Invest Like the Best with Patrick O'Shaughnessy - Karen Karniol-Tambour - Macro Headwinds vs. Tech Tailwinds - [Invest Like the Best, EP.329]

Starting point is 00:00:02 Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, stories, and strategies that will help you better invest both your time and your money. Invest like the best is part of the Colossus family of podcasts, and you can access all our podcasts, including edited transcripts, show notes, and other resources to keep learning at join colossus.com. Patrick O'Shaughnessy is the CEO and founding partner of Positive Sum and the CEO. of O'Shaughnessy asset management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of positive sum or O'Shaunacy asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of positive sum or O'Shaunacy asset management may maintain positions

Starting point is 00:00:54 in the securities discussed in this podcast. Today's conversation was recorded during last week's Sone Conference. I sat down with Karen Carnial Tambor co-CIO at Bridgewater Associates. I hosted Karen on this show two years ago, and if you listen to that, you'll remember she has a rare skill for distilling and analyzing complex macro topics. Today's environment is strikingly different to the summer of 2021, so this is a timely conversation on the big macro variables that are on investors' minds today. Please enjoy my conversation with Karen, and if you want to listen to the other fireside conversations with Sam Altman, Patrick Collison, and Stan Drunken Miller. I recommend watching them on YouTube through the link in the show notes.

Starting point is 00:01:39 Karen, it seems like every single time I talk to you, you get promoted. So if we keep doing this, you're going to be president in a few years or something like that. Congratulations on the new position. Thanks. I'll keep talking to you no matter what happens. I promise that. I would say that the theme thus far today of the big conversations, the fireside chats like this one, has been this clash of what I'll call macro headwinds that Stan Druck and Miller just laid out for us. And technology tailwinds, the revolution that's going on in the world of artificial intelligence that Patrick Collison and Sam Olman started the day with this morning. I would love to hear your take on something like AI.

Starting point is 00:02:19 Obviously, you're focused on the very big global picture of capital markets and all different asset classes. and when you introduce a force like this into the field, I'm sure it's something that you've considered deeply. So what is your reaction to watching this technology unfold in just the last few months and how do you think it affects the big picture? You're completely right. I'm the last person you should listen to in terms of actually explaining the technology whatsoever. But I think the bestest thing about in terms of analogies to what's happened so far,

Starting point is 00:02:48 which is when you have secular forces, they tend to be slow moving and affect a lot of things that the matter for macro, but affect them over time and over decades. And in my view, we're kind of living right now with the after effects, having just been through a very long cycle where a few big macroeconomic forces really shaped our world and shaped it really broadly, economically, socially, politically, over a few decades.

Starting point is 00:03:12 And if you start around the 90s or so, you get these big forces of globalization and automation that, to simplify, and obviously a lot's been written about this, take this section, a bite, if you will, out of the U.S. labor market and the U.S. economy that was mostly manufacturing, and totally upends it. All these people, these people, manufacturing jobs in certain people in certain locations, and moves a lot of those jobs to cheaper countries, mostly China. So now you have all these jobs disappear. And then the rest of the ones that are left get massively more automated. So people who are left in the U.S. doing manufacturing jobs,

Starting point is 00:03:45 I know highly, highly, highly radically more productive than they used to be. So you have a productivity the explosion in the manufacturing sector requires a lot fewer employees. That's a huge change. It took a long time for that change to happen to probably, I don't know, 20 years. And the effects of it affected everything in macro gradually over that time period, meaning you had higher profits, really good for companies. They could get more productive, shift events abroad. It was really deflationary.

Starting point is 00:04:10 That was a big part of what kind of allowed Federal Reserve to keep racial and all that. It had big social consequences, inequality got bigger. and a lot of the populism we see and the political consequences, slow moving, but a lot of our conflict with China comes out of two decades with a slow train going through and making its way through our economy, and this happened all over the world. And I think when I look at what's happening with AI, the big obvious question is, are we about to go through this again

Starting point is 00:04:36 and way, way, way bigger? Because when you look at estimates, and again, I'm certainly not an expert in technology, but you look at open AI's estimates, you look at Goldman's estimates, they all have different methodologies, they all say the percentage of labor market that could be affected by AI in the same way the globalization, automation, touch manufacturing, it's a much bigger bite in theory. So you could be hitting a bigger sloth than the people in manufacturing. And that effect might be even faster and even bigger than what we just lived through.

