Transcription
Hey, this is Steve Eisman. This is another episode of The Real Eisman Playbook. There are just so many issues going on these days. Cross-currency, politics, war. But from an economic perspective, I think the biggest issues are the impact of AI, re-industrialization, short-term, the so-called big beautiful bill, unemployment, the deficit, and the overall investing environment. And these are major issues, and we've actually never had an economist on to sort of plow through all of them. So today I've invited Torsten Sllock, who is the chief economist of Apollo, an excellent economist, and we're going to go through a ton of issues and afterwards, I'm going to come back and talk about lessons learned. See you soon.
Hi, this is Steve Eisman and welcome to another episode of the real Eisman playbook. So there's so much going on these days. AI, K-shaped economy, oil prices, the deficit. I mean, it's just hard to keep up.
>> So, today we have as our guest chief economist at Apollo, Torson Slack, who's going to help us, I hope.
>> I certainly hope my best to go through what must be like every day. You can't believe how much information is coming. So, Torson, welcome first of all.
>> Thank you, Steve. Thanks for having me. So let's start with a simple topic. Give us your very broad overview about the health of the US economy. A simple question.
>> Well,
>> and then we'll then we'll dig deep.
>> Well, thanks all again first for having me. But it's really quite simple initially. What are the headwinds and tailwinds to the economy at the moment? Because there are three very important tailwinds that are driving growth. First of all, we have an AI spending boom because of the data centers and the energy associated with the data centers. We calculate that that contributes at the moment about 1%ish point to GDP growth. Normally GDP growth at two, and now 1% is coming from the AI spending boom alone.
>> So in other words, GDP growth this year.
>> You estimate up about two and a half percent of it is purely from AI spending.
>> Absolutely. So that's both the boom coming from the data center and energy buildout, but also the associated wealth effects from the stock market being high and the increase in consumption, especially for high-end consumers. So this is a very important source of growth. That's very unusual. We have not seen this source of growth for literally decades before where we've seen one sector in such a significant way contributing. Even with housing, we didn't see a contribution that was as high as 1 percentage point because this sector is just really, really significant. The second source of growth is the industrial renaissance. Industrial renaissance means politicians that want to do home-shoring or production of semiconductors. This was the Chips Act under Biden, home-shoring of pharmaceuticals, prescription drugs, and of course, importantly, also home-shoring and production of defense. You know, I've had industrial economists on and when I would ask them, is there evidence that of of this? In other words, people building factories in the United States, their response generally be that was that literally. So you're saying it's stronger than eh. It is a bit stronger than a. It only adds 0.3% GDP. So not a full percentage point like the AI spending boom, but we are seeing especially after the Chips Act, we saw significant increase in manufacturing capacity for semiconductors and we've also seen significant increase in capacity for manufacturing generally. So that means the ISM in the last five, six months has started to go up. So the manufacturing sector is doing a little bit better than a, but it's not as big a source of growth compared to the AI spending boom.
>> So 1% from AI.
>> 0.3.
>> 0.3 from re-industrialization.
>> Exactly. From the globalization reversing.
>> That's out of two.
>> That, that's out of two. And then the last thing we have is 0.9 coming from the one big beautiful bill. Remember the one big beautiful bill which was signed last year. It lowered taxes retroactively for consumers so that taxes were lowered starting January 1, 2025. The consequence of that is when people are filing their taxes this year, both those who did in April and those who had extensions, last year the average tax refund was around $3,000 and this year the average tax refund for households is about $4,000. That means over the next six months we will continue to see consumption do really well. That's a very strong tailwind coming to consumers because of the one big beautiful bill that was implemented last year.
>> So let me pause you on that one. Okay, I'll grant you that. But that, that's one time.
>> That is indeed one time. So 2027, 90 basis points of growth. If what you're saying is 90 basis points of growth this year is from the one big beautiful bill, next year it's not going to be there.
>> That's absolutely correct. So it will be smaller. And that's why if you add those things up, AI about 1%, the industrial renaissance about 0.3, and 0.9 from the one big bill, you get to a little bit more than 2% this year, right?
>> But what's most important about these three different sources of growth is that they are not sensitive to interest rates. Right? In other words, this is not your traditional economic situation where interest rates go up and the economy slows down. We are seeing the sectors that are sensitive to interest rates, namely housing and autos, are not doing well because they are very sensitive to interest rates that have gone up in the front end and in the long end of the yield curve. But at the moment, because these sources are not sensitive to interest rates, that's why Kevin W is dealing with a strong economy, high inflation. That's why long rates continue to be high because the economy is just not slowing down. So that's why you're right, when we come to 2027, that's a different discussion. But for the next six, nine months, we still have strong tailwinds coming from the AI boom, strong tailwinds from the industrial renaissance, and strong tailwinds coming from one big beautiful bill.
>> Okay, so since you brought up wash, let me press wash a little bit. Given all what you've just said, would you agree that the probability of the Fed cutting rates this is zero is zero?
>> Yes.
>> Zero?
>> Zero. It's not going to happen.
>> Not going to happen. Economy is too strong. Inflation is high for a number of different reasons, partly because the economy is also because of tariffs, also because of, of course, oil prices that have gone up. And we're also seeing now a contribution to inflation of 0.3 coming from the AI and data center buildout because semiconductors are more expensive, labor to build data centers is more expensive, and you also have equipment is also more expensive, and energy also being more expensive is also adding to inflation. So there is literally zero chance that he will cut interest rates this year.
>> How about raise them? Well, the market, as we speak today, are pricing that the Fed will be hiking rates in September and in December. So that's two hikes.
>> Wow.
>> So that's pretty a shift.
