Transcription
[Music] It's like tequila shots. You've never known when you've had enough until you've had too much. And government debt tends to be the same story. You feel good, you feel good, you feel good, and then at some point you're throwing up in the bathroom. So yeah, your point is, when do we start throwing up in the bathroom? And the answer is, I'm not quite sure, but I know it's not a great asset class to own because at this pace, you know, it's like you're seeing the guy at the bar just pounding the tequila shots and you know there's no, there's nothing good coming out of that. You're not quite sure when he's going to hit the wall, but you know that wall is there.
>> Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes, and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world. So you can take your manager due diligence or investment career to the next level. Before we begin today's conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also, understand that there's a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions. Here's your host, veteran hedge fund manager Neils Krop Len. Welcome, or welcome back, to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle. We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game-changing issues and hopefully dig out nuances in their work through meaningful conversations. Please enjoy today's episode hosted by Alan Dunn.
[Music] Thanks for the introduction, Neils. Today, I'm delighted to be joined by Louis Gav. Uh, Louie has been on the podcast a couple of times before, so he needs no introduction, but for those who haven't heard from Louie before, he's the founding partner and chief executive officer at Gavocal. He's been in the markets many years and the author of several books. Louie, great to have you on. How, how is holding your side?
>> Uh, things are good. It's, uh, it's, I'm delighted to be back. Thanks, uh, thanks for having, inviting me.
>> Not at all. No. And as I said, you were on, I think it was October last year and the summer the previous year. So, if people want to sense check how your views have evolved or hear your full backstory, they can, uh, they can listen to to those episodes. But
>> hope I didn't say anything too embarrassing back then.
>> I can't remember, I can't remember what I said. Hopefully, hopefully it's stood the test of time.
>> I had a quick look back. It is funny how you kind of forget what, what was topical at the time, but you did, I mean, to your credit, you had a couple of very good calls. You were, uh, pretty confident that you were confident that Trump would win. And, uh, so you and was it the French guy who had the big bet on, on the p, on the, uh, the betting markets?
>> Yeah, that's right. The, uh, the, the French whale. A lot of people asked me if that was me, and it wasn't, just to be very clear. Uh, that was not me. Uh, but yeah, I had quite a number of clients ping me and saying, "Hey dude, what are you doing putting out such big numbers on, on the US presidential election?"
>> Well, you, you seemed equally confident at the time and you were right on that. And, and the other point, the last couple of times you've been on, you've been definitely in the no recession camp on the view that, um, such large deficits in the US are not normally associated with recessions. And obviously, the deficits have not got any smaller in the last couple years, so they've been getting bigger. But we have had some weak data out recently which have kind of reignited calls for maybe a, a possible imminent downturn. So maybe that's a good starting point. How are you reading the data? Uh, do you see increased concerns on that front?
>> Yeah. Um, look, I am increasingly concerned. I became a lot more concerned when, uh, with the tariffs, uh, back, uh, back in April when, when these were announced, and both Anatol, my business partner, Anatol Kitki, the Cal and Gavcow, and, and myself wrote, wrote a number of pieces. Now, usually, you know, I, I start off with, with the premise that what matters the most is the cost of capital and the cost of energy. Uh, when the cost of capital is, is low enough and when capital is plentiful, and when energy prices are low enough and energy is plentiful, usually, you know, the economy just moves forward because, you know, every entrepreneur wakes up every morning trying to figure out how to make more money, how to produce more with less, etc. And that's what drives our capitalist system forward, which again, unless you have the breaks of two higher cost of capital, too high cost of energy, that, that usually works. Uh, and that was part of the reason I was sort of dubious on the whole, "Oh, we're heading into recession," uh, because in my, my career, most of the recession have been, uh, preceded by either massive price, you know, big increase in the cost of capital, especially the cost of capital, I would say for the private sector, more for the government, i.e., widening corporate spreads, and, and we didn't have that, and we also had a cheap price of energy. So, I don't know, I felt pretty, I felt pretty confident. But, um, but inherent in that belief is also kind of the hope that entrepreneurs wake up in the morning feeling good about the future, wanting to invest, wanting to, uh, to, to move the ball forward. And this is where, you know, the tariff throws an interesting wrench. Um, because they, they add a lot of uncertainty. Now, the reality is, most entrepreneurs just want certainty in their lives. You know, it's, they, they want to know what the tax rates are going to be. They want to know what the regulations are going to be, and then they get on with it. Um, now, of course, every entrepreneur wants a lower tax rate. Every entrepreneur wants lower regulation. But by and large, you deal with, you know, you're told the rules of the game, and then you, you go out and play it. Uh, or not, or you decide, you know what, I don't want to play this game. I'm taking my ball and going home. My big fear when the tariffs hit, and, and I wrote it at the time, was that, uh, when you look at the construction sector, uh, in the United States, you're dealing with a bunch of entrepreneurs there who are still carrying the scars of 2020 and '21. You know, in 2020 and '21, you had massive supply chain dislocations. You had bare shelves at Home Depot, lumber prices spiking, etc. And so, a lot of projects got delayed. A lot of projects and delays in the construction industry means all of a sudden margins disappearing. And so my fear was that given these scars from the 2020, 2021 experience, a lot of the people in the construction industry, and I was seeing this, talking to people, would react to the tariffs by saying, "Look, I don't know if in three months' time I'll get the pipes because the pipes are made in China. I don't know if I'll get the electric wire that's made in China." And, and the problem is, if you don't get the electric wire, then it postpones everything, right? It's like, if I can't get the electrician in today, then I can't get the plumber in the next day, and if I can't get the plumber, then I'm going to get the drywall guy in. Um, and so everywhere around me, following the, the tariffs, I was hearing of, you know, like projects being put on hold. Now, the reason this matters now, you could say, well, you know, construction, it's, it's only like 3 or 4% of US GDP, etc. But it's a huge employer. Uh, it's a massive, massive employer, which, by the way, that's another uncertainty is, you know, am I going to, you know, there's, there's a lot of illegal workers in the construction industry, especially in the whole southern belt of the United States and Florida and elsewhere, where, where construction has been absolutely booming for the past, uh, for the past decade or so. Whether you look at your Arizonas, your Nevadas, your Texas, your, uh, your Florida, this is where most of the construction was happening. Um, so you're dealing with, all of a sudden, if you're an entrepreneur, uncertainty of, am I going to get the parts I need when I need them at what price, and am I going to get the workers and at what price? Maybe it's just easier, I hold back and, and not do anything. And, and I think what's interesting in the recent weak data that has come out is the extent to which it does seem to point towards weak construction. And again, like the, the PMI surveys that just came out yesterday, were pointing, like, the, it disappointed, and it was all basically construction. So, do I think we're going to have a US recession? It's, it's a tough one because it's, you know, if you look at typical models, cost of capital, budget deficits, cost of, cost of oil, you would say no. But so you almost have to make the argument that it's different this time. But if ever there's a time to make the argument that it's different this time, it probably is today, where, where policy in the US is very different than, you know, you and I have experienced through our careers. Uh, so it's, it's hard to have a strong level of conviction, uh, either way. But I am, I am fearful that the odds of recession are going up. Yes, I'm not like banging, banging my fist on the desk saying, "Oh my God, you know, to your listeners, watch out, US recession coming," etc. And I'm not doing this, but I think we have to acknowledge that the odds are probably higher than we've seen, uh, since the start, since the post-COVID era.
