Surviving the Market: Lessons in Cycles, Risks & Resilience

In this thought-provoking episode of SOS Stories of Survivors, host Serina Dansker sits down with Michael Litt—a seasoned financial strategist with over three decades of experience navigating the complexities of global markets.

Episode Transcript

Speaker 1 (00:34):
Hey there, and welcome back to SOS Stories of Survivors.
Today we are talking about financial survival and mental survival.
Picture this Washington, DC just passed this huge stimulus bill,
so big that our national debt may raise to fifty
three trillion dollars by the year twenty thirty four. That's

(00:56):
absolutely mind blowing. Today here on SA Stories of Survivors,
we are welcoming my friend and financial guru, Michael Litt.
Michael was the partner at the front Point Partners, which
is the hedge fund that was featured in The Big Short.
He's been advising institutions and clients and he's now sharing

(01:20):
what he sees for the market going forward and what
risks and pitfalls are out there. So please join me
in welcoming Michael Litt. And also something you guys should know,
he is going to be premiering on Soosradio Dot Live
his show That Guy is Lit, So stay tuned to
hear more about that. Welcome Michael. So glad you could

(01:42):
join us today.

Speaker 2 (01:44):
Thank you, Serena. It's good to be here and it's
a fun topic to talk about because there's a lot
going on.

Speaker 1 (01:51):
Oh my god, I just want to I want to
get right into this, but first, I really I think
our listeners want to know about you and your background.
You've said you've been around the mark market since in
early age, probably like fifteen years old. Were you really
running trades for your uncle on the Mercantile Exchange.

Speaker 2 (02:08):
Yes. I remember this movie they had way back in
the day called The Oliver and there was a character
in Oliver called the Artful Dodger and he took Oliver
running around everywhere in London and taught him the streets
and you know, sort of they were street urchins and
they taught him the ways of the streets. Well, when
I was fifteen, my uncle brought me down to the

(02:30):
Mercantile Exchange and had me running paper around to different
pits and putting trades in for him. And they were
in like the Deutsche in the Deutsche mark currency, which
we'll talk about later actually, and financial futures, treasury securities
and eventually the S and P five hundred futures, a

(02:51):
lot of meats, you know, trading feeder cattle or pork bellies.
Things you hear about. But actually, at fifteen I was
running around like the Artful Dodger on the Crazy loud,
you know, sort of insane floor learning how to trade
at the age of fifteen.

Speaker 1 (03:09):
That's absolutely incredible. And what lessons did you learn about
risk and discipline in those early days.

Speaker 2 (03:18):
It's a good question, you know. It's interesting that markets
moved what they call upstairs, so people were trading with
electronic screens, which is how everybody trades now, and for
a long time they call each other on phones and
execute trades. Now they just execute, you know, electronically. But
what I experienced there when my neuroplasticity was impressionable was

(03:44):
the body language of people as markets were moving, and
so you could really see sort of into the soul
of markets and how people behaved as markets moved. And
so that's very much imprinted on me and it helps
me a great deal in seeing things that others might
not be able to see.

Speaker 1 (04:03):
Wow, I mean that I was in financial advisor in
my prior life. And when you say body language, you
learn to read people, and body language is a huge
defining characteristic. I find that really amazing and really impressive
that at the age of fifteen that you were able
to connect with that. I applaud you for that. I

(04:27):
have to ask you, I mean, you were on the
mercantile exchange floor, then you went to Morgan Stanley and derivatives,
and then to front Point as a partner. Was there
a thread that connected you between those positions in your career.

Speaker 2 (04:44):
Yeah. Interestingly, the derivatives working in first asset management and
then the derivatives group connected back to the financial futures
and the options on the futures that were traded. So
understanding deriva came from that original because futures by definition

(05:05):
are derivative securities, and so that experience led to that
and combining understanding what we call non delta one securities,
which is an option. An option is not owning say
Apple stock, right, You own an option on Apple stock,
so it might go way up or it might go

(05:26):
to zero.

Speaker 1 (05:27):
Right, So it's an option to either buy or sell.

Speaker 2 (05:29):
Right, it's an option to either buy or sell Apple stock.
But it has its own life. It's different than it's
related to, but it's different than the stock itself. So
there's a kind of mathematical relationships between those derivative securities
and the stock or the bond itself, So that those
were related. Going to front Point had to do with

(05:53):
understanding a lot of different securities markets at that point
and being able to write about, write research papers and
allocate amongst the different investment strategies we had. And that's
what I was doing, was allocating capital to different teams
when opportunistically, when their opportunity set was most attractive in

(06:15):
our view. Now that was a judgment call, but understanding
all the different global markets and the different securities in
those markets was required to be able to make an
informed decision with respect to allocating capital, and we ended
up ultimately Front Point peaked out at I don't know
what it was, thirteen or fourteen billion dollars, which was

(06:37):
a lot for a hedge fund back in that day
and made us one of the larger hedge funds out
there at the time.

Speaker 1 (06:46):
Well, let's talk a little bit about that. From Point
is the central character in that movie and book The
Big Short. So what did that movie slash book get
right about from Point and about the analysis and structuring
behind what went on there, and talk about your role

(07:08):
in all of this as well.

Speaker 2 (07:11):
Well. The first thing I would do is give Michael
Lewis a lot of credit. He does his research when
he's writing a book, and he found out everything that
we were thinking and doing. And I think he probably
did with the other two funds, Michael burry Is at
one and the two guys in the garage Browning Capital
in Colorado or the other one. But he learned, he

(07:34):
went and did his homework on and I will say
that the book accurately, quite accurately reflects a lot of
what went on, not only at FRUM but in the
marketplace and with respect to how people were behaving. So
I think the first thing is that the book got
it pretty much right. The movie didn't stray that far
from the book. And one of the interesting things is

(07:55):
Michael Lewis said with Liars, Poker and Moneyball, they actually
had him on the set, they had him involved in
some of the scriptwriting. With The Big Short, he was
not at all involved, huh, But he said, in his opinion,
it turned out to be the best of the movies,
so he said, maybe I shouldn't be involved. But they
had to leave a few things on the cutting room

(08:17):
floor in terms of details, but they pretty much stuck
close to the book and executed in some ways capturing
the excesses of the people in the marketplace and the regulators,
the government officials the origins at Solomon Brothers with lu Ranieri.

