Speaker 1hello fellow rebel capitals hope you're well i am back with my good friend lynn alden and lynn it's been too long hasn't it it's been way too long happy to be back what's been on your radar in terms of macro well so i mean
Speaker 2obviously a lot going on
Speaker 1right yeah there's a lot going on i you
Speaker 2know i think that obviously the the war is still a big factor obviously the most recent i mean the combination of midterms uh as well as uh the nvidia news um you know it's kind of been a one two punch for headlines uh i tend because i take a fairly longer term view of investing i tend to fade how important politics is on investing like uh you know some investors traders will make pretty quick trades based on you know outcomes um whereas my my decisions tend to be rarer related to politics that that includes the u.s that includes some places in latin america uh i i tend to have a little bit more of a structural view uh and so far no major surprises obviously i'm you know moderately surprised like others at the at the maybe the magnitude of some of these election outcomes uh but they they went directionally like people were expecting uh so uh that you know i and i you know i've been analyzing kind of their potential impact on the ai trade and that's of course where the nvidia news factors in as well um my my base case is that still has time to run i think i i think that there is froth in the trade but i still think that that trade is probably uh active what
Speaker 1specifically the whole thing or are you just focusing on like the nvidia's the the the picks and shovels or is it the data centers or you know are you getting specific there yeah so
Speaker 2my my preference has been in the semiconductor space because that that's been more profitable growth uh and maybe maybe my bias is a background in electrical engineering it just it's it's a background in electrical engineering it just it's a background in electrical engineering it's a uh the the area that i am most concerned about longer term is the frontier models uh yeah uh you know with the open weight models you know generally months behind and therefore those companies trying to erect uh regulatory moats uh to protect you know what are essentially trillion plus valuations uh that that's the part where i would be concerned about being an investor unless i already had a very low cost basis in that so early investors great job but i'd be really concerned about capital in those the data centers uh you know i they don't have the moat that like a semiconductor company does um i think when they go down enough they can they can enter kind of the value space um uh but you know those are those are those are more challenging it's generally it's more aggressive capex uh that there's generally leverage involved uh to a much greater extent than the semiconductor companies uh and i i'm not very bullish on the hyperscalers um now they they do have wide economic moats um uh partially because of their other businesses as well as the sheer scale that they can operate on but all of the hyperscalers except for microsoft are now free cash flow negative so alphabet oracle amazon meta they're all free cash flow negative at the moment microsoft still has positive free cash flow but at a much reduced level which is not always a bad thing but it just shows that the sheer level of reinvestment that they have to do and you know we're trained a lot on their 2010s performance where they generally had these like network effect businesses with fairly low reinvestment needs now because they're so big their actual dollar numbers of reinvestment were pretty significant but as a percentage they were low so they were able to build fortress balance sheets return you know do a lot of buybacks initiate dividends in some cases uh whereas now and they didn't really have each one was kind of without core competition there was no real competition for google there was no competition uh for meta really there was no competition you know for microsoft really or apple even to some extent so that they are they have these kind of like the firm moats but now they're they're more in direct competition with each other in a very expensive way uh and so uh semiconductors are interesting because you know the investors in those spaces are kind of trained to invest for cyclicality right so they they treat a ram a memory stock in a similar way that they treat a commodity producer where they know that when when times are good you put a low multiple on it because eventually times are not going to be good so then it becomes a question of timing and just you know how long that cycle lasts um so i you know i think semiconductors are interesting on dips um i think that trade's probably not over yet there's also potential strategies around kind of volatility selling to some extent uh if you're cautious um but you know i i you know i i think generally speaking when i want to get into unprofitable investments i go into venture in in the public market space i generally want to stick to profitable investments that tends to align with my strategy which which puts me which which puts me more in the semiconductor yeah puts me more in the semiconductor
Speaker 1camp yeah it's it's funny you say a political moat when referring to the frontier models because it seemed to me back when they were calling for like the end of the world due to ai i was like okay it seems like they're all pushing the same narrative here and they're all asking for regulation and whenever a huge mega corporation is asking for more and more regulation it usually ain't because they care about the average joe and jane it's because they care about creating monopoly they they want to push out all the competitors yeah so did you see it that way as well yeah
Speaker 2yeah that's why i think that they're because their economic moat is now fairly thin i mean it's measurable in months really uh which wouldn't be a problem if they were a smaller companies but when you have trillion dollar valuations and your open weight models uh you're in a constant competition against them they're also unprofitable by the way that these you know frontier models so you're running unprofitably uh and there's always these open weight models nipping at your heels um uh they've kind of shifted toward regulatory mode capture uh and this is you know any any kind of large industry that sometimes becomes a strategy where you try to raise the floor uh and make it harder for new entrants to come in uh you know the the cost of things um uh and and and so you know there's this kind of this the concern and the reason it works i think in this case is because you know there's always a grain of truth with this so for example it is no secret that there are and we're in a current era of cyber security risk because these you know the cost of hacking has just gone down considerably so it takes time for the existing base of code uh and know how to catch up with that to make sure that ai is also defending against all these things and whenever you have a transition like that things are going to break uh so every time there's a big big breakage it's easy to say look if you know if we just banned all open weight models somehow in the world you know like then and that becomes like a convincing narrative um but yeah i think a lot of it's for regulatory uh concerns it's also why
Speaker 1both things can be true at once
