Transcripts
Erik: Joining me now is Carlyle's Chief Strategist for Energy Pathways investment, Jeff Currie. Jeff, it's great to get you back on the show. It's been way too long. You just penned a great article that is all about capital rotation and why you think we're in one now, and Europe is going to be the big benefactor. Tell us more.
Jeff: It's a pleasure to be back. And the piece was focused on European defense, in the sense that it's going to create a need for a large-scale investment in old economy, asset heavy type industries, and the real catalyst to this was the lifting of the debt break in Germany. Now, this piece that we put out is a follow up to The New Joule Order that we put out a few months ago. And in The New Joule Order, we made the argument that the Bretton Woods system is breaking down, the US is retreating, and this is going to have a significant impact on the dollar, energy and military investment. And this piece we put out yesterday was really about the military investment component, but I want to talk about this breaking down of the Bretton Woods system and the retrenching the US. And the way I like to think about it is, if the dollar was the heart of the system and the oil was the blood going through the veins of the system, the US Navy was the muscle of the system. In other words, for the last 75 years, the US has used its military might to protect global sea lanes for global trade. The dollar was used as the medium of the exchange. And when you think about if you had protected sea lanes, you will start importing oil as your primary energy source. It is the most portable, the most storable. And as a result, we had supply chains that stretched all around the world with previous adversaries, and the biggest commodity being shipped was energy. That's your strategically most important commodity. And as the US retreats, it brings all of these into play, and I like to call it bonds, barrels and bombs. The bonds of the dollar, the barrels are the oil, and the bombs are the US military, all three of these are under pressure.
And talking about this now in the context of the capital rotation is, as the US retreats, Russia is getting more aggressive, and as a result, the situation in Europe, it is now existential that they need to make these kinds of investments, and when we look at the potential return in old economy, they're undervalued tremendously. Europe specifically is undervalued by about 40%, and all the complaints about Europe being the superpower of regulation, what did it get out of it? The lowest debt to GDP ratio. It has the highest level of income and wealth equality of the major regions in the world. And instead of having crippling market concentration, like most parts of the world, it has consumer surplus. So, it has all of the requirements, and plus, a steep value discount to track that capital. And I’d argue, what we saw going into the events in Iran and in Israel on Friday is the dollar was weakening tremendously. Part of that is, we saw the outperformance of Europe. I like to point out, since ChatGPT was first announced in November of 2022, Europe has outperformed the US by 20%, meaning what's going on in Europe right now is likely bigger than AI. In fact, AI’s CapEx since that announcement, has been 500 billion. German defense alone is going to be more than 1.5 trillion, already announced. So, this is big. And one last point I want to make here is that when we think about Silicon Valley and AI, they are simply an extension of the US military industrial complex. It started out with DARPA, creating the internet that created AI. Think about Silicon Valley. Where does the name come from? It comes from, they needed to come up with a material that would not melt in a B-70 bomber in a Minuteman missile. And they had, they came up, Fairfield semiconductors came up with the silicon chip, and that's where it came from. So thinking about it, why does Europe not have a Silicon Valley? It never had military industrial complex. So, this is huge, and we think it's going to create a productivity a boost there. And again, going back to the steep valuation discounts, and I think, the point being is, I think this rotation is all underway. And if you put it in context of previous rotations, we saw one in 2000 to 2003, when capital left the dot-com boom and went to bricks again. You know, you had overvalued tech and undervalued commodities in heavy asset, heavy sectors. And then the next one was 2014, 2015, when money left bricks and went back to Silicon Valley for the MagSeven. And again, it was overvalued commodity, heavy asset plays in China, and undervalued tech in the US. Now, we're kind of in the same, in a point here where you have undervalued heavy asset commodity sectors against relatively steeply valued tech sector. So, this is probably a process that's going to go on for a while, and it's pretty consistent with things we've said in the past. But I think the catalyst here is, really, European defense, and the potential there with the lifting of the debt break, they have the spare fiscal capacity. They have industrial capacity. All the ingredients are there.
