AI Dominates Economy and Markets with Torsten Slok | The Real Eisman Playbook Ep 68

Hi, Steve Eisman here. On my weekly wrap, I try to both teach and convey information as objectively as possible. But in today's media, on any important story, if I read about it in a newspaper with a leftist slant, I'll get one depiction of the story, but if I read about it from a more conservative publication, I'll get a very different take. What's the news and what's opinion is increasingly hard to differentiate? That's why when I look into news events, I first go to ground news. Ground news is my solution for getting to the facts of important stories, but also to see how left, right and center are seeking to convey the same exact story. Take, for example, the headline, Trump Treasury Secretary calls for single stock trading ban in Congress. To understand the story, I went to ground news.com and clicked on that particular story headline. There, I immediately saw four tabs, left, center, right, and bias comparison. When I clicked on the center tab, a series of headlines appeared all from center-leaning sources. I could then click on any of those headlines and read the story at the source. The same happened when I clicked on the left tab and on the right tab. The bias comparison tab showed ground news on analysis of how all three political leanings convey the same exact story. I find the ground news system enormously helpful because it allows me to easily separate the facts from opinions. I use ground news and I recommend you try it out. Go to ground news.com/real to get 40% off their unlimited access vantage subscription. That's ground news.com/real. Ground news.com/real. And if you don't mind, use this link to get the discounts they know I sent you. 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-currents, politics, war. But from an economic perspective, I think the biggest issues are the impact of AI, the industrialization, short-term, the so-called big, beautiful bill, unemployment, the deficit and the overall investing environment. These are major issues. We've actually never had an economist on to plow through all of them. Today, I've invited Torsten Slok, who is the chief economist of Apollo, an excellent economist. We're going to go through a ton of issues. 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. There's so much going on these days, AI, K-shaped economy, oil prices, the deficit. It's just hard to keep up. Today we have, as our guest, chief economist of Apollo, Torsten Slok, who's going to help us, I hope, I certainly hope to go through what must be like every day you can't believe how much information is coming. It's a Torsten 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. And that will dig deep. Well, thanks again, first of all, for having me. But it's really quite simple initially. What is the hit wins and tail wins through the economy at the moment? Because there are three very important tail wins 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% is point to GDP growth. Normally, GDP growth is 2. And now 1% is coming from the AI spending boom at loans. So in other words, GDP growth this year, US may be up to about 2 and 50% of it is purely for may I spend? Absolutely. So that's both the boom coming from the data center and energy build out, but also the associated wealth effects from the stock market being high and increasing 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% is 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 of production of semi-contact justice for us to tip-sack on the Biden, home-shoring of pharmaceuticals, prescription drugs, and of course, importantly also home-shoring and production of defense. I've had industrial economists on and when I would ask them is their evidence that of this, in other words, people building factories in the United States, their response generally me. That was literally, so you're saying it's stronger than air. It is a bit stronger than air. It only adds 0.3% to the piece or 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 semi-contactors 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 air, but it's not as big a source of growth compared to the AI spending boom. So 1% from AI 0.3% in reindustrialization. Exactly. From the globalization of grossing. That's out of two. 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? Lower taxes retroactively for consumers so that taxes were lower starting January 1, 2025. The consequence of that is when people are filing their taxes this year, both those who did in April, those who had an extension. 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's one time. That is indeed one time. So here we've made 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 reindustrialization is about 0.3 and 0.9 from the one big, beautiful bill. You get to a little bit more than 2% this year. 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 success 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 along in the view curve. But at the moment because these sources are not sensitive to interest rates, that's why Kevin Worsh 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 interest rates and strong tailwinds coming from the one big, beautiful bill. Okay. So since you brought up Worsh, let me press Worsh a little bit. Given all what you've just said, would you agree that the probability of the Fed cutting rates is 0? Yes. Zero. Zero is 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 strong, also because of tariffs, also because of course all the 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 build out because semi-contactors 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 little zero chance that he will cut interest rates this year. How about raise them? Well the market as we speak today pricing that the Fed will be hiking rates in September and in December so that's two hikes. Wow. So that's pretty shift. That's very dramatic shift as you and I know very well in the beginning of the year that 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 will maybe, especially after his latest press conference where he said, I'm not going to give any forward guidance. And we don't give forward guidance. The market has to start guessing and that's why you and I and I are 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 worse to cut rates over the next six months. It sounds like that's pretty bad for housing. Well because housing and not that housing is so good right now either. You were 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 pillars 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 all those 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 investor of any sense. 