>> Okay. And you're seeing that very much being driven by the construction side, obviously, you know, consumer spending has slowed as well. I mean, are there other dynamics at play? Obviously, with tariffs coming through, it's going to be a hit to disposable income, um, in real terms. Any other channels you see kind of confirming the, the weakening economy scenario?
>> Yeah, look, I, I think all of these make sense, but again, for me, construction's a huge employer. Construction's also, you know, there, there's a huge multiplier effect, um, in, um, across communities everywhere. So, I do worry about that. Yes, indeed, I think there is the squeeze on, on US disposable incomes, um, and both from, you know, inflation that is still there. I think, I, I can't remember the exact number, but I think inflation has been above the 2% mark of the Fed for something like 46 months in a row. Don't quote me on that exact number, but it's in that ballpark. It's essentially four years. The, the bottom line is, yeah, there's, you know, you look at consumer being squeezed, you look at construction being highly uncertain, uh, and frankly, even capital spending in general. Like, if you look at the boom we've had in the US, it, it rested on many things. One of them was, of the recent years, was capital spending and AI. Um, now, this, this might continue. However, um, what we're increasingly seeing is that the hoped-for returns to the likes of Google and Microsoft and Apple, etc., and, um, and Facebook and others, uh, you know, the hope for returns aren't that great. So, at some point, you know, does the AI, like, sort of rush ahead continue? We've had very, very strong consumer spending, which was partly linked to, I think, the wealth effect on, um, on houses, on equities, on crypto. Now, granted, you could say, well, equities are all-time highs, crypto essentially at all-time highs. So maybe that continues, uh, but maybe the lower-end guy does, does get squeezed. And then you had construction that was like booming, and I think that part is slowing really hard.
>> Yeah. And I mean, obviously, when tariffs came along, there were a huge uncertainty, and that was a theme of Q1, Q2. I mean, it was reasonable to say, well, businesses will postpone, um, spending decisions or investment decisions. We don't know what it's going to play out like. But now, I suppose you could say it is increasingly apparent what it is playing out. It's kind of 15% or 20% in most cases. Okay. We haven't got a deal with China yet, but the noises are positive. I mean, can you, do you think as we get into Q3, Q4, we'll get to a point where there is certainty on the tariffs, or be that they are, are now here at, at kind of elevated levels?
>> Yeah, look, I think the, this really, the three countries that matter the most for the US is, you know, what the US trades the most with are Canada, Mexico, and, uh, and China. Uh, now, um, when it comes to Canada and Mexico, you know, to your point, just like Europe, just like pretty much everybody out there, you're going to be in the 15 to 20 range. Um, and I don't think that's inconsequential. You know, that's, that's a pretty high number. Somebody's going to have to pay for that. Now, I think that the premise that, uh, of the Trump administration is that either foreigners will pay, or, or corporates will, will take the hit on their profit margins. Maybe, maybe they turn out to be right, but if, if the lower-end consumer is made to carry some of that bag, then, uh, you know, that bag, that bag's already pretty loaded. The, the low consumer is pretty stretched in the US. So, um, so yeah, so you, that's, and then you, you indeed have the elephant in the room, which is China, which is right now at 50%. Now, 50% essentially kills the trade. Now, you know, China, unlike other countries, hasn't come grubbling. They've, and quite the contrary, they said, "Okay, we want to go down this path. We can raise tariffs on you. We, uh, we can block the export of rare earths. We can block the export of magnets. We can bring your entire auto and armaments and aerospace industry to its knees in about three months." So, you know, fine. That's, you know, you, you want to play, let's play. Uh, let, bring it on. Um, and, you know, I think the perception in China is that, of course, this will hurt the Chinese economy, but that China's ability to withstand pain is much greater than the US's ability to withstand pain. That essentially, you know, if the GM factories are shut for two weeks, um, then Trump will be seen as a failure. Uh, you know, the whole "Make America Great Again," American industrial renaissance, etc., doesn't work if Ford and GM can't get rare earths and, and magnets to, to make cars. So, so China has played that card. Uh, it's played it, uh, it's played it quite aggressively. Um, which does probably open the door for, for a deal, uh, at, at some point. But it really seems like China's not rushing to get a deal.
