Speaker 1Welcome to the Excess Returns Weekly Wrap. I'm Jack Four Hind. And given all that's going on in the economy, Matt, and given the clips we've got today, I'm going to avoid even telling a bad joke at the beginning. We're just going to get right into the clips.
Speaker 2Don't tell any bad jokes at the beginning. If you're watching because you're taking care of your own money, your client's money, or any mix of the two, we've got clips for you. You have a lot of conversations. I know I'm having a lot of conversations. These are the weeks where the normal amount of conversation volume goes from the steady background, regular few things a day to like overdrive. So hot tin roof is the vibe I'm coming in on this one with you.
Speaker 1Yeah, obviously a rough week for the market. We'll see. We're taping this on Friday. It seems like it might open up a little bit, but I can imagine this to be all kinds of crazy volatility today. And what's interesting is we recorded all these clips before this, but many, many of them apply to what is going on right now. We have many people talking about this type of situation. So let's go ahead and get into them. We've got a lot of stuff to get into, Matt. Check out that macro talk podcast.
Speaker 2It's really cool. Ahan doesn't totally hate bonds. That's the one almost joke for this. Kind of amazing to be like,
Speaker 1I was waiting to see if you'd say love bonds, but I would say that, but I was trolling him for it
Speaker 2pretty hard. There was a little bit
Speaker 1of a little bit of to move towards.
Speaker 2And I, I will say recording that we recorded that one on Wednesday. And to your point that all of these are relevant, even if they were before, like none of these are new issues. It's just the market response and how it's tracking along. So a number of the things that Bob said were sort of in play from markets, a market structure standpoint were incredibly, incredibly valuable to me this week. So happy that we did that on, I think that was Wednesday after market. I did that with them. And like, again, all of these are good. And I think that's, I think it's a great thing to do. I think it's a great thing to do. So let's, let's get into
Speaker 1the clips and it's funny, like the, the title for the first one is AI is holding up stocks while liquidity slows for Michael. How it turns out AI might not be holding up stocks anymore. So here's Michael talking about the liquidity
Speaker 3situation. Well, I think it's telling you exactly that. I mean, the liquidity merges in a cycle and we've already seen the peak of the cycle, at least in terms of the growth rate of a currency that occurred in the late 20th century. Yeah. 25. And this year has already been a year when you've seen liquidity conditions progressively falter. Uh, I'm not gonna say that liquidity in absolute terms is lower, uh, always falling, but certainly in terms of the growth rate, it it's very clearly slowing and that's making, uh, asset gains a lot more difficult. You're starting to see a lot of choppiness in risk asset markets. Uh, some leading indicators, things like Russell 2000, you know, small cap stocks, which are very liquidity sensitive, things like Bitcoin, again, very liquidity sensitive, gold, liquidity, sensitive credits, spreads, liquidity sensitive, all these things are starting to perform poorly and the market is being increasingly sort of held up by the model trade, which is AI. And that may well be coming to an end at some stage. And I think the thing to remember is that, you know, not withstanding the fact, this is fantastic technology and it clearly is, you know, world changing. Uh, but, you know, capital intensive industries will be cyclical and that cycle often bites because of financing conditions or inability to fund, uh, new CapEx. And that may be the challenge that's out there that we've got to consider.
Speaker 4How do you measure global liquidity? I mean, you talked about those asset classes that are seeing under some pressure, but what, how do you look at global liquidity specifically and what do you measure it by?
Speaker 3Well, I mean, the answer, the straightforward answer is the global liquidity as we define it is the flow of money or flow of funds through world financial markets. We draw the distinction between financial market liquidity and real economy liquidity. And I think the key point here to understand is that all money that's anywhere must be somewhere. So if it's in the real economy, it's not in financial markets or simply vice versa. If it's going in financial markets, it's not in the real economy. So we're focused very much on the financial market, uh, flows of money. And another way of a practical way of sort of understanding that, which is particularly, uh, relevant in the case where you've got a refinance debt is that, uh, liquidity represents the, or measures the financing capacity of the financial sector is that the balance sheet capacity, how much space there is in a balance sheet to take on, uh, uh, debt, to refinance it, to roll it over, to read it, underperform, to perform, uh, transactions in financial markets.
Speaker 4What is this idea of that? And I love that, that all money that is anywhere must be somewhere. But you recently wrote that wall street is increasingly competing with main street for liquidity. Can you just explain that? Yeah, well, it's,
Speaker 3it's exactly that point, Justin. I mean, the fact is that if you've got money, uh, which is being required for, let's say capex build out in the AI sector, uh, the big hyperscalers, which were, you know, let's say, uh, 18 months ago, I had treasury departments that were flushed with cash. That cash is now being redeployed. Out of the financial markets, it may have been vested in short-dated treasurers, who knows, or whatever the financial asset was. Uh, it's now being redeployed into, uh, you know, real widgets or real things, uh, in, uh, in mainstream and it's driving the real economy. It's no longer features in, uh, you know, in financial market statistics. It's basically there in terms of, uh, uh, real
Speaker 1capex spending. I love this idea, Matt, that all money that's anywhere must be somewhere. Um, and this is sort of what he was talking about is this liquidity picture. First of all, he has really great charts in this episode about liquidity, but the liquidity picture, like the liquidity in financial markets and liquidity in the real economy are related to each other and things can drain back and forth and they impact each other. And that was one of the biggest takeaways I took from interviewing him is, is that's important. And given all the debt that's out there right now, given the AI refinancing, giving you everything that's going on, it's important to pay attention to both of those.