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 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. I would say it's a long two- factors. One, and this is what I'm curious with what you think about. Number one, this is now a very capital intensive business. 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 modes in this business, that 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 modes. And that's not a recipe for longevity. So I'll be curious what you think about that. So absolutely on the first point, if you look at the free cash flow for the hyperscalers, 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. Right. Because the capex requirements and it's 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 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 build out. Because they really view this clearly as existential that they got to have the capacity, the computing power that is 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 modes, let's assume that there were very high modes. And 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 money because at the end of the day, you're going to have a business that's a duopoly or a very well protected. But if you're asking me to give you money for a business that has no modes, I want to give it to you. I'd rather I'd rather biceps go that's going to supply you is the analogy that I've drawn is it's kind of like comparing airlines to trans dime. Airlines, the terrible business because it's very capital intensive and you have no pricing power. And trans dime, which supplies parts to airlines is a great business. So I'm just curious as an economist, if I'm right, what does that mean? What's exactly most important about this discussion is exactly are there no modes for everyone? Or is it just modes for someone for the hyper scalars? There could be smarter hyper scalars that will end up being the winners and others who will end up not being the winners. In other words, there are clearly modes in the sense that there are some, including of the private hyper scalars 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 capacities that's being rolled out. Is that all going to have modes? 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 could 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 modes that might be a lot more shallow or match me much smaller. Let's imagine that one of the companies that has no modes is ChatGPT, OpenAI, just hypothetically. I've got no skin in that game. 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 Thropic, or 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 mode 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's 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 mode over here and for the fact that this is a good service because this is a US service rather than running a risk of doing this inside an open source model or in a Chinese model. So from that perspective, there is some unique characteristics by the US hyperscalers, redsives 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 think that when they throw the term out there, 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. 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, reds to 2019, have literally savings that are trillions of dollars higher than where they were in 2019. Trillions, about one and a half trillions of 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 you're saying is people 25,000 below have no more savings than that in 2019. And people at the upper end have truly in a half more savings. Yes, 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 upper end also own fixed income. So when the Fed still has interest rates high and still talk 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 it's 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, 9, 10%. And those returns you can get in private credit, public credit, fixed income is basically at the highest level we have seen literally in 20 to 25 years. So for that recent high income households continues 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-shape situation and that continues to the legs are just getting longer in the case, if you will, because the stock market obviously continues to do well and the cash flows continues to also do well. There is now also a k-shape 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 rates to people that are in the middle and the high income distribution. So that means that the k-shape situation is not only in wealth, it's also in income growth. And finally, there's also a k-shape situation when it comes to inflation. The New York Fed has measures for inflation across income distribution and people at the bottom of the income distribution that's paid 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 relative to people at the top and in the middle. So from that perspective, the answer is there's a k-shape situation for wealth, there's a k-shape situation for income growth and there's a k-shape 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 with cater to high income names continue to outperform discount retailers. So that's why the k-shape 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 flip it flip in one day. So this is long term. Absolutely, the net effect of the k is that in aggregate, the top 20% of consumers day 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 red book for same-store retail sales, so that meaning red book goes out a week, once a week and ask 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-gating water and water, you're still seeing an aggregate because the bigger part of the case still has such a big weight that in aggregate, the consumer section is still doing well. So that's why the answer to your question is, if the k continues, it almost instead becomes a political discussion. Even what does it mean when you have a bigger and bigger share of the lower leg of the k that continue to face hit wins. 