>> So, I mean, what, what is a likely deal, would you say, um, given all of that? So, if you look at right now, China is at 50, 20 of which is, um, the penalties for fentanyl. Now, already the US is now going around saying, "Oh, you know, there's been huge progress on fentanyl. It's, uh, it's now, it's now much, much better." So, so they can move pretty quickly from 50 down to 30. Um, I mean, the US can decide that unilaterally, just say, "Okay, fentanyl, you know, China's done tremendous work there. Well done. So we'll bring it back down." So, they've given themselves this leeway with the fentanyl tariffs, by the way, tariffs that were also imposed on Mexico and Canada, and the US said, "Okay, you know, they're making progress, so we're taking that off." So, I, and I suspect that's what will eventually happen. Now, you know, once you get down to the 30%, after that, it's like, hm, it's not obvious that, uh, it goes lower from here.
>> Yeah. So, you think that it could settle somewhere around that kind of baseline, um, which would obviously still, still be significant.
>> I think 15 to 20 on everyone, and probably 30 on China, is, I think where we, we basically end up with, with the occasional other country that may also be at 30 or 35.
>> It, to the question on, um, impact on inflation. Uh, obviously, it's a, it pushes up the price level. We've seen a little bit of that in the most recent inflation data on the good side. I mean, that's been offset by weakness, I think, in the services side. Do you think we'll see more? And then where do you stand on, like, will it be more persistent over time? Like, Chris Waller seems very intent on the view that it's a one-off price impact and it's not going to lead to sustained inflation. Would you be as confident on that view?
>> So, I, I hate to make, like, a Jesuit priest and answer your question with another question, but I think that the answer to your question depends a lot on, uh, what your outlook on energy is, and what your outlook for the US labor forces, because the reality is that goods, you know, within the US, like goods inflation is, is only a fraction. What, what probably really matters is whether we start to see wages push higher. Now, historically, a huge catalyst for wages pushing higher is, um, is higher energy prices. Somehow, there's a psychological element to, to energy prices. Perhaps because, you know, when we drive to work, we, we see the gas price on, on the side of the road. Um, perhaps because it's the one thing we, we buy consistently, and it's always the same thing. I fill up my car every week, and I know I pay X to fill up my car, and, and so right now, energy prices are low. Gasoline prices are low, and so, you know, wages are still not really rising all that fast. Even with the immigration crackdown, um, even with the immigration crackdown, wages haven't been shooting up. Now, fast forward six or 12 months from now. If energy prices have moved up, and at the same time, you've got a tight labor market because you've, you've kicked off all the illegal immigrants, then you really have the recipe for, I think, an inflationary spiral where wages go up. At the same time, good prices are going up, um, and gasoline prices are going up, and then the, the narrative, the popular mood really starts to swing to, "Oh my God, there's so much inflation." Um, so energy prices at this juncture are really, really critical, and I would say that if energy prices start to rise, uh, then probably President Trump's, uh, presidency start becoming, starts to become very challenging. As long as energy prices stay low, basically the show, more or less, may manage to stay on the road. So, I hate, hate to hate. Now, I happen to be a bull on energy. So, I happen to be an inflationista. Um, but I, I willingly acknowledge that energy prices today are low. Um, and that we're going through an interesting time in, in energy. Uh, because on the one hand, I think we've underinvested in carbon for, for 10 years now. And the scope for oil and natural gas, etc., to go up is there. But at the same time, you have the, you know, the biggest energy importer in the world, namely China, that has invested like absolute crazy in its ability to deliver electricity and to essentially fund its own transition, uh, transition from carbon-based energy to, to electricity, whether that electricity is produced by nuclear, by solar, by, you know, LNG plants, by hydro, by coal-based fire plants, but the, you know, China now produces twice the amount of electricity that the United States does. Um, so which is, which is funny because the US is still supposed to be at least a third bigger as an economy, but when you look at electricity production, if you think that's probably a decent proxy for the size of a, of an economy, China is now twice the size of, of the United States. So, all this to say, we're, we're at an interesting point where, you know, the energy of the future is electricity. It's, it's not gasoline. It's not diesel. The energy of the fuel is electricity. China is moving very rapidly in that direction. The rest of the world not as much. But meanwhile, we've also massively underinvested in carbon. So, depending on where you fall on the energy question, I think will dictate how you fall on the inflation question. So, I'm a bull on energy. I think energy prices move higher. I think inflation thus moves higher.
>> And what's the bull? I mean, I, I get the underinvestment case in energy. Um, obviously, oil prices have been stuck here in a range for quite a while now, and obviously, we've had geopolitical events. We've had Iran strikes, etc. And, you know, the view is always seems to be, you get a spike, it's a good opportunity to sell because the market's quite well supplied at the moment. So, what changes on that front, or what, what are the risk factors do you think?
>> Yeah, look, I think the main thing is it's, uh, big energy bull markets are driven first, are driven more often than not by demand. And so, I think what, what changes, what people underestimate is, you know, you could look at energy, essentially, you've got different billion-dollar, billion-people markets. So, China's a billion-person market, like, I'm rounding, of course, it's like 1.3, but let's just call it a billion. India's a billion. Africa will very soon be a billion. Um, and then the developed markets are essentially a billion, and then everybody else is a billion. Um, if, if I'm going to make it like, very, very simple, simplistic. So, Africa has been a huge net energy exporter. That probably changes in about three or four years as, you know, as between their population growth and their standard of living growth. So, they, they switch from being an exporter to an importer. You know, India continues to import more and more. Uh, so, you know, I think people focus on China because it's been the big story of the past three decades in energy, and then they say, "Oh, look, China's energy needs are plateauing. They're importing less, or they're importing as much. They're no longer growing." But it's, it's missing the story that's occurring elsewhere in emerging markets. So, when you look at total oil demand, it's still growing by a million to 1.5 million barrels per day every year, you know, ballpark. So, for that given, you know, the fact that, you know, wells, wells lose capacity over time to make that extra million and a half barrels, you need to, to continuously invest. Now, today, you could say, "Yeah, but, you know, what OPEC probably has two million surplus." Yeah. And that probably covers you for the next year. And then what? So, then what? You could say, "Well, you know, you got some coming out in Surinam and some coming out in, um," but here's, here's a fun fact on the other side, you know, from nowhere five years ago, China is now the biggest car exporter in the world. Like that somebody, something that nobody expected. Like, China is now the biggest car exporter in the world. And 85% of the cars that China exports on any given month, 80 to 85% are ICE cars. Like, then the electric cars stay at home, and the ICE cars go abroad. Um, why? Because the cars go to emerging markets. And when you live in Colombia, when you live in Indonesia, your electricity grid isn't going to support electric cars. Also, electric cars depreciate too fast for emerging market investors. Good thing about ICE cars is they last 20 years if you take care of them. So, now, all of a sudden, what you have in Indonesia, in Vietnam, in Colombia, in Brazil, you have people who buy cars who never bought cars before because they're buying Chinese cars for less than $10,000 a car. So, you have all of a sudden people driving ICE cars all across the global south that were not consuming gasoline up until five minutes ago. And I think that's, that's the part that, uh, perhaps people are missing today is, yes, on the one hand, OPEC's got this extra two million, etc. But at the pace at which China is exporting cars, you're going to need gasoline, you're going to need more refineries. You know, nobody's building refineries. You're going to need more refineries, etc. And so, uh, so yeah, I, I do tend to think that the risk is, is to the upside.