>> It is a very dramatic shift. As you and I know very well, in the beginning of the year, the dot plot was clearly saying that the Fed is going to cut, cut, cut, and rates are going down. And now suddenly we have a situation where the market is pricing that well, maybe, especially after his latest press conference where he said, "I'm not going to give any forward guidance." And when you don't give forward guidance, the market has to start guessing. And that's why you and I are now guessing. And the best guess that the market has at the moment is that we will see hikes coming because the economy is really strong and we have some upward lift. Inflation at the moment is three and a half percent. That means we have some strong tailwinds not only to GDP growth, also to inflation, and that just makes it impossible for wars to cut rates over the next six months.
>> Sounds like that's pretty bad for housing.
>> Well, because housing is...
>> Not that housing is so good right now either. You are the world expert in this, of course. But it is absolutely the case that housing lives and dies on what's going on with mortgage rates. And housing is already experiencing very little supply. The home builders have been very reluctant to produce and create more housing. And if you're on top of that, on the demand side, also have that rates are very high for a very long period because we now have a strong economy and upward pressure on inflation. It is indeed the case that the most sensitive parts of the economy, housing and autos, are just not doing very well at the moment. And we expect that to continue because the growth is not coming from traditional sources of growth that are sensitive to interest rates. It's coming from these really unique three areas of the AI boom, the one big beautiful bill, and the industrial renaissance.
>> All right, so let's dig down into AI a little bit. So tell me if you agree with this or disagree with this. Seems to me, I mean, not a day goes by that something dramatic doesn't happen with AI. It's it's kind of it's pretty hard to keep up. I get the impression that at least part of the AI story has really dramatically changed in the last, I would say, not even more than a month. And I would say it's along two vectors. One, and this is what I'm curious what you think about. Number one, this is now a very capital-intensive business. You know, last year, for example, Google spent $80 billion on AI and basically funded it from its own cash flow. And this year, they're spending $190 billion and they just raised $85 billion in equity. And so, you're starting to see more and more companies raise capital because the demands on their balance sheets are just so huge. So that's new. And the second thing, which maybe is even more important, is I get the impression that there are no moats in this business. People flip from Gemini to Claude to ChatGPT. So you're talking about massive companies spending trillions of dollars for something that may have no moats, and that's not a recipe for longevity. So I, I'd be curious what you think about that.
>> Yeah. So absolutely on the first point. If you look at the free cash flow for the hyperscalers, it has absolutely gone from being very, very high and literally is dropping down over the next six, 12 months towards zero, and it might even begin to go negative because the capex requirements, which is so massive.
>> It's very, very, very substantial. And these are, and continue to be, very profitable businesses. Especially the Magnificent Seven, of course, which we have most information about, have had significant cash flows, have continued to do so well. And they have now decided to spend an enormous, into the trillions, as you're saying, in terms of spending on data centers and the energy buildout because they really view this clearly as existential. That they've got to have the capacity, the computing power that's needed in this case, of course, to deliver all the demand for compute that's going to come along. And to your second point, I think actually my second point is more important. Because if there were moats, let's assume that there were very high moats. As an investor, I would say, "Okay, so you're going to spend a lot of money, but you're going to spend a lot of money, and I'll give you because at the end of the day, you're going to have a business that's a duopoly or or or very well protected." But if you're asking me to give you money for a business that has no moats, I don't want to give it to you. I'd rather, I'd rather buy Cisco that's going to supply you. Is the analogy that that I've drawn? It's kind of like comparing airlines to Transdime. Airlines is a terrible business because it's very capital intensive and you have, and you have no pricing power. And Transdime, which supplies parts to airlines, is a great business. So I'm just curious as an economist, if, if I'm right, what does that mean? What's exactly most important about this discussion is exactly, are there no moats for everyone, or is it just moats for someone?
>> For the hyperscalers?
>> There could be some of the hyperscalers that will end up being the winners and others who will end up not being the winners. In other words, there are clearly moats in the sense that there are some, including of the private hyperscalers, that have clear pricing power and clear products that they are rolling out in a very substantial way. But the question becomes, of all the capacity that's being rolled out, is that all going to have moats? Or in other words, are they going to have pricing power? Are they going to have special products? Or is there a scenario, as you're saying, where you can begin to worry about that some of them may not be able to survive in this situation, even though compute demand continues to go up, which is absolutely indisputable that there will be almost unlimited compute demand. The question is, what is the price that they're going to generate? In other words, what's the revenue they're going to generate on that compute demand? Because if the price of compute, the price of tokens, keeps going down towards zero, then it may absolutely be the case that there are some moats that might be a lot more shallow or be much smaller. I mean, let's imagine that one of the companies that has no moats is ChatGPT, OpenAI, just hypothetically. I, I've got no skin in that game, but and that one day OpenAI is in huge trouble. The ramifications of that, because so much of what's being spent is related one way or another to OpenAI and and and and Anthropic, are massive. I mean, Oracle, for example, has a $600 billion backlog, but half of the backlog is OpenAI. I mean, it's a little scary what's going on. But the added issue here is also because from a pure competitive perspective, the competitive landscape is also dominated not only by the names we're talking about here in the hyperscalers, but remember also that a lot of this also happens to then turn into more open-source models, including Chinese models, right? So that means that if you are a business and you say, "I need some compute to do some things for AI," well, are you willing to instead say, "It may be that the price of tokens, say from a Chinese model, is only 1% of what is the price of a token from a US model?" It still raises some important questions. Are you still willing to go after the cheap model because it runs the risk that you have to upload your data into, say, Chinese models and therefore into something that could become a much bigger issue, rather than just thinking about the cost? So the moat is also, and should also be, in my view, thought of as there is also this proprietary discussion about, you're right, the data is transferable, the models are replaceable, and they can replace each other very easily. But it still ends up being a discussion that those that have the cheapest tokens at the moment, at least they are certainly the Chinese models, and that becomes important because a lot of businesses might be able to say and willing to say, "You know what? I'm willing to pay for the moat over here and for the fact that this is a good service because this is a US service, rather than running the risk of doing this is an open-source model or in a Chinese model." So from that perspective, there is some unique um characteristics by the US hyperscalers relative to the hyperscalers, especially again from China.
