The Compound and Friends - The New Kings of Wall Street

Episode Date: October 13, 2023

On episode 113 of The Compound and Friends, Michael Batnick is joined by Jan van Eck and Andrew Beer to discuss: the bond market, the national debt, private-credit, alts, managed futures, the Sam Bankman-Fried trial, and much more! This episode is brought to you by iShares. To learn more about the iShares Semiconductor ETF (SOXX), visit: https://www.ishares.com/us/products/239705/ishares-semiconductor-etf Check out the latest in financial blogger fashion at The Compound shop: https://www.idontshop.com Investing involves the risk of loss. This podcast is for informational purposes only and should not be or regarded as personalized investment advice or relied upon for investment decisions. Michael Batnick and Josh Brown are employees of Ritholtz Wealth Management and may maintain positions in the securities discussed in this video. All opinions expressed by them are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. For additional advertisement disclaimers see here https://ritholtzwealth.com/advertising-disclaimers. Investments in securities involve the risk of loss. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The information provided on this website (including any information that may be accessed through this website) is not directed at any investor or category of investors and is provided solely as general information. Obviously nothing on this channel should be considered as personalized financial advice or a solicitation to buy or sell any securities. See our disclosures here: https://ritholtzwealth.com/podcast-youtube-disclosures/ Learn more about your ad choices. Visit megaphone.fm/adchoices

Are these on yet? These aren't on yet, right? Yeah. Oh, they are? Hello? I feel like I can't hear myself. Eh, maybe I can. Maybe I can. Maybe I can. Maybe I can't. All right, gentlemen, headphones on. Andrew doesn't have headphones. Nah.

John, are those right? For Andrew? Yes. Okay. So, Andrew, you started... Did you start in the business with Seth Klarman? Yeah. Well, in the hedge fund. After business school, start in the business with Seth Klarman? Yeah. Well, in the hedge fund.

After business school, I went to work for Seth Klarman. How did you get that gig? So I was in my second year of business school, and I was going down a private equity route. I'd worked for a guy named Tom Lee. I thought I was going to be, you know, like KKR, TPG, something like that. And one of my professors came to me and said – there's a guy named Seth who was a student of mine. We helped put him into business. And, you know, we think he's one of the smartest guys to me and said, there's a guy named Seth who was a student of mine. We helped put him into business. And, you know, we think he's one of the smartest guys who's ever come through here.

You should go talk to him. And so I went. I had no idea what a hedge fund was, but I went and talked to him. And they grilled me for about two hours, sort of a brutally difficult interview. And I thought it was really cool what they were doing. So that was the big thing. Grilled you how? Like how smart are you type questions or like philosophical weird questions? So back then, this is post,

remember the Resolution Trust Company? Savings and loans. So savings and loans went bankrupt. What? I can say yes. I can say yes. I don't remember it. I think we're older. So late 1980s, savings and loans go bust.

You know, every 10 years we have a banking crisis in the United States. That was that. Yeah. And so government takes over all these savings and loans go bust. You know, every 10 years we have a banking crisis in the United States? That was that. Yeah. And so government takes over all these savings and loans, and they've got all these loan portfolios, real estate loans, et cetera, et cetera. And they created something called the Resolution Trust Company, then sell these off in auctions.

And this was 1994 when I ended up joining, but 1992 and 1993 when Valpost got into it, no one had capital. If you were a real estate investor, you were on your back. Everybody, most people were on their backs. And so they, in a number of hedge funds, started to figure out, are these interesting things to buy? So if I go into an interview, I don't know what any of this stuff is. And they give me a three or 400 page prospectus. And they told me I had 20 minutes to read it. And then they were going to come in. Then four guys came in and grilled me on it. And then, yeah. Then they asked me like logic questions and stuff. Like, you know,

you take a cube with a hundred, um, a 10 by 10 by 10 cube and you paint the outside, you know, uh, how many cubes don't have any paint on them. And it was just, it was, and this went on for two hours and I thought, cool. So 20 minutes to read the perspectives. Yeah. To say grass doesn't go on a busy street with bald people. That's what I like to say, but I don't have that type of mental horsepower. Holy shit.