>> That sounds like maybe a story for next year or thereafter, and not necessarily for the next six months. You, it's these things are always so hard to tell, right? Uh, what I do know is that today's equilibrium is unstable. Um, now, you're absolutely right that it could be stable for the next six months, 12 months, 18 months, absolutely. But I think that if there is a risk to our system today, if there is a risk to global economic growth, if there's a risk to, you know, we're now set on an easing stage for central banks everywhere around the world, whether, you know, the Fed that's going to be easing, the ECB that's easing, saying, you know, EM central banks everywhere easing, etc. If there's a risk to this whole environment, it is that oil prices spike. Now, granted, I take, I take your point. It's like, yeah, but that's not going to happen in the next six months. Probably like 90% chance it doesn't happen in the next six months, but what if it does? What if in that 10% chance it does? Then it's going to obliterate your portfolio. So, at the very least, you don't invest on the premise that this is going to happen, but you, you buy protection for your portfolio in case it does.
[Music] You mentioned easing likely for the Fed. I mean, is that, do you think now we're the Fed, the Fed's going to come under so much pressure that it will cut in September? And how much between now and the end of the year?
>> Yeah, I think it cuts in September. I think it cuts in September unless, um, again, I'm sounding like a Jesuit priest, like hedging everywhere. Uh, but there's two CPI prints between now and September. Unless you get two bad CPI prints, uh, and by bad, I mean, they CPI that surprises on the upside, that it turns out to be much stronger than expected. Unless you get that, I think you're getting the, those job numbers we just had almost guaranteed that you're, you're getting, you're getting a cut in September. Now, you know, beyond that, is it going to be 25? Is it going to be 50? I think a lot of that will be driven by the data between now and then, uh, but, you know, recent PMI, recent ISM, I've looked softer. Like, if all these things continue, then yeah, probably 50.
>> Okay. And then that allows, that allows, uh, you know, the Fed to sort of at least get Donald Trump off their back a little bit. Speaking of which, the, the big topic in, in with respect to the Fed is what happens next. So, obviously, it seems like Trump isn't going to fire Powell just yet, but obviously, the window for putting a replacement in is, is opening. Obviously, there's a spot for a new governor, and then which may or may not be the person who becomes the chair. What's your thinking on this? Obviously, it's kind of two Kevins and Chris Waller, probably the three names. I know there's a fourth. I'm not sure if that's best to he who's now seem to be ruled out, or if there is somebody else. But back to the betting markets, they are the top three contenders. So,
>> I thought Trump wanted to appoint himself.
>> Well, that was also muted at one point. Yeah. Not, not impossible, but yeah. Yeah.
>> Yeah.
>> Yeah.
>> I, so, first, I don't think he fires Powell. Uh, I don't think he fires Powell because Powell, at this, at this stage, he's set him up as the perfect scapegoat. You know, he's done these big tariffs, which may or may not work. It's a big gamble. Um, if it pushes the US into recession, he can turn around and say, "It's the Fed's fault. It's Powell's fault. I've told you all along, this guy's an incompetent," etc., etc. So, he's set up Powell as the scapegoat. So, why would he want to get rid of him? Like, as soon as he get rid of, gets rid of him and puts in the other guy, then he owns the economic situation. Uh, either guy or girl. He, then he owns he owns the economic situation. So, I think Powell essentially serves out his term because he serves a purpose now, uh, which is the being a scapegoat. Um, beyond that, who he picks, uh, I think at this stage, the, what really matters, uh, more is that, you know, it's been signaled, it's been telegraphed that the Fed from here on out will be easier, will be following easier monetary policies, and will be essentially pushing the US towards a weaker dollar. Um, and, you know, I would say, who cares about the personalities at the top? What, what matters for us as investors is the, the highest odds are that we're going to have a set of policies that almost guarantee steeper yield curves and a weaker dollar. And, you know, so that, that's what matters to us. And a steeper, a steeper yield curve, a weaker dollar, that, that usually means outperformance of financials, which is what you're seeing in markets everywhere. It usually means outperformance of emerging markets, which is what you're increasingly seeing. Um, usually it means the outperformance of value against growth, which we're not really seeing yet, but, um, I, I think we'll, we'll see, you know, probably further down the road.
>> Plausible. I, I mean, the one thing I would say is, like, the likes of Kevin Worsh, um, has very distinct views on, you know, balance sheet normalization and, and, and, you know, being very critical of the Fed's approach around QE. So, I mean, if we saw him come in, you know, obviously, he's in favor of rate cuts at the moment, but he does seem to be a bit more of independently minded than maybe say, Kevin.