Starting point is 00:05:03 And we're still dealing with the aftershocks of all that. So it's not really something I think people can ignore. Just this morning, a company called Intercom, which does customer service chat interfaces, announced a new AI powered service. And the stats that they report on the amount of things that can be handled end-to-end by LLMs by AI versus no people involved is staggering. They're starting to see little green shoots like that, that this stuff is real and it's going to impact labor and everything else.

Starting point is 00:05:30 But what things are you watching that would bring your level of attention where you might actually take action in the portfolio? For investors out there that are thinking big picture, Are there certain things that you watch most closely or might begin to watch most closely as this unfolds? Well, the big thing is it has to be big enough to offset the massive inflationary forces that are going the other way. So everything else in the world is kind of going the other way. I think that if you look at what companies are doing right now, sure, some companies are already integrating AI. We have to figure out how fast that's going to happen.

Starting point is 00:06:03 But companies all over, I think it's the biggest wave of what I would call non-economic spending companies have ever had to do, which is that big wave I was talking about in 1990, every time a company spent a dollar, they pretty much knew it was going to reduce their cost base. They knew it was going to be deflationary. So they were spending money to take money out of the cost base, to go make that worker more productive, to go make their supply chain more efficient, to go move things to China. Now, companies are basically being told, go make your supply change more resilient instead. And what does that mean? That basically means go spend money to become, in some sense, less productive. I have the most productive supply chain today and I have to go double due. I have to

Starting point is 00:06:40 go spend twice. And they're also being told you should go and decarbonize. That's a great idea. The world greatly needs that, but that's not spending that tomorrow you're saving money on. It's in some sense you have to rebuild the whole energy infrastructure. In that moment, it's inflationary. We're being told, let's go subsidize all sorts of things in order to get more competitive and build things domestically. We didn't need to build domestically before. So that's a massive wave of pretty not economic spending that's kind of structural. inflationary force. And that's already some number of years in the making. Right now, I think that wave, if you will, is ahead of the AI wave in terms of companies need to do that spending. It's already

Starting point is 00:07:15 kind of a system. It's also going slowly. It's not like anybody's about to go completely get out of China, but that is a structural inflationary force. And what we have to watch is how will that structural potential deflationary force could massively upend the economy called technology and AI, what pace is that going to go and what's going to be faster and better and stronger? And the biggest thing I worry is just a more volatile environment. You have a likelihood for more volatile inflation, more volatile shifts. I might be a lot faster than mobilization and automation did. And that causes the assets you hold to look very different. Sam, Aldman, this morning said something else really interesting when asked what's an area of the world that might get affected

Starting point is 00:07:55 by all this technology that people aren't talking as much about. And he actually said that he thinks some investor will figure this out, figure out how to use this technology to earn fantastic returns. Bridgewater is famously systematic, an enormous consumer and user of data in its investment process. What do you think about that idea of using some of this cutting-edge technology to inform or make investment decisions and whether or not that will be a competitive advantage? I'd say nobody knows the answer to that question yet, but I do know that we and others are going to work really hard and trying to figure that out. We certainly don't know the answer today, but we'd be a idiotic not to go and

Starting point is 00:08:35 invest energy trying to figure that out and trying to see it. So I can hypothesize. I could tell you all the things that seem promising and unpromising about it, but the technology is evolving so quickly that do all by our investors, we at least have to be asking the questions and studying it. Can you describe how the setup of that work plays out? And I'm also curious for your thoughts. Let's say that isn't true, that nobody is able to use this technology to earn an investing edge. Why might that be the case? Well, I think the most obvious reason in macro, and obviously I can't speak to all the different types of investing out there in the world is that by its nature, you're learning from history. And there's a pretty short history of macro markets. And there

Starting point is 00:09:15 were a lot of things that were true in that very short history of macro markets that might not be true in the future. So it's pretty easy to optimize or use a very short history to come to very bad conclusions. And so you can easily imagine doing it poorly. Now, it doesn't mean there isn't a way to do it well. I bet there's a way to do great. But that doesn't mean that'll be easy to find. And it's easy to imagine messing it up. It's very different than a problem called Tell Me What's a Cat, where I can show you 10 million videos, and my risk of being wrong is very, very low, and I've got a really wide range of data. Yeah, exciting but dangerous seems to be the summary of applying some of these technologies to investing. Bridgewater's famous daily observations note that it sends to its investors