(08:38):
I think they might have captured some of that even
better than Michael Lewis did in the book. So I
give them a lot of credit for getting most of
it right.

Speaker 1 (08:47):
Frankly, Wow, wow, I've got it. Like educated our listeners
a little bit on the Big Short. I mean, this
was during the financial crisis that took place back in
two thousand and eight nine to that, I want to
say seven, but yeah, two thousand and eight nine, and
you know, the Big Short really talks about what some

(09:09):
of the catalysts were behind it and the housing market.
And there's a story circulating out there that you actually
authored a piece of research that was one of the
reasons why from Point actually did the trade that they did.
Can you explain a little bit about that.

Speaker 2 (09:33):
Yes, my partner Gil Caffrey and I had observed that
there were a lot of excesses in terms of the
way investors were behaving. And it's very you can see
excesses when they are happening. The most difficult part of
taking advantage of that is knowing when that's going to end,

(09:54):
when the party is going to get broken up. If
you will.

Speaker 1 (10:00):
Ought.

Speaker 2 (10:00):
We wrote a piece called The Great Compression, which was
about the compression of risks credit spreads, which is how
much you get paid to take risk in owning a
credit instrument or lending money to somebody. So people were
willing to lend money for very small incremental returns, which

(10:23):
didn't seem consistent to us. And it was really driven
by these leverage securities. There was just so much capital
being put into the credit markets that it was essentially
driving up the price of the bonds and down and
driving down the credit spreads. Hence the Great Compression. And
we saw that this was going to end. We just

(10:44):
couldn't didn't know when. And yes, that was a widely
read research piece, and people still to this ste go
back and say it was the story was told in
the paper, the Great Compression, what was going to happen.
But I'm telling you, we couldn't know when it was
going to happen, and we and we didn't. We were
a little early, just in the in real life and

(11:06):
in the movie Michael Berry's care or No, the Michael
Burry character, right, who's christ played by Christian Bale, Right,
he is so early that he's you know, he has
to like like essentially black calls from all his investors. Right,
that's a real that's the real risk of trying to

(11:29):
predict something like this that's more more real than anything
else in the movie.

Speaker 1 (11:35):
Well, yeah, I mean timing the market, right, I mean
you can the writing is on the wall a lot
of the times, and you could see things you know
going to happen, and and but then you know something
else will come and blindsided or you know a different uh,
something else will emerge socio politically or what have you
to alter the timeline on what you're expecting to happen.

(11:57):
So it's that's a real concern. Is there a durable
lesson that you'd want investors to take away or not
forget from what happened between two thousand and seven and
two thousand and nine, only because we all as humans
we have short memories, you know, but history repeats itself
a lot, And I'm just wondering if you have any

(12:18):
any thoughts on that.

Speaker 2 (12:20):
It's a good question. I think there's a general lesson
and then there's a specific lesson. And the general lesson
is that eccesses occur, and in the period building up
to them, everybody believes in whatever the mantra is in
the marketplace at that moment, and everybody is willing to

(12:44):
go along with the crowd. It's never any different, it
really isn't. It was that way with the dot com
It was that way with the credit markets. Okay, it
was that way with growth stocks in twenty nineteen, twenty twenty.
People don't realize we had a crash in growth stocks
in twenty twenty one. There are many growth stocks that

(13:06):
went down eighty to ninety five percent. Crypto went down,
and a lot of them have not recovered anywhere near
AI stocks and extremely MEGACAPEI stocks have. But that masks
what went on between twenty one and today twenty twenty
five in terms of the losses there. We may have

(13:27):
excesses at this moment in time now, but again people
will still go along. In terms of the specific lesson,
it has to do with housing, and we'll get to
that today. As we get into our discussion, I'm going
to make a point about the very well intended social
policy driver that led to the excesses in subprime mortgages

(13:51):
and the credit markets and how it relates to a
housing market today.

Speaker 1 (13:57):
Yes, yes, let's start talking about I mean, you have
a slide up on the screen right now, can you
talk about what this chart is showing us? I mean,
I see, you know, it's referencing the new stimulus bill
that was just passed. I see a lot of dead
on there. So let's let's let's get down and talk about.

Speaker 2 (14:21):
This, right. I mean, everybody knows about OBBBA, which was
passed in July by Congress and the Senate, and it
barely passed. It was there were a lot of there
was a lot of negotiation going on. Even today, I
learned about an element of this that was taken out
at the last minute that had to do with drug pricing.

Speaker 1 (14:43):
Right.

Speaker 2 (14:43):
There's there were a million things in this bill. Something
stayed in, something's got taken out. Some things are good policies,
some are bad. At the highest level. The blue bars
in this chart represent the tax stimulus or cuts, the
net tax stimulus or cuts that are estimated to occur

(15:06):
because of the bill. So be getting in twenty five
there's a small increase of one hundred billion, but then
there's a half a trillion dollars or five hundred billion
every year that our tax cuts. Those are reductions in
revenues to the government, so they add incrementally right to

(15:26):
the deficit. In total, we are going to add, as
we'll see in a moment, somewhere between two and three
and a half more to the deficit over the next
ten years because of the bill, and the baseline additions
to the deficit were projected to be seventeen and a
half billion, So now they're projected to be seventeen and

(15:48):
a half trillion, I'm sorry to you. And now they
are projected to be twenty one trillion by most estimates,
and that could vary by a trillion or a trillion
and a half, but you're going to be somewhere between
twenty and twenty three trillion dollars of incremental debt between
now and twenty thirty four. Now where does that money go,

(16:12):
Because it's going some of it's going to households. And
then we have another thing going on, which are the tariffs. Right,
So two big economic events occurred somewhat simultaneously, and so
in this chart, the orange represents the OBBA either increase

(16:34):
in taxes which is negative below the horizontal line, or
OBBA at being a tax cut and more house more
net household income. For the orange bar being above the line.
One thing you'll notice about the orange bars when you
go to the right, there's very large positive twelve thousand
dollars per household, and that's for the top death style

(16:56):
of income earners. Okay, you would expect that to largerie
because they pay the largest amount of taxes. What is
surprising is that tax benefits follow away pretty quickly as
you go from right to left. So as you go
from the ninth and eighth decile household incomes, they still

(17:18):
do pretty well. By the time you get to the
middle class in the fourth through seventh, they're getting a
little bit. But the blue bars, which are the tariffs,
are all below the line. So the tariffs which get
paid at the customs house are going to be paid

(17:38):
by the consumer, Oh absolutely, and so consumers are paying
all of the consumers are paying for that. When you
add the either net increase in taxes and the what
you pay for tariffs, you get the black dot. So
net of the two, the only households that have a

(18:01):
net benefit from the tariffs, the combination of the tariffs
and OBBBA are the top ten percent of income earn
our households, the eightieth to ninetieth percentage, households basically break even,
and the you know, the lowest income up to the
eightieth percentile are essentially going to be worse off.