>> That is, that is, that's a very fair, fair point. I'm a big believer and a big proponent. I always say that, look, as money managers, we're paid to adapt, not to forecast. Um, so, uh, I, I'll be dead honest with you. I'm not actually spending that much time thinking through all the various scenarios of, you know, once who gets it and what they do once they get it, etc. Because, uh, like, once we know who it is, then, then I'll start thinking, okay, so it's this guy, so it probably means this, this, and that. Um, having, having said that, uh, you know, people change their minds, people evolve as well, but, uh, so, so it, it's like, it's like I fear that trying to anticipate the various guys' moves is maybe too many chess moves ahead. You know, I'm, I, I played a fair amount of chess in, in my youth, and I was never very good because I could never, I could never do more than sort of three moves ahead. Like, you know, the really good guys got like six moves ahead. I could do about three moves ahead in my head, and then I'd, I'd sort of lose it. And as an investor, I try to do the same. I try not to be too many moves ahead because it, it just, the, the complications just get too big.
>> Fair enough. Um, I mean, you did mention a weaker dollar, and this has been a theme this year. Obviously, the dollar has had, I think it's like the worst start measured on a, on a calendar year basis. At least it did going back a few weeks when the narrative was all about kind of outflows. The end of US exceptionalism, obviously, was one narrative which has kind of diminished a little bit as, as the equity market has come back, and then outflows from the US market. Um, obviously, some hedging pressures as well, undermining the dollar. So, putting all of that together, and obviously, you know, in the background chatter about, you know, US reserve status under pressure, as well. I mean, I suppose that's the consensus view. Hard to disagree with it. What, what do you think?
>> Yeah, I think it's hard to disagree with it. I think we are seeing a paradigm shift in, in the US dollar. And, and look, perhaps the most important shift in, in the US dollar. You know, if you were a French pension fund or a Korean insurance company, for years, you bought US equities, and you were long the US dollar, and if ever there was a market accident and equities went down 10%, typically your own currency went down five. So, net net on your US equity position, you would be down five. So, it was, yeah, nobody likes being down five, but it's not the end of the world. So, the fact that for years and years, the US dollar was this port in a storm, this, uh, this shelter in rough, in rough seas, um, meant, made US assets very attractive. It made the US dollar very attractive, and sort of a very reflexive move for foreign investors. And I think this was shattered this year. We saw it very well in April when, you know, the, the liberation day tariffs were announced. Instead of going up, the US dollar went down. In fact, for a period of about eight days, you had the bond market in the US, the equities, and the currency all falling at once. And if you've ever done the emerging markets, you recognize that pattern immediately. Uh, you recognize that pattern, you're like, "Okay, I've seen this movie before. This is an EM crisis. I'm out of here." When you see those three things fall together, it's usually, it's a, it's a big warning bell. And, you know, that's why I think Bessent and Lutnik had to intervene. And, you know, they, they talked the tariffs back and, and stabilized the markets. But the message was nonetheless sent that from now on, when US equities falls, so does the dollar. And therefore, this makes US assets just, this shift in correlations makes US assets a lot less attractive to, to most institutional investors everywhere. So, I think that's, you know, you got that. Of course, you've got the greater uncertainty around politics. Um, and policies in the US. And politically, it's now no longer, uh, good to be seen being overweight the US. If you're running a public pension fund in Holland, uh, or you're running a sovereign wealth fund in Singapore, like being massively overweight the US may not be the smart trade. Um, so, so bottom line, I think the default mode amongst large institutional investors is now to bring money home. You know, for the default mode for 15 years was, I invest in the US. Now the default mode is, is bringing money home. But, but the problem when you talk to pension funds in Germany or pension funds in Canada, they always tell you the same story is, I want to bring money home, but I don't have any assets to buy at home. Now, this is where it gets interesting. Is if you look at the new chancellor in Germany, the new prime minister in Canada, new prime minister in Canada, you know, comes out of Goldman. I, I tend to believe that you can get the guy out of Goldman, you're not going to get Goldman out of the guy. So, if you now have pension funds that come to CM and say, "Hey, uh, Prime Minister Carney, give us assets to buy." Uh, he's going to say, "All right, I know how to do this. Uh, let's build some infrastructure bonds. Let's, uh, IPO the airports. Let's build pipelines into British Columbia to sell the oil to, to Asia, and give all these Canadian pension funds that have hundreds of billions invested in the US opportunities to bring money home." And I don't want to pick on Mark Carney because you take the German chancellor, he used to be the CEO of BlackRock for Europe for six years. So, how hard is it for him to structure infrastructure bonds and call the head of every pension fund in Europe that he knows on a first-name basis? Probably not, probably not very challenging. So, I do think this trend is, is starting where the marginal dollar, instead of being invested back into the US, is now increasingly going to be invested domestically.
>> Makes sense, I guess. I mean, the one thing that that it ignores is, is the AI theme, and, and the Mag Seven have, have come back, you know, having been under pressure for a while. Um, so if, if investors want to play that theme, that obviously the US still remains the obvious place to go to. I mean, you mentioned that maybe some questions around the return on investment, but, you know, at the same time, recent results from, you know, Meta were encouraging, and, and I think the likes of Microsoft and, um, a number of them were, were announcing upgrades to their capex spend. So, I mean, for the moment, it's, it still seems to be raging on. Um, is that not part of your, your, the picture or your?