Starting point is 00:09:52 and others often lays out big picture things in fairly simple terms. If you were writing one of those tomorrow about just the general state of capital markets, what would be the key themes of your view today looking forward? I think the simplest thing I would say is that the world is changing really rapidly and capital markets tend to be slow to adapt when things structurally change. Because people trade based on our experience. They trade based on what they're used to. They have lived experiences in the markets that are a certain way. And so whenever you see big structural changes, markets tend to lag that, tend to just take time for investors to kind of follow up on that. And you know, the most obvious case of this is, look, inflation's been running well above what

Starting point is 00:10:41 the Fed wants to be for a while. And markets are basically telling you, don't worry, the Fed is always right. And if it wants inflation to be 2%, it's going to be 2%. And it's going to work out. And so almost no matter what happens to inflation, if you were to tell me, wake me up from no percent, the night five years ago and say inflation would be high it is, what do you think markets would expect? I wouldn't have expected the markets would say, don't worry, it's going to go back, it's going to go away. The Fed will always get what it wants. I think it's the nature that it's been so successful, and central banks have been so successful for so long in containing inflation that it kind of underpins people's expectations. And so you've set up in this world where a lot of

Starting point is 00:11:17 what was true about the last 40 years, deflationary, and because of that, it was very easy to always make money and risky stuff. The reason it was easy to make money and risky stuff is that every time anything went wrong, central banks would just solve it because there was no tension in what they were experiencing. It was pretty much, if things are bad, ease. If things are bad, ease. Why? Because if there's not going to be any inflation, there's nothing wrong with easing. You can just always ease as much as you want. There's no tension. Just go make growth as well as you can. You'll never get inflation. The idea that we're in a different world today, where that's not the case anymore, or actually, if the economy starts going bad, it's a very tense situation for a central bank.

Starting point is 00:11:56 You do not want to be that central bank that let inflation get out of control. And we lived through these mistakes in the 70s and so on. They're actually tension for the first time. They're actually constrained saying, what do I want, growth or inflation? I don't think that tension is understood yet by the markets. And I think we're about to go experience it because I just don't think that inflation is going to magically return to where it was before. What do you think that prevailing valuations, let's say, just unlike the big asset classes,

Starting point is 00:12:20 tell us about what the market thinks is going on. What does it seem like is in prices right now, if you will, as you look at S&P 500 multiples or something very basic like that? Well, I think the stock market is telling you that there's going to be a modest economic slowdown, pretty contained economic slowdown, nothing like significant recession or anything like that. And that with that slowdown alone, the Federal Reserve is going to find that sufficient to go ease from 5% to 3% extremely quickly, that is going to do that despite where inflation is today, because inflation is going to go back to totally reasonable levels that they want very, very quickly. And you see that kind of across stock and bond pricing.

Starting point is 00:13:04 Bond pricing is telling you inflation to be fine. There's no inflation from anything like resembling long term, and the Fed's about to ease pretty significantly without a significant slowdown. And where that sort of leaves you is that the market, I believe, is asymmetric. It's very asymmetric because if you actually get an economic, would slowdown. That's obviously very bad for stocks. I'm going to tell you that that would be pretty bad, but there's really not much of a recession priced into them. It would be pretty bad. And usually the way you get out of that, as I was saying, is that every time there's a slowdown,

Starting point is 00:13:32 the central bank just comes and eases right away. Now, not only will it be much harder for them to ease because inflation has been more of problems, the tension is there, but that easing is already priced in. And so even if they do bite the bull and say, I'm not going to worry about inflation and ease, it's already in the market prices. It's not going to surprise the market so much. And then on the other hand, if the economy doesn't slow so much, if we don't get that kind of recession, if the equity prices are right, that you're not going to get a big recession, the Fed's going to be a tough spot because I don't see why inflation is going to come down with the recession. You have a very, very strong labor market. If nothing slows, and so if they don't ease, like is already priced, they're going to be disappointing. So, if they don't ease, so every day once we hit summer, the Federal Reserve doesn't pivot and ease. That's effectively a tightening relative to what's priced in. That's also disappointing. So that's a lot of room for disappointment that can happen whether the economy's strong or weak. That's all sort of like what I'll call relatively near to intermediate term future. How do you think about portfolio positioning in light of that general view when for a long time it's paid just to be long risk and have a very simple portfolio because of everything you've discussed?