>> Okay, let's switch gears. Let's talk about the K-shaped economy, the K-shaped consumer. Why don't you first define it? I mean, people throw this term out all the time, and half the time I, I think that when they throw the term out, they don't even know what they're talking about. So I say to you, person, K-shaped economy, K-shaped consumer, define this for me. Like, what is this all about?
>> This is all about three things. Number one is about a K-shaped situation in wealth. That high-income households today, relative to 2019, have literally savings that are trillions of dollars higher than where they were in 2019. Low, trillions, about one and a half trillion dollars higher than where it was in 2019. That's why the airlines have been saying quite simply, basically, that they have no problem selling business class tickets to high-income households, but they're having some challenges selling business class tickets, sorry, economy class tickets to low-income households. Okay? Because low-income households, the bottom 20% of the population, people who make less than $25,000 a year, their savings cumulatively as a group today is literally in dollar terms exactly the same as where it was in 2019.
>> So what you're saying is people $25,000 below have no more savings they had in 2019. In nominal terms.
>> And people at the upper end have a trillion and a half more savings. That's an enormous disparity.
>> And that's because people at the upper end have been benefiting from three things: benefiting from stock prices going up, home prices going up, and people at the other end also own fixed income. So when the Fed still has interest rates high and still talks about raising interest rates, that means that the cash flow you get as a high-income household is at the highest level in fixed income that has been in decades. That means that high-income households are not only making money on their stocks and on their home prices, but they're actually also making money on the cash flow that they get because some Apollo funds pay like 8 and 10%. And those returns you can get in private credit, public credit, and fixed income is basically at the highest level we have seen literally in 20, 25 years. So for that reason, high-income households continue to benefit both from asset price inflation and also from cash flows being very, very strong. So this is the first answer to your question, namely, when it comes to wealth, there is a K-shaped situation, and that continues to the legs are just getting longer in the K, if you will, because the stock market obviously continues to do well and the cash flows continue to also do well. There is now also a K-shaped situation, secondly, in wage growth. The Atlanta Fed has wage growth measures across income distribution, and people at the bottom are seeing lower wage growth relative to people that are in the middle and higher think income distribution. So that means that the K-shaped situation is not only in wealth, it's also in income growth. And finally, there's also a K-shaped situation when it comes to inflation. The New York Fed has measures for inflation across income distribution, and people at the bottom of income distribution then spend a bigger share of their consumption on food, energy, and housing, and these have seen a much bigger increase in inflation. So people at the bottom are also facing a higher inflation rate related to people at the top and in the middle. So from that perspective, the answer is there's a K-shaped situation for wealth, there's a K-shaped situation for income growth, and there's a K-shaped situation for inflation. And lastly, if you look at stock prices for baskets of luxury names in consumer spending have outperformed over the last several years, a basket of retailers that of course cater to discount or value names. So that's why this discrepancy, you can look up on your screen every single day. What is the difference? And it just continues to be the case that high-income names and those who cater to high-income names continue to outperform discount retailers. So that's why the K-shaped situation continues to be a major theme in the outlook at the moment.
>> Okay. So grant that, what are the implications for the economy?
>> So the long term for this, because this is not a trend that's going to flippity-flip in one day. This is long term.
>> Absolutely. The net effect of the K is that in aggregate, the top 20% of consumers, they account for 40% of consumer spending. The bottom 20% only account for 8% of consumer spending. So in aggregate, total consumption is actually still okay. If you look at the weekly data from Redbook for same-store retail sales. So that means Redbook goes out a week, once a week, and asks retailers, what were your sales this week relative to the same week a year ago? And that's still holding up very nicely. So that means that in aggregate, despite the K getting wider and wider, you're still seeing in aggregate, because the bigger part of part of the K still has such a big weight, that in aggregate the consumer is actually still doing well. So that's why the answer to your question is, if the K continues, it almost instead becomes a political discussion. What does it mean when you have a bigger and bigger share of the lower leg of the K that continue to face headwinds, not only because of the three dimensions I mentioned with wealth and income and inflation, but there's also the added issue that when you look at the language rates on auto loans have been going up, the language rates on credit cards have been going up, and the language rates on student loans have also been going up. Because there are a lot of households in the bottom and the middle of income distribution that also are facing higher interest rates because they have this problem that they have now also, not only a K-shaped situation for wealth and income and inflation, but also because of this issue that delinquency rates are going up, especially for people in the middle and the bottom of the K.
>> Sounds pretty grim.
>> So that means to your question before, that it means that the share of households that are getting impacted on the lower leg of the K is unfortunately just growing and getting bigger and bigger. And that's of course why this becomes a political discussion. Well, what do they do?
>> Well, the worse it gets, the bigger the political discussion.
>> Because then they become a bigger part of the population. And you can then ask, who do they vote for? And what are they doing? And this is becomes ultimately the risk, namely, meaning risk from an upside down side. But what is exactly the outcome when you have that K-shaped situation is unfortunately continuing.
>> Let's switch to private credit.
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>> Talk to me about, from an economist's perspective, what does the growth in private credit mean or not mean? And what do you think of the the over-indexing of private credit to software?
>> So let's back up and think about exactly why private credit. And why the financial system has changed so much since 2008. Because Dodd-Frank, as you know better than anyone, was implemented. And that meant that the banks were essentially asked to do less, and the market was asked to do more. So let's just agree that this was the rules changes that came after the...
>> There's no question that's what happened.
>> This is what happened. This is where we are today. Right?