Speaker 1 (18:25):
That's that's that's always typical when you see sometimes of
these bills where they hide everything and it makes it
appear like, oh, this is going to be great for everybody,
but really it's it's the it's supporting the wealthy. As
these numbers show.

Speaker 2 (18:46):
This next slide actually just shows the incremental addition to
the deficit. Now you will hear some people who are
I always have to take a neutral stance politically, because
if you're in the business that I'm in, where you
have to make money by what you believe about the markets, right,
you ignore politics, or try to ignore politics. You look

(19:07):
at the data, you look at the impact of the policies.
Some people will estimate that the incremental addition to deficit
is three and a half trillion over ten years. Some
people will say it's three trillion. A very administration friendly
group called the Tax Foundation. I put them on there

(19:27):
because that's about as friendly set of assumptions as you
can make about OBBBA there. They think it will add
one point eight trillion. Wow, So somewhere between a very
rosy you know, looking at the world through a rose
colored glasses, you could say, well, it's only adding one
point eight trillion, and you know, a lot of the

(19:48):
other estimates by penn Yale the Congressional Budget Office are
more sort of three to three and a half trillion,
So there's not a lot of argument. But we do
get to fifty three trillion dollars in debt ten years
from now, and there's a little ass risk here because
at the bottom the Social Security Trust funds are estimated
to run out in twenty thirty three. So we're going
to get to an intersection where we simultaneously are on

(20:10):
a pay as you go with Social Security and we
have fifty four trillion dollars in outstanding debt.

Speaker 1 (20:19):
That just blows my mind, okay, because I mean, we've
always suspected that we were going to run out of money,
just based on the population, the baby momers, and the
amount of money that was going into Social Security versus
the amount of money that would be coming out. But
with all the growth in the market, I'm you know,
I know that they put some Social Security into the market,
or they've done some hedges and they've made it easier

(20:42):
for people to save for retirement by increasing the minimums.
But what does that mean for consumers or for the
everyday person that's that's hoping to retire one day and
take some of the money that they put in their
entire career.

Speaker 2 (21:01):
Well, what it means is that you have to save
more for your retirement because they are going we're going
to have to deal with this deficit, right and the
fact that Social Security will not have a funded pool
of assets sufficient to pay for Social Security obligations beyond

(21:23):
this date. One of the consumers actually very smart, and
the consumer is sort of picking up on this now.
And what we see in consumer sentiment surveys, which is
one of the things that I watch, is that they're
quite love. In fact, the number between fifty five and
sixty five that we've been seeing is sort of a

(21:45):
recession level consumer confidence. We are not in recession, and
the probability we're going into recession is still not that high. Right.
The economy and earning seem pretty good, though we're seeing
elements of the economy begin to slow down at the moment. Okay,
so the consumer is seeing all this, and we've been

(22:09):
in a good economy for like three or four years.
Now very good economy. And I'll talk a little bit
about why that's true and why the consumer actually had
had been kind of in a pretty good place but
is now sort of reconsidering. Okay, One thing that you
should keep in mind is that when we look at

(22:31):
gross domestic product and when the person on CNBC or
the nightly news says, oh, the economy grew two point
three percent last quarter, what they mean is the gross
domestic product on an annualized basis increased by two point
three percent. Right now, the biggest driver is actually consumption expenditure.

(22:54):
It's almost seventy percent of final demand. Investment expenditure by
business is really only thirteen percent. Government spending is twenty
two percent, and net exports are negative three percent. That's
because we import more than we export, so they subtract
from they are a net reduction to GDP.

Speaker 1 (23:18):
I have a question, I mean, do they exclude certain
numbers from GDP to to manipulate the numbers. You always
hear people say, oh, well this is X gas and
oil or what have you. You know, what do you
what do you think about that? And what's your take
on that?

Speaker 2 (23:37):
The number the numbers we publish on economic data on
a labor statistics that was in the news as the
person who calculates the jobless numbers plus their job over that.
They're not political. They are the Federal Reserve and the
Bureau of Labor Statistics, the International Supply Managers, the University

(24:02):
of Michigan Survey. Those are pretty clean data. There was
data coming out of China that we had some questions about,
and China has stopped publishing a lot of data because
they didn't like the answers they were getting. Okay, and
hopefully we don't go that direction because I use a
lot of that data. I will be I will be
disappointed if we stop, if we stop getting data. So

(24:25):
the question is how do we how do we pay
back all that debt? And that's why the consumers a
little hesitant here. They're not They're they're pretty intelligent as
a group. There was this movie back in the day
with Chevy Chase called Fletch and there's a scene where
he's at a country club and he walks into the
He's not a member, so he walks in and he's

(24:46):
he orders a drink and the fella says, who you
know what account is this, and he said charge it.
He says, charge it to the underhills. So it became
kind of a running joke between my friends and I
charge it to the underhills. Who's paying for this round? Well,
but the underhills are going to have to pay all
this debt back. And the question people ask me all
the time is how are we going to pay all

(25:07):
this debt? Right, it seems, but historically the way they
did it was they printed these coins, and each of
these coins has the same glorious leader on printed on it,
and they an unclipped coin was the one on the
far left, and then over time, as it was in circulation,
people clipped some whatever metal. Maybe this was made of silver.

(25:29):
They clipped some silver off the edges and round it
out a little bit, and then over time they clip
it a little more. So whatever saying was on the
outside there in Greek or Latin got lost, and believe
it or not, the coin on the right, it half
of its metal is missing. So you could take that
clip metal, melt it down and make it a whole

(25:51):
nother and then tire another coin. Wow, okay, And that
is essentially clipping coins is the equivalent of what it's
called devaluing your currency. Yeap, So I borrow from you
fifty three trillion dollars devalue my currency I borrow, I
borrow these from you, right, and then I pay you

(26:14):
back in those right, because I've got twice as many
of them.