Yeah, so it's fine. So I got very intrigued by it. I almost went into academia as well. I almost did a doctorate when I was at Harvard. So what were you doing there? Were you an analyst? So I just sort of, you sort of just get dropped in

right into the deep end of the pool as a portfolio manager. You know, you're supposed to go out and find ideas. Again, back then it was 1994. The world was very different. You could buy stuff. If you did the work in esoteric areas, you could find stuff that was really cheap. And so there were things- Like cheap and also like you could actually make money, not just cheap like it is today, and you never make money. Cheap and built to say that way. No, no. These were things like I did some of the first

purchases of limited partnership interests owned by Japanese financial institutions in private equity firms. And so I was literally going door to door, meeting Japanese financial institutions and saying, hey, can you look in that drawer over there? Do you have anything that you guys bought in the 1980s you're not sure what to do with? And we would do all the work. We'd have to negotiate the agreements with not just them to buy it, but also with the GPs because you needed their permission to do it.

And we were buying them like 20 cents on the dollar. So I'd go to the GPs and say, hey, I've got a deal to buy this thing for 20 cents on the dollar. And the dollar was actually worth a dollar. Yeah. No, it was like with publicly traded stuff. I mean, it was like, it was, it was huge discount. And they'd say, well, we'll only give you permission if we can buy half it ourselves.

So I did stuff like that. I did some, it was, you know, it was pretty much you'd walk in and try to figure out where you could find the ways to buy dollars for as little as possible. And Seth is, you know, he's a giant of the industry. He is just unbelievably smart and very intimidating to work for, you know, because of his intellect. But do you think there are inefficiencies in the market now? I kind of feel like with sell-side research, budgets being shrunk, and so much money in indexing, I kind of think there must be some inefficiencies in the market.

Like if you were to start in the industry now, I know you don't do public equities, so I kind of wonder, maybe not the worst thing. No, it should be. Small hedge fund, don't manage $10 billion. Well, that was always the thing. They have this thing in the hedge fund industry where they say size is the enemy of performance. And so when I joined Ball Post in 94, it had $600 million in assets. Three years later, I leave it as $1.8 billion.

10 years, 15 years later, it's got $32 billion. So what you could do at $600 million, I could do this weird stuff back then. Because if you could do $5 or $10 million of it. You could move the needle. It would move the needle. But once you get really big, you can't do it. You start buying Apple. You buy Apple, right? You know?

Yeah. You short indices. You buy Apple. It's a big needle. Well, and that's been the challenge. So I think, yeah, if you said, I want to start a small hedge fund, and I'm more interested in generating returns, then there must be huge opportunities because who buys small cap stocks anymore on a stock by stock basis?

Well, there's no research out there. Yeah. I mean, I was looking at crypto companies, which is a weird diversion. But I mean, there was never any coverage. Like, subrogate these banks that were key to the industry. No one knew them. And then they went away. I mean, back, you know, when I was at Bell Post, again, also the hedge fund industry was in its infancy, right? So what we would do is we would find a cheap stock that Fidelity and other guys

didn't know about. I bet you would tweet it. Well, pre-tweet, you would do an ideas dinner in Boston and you'd have, you know, Fidelity and Wellington and XX, all these kind of long only guys. And your job was basically to go there and after you'd bought it to convince them that this thing was much cheaper than anything else that they'd owned. And so the victory was if one of these guys bought it, you know, it would move the needle to the tune of 20%. So you're trying to create your own catalyst. And so you did that for how long? Three years. And then I left. Then first thing I did was try to buy two publicly traded companies that basically applying the same analysis, but I could see that the portfolios were very, very cheap.