Speaker 2There's bottlenecks all over the place. I love that framing that because this is basically the on the sidelines arguments, which by the way, it's completely false, right?
Speaker 1The cash is never
Speaker 2on the sidelines. And this is how you explain it. You explain it by going, no, there's actually a, a whole pie here with all these little bottlenecks and transmission and mechanisms and different things will show up at different places at different points. And so his explanation on how this works together, I think it actually fits compliments really well. The Bob Elliot and Han Manon episode two, understanding this is like, when we look at like the 10 year up 76 basis points, look at like, why haven't double B to single B spreads moved all that much yet? We've got triple C's like in the mid teens somewhere now. Why does that work? Because when capital needs to move and it can't move from these different liquidity pools, that's where stuff stacks up. And this is a brilliant framing of understanding that system.
Speaker 1Yeah. And it's not in this specific clip, but he was talking about this idea of the stock and the flow of liquidity. And I think that's really important to think, keep in mind, like liquidity as a stock, it's still very high right now, but it's coming down. And that's what really matters in there. Like it seems like in everything investing, right? Is the rate of change, what's changing, not where we are right now. And so that's what concerns him is he's seeing this downturn in liquidity, even though it still remains pretty high. I think who knows what it is right now, but like that was, we recorded a few days ago.
Speaker 2Yeah. But that's, that to me is the profound point. It's the change in the liquidity that matters. And if you look at different parts of the market and I'm just picking on yields and credit as an example, if you look at different parts of the market, you can see it's the old garden hose thing. The hose is at a trickle, but you put your thumb over it and you shoot your brother extra hard. It's like that kind of a thing, different places, different bottlenecks. And we are literally seeing the impacts of that, where we can say liquidity seems like it's abundant, but if liquidity were truly abundant and evenly distributed, you wouldn't see these things going off with high pressure. Like we've really seen take off in the last quarter.
Speaker 1And just to compliment me and Claude, the idea of the water flowing out of the federal reserve and the YouTube thumbnail was just, it was, it was just an outstanding work by us. I applaud. Well, well, I don't think anybody even noticed because it's like blended in the
Speaker 2background, but when I, when I appreciate things that many others don't listen, there's two things I noticed. One is a Jack thumbnail design, nice little chef's kiss. And the other is some random stuff in the background of a podcast interview. So I'm right there with you.
Speaker 1So, so every time I get pumped up about AI and how much it's influenced the economy, I always go back to Bob Ellen because when he was on the podcast, like four or five times ago, and we repeated every time that you did this time, we always ask the question, are we making more money? And when I go back to that, I'm excited anymore. So here's Bob talking about that.
Speaker 2The, the chart that you had, Bob, that revenue growth at the leading AI labs appears to have shifted from parabolic to linear. I thought this was a really useful framing for me personally to hear. Can you explain what that is? What you mean
Speaker 5by that? Yeah, I think, you know, part of the question here, if you look at what all the investment is, that's expected, um, to occur, uh, by let's say 2030, there's something like $10 trillion of investment that, that needs to occur, that that's expected to occur, uh, by 2030, uh, related to AI, um, and the build-out in order to support that $10 trillion of investment and get a decent return, you have to basically, you know, you could argue exactly what the number is, but let's say you need three to 4 trillion of annualized revenue that, um, that, that investment is essentially servicing. And in order to get there, given today, we're basically at, you know, maybe a hundred and 50 billion, maybe 200 billion, if you like, really, you know, look under every rock and every nook and cranny. well, we're at the end of 2026. We've got, say, $200 billion. We need $3 trillion of annualized revenue by 2030. That's a big gap in the market, right? That's a big, big gap. And the only way you're going to get there is if we're seeing exponential growth. And so I think a lot of these expectations got built up over the summer, you know, in sort of the second quarter and over the summer where token maxing was like the fad. And, you know, it did look parabolic. But then since then, lots of different charts show at best slowing growth, even in a short-term basis, actually kind of flat revenue growth from some of the highest frequency AI adopters. I put something on Twitter yesterday saying that this was sort of a Rorschach test. You know, it's a chart that looks like kind of slow and then accelerates and then is kind of flattened out for the last, you know, three or four months. It's like, what do you make of that? And the AI manics say unconstrained, incredible growth. And like, it seems crazy to me that that would be your interpretation of a chart that's been flat for four months. And so I think that that, you know, you can't have many flat for four months periods if we're going to go from $200 billion to $3 trillion in the course of a couple of years. Like we are so far off the curve in order to get to what is priced into the market right now.