Speaker 1 (26:18):
Yes, of course you do.

Speaker 2 (26:19):
So it really only costs me twenty one and a
half trillion to pay you back. That's the concept of
devaluing your currency if you get too much debt. We've
seen that historically. This is an age old practice. But
what's already happening.

Speaker 1 (26:37):
Well wait, wait, I gotta I gotta ask it this though,
So you're devaluing the money, so someone's going to have
to pay for it. So of course we say the
underhill is tongue in cheek, But what does that mean
for like gen z And let's just explore just for
a second the mental impact on that. You know, for
we are we have if our currency is devalued and

(26:59):
I know you're going to get to that in a second,
what does that mean for our spending and our children's
generations and their children's generations.

Speaker 2 (27:09):
I really think that the cohort that are the underhills
that we've charged this whole thing too. And it's a
demographic reality. The baby Boomers were a population kind of
like a rat moving through a snake. Okay, it was
a large population group. It's not just the United States

(27:31):
that has experienced that demographic it's in Europe. Japan hit
it first, right, Europe and the United States are hitting
it contemporaneously, and even in a larger way. The rat
is bigger. It's more like, you know, it's more like
a raccoon going through the snake in China. Yes, China

(27:51):
has an even bigger demographic problem that it hits a
little later than we do. But it's a larger demographic
and balance, and that demograph can balance ends up weighing
heavily on the younger cohort. So the younger cohort in
this case are the millennials and the Gen zs. So

(28:12):
the millennials and the Gen zs really need to maximize
if they have qualified and retirement plans like a four
oh one K, they really need to maximize those. Yeah, Okay,
those are tax advantage programs, and I think they also
are one of the big dividing lines between households that

(28:35):
are wealthy and not wealthy is homeownership. So they really
need to try to get into get on that ladder,
that homeownership ladder, and we're going to talk about that
a little bit later. One of the realities for them, though,
is that the devaluation the currency is their measure of wealth,
it's how they get paid, it's mostly what they save
their money in. Right now, households in the United States

(28:57):
have the lowest exposure to non dial our assets that
they've had in like thirty five years. Wow, because we
are so enamored with the S and P five hundred
and the AI stocks and indexed US stocks that we
have sort of turned away and really we believe strongly

(29:20):
in our prospects against non US dollar prospects. Interesting, and
that may be that may be something that I allocate against.

Speaker 1 (29:31):
So as I see, I mean, I see eurostocks on
your chart here are up twenty four percent year to
date while the SMP is up seven percent. So how
should our younger people think about a global diversification without
feeling overwhelmed because it can be overwhelming with all the
politics and the wars and everything else going on.

Speaker 2 (29:54):
So the euro has already gone up about twelve and
a half percent against the dollar this year, so the
devaluation has already be gone. Wow. And when you translate that,
that is, as I said, that's your wealth, right, that's
the gen Z's wealth, that's the baby that's everybody's wealth
who has all their money in US dollar assets, whether
it's your house, you're checking account, your four oh and

(30:17):
k and stocks and bonds, it is a devaluation relative
to another currency. Now that doesn't feel like much to you, right,
because you're buying things in dollars and you have dollars.
But when you look at how the eurostock six hundred
index has performed this year relative to the S and
P five hundred, it's almost twenty percent behind.

Speaker 1 (30:40):
Wow.

Speaker 2 (30:40):
Right, And as I said, US investors have the lowest
allocation to those types of assets they've had in many,
many years. So the gen Z millennial baby boomers. If
the risk is that we devalue our currency and we

(31:01):
import inflation, devaluing your currency over time is one component
of upward inflationary pressure, right, and you will need assets
that hedge your wealth against inflation. Housing is one thing
that has historically done well against inflation. Right. Commercial real

(31:22):
estate property has done well commodities have done well. It's
one reason commodities are doing well on a dollar basis
right now, because they're cheaper. For somebody who owns zeros
to buy oil is cheaper. Gold is cheaper in dollars.
Gold has gone up a lot, but not neuros. Right
to them, it doesn't look like gold is creating that

(31:45):
much economic bet. That's why a devaluing dollar is an
asset want you want to hold some commodities. Stocks tend
to do pretty well in inflation, except when you get stagflation,
where both the economy is doing poorly and inflation is
going up.

Speaker 1 (32:02):
Yes, so let me ask you this. So excuse me
for someone out there who you know is trying to
to build their wealth, and let's say they want to
be there by by their first home or whatever. They
see that the government's borrowing, borrowing, borrowing, So should families

(32:24):
borrow to What is the strategy or you know, between
taking on debt and and what impact is having so
much debt cause that that stress to repay, because that's
a big thing, especially when interest rates were starting to
go up, and get every dollar or every percentage point

(32:47):
that the that interests grow up equals real money coming
out of your pockets pay those mortgages.

Speaker 2 (32:54):
Okay, we're going to have to unbundle that. The first
thing I'm going to talk about interest rates, because interest
rates will determine where you can borrow money and get
a mortgage to buy a house. Right, because most first
time home buyers are going to have to take a mork,

(33:15):
so they're not going to buy a house per cash.
Let's assume that, right. So this, the green line shows
you the percentage of our thirty year bonds, this thirty
year US government bonds that get bought by foreigners. Well,
what's happened recently is foreigners have sort of pulled back
from buying our bonds. It's actually at a very low percentage.

(33:35):
They buy almost two thirds of the bonds we issued.
So make no mistake about it, our deficit is financed
by foreigners, not just us. They realize that this currency
devaluation strategy maybe in play. They don't want to lend

(33:58):
us those big coins on left and get paid back
in the little coins on the right. Right, that's already happening. Now,
Well what does that mean for me?

Speaker 1 (34:07):
Yeah?