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 link is in the description. which 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 the distribution that also are facing higher interest rates because they have this problem that they have now also not only a k-shape situation for wealth and income and inflation, but also because of this issue that the language rates are going up, especially for people in the middle and the bottom of the key. 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 upside-down side, but what is exactly the outcome when you have that the k-shape situation is unfortunately continuing? Let's switch to private credit. Steve Eisman here, starting something new isn't just hard. It's terrifying. So much work goes into this thing that you're not entirely sure will work out and it could be hard to make that leap of faith. Trust me, I know. But now, I know that I was right in believing in myself and launching my podcast business. Despite all the fears and hesitations, it also helps when you have a partner like Shopify, I'm your side to help. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the US from household names to brands just getting started. Accelerate your efficiency, whether you're uploading new products or trying to improve existing ones. Shopify is packed with helpful AI tools that write product descriptions, page headlines, and even enhance your product photography. And did I mention that iconic purple shop pay button that's used by millions of businesses around the world? It's why Shopify has the best converting checkout on the planet. It also helps boost conversions, meaning less carts going abandoned and more sales for you. It's time to turn those what ifs into with Shopify today. Sign up for your $1 per month trial today at Shopify.com/Eisman. Go to Shopify.com/Eisman. That's Shopify.com/Eisman. When my kids were little, I woke up one morning in a pack. I realized that if something happened to me, my family would be completely unprotected. I immediately went out and got life insurance so that my family would be financially secure and I have never regretted that decision. Stop procrastinating. Fabric by Gerber Life makes it so quick and easy to make sure your family has more financial protection this year. Fabric by Gerber Life is term life insurance. You can get done today, made for busy parents like you, all online on your schedule right from your couch. You could be covered in under 10 minutes with no health exam required. If you've got kids and especially if you're young and healthy, the time to lock in low rates is now. Fabric by Gerber has partnered with Gerber Life, trusted by millions of families like yours for over 50 years. There's no risk. There's a 30 day money back guarantee and you can cancel it any time. They have over 1,905 star reviews on trust pilot with a rating of excellent. Join the thousands of parents who trust fabric to help protect their family. Apply today in just minutes at meetfabric.com/Eisman. That's meetfabric.com/Eisman. M-E-E-T fabric.com/Eisman. Policies issued by Western Southern Life Assurance Company, not available in certain states, prices subject to underwriting and health questions. Talk to me about from an economist perspective, what does the growth in private credit mean or not mean? And what do you think of the over indexing of private credit to software? So let's back up and take about exactly why private credit and why the financial system has changed so much since-- 10th of crisis. Because, dot-fring, 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. What are the consequences of this? Well, where we sit right now, if I just back up and you asked me as a macro economist, 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 the stress 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 in distress. Why don't you instead give me some equity in your business? Why don't we extend the maturity of the loan? Let's make it the 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 the fall rates are going down. Distress exchanges are going down. L and M's are going down. So what is the problem in credit? In this case, exactly through your question, the problem is in credit that there are some success in credit that have much higher leverage and much lower coverage ratio. And one sector that after this stands out is just for viewers. Because that everybody knows what is coverage ratio means. 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 success in credit or really all success 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 equity and credit to understand these sectors highly leveled, are they able to pay their debts, where are their coverage rate, where there's 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 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 this year. And so the coverage ratio is deteriorating. So the coverage ratio is deteriorating because these companies aren't, unfortunately, not being helped by the fed hiking rates. So that's why I view 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 for 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 ventures in software were originated in 2021 and 22. And a lot of these ventures have a seven-year maturity on that 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 2020, 2027. A little bit, but most of it is 2020. 