>> What are the consequences of this? Well, where we sit right now, if I just back up and you ask me as a macroeconomist, what's the situation in credit? Well, if you look at default rates in loans and in high yield, they have actually been going down for the last 12 months. If you look at distressed exchanges, meaning that I borrow $100 from you, I come back two years later and say, "Sorry, I can't pay you back." You can then decide to say, "It looks like you're in distress. Why don't you instead give me some equity in your business? Why don't we instead extend the maturity of the loan? Why don't we lower the interest rate of the loan? Let's make a deal and we will change your capital structure because you were not able to survive higher interest rates. Let's try to find a solution out of this." But distress exchanges have also been going down. So not only are default rates going down, distress exchanges are going down, and finally, liability management exercises are also going down. So let's agree at the highest level, credit is actually getting better because default rates are going down, distress exchanges are going down, LMEs are going down. So what is the problem in credit? And this gets exactly to your question. The problem is in credit that there are some sectors in credit that have much higher leverage and much lower coverage ratio. And one sector that absolutely stands out is...
>> Just for for viewers, because not everybody knows what is coverage ratio mean.
>> The leverage means, of course, how much debt you have in your business. And coverage ratio means, what are my earnings divided by my debt servicing cost? In other words, what is my the coverage ratio?
>> What's my ability to pay my interest?
>> Exactly. Bottom line, am I able to pay my debt? Am I not able to pay my debt? And if you do a simple scatter diagram of all the sectors in credit, or really all sectors in the economy, and ask which sectors have a lot of debt, which sectors have little debt. So that's a very important exercise in equities and in credit to understand, are these sectors highly levered? Are they able to pay their debts? Where are their rate, where is their ability to pay their debts relative to other sectors? And software stands out in a very significant way by having significant amounts of debt and at the same time having actually very little ability to service that debt. So even before...
>> And it has very little ability to service that debt because...
>> Because interest rates are now higher for longer, because Kevin Walsh is about to raise interest rates later.
>> So the coverage ratio is deteriorating.
>> So the coverage ratio is deteriorating because these companies are unfortunately not being helped by the Fed hiking rates.
>> Got it.
>> So that's why if you now, even before you and I begin to talk about AI disruption, we can talk about AI disruption. Some software companies in cybersecurity may be better. Some software companies in education may be worse. So from that perspective, there are some nuances. But the big picture is all software companies across the spectrum, they have very high levels of debt and very little ability to service that debt, especially now that Kevin Walsh is about to raise interest rates. So therefore, it becomes important to look at the maturity wall. A lot of these vintages in software were originated in 2021 and '22, and a lot of these vintages have a seven-year maturity on their debt. That means that exactly in 2028 and '29, we are running into the maturity wall for software. That means that...
>> So there's some in 2027?
>> A... little bit, but most of it is '28 and '29. So that means if Kevin Wars is not lowering interest rates before we get to 2028, these companies will have significant problems rolling over their debt. So even before we debate whether AI disruption is going to create a terminal value of software companies that's very low, we already have the macroeconomic problem that when interest rates are higher for longer, because inflation is higher for longer, the sectors that have a lot of debt and the sectors that have little ability to service that debt will continue to struggle. And software, unfortunately, stands out as the number one sector that's vulnerable in that environment. So that's why yields on loans and software continue to trade higher and higher. At the moment, you and I can take $100 and put into software loans and get 12%. I...
>> I mean, if we buy it in the open market, we're selling it less than par.
>> Absolutely. So if we buy in the open market, you and I could basically say, we get 12% return in software loans. I mean, 12% that's pretty juicy in any investment. But the reason why the market still trades that wider and wider is moving up towards 12.5% is that if these companies have a terminal value that's zero, and at the same time, they also are not able to roll over their debt, then they will be facing significant headwinds. It's a double whammy to software coming from the terminal value being questioned, and at the same time, rates higher for longer, meaning that they're not able to service their debt. So the bottom line is, there is one sector and in particular, that sector alone. There's also some parts of healthcare, small parts of consumer services, but the software sector really stands out as the number one problem in credit. And this gets back to what you asked about, namely that in direct lending or in private credit, which is a $2 trillion market, $500 billion of private credit is software that was originated in the last six, seven years. So for that reason, software is a significant part of private credit and is a significant part of public credit. And it is those parts of the credit market that are wrestling with these problems of rates higher for longer and the terminal value, whereas the rest of the credit market, very broadly speaking, is actually in good shape, exactly exemplified by the fact that default rates are going down, distress exchanges are going down, and LMEs are going down.
>> You know, $500 billion sounds like a big number, but would you agree that in the context of the US economy, which is a $31 trillion economy, eh, it's not? In other words, for the people who made these loans, God help you.
>> Exactly.
>> But would you agree that for the, the implications for the US economy overall are not so bad?
>> Yeah. Because what's also important back to this upper crisis, and again, you know, much better than anyone, is of course that it all becomes a question of where are these loans located?
>> Right.
>> Are they on very levered balance sheets? And the generally speaking, the banking sector, of course, as you know better than anyone, was like levered 20, 30 times at the time in the GFC.
>> 40 in some cases. 40. And of course, now you have the BDCs, by law, are only levered twice, two to one.
>> Yeah. So that means that of course, if it is even in BDCs, and if this is in pension funds around the world, if this is insurance companies around the world, then of course, this is indeed a smaller number and therefore not a magnifier the way that we saw during the GFC when subprime was located in balance sheets that had to deal very, very quickly. So in other words, and this might be the way that the Fed is thinking about it, some people make investments and lose money. Some people make investments and make money. And to your point,
>> You're a big boy.
>> Exactly. You have some losses, you have some gains. And $500 billion, yes, it's not, of course, it's a huge number in some dimensions, but from a macroeconomic perspective, the US economy is like $33 trillion GDP. Yes, it makes some importance, but it's not anywhere near those systemic levels that we had with subprime in 2006 and '7. So I actually think the software story is even worse than what you're saying. Not, not from a macro perspective, but just from from a micro perspective, in the sense that if you look at any, all the public software companies, you know, like Salesforce, ServiceNow, they're down 50, 60% from from their peaks. So if you're the lender, and it's 2028, and the loan is now due, the discussion is not just, well, you're a riskier company, I want to charge you more interest. You're, you're going to the private equity owner of the company and you're saying, "Dude, the value of your equity is basically gone. You got to pony up more money. Otherwise, we ain't going to make, we're not going to, we're not even going to have a discussion about lending you, you know, rolling over your loan until you pony up more equity." And then the question is, if the private equity has to decide whether they want to do that or not.