Starting point is 00:14:33 How is that different today? How do you think about positioning against this asymmetric setup that you described? I is one of the toughest times to be an investor in many years because risk assets have been so good. And I think risk assets are about as unattractive as we've seen a very long time. We're seeing that come to fruition. They don't just bounce back and just get automatic rallies no matter what. So it's a hard time to be an investor. I think as an investor, you have to think about diversification in a different way.

Starting point is 00:15:01 Diversity just wasn't that important because the one asset people hold, equities was just the strongest outperformer. And the different places investors can look, they can look geographically. They can look at geographies that have less of this tension, places like Japan or China, where you're in a different situation, you're not about to hit a big central bank tension. Japanese central bankers are pretty excited about getting higher inflation. They've won for a long time, and it's far from you're out of control.

Starting point is 00:15:25 And you can look at asset classes you haven't typically looked at. We can talk about gold, but that's certainly something that ignored for a while because it didn't seem like there was a very good reason to have an alternative to real money, and that environment's changed somewhat. And in general, you kind of see a reassessment of assets that were ignored for a long time, saying maybe they have different characteristics in this environment. I feel like gold, which you mentioned, is like almost literally the opposite of AI. It's this latent thing that just sits there and has always been an interest to lots of investors.

Starting point is 00:15:56 I know you're writing about this right now, too. So maybe tell us a bit about I can't even make sense of gold. There's no E against which to measure the P. It seems just like a confounding and confusing lump of metal to me. How do you think about it? And in general, like what's your model for thinking about it? And then maybe specifically right now. Well, you're saying it exactly right.

Starting point is 00:16:13 I think the right way to think about it is, first of all, it is a lump of metal that people have thought has value for, I don't know, at least hundreds of years, probably thousands of years. So a lump of metal, people have thought has value for thousands of years. So what you're getting is something that you can be pretty sure someone in the world is going to find valuable. The problem is when you hold gold, no one's paying you on interest rate. No one's paying you earnings. You're not getting any of those dividends that you usually get by holding financial assets. And so what you basically need to trade off when you choose whether to hold gold is, how worried am I about my money's going to be inflated away?

Starting point is 00:16:44 my money's going to be confiscated. I'm going to have problems with holding financial assets. On the other hand, what am I giving up by holding this lump of metal piece of something that people have thought is valuable for a long time. So if you look at coming into this environment until today, basically the real interest rate is a good approximation for what are you getting by holding financial assets. You're getting at least that. Maybe you're getting even more than that. And it had fallen so much that you're basically making a zero real return, sometimes negative real return on the alternative to gold. So it didn't seem like you're giving up a lot. It wasn't a opportunity cost to be in gold rather than in financial assets and gold had pretty long bull run.

Starting point is 00:17:20 And every time it fell was when basically rates rose. Every time those are real tightening, like a taper tantrum kind of event, you basically had gold fall because it was like, wait a minute, there's actually an alternative that gives me any kind of yield rather than being stuck in zero. And now that's changing. The reason I think that's changing is big shift, I believe happened basically when Russia invaded Ukraine and Western governments, U.S., Europe and so on, basically said, wait a minute, Russia, we feel like one of the ways you can exert pressure on you is not to give you access to all the dollars and euros that you have.

Starting point is 00:17:49 And so they in some sense weaponize the dollars that we have saying if you have a conflict with us, we're going to try and not let you use those dollars. So for people like Russia, which there are other countries that may one day find themselves on the other side of a geopolitical conflict, then we're obviously in a shift towards create power of conflict. The opportunity costs became less of a big deal relative to, wait a minute, my assets to actually be confiscated. Saving in gold starts looking a lot more attractive. So you've seen a lot of central banks shift more into gold. You've seen gold rally despite all the tightening that central banks are doing.