Speaker 2 (34:08):
Okay, don't I don't. I don't feel So what you
know what. They can go by their own I don't care, well,
you kind of do care. I'll tell you why you care.
The reason you care is the black line is the
current yield curve. So on the left is one month,
and it goes three months, six months, one year, two year,
all the way out to thirty years. And what you

(34:29):
can see is that the black line slopes upward. Right.
Interest rates are about four and a quarter percent for
in your money market fund, but it goes up towards
five percent as you borrow longer. That's called the term
frameum you pay more for longer data. Now interest rates

(34:51):
a year ago, when the Federal Reserve had the interest
rates elevated because they were trying to slow down inflation,
then they lowered short term rate right. What's interesting about
the blue line relative to the black line for those ten, fifteen,
twenty thirty rates. By the way, those are the rates
that determine mortgage rates, not the short term rates. It's

(35:11):
the long term rates. Why did the black line go
up while the blue line went down? So the Federal
Reserve lowered rates, the blue line on the left came
down to the black line, and on the left side
of it but the black line went up for the
long rates that determine mortgage rates, and mortgage rates have

(35:33):
hung out around six and a half PERCENTEP. Right. Well,
the part of the reason is because those foreign buyers
have stepped back, I say, and when they step back, right,
this is part of the answer. When they step back
the long rates, which they if they're buying two thirds
of that, then the next buyer is going to buy

(35:54):
them at a little bit of higher rate. So there
is a what we call a term premium, and the
term premium for long term US government debt has gone up.
The market is anticipating that all of this debt is
going to come to market, This fifty three trillion is
going to have to be financed, and that it's quite
possible that the dollar is do value. So that impacts

(36:19):
That's how that's how all of that impacts young people
who are trying to buy a house. It makes the
mortgage rates higher than they otherwise would have been.

Speaker 1 (36:28):
Wow. So just to you know, are there risks or
nut risks? Are there things where investors can guard against
having to pay substantially higher mortgages when they're purchasing houses

(36:50):
or I guess what kind of time horizons. Should should
someone who's looking to get into the housing market housing
market be looking.

Speaker 2 (36:58):
At That's a good question. One of the problems we
have in this country right now is that the percentage
of home transactions that our first time buyers has declined
to a low point. Okay, less than twenty five percent

(37:19):
of home purchases are first time buyers right now. They're
having a harder time getting into the market.

Speaker 1 (37:26):
Yeah.

Speaker 2 (37:28):
Part of it is the price of housing. Since we've
had full employment for a while and we have had
the cost to build a home, land and all the
components to build a home have gone up. As we
saw from the last chart, interest rates are higher, YEP. Tariffs, well,

(37:52):
teriffs don't play into the housing just yet, but they
will because they're not going to allow building costs to
go down. Building costs will on average go up, right,
And as we saw, the consumer's going to have less,
not more money. Most households will have less, not more
money when you net out tariffs and TOPBA right. So

(38:14):
that's not going to help this chart, which worries me
because the truth is young savers need to maximize their
qualified retirement plan for one case, right, and they need
to get into the housing market because homes do well
against inflation, and if you're devaluing your currency, there's a

(38:37):
bias towards higher levels of inflation. Even though six and
a half percent might seem high, or six a quarter
or six, it's probably going to have been prudent to
buy a house and sign up for a fixed rate
mortgage at that level. Now, remember, in the United States,

(38:58):
we have a very unique thing. If mortgage rates do
go down to four and a half or four and
three quarters or five percent, you can refinance your mortgage
at that rate right with no penalty after a short
period of time. I think people, you know, young couples,
young families, they're going to need to be aggressive about

(39:21):
buying homes. And you have to realize going back to
we'll go back to a period of time in the nineteen.

Speaker 1 (39:27):
Seven I'm just going to ask you about that.

Speaker 2 (39:29):
We're going to go back to that and talk about it,
and there's a little bit of a lesson there. But
one of the things you wanted to own during that
period was a home. Yeah, it was probably one of
your best investments because stocks during the seventies were terrible investments.

Speaker 1 (39:47):
Does it matter what part of the country that you
live in when you're talking about buying a home is
it doesn't matter by city, by region.

Speaker 2 (39:57):
It always matters. I think I understand the micro housing markets.
Some markets are do better than others at different times,
and after the fact you can usually explain why. But
there is no question that in some markets. I was

(40:18):
looking at the Louisville market the other day, for instance,
and home prices have The cost to build a home
in Louisville, Kentucky has gone up between ten and thirteen
percent over the last twenty four months.

Speaker 1 (40:31):
Wow.

Speaker 2 (40:32):
Right, And so what was an affordable market is less affordable.
Nashville is even worse. So markets that were affordable have
become not unaffordable, but less affordable. Because home building in
the United States, the volume of homes being built has

(40:53):
not caught up with the deficit of homes that were
not built during COVID, and because of the cost of
building a home right and the labor and components required
to build homes, we're having a hard time catching up.
So it's a very different scenario than two thousand and seven,

(41:17):
two thousand and eight, two thousand and nine, where we
had homes being built speculatively that weren't being purchased by
by families to live in. They were built, they were
being purchased as speculative assets, and they were empty. Similar
to China, where they have they don't have that many
saving options, so they speculated on real estate and it

(41:40):
ended up being a disaster. We now have the opposite
problem where we have this cumulative supply shortage of somewhere
between four and six million homes. We'll probably see more
multifamily homes, more town homes that can be affordable. We
probably need more of that type of housing, smaller single

(42:02):
family homes maybe on smaller acreage to make them affordable.
But somehow we're going to have to make that deficit up,
And that deficit is the reason why owning a home
is probably a smart strategy for the next decade, because
we do have a real supply shortage of homes in

(42:22):
this country that was partly due to cost cost issues
and partly due to the logistics of not enough home
building resources, labor coordination logistics, and partly because of that
we've been fully employed and demand for homes. We're also

(42:43):
getting kind of a funny thing where millennials did household
formation on a delayed basis, but gen zs are doing
it closer to on schedule, so you're getting contemporaneous between
those two generations. Household format.

Speaker 1 (43:01):
Very interesting. I am really interesting to see where all
of this takes us. We've talked a little bit about
how higher rates crowd out, you know, priorities, so someone
with student loans or mortgage debts are able to reset

(43:24):
with with with with refinancing their mortgages when interest rates drop.
But you've also cited the nineteen seventies dollar crash as
a cautionary tale. Can you walk us through these thought
processes that I am spewing at you.