>> Absolutely. And we've seen some examples of this more recently, of course. But you're right, it's absolutely the case. This is page one in your finance textbook, right?
>> This is private credit. You are senior to, of course, private equity. And if you are the equity in these businesses, and if private credit in software is in trouble, then of course, private equity in software is almost in even more trouble.
>> Let's move on to, um, just general employment. How's the, what's the employment situation like in the United States?
>> What's remarkable about the discussion we had earlier about AI? There's so many stories being told about mass unemployment going up 10, 20%. People freaking out, losing our jobs. But there are two important dimensions of this in the data at the moment. Number one is non-farm payrolls continues to be incredible. Why is that incredible? Because we have the tailwinds from the AI spending, the one big bill for bill, and the industrial renaissance. But it's also the case that it's incredible because clearly AI is not resulting in mass unemployment. So the first conclusion is, we are still creating a lot of jobs in this economy. And this is despite that immigration has been slowing down. Remember, it was the case in 2022, '23, and '24 that net immigration, legal and illegal, into the US was 3 million people came in every single year to the US. Now...
>> 3 million?
>> 3 million people every single year. Today, basically, net immigration is zero.
>> That has resulted in our friends at the Federal Reserve putting out working papers, blog posts saying, "Well, hold on. If we're not having 3 million coming in every year, non-farm payrolls has dropped from when it was 3 million, it was 200,000 every month. Now they break even for non-farm payrolls, according to the Dallas Fed, is 30,000. In other words, a dramatic drop in the number of jobs because we simply have much fewer people coming into the country." So from that perspective, 172,000 in job growth, 100,000 job growth is a phenomenal number, way, way higher than the numbers that you would be getting if you just looked at the demographics alone. So that's why the labor market is actually in really, really good shape, which is likely also, again, back to the reason why Kevin Moss and the FOMC is worried about maybe they have to hike rates, is because it's not only inflation is three, three and a half, but it's also the fact that we have a labor market they're actually quite strong. Even if you look finally at another indicator of the labor market, let's look at the unemployment rate for people that are between 20 and 24. It's been getting a lot of attention that young people can't find a job. Young people...
>> It's hopeless.
>> It's hopeless. This is the anecdote in the urban myth, including here in the streets of Manhattan, when you hear this story at the moment. But if you actually look at the BLS data for the unemployment rate for people between 20 and 24 years old, it has actually gone down in the last six months, and it's gone down more than the aggregate unemployment for everyone else. So maybe we have many more dorm room entrepreneurs that are sitting at home inventing new businesses. And they're much more solo entrepreneurs, individual people who basically now have access to tools in AI, access to loops, access to agents, access to ChatGPT to basically start a new business. And I am of the strong view that because of that, the labor market is actually benefiting from, if a fraction of all the new businesses that are creating at the moment, which by the way, is at the highest level ever in US history in the weekly data from the Census, we have never seen so many businesses being created as we're seeing at the moment. If a fraction of them are successful, they will also create employment. So if I didn't get a job at a bank or in consulting or legal services, why don't you and I coming out of college open a new business together? 100%. And that's become easier than ever before. So that's why I think that yes, there is a net displacement effect in particular in T marketers and others where people might be losing their jobs because of AI. At current rates, about 100,000 people are losing their jobs in T marketing, but at the same time, the net effect of that is relatively small compared to the hundreds of thousands of people who are basically out there inventing new things and coming up with new businesses. We get a much more dynamic capitalist economy as a result of AI, and we should all be very excited about this.
>> So let me go on a little bit of a tangent off of what you just said. So what you're, you're, you're saying is that the US economy is incredibly dynamic.
>> Exactly.
>> I, I would say the US, I mean, hopefully AI lasts, lasts forever and we're all great. But I mean, we'll be a year from now, you'll be back and we'll have another discussion about it. But as of now, the US economy, I, I would say is more dynamic than it's ever been in, in its history, or certainly for a very, very long time.
>> I agree. So I worked at the OECD in Paris, which looks at structural issues in economies. And they sometimes point out that the healthcare system has some challenges in the US. There's some other challenges with pensions and other things. But broadly speaking, the number one indicator in all OECD work that looks at what are dynamic economies is that is it easy to fire and hire workers? In France and Germany, it's incredibly complex to fire and hire workers. And the US has the most dynamic labor market. That's good. Of course, if you're an employer, and if you are a good worker in your job, it's actually also good for you and me. So in that sense, a very dynamic labor market is a critical part. A very competitive product market is a very critical part. And perhaps most importantly, a financial system that's willing to finance risk is also not what we have in Europe. Unfortunately, we don't have in Japan.
>> That's actually my, my, my tangent, which is you're starting to answer. So let me get my question in, which is, why is Europe so incredibly sclerotic in terms of its? I mean, it's, it's almost an embarrassment. I mean, I was looking at statist. I, I had a, um, a guest on, um, last year who wrote, I would recommend this book to you. It's called Kaput, The End of the German Economic Miracle by Wolfgang Munch. He's an excellent book, and and we're going to have him back on soon again. But I was looking at, um, so because of, I, I interviewed him and I read the book. I always try and keep up like, what's going on in Germany.
>> Yeah.
>> German GDP hasn't grown a dollar in like the last three years. This is like, what is going on in Europe?
>> Six months are going, unfortunately, further down. Negative.
>> So the answer to that question is exactly the things we just talked about, namely the three areas where Germany unfortunately still needs to do a lot of homework. Number one, it is still very difficult to hire and fire workers in Germany. It's hard to hire.
>> Also difficult to hire.
>> Why? Explain that to me. How, just mechanically, why would it be hard to hire someone?