Speaker 1Yeah. So, I mean, this is the big question, right? This idea of, can the AI revenue catch up with the spend? And Bob is obviously not that optimistic, but also he sort of set the stage for how much this has to happen. Like we've got a lot of revenue we've got to generate if we're going to catch up the spending. And then Bob is not seeing, like in the overall economic data right now, Bob is not seeing any kind of significant impact from AI. The numbers are profound.
Speaker 2Like this is one of the things you want a wet blanket to throw an AI. Bob Elliott's your man right now, because I believe the number he said was, we're running at like $200 billion right now. And we need to get to something like an annualized rate of $3 trillion by 2030 on this. So could it happen? A lot of the bulls will tell you it will. A lot of it's just capacity coming online and how we get and whatever happens now post midterms with this. But that gap and closing that gap to justify this build out, like we're not tracking really well here. And that's that parabolic to linear metaphor that he used as well.
Speaker 1Yeah. When I look at what we're doing with it, like I try to think about that. Are we making more money? My arguments always fall apart when I start digging in the weeds. So I'm thinking about, let's say for instance, like because we're using AI, we're getting more views on our YouTube videos. I'm like, oh, so there we are. We're making more money. We've got advertising money. But then I got to think about, well, but who's getting less views on their YouTube videos? Because we're getting more. So in aggregate, are we making more money? Or like if I'm able to do all this video editing and I don't have to hire a video editor, am I making more money? Yes. But is the video editor making less money? And it's like, that's the problem with all this stuff is like you need like the productivity growth. You need the overall economic growth for everybody to be making more money, not to have it be transferring money from one person to a different person.
Speaker 2Yeah. We're just, we're just not there yet. It's in a converse, in another conversation with Mike Green that I had recently, Mike was literally saying my productivity is through the roof. I'm feeling all the benefits of these things. But to me, that just means like, and this is him speaking to me, that just means I'm going to work 18 hours a day and do the work of like 34 different people, which you and I can both relate to. But at the aggregate level, I don't know that that's actually helping or moving the needle yet. I'm still optimistic on the uptake of this. I still think there's a lot of ways in adoption that we haven't crossed yet. And it's that old product adoption life cycle, the Jeffrey Moore stuff that hasn't taken hold here. But seeing the numbers as Bob Elliott paints them against the picture, it's a pretty jarring backdrop for the revenues being able to justify the spend.
Speaker 1So on the idea of AI spending and profits, we've got another great clip from Clip Beta with Dave and Cameron talking about that idea. So here's them talking about that.
Speaker 6Like, yes, it's worth talking about re-rating like the semis right now. But like, as we're literally as we're doing this, Intel is trading down over 30% on a beat. Like, honestly, like if you look at their actual core numbers, they had a fantastic freaking quarter, 80% data center growth. I mean, these are ridiculous hyper growth numbers and the stock is down 30%. Yeah. And what was priced in
Speaker 2to that expectation to beat and be down 30%.
Speaker 6Right. And the reason they're down is because they, I believe, like from my naive reading, I'm not a single stock analyst, but what I read of the transcripts was they were fairly realistic about what their two, three year prospects were. It's like, we're not going to grow 100% a year forever. Surprised. Like you can't do that. And because they had the temerity to be just slightly real, I think in a way that we all believe the stock is down 30%. I mean, we're talking about an enormous wipe out of wealth in one name there. Are we just setting ourselves up for like a cascade of these kinds of announcements? Because I mean, Amazon came out last night and said they expect to continue their 40% AWS growth. I mean, come on, right. Do that for seven years and they're the largest company in the universe. Like you can't do that forever.
Speaker 7Yeah. I mean, it's like not to do an analog too much, but remember the analysis where if you had a price in what it would need to take to justify Cisco's multiple back in 1999 and 2000, it would be bigger than the entire economy and, you know, in a decade. Look, I think that it is clear that these earnings just have to slow down because of law of large numbers. But what's fascinating is that the market has them slowing to what it's going to be in the future. And so I think that's still a super normal pace. So if you're growing 130% this year and you're slowing down to 50% next year, it's like, oh, darn. But the one thing I would watch is you, I was going through, I was like, okay, how could the market be, what could happen in order for us to have 27 be the peak in earnings for semiconductors, even if companies continue to spend money? Well, it all comes down to margins. Look at the operating or sorry, the gross margin for something like Micron, I know it's been talked and debated about a lot. Right now, the gross margin for Micron is at 85% on a 12 month forward basis. The street, if you look at its forecast for where gross margin will go, is that it's going to expand in 27 and stay stable in 28 and decelerate slightly by 200 basis points in 2029. Okay. The last time that Micron's gross margin peaked was from 22 into 23. It peaked at 45% gross margins in 2022. And it dropped by a little bit. So it's going to be a little bit at negative 9% in 2023. So there is no kind of historical precedent of the what's the Irving Fisher, you know, stocks have reached a sustainable high plateau. Gross margins do not hit a sustainable high plateau. So the funny paradox of all of this is that we could find ourselves in a world where the US economy is fine, that data center spend is still happening. Top line growth is still positive. But earnings are falling because of margin normalization. And it's such a funky world to be in. Because we making sense of that and how you navigate it is challenging.