Speaker 2both things can be true and it's also why uh doomerism sometimes doomerism is good marketing because you'd have these viral moments where like you know someone will be like hey this thing almost broke out of the lab and then it just go oh it's all on twitter it's like you know all that basically means their head now and you get you get this kind of like uh community marketing on your behalf they didn't have to pay for uh and years go by and it's it's you know they're they're tools that are they're very powerful um yeah and then of course they you know this they capture a lot of um uh concern as well
Speaker 1yeah it's basically propaganda and it's it seems it's necessary because there is no other moat like i know just in my personal day-to-day experience i just bounce back and forth between like chat gpt and gemini and sometimes i'll go a couple weeks and notice that chat gpt is giving me a little bit better answers or they're giving me answers that like include graphs without me having to ask and i'll be like oh that's cool and i'll just go over there and use them for two weeks then jim and i will do the same thing and kind of one up them and i'll use them for it but there's no like there's no network effect whatsoever so it's like they've either have the option of creating that regulatory moat like you said or just you know they're too big to fail i mean that that's really to me it looks like their only game and then i take it the next step and i'm like well who depends on them having an economic model well nvidia and then you look at the circular kind of relationship with the whole ecosystem and i always look at like a jenga puzzle and to me it looks like that jenga puzzles like an inverted pyramid and there's only one piece at the bottom and that's the frontier models and you take out that one piece and nvidia you know i'm not saying they go bust but if you look back at uh you know what happened in the dot com it wasn't necessarily that the revenues went negative for the companies that were making money it was that they just went from 70 growth down to 50 growth and and that is the pin that that pops everything so that that's uh and then also too you know what i'd love to get your opinion on is as far as i can tell these capex bubble cycles kind of always always play out the same way it's like it starts with funding from cash flow and then once that's gone you start funding with debt and then once that's gone because the interest rates are going too high and you're like okay let's move on to equity and then once the equity falls in price because you're diluting shareholders then the only thing you have left is just firing workers and it and that's kind of how things seem to play out and you talked about microsoft being cash flow negative or excuse me positive but they just announced they're laying off like 60 000 workers so it seems like we're kind of in that last stage have you have you noticed that studying
Speaker 2history uh so there's that and there's also the venture cycle so we've had a couple parallel Obviously, the frontier models we were just talking about, they were VC funded. And, you know, the whole process there, and it's, I mean, for the most part, it's rational. But, of course, it can get into bubble territory from time to time over the years and decades that Ventures existed, which is to say there are certain ideas that can scale. You're going to run unprofitably for a period of time. And sometimes the economics are about trying to capture market share. So you can hit critical mass and then eventually shift toward a profitable model. That can be reasonable in certain industries. You know, there's some businesses that are not really venture types. So you generally want to be more profitable from the start. And there are other ones where the growth potential is so huge, you really want to gun it for several years. And so what you do is you raise a lot of capital from Venture investors. And then essentially what they do is they underprice their products. So, you know, they'll sell $1,000 worth of basically compute for half the cost for the consumer. And they're kind of looking at the math. They're saying, well, the cost of compute is going down. You want to capture market share. So, you know, we're currently in the business of selling $20 bills for $10. And look at our growth numbers. That's right. And that, again, that can be the right strategy sometimes. If you eventually have an eye toward how you could shift toward profitability once you hit a certain scale. And if you don't overdo it. And I think the challenge. So that was like an early source of funding. And then, of course, you know, when you have those VCs funding it, those companies can go out. And they can buy compute. You know, they can buy semiconductors. They can rent or buy data center space. And then the hyperscalers get involved. And like you said, they, you know, they fund first with their existing cash hordes that they build up. Then they say, you know, we actually, you know, we have a low cost of capital. So let's issue some debt to do it. And we're going to stop. They also just stop buying back their own share. So, you know, free cash flow, existing cash, debt and equity, depending on the company in question. They kind of, you know, you start with the lowest cost of capital. And as, you know, as you exhaust some of those, you get into the. The higher cost source of capital or the higher risk. And then there's also, of course, that the venture side can run out, which is if enough venture investors or now that now that they're in the game of trying to go public. Right. So, you know, these companies will be in the also in a kind of a similar game of either issuing equity or debt to fund their growth and their unprofitable baselines. You know, if enough investors say, I'm not sure if I want to pay a trillion dollars for this kind of not not wide moat company. It's not to say that they have no moat like the frontier models like they're still economy of scale of hiring the best people and, you know, having a really good funding source. So, I mean, there's some scale there, but like you said, the switching costs are low, no real network effect, really hard to build a moat. I think the actually the end the end, you know, I think there eventually will be a bust, of course. I mean, we didn't end cyclicality here, but I think structurally speaking that the winner will be kind of the businesses and the individuals that make use of these. Because I do think. I think that the cost of compute is going to go down. I think that, you know, the effectiveness of these models is going to keep going up for quite a while. Openweight models are going to keep it pretty competitive. I think it's hard to stamp them out, especially globally. And so I think at the end of the day, the winners are going to be individuals and businesses that are effectively using AI versus those that are either late to the game or not using it effectively.
Speaker 1I mean, the same thing as the Internet. If you look at the big winners in the Internet or the. Companies that leverage the Internet to change the game and disrupt an industry. I mean, Amazon's a perfect example of that or Netflix. You know, those are the big winners from the Internet. It wasn't necessarily the guys that were laying out the fibers and whatnot, you know. So I think it's rational to assume that we're going to see the exact same thing play out in this in this cycle when everything is said and done. I know you talk about fiscal a lot. How does fiscal play into. Everything that we're discussing.