>> Because if you, once you hire someone, if you turn out that you hired me for a job and you send, "Well, this guy is not really working," it's really difficult for you to get rid of me again.
>> Because then you need to go through, um, the trade unions, their organized systems. And France is the extreme of this case, namely, you can't even get on permanent contracts. You have to be on temporary contracts. That creates all these dual labor markets. Unfortunately, Europe and Germany and France are at the peak of this on, meaning in a bad way, that it's just become still very difficult, despite that we're sitting here in 2026, to hire and fire workers. That means that if you and I have a good idea and we want to open a business and we say, "Let's go out and hire some people to help us open this business."
>> We don't want to do it in Germany.
>> Reluctant to do that because you say, "If I hire this person, I can't get rid of them again. If we do see a slowdown in demand, right?" That's very different from the US. If we go out and hire someone here in New York City, well, if our business does great, we can go and hire a lot more people. We may have to pay for them. But if we have some problems, of course, then we have to fire these people quite quickly, and we can do that in the US. So the labor market is just very rigid. And the product market is also very rigid in Europe, including in Germany. There are issues, of course, also when it comes to product market competition. There we see as indicators comparing competition in the US relative to Germany and Europe, and it's also the case that it's not very competitive there. All kinds of monopolies, there are all kinds of problems with pricing, there's also all kinds of problems with tariffs. So a lot of things are also making product markets less competitive. And finally, financial markets. Unfortunately, to your point, if you think about the sclerotic situation in the US, sorry, European financial system, there are basically traditionally people talk about the European financial system as bank-based, and the US system is market-based. Correct.
>> And we want the European system to also be market-based because think about it, you and I, a company in Germany, we would like to borrow some money. We can go to a bank in Germany or in France, and we would like to borrow some money. And if they say yes, it's great. If they say no, we really have other places to go. But if you and I go to a bank here in Manhattan and say, "We'd like to borrow some money," and they say no, you and I will say, "Great. We have some good friends in venture capital. We have some good friends in private equity. We may have some good friends in private credit. We could also do an IPO. We could also do various things when it comes to borrowing in even secondary markets." So the financial system is just not very diverse in Europe, unfortunately. And that's a problem for Europe that they're still working on the Capital Markets Union on the financial system generally being able to provide more risk-wing capital the way that we have. Go to Silicon Valley, and you can get money for just a piece of paper on a very and simple idea. So that means that in the...
European situation, we just have unfortunately much more red tape, much more regulatory complex environments and the financial system is just not very good at allocating money to a lot of good ideas. And that's why unfortunately for the Europeans, a lot of Europeans go to Silicon Valley, come to New York City to basically say I would like to borrow some money here rather than borrow and do my little business in the Euro area. And then fortunately the consequence is that a lot of growth is literally all good ideas are coming to the US and that's what is the main problem there. Some ideas and some corners of Europe is moving a little bit in the right direction. But the big answer to your question is that it's difficult to hire and fire. The product markets are not as competitive as in the US and the financial system unfortunately is not as diversified. It doesn't provide the same type of resources available to people who have a good idea like we have in the US.
>> Do you think there's a growing recognition in Europe that this is a problem or not really?
>> So the drugy recommendations.
>> Okay. So I I'm going to challenge you on that. Okay. So, so before I I found Wolf Gang last year,
>> I when I was starting my podcast, I took out a piece of paper and I and I wrote down all the topics I want wanted to do on my podcast. And one of them was why is Europe so bad? Yeah.
>> And so then I started looking around for for something to read and um friend of mine put me on to Mario Draggy's white paper. So I it's 100 pages long.
>> Yeah. and I started to read it and by the time I got to page 10 I was asleep because he his his paper basically said we have a problem but I don't want to upset anybody about and talking about the problem and and so I said this is ridiculous and eventually I found Wolf Gang's book which which I much more helpful so if if that's what everybody points to is the draggy white paper it's hopeless.
>> I know he did so he was commissioned to write a white paper or a report and say what do we need to see can you come with some specific policy proposals and he came with basically 200 different things that he wanted to see changed so that's why there are now institutions including bugal in Brussels which is a think tank basically similar to Brook kings in DC and they basically tried to track of all the things that he suggested now they're almost two years ago how many of these things have been implemented and the answer is this is now two years ago and of all his proposals only 10% in round numbers have been implemented so yes it is it's not quite falling asleep, but it really the speed with which the Europeans are moving. So, I both have a European and US passport to be clear, but the speed with which the Europeans are moving is just not very impressive and it's not helping themselves.
>> They're not panicked.
>> They're not helping themselves that they're not doing their own homework and it's very unfortunate because they absolutely need especially with this new situation that China is also leading on AI and that's beginning to become an issue also of course for the sector. Absolutely. And that's why if you now have that anyone who has an AI and D idea in Europe actually goes to the US then again they're not helping themselves. I think they are waking up a little bit. Of course they woke up a lot on defense for a number of different reasons but I think they're also beginning to wake up more on AI. But that's why from an Apollo perspective, we need financing, a lot of strategic financing for the industrial renaissance, not only the US, but also in the European case for defense, for infrastructure. Exactly. For data centers, for things that require financing to make sure that Europeans also can catch up and continue to be competitive in the global economy.
Let's switch gears one more time. Let's talk about the US deficit. So I have my own views about this but I'd be curious as to yours which and let me just intro in introduce the concept in this wonderful deck you point out that uh federal US debt to GDP is around like 100% or so when it's going to 175%. You know when you watch CNBC not a week goes by that somebody doesn't come on and and does what I like to call virtue signaling when it comes to the deficit. Meaning I am so against the deficit. your guest last week, he said he was against the deficit, but I'm much more against the deficit than him. And and and each each guest strings out this um disaster scenario, which by the way, Pete Peterson strung out 40 years ago.
>> Yeah.