Speaker 1This Micron gross margin stuff is insane. Like the Cameron had, like, what actually is the range of Micron's gross margins? I think it's like, what is it 85% now or something like that? Yeah, what it's been like in the last time it went through a cyclical period, like it was high and minus whatever percent it's like, that's a tough business.
Speaker 2It's a really tough business. And this is part of that whole, like, I think it's the Moldavsky effect, where it's this has been in my brain since Micron, whatever, 10 years ago with the David Einhorn pitch, where he was like, Micron should have higher highs and higher lows over the next several cycles. And he was saying this, again, a decade ago or something like that. With the core logic being though, the way that you have to think about and trade semiconductors, if you're going to invest in them, is the same way you would think about and understand doing like refiners. So basically, what's going to happen is they're going to have this astronomical amount of growth, they're going to look really cheap relative to that growth on the way up. And then they're going to top out blowout. And the question you have to ask if you're buying any of these companies is in the next cyclical trough, when by the way, they're going to look expensive, because their stocks are going to fall way faster than their earnings are going to fall, then is that new baseline level higher. So we're at a part in the cycle now, where the profits are peaking, where we're starting to see some of the air come out of the share price, certainly in the last few sessions, certainly in the last few weeks, certainly this week, we've seen some real wreckage across the semis. But the question you have to ask yourself is, where are you looking through as an investor? If you're a trader, maybe you're out the door already, but you're an investor, are you actually expecting these to settle in at a higher low than the previous cycle? Because this has been a blowout in this cycle. The trickiest part here still being though, like, less growth does not equal no growth. And that's the part I'm having my the hardest time wrapping my brain around. Because yeah, the operating margin is going to go down. And I'm going to have to think about how I'm going to go down. And I'm going to have to think astronomical and collapsing in the share price. But like, these are companies that are still going to grow, just at a far lesser rate right now. And that's how cyclical are they? It's kind of
Speaker 1the question, you know, one of the problems cyclicals is they're the bane of like value investors like myself, because because of that, when they look inverted, that's when you don't want to buy them. You don't want to buy them when they're cheap. And that's really, really hard to comprehend for somebody. But that is the case. And it gets back to the people will talk about the earnings bubble type idea, which is, yes, does Nvidia look very cheap right now? Yes. And could it end up being cheap in the long term? Yes. But if these are peak earnings, it's not cheap. And that's the problem is that's very, very hard to figure out. out in real time. And anytime you use any kind of quantitative value screen, you get tricked by these things every single time. Because a lot of times they're the most attractive when they're expensive and the least attractive when they're cheap. And that's hard to understand.
Speaker 2Super hard to understand. That's where if you are a long-term investor, the way you are looking through this is going to matter most to your outcome. Because the price you're paying today is some cyclically adjusted figure to understand where we are and where you think we're going. That's for each individual investor to figure out for themselves.
Speaker 1So we've got John Davey next from Astoria Advisors. And this is a question I think a lot of people are asking, which is, how do I diversify without getting rid of the S&P 500 or getting rid of tech? Because obviously, if you tried to diversify and get rid of those things, it hasn't done very well for you. So how do you do that? Here's John talking about that.
Speaker 8Well, and let me clarify. So we're not saying dump your spy or your cues, right? We're just saying on the margin, start to trim and diversify, right? If your goal is to get higher beneficiary frontier, if your goal is to have the diversification that we think you should have. So there's a couple of things we do. One is we mix in value. We own international. We've gone equal weight. So I'll give you an example. We run this one ETF ROE, which is 100 stocks equally weighted. And we sector optimize against the S&P 500. The issue that I see with the Russell 1000 equal weight index is that when you equally weight like 500 stocks, each stock is 20 basis points, right? Like in the S&P equal weight. Or in the Russell 1000, it's like 13 basis points. You have these really interesting skews where you're massively on the way tech and you're sort of overweight some of these other sectors that you don't necessarily want to be. So our fund year to date is outperforming the S&P by 10%. So it's up like 23% as of October 22nd, you know, 2026. And then we have the S&P 500 index. And the S&P is up, let's say, 13%. And so we would argue to maybe Jack, one of your earlier questions, like the S&P is sort of masquerading the risk underneath the surface because it's really just seven stocks that dominate the risk. Whereas in our fund, you know, we equally weight 100 stocks. And so we spread the risk out while we main sector neutrality. So I mean, that's one example. And we've been running this fund for three years. And if you look, you know, since three years ago, I think we're like neck and neck with the S&P 500. And so we're like, you know, not a little bit higher. Well, we've like sort of distributed our risk so much more. So I mean, that's one way, you know, we do own a lot of international just because we think that international has, you know, offset and factor exposures. International stocks pay dividends. You know, they buy back shares. S&P dividend yield is very low. It's like 1%. You know, we own like some banks stocks. We think banks, it's having a tough go of late. But in general, banks are, you know, good value plays. So those are the sort of strategies. We will never say like dump your spies and queues and buy some value ETF. But there's ways to tilt the portfolio, such on days like today or the last month, you know, where you're you have some protection from just like the spies and queues, which have like these enormous drawdowns because of like meta's earnings last night or, you know, some of the hyperscalers, you know, risk event that
Speaker 1burn. One of the things I like that he said, and I think it's really, really important is whenever you run any of these funds that are different, you have to be aware of the benchmark weights just because you can't like if you had made a massive bet away from tech in the past five years, like you're not even in business anymore. And also it's going to lead to bad investor behavior. Like if you're too far from tech and tech outperforms for a long period of time, they're going to sell your fund. They're going to go chase something else like that is the hardest part about this is how do I reflect fundamentals? How do I reflect things like value? But how do I of how different I am than the benchmark and don't allow that to get too far. And I think that's really important when you think about diversifying away from the S&P 500 is I can't be completely different from the S&P 500 because that leads down bad paths.