Speaker 2Yeah, good question. I often say that we have this two speed economy now. I'm not obviously not the first person to point that out, but it's like, why do we have that two speed economy as well? If you're if you're on the right side, if you're on the receiving side of either those deficits or that cap expending the AI cap expending, those are the two main areas that have been in a really good place. Whereas if you're not and if you're on the kind of the wrong side of, say, higher rates, like you're a younger family looking to buy a home, you're not very asset rich. That's when you're you're facing kind of the challenges. You're on the other side of this K economy. So basically where fiscal ties in is, I mean, you know, when you're running structural seven percent of GDP deficits, you know, it's not like covid era hyper stimulus, but it is historically a hot fiscal environment, a loose fiscal environment, which all else equal tends to raise the floor of nominal GDP, raises the floor of inflation compared, you know, which is then offset by other things. Yeah. Yeah. Deflationary tech and so forth. But you're all us being you will compare to a two percent deficit. You're raising the floor of what's happening. You know, bank lending raises rates, by the way. Yeah. Which raises rates, generally speaking. And, you know, bank lending is is moderate at the at the moment. So it's not it's not like super aggressive. But when banks buy treasuries on fractional reserve, I mean, they're basically lending to the government, which is then spending into the economy. So you still get you get money supply growth that way. So, you know, you're you're. It's contributing to money supply growth and GDP growth, despite if you just looked at, for example, the housing market, it would look like a recession in a sense, like this year, the low amount of turnover, the difficulty of affording a home. Those are all real things. Obviously, there's, you know, certain issues in commercial real estate and private credit and all this. But then it's offset by fairly large deficits that is, for the most part, hitting spendable areas in the economy. So, for example, Social Security. Social Security goes out to seniors and seniors then spend it either sometimes on, you know, their own adult children, sometimes on just things they are consuming themselves, then, you know, a lot of that deficit is going to health care. So, you know, those health care workers and the companies there that that's revenue and income from them and then they're spending it into the economy, the defense industry, you know, they're receiving money and then they're spending it in the economy. And then now the interest expense is that it's over a trillion dollars, you know, many pool. There's that spendable. Money for a lot of people. There are people with money market accounts that, you know, kind of by extension have treasuries. And then every time, you know, the Fed raises rates, they actually get a small raise and they can actually go out and spend a little bit more potentially. And so that that that's, you know, it's that that's currently a slight source for running it hot.
Speaker 1Yeah, I think the key there is something we've talked about a lot over the last six years of knowing each other. And that's the concept. Of it being higher than it otherwise would have been. Yeah. So you can have that that term you came up with that I use all the time is it doesn't necessarily have to be inflationary, but it can be anti deflationary. Yeah. And and that's really an important concept here. So when you're talking about the fiscal, you can have all this fiscal and you can still have or nominal GDP. But we can but it's definitely higher than it otherwise would have been. That's for sure. And so the way I always try to look at that is I try to look at it as though it's a bucket of water. And you've got this hose, which is the fiscal at the top. But then you also have a hole at the bottom. So a lot of it depends on how big that hole is at the bottom. It determines if the water level is staying the same or maybe even going down or going up. I think that's a good visual for people to. Really think about that goes back to that. Well, the water level is higher than it otherwise would have been, but it doesn't necessarily mean that the water level is increasing. And I saw Druckenmiller make this argument the other day where he was talking about exactly what you're saying, how fiscal is adding to nominal GDP. And we wouldn't have nominal six percent. And he was going back to the GFC and other times when we had this big recession and huge deficits. And he's pointing out. The fact that the hole at the bottom of the bucket during those times was a lot bigger than it is when you have the unemployment rate at four point one percent. So do you think about it in those terms? So it's not just fiscal, but it's what is fiscal doing based on everything else that we're looking at in the macro economy?
Speaker 2I do. And this was a big topic I had back in 2020, 2021, when I was having debates with, say, investors about inflation versus deflation, bond bear versus bond bull. And so when I would kind of debate my deflationista friends as I was in more of an inflation camp, I had charts on this where you have to you have to take into account not just the fiscal side, but then also what's going on in the private sector, for example, and that's that's either a hole in the bucket in some cases or it's another faucet into the bucket. And so, for example, if you have a booming credit environment, that that's a source of fractures or money creation that that's out there adding. Adding to the hotness that the higher cycle. On the other hand, if you have loan destruction, you're destroying broad money in that sense. Bigger hole. Yeah. And so, for example, in the global financial crisis, the fiscal injection was in terms of order magnitude roughly on the same scale as loan destruction that was occurring. And so you had money supply that was in the broad sense, broad money supply did not have a big uptick. You know, if you look at the M2 chart itself. you'd barely say anything crazy happened, right? Because there's other things that were crazy, but they were kind of balancing each other out. Whereas, for example, when you fast forward to COVID, you had the sheer scale and speed of the fiscal injections before you really had too much loan destruction resulted in just a huge, you know, you're pouring money in a lot faster than it's draining out. Which is why that time we did get that inflationary wave, both in terms of money supply growth and then in terms of price impacts compared to the global financial crisis.
Speaker 1And you had the credit hose as well. Yeah. Because everyone was pulling down their line of credit, which really contributed to that 25% increase in M2, you know, that we saw. So you got the Fed, you got the banks, you got everybody. And then on top of that, the government spending the money. I used to say they're taking money from savers and giving it to spenders. So on top of the two hoses going into the bucket, you have the velocity of the money increasing dramatically as well. So what do you think is going to happen?