Speaker 2 (43:44):
So similar to trying to derive the issue with you know,
allocating money to subprime, shorting subprime mortgages, or shorting credit
or hedging credit because credit was already we learned from
history by looking back these you know, we were seeing signals,
we were seeing signs of things. So one of the

(44:06):
things that really concerns me now this is now we're
switching to twenty twenty five. Right, That's what concerned me.
That housing doesn't concern me. There's the opposite problem what
concerns me. And I keep saying this and all the
interviews I do with people is the third rail is

(44:26):
the independence of the Federal Reserve. We must have independent
monetary policy, independent from the government. Countries like Argentina don't
have independent monetary policy, right and it ends Venezuela doesn't
have independent Zimbabwe. These countries don't have independent monetary policy

(44:50):
and central bank decision making that's completely independent from the government.
Back in the nineteen seventies, we didn't not have that.
Arthur Burns was at charge of the FED and they
refer to this as the Arthur Burns FED, and William Powell,
who runs the FED currently has actually made speeches indicating

(45:12):
he does not want to be the Arthur Burns FED.
And Arthur Burns FED was sort of told by Congress
at that time mostly Congress was a very powerful back then,
that he could not raise interest rates above a certain
nominal level, like rates could not be above four percent
or five percent. That's right. Forget about what's happening with inflation,

(45:36):
right or employment, but you can't be above that, right,
it's not the constituents won't be happy and that's it
sounds innocuous, right, But what it led to was runaway
inflation in the United States. I remember that so, And
the funny thing is we're at about two and a

(45:57):
half two points percent inflation right now, which is where
it was in nineteen seventy two on the left side
of this chart. But by nineteen eighty it was over
twelve and a half percent. Wow, mortgage rates went from
where they are today six and a half percent to
seventeen eighteen percent.

Speaker 1 (46:18):
Can you just say that one more time?

Speaker 2 (46:20):
Mortgage rates when that FED who was not operating independently
from Congress, went to eighteen percent.

Speaker 1 (46:31):
That's incredible.

Speaker 2 (46:32):
Now, home prices increased wildly in the seventies. You wanted
to own a home, yes, because inflation.

Speaker 1 (46:41):
Was so high, but could you afford it?

Speaker 2 (46:44):
Cost of building a home was so high that there
was no supply coming to the market. So it sounds yes,
your logic path seems like the right one. But what
happens is that the supply gets shut off, The supply
new homes gets shot off, and household formation continues. So
there's demand for homes, but there's not enough supply, and

(47:04):
the cost of building one goes up and up and
up because inflation is going up, you know, seven, eight, nine, ten. Now,
then over twelve percent. Wow, And this the economy was
not doing that great. It had a few good years,
had a number of bad years. There were a number

(47:25):
of recessions during this period, and so the stock market
really did kind of kind of lousy. And that was
a period referred to as stagflation, a stagnant economy with
accelerating inflation. There are elements of that today that are present. Now,

(47:48):
I'll tell you why it won't get that bad. And
the reason it won't get that bad is because back then,
wages were indexed to inflation.

Speaker 1 (47:55):
Okay, so you.

Speaker 2 (47:57):
Really had kind of a really a real negative feedback
loop where inflation was high, so everything, all the wages
went up. Today, you don't have wages that are set
to inflation. In fact, if we have a recession of
people will lose their jobs and also are fed.

Speaker 1 (48:17):
Is not our fed is independent now as opposed to
back then?

Speaker 2 (48:21):
Right, that's coming into question. Under the current administration. There's
been some the termination of the person who calculated the
or it was in charge of calculating the job's number,
and the conversations between the administration and Chairman Powell have

(48:41):
indicated that the administration would like to dictate where interest
rates are.

Speaker 1 (48:47):
Oh boy, and.

Speaker 2 (48:48):
That takes us back to the Arthur Burns fed Now
what happened, and we didn't have the euro back then,
but we're now back to the clipped coins issue. And
this is why having a larger portion of your portfolio
in non dollar assets, emerging markets stocks, European bonds and

(49:11):
European stocks, things of that nature. The Deutsche mark went
up forty, meaning the dollar lost almost half its valid
Remember our clipped coin that was half the size. That's
what happened. That's exactly what happened. The dollar got clipped
to half its size against the deutsch mark during that

(49:32):
stagflationary period. Wow, and that contributes to inflation. That because
anything you have to buy from Germany, right, or the
Germans can pay a lot more for commodities, they'll drive
the price of commodities up. But for us with our
our you know, little coin, right, we have to pay

(49:53):
more of those little coins for physical commodity, whether it's
lumber or soybeans, copper. Just think of all these things.
So this is, uh, this is sort of in play.
This is something that I'm now starting to think about

(50:15):
and how do I invest recommend asset allocations against not
this being a certainty, Serena, but this type of these
characteristics being an increasing probability.

Speaker 1 (50:30):
Okay. So with that said, so so how so so
this impact on currency and seeing how history can repeat
itself and seeing where we're where the writing on the
wall could possibly be headed. What what could we do

(50:59):
to above this inflation? You know, can can wages like
they had in the past. Can't we just drive interest
rates down based on based on our wages? Cann't? Can't
we we do something where we can change the course

(51:21):
of things before it's too late.

Speaker 2 (51:27):
That gets us back to the subprime mortgage crisis. Okay,
the goal of the and it sounded also it started
actually under George H. Bush Bush. Why was we really
started focusing on that issue that I mentioned earlier where
household wealth. Household wealth can be divided into two categories,

(51:48):
those that own homes and those that do not. Okay,
And policymakers said, you know what, we need to have
more people in that camp that own homes. Okay, so
let's make it easier for them to buy a home.
So let's reduce the stringent to get mortgage approval. Now,
it started out in kind of a small way, and
there really wasn't that much uptake. Initially, subsequent administration sort

(52:11):
of leaned into that policy initiative because it sounded good.
I mean, it really sounded good. Hey, more people are
going to own their homes. This will improve neighborhoods, This
will improve stability of the household, this will improve household wealth.
And so we pushed from sixty three sixty four percent
of home households owning homes up to sixty eight sixty

(52:32):
nine percent. Unfortunately, that five percent couldn't pay their mortgages, right, Yeah,
and so doing something that sounds constructive turned out to
be a problem. Now, what's going on right now is
that this is unusual. US and European inflation expectations are divergent.

(52:56):
Europe's are going down and the US are going up.
This is in part due to the teriffs, It's in
part due to labor supply constraints we're going to have
because of changes to immigration policy. It's due to in
part the depreciating dollar, and so we have more inflationary pressures.