So I spent a couple of years doing that. And then by the early 2000s, I was focused on creating hedge funds in different areas. And one of the things we talked about at lunch was I started a hedge fund and made my first investment in the commodity space in 2000. And again, you talk about inefficiencies. in the commodity space in 2000. And again, you talk about inefficiencies. That was a time where if you were willing to send somebody to a port in Brazil and count the number of pallets of sugar that was going on to ships and the number of ships that were

going out into the sea, you had a huge advantage in terms of thinking about the future price of sugar. Today, all that stuff is automated. So you have to find new ways of competitive advantages. And so I started a hedge fund that did that, basically gave money to guys who did that. And then similarly, and this is where we line up in other ways, I started one of the first greater China hedge funds with a different group of guys a few years later. So the 2000s were very much about trying to find areas that I thought would grow in the hedge fund space and then

finding the right guys and putting together the businesses and essentially putting people in business to grow. It's really similar to our business philosophy, right? We look at what's happening around the world, whether it's political trends or economic or market structure, and then say, okay, how do you get exposure? Except we're offering it more in indexed form and saying to investors, instead of doing it all in one fund, saying, hey, here's like a greater China. Like, do you like this exposure? Do you believe the thesis? Go for it.

How much of your business is based in the States? 80%. Okay. How long we got? Looking pretty good. Just a second. Okay. All right.

You know, we're going to save Jan's incredible clip. We're going to save that for the show. Okay. So 80%. And the rest is where? Australia and Europe. Australia has like a similar environment to us in terms of advisors, right? Yes. Yes. Independent advisors. It's really good. And the banks, you know, a little bit on their heels. The Canadians do it a little bit. They're a little bit behind us, right? The Canadians kind of, they're also kind of an oligopoly when it comes to banks,

but they really control distribution of asset management products. I mean, even BlackRock, I think, stepped back from doing their own stuff in Canada and they just partnered with the bank. You guys hear that? Banks have a walk. Does that mean the show's about to start? Am I imagining the music?

Do I hear a hint? No, we have it on low. Okay, I feel like is that... You trying to tell me something? We were about to, but we're moving some boxes real quick. All right, so we're 30 seconds out. You guys ready to have some fun? Yes, sir.

So no computer for you? You're rolling naked? I'm rolling naked. Okay, you? Comfortable? You got notes? Good? Good?

Water? I won't look at them. I got water. All right, John. John, what do we got? You got notes? Good? Good? Water? I won't look at them. All right, John. John, what do we got? Coming in with three claps. We got The Compound and Friends. Episode?

Episode 13. No, no, no. One. One thirteen. One hundred thirteen. Welcome to The Compound and Friends. 113. be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast. Today's episode of The Compound and Friends is brought to you by iShares by BlackRock. AI, artificial intelligence, has emerged as a defining theme of 2023. Semiconductors are the bedrock of the digital economy, core enablers of the data revolution, and at the forefront

of technological innovation. With chip demand set to rise over the coming decade, the global semiconductor industry is projected to hit the trillion-dollar mark by 2030. Nearly 70% of this growth is expected to be driven by three segments, computation and data storage, automotive, and wireless. This is a long-term theme, but it is playing out in real time. We have seen year-to-date net flows of $1.8 billion into semiconductor subsector ETFs. Investors looking to gain semiconductor exposure may want to consider ETFs that target the entire semiconductor value chain, including companies focused on the design, fabrication, and assembly of semiconductors, like the iShares Semiconductor ETF that's's ticker SOX, S-O-X-X.

All right, you notice, it does feel, oh, Duncan's controlling the, should we do one for Josh, one of the pow-pow-pows? All right, so Josh has conspicuously asked from this episode, it's his, I think it's his 20th anniversary. So he is enjoying time with his wife in Nashville, Tennessee. So you're stuck with me and two very special guests that I'm incredibly excited to have on the show. We're going to start with returning champion Jan Van Eck. Jan is the

CEO of Van Eck, an ETF and mutual fund manager with 77 billion in AUM. Is that about right? Yeah. Give or take a few bill. My partner, Chris Venn, said, he's like, holy shit, VanEck's coming in? He goes, do you know, the first thing that I sold in this business in 2007, I was cold calling, and somebody said, I want a hard asset. Do you have hard assets?