Speaker 2Yeah, so that was a very inflation environment. And at the current time, we're fortunately in a more muted environment than that. But when you add the components together, basically you have above baseline fiscal, largely for reasons that are pretty locked in. So no recession, but above target fiscal, largely because of demographics reasons and healthcare expenses and all the reasons. And now interest expense is a big component. So there's all of that. And then you have a fairly moderate lending environment. So loan balances are going up. They're not above target. So that's not really the core cause of inflation the way it was. For example, in the 70s, that was peak bank lending. That was baby boomers entering their home buying years and therefore peak credit formation. So if you look at just loan growth year over year, that was like the 70s were where it was at. Now it's moderate. So it's not like Japan. It's not like one of those deflationary loan areas, but it's moderate to even slightly below baseline a little bit, all set by above baseline fiscal. And so I describe it as a mildly run in a hot environment. I also describe it as a gradual print environment with a Fed that's kind of treading water on its balance sheet going up for periods of time, nothing particularly large. So I tend to fade the narratives that a very large print is around the corner, a very large crash is around the corner. There's always risks that can happen. But in a probability sense, I've been fading those narratives. And it's more been kind of expecting this kind of grindy, slightly hot, you know, investing and GDP type of environment.
Speaker 1Yeah, pretty much what we've seen over the last couple of years or so. Okay, so I think what's good for investors. Okay, so I think what's good for investors is we don't have to wonder about the hose that's coming in from fiscal. We know that's a constant, if not going to increase, right, as far as government spending. Yeah, we could say that with a lot of confidence. So then the only other, I guess, variables you have is credit growth, which you said is pretty mild. I consider that more money printing, right, because that's going directly into the economy as far as M2. So what indicators do you use to determine how big that hole is now and how big it might be in six months or a year?
Speaker 2Yeah, good set of questions. I mean, one is kind of the structural one, which would be productivity growth, right? And, you know, new technology unlocks can give you more productivity growth. For example, like, you know, the build out of, you know, industrialization, for example, is a huge tech unlock. I mean, one is kind of the structural one, which would be productivity growth. For example, like, you know, industrialization, for example, is a huge tech unlock. The rise of China when they when they when they kind of shifted toward a more workable economic model, that that was a huge kind of economic unlock and that it spilled over into countries like Australia that are, you know, commodity producers that that, you know, had to supply. So they would they went this really long period of time without a recession, and just above average productivity. And right now, we're obviously in a potential area of AI productivity, where some economists have kind of point out that it's it shows up kind of irregularly. So it's not as though we've seen some giant uptick in AI related productivity. I think it's probably because in an economic sense, it's still fairly early in terms of it being incorporated and the expenses are still here with us. And so so we're kind of in investment phase. So it's actually more balances out. Because obviously, things like building data centers, building all these chips, trying to get more power online, that's actually in the near term, potentially inflationary, you have more entities fighting over over, in some cases, pretty scarce resources. But once that's built out, and then potentially, once we have this, you know, potential down cycle, we were talking about earlier in the conversation, right, when we overbuild some of this, and some of this leverage and funding pops, we're probably gonna have overcapacity. And then that'll be deflationary on a large scale. on a lot of, I think, goods and services, because we'll have all this more productivity in place and less, you know, it's less aggressive, new capacity coming online. And so I think that'll be deflationary. So I certainly watch the AI cycle, the funding cycle, the demand and supply bottleneck cycle. So that's a key thing I'm watching. The other one would be war, of course, I mean, you know, war generally is inflationary. If you're if you're, you know, when you build refineries, you're you're being more productive, and you're blowing up refineries, you're being more productive, and you're blowing up refineries. you're you're destroying productivity, and you're creating bottlenecks, or, you know, if you're making it harder, or more blockages to move around energy or supplies, when you add the cost of insurance, when you do all this, when you spend money on missiles, so all these things around the margins are generally inflationary. And so whenever that's heating up, that's obviously adding to it, it's adding to diesel prices over time, which then of course, contribute to just higher costs of, you know, businesses getting, you know, food and other other things on the shelves for consumers and businesses to buy. And so, you know, the, it's those things mainly, and then I'm also always just kind of monitoring the credit cycle. So what's happening, both in private credit, private equity, as well as, you know, what is the current rate of bank lending out there? And is it is, you know, is it accelerating or decelerating?
Speaker 1So here it is, guys, this is the rebel capitalist newsletter delivered to your inbox. Twice a week, completely and totally free of charge. But this isn't just a newsletter that tells you what's going on. Although you'll get some of that, it's going to help you set up your portfolio in a way that will help you achieve your financial objectives. So we have two emails per week. One is the macro alert, it's going to tell you exactly what you need to know about what's happening in the macro space that week. And the second is the trade alert. And I'll give you an example of that right here. That's going to be my trade alert. Trade idea of the week. Now, this is not investing advice. This is for, let's say, educational purposes only. But it's going to help you see possible opportunities that are out there as we go through this credit cycle, as we go through this crash, or as we go through a potential reset. This newsletter is all about giving you the valuable information you need quickly and concisely. And doing so in a way that is actionable. So if you want to prepare yourself before it's too late, if you want to take advantage of opportunities that we absolutely will have regardless of what plays out over the next year, sign up totally free of charge. You don't have to give your credit card or anything like that. Just go ahead and click the link in the description below. How far can inflation go before it comes disinflationary? And what I'm talking about specifically like 08. Right, like we're all good. So many people remember how that movie ended. And they forget how it started. And it started with oil going to 140. And the CPI going from sub two in 07 to 5.6 in July. And you get to a point where the higher energy costs are trickling through the economy. But then that creates the demand destruction, which ironically leads to disinflation. And sometimes outright deflation. So how do you reconcile that with the supply shocks that have definitely contributed, and I would say are probably mostly responsible for the increase in CPI that we've had since the Middle East conflict?