Erik: Joining me now is Commodity Context founder, Rory Johnston. Rory, it's great to get you back on the show. It's been way too long. Let's start with the crude oil market. Almost feels to me like we're seeing the beginnings of maybe an upside breakout. What do you think?
Rory: We’re definitely at the highest level. I mean, with Brent kind of sitting around $67-$68 a barrel, highest level since the latest sell-off in April, still a decent ways off of kind of where we started, prior to President Trump's Liberation Day tariff announcements and the kind of double tap follow on of OPEC+ announcing this kind of accelerated production increase schedule. But it definitely looks like things are firming up. I think a lot of the kind of teasing, kind of temptation of us dipping into full curve contango, seems to have been at least averted for now. But what's left us with is the fact that the curve is in this very, very weird shape, and in some cases, at least on the Brent curve, kind of an unprecedented shape that you have extreme backwardation now, or at least material backwardation across the first 4, 5, 6 months of the curve, and then you have broad contango everywhere else through. You've seen it, historically, where you have like lighter backwardation at the front. But this kind of juxtaposition of very steep backwardation at the front and broad contango is pretty unprecedented. And I think that is a kind of a flattening of the entire debate in the oil market right now, between these expectations of looseness to come and the reality of kind of still reasonably tight markets by any other way we measure them.
Erik: Joining me now is Stone X head of global macro strategy, Vincent Deluard. Vincent, It's great to get you back on. It's been too long. Let's start with the markets and what you see coming. I think you've had a pretty good spring. You kind of called the correction in March. What's the outlook now? I think you were looking for a deeper correction in the summertime. What's the outlook? What are you forecasting, and what's what do you see coming?
Vincent: So we had a call for a March correction bear market called "Beware the Ides of March.” I must say, I got a bit lucky with the tariffs. I got some help from Orange Man. And then when we saw the market in dislocation, by late March, early April, it was clear that the TACO trade, things would bounce off. So, we published a report called “Spring Rebound, Summer and Fall Correction.” The idea was that the market would retrace most, if not all, of its losses, and then kind of hang around the summer, which is typically a boring period, and then in the fall, we'd meet some of the unsolved issues that hadn't been addressed in the spring. I've updated that because the rebound has exceeded my expectation. I mean, we’re basically back at an all-time high. The market went up almost like 15 days in a row after the pause on tariffs, what I thought would be the trigger for the second leg, which is rising bond yields, has also happened. I mean, we are at a cycle high in a 30-year, the 10-year is not far behind. So, I'm starting to wonder that this kind of second leg, maybe a retest of the low, or maybe not, we go fully too low, but certainly significant drawdown would happen in July instead. And July would seem like an inappropriate date for correction. This is when the 90-day pause on tariff ends. I doubt that we'll have big, beautiful deals with 200 countries. Since we don't have somewhat BS deal, we have one, the UK, now. So we'd better get signing right now. So, with this policy risk on the tariffs, this policy risk on the Fed, obviously, we kind of pushed out the rate cuts, but that means that the July meeting is the one that becomes key, partly because there's a part of the market that expects cuts, and certainly they expect guidance on these cuts, which may not come. July is also going to see the impact of tariffs filter through the economic data. I think now we’re enjoying this kind of almost illusionary relief, where, oh, look, Q1 is fine. Of course, Q1 is fine. I mean, the first tariff payments were made. If you look at Daily Treasury Statement on April 22, so you're not going to see that on the Q1 data, and you're barely even going to see it in most of the Q2 earnings, either. I think that the way you're going to see it is going to be the guidance towards Q3, Q4, which will be made in July. July, of course, will be earning season. When companies are about to report earnings, they can't complete buybacks. So, if we see some weakness in the market, there wouldn't be that buyback bid to stop it, which I think was a factor when we had the big waterfall decline in April. There was no buyback to stop it. Now, eventually, the buybacks will come back as companies report, but there will be that window of weakness, and then finally, from a flow perspective, stocks have completely destroyed bonds. This quarter, we are up 20 plus percent on stocks, while bonds are flat to down. So, if you are a target date fund, which is the way most US retirement savings are managed now, you are way overweight in stocks and way underweight bonds. So, you'll probably need to sell some stocks, buy some bonds, or at a minimum, when you see the paychecks come in June for Q2, you'll allocate all that money into bonds and none of that in stocks. So, you have policy risk, you have Trump risk, for lack of a better word, earnings, I think is going to be okay, but let's call it garden risk. And on top of that, you have poor liquidity due to lack of buybacks, and then the target date funds at a time when, typically, people are on vacation. So, yeah, I think we had a very nice run. I'm not structurally bearish. I don't think stocks are actually that expensive, but I would put some hedges ahead of the summer season.