Starting point is 00:18:19 And then for let's got more ordinary investors that are less likely to find themselves on the other side of Western sanctions, the fact that inflation is more volatile certainly raises the probability that you're going to get some version of a debasement event where you lose your real purchasing power. And so suddenly that opportunity costs starts seeming a little less like the driver of whether or not to hold the assets. Stan Drucker Miller used a really interesting, although somewhat terrible. terrifying analogy of us sitting on the Santa Monica Pier and all the near-term stuff you talked about

Starting point is 00:18:47 is sort of like this smaller 30-foot tidal wave that's coming our way. And we're all focused on that. But way behind that, a couple miles is some 200-foot title wave that's coming in the form of things like much longer-term concerns, demographic shifts and government debt levels, things that tend to move much more slowly than asset prices. How do you think about that category of big, longer term, slower moving, but extremely important macro variables. I think the biggest thing that affects you as an investor is that those longer term variables, it goes so slowly that they form your assumptions of what assets even are. And they end up seeping into your portfolio construction because they're just part of that,

Starting point is 00:19:28 what is this asset anyway? And what are the assumptions on which you're building all the things you're building in your portfolio? And when they start to shift, you don't realize you need to fundamentally re-question your assumption. So you're obviously not going to trade three-month move based on a demographic shift. But a lot of these slow-moving effects do end up then seeping into how to assets behave. I'll give up one another example of that, which is emerging markets.

Starting point is 00:19:48 I think we're a while we're kind of like just a higher risk version of what the S&P was, which is it moved together. They were highly correlated, but one was just riskier. And that's changed somewhat, probably because a lot of emerging markets have gotten to be to their own drum, they're doing their own monetary policy. They're thinking, wait a minute, I know about this thing called high inflate. they tightened a lot more aggressively into seeing high inflation. And so suddenly the correlation start with different.

Starting point is 00:20:13 The fact that inflation is becoming more volatile means that stocks and bonds aren't suddenly so magically correlated. So as an investor, you kind of have to think about the long-term trends, both in the perspective of a lot of times you are investing for the long run. You do care about in 10 years what's going to be the value of stock market. But that is hard to do. You can't really just invest for a 10-year period. You really want to think about those long-term trends.

Starting point is 00:20:33 How are they affecting my view of what is my asset and what is likely to do well and poorly? and therefore what kind of diversification do I really have? What do you think are the right components of the famous term at Bridgewater is the all-weather concept, the all-weather portfolio? Regardless of what the macro environment throws at us, it'll be able to handle it because it's well diversified. But it just seems like everything you're describing is maybe a bunch of stuff that we've just never seen before.

Starting point is 00:20:57 And like you said, our sample size is pretty small. So how do you reason about what belongs in an all-weather portfolio and sort of the relative balance or weights of those assets up against some of these novel interesting variables? Well, you have to ask yourself, the concept behind having an all-weather portfolio is basically to say, what are the things that are going to happen in the world that are going to affect my assets? And can I find assets that have the opposite responses to that thing happening? And some things, you just cannot find opposite response. So, for example, if the Federal Reserve has to radically raise real interest rates to deal with

Starting point is 00:21:32 inflation and you've seen this happen in the past, that is just a discount rate on every cashful into the future. There's no diversifier for you except for being in cash because any cash flow under the future, there's now a higher discount rate and it's going to do badly. And so you just know that's a risk of you can be in cash or you can have that risk. But then other things, you can say, oh, there's real diversification available to me, hence I can build an all-weather portfolio will do well no matter what happens. And then the big drivers of assets that you tend to be able diversify, first of all is, it's basically the economy. It's like how much economy is there or growth and at what price is that happening or inflation. And there are these natural diversifiers

Starting point is 00:22:08 that get built into assets that have different structural components. The easiest example of this is when you have your bonds, U.S. government's willing to pay you either in a nominal or in a real rate. They're willing to literally pay you CPI or to pay your rate this predetermined. And so that's kind of set up to say, look, if inflation is high, I'm going to pay you out. If inflation is higher, going to lose purchasing power. And so those two bonds are set up to have opposite. opposite structural fundamental biases. And if you put them together, now you have something that you don't care anymore, that inflation is going to be. You can do well in one case, well, in the other case, you're not exposed to that anymore. And so I think the best you can do as an investor is