Speaker 2Yeah, that's where I think that money supply would come into play, both in terms of the credit cycle and in terms of fiscal. And so, you know, you can imagine a couple different scenarios. So in 2008, you know, obviously, prior to that energy prices, like you said, were getting very high, while money supply growth was still normal, for the most part. And you had a somewhat of a crowding out effect where, you know, basically people, people in business are spending more money on energy. And, you know, they then were, you know, they had the, of course, the adjustable rate mortgages, the over levered housing, which is now inching up in interest rates, because the Fed's trying to fight that inflation. So you're popping a credit bubble. And that was also peak private sector debt. So in terms of, say, mortgage debt relative to GDP, but more broadly, I mean, just like banks had, you know, 3% base cash compared to assets, for example. Or they had their generationally lowest mix of cash and treasuries as a percentage of assets and a generationally high ratio of assets that are more prone to nominal default, so different types of lending or securities. So banks were at their peak level of leverage. Going back literally to the time you compared this would be the Great Depression. So in our lifetime—
Speaker 1Powder keg. It's a disinflationary, deflationary powder keg. And by the way, I want to point out for the viewers who might not have caught that, when you're talking about private sector debt being at all-time high, the reason that's really important is because you increase interest rates. That's going to be a higher tax burden on the average Joe and Jane in aggregate total, where if the private sector debt isn't that high and you increase interest rates, it's not going to be as much of a tax.
Speaker 2Yeah, so we had a private sector debt bubble. Then we had inflation, and we had higher rates, and it pops that. So then what we talked about before, loan destruction. It's money destruction, as well as just consumers say, look, I spent all my money on gasoline this month, my spare money. I can't go to the movies, or I can't go out to dinner. I can't do the remodel that I was going to do. So that's when you start to get that disinflationary cycle. Now, it took a little while for money printing to kick in before they did in fiscal injections, before they increased the base money to do stuff like that. So it took a while for these— And like we said, by the time that they hit, they were— They were roughly the same magnitude as the losses. So we didn't get that big uptick in money supply. Whereas if you had a different scenario where just as soon as— Let's say in 2007, you started seeing just the increase. If you said, okay, we're going to give every American $5,000, and we're going to issue a ton of bonds to do it, and if the bonds run into liquidity problems, well, the Fed's going to increase their balance sheet to buy those bonds, right? You would then front run the kind of— It'd be more like COVID in that. You'd be front running the loan destruction cycle. You'd be front running that, and you'd be basically supplying more dollars out there, which would— Then you'd get that— You'd add to the inflationary fire in the nominal sense. You'd obviously have other problems, but you wouldn't have that same credit crunch.
Speaker 1Yeah, which would support the labor market as well, so you wouldn't have that spike in unemployment.
Speaker 2Yeah, and of course, the challenge, you look more like COVID, or you look more like Argentina. How does Argentina often— I mean, the money supply growth is insane in places like that or Turkey, and so it becomes a question of what's real versus nominal in that sense. So basically, where inflation becomes deflation or triggers a deflationary cascade is generally when it triggers a private sector debt bubble that is then not offset by immediate and massive fiscal and money supply growth responses.
Speaker 1When we go back to the powder keg, I totally get what you're talking about as far as credit. My mind, the first thing that I would do if I was trying to make that analysis, because it does go back to money supply growth, because if— Just for the audience, guys, if you have the money supply growth where it needs to be, then that would imply that incomes can go up at the same rate or almost as high as the energy prices, and you might get that wage price spiral where you're not having to rob Peter to pay Paul. But if the money supply isn't going up— If the money supply isn't going up as fast, that implies that you're not going to be—or the businesses aren't going to be able to afford to increase their wages. So that's why it's extremely important. So what I would do is I would look at the rate of change in M2 money supply versus other timeframes throughout history, because you can't just say, well, the money supply increased by 40%. Okay, is that high? Is that low? What does that even mean? So if we go back and see that— Let's say the money supply growth over the last five years was 80%, and then you go back to the 1970s, and it was 70% during that same timeframe, then you'd be like, okay, this could be the 1970s. But if the 70s were 70% and now we're at, let's just say, 30%, then you'd be like, okay, this is likely going to be more like the GFC. That's where I would start. Tell me, does that make sense to you?