>> So,
>> what's fact, what's fiction? What do you think? What's really interesting about that discussion is absolutely we have an enormous budget deficit and of course we have significant deficits every year. The government deficit at the moment is about 5%. And we have debt levels that of course continue to just go up literally since 1776. We are entering a period where we'll have the highest level of debt for the government ever. I mean in US history. So let's just start out by concluding that the trend in this is not our friend. This is a major challenge. So now this becomes important because the question is of course well why are interest rates then still so relatively low?
>> Yes.
>> And the answer is that the rest of the world is still buying a lot of US assets. Importantly, they're still buying a lot of US treasuries. The rest of the world, by the way, is also still buying a lot of US credit. And the rest of the world is also still buying a lot of US equities. And why is that? That's because, back to what we spoke about before, if you are a pension fund in Europe, you have to be invested in AI, you must be invested in the US. So, pension funds in Europe have significant allocations in dollars to US AI. If you are pension fund in Europe, you see your own interest rates at relatively low level. You see higher returns in the US. you again say I got to also allocate more to the US that also helps finance US deficits because the level of interest rates is simply higher in the US than it is in all European countries. So the reason why this is still able the government is still able to finance the deficit is that there is an incredible willingness especially among foreigners to still buy US government debt and buy US credit and also buy US AI meaning stocks and other products of course that gives you AI exposure. The first answer to your question is there's a remarkable willingness especially among foreign investors are buying US government debt because the low interest interest rates is higher and that's of course helping when you want to cut coupons and you are a pension fund or insurance company in Japan in Europe in Taiwan and of course also in Canada. So now here's the other side of the problem. If you look at the domestic investors
>> I haven't heard a problem yet. I've I've only heard that it's not a problem.
>> So far we have the foreigners are happy to come to the US with money. But the problem now is in the US that there are two problems. Both when it comes to institutional demand for treasuries and also when it comes to retail, meaning household demand for treasuries. Remember, normally if you are a pension fund and insurance company in the US, you would have some 30-year liabilities. You need a 30-year asset. Historically, you would say, "I'm buying US treasuries because that matches my 30-year liabilities in my insurance company." But today, insurance companies and pension funds are not buying US treasuries. They are buying privately issued long-duration assets. They're buying privately issued long-duration as in data centers, infrastructure, climate, energy transition, you name it, long-duration assets that have a better risk return profile. That means that from an asset allocation perspective, pension insurance in the US has been moving towards privately issued long-duration assets instead of buying long-duration US treasuries. That's a challenge. That's a headwind. That's why the of course market is worried about that the Treasury and the Tback, the Treasury Bing Advisory Committee is at risk that if they issue more long-duration assets, then there will not be enough demand. So that's the institutional side has been switching towards privately issued long-duration assets and the retail the household side has been also switching in the last several years away from instead of buying long-duration US treasuries in ETFs their flows have continued to go down instead households are now buying money market funds and short duration government bonds so that's another way of saying why do you think that is
>> because the yield curve is a lot flatter now and you suddenly get a very high return when the Fed keeps rates higher for longer
>> in other words you're getting enough and the short end of the curve if you're a household. Why do I need to buy something 30 years out?
>> And and in response, the Treasury both under Janet Jillen and under Scott Besson have been issuing much more T bills because hey, now there's all this demand from households to buy short duration assets. So that's why now households are willing to cut coupons in the very front end. So there's a different way of saying in summary that for a number of different reasons, there's less appetite for the long end from institutions because they're now buying other privately issued long-duration assets. And there's also less demand from households because I get less out of buying long duration US treasuries. If I can cut coupons in T bills, that basically gives me a return that's also quite decent. So that's why the challenge at the moment is that when the debt level continues to move higher and higher and higher, we run into the risk of course that at some point then the Treasury needs to think about where on the curve are we issuing and there's just less and less institutional demand in the long end, less demand from households in the front end. It's only really the foreigners that have been holding up demand in a very substantial way. Especially private investors, foreigners have been kick cutting coupons and putting money into the front end. So that's why if you segment who the different players are in the treasury market, it used to be that it was China which was not interest rate sensitive but all these entities namely foreigners and institutions and households they are very interest rate sensitive. So we have a situation where you could worry about a spring coil effect where everyone is saying great rates are high, rates are high, so now I'm plowing money into treasuries. But if the Fed succeeds with cutting rates a lot, then foreigners might not be buying so much, households might not be buying so much. And suddenly the interest rate sensitivity will become a very important part of why there is a risk that the US government deficit cannot continue and the US government debt level can continue to be at these very very high levels.
>> How worried are you about this
>> at this point? Because the AI boom continues and at this point because rates are higher for longer and the Fed is about to hike rates. I'm not worried about this. Definitely not this year. But I am worried about the dynamics that we have shifted from Chinese being not an interest rate sensitive buyer to now having these different groups of much much more interest rate sensitive buyers. And by the way, the basis trade and hedge funds have also been benefiting a lot of course from some of these developments. That also means that if these new entities or buyers suddenly are much more interest rate sensitive. If we do get a situation where the Fed will have to cut rates dramatically down to zero, then suddenly there might be much more risk involved with treasuries because now we suddenly have a much bigger group of investors who are much more interested in what is actually the yield that I get on this investment that I that I'm doing relative to when it was China where it was purely done for FX reasons to protect the exports and not so much with consideration to what the level of interest rates were at. So the answer is I'm not worried about that over that the next several years I still think we'll be okay but it's very clear that the trajectory that we are on as J Palway always was saying and Jenna and Benanken that is an unsustainable trajectory and at some point this will come home to roast and be something that's important for financial markets but we're just not quite there yet. Let's just quickly about China and then about big risks. Um is there any risk that China ever dumps treasuries?