Starting point is 00:22:41 basically say the big forces you can be immune from. And I believe growth and inflation are good examples where there are a lot of assets that do well when growth is rising and growth is falling, inflation is falling. So you can build that resilience. And then you can kind of look and say, can I do it geographically? Meaning if I didn't do it perfectly, can I just have assets? in other parts of the world, they just aren't going to have the same growth rate, aren't going to have the same inflation rate. Those are going to go through a different cycle. So if I have a problem in one area, it might not affect me in the other area. One of the things about modern data on capital markets, having looked at it a lot myself,

Starting point is 00:23:12 is that the vast majority of the high quality data comes during a period where, effectively, America was the global superpower that there really hasn't been a lot of geopolitical instability since World War II. Obviously, there's been forms of it. But it seems like the rise of China is an important thing to talk about in that landscape, again, because it's sort of an unusual thing relative to the data set that we build a lot of our history and understanding on. How do you think about China's rise, China's power, what I'll call a potential conflict between the U.S. and China, just it as a variable, I'd love to hear your take on. Well, I think that the biggest thing you said was the fact that investors most, which is that

Starting point is 00:23:51 the U.S. has just been so the winner for so long, and specifically U.S. stocks and U.S. tech have just killed everything. They've eaten the world. And if all you did was buy that, you did great. And the problem is that once that's happened for 20 years, that already gets put into price. And so if in the beginning of that period, you knew that that was going to happen, you did great. But now that it's already happened for a long time, it's already very much priced in. And so that assumption of the U.S. being the superpower is now built into the prices. And if you're now focused on the U.S., which most investors all over the world are, if you look at global stock market index, it's like 65% U.S., 70% U.S. So, everybody,

Starting point is 00:24:27 is naturally bandied towards an index holding mostly U.S. That means the expectations of continued U.S. winning against everyone are already in your portfolio. It has to re-win again in an even bigger way for you to actually make money off of that. Then on the flip side, China's priced terribly. You have pretty attractive valuations there. Now there's a lot of good things to worry about with China. I don't think it's a slam dunk because they have an amazing decade ahead of them. But certainly the pricing is much more there to compensate you for that rather than pricing in an amazing decade.

Starting point is 00:24:56 And I think what's happening more broadly is that conflict between the U.S. is very much heating up. It's in some sense, I like to say, metastasizing, meaning that it went from a little bit of something that gets a little bit discussed, but it's a piece of a discussion versus something that's really seeped into the policy establishments and becoming a big part of how different policymakers in both countries think about their role, what they're supposed to be doing, what's happening. So you see it kind of affecting all the decisions being made, both the U.S. and China and then places like Europe and Japan. They're making a lot more decisions to say, how do I get more competitive relative to the other side? And then how do I stop myself from being too reliant on the other side? And those are big decisions. So what you're getting as a result of that is very different winners and losers. You're getting governments that are much more comfortable throwing their weight around,

Starting point is 00:25:42 especially in places like the U.S. where, let's be honest, I think of the government choosing winners or losers or deciding what happens in the economy was like a bad, bad thing to say, that's not us, that's the communist. We don't have the government get involved in the winners and losers. there's much more of a sense of, well, if you want to beat the Chinese and they're doing it, how can we not do it? So much more comfort saying, let's subsidize the things we want, whether it's semiconductors or green energy, let's get in there and really choose how we want the world to be. And so we are effectively choosing what industries are we want to make successful and how are we going to set that up. Different countries are more or less successful as we kind of say, well, if you want to get around China, who's the best replacement? Where can I put my things that's not China? So those are very different forces that are affecting either sectors individually or countries individually,

Starting point is 00:26:24 people trying to get around the other superpower or set up for success and be competitive against it. How do you monitor for things that are sort of like beneath the surface? Obviously, the most recent would be like some banking crises that have popped up, banks that have gone under after a long time of nothing like that. And I think if you had asked general investors three, six months ago, they would have said there's tons of liquidity and solvency and great balance sheets, et cetera, in the banking sector. And yet we've had some well-known banks fail. How do you monitor for things like that that are below the surface narrative to watch for them in terms of ways that would affect investment decisions? I think that two things. One is I'm a little bit surprised