Speaker 2It does. It's certainly a big— It's an important component of what I would look at. I would look at money supply growth, but also I would look at the source of the money supply growth. So what's happening with bank lending? What's happening with private credit, which is a little bit different than bank lending? I would look at what's happening with fiscal, and then who's buying the bonds? Are the bonds being bought by things that generally, if they buy the bond, they can't buy something else? Or are they being purchased on a fractional reserve? So you can shift the ratio. You can shift the ratio of, say, broad money to base money, depending on either various bank regulations or just risk-on or risk-off decisions. So it's money supply growth, but it's a little bit more granular. It's like sources of money supply growth and how they net together. And then I'll also just look at things like where is there potential powder kegs in the form of too much leverage? And what I mean by that is, for example, in the global financial crisis, banks couldn't be in worse shape. They couldn't be going into that, like it's like global depression territory, whereas, for example, the reason in March of 2023 when Silicon Valley Bank was failing and a couple others, I was right there on Twitter saying, look, this is not going to be a giant bank failure, like it's not going to keep cascading to other banks because it was a fundamentally different problem. Like a handful of banks had a specific problem and they got blown up. But the broader system was actually not nearly. It is leveraged as as 2008. So banks, for example, had a higher ratio of cash and treasuries as a percentage of assets. And of course, some of them did have significant problems. But, you know, once once that initial wave went down and, you know, of course, there was a federal response. But in the grand scheme of things, I mean, look at total bank assets of 25 plus trillion. The response was tiny. And the the issue kind of. That point worked itself out, the the the rates were no longer rising, the the the most vulnerable banks, which means a combination of ones that were, you know, very exposed to long duration as percentage of their capital, while also having flighty deposits. You generally needed both of those problems if you had one of the other or neither. You generally survived. But if you had both, you were generally in trouble, for example, Schwab had exposure to the long duration. But they didn't have the. Flighty deposits and Citi, you know, Citi had in theory exposure to flighty deposits because they had a high ratio of business deposits that were not fully FDIC insured, but because they were so big and because they didn't really have the duration problems, they didn't get it. They didn't have an issue. Whereas when you have, you know, Republic or Silicon Valley, you had both. And that's where the crisis was limited to. But basically, that's a long way of saying that in addition to those money supply. The growth and the granular aggregates that lead up to it, it's also where do we have just sheer amounts of leverage? You know, where do we have these upside down pyramids and how how wide is the top versus how narrow is the bottom? Like how fragile private
Speaker 1credit to what do you think about that as far as that? Do you think there's systemic risk there with the bank's balance sheet?
Speaker 2So I'm on record saying I don't think there's that much systemic risk, which is different than saying I don't think there's risk for private credit investors, because in some sense. What private credit is, it's actually it's actually kind of close to full reserve banking. So instead instead of making a liquidity mismatch promise like a normal bank, you know, you're told you can pull your money at any time and then the bank goes and puts a percentage of that into longer duration assets and they play the odds that not so many investors are going to want to pull out at the same time. And if they do, that's where they would either borrow from another bank or from the Fed using collateral, whereas a credit fund basically says, OK, you're an institution or you're or you're an accredited investor. And, you know, you have spare capital and you're going to invest in this fund and we're not going to promise that you can get it all at any time. Like, you know, we're going to try to make quarterly liquidity possible, but it depends how many of you want money back. It depends on the financial conditions of the investment. And so, you know, when that when that has losses, it's not as bad as a bank losing payroll of companies or bank losing the checking accounts of people. It's losing basically interest. It's not as bad as a bank losing payroll of companies or bank losing the checking accounts of people. And then some of those private credit funds do borrow from banks.
Speaker 1Yeah, that's kind of where I was going with it.
Speaker 2So that's where you got to watch out for. But then you quantify it. So you look at how much in the aggregate are they borrowing from banks? You look at total bank lending books and you say, OK, well, how does that amount compare to their total books? And it's something like seven percent of bank assets. And it's generally still smaller than 30%. Total bank capital. In addition, those banks are kind of first in line. So, for example, the investors would have headaches before the bank wouldn't get paid back. You'd have to have pretty severe losses in private credit before you'd have, you know, kind of banks start to get hit. And then when if banks do start to get hit, that's seven percent of their asset book is what's getting hit. Now, of course, if that's happening, probably other parts of their asset books are getting hit. Right. So but that's where you want to look at things like how much. of the bank assets in cash treasuries, those things that are kind of nominally resistant to default, unless we have a political crisis or something, versus how much is private sector exposed. And, you know, on that front, I'm not that concerned. Now, you know, I can imagine, you know, at some point, some bank's going to fail. And it's going to be, you know, some smaller midsize bank that people probably didn't hear of ahead of time, because that happened to be the one that's like, you know, 30% exposed to private credit lending. Like you're going to have probably the Silicon Valley bank situation, like a niche thing that explodes. And it's like, look at that. But that's different than systematic bank failure. So I tend to be concerned around private credit investors themselves and less concerned around spillover in the banking system, with the exception that, you know, of the thousands of banks in the country, there are probably, you know, some that are over their skis and exposed there.
Speaker 1Yeah, where I get concerned, in addition to what you were saying, is how the increase in perceived counterparty risk impacts the banking liquidity. So if you got, you know, one of these funds blows up, and all of a sudden, you know, everyone overreacts, and like, okay, we're going to cut off all lending to private credit. So money gets super tight in that industry, which can lead to kind of this domino effect that becomes much, much bigger than it otherwise would have been. That's kind of, I see things through the lens that you were just talking about. But I also try to look at it and layer over, okay, what happens to how tight money is within that industry? And how important is that to the industry?
Speaker 2Yeah, and that's, that's where I think the investors would start taking the brunt of the hit, because that's where you'd have to see, you know, close end fund investors would be told, hey, like, you're not getting your money out anytime soon. It's different than saying we're not getting the money out. And so, you know, at the moment, because our banks stop lending to us, because, you know, 20% of you want out this quarter, and you know, we have two, we have 3% available liquidity. So most of you are not getting out, you can contribute to a down liquidity cycle, which, which can, you know, eventually that can say, well, it's like, well, if you're an institution, and you're, you're, you're private credits more locked up than you thought, then maybe you have to trim some equities to meet obligations. So then you can, you know, you can sell a stock you might not have otherwise sold. And so any part that's, you know, subject to inflated valuations, or has done well as potentially at risk, or just in general market risk. And, but I would still separate that to some extent from a, from a systemic bank crisis. Yeah. I mean, there's, there's levels to this, right? So obviously, you know, a down liquidity cycle that also contributes to a, you know, a 20% correction, the S&P, and, you know, maybe eventually start, start calling, causing higher inflation. You know, I mean, a higher unemployment, I meant to say, that is a cycle that I would absolutely be on the lookout for should it start to materialize, which is a little bit different than just, you know, straight to bank crisis.