Speaker 2This is the lesson of the last, I mean, our entire professional career, right? This is basically the lesson you had 2000 to like 2010, where I'm not in the industry, except for the tail end of that, where it's like not owning the S&P is a good trade for at least the whole decade span. But then once you get into period through present, for the most part, you've wanted to own America and not own anything else. So if you're going to at all tilt away from this, you have to understand what you're giving up and paying out the nose for. I'll be honest, it was really tough at the beginning of this year, literally saying we want to lean deeper into all the things he's talking about, lean deeper into international, lean deeper into quality, lean away, basically from large cap dominance in the US. And that's really hard to do. And that like we're just talking about gaining a little bit of money in the US. of the pie, which is an equal, equally crazy puzzle when you're trying to solve for this stuff.
Speaker 1I like what GMO did like they had at a point like a long time ago, they realized all their clients were angry when they were underperforming during a period where they thought the market was overly expensive and ended up being correct. There were some that were mad that basically said, you know, if you hate the S&P 500, why do you have any money? And there were other people that are saying, you know, you're deviating way, way, way too far from the S&P 500. This bet is hurting you. And so they went to like where they had benchmark free portfolios and then other portfolios and like kind of explicitly stated it. And I think that's an interesting way to look at it, because for your average investor, the benchmark free portfolio is a very, very tough one to follow. But there are some people who can do that. And so I think maybe differentiating that and letting investors know what they're getting was really important. Yeah, letting them
Speaker 2know what they're getting. And then this is kind of the this is the false promise of goals based or goals driven investing is that you can let go of the benchmarks and you can let your own personal goals dictate how you respond and react to your portfolio. Now, the reality is it's really hard for most people to not benchmark against something rational or irrational. People want in to baseline themselves against some of their external metric. And it's usually not their own goals, because when their neighbor is doing good, they want to be doing good. And when their neighbor is doing bad, they want to be doing extra good because we all want one on our neighbors. So it's a tricky conundrum. And you have to, I think the magic part of this is to basically figure out like on the low end, what are your acceptable results, where you can say, yes, this did great. I still hit my number, and how to understand that in both directions. On the high end, you can go like, okay, great, this gave me two to three times or whatever my average on this really great year. Maybe I did better than the market. Maybe I did it on a risk adjusted basis. But you have to be solving for that in both ways. How can I be comfortable with the index? How can I be comfortable with my own goal path?
Speaker 1Yeah, one of the hardest things to do, like when you run things like the permanent portfolio is say, like, you know, this six, 7% return, we put up this year, you're well on track to meeting your investing goals. And then the neighbors like blowing it out in tech stocks. They're like, I don't care that I'm well on track to meet my investing goals. Like my neighbors get these huge numbers. And that's one of the hardest things.
Speaker 2Yeah, it's it is the hardest thing. And it's hardest to be reminded of it in a piece like a time like this. Like you don't want to have schadenfreude for the guy who's all in semis and is getting his butt handed to him in the last week. But at the same time, you know, like, what do you own and where that differential is when you're applying the benchmark and which benchmark at what time? The average person is not wired to handle this. And even us as professionals, it's, it's really hard to do.