Starting point is 00:27:04 by the degree of surprise to the bank failures because it's funny, but you had the fastest rate of tightening we've seen in so long, and it's almost like we expected it. It wouldn't matter. We've forgotten that when you massively raise interest rates, there is a point to doing that. The Fed's doing that for a reason. It's trying to slow the economy. It's trying to get control of inflation. And the way that rising rates work is that they create a credit tightening. They go through the credit system and create a tightening. So that doesn't mean you'll literally have bank failures. That doesn't mean you specifically can plan a bank and say, you know, this one's going to fail. But it does mean that this is the fastest rate of tightening you see it in decades. You should expect

Starting point is 00:27:39 that to flow through to tighter credit conditions to a credit system that's more vulnerable. Someone is going to be holding all those assets, especially when that much debt was issued, and say, oh, I have losses on those assets. And so I should have who hold those assets. and how does that then work and flow through? And it comes back to what I think has been probably the biggest source of insight for me in terms of thinking about trading markets, which is it's much easier to talk about fundamental value

Starting point is 00:28:04 and pontificate what you think will happen in the world and forget that at the end of the day, for an asset to move, someone has to buy and sell it. And so to me, grounding in who literally holds assets, what happens on their balance sheets, what are all the considerations on them, and what's going to cause them to buy and sell and why. It's both the thing that can help you most say something like, that bank's

Starting point is 00:28:25 probably going to fail, because I actually understand what's on the balance sheet, how to market to market, what are all the regulatory things affecting it? And the result of that, which is when you get different set of circumstances to come to the world, who are the buyers and sellers that get affected, where are they then going to go and buy and sell? That's what's actually going to cost prices to move, not you and I, Patrick, talking about what should be the price of something, but someone buying and selling. And when you do that, you realize a lot of buyers and sellers do things for reasons other than the fundamental value of the thing they're buying and selling. There are a lot of pressures on people that lead them to buy and sell and create market

Starting point is 00:28:58 prices that are because of those circumstances. And a great example of it is these banks that fail, which is if you print tons of money and a lot of that gets routed via the venture capital industry to all these startups, and now you're a bank that serves startups, you're going to get a huge influx of deposits and not have nearly as much need to lend it out the other end because there's a lot. There's just this huge excess of money. And so that imbalance between lots of money printed and not many people needing to borrow existed. And the question is who would end up with imbalance?

Starting point is 00:29:25 What would they do as a result of that? And what you saw is the bank said, well, I got to make money somehow. It's not like I don't know what this thing called duration risk. I don't have any choices. I don't have any credit risk to take because I don't need to make that many loans or else my influx of deposits. So you want me to be profitable? I guess I'm going to take duration risk.

Starting point is 00:29:40 When that turned, I had losses. I've kind of asked about the obvious variables. China, AI, inflation, valuations, et cetera. What are some non-obvious variables that have your attention, if any, that you're surprised aren't on par with some of those things that I've asked about so far? It's a squishy thing. And so it's hard to talk about, hard to really put your finger on it. But right now we're seeing an obvious manifestation of it in the debt ceiling, which is

Starting point is 00:30:07 the quality of governance matters a lot. It underpins a lot what we're doing or kind of investing in markets. We assume a certain level of governance is kind of a given when we buy assets and assume normal functioning. And that's gone at different times threatened and unthreatened. But it's something to keep watching kind of how that squishy things evolving. It's hard to measure. Biden gets elected. I was talking about the U.S.

Starting point is 00:30:30 We talk about any country. And this is how it all over the world, this deterioration and governance. But Biden gets elected. We were really nervous. It was going to be really impossible to get anything done. And then actually Biden got a lot done legislatively. And we had some of the biggest push of industrial policy we've seen in a very long time, policies that were really going to shape the economy. And then you have the death ceiling

Starting point is 00:30:48 thing on the other side where you sort of say, well, this is not a manifestation of particularly good way of governing anything. No one would want a system that works the way that we're currently operating. And so it's a hard thing to measure. My intuition is that when you get a divergence between people's experiences and social, environmental outcomes and economic outcomes and you get these big divergences, it's hard to keep political system together when you get too much polarization. which is why I'm so scared that coming out of these decades of globalization automation that we talked about in the beginning of our conversation, we already created these big cleavages, having more of that ahead of us could become even worse and we don't really know what's coming at us.