>> That's a massive part of the picture. Uh, that's a massive part of the picture because you're absolutely right to highlight it, and that you've had an epic capital spending boom in the US where I actually recently wrote a piece on this where capex in the US over the past few years has gone from 9% of GDP to 11% of GDP, and this 2% of GDP increase in capex, by the way, historically, it tops out at around 11.5%, like in 2000, it topped out 11 and a half%. Uh, that extra 2% um has really gone to a handful of companies because that increase in capex, uh, some of it has been in data centers, some of it has been in, you know, building out new power plants, although nowhere near enough, and some of it has been, most of it has been in AI. You know, it's, it that 2% it's gone basically straight into Nvidia's bottom line, exaggerating, of course, but don't, don't send me data saying it's no, it didn't all go into, but it's gone into, uh, to Nvidia, and yes, to Microsoft, and so, so the question now becomes, um, you know, you've had this huge increase in capex, what do we get on the other side of it now? Do we get the productivity gains, and do we get the profits that flow to these businesses that have essentially turned themselves, you take a Facebook, it's essentially turned itself from an extremely asset-light business into an increasingly asset-heavy business. Now, again, if the money flows in, then happy days, then the show stays on the road. And, yes, people want to keep buying Facebook, and they'll want to keep Nvidia, etc. If the, the returns don't come through, if AI turns out to be very commoditized, and if the, the profits on there, or the productivity gains aren't what was hoped and expected, then the US really hits the wall really, really, really hard because right now, what is keeping the show on the road to your point is this excitement around AI. Uh, take that away, and all of a sudden things start to look pretty dire.
>> And what's your thoughts on in the next downturn? I mean, there is a view that because now of increased usage of AI, LLM, etc., that, you know, a lot of those entry-level positions are not being filled, and that in the next downturn, we could see, you know, even more adoption and PE corporates trying to squeeze as much out of AI as they can, and much higher unemployment. Is that too early to expect that, or is that a risk factor on your radar?
>> No, I think you have to worry about that. I mean, look, that, that's the very lynchpin of the AI hope is the idea that we're going to get
>> That's the productivity gain, isn't it?
>> Yeah.
>> It is. So, it's, you, you have to worry about it because either A, this is, so there's two options. A, this is going to be real, and where, you know, all this, to your point, the entry-level jobs in insurance companies and in banks and, and in a lot of places are, are going to disappear, and so then you have to wonder, okay, so what does that mean for our societies? What does that mean for, for jobs in general, etc. So, so that's your one path. Uh, and the, the other path is, like I said, I think it, it turns out to be a dud. Uh, nowhere near as, uh, as productive as, as we'd hoped, and we have a, a hell of a stock market correction. It's, it almost, uh, reminds me of that Woody Allen quote, right, about how, you know, you, we've reached a fork in the road, on, on one side lies, uh, despair, and, uh, and the other lies, uh, you know, misery, and that I hope we choose wisely. So, I, I don't want to sound depressing for, for your listeners. Um, I tend to believe, and I may be wrong, uh, you know, but from my own playing with it, from, I tend to believe that the level of hype on AI is off the charts. Um, and that there will be some productivity gains, sure, but it'll be nowhere near what, uh, what we're being told. Uh, and it won't be near enough to justify, uh, either the levels of capex that have been put into this thing, or the levels of, uh, the valuations on, on a lot of assets. I mean, I look, I'll give you just two examples, right? Um, if you go back to 2008, in 2008, the whole world from peak to trough lost 18 trillion in equity market cap, right? U, so you had essentially 500 billion of losses on mortgage bonds that triggered 18 trillion of market cap equity losses. It was a bloodbath. 18 trillion. Now, yeah, now, okay, keep that number in mind for just a second. Today, if you look at Nvidia plus, um, plus crypto, just those two assets, Nvidia and crypto, uh, there today, together, it's more than an $8 trillion market cap, right? Uh, now, crypto and Nvidia, just two years ago, crypto and Nvidia, just two years ago, were two trillion market cap, so they've gained 6 trillion in market cap in two years. Now, 6 trillion is a lot of money. You know, there's, there's, I think there's only two economies in the world that have more than a 6 trillion GDP, the China and the US. So, 6 trillion is a huge amount of money, and that's what, that's what's been gained in just two years by those two asset classes. Now, when you look at Nvidia, and when you look at crypto, these are asset classes that every three to four years lose 75% of their assets. That's just what they do. I mean, it doesn't mean they're bad. I'm not putting a value judgment on it. I'm just saying, like, look, these are highly, high, these have asset classes that through history have had massive volatility and massive downside, upside, and downside volatility. Now, you could say, "Well, this has changed now, that that's over," but let's imagine that it hasn't changed, that, you know, at sometime in the near future, we got a 75% wipeout on these guys, that will be 6 trillion, that will pop away like this. That's a third of the equity loss of 2008 in just two asset classes. Now, imagine the, the impact this will have then on, on capital spending. This impact this will have on consumption. You know, there'll be a lot less boats being sold, uh, and a lot less, uh, sports cars, and whatever else. So, um, the, for me, this is now the, the big risk in the market, to be honest, is we've reached a point where the hype on AI, the, the results really have to be pretty outstanding for to match the, the level of hype that that was put in.
>> You mentioned earlier about the period in, in April with the dollar, bonds, and equities selling off at the same time, and, you know, it brought into, I suppose, focus the kind of maybe structural concerns about the, the long end of the curve in the US that you mentioned, the likelihood of steepening, but we've had the big beautiful bill, you know, deficits are not getting any smaller, they're getting larger, um, and on a kind of, on a trend basis, year on year, we've just got used to kind of six, seven, 8% of GDP. Um, but we're not
Seeing a huge reaction from the bond market. Obviously, yields went up to maybe four, five, 4.6%, or back to four and a quarter now. You know, there was a view in the markets, do deficits matter? I mean, at what point do they matter? It's, uh, it's the old story, right? Uh, it's like it's like tequila shots. You, you've never known when you've had enough until you've had too much. And, and government debt tends to be the same story. You feel good, you feel good, you feel good, and then at some point, you're throwing up in, in, in the bathroom. So, yeah, your point is, when do we start throwing up in the bathroom? And the answer is, I'm not quite sure, but I know it's not a great asset class to own because at this pace, you know, it's like you're seeing the guy at the bar just pounding the tequila shots, and you know there's no, there's nothing good coming out of that. You're not quite sure when he's going to hit the wall, but you know that wall is there. Yeah.