28 and 29. So that means, if Kevin Walsh is not lowering interest rates before we get to 2028, these companies will have significant problems rolling over that 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, this sexist that have a lot of debt and the sexist that have a little ability to service that debt will continue to struggle and software unfortunately stands out as the number one sexist that's vulnerable in that environment. So that's why yields on loans in software continue to trade higher and higher. At the moment, you and I can take $100 and put into software loans and get 12%. If we buy it in the open market-- If we buy it in the open market-- Because it's a sound head less than par. Absolutely. So if we buy it 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% and a half percent 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 that debt. Then they will be facing significant hit wins. It's a double way 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 that debt. So the bottom line is there is one sector. And in particular, that sector alone-- there's also some parts of health care, 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 it's 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 broad-speaking, is actually in good shape, exactly exemplified by the fact that the fall rates are going down, just restricts, changes are going down, and enemies 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, is that my. And, in other words, for the people who made these loans, God help you. Exactly. But would you agree that for the implications for the US economy overall are not so bad? Yeah. Because what's also important back to this, up-prime crisis, and again, you know, much better than anyone, is of course that it all becomes a question of where these loans located. Right. Are they on very live-out balance sheets? And the general is speaking, the banking sector, of course. And as you know better than anyone, was like live-out 20-30 times at the time in the TFC? 40. In some cases, 40. And of course, now you have the BDCs. By law, I only live up twice. 2-2-1. 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 top prime was located in balance sheets that had to do live-out very, very quickly. Right. 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 a, of course, it's a huge number in some time mentions, but from a macroeconomic perspective, a 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 2007. So I actually think the software story is even worse than what you're saying, not from a macro perspective, but just from a micro perspective. In the sense that if you look at any all the public software companies, like Salesforce, ServiceNow, they're down 50, 60% 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 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 will 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 it's private credit in software, it's in trouble. Then, of course, private equity in software is almost an even more trouble. Let's move on to just general employment. How'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, 10, 20%. People freaking out. All losing our jobs. Right. But they're 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. They want big bill for bill and industrial re-enhanced. 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, 2023 and 2024 that net immigration legal and illegal into the US was three million people came in every single year to the US. Now three million. Three million people every single year. Right. 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 three million coming in every year, non-farm payrolls has dropped from when it was three million. It was 200,000 every month. Now they're breakeven for non-farm payrolls according to the data spent is 30,000. In other words, at 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. OK. So that's why the legal market is actually in really, really good shape, which is likely also again, back to the recent white Kevin Walsh and the FMC is worried about maybe they have to hide rates. It's because there's not only inflation is three, three and a half, but it's also the fact that we have a legal market that 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. He's beginning a lot of attention that young people can't find a job. No, it's hopeless. It's hopeless. This is the anecdote in the urban myths, 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 there are much more solo entrepreneurs, individual people who basically now have access to tools in AI, access to loops, access to agents, access to chat GBG, 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? We'll start something. 100% and that's become easier than ever before. Right. So that's why I think that yes, there is a net displacement effect in particular in telemarketing as another where people might be losing their jobs because of AI at current rates, about 100,000 people are losing their jobs in telemarketing. 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 saying is that the US economy is incredibly dynamic. Exactly. I would say the US, I mean, hopefully AI lasts forever and we're all great, but I mean, a year from now you'll be back and we'll have another discussion about it. But as of now, the US economy, I would say is more dynamic than it's ever been and it's maybe in its history or solely for a very, very long time. 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 work at 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. Right. And the US has the most dynamic labor market. That's good, of course, if you're an employer and if you are 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 any kind of. And actually my tangent, which is a US starting answer, so let me grab my question in. Which is, why is Europe so incredibly sclerotic in terms of its. I mean, it's almost an embarrassment. I mean, I was looking at. I had a guest on last year who I would recommend this book to you. It's called Kaput, the end of the German economic miracle. By Wolfgang Wunscher. He's an excellent book. And we're going to have him back on soon again. But I was looking at. So because I interviewed him and I read the book, I always try and keep up what's going on in Germany. German GDP hasn't grown a dollar in like the last three years. This is. What is going on in Europe? Six months are going unfortunately further than. 