Erik: Joining me now is Mike Green, Chief Strategist and Portfolio Manager for Simplify Asset Management. Mike, it's great to get you back on the show. It's been way too long. I want to start with something that you've been talking and writing about lately, which is, when you have the scope and level of change in government that we're seeing under the Trump administration, not only does that change the economy, but it also brings into question the metrics that we use for measuring the economy. Tell me what's going on in your assessment. Is the market correctly discounting what the real economic effects of Trump policy are? Or, is Trump policy actually interfering with the way we measure these things to the point that we're losing track?
Mike: Well, I think it's a combination of the two. And I don't think it's unique to the Trump administration, although I do think the disruption that is underway in the Trump administration will play a role as we roll forward. Your listeners who have heard me talk before know that my primary area of research, my primary focus is on the market structure impacts of the growth of passive investing. And what that leads you to understand or believe is that the market is being inflated by our style of investing. You put money into a passive index fund, it allocates very large sums of capital to the largest companies. Those companies are highly inelastic in their price response, meaning small changes in supplier demand can cause significant price change. You can think about it as a multiplier, right? So, the traditional thought process behind something like the Efficient Market Hypothesis is that a dollar into the market has very little impact on security prices because it's really an information exchange. You’re saying I have a strong view about X, but somebody on the other side of the trade has an equally strong view that X is not true, or they have their own reasons for selling. And so, the net impact of flows into the market under the EMH are very, very small. We now know that is not true. The academic research that has emerged in the past decade, starting with Ralph Koijen and extending to his work with Xavier Gabaix called the Inelastic Market Hypothesis (IMH), identified that stocks are highly inelastic. And in fact, what we're seeing is somewhere in the neighborhood of about $7 to $8 worth of market cap created for every dollar that flows into the markets. That suggests that the EMH is misspecified about 800 to 1. That research has now gone further, augmented by an individual named Valentin Haddad at UCLA, who has looked at the market cap impact of that. And I've done a lot of work with Valentin at this point. And what we're finding is that for many of the largest stocks, the NVIDIA's, the Apple's, et cetera, of the world, that inelasticity is an order of magnitude higher there.
So, we're seeing between $75 and $100 of market cap created for each dollar that flows into the market. As long as people have jobs and are contributing to 401Ks and their retirement flows continue to be positive, and that's been augmented by policy choices like Secure Act 1 and Secure Act 2 that have increased participation and increased employer contributions, that means that the market isn't really pricing anything anymore. What it's really doing is reflecting those flows. And Trump's policies, while they've interjected uncertainty—uncertainty doesn't mean fire the workers you desperately tried to obtain over the last five years—we basically have businesses in a holding pattern where they're starting the process of thinking about firing people. You just saw Facebook introduce performance metrics, et cetera, and the objective being to move to a GE type model where they lay off the bottom 10% of performers on a continual upgrading basis. That's telling you that the uncertainty is likely to morph into some form of increase in unemployment. We see this in employee uncertainty indices. ‘Jobs hard to find’ are getting higher relative to ‘jobs plentiful,’ fear of losing your job is starting to rise. All of those are telling you that we're looking at a scenario in which unemployment could begin to rise fairly significantly. And if that happens, then those flows can change. But in the meantime, we're used to thinking about markets as discounting mechanisms, and we ask ourselves, what is priced in? If the market is going higher, it must be good, things are about to occur. The market is discounting something positive in the future. I just don't think that's true. I think that it really reflects the fact that companies have not yet laid off the employees despite the fact that we're seeing significant weakness and demand.