(53:18):
They're going to show up on a delayed basis. It's
more likely we see incremental weakness in the economy. Before
we see the inflation showing up, but it's already out
there in the expectations, and that's one of the reasons
we saw those longer term rates that determine mortgages the
black line and the earlier graph being higher than they

(53:39):
were last year because we had expectations for lower levels
of inflation a year ago. On a forward looking basis,
now we have expectations for slightly not the kind of
inflation we saw in the nineteen seventies yet, but certainly
a percent higher than we see right now. Also a

(54:00):
cost to uncertainty, and we've had a lot of uncertainty.
The administration has had some policy changes, which people talk
about and after a while they stop talking about it
because it happens quite often. I've noticed that there's almost
sort of a numbness to it after a while. But

(54:20):
some economists have looked at this line shows that remember
that GDP number we talked about, which is our economic
growth uncertainty, and these are quarters, one quarter, two quarters,
so these are three month increments. But the longer you
have uncertainty, the more you create lower gd you subtract

(54:44):
from economic growth. So if it only happens for one
or two quarters, you lose about six tenths of one percent.
But if it goes on for a full year, you
lose one to two, one to one and a half percent.
So the longer, how does uncertainty manifest itself? It manifests
itself in businesses not moving forward with a project. What

(55:07):
we're seeing in the labor market is that businesses aren't hiring.
They aren't firing, but they aren't hiring, and so those
are what I would say decisions that are not being made.
People in commercial real estate tell me that projects have
been mothballed. They're not going forward with those projects. There
are projects where the cost due to the tariffs. One

(55:30):
of my friends is redoing a fancy store on Fifth Avenue.
He ordered these big glass sheets because they sell a
very high end product. You have to show off with
special lights, you know, the kind of bling you wear,
right of course.

Speaker 1 (55:43):
And.

Speaker 2 (55:45):
The glass has extruded aluminum frames and extruded aluminium has
it Not only is there a fifteen percent terror for
that country in Europe worts made but aluminium, it's an
extra twenty five percent. So when he went to pick
up the big glass terms of which he had millions
of dollars of these, the tariff bill was forty one percent.

Speaker 1 (56:06):
That's insane.

Speaker 2 (56:07):
So he has people who have similar projects who are
holding off.

Speaker 1 (56:14):
You can't sustain a business as you're continually losing money,
I mean for so long to make up that deficit.
It takes longer and longer and longer the longer you
try and stay afloat. It's just like you know, as
an individual with credit card debt, you know, if you
keep just paying the minium payment, that debt is going
to keep growing and growing and growing, and until you

(56:38):
just paying back hundreds of dollars more than you borrowed initially,
or thousands or depending on what the amounts are. But
how how are we going to fix this?

Speaker 2 (56:49):
Well, he had to pay the tariff and turn around
to the customer and say here's.

Speaker 1 (56:54):
The teriffic Yeah, right, that's just going to pay for it.

Speaker 2 (56:57):
And so the customer had to pay for it. Yeah,
Walmart's THEFO said in no uncertain terms that the customers
were going to pay for the tariffs on the increase
in prices in Walmart. Right, and those are those lower
income death styles we saw earlier, right, And they're going
to pay their their share of the tariff. So one

(57:20):
thing that I'm seeing already is one of the things
that was really sticky. Remember we had the inflation after COVID. Yes,
a lot of it was what we call services inflation.
Remember when the electrician and the plumber would come over
and you feel like you were getting absolutely yeah, it
was a shakedown, right, it was a shakedown. Those were services,

(57:41):
and those were services inflation, and you were You were
right to feel that way because services inflation was running
up during that you know, two year period up close
to those nineteen seventies levels.

Speaker 1 (57:52):
Wow.

Speaker 2 (57:53):
Right, Goods inflation was actually the grocery store and the
cost price of goods was actually much more muted. Rents
actually were a problem. Rents went way up during that period.
They're still high in certain markets. Yes, in some markets
there was overbuilding. In the southeast of the United States.

(58:15):
They're actually falling. Oh really, yeah, a lot of people
don't know that. But what we've seen recently the green
line on the far right is all of a sudden,
services inflations are jumping up again. This is a forward indicator.
This is kind of stuff I look at. You don't
see it yet, right, but you're going to see it

(58:36):
because it's baked into the price of a lot of
things that you buy or services you look for. So
we're already seeing elements of that inflation starting to come back,
and services inflation is really hard to get rid of
once it sort of gets some things.

Speaker 1 (58:53):
Yeah, interesting, I am all right. I want to ask
you a couple of questions. I want to I want
to wrap this up and then I'm going to ask
you some fun questions, but just in general, can you
just give us your your thoughts as to what we

(59:15):
can expect next from the markets?

Speaker 2 (59:17):
The market? You know what I always say when I
speak at conferences they have me get up at you
know what they do is they serve. There's all these
people in a room. You know, there's ten or twelve
people at a table, and it's an industry, right might
the National Manufacturers Conference on the National real Estate Developers
And I meet some of the people and I always
ask who like the big personalities are because then I

(59:39):
can kind of rask that person from the stage and
that's kind and everybody laughs. But I get to eat
my salad and then they say you got to go
up the stage, so I never get to eat the
chicken or salmon or steak, whatever they're serving. I never
get dinner. I always get I get the salad. So
speaking is a good way to be to have a diet.
It's like it's a really great forced diet. But the

(01:00:04):
you don't got anything to talk about? Yes, I do.
So the people when I get up there, they always
ask me. Invariably, I get through my little talk and
my slides, make a lot of jokes, you know, as
the big the big wheel in the out in the outfit,
and then they ask me, Okay, what's gonna happen to
the markets? And I always make a joke and I say,

(01:00:26):
you know, after the big short, I had this crystal
ball and then I dropped it broken. So now it's
so much harder for me to answer the question. Right,
people do they assume I have sort of a crystal ball?

Speaker 1 (01:00:39):
Of course.

Speaker 2 (01:00:40):
It really is triangulating all this information in my head,
going back to the artful dodger and fifteen year old
kid on the floor of this exchange. I'm trying to
get a feel for the body language I'm seeing in
the marketplace. So we do see that the services and
ploee is rising. We do see that the dollar is

(01:01:03):
going down. We do see that there are concerns about
independence of the Federal Reserve. These are things I'm observing.
This chart actually shows earnings growth. The red and the
blue line are roughly the same thing. You just adjust
the blue line and you get the red line by
subtracting the level of inflation. But they're roughly the same thing.