Speaker 1Have you noticed lately this tug of war? That's how I've been explaining on my videos between the Dow and the NASDAQ. I mean, outside of the blue wave and kind of, you know, Jensen and the Chinese gal and whatnot. That's how I've been explaining on my videos between the blue wave and kind of, you know, Jensen and the Chinese gal and whatnot. It seemed to me like it was one day, Dow up, NASDAQ down. The next day, NASDAQ up, Dow down. And it's just basically capital going from here to here to here to here to here to here. And it was like they were in this tug of war to determine, you know, who's going to win. Is it going to be the Dow? I'm talking about the companies there. Or is it going to be the, the NASDAQ? Did you notice that? And if so, in, I know you're a student of history, is that typically what happens in these, in these cycles?
Speaker 2So obviously, when you go back far enough, things get different. But I have been noticing this. I mean, sometimes it's more specifically, you'll have, you'll have an AI trade versus software trade, for example. And then, and sometimes you'll have AI just more broadly versus value. I think there's a couple of reasons for that. One is, I mean, there is competition for capital. And so if you have an unusually fast build out in one industry, in this case, AI, you know, data centers, semiconductors, and so forth, that is a massive source of capital, which means, you know, they're raising a lot of debt and financing in general. So if you're, if you're, if you're also trying to raise, you know, financing or, or equity or stuff, and you're in a, you're a completely different industry, you know, you're in the grocery industry, or you're in the chemical industry, you're competing with like Microsoft raising bonds, you're competing with like meta raising bonds, or, or, you know, a hot new venture fund that's coming out saying we're AI. So we're raising all this money. And if you're a venture fund that's, you know, trying to do something different, you're, I mean, you're just, you're out of the conversation, right? So it's just your, your cost of capital is higher now. And that generally includes those, those value companies. So that, that's like a funding source for this other thing. Now, anything that, that tells investors or these days, realistically, their algorithms, anything that says, Hey, here's a new signal point that might, or at least even, even around the market and slow down AI CapEx, right? Like, Hey, we're worried about this company or, Hey, this, here's this data center that just announced this, or here's this thing. Then algorithms or investors can say, Hey, if that slows down slightly, then maybe these other things have been punished. Maybe they deserve an update now because we have a slightly new piece of information that gives us an idea of what next year might look like. I think that that's one factor. Then of course, like algorithms just amplify anything because then algorithms can try to front run that and say, well, other algorithms are going to think that. So even if we're not sure, let's just, let's just, you know, it was, it was up yesterday. So let's go to the Dow today. But yeah, and it's just, you know, it's, it's, it's competing for capital in that sense. And I think that that in some ways it makes sense for any volatile uncertainty, which is you have a new technology or at least a new technology at scale. And there are kind of valid different opinions on how big or how long the cycle will be. And to some extent, it's a very binary outcome. You know, I mean, if the, if the AI cycle ends in 2027, that's a very different situation than if it ends in 2028 or 2029. And so any kind of new data point that gives us an indication of how long or how big this cycle is going to go before it eventually has a down cycle is kind of trading information. And so it's, it's, it's a, you know, it adds to volatility and kind of that seesaw. How
Speaker 1important do you think the anthropic IPO is?
Speaker 2I mean, I think it's, it's, it's quite important. You know, it's, but I still, like, I, I, because I'm bearish on the frontier models, you know, it's certainly, it's important for that unlock. It's important for, for the employee liquidity. It's important for just the ecosystem.
Speaker 1Yeah. Because if that, if that takes a dump, right, if that, then what happens to open AI, they can't get, they have to have the money. And then it goes back to the Jenga puzzle. And also too, I did a video the other day about trailing 12 month, equity issuance, because to your point, there's a limited pool of capital that's willing to go into these entities. You know, it's not like treasuries or something where, or banks can buy that, put it on the balance sheet. So what ends up happening is over the last 12 months, you've had about 200 billion in issuance because of SpaceX and all these things. And that's actually really high relative going back 20 or 30 years. So on top of this 200 billion, now we're going to have a total of 100 billion in equity issuance. So if you're looking at an anthropic, say another a hundred billion, then you might have open AI, another a hundred billion, then Meta just announced 95 in equity issuance in different tranches. So at some point it's like, okay, we've got a deluge of supply of equity. And to your earlier point, not that much capital. So I think those are the
Speaker 2reasons why I think that anthropic IPO is pretty important. If you end up having to delay it because you couldn't get the valuation you expected, that would, I mean, that would, like I said before, that whole venture cascade would be at risk of triggering because all this venture money that expects the next round to be higher or expects an exit in the near term, they would have to reevaluate all of that. And I think we will hit that point eventually. Now the question is, do we hit it? Obviously, the other way of hitting it is you have successful IPOs, but then over time they stagnate and then obviously investor interest in them dries up, venture interest starts to dry up. So that becomes a question of timing. If you have a flawed or shelved IPO, that generally would likely pull forward our estimate for when the cycle is going to have a down cycle. Whereas if you land the IPO, that's a data point that you still likely have time. So these are all signposts on the way toward how long and high duration the cycle is going to be. So that's kind of a question of timing. Trey Lockerbie : And what's interesting about the semiconductors is, I mean, they are trying to play this game. It's not super dumb money, which is, a lot of investors have it in their mind that semiconductor companies are expensive. And of course, in market cap terms, they are. But for example, Nvidia trades at a lower earnings multiple than Coca-Cola. And that was even before this recent news. And so part of that is because if you look at what Wall Street analysts consensus expect, they expect way faster earnings growth for NVIDIA than Coca-Cola. So NVIDIA investors are paying lower multiples for a company that in theory has higher growth and a very good market share. David Gardner : And I think it's a good question. I think it's a good question. Trey Lockerbie : Yeah. David Gardner : I think it's a good question. very strong balance sheet. Um, uh, but investors are, are just more doubtful of, of the cycle than they are, for example, of the soda cycle. Uh, and so there's actually some rational fear, I would say in, in Nvidia investors that are actually kind of looking at Wall Street analysts and saying, I'm not truly full. I, uh, I'm not sure I believe you. And then for memory stocks, it's of course, even more extreme, which is you'll have in some cases, single digit earnings multiples or cashflow multiples. Um, because you know, they're looking at margins, they're looking at the growth and they're trying to say, well, when does this cycle end? I don't want to be holding the bag when it, when it has a downturn because it's historically very volatile. So semiconductor investors are often already trying to front run when, when this starts to roll over.