And he went to his partner in the corner office, what do we got? He goes, VanEck. That's what we were known for, absolutely, since 1968. Incredible. Incredible run. Andrew Beer. Andrew is a managing partner in co-portfolio management at DBI Investments. That's what we were known for, absolutely, since 1968. Incredible, incredible run. Andrew Beer. Andrew is a managing partner in co-portfolio management at DBI Investments. That's Dynamic Beta Investments, a hedge fund replication platform that seeks to outperform hedge funds with lower fees and greater liquidity.

Andrew, welcome to the show. Thank you. It's great to be here. Almost a billion dollars or give or take a billion dollars? We're 2.3 as a firm. I apologize. As a firm, we've got our U.S. business has about a billion dollars or give or take a billion dollars? We're 2.3 as a firm. I apologize. Oh, okay. As a firm, as a firm. As a firm, we've got, our US business has about a billion. And is that the largest liquid alternate ETF or managed futures ETF? Sure. So we manage an ETF that is a managed futures ETF that is now, I think it's by far the largest alts ETF at this point. Congratulations. Thank you. Incredible. All right. What a week. A lot

of data. We got CPI today. Are you guys at all surprised with the reaction specifically at start with the bond market? The 10-year is opened up the day at 453 or so, and it's now at 47. Pretty big move. I'm not surprised. Look, I think spending's addictive. And I think we haven't figured out how to, I think, you know, people are going to keep spending money until something really bad happens and it hasn't happened yet. And so I think, you know, there's been this pattern over the past few years of people expecting and hoping really that inflation would kind of go away on its own. And my guess is it doesn't. But again, I'm not an expert in it. I'd value Jan's opinion more than mine. I'm not an expert either. But I just think,

you know, you look at history, and it's very rare that we've had an inverted bond market, right? It's less than 10% of the time. It's usually not even this long. And you wonder why, because it doesn't make any sense. You're getting less yield for more risk, right? There's greater volatility at the 10-year than there is at the short end. It just makes no sense. So I think we're going to have a normal yield curve at some point. How do we get there? I think both ways. I think 10 years could go higher, over above 5%.

And I think at the short end, I mean, I think we're kind of the feds in this higher for longer mentality. But I think you could see rates, short rates at 2.5% and the 10-year at 5%. Like, that's not crazy. We're going to get there. We're absolutely going to get there. Because investors, if the public, you know, if the Fed and government actors are out of the bond market, right, private investors want more return for more risk. Like, this is 101, right?

So we're going to get there. All right. If the government gets out. And I have huge fights with people. And I think they're just, you? So we're going to get there. All right. So if the government gets out and I have huge fights with people and I think they're just, you know, the smoking stuff, I think they think the QE is coming back and maybe it is if we hit a crisis. Smoking opium. Am I right? Something out there.

All right. So September, 2023, 0.4% month over month. John, let's try to please year over year. It's trending in the right direction for just about 4% or so. But I want an alternate take from our friend Jeremy Schwartz, who said using more real-time series for shelter, both alt-core and alt-headline below 2%. So alt-inflation is below the Fed 2% target. And what Jeremy is showing is, John, next chart, please. So he's showing the headline CPI with real-time shelter versus BLS shelter. And with real-time shelter, again, there's all sorts of funky stuff with owner-occupied rent. In the data series, we're

under 2%. Next chart, please. I'm sorry. 1.84%. So if inflation, one more, if inflation continues to come down, if you're still seeing a strong labor market with wage greens slowing, it seems as if the Fed is on pause, an 88% probability of a pause for November. Here we go. So what's wrong with what's going on right now? What's so bad about this? Well, look, I think if inflation comes down, that's great. I mean, the Fed right now is between a rock and a hard place because they don't want to take the pedal off the brake, take their foot off the brake, and have inflation take off again. And in the preceding chart, the experience of the 1970s was Arthur Burns raised rates to drive down inflation. Inflation came back down. He took the pedal. He took his foot off the brake,

and then inflation took off like crazy. John, please throw that chart crime back up. That is definitely a chart crime. A chart crime perpetuated by Larry Summers, of all people. So, all right. So the fear is what? That if the Fed, I agree that they've done so much work and the market has done a lot of work for them, for them to even remotely turn dovish at this point, like they're on the one yard line, just finish the job. So is the fear that if they talk dovish or if they signal anything that financial conditions are going to ease as quickly as they rose? Well, look, I mean, the people are calling their bluff, right? They're basically saying that things are going to come down smoothly.