(01:01:24):
And it shows the growth of the S and P
five hundreds earnings year over year. So our earnings growing
twenty percent a year or ten percent a year, or
our earnings flat year over year or shrinking. Right, So,
going into the end of twenty twenty four, earnings growth
was accelerating and it looked like we were going to

(01:01:47):
have sort of a twelve percent earnings growth, and that's
kind of a healthy growth rate for earnings. Sure, right,
earnings are still growing. We had a very robust second
quarter report for earnings, but the forward earnings now are
projected to only grow at eight percent, not twelve percent.

(01:02:10):
So it's the sort of momentum earnings growth momentum is
coming off, right. I think there was probably a lot
of accelerated economic activity in the second quarter. Whenever I
ask somebody, hey, did you buy something before the tariff's
kicked in, and you thought that, did you buy a
bunch of stuff? Of course, I haven't talked to a

(01:02:31):
single person who hasn't said yes to that question. I
think in the second quarter we had a kind of
a beat. The beat the tariff consumption.

Speaker 1 (01:02:43):
It's more of an anomaly.

Speaker 2 (01:02:45):
It's temporary, it's temporal, and I'm thinking we're going to
get a slow down, but we aren't going to see
it until we start seeing third quarter estimates and forward
guidance on earnings. And that is what concerns me, is
that that blue and red line could start heading start
migrating down back towards lower year over year earnings growth.

(01:03:06):
The stock market's training at a pretty high multiple to earnings,
which if you're paying a high multiple of earnings, you
should get a lot of growth. You should get a
lot of earnings growth. Right If earnings growth starts to
come down and disappoint, the level at which the market
is trading is susceptible. Now. I think the market could

(01:03:29):
go higher from here in the near term because as
that economy, as the economy slows down, there's going to
be reason for the Fed to continue cutting rates one
quarter point in September and one quarter in December. That's
what's expected. I think that's probably a pretty good bet
on balance that will tend to support the market through

(01:03:50):
the end of the year. What concerns me is these
other longer term effects. The FED cannot impact services inflation,
it cannot impact earnings dynamic, It cannot impact that consumer
sentiment that, as we saw, is low, and they may

(01:04:11):
pull back. They may know they have to save more
if prices are going up and they can consume less
and everything's going to cost more at Walmart or at Tiffany's,
all along the food chain, the consumer is going to buy.
Maybe they spend the same amount of money, but they're
going to get fewer units and they're probably going to

(01:04:31):
have to shift more of their spending into what I
would call non discretionary things that have to buy. So
watching this, I think between now and your end, these
interest rate cuts could probably That's why the market is
staying elevated right now, again still far behind the eurostock
six because of the currency and the fact that Europe's

(01:04:56):
inflation's expectations are coming down, they have more room to cut,
They have more fisk room to do fiscal stimulus than
we do. But that is something I'm concerned about in
the near term. I think you can be reasonably constructive
that the markets aren't going to crash medium and longer
term beyond the end of this year. Then I'm going

(01:05:18):
to get a little bit more concerned about owning a
market that has declining growth prospects at very high valuation.
They use the term another way of saying high multiple
of earnings is high valuations. We are at the higher
end of the valuation range. Historically, we're not way above it,

(01:05:39):
but we're just at the higher end of the range.

Speaker 1 (01:05:42):
I have a quote that's crazy. I mean, it's really
enlightening to see where the markets can go, and I'll
be really interested to see how things shake out. But
I'm going to lighten it up a little bit right now,
and I'm just going to ask you what the best
money advice you ever got was.

Speaker 2 (01:06:00):
I had an answer to this once, but I forgot it.
You know, I people have told me some simple things.

Speaker 1 (01:06:10):
I think.

Speaker 2 (01:06:11):
I think there was this guy named he was his
kind in San Francisco. I worked with a long time
ago at Morgan Stanley, and he was very proper. He
belonged to the Olympic Club, which was like a men's club,
you know. And he used to go up to this

(01:06:31):
place up in the Redwood Forest with called the Bohemian
the Bohemian Club Retreat, that's what it's called. It's called
the Bohemian Club. And it was like an old school
club that'd go over there and have lunch and have
you know, you know, Jim Martinis. And and he said
to me, you really have to just save and invest.

(01:06:55):
You're gonna have a lot of friends that are going
to live high on the hog. Live, do some live reasonably,
but save really saved money. Don't save money because you
spend it by something that's on sale. Save money, buy
a house, he said, you will have so many friends

(01:07:17):
that think that the gravy, you know, whatever. They may
be having a good year, it's going to go on forever,
and it won't. And you'll see that. It's that old,
he said, the old story about the grasshoppers and the ants,
where the ants, you know, busy work and save and
putting away everything, building their house, and the grasshoppers are

(01:07:37):
laying around in the sunshine, right, and the grasshoppers starve
to death and die when the season changes and the
ants survived. I think that advice and I kind of
followed that path and it had and it kind of
translated to family stability and everything else around. And I know,

(01:07:58):
you know you talk about that all the time, right,
so I think it actually it spreads a lot of
positive things outward in your circle.

Speaker 1 (01:08:10):
I think that's amazing. And I got to tell you, Michael,
this was a master class. I've learned so much from
you just in this one hour. And I have to
tell you that we are so thrilled to announce that
guy that that guy is Lit is going to be

(01:08:30):
a new segment on Sosradio dot Live where Michael is
going to drop short takes on markets, risk and opportunities
that are available. And you should definitely subscribe to Sosradio
dot Live if you're not already a member. And I
want to thank you so much for joining our show.
But I like to close every segment with one of

(01:08:52):
my sons, Scott's poems, and today's segment is our Today's
poem is called the Struggle. And I got to put
my glasses because I can't see it, but here we go.
The way I feel can't be described into words. Or rhymes.
Get with the times. The kids I once knew are developing,
not relishing and the innocence they once had. I can't

(01:09:13):
handle the weight on my shoulders as heavy as boulders
that pull me down to the ground, make me pin
flat down, losing airs, lies fill my lungs. My body
speaks the opposite of my mind. I can't take control
of the situation at hand for my body and mind
don't communicate. They can't agree on a compromise, so therefore

(01:09:33):
can't synchronize. I still get blown away by how my
son's poetry can transcend just different topics. I mean, you
could take this and even put it into the market,
and how it can totally affect you and deflate you
and really recavoc on your body. But I want to

(01:09:53):
thank you for joining us today on SOS Stories of
Survivors where survival sparks the soul, and please rate us,
donate and subscribe and we'll see you next week. Thank you, Michael,
Thank you,