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. Is it a part of hire? Also difficult to hire. Well, it's fine that to me. It just mechanical. So why would it be hard to hire someone? Because if you want to hire someone, if you turn out that you hired me for a job and you stay. You stay. Well, this guy is not really working. It's really difficult for you to get rid of me again. Right. Because then you need to go through Ike-Metal, the trade unions, the 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, meaning in a bad way. That is just become still very difficult. Despite that, we're sitting here in 2026 to hire and fire workers. That means that if you want to 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 for us. We are not in to do that because you say, if I hire this person, I can't get rid of them. Again, if we do see a slow down in demand, 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 on high 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 was this indicator of comparing competition in the US, relative to Germany and Europe. And it's also the case that it's not very competitive. There are all kinds of monopolies. There are all kinds of problems with pricing. There are also also 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 stick 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. Yes. 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 are company in Germany. We would like to borrow some money. We can go to a bank in Germany on France and we would like to borrow some money. And if they say yes, it's great. If they say no, we really have men on the other places to go. But if you and I go to a bank here in Manhattan and say, well, I should borrow some money. And they say, no, you and I would 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. OK. We could also do IPO. Right. 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 market union on the financial system, generally being able to provide more risk-willing capital. The way that we have go to Silicon Valley and you can get money for just a piece of paper on a very 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 pay. I would like to borrow some money here rather than borrow and do my job. in 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's some ideas and some corners of Europe is moving a little bit in the right direction. But the big answer to the question is that it's difficult to hire and fire. The product might as well not as competitive as in the US and the financial system, unfortunately, it's 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. - Hi Steve Isom here. Some are always changes how I get dressed. I want pieces that feel lighter and more breathable. Things that are easy, but still put together. That's why I keep coming back to Quince. They focus on high quality essentials that feel and look amazing. Think breathable, linen and soft organic cotton. Well made basics, but without the luxury markup. It's that rare balance where everything feels elevated, but still effortless. Everything at Quince is priced 50 to 80% less than similar brands. They work directly with ethical factories and cut out the middlemen. So you're paying for quality, not brand markup. Recently, I bought a gorgeous blue linen shirt and a super comfortable Terry cloth sweatshirt and I'm wearing that right now. And I love them both. Elevate your summer wardrobe, go to quince.com/eyesbin free shipping on your order and 365 day returns. Now available on Canada2. That's quince.com/eyesmin. Q-U-I-N-C-E dot com slash aismen for free shipping and 365 day returns, quince.com/eyesmin. Do you think there's a growing recognition in Europe that this is a problem or absolutely? Not really. So the drug recommendation-- OK, so I'm going to challenge you on that. OK, so before I found Wolfgang last year, when I was starting my podcast, I took out a piece of paper and I wrote down all the topics I wanted to do on my podcast. And one of them was, why is Europe so bad? And so then I started looking around for something to read. And friend of mine put me onto Mario Draghi's white paper. Yes, exactly. So 100 pages long. And I started to read it. And by the time I got to page 10, I was asleep. Because his paper basically said, we have a problem, but I don't want to upset any party about-- and talking about the problem. And so I said, this is ridiculous. And eventually I found Wolfgang's book, which was much more helpful. So if that's what everybody points to is the Draghi white paper, it's hopeless. I know. 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 Brugel and Brussels, which is a think tank, basically similar to Brookings 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 the his proposals, only 10% in round numbers have been implemented. OK. 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 a 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 panicking about it. They are not helping themselves. 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. And they're nowhere. Absolutely. And that's why if you now have that anyone who has an AI and the 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 that it also begins 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 of any sense, 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. And let me just introduce the concept. In this wonderful deck, you point out that federal US debt to GDP is around 100% or so when it's going to 175%. When you watch CNBC, not a week goes by, that somebody doesn't come on and does what I like to call virtue signaling when it comes to the deficit. Meaning, I am so against the deficit. You were a guest last week. He said he was against the deficit, but I'm much more against the deficit than him. And each guest strings out this disaster scenario, which by the way, Pete Peterson strung out 40 years ago. Absolutely. 