Speaker 1Yeah. So that would imply that we're in 1998 and not 2000. I mean, that's,
Speaker 2that's my estimate. Um, I, I think we probably see this going out to 2020. Um, but I'm always evaluating if I'm wrong or not. Right. I mean, it's always like a matter of probabilities. And so for example, if we were, if we saw an anthropic IPO get shelved, right. Uh, we'd be having a different conversation probably around timing.
Speaker 1Right. Yeah, exactly.
Speaker 2And it's not, it's not always the case that every bubble has to just completely go off the rails. I mean, sometimes, you know, a bubble can peak at a lower ratio than people expect. Um, so there were, there were certainly already, there were certainly parts in the semiconductor cycle where they got a little bit ahead of their skis, you know, back in June of this year, for example. Um, uh, and so they have gotten ahead of their skis. Uh, but yeah, at the moment, uh, semiconductor investors are, you know, a little bit spooked around, um, uh, they seem to be somewhat doubtful of the wall street analysts for their earnings and, you know, perhaps rightly so. Yeah. What have you been thinking about the last couple of weeks? Uh, well, a lot of it's private equity just because of the, um, the orange juice, uh, company that, that, um, uh, we've been involved in Jeff, Booth and, and a couple of, uh, others partners.
Speaker 1I didn't, I didn't hear about that.
Speaker 2Uh, so yeah, we, we, uh, raised capital. Uh, this is public to, uh, acquire, um, businesses, uh, in a similar way that private equity does, uh, except, uh, instead of a fund structure, uh, uh, we have a, a company structure. So it's a permanent capital vehicle. So the difference is that we acquire, we, we, we seek to acquire companies more like Berkshire Hathaway would, which is you buy and hold indefinitely. Um, uh, versus buying to, uh, flip and optimize and, and get out quicker. Um, and so, uh, yeah, it's a, it's a kind of like
Speaker 1what Hermosi does.
Speaker 2Uh, there's, there's a handful of companies that do it. There's like bending spoons is doing it in the software sector. Berkshire, like I mentioned, does it at the largest scale. Uh, there's also niche ones like Illinois tool works, does it for engineering parts? Uh, and it's basically, you're taking a
Speaker 1long-term equity position. You're not buying the company outright. You're just buying like a, a majority position or it's buying the comp buying
Speaker 2the companies outright in a similar way that you would. Yeah. Except instead of a fund structure where you're on this, you know, you're on like a 10 year clock to, uh, you know, rate you raise capital, you deploy it, and then you generally, uh, lever and, uh, uh, try to find a new buyer for the business, either the size, uh, this one, the exit is that eventually the, the goal is for the company itself, the shares to become liquid. So, so the investors, they can get liquidity that way. Um, and so it just changed the incentive structure. I mean, a lot of people, for example, you know, they had their veterinary clinic or their, or their taco shop and, and suddenly private equity bought it and kind of the quality deteriorate over time because you have, you know, not there's anything wrong with PE per se, but when it's the only game in town, you get an incentive structure. That's inherently short-term focused. Uh, you're more incentive to optimize the next call three years rather than build a 10 plus year or just indefinite business. Um, and so we, we think there's a differentiated strategy for that. So, uh, uh, you know, people that are either interested in selling businesses or, uh, you know, potentially investing, we have orange juice.com. We managed to get the domain. Uh, so, uh, how are you serious? Yeah. Orange juice.com.
Speaker 1Yeah. I will. I, I could go down this rabbit hole all day long, but Lynn, how can people find out more about what you do?
Speaker 2Uh, Lynn Alden.com. People can check it out. Um, uh, uh, or, uh, orange juice.com. If they're interested in, uh, some private equity work,
Speaker 1that sounds really cool. Yeah. So I wish we would add a lot more time. Cause I, I wanted to dive into that. So we'll have to have you back on soon so we can discuss kind of what you're doing in your, in the investing world, uh, which not too many people know about. They just know you from the macro stuff, but more recently, um, you're, you're, you're, you're really all about kind of investing directly in these companies that got massive upside growth. So exciting stuff.
Speaker 2Definitely. Thanks for having me. And of course, always happy to come back.
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