But again, remember, they're also looking at this chart here. So what this chart basically shows you is that we've had this kind of ramp up in inflation. In the 1970s, you had a ramp up in inflation. They're looking at this bullshit? Yeah, yeah. I like this. Go ahead. Why?

Well, because I think they're looking at it, right? In the same way that in the 2010s, the people who work at the Fed are human beings. They care about what people think about them. They care about their impact on the economy, et cetera. They're looking at this chart. In the same way in the 2010s, everybody in the Fed was worried about being Japan, right? They'd all studied Japan

and nobody wanted to go into this deflationary spiral. And so what they do is every time, you know, there's a, they have a very, very trigger happy response to dropping rates whenever they think anything's going to go wrong because they don't want to have a wealth effect drive people – drive the economy further into deflation. So they're looking at this chart. And if you look at the middle of that chart, they don't want to be Arthur Burns. Arthur Burns is the arch criminal of the monetary world for having taken his foot off the brake then and letting inflation come back. My first job in 1990 was working for Paul Volcker.

And so people view Paul Volcker as the hero who took it from – he became the chairman of the Fed in August of 1979. So look at where he gets the job at that point. After he takes the job, it goes up even further, and then it comes roaring back down. So over the next three years, he brought inflation down and was the most vilified man in America for that three-year period of time. Powell doesn't want to be that person either. Were there not exogenous reasons for inflation going back up when it did? I mean, there was a confluence of factors, not just him taking his foot off the brake. No question. I mean, we had OPEC, we had all sorts of other issues. But what's to say we won't have

other circumstances like that today? I mean, the whole point of the unexpected is that we're not prepared for it. We can't price it in today. Again, I have absolutely no confidence in my view on the direction of inflation. I just think as a general matter, I mean, it's not like the government wants to stop spending money right now. I don't think individuals want to stop spending money. I think that a lot of the lessons of the past several years have been you keep spending money. In fact, over the past decade, you keep spending money and somebody will bail you out. Look, I'm a broken record on this. There's only one sort of statistic I care about when it comes to inflation, which is services and wages.

I don't care about goods because oil commodity prices are mean reverting. Sooner or later, ag prices will come down. Remember right after Ukraine war, blah, blah, blah, blah, blah, lumber, they all come down. Oil prices come down. No doubt to me, shelter and housing, we're in an air pocket. 8% mortgage rates, right? We're falling. So I get it. Not those parts, but I care about wages, right? We have strikes going on. People feel the inflation. They still want to get paid more. So I think until that goes away and those lines are higher than CPI and all these other trending lines. So that's the one that I look at, Michael. And I don't disagree. I think it's possible that it hits a trajectory where it trends towards 2%.

And then that's where you get the cut in the short-term rates next year and you get a normal yield curve. So I agree with you on the wages part. And I'm holding up my computer, sorry, for the audience. So the top chart is – do you remember this chart? The best way to get a wage increase two years ago was to switch jobs. So this is job switchers in blue, job stayers in red. They're both coming down the same direction. Average hourly earnings of 0.2% month over month. Average hourly earnings year over year, up 4.1%, the lowest in over a year. I'm definitely not

saying that everything is fine and there's nothing to worry about, but it is remarkable that the job market is still as strong as it is, that the job and financial conditions are tightening. And yet, like the economy, even with the frozen housing market and all of the shit that's been thrown at it, we're still humming along. So this is a cumulative change of financial conditions. A lot of the work has been done by the strengthening dollar and interest rates rising. And people won't stop spending. And it's very simple. It's because they still have a job.