>> Well the issue of course is that this has been getting a lot of attention. China used to have at the peak $1.3 trillion in US treasuries. Now they're down closer to around 700 billion. So China has already been offloading treasuries over the last 5 years. So there's already a development where China is more gradually lowering their holdings of treasuries for a number of different reasons. Now they have less trade directly with the US. They trade more with others which is not in dollars. So there's a number of different dimensions to why that's been happening. But in short, if they were to do that, the risk of course would be that the US economy, if you really saw a significant spike in long-term interest rates would begin to slow down very very hard. And if this slowdown would be very hard in the US economy, that will also begin to hurt therefore Chinese exports to the US. So that's why they are probably having a strategic consideration. Yeah. Because they don't want to slow their own economy. They still depend importantly on exports to the US. although they have been diversifying away to Europe and other emerging markets then they are generally not interested in slowing and crashing the US economy because that would also result in much less demand from you and me and others in the US buying Chinese goods. So I take that they're probably trading very carefully when they think about how they want to think about that topic.
>> Okay, let's just finish up with from an economist perspective what do you think the biggest risks in the market are?
Well, I think one thing that is very important in markets at the moment is that AI has absolutely turned out to be almost everywhere. If you and I think about the 6040 portfolio and I think about 60% equities, 40% fixed income. Let's talk about what is in my equity first. Well, the S&P 500, the 10 biggest stocks now make up 42% of the index. So, let's just agree that returns for the last 5 years, basically half of it has been coming because of AI. So AI plays a very important role in my returns in equities have played for the last several years and at the moment have such a big weight that it continues to be a huge bet if I put money into the S&P 500. So the first conclusion is let's just agree there's one factor playing out in AI is the key factor in equities. But even now in fixed income in credit because the hyperscalers are issuing so much debt that means that the IG index is changing. It used to be that IG was government bonds. IG is investment grade
>> investment grade credit and it also used to be banks. Those were the two main components. There's also a little bit industrials but mainly banks and also government bonds but now there's a new player in investment grade credit and that is hyperscalers that are issuing $700 billion in debt this year. That means that AI is suddenly also becoming a very important part. So that means that in my 40, not only do I have a lot of AI in my 60 in my 6040 portfolio, but I also have a lot of AI in my 40. And finally, if you and I also put money in venture capital, venture capital used to be pharma, biotech, prescription drugs, new medical products, but now 87% of venture capital is also AI. So now I wake up in 2026 and I look at my 6040 portfolio or 60
>> 6040.
>> It's it's I mean it looks 60/40,
>> but it's basically all AI in my equity portfolio. It's a lot of AI in my fixed income portfolio. It's also AI in my venture capital portfolio.
>> So AI better work.
>> This AI, I think, better work out. it better work out
>> because if that doesn't work out then your portfolio will be in trouble. That's why ironically the best investment recommendation today is the new 6040 is really to do 60 maybe AI and 40 non AI. So in other words, the best recommendation for investors is to invest in nonAI things that are not correlated with this one factor. Because if there's one thing we have learned in finance since the financial crisis is factor investing, you don't want to be exposed just to one factor. And at the moment there's one factor staring all of us right in our eyes and that is AI is literally everywhere. And that's of course means that value investing, which you will appreciate more than anyone else, is actually superior because I'm already exposed to AI everywhere. But the problem with that thesis, which is wonderful, is that all the stuff that you would want to that you like if we drew up a list like what can I invest in that's not correlated and then I look at the chart of those things, the chart looks terrible of every single one of those things. It's like hasn't moved in years like consumer staples for example
>> 100%. But that's exactly why those things haven't moved for years. But if you now are going to see back to our token discussion and demand for comput and data centers and if you if there truly is no mode as you were saying of course then we will have some problems in the AI world and if that's the case then of course these things are about to take off like a rocket because then investors will be saying I got to buy something
>> I got to buy something else which is not this thing that is the one factor that is now the biggest risk. this I to be sure large language models I have seven on my phone they are incredibly helpful they will change your life my life is changing all of our lives but that's not the same thing as saying that the revenues that are coming in for the AI firms is going to come at the speed that is priced in markets today
>> right
>> okay Torson thank you very much we'll have you back
>> thank you and we're back so I thought one of the first interesting things that Torston said is that this year GDP will grow a little bit more 2% and if you divide it up 1% of that 2% comes from AI spending 3/10en of 1% comes from the re-industrialization and onshoring and 90 basis points comes from the consumer getting a lot of money back from tax refunds from the big beautiful bill actually raises an interesting issue in that those tax refunds won't exist next year so you know the base of GDP growth um will be sub should be sub 2% in 2027 unless something else happens. You then we started talking a lot about AI and the dramatic impact it's had on the US economy. We then move to how dynamic the US economy really is that interestingly enough despite all the you know news stories that you hear about people losing their jobs the unemployment rate is actually still excellent. Job creation is very very strong and job creation is actually very very strong statistically amongst young people which belies the stories that that you hear about. So the US economy is is very dynamic. It's still growing but it's unbelievably AI dependent and you know we talked about some of the bare case stories of AI which are that it's become more capital intensive. There are potentially no moes and these are things that everybody should keep in mind about future risks. Then we moved on to Europe where Torson basically agreed that Europe is sclerotic and nothing's going to change anytime soon. And we ended up with an interesting comment from Torson about investment risks that people think that they're diversified because they have 60% of their money in equities and 40% of their money in debt. And what they're missing is that of the 60 because the large companies now make up 40% of the S&P and so much is AI related, if you own the equity markets or own the general indexes, you are very heavily AI indexed. And then on the debt side, you would normally think that would be diversification, but because of all the debt being issued by AI data centers, debt is now becoming overindexed to AI. So people are incredibly overindexed to AI. This AI story better work because if it doesn't work, the losses that people are going to experience are going to be mammoth. And I think that was the concluding message that I wanted to bring home. Thanks for watching. See you soon. This podcast is for informational purposes only and does not constitute investment advice. The hosts and guests may hold positions in stocks discussed. Opinions expressed are their own and not recommendations. Please do your own due diligence and consult a licensed financial adviser before making any investment decisions.