
Butyeah, for all of ourlisteners obviously keep tuned and
make sure to follow Louis workat Gavekal l to get his insights
over time. But from all of ushere, thanks for tuning in and we'll
be back soon with more content.
Thanks so much, Alan.
Thanks for listening to TopTraders Unplugged. If you feel you
learned something of valuefrom today's episode, the best way
to stay updated is to go onover to iTunes and subscribe to the

(59:19):
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