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 a significant deficit 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 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 and dollars to US AI. If you are pension fund in Europe, you see your own interest rates are 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 to come on 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. So the first answer to your question is there's a remarkable willingness, especially among foreign investors buying US government debt because the level of interest rates is higher. And that's of course helping when you wanna cut coupons and you are a pension fund on insurance company in Japan, in Europe, in Taiwan, and of course, also in Canada. So now here is the other side of the problem. If you look at the domestic investors, I haven't heard a problem yet. I've already heard this. It's not a problem. So far, we have the foreigners 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-alibalities. You need a 30-year asset. Historically, you would say I'm buying US treasuries because that matches my 30-alibalities 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, any decision, 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 hit when that's why the, of course, market is worried about that the treasurer and the tea pack, the treasurer's buying a 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 going bonds. So that's another way of saying, why do you think that is? Because if you'll curve is a lot flatter now and you suddenly get a very high return when the Fed keeps rates higher for longer. So in other words, you're getting enough at the short end of the curve if you're a household. Why do I need to buy something 30 years out? And in response, the treasury, both under Janet Gillan and on our Scarpessen have been issuing much more teapots 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 and teapots 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 high and high 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. There's only really the foreigners that have been holding up demand in a very substantial way, especially private investors, foreigners have been 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 wear about a spring coil effect where everyone is saying great rates are high rates are high. So now I'm applying 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 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 of buyer 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'm doing relative to when it was China, where it was purely done for FX reasons to protect their exports and not so much with consideration to what the level of interest rates were at. And so I'm not worried about that over that in the next several years, I still think we'll be okay, but it's very clear that the trajectory that we are on as Jay Powell always was saying in Janet Dela and Penanke, 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 so quickly about China and then about big risks. 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 close to around 700 billion. So China has already been offloading treasuries over the last five 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 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. Consider it careful. 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 think 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 60, 40 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 five 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. Right. 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 hyper scalers 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 credit. And it also used to be banks. Those were the two main components. There's also been industrials, but mainly banks and also government bonds. But now there's a new player in investment credit and that is hyper scalers that are issuing 700 billion dollars 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 60 40 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 farmer, 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 60 40 portfolio or 60 20 2040. And it's not 60 40. It's, I mean, it looks 60 40. But it's basically all AI in my equity portfolio. Right. And my fixing portfolio is also AI in my venture capital. So AI better work. This AI think better work out. Better work out. Because if that doesn't work out, then your portfolio will be in trouble. That's why I run into the best investment recommendations today. It's the new 60 40 is really to do 60 maybe AI and 40 non AI. So in other words, the best recommendation for investors is to invest in non AI. 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 running our eyes and that is AI is literally everywhere. Everywhere. And that's of course means that value investing with 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, that use, 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. This like has been 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 compute 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 else, which is not this thing that is the one factor that is now the biggest risk. So this, I, to be sure, last 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. Torsten, thank you very much. It was very interesting. Well, I'll be back. Thank you. And we're back. One thing things that Torsten said is that this year GDP will grow a little bit more than 2%. And if you divide it up 1% of that 2% comes from AI spending. Three tenths of 1% comes from the reindustrialization and on-shoring. And 90 basis points comes from the consumer getting a lot of money back from tax refunds from the big, beautiful bill. It actually raises an interesting issue and that those tax refunds won't exist next year. So the base of GDP growth should be sub 2% in 2027 unless something else happens. Then we started talking a lot about AI and the dramatic impact it's had on the US economy. We then moved to how dynamic the US economy really is that interestingly enough, despite all the new 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 you hear about. So the US economy is very dynamic. It's still growing, but it's unbelievably AI dependent. And we talked about some of the bear case stories of AI, which are that it's become more capital intensive. There are potentially no votes. And these are things that everybody should keep in mind about future risks. Then we moved on to Europe where Torsen basically agree that Europe is sclerotic and nothing's going to change anytime soon. And we ended up with an interesting comment from Torsen 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 as 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 over indexed to AI. So people are incredibly over indexed 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. [Music] This podcast is for informational purposes only and does not constitute investment advice. A host and guests may hold positions in stocks discussed, opinions expressed on their own and not recommendations. Please do your own due diligence to consult the license financial advisor before making any investment decisions. [Music]