So I look at, I do look at the fiscal situation across most of the OECD, and the reality is, you could say, oh, it's bad everywhere, etc. But, but there's really three countries that are, that have really bad fiscal situations today. One of them is my own, of France. The other is the UK, and the third is the United States. These are really the three countries where when you look at the increase in debt, you can start getting worried. Uh, now, the UK and the US still control their central bank. So they have the option to monetize the debt, to essentially take the pain through currency devaluation, through currency devaluations, and, and a weaker currency. It's harder for France to do this because we're obviously part of the euro. And so, you know, if, if you want to look for a debt crisis, perhaps the, the more obvious candidate at this juncture has to be, has to be France, where you have a very tenuous political situation. Uh, you know, you, you have a government that can't pass a budget, that's coming back in September from holiday, uh, doesn't control parliament because parliament is divided, a third, a third, or a third, and every one of those three groups hates the other two. Um, you know, where basically building coalitions is is impossible. And then you could say, well, if France hits the wall, then maybe that gives another, um, boost to US Treasuries, where foreign, you know, foreign investors say, ah, you know, Europe, it's, it's screwed. These guys can't fight their way out of a wet paper bag. I thought they had it together, but they don't. Um, by the way, I'm not saying this is going to happen, but I think that the risk of that is not zero. And then, you know, money comes back into US Treasuries. So, you know, you can actually make a bull case for, for US Treasuries. Personally, I don't own any US Treasuries. Um, I think the US dollar is a structurally weak currency from here on out. I personally have no interest in owning bonds in currencies that depreciate. I like to own bonds in currencies that appreciate. Currencies are bound to be strong. I have no interest in owning US Treasuries. But you could see an argument where, okay, actually, out of the three weak links in the system, France is the weakest link, and when it breaks, they'll boost the US.
>> And what's the scenario for, you know, French problems? Obviously, in Europe, we've had a lot of, we've had easing from the ECB. So they've been, you know, much, much more ahead of the curve, I guess, than the Fed has been. And obviously, as you say, in Germany, we've had the debt break being loosened. So, >> maybe it doesn't, which is why I said I'm not sure, I'm not sure we go this way.
>> Shifting gears. I mean, last time you were on was kind of, I think, October last year. It was not long after the big kind of China announcement. Um, the stimulus at that point, it was a kind of a big spike in the equity market. It's been kind of up and down since then, but probably a little bit higher. So, you know, hasn't reversed, but, um, you mentioned the kind of the, the China now, the exporter, the largest exporter of cars in the world, and that's been the Chinese strategy, isn't it? Flood the world with its, uh, excess manufacturing capacity today. I, I guess countries like Indonesia, as you say, Brazil, have been happy to absorb that excess capacity. I mean, where do you see China now in its process of coming out of that big deleveraging that it's been going through for the last number of, yeah.
So, I'm not sure that it's been China's strategy to flood these other countries. I think China's strategy is actually a bit different. The, the way I conceptualize China is that China was humming along, and in 2018, the US embargo on semiconductors was a massive shock to the system. That when the US said, no more high semiconductors to China, essentially the Chinese leaders panicked. They thought, okay, if they're blocking us from semiconductors today, tomorrow it could be auto parts, it could be tires, it could be chemical products, it could be anything. The US is trying to trip us up economically. We thus have to become self-sufficient and independent, resilient on every single supply chain. And so in 2018, essentially the government tells the banks, "Guys, normal loans to real estate, normal loans to the consumer, all the money has to go to industry." And so we, we go through seven years of all the loans. Like, if, if you were an auto manufacturer, you'd get a loan. If you were a battery manufacturer, a chemical producer, like whatever, you were getting a loan. Uh, if you wanted real estate, forget about it. Um, and so you see real estate loans absolutely collapse, and you get a, a epic real estate bust, unsurprisingly. Imagine if tomorrow the, uh, the Irish government told, uh, the banks, you're not allowed to lend to real estate anymore. What that would do to, to the real estate market? Uh, probably nothing good, especially if, you know, valuations were stretched to begin with. And then you also had fairly little consumption because, you know, you, you lived through it in Ireland when people's real estate goes down, you tighten the belt, and it's not like you go out to the movies or the restaurant. So that was the story, really, of the past six, seven years. And while this happened, it did create all this excess capacity that, that you talk about. Um, and so now today, China turns around and produces all these cars, all these tractors, these telecom switches, these railroads. Um, and then indeed, the question becomes, okay, where are we going to sell all this stuff? Now, the obvious market would be obviously the developed markets, but there, there's protectionism against China. Um, and frankly, the Russia invasion of Ukraine and the fact that China has sided with Russia has has made all that part, you know, even more complicated, uh, and the western world is even less likely to do business with China. So then the only market becomes the, this global south, for lack of a better word. It becomes Latin America, Middle East, Southeast Asia, Central Asia. Um, but all these countries are poor countries. So China's got to provide funding, and this is where we are today, is like, okay, China is now starting to export these cars, these train systems, etc. In what currency are we going to fund this? Uh, and this is where it gets interesting. Is if you go back to 10 years ago, 5 years ago, all China talked about was funding its trade in its own currency, in the renminbi, uh, and it talked about the offshore renminbi. And what China was saying was essentially, look, Indonesia, we'll buy your coal for renminbi, and if you don't want to keep the renminbi for, you know, whatever reasons that are yours, you can come to Shanghai and exchange your renminbi for gold. And now what they've realized is that the more they trade and the more they push out the renminbi, the more people buy gold on the other side, and so gold starts to go, not yet, but starts to move parabolic, it starts to move up. Now, the risk now, if you're Chinese, if you're the Chinese central bank, if you're the PBOC, the risk is that gold really, really starts to shoot up because Chinese investors themselves, first, love gold. Secondly, love a momentum trade. They're like, they're the biggest momentum investors. So, gold starts shooting up, then they all start buying gold. And the risk then is the gold goes absolutely