Starting point is 00:31:25 But that quality of governance, investment returns away that's very hard to measure and very squishy, but it matters a lot. All you have to do is look at countries in the emerging markets that basically have gotten kicked out of access to capital markets because of bad governance and say it really matters at extremes, and it's hard to know if we're walking that line. In a time like this is the debt ceiling, it certainly feels like that. like we're walking out line. Yeah, it's a great answer because it's something that I know of no one that's questioning. It's sort of like price for perfection in that sense, that we just sort of

Starting point is 00:31:51 assume, especially in the U.S., that things on the governance side and the rule of law and all this stuff will be totally fine. So it's a really, really interesting thing to think about. I'd love to do, like we did last time, just a really fast, overrated, underrated, just in some of the major asset classes if you're game for it. Let's start with the basics, U.S. stocks, overrated or underrated? Way overrated. Just because of valuations? I mean, you could get a recession, you don't have any degree of inflation volatility priced in, you already have Fedis and priced in, there's just room for downside. The thing that may be even underrated is the beneficiaries of all the say I stuff,

Starting point is 00:32:26 they may still be underrated. If you just say the stock market, especially if you can't take out the fact that a couple companies tend to be the mega caps they dominate it, overrated. What about international developed markets, not emerging? I'll ask that separately over or under. Depends. wish, I think Japan is highly underrated. It's almost like everybody decided that Japan's socks coming out of what they had done years ago and everyone ignores it. Every time I write anything

Starting point is 00:32:50 about Japan, nobody pays any attention to it. Nobody wants to talk about Japan. It seems much better price to me than the U.S. What about emerging market stocks, which have really languished for a long, long period of time now? Underrated. Because of the inverse of the U.S. story. When all this money got printed and everybody got checks into their house, what do they buy? They bought crypto. They bought tech. They used to buy emerging market stuff. That used to be the risky stuff to go buy, but that's not what they bought this time around.

Starting point is 00:33:17 So you just don't have as much capital buildup. And so as we're seeing, the capital gets sucked out and causing bubbles to deflate in places we all know well, it's actually a pause and say, wait a minute, we're actually not seeing that happen in the classic places where it happens, which is emerging markets. Basically, zero mention of crypto today. So Bitcoin overrated or underrated. I don't know. I never want to even say the word because every time we say the word, you get head. as if you're like a major authority on the topic.

Starting point is 00:33:44 So don't know. How about gold? Definitely underrated. I think it's got a long way to run. I think that there is a lot of actors in the world that are experiencing, wait a minute, the geopolitics can make it risky for a million dollars. There's not a lot of great alternatives. And they're slow movers.

Starting point is 00:34:02 They don't do it in a day. And I don't think this geopolitical turmoil and this idea that inflation is more volatile than it used to be and it's tougher for the central bank to handle it is going away. And so to me, that's a slow-moving, slow secular pressure into gold. Last one. The potential for deflation. Probably underrated because most of the people who are really close to what's likely to be a tech miracle are not the same ones that talk about inflation and deflation all day. So you don't hear a talk about a lot.

Starting point is 00:34:30 It's certainly a possibility depending how fast the tech moves. I know you are only a couple months into the new role as the CIA at Bridgewater. But what is it like so far sitting on top of an investment? process with such a large asset base. What has surprised you so far about the responsibilities of the new role? You grow up in this industry and you know that there's just so much happening in the world at some level curiosity is all it matters. Being a good investor is just about being really curious and learning a lot and knowing what you don't know. And probably the first lesson Ray Galli ever taught me when I was young as he started talking about you got to know what you don't

Starting point is 00:35:08 know, but it never ceases to amaze you how true that is. Now it's the most important thing in this job. The bigger the breath, the more you realize there's so many topics, there's better expertise than you. And a lot in this job is about being really curious and realizing what are all the areas of expertise you need to make good decisions. Karen, I absolutely love doing this with you every time we do it. Thank you so much for joining us for the final session today at sun. Thank you so much, Patrick. If you enjoyed this episode, check out joincollasus.com. There you'll find every episode of this podcast complete with transcripts, show notes, and resources to keep learning. You can also sign up for our newsletter, Colossus Weekly, where we condense episodes to the big ideas,

Starting point is 00:35:47 quotations, and more, as well as share the best content we find on the internet every week.

Invest Like the Best with Patrick O'Shaughnessy - Karen Karniol-Tambour - Macro Headwinds vs. Tech Tailwinds - [Invest Like the Best, EP.329]

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