Speaker 1So one of the interesting things that's been going on the economy is spending has been growing faster than wages. And you know, that seems on the surface, like that can't happen. Here's a Hanvan on talking about why that's
Speaker 9happened. So, you know, if you if you think about nominal growth, we're running at somewhere, depending on your look back or you're figuring it out, you're looking at about six to 8% nominal growth, it being you know, really ridiculously high, let's call 6% the real trend of that about 70 70 plus percent is consumption. So between four and 5% of that is just consumption. Now, the interesting thing is that what percentage of that consumption is driven by the saving is almost 2%. And so, you know, sans that, that the saving impulse, we would have consumption, which is 2% lower, which is, you know, and if you look at kind of that contribution of the savings to personal consumption, it is at levels that we have just not seen on a consistent basis on in most of macro history. And so that the saving driven impulse is really, really a very serious thing. And I think that, you know, to kind of contextualize what's going on there, you of course, have, you know, relatively anemic wage growth, and there are reasons for relatively anemic wage growth. But, you know, in addition to that relatively anemic wage, what you've had a very, very dramatic increase in household wealth, which has come from both real estate wealth, and pretty market wealth. And the combination of those since, since COVID has been a huge source of funds for households. And so despite the fact that we've had kind of this fallout in income for households, and wages for households, we still have had the aggregate sources of funds for households, and we still have had the aggregate sources of funds for households, extremely strong. And that's really one of the things that supported what this this ongoing the savings impulse. Now to speak about, you know, the the wage dynamic, I think that part of it is part of it, you know, Bob is more in the no hire, no fire kind of camp when it comes to the labor market. But when when, when I look at the labor market, I see, I think there are three drivers of the labor market. There's the existing clip of population growth, there is the participation of that population growth. And then there's of that participating population, how many people are getting hired. And so when we look at the hiring, in that aggregate, hiring is pretty strong or unemployment is pretty low. What's really dragging on the labor market today is a decline in population, which is driven by a decline in immigration, and a very dramatic decline in participation, which is also driven to a certain extent by immigration and also driven by demographic shifts in the change of composition of the age of the workforce. And so you kind of have these secular big weights on wages and a business cycle that is relatively tight. And so you, in aggregate, have this weak income dynamic, but you have a very strong balance sheet dynamic and an aging population. And the combination is what gets you to that dis-saving impulse.
Speaker 1So this is the key to the whole thing, right? This dis-saving thing and the wealth effect. I mean, that's a huge part of what's going on in the economy right now is we've generated so much wealth in the stock market that people can spend. More than their incomes. How long can that go on? You know, what's the implications when it ends? Like, those are all the questions people are asking. But what's interesting about it, to me at least, is, and Andy's talked about this too in our podcast with him, Andy Constant, like this can go on for a while. A lot of people think about this idea of dis-saving and say, oh, it's about to explode. The market's about to melt down. The economy can't possibly sustain this. And it's gone on for a long while. But on the other side of it, you do have to worry about if when what we're seeing right now, if you do see a significant decline. In the stock market, if wealth goes down, obviously that can't continue as long. Are we more vulnerable to that type of thing?
Speaker 2Well, let's get this on the table first. The word dis-saving is a terrible word. It's not a great word. It's a terrible word.
Speaker 1I'm not sure there's a better word we can come up with, though.
Speaker 2That's the problem. We need to coin something here. It accurately describes what is happening, but it is a terrible word. Because as soon as you start to modify the sentence in some other way, like, there's more dis-saving, like, yeah, the modifier is what, like, did the English teacher get mad
Speaker 1at that point? Is it the double negative? The English teacher in my brain trying
Speaker 2to talk to them about this one was, like, freaking out. Like, my mom and my grandmother are, like, somewhere out there cursing at me this whole time, being like, you can't say that. I'm like, I'm trying to talk to the quant macro guys. Like, they know what I mean, but it's hard to process. So, yes, the key part is here, it can go on longer than you'd expect. And part of that is because, like, when we're talking about spending down saving, or we're like you often you still have income you still have things going on in aggregate and something we got a lot into kept coming up in the conversation with ahan and bob was this k-shaped economy effect too and when we think about like well where's the cash flow that's coming in to offset some of the dis-saving that's going on on each leg of the K. And the part that I'll keep coming back to on this is that Eric Pakman said about where's the labor growth coming from. Ahan mentioned how much we've lost in population growth due to just the change in immigration policy. The other part of it, when you look back over the three years or so with data for the people, basically when we look at what's come into the labor market, where have the new jobs and where's the new hiring taking place for income, none of it's been good paying jobs. So like one third of it goes to health care and elderly care spend. And those jobs are like thirty five thousand dollars a year. The other part is like bars, restaurants and local governments. And they're making like forty one thousand dollars a year. So all the job growth that's actually here and masking some of the employment situation is also saying anybody who's losing like a hundred K plus job, which we are net shedding in the economy, the only things we're adding to offset are basically like $35,000, $40,000 a year jobs, and the saving is running in the face of that. The income is not replacing the lost income from the lost jobs with this wage puzzle that we have. Can it go for a while? Can this cyclically bend before it turns into a wreck? Absolutely. But tracking this and figuring it out, really, really hard in practice.
Speaker 1This is the whole K-shaped problem because rich people are driving the economy right now, but rich people's spending is going to be more dependent on the stock market than it's ever been.