bananas, and then it crashes, and you've wiped out an entire generation's worth of savings, and you, uh, and you've made people very angry in the process, and you've, you know, destabilized social peace. So you will have witnessed perhaps that in the past sort of year, there's been a big change of rhetoric from the PBOC. Um, and I'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 the renminbi, and we have the Hong Kong dollar. Now, we can use the renminbi to fund our internal trade, and we can use the Hong Kong dollar to fund the external trade. Uh, but of course, if we're going to fund all this trade in Hong Kong dollar, um, then we're going to end up with a lot of excess liquidity in Hong Kong dollars. All this Hong Kong dollars that get created, pushed out into the system, eventually come back into Hong Kong, into Hong Kong banks, by Hong Kong assets. So I'm, I, I think we've started this cycle. You know, last year, the Chinese equity markets were actually the one market that outperformed the US equity markets. Uh, this year again, Hong Kong is is massively outperforming. Um, and, and nobody cares. Um, nobody cares. You know, I look, I look at China, you know, I, when I look at any market, I look at it through five prisms. Um, first, I start with fundamentals. Does it make sense? You know, and I would say China today, they, they put down more patents than any other country. They've gone from graduating a million university students a year to 13 million university students a year. They spent the past 20 or 30 years dramatically improving their infrastructure to the point where they now have the cheapest electricity costs in the world. Um, they, they have the cheapest transportation costs in the world. So the fundamentals actually make sense. Then I look at valuations, they're still very attractive. The momentum is now very solid. Then you look at investor positioning, and, uh, you know, nobody owns China because remember, they're always about to invade Taiwan and all sorts of crazy stuff. And then finally, you look at policy support, and this is where you've had the biggest shift in China is that up until a year and a half ago, the rhetoric from the Chinese government was, push, put all the money in building industry, and now the rhetoric is, we want asset prices to go up, uh, and we want to create a positive balance sheet effect, uh, partly to boost domestic consumption. So, yeah, I think, look, we've started an, an equity bull market in China, and frankly, nobody's involved.
So the, the transmission mechanism in the, the, the Hong Kong dollars is are lent to kind of emerging markets, who would then sell those back to back into the system in Hong Kong. So you got more liquidity in the system there that flows into the equity market, and, and basically you see the excess liquidity. One of the things that's been a head scratcher for many investors is the extent to which Hong Kong interest. So Hong Kong is pegged to the dollar. For your listeners who don't know this, the Hong Kong dollar is pegged to the US, uh, dollar. So historically, the, the interest rates are roughly the same, uh, because otherwise there's always an arbitrage opportunity, right? If I can borrow Hong Kong dollars that's pegged to the US dollar, and now at periods of crisis, what would usually happen when people worry, oh my God, the peg's going to break or whatever else, at periods of crisis, Hong Kong dollar interest rates would move far above US interest rates to essentially attract people back into the Hong Kong dollar. Um, this is how the peg works. All year long, you would have seen that high ball rates are like way, way below US interest rates, not by little, but by like 200 basis points, which is frankly unprecedented, um, and is a testimony to all the excess liquidity that is now sort of flowing into the Hong Kong dollar and, uh, sort of broader world.
Do the, do the Hong Kong banks not just buy the dollars and is there an arbitrage there that they're, that somebody has got on a huge scale?
>> No, I think the, the Hong Kong banks do, uh, do do it, but they've got so many, so many deposits in, in Hong Kong dollars coming, coming in. They don't know what to do with the Hong Kong dollars.
>> Yeah. Okay. Just conscious of time. Outside of Hong Kong, well, which is not really emerging, I guess, but emerging markets more broadly. I mean, you painted a positive picture from the perspective of, you know, an environment of, you know, a weaker dollar, which would generally be positive for global liquidity and for EM. I mean, from a more kind of structural growth perspective, how do you see, how has EM been playing out? Obviously, the tariffs, I guess, are a headwind for certain countries, um, or not, or how do you see that?
Yeah, I think, uh, look, to the extent that everybody's getting them, it sort of, it sort of evens out. Uh, it evens out. Now, you've had some that have been punished more than others. Brazil is the obvious one. Now, I, I happen to have been and remain a bull on Brazil. Um, I, I look, and for that matter, the whole broader Latin America, uh, spectrum. You know, today, especially if you're a fixed income investor, it's the one part of the world where you can easily anticipate 150, 250, 350 basis points of of interest rates, uh, drop over the next 18 months. Um, and, you know, like today, you can go out and buy a Brazilian TIPS giving you 7.5, 8% real returns. You can go out and buy Brazilian bonds that going to give you 14% nominal at a time when inflation is roughly five, 5.5%. So the, you know, nowhere in the world has that level of real rates. And, you know, in, in a weaker dollar world, the local central banks will have their hands free to to cut interest rates much more aggressively. So I think there's, there's tremendous trades to be had in Latin America. Um, there's, um, yeah, I think the Chinese equity market has started a bull market that few people are even noticing. So, yeah, there's, there's things to do out there.
So is that your top, top tip for the coming year, months? I mean, is that what your most high conviction view, bullish EM, or what would you say?
>> Oh, yeah, my, look, my highest conviction move, believe by far, is we, we're starting a new bull market in emerging markets. Um, a bull market that won't be derailed until we either get a new Fed tightening cycle, which seems highly unlikely right now, where, you know, we're going quite the opposite, uh, or until we get much higher energy prices. And, and again, as you pointed out, right now, things are stable. It doesn't seem like a spike is the most likely scenario for the next 6 to 9 months. So now I want to buy hedges against that spike because I'm super long in emerging markets, and I do worry that they would get squeezed if energy prices shot up. Um, so I want to buy hedges against energy prices shooting up, but, you know, to protect my EM positions, but EM is where you want to be.
>> Good. So, well, great to have you back on again. I'm sure we, we'll do it again maybe next year at some point and, uh, reassess all, all of those calls. But, uh, yeah, for all of our listeners, um, obviously keep tuned, uh, and make sure to follow Louis' work at Gavacal, uh, to get his insights over time. But from all of us here, thanks for tuning in, and we'll be back soon with more content. Thanks so much, Alan.
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