Erik: Joining me now is Bianco Research founder, Jim Bianco. Jim, it's great to get you back. I got to tell you, buddy, I think you were probably the most prescient of our guests this year, this calendar year, or in the last year, for that matter. The last time that I had you on, you said, look, it's time to reset our expectations. The Trump and Bessent have big, big ideas. They're not just jiggering a little thing here and there. They really want to change the structure of the system. We've got to be ready for them to have some big ideas, and you perfectly set the stage for what was coming with the tariffs. Now, what I'm seeing, Jim, is almost everybody seems to be feeling like, okay, seems like maybe this tariff battle is starting to wind down. And I don't know what your take is, but my feeling is okay. If that's really winding down, the right question to ask would be, what does Trump have next on his list, after tariffs? And it feels to me like everybody's saying it's done now? Is it done now? Is something ending, or are we just at the beginning? And how should we be thinking about where we are in this process?
Jim: No, thank you for the kind comments. I think no, we're kind of at the end of the beginning is where we're at now. As far as tariffs winding down, let me take that part first. I've said, you know, the problem I have right now, within the messaging that you get out of tariffs, there's two messages that a tariff can employ. One is leverage. I'm going to use this club to beat you unless you give me what I want. And what I want is freer trade and more access to your markets. If you're going to use tariffs for that, I think everybody's fine with that, and that is what kind of everybody wants, and that's a bullish outcome. But if you're going to use tariffs as a source of revenue and create the external revenue service, and we're going to raise all this money, and we could do away with income taxes, that's just a massive tax increase, is what that is. And that is problematic. The issue that I have with Trump, Trump especially, is he kind of says that they're both tariffs and revenue in the same sentence. And I was like, well, they can't be both at the same time. They're either one or the other. So, when people start to say winding down, that the tariffs are winding down, I think what they mean is there’s going to be leverage. The leverage is going to result in what we saw with the deal with the UK, an opening of markets, a less restriction on being able to push goods into each other's markets, a leveling of the playing field. I'm not so sure that that's really what it's going to be at this point, and so we'll have to see where we go with the tariffs.
Now, to the second part of your question, what's next? As well, when I was on with you last time, I said, look, he is talking about a reordering of the financial system. I'll remind everybody that in June of last year, Scott Bessent spoke at the Manhattan Institute, and he said that we're in a rare period of time that only comes around once or twice a century when we completely reorient the global order. And now he's talking about the monetary and trading order, maybe not the political order, but that might flow from it, and that he wants to be part of it. And, well, he's the Treasury Secretary, so he's definitely going to be part of it now. And so, I think that that that's the second part that's coming, and what that's really going to be is, if I had to put it bluntly, the United States has a debt and deficit problem. We have too much debt. Our deficits are too big. There is an inability of Congress to cut spending, and so we need to find more revenue. Tax the rich. Well, that's not going to work, we've tried that. Tax the middle class. That's not going to work. We've tried that. Well, who else is there to attack, tax? Tax somebody who doesn't live in the United States. And so that's what tariffs are. That's where the other thing that's been kind of lost in the shuffle a little bit, is the idea that Europe needs to step up and spend more on their defense so we don't have to.
And then the other idea, which is this, from when we're recording the week before Trump gave a speech in Saudi Arabia where he talked about, that the main benchmark going forward from here is not going to be ideology and war. It's going to be trade. And I want to do deals with Iran. I want to do deals with Gaza. Remember, he wanted to build a hotel in in Gaza City. He wants to do economic deals with everybody, which means less of an impetus for the idea of conquest in war. So, this is very different than what we've seen before, and this is a different type of global order that we're going to. And the last point I'd bring up about this is, I agree with Trump that the status quo could not hold. We were at a point with debt, deficits, the imbalance of trade. Look, we set up a World Trade Organization, and we set up a lot of these trading rules over a generation ago, and they're not really applicable for the kind of economy that we have now. We had to change. Now, we can quibble whether or not this is the right change, and this is my pushback against the Trump critics. He's proposed a bunch of radical policies to change. Okay, you don't like them. The answer is, let's just go back to the status quo. The answer is, give me another set of radical policies to change it to. But we're going forward with this kind of change, and we have to start to accept it and the ramifications for financial markets they're in.
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