Speaker 2As they always do. But now it just feels more pronounced because of that stock market. Yeah, well, the wealth effect
Speaker 1is probably the strongest it's ever been, right? I mean, spending is probably as dependent on the stock market as it's ever been. And so if you've got rich people driving the economy, if you do get a significant downturn, you could argue it becomes more problematic. Now, you could argue on the other side that policymakers are likely to intervene quicker because of that, because they don't want to see the economy falling down. So as they have it every other time, if things get bad, they're going to intervene because of this whole situation yeah and you know like let's face it
Speaker 2it's that upper leg of the k when we talk about elderly work and home health aids and stuff like that now it's affecting the entire the entire economy every age is dealing with that this is just a glut in the baby boomer population and beyond that we're still dealing with silent generation that's still around and everything else but the reality is the people with the most discretionary spend from that are from the top they're helping support some of this job growth and some of what's keeping this going. Stock market goes down a lot. If home values are ever to dip again, these are the things that we actually have to be worried about and what the total flow through is on that side of the wealth effect.
Speaker 1So our last clip, we're back to Michael Howland. And he's talking about this idea, there's so much debt out there and that debt has to be refinanced. And he thinks that's an issue maybe people aren't paying enough attention to. So here's Michael talking about that. We've been talking about bubbles a lot in the podcast and also whether it's even valuable to try to call something a bubble. But do you see something unique in the liquidity when we have a bubble? Like if in the late 90s or in other periods we're in bubble-like periods, is there something unique that goes on in liquidity relative to other periods? Well, there's something very unique about the current one.
Speaker 3Yeah, absolutely. There's a lot of unusual characteristics when it comes to the nature of the bubble. I mean, one of those is that we've seen since the GFC, the response of the authorities to any crisis has been through liquidity of the system. Now, that may be simply a function of the fact there's a lot of debt out there that needs to be rolled over. And, you know, one of the things that, you know, we maintain in our work is that, you know, capital markets have changed their nature. They're no longer new capital raising mechanisms, as the textbooks tell us. They're basically debt refinancing mechanisms because there's so much debt out there. So clearly the nature of the financial system has changed. And if you're refinancing debt, the interest rate doesn't matter so much. I mean, just think of a home mortgage. I mean, if you've got to refinance your home mortgage, you want the role on the the role you want the role on the mortgage you're not so worried about the interest rate including interest rate matter if you don't get the role you're homeless right um so that's the same thing with debt you need the role in the debt uh world of lots and lots of debt you need to refinance and so financing capacity is really crucial and so liquidity is really a key factor in terms of understanding that part of the equation the other thing that is an interesting corollary of um of um the recent uh of the recent policy responses is that interest rates have also been slashed and in what i was in salary brothers one of the uh one of the books they always got us to read was a book which is a great cure for insomnia which is called a history of interest rates by sydney homer which goes back 5 000 years and tracks the history of interest rates through you know greek and roman civilizations and whatever else and nowhere in those pages is there any reference to interest rates so what we've been through in the last few years the last five years has been completely unprecedented and the central banks did i think a reckless thing by slashing interest rates because what the low interest rates do they incentivize us to take out debt right it's exactly what we don't want to be doing we should be paying back the debt not taking a new debt and not it wasn't just the fact that you got a new debt taken off you also got terming debt so basically a lot of businesses a lot of households even governments refinance their existing debts in 20 uh 2020 21 22 and turn them out to later in the decade so what you're getting now in the system is something called the debt maturity wall so the debt maturity wall is not new debt it's actually old debt coming back into the system very to be refinanced and these numbers are these numbers are awesome and we're looking at you know a lot of interest rates and we're looking at you know a lot of interest rates and we're looking at you know a lot of interest rates and we're looking at you know a lot of interest rates and we're looking at you know a lot of interest rates and we're looking at you know a lot of interest rates and we're looking at you know a lot of interest rates at least and we're looking at you know a lot of interest rates at least four to five trillion dollars a year four to five trillion dollars a year four to five trillion dollars a year of increase not absolute amount but of increase not absolute amount but of increase not absolute amount but increase each year in the amount of debt increase each year in the amount of debt increase each year in the amount of debt that needs to be rolled and we're talking that needs to be rolled and we're talking that needs to be rolled and we're talking about a total role of something like 50 about a total role of something like 50 about a total role of something like 50 trillion for advanced economies so you trillion for advanced economies so you trillion for advanced economies so you know capital markets just think about know capital markets just think about know capital markets just think about this capital markets all about debt this capital markets all about debt this capital markets all about debt refinancing they're not about raising refinancing they're not about raising refinancing they're not about raising new capital i mean parche you know the new capital i mean parche you know the new capital i mean parche you know the latest ai boom which is unusual but latest ai boom which is unusual but latest ai boom which is unusual but basically for decades they've been basically for decades they've been basically for decades they've been refinancing dead so you've got to do refinancing dead so you've got to do refinancing dead so you've got to do this refinancing on top of this refinancing on top of this refinancing on top of 2 trillion every year of federal debt 2 trillion every year of federal debt at least a trillion probably of ai at least a trillion probably of ai at least a trillion probably of ai hyperscaler dead which is coming through hyperscaler dead which is coming through hyperscaler dead which is coming through so the numbers are already starting to so the numbers are already starting to so the numbers are already starting to compound and the question is if you've compound and the question is if you've compound and the question is if you've got debt which is growing exponentially got debt which is growing exponentially got debt which is growing exponentially and you've got liquidity which is which and you've got liquidity which is which and you've got liquidity which is which is inherently cyclical you can see is inherently cyclical you can see is inherently cyclical you can see there's a problem
Speaker 1there's a problem there's a problem so matt i love this debt grows exponentially, but liquidity is sick. That is a great, that is a great statement. And it's not necessarily the most positive for
Speaker 2our current situation. No, it doesn't make me, doesn't make me feel good, but he's, but he's dead. He's dead right. He's dead right on this.
Speaker 1Yeah, no, absolutely. I mean, this idea that what he was saying is like, a lot of people think about capital markets as a way like to get new capital for things. But a lot of this right now has become refinancing, like refinancing. There's so much debt out there that like the rolling of this debt, is a big, big issue. And he made the point in the clip, this idea that when you're when you are refinancing debt, yes, interest rate is very important to you. But the most important thing is that you're able to refinance the debt. And he used the example of a home. like if you can't refinance your home, you get kicked out of the home. So like, this is a big deal. Like your number one priority when you're refinancing debt is you have to be able to refinance the debt.
Speaker 2I can't remember who said this to us recently, but it's, it's an old debt market thing, which is there are only two types of deals, those that are oversubscribed and those that are undersubscribed. And the problem is like, you know, A, there's no middle, but B, like the unsubscribed ones are all the problem. The stock and flow idea that we talked about at the very beginning applies to this. And I think this explanation on top of the Michael Howell one from the very beginning really drive this point home. The only problem is when you can't refinance it because that's a stock issue. The stock needs to get passed forward. When the stock stops being passed forward or ceases to function, then you have a whole other problem on your hands. I think a really useful metaphor for this too, is like you think about real estate, you think about something where you know there's a stock. If all of a sudden people start net leaving an area and there's not a next person to buy that house, then you're going to have a problem. And that's a problem. You get Detroit 20 years ago, you get situations where you get Baltimore, you get these areas where all of a sudden there's just ghost cities where there used to be people living because the people to pass that stock forward to left. If we're looking at debt markets right now, the question is, how does that refinance happen? How does that stock in debt get passed forward? And that's what keeps the music playing because otherwise, like right now, this is why we can still see these oversubscribed deals in some of these places. As hyperscalers are still looking to raise money, we'll see what happens with anthropic, some of the other stuff here. But as this is getting passed forward, so far, we've been able to pass that stock forward with a little bit of strain around the margin. Big questions if that starts to change.
Speaker 1Yeah, we're definitely gonna have to have Michael back because liquidity is gonna be such a huge part of what's gonna go on in the market in the next year. So like six months from now, we're gonna have to have Michael back and talk about this again.
Speaker 2Clearly, that's the story of this year. And it's a matter of does this turn into something more or not? And also extra bonus plug back to like him and Bob Elliott, I don't know if we ever get them together. But this is a really interesting place. Bob Elliott's the one in talking about his interpretation of the Silicon Valley bank collapse. I know we were talking to him then too. And just thinking about like, when do these things turn into a mess? And this links back to his his prior hedge fund days when he was doing
Speaker 1that work. Yeah, so we got lucky this week with the cliffs. Now we had we had a lot of different angles to talk about something that's definitely front and center right now. We were able to talk about it from liquidity perspective, the economic perspective, and we'll see what happens going
Speaker 2forward. We will certainly see what happens going forward. I sense we will have no shortage of things to talk about for a good ways to come here.
Speaker 1Yeah, we know we've got we got some great clips coming up on my green next week. So we've got a lot of other people who are going to get to give a take on many of the same issues.
Speaker 2Oh, I'm excited. I'm previewing this one to 100 year thinkers with Robert Hagstrom and Chris Mayer and Bogumil Baranowski. This is the most like you wonder what long term thinkers are thinking when the market's doing short term nonsense. I feel like this was a vetting session for both are venting session for both of them. To basically be like, what the heck is going on? And this was a on Thursday as the giant wreckage was happening in tech and everything else. And they're talking about what they're feeling what they're talking to investors about, and how they're trying to retain a long term view and a market that's stealing all of your short term attention. Crazy cool to just be a fly on the wall
Speaker 1for that. And that's why we wanted that show to exist, basically, for this exact reason. We're all wrapped up in like all this craziness in the markets and free fall. Like, we wanted people who are going to take a step back, certainly recognize that that exists, but view it as something that's in a different context.
Speaker 2Yeah, because this is what this is about. Markets are long term games, we're trying to play long term games with long term people. That's what this channel is for. That's what we're trying to do. And this week was a masterclass, some of the ones we got in the bag to put out in the next few days, masterclass, learning so much. It's really exciting to be able to do this.
Speaker 1Well, before we play too long term of game in this podcast, that should probably close it out.
Speaker 2All right, make sure you check us out over on the sub stack wherever you are watching and listening. Thank you so very much. Like, comment, subscribe, all the things below. And we're out.
Speaker 10Thank you for tuning into this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the excess returns network at excess returns pod.com. If you have any feedback or questions, you can contact us at excess returns pod at gmail.com. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the or their clients.
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