I think the lesson of the past decade, well, certainly the last three or four years, has been the range of outcomes is much wider than we expect. So two years ago, a little over two years today, the two-year was at 30 basis points. It's at 5% today. a little over two years today, the two-year was at 30 basis points. It's at 5% today. There is, in August of 2021, a survey of economists, two-thirds thought there'd be no rate hikes the following year. No one has a crystal ball of how this is going to play out. I've described the economy as like a drunk stumbling across a highway. That basically, he stumbles across a highway, and then here comes oil at 150. And then you close your eyes, you brace for impact, truck's gone, dust settles,

the guy's still stumbling forward. Then it's gas rationing in Germany, then it's China and COVID lockdowns, then it's SVB, and it's all these different things. And the economy still keeps going. And I don't know of a person who would have predicted that rates would have gone this high, and something big wouldn't have broken. So we don't know. I person who would have predicted that rates would have gone this high and something big wouldn't have broken. So we don't know. I think what you're describing, there's been rolling recessions, right? Remember all the tech layoffs that we were talking about in 2022? There's been pockets of recession.

Certainly, the tech experienced it. Housing is, I mean, effectively, mortgage purchase applications are near an all-time low. There's very little activity going on. And yet the economy will not roll over. The last time Jan was on, I don't remember exactly when this was, forgive me, but definitely one of the clips of 2022. Josh and I have, this is actually, holy shit,

this is a freezing cold take from us. Jan was screaming about there are no buyers. And I'm saying, well, what about ETFs? What about, and personally, like my worst call ever, I didn't think that we would live in a world where the 10-year would be much above 3% because I thought that there would be so many buyers, specifically individual investors,

waiting to take the bait, which they have, by the way, but it didn't replace the amount of buying that our government was doing. And we'll get to that part in a second. But before we do, please, John, throw up Jan's victory lap. Tenure at 3%, it seems to have backed off.

I don't think three and a quarter, anyone would say, is the top that we'll see. But it's nice that the buyers at some point came in. Because January, February, March, there were no buyers in sight, or April. When you talk to people about the bond market, what do you try to make them understand? There's only one buyer.

There's only one buyer. I got to yell at you? There's only one buyer. There's only one buyer. I got to yell at you? No, I get it. There's only one buyer. No human being I met ever owned a treasury. Yeah, but what about the ETFs? It was only the Fed. It was the Fed was hoovering up these bonds.

I'm embarrassed. Let them get out of the market, and then you can talk to me about buyers. Okay. There are no buyers in IEI, in SHY, in... Okay. They're not big. But I think everything prices off at Treasuries.

I agree with you. So let's get the Fed out of the markets and then we can get some kind of transparency. Let's get them out so we can get them back in. Yes. Very quickly. If they get out fully in June, I predict they're back in June. By the way, the 10-year's at 2.8.

So it's coming down. Yeah. Holy shit. By the way, yeah, I credit to you. That was May 2022. The 10 year was at 2.8%. And here we are. What do I say it's at today? 4.7. World looks a little bit different. Yeah. But I mean, it's something that you have to know about market structure. And for the whole decade since the financial crisis, literally central banks, and not just here, central banks, developed market central banks were just buying up everything. You know, you'd get to 901 if the market opened at 9 in London. And boom, all the bonds were sold because the central banks were right there.

And the sales guys could take the rest of their day off. So you just have to realize, and you saw this with, you know, you've seen this time and time again, but with Europe, right? Why did Greece bonds trade through Germany? Because governments are so manipulative, not manipulating, sorry, being involved, being active policy actors in the fixed income markets. And so that's really the only risk to my scenario of a steepening yield curve is the Fed comes back and they stop QT and they do QE again. And I think the people that are hoping for that are hoping for a policy response that because of what we were talking about before, in the 1970s, they don't want to make that mistake again.

But what do you think happened after SVB? After SVB, we had the 10-year treasury dropped. And I've heard people describe it as it was essentially a quiet intervention by the Fed to pump liquidity into the system to prevent the banking system from collapsing. Right. And do you, is that what you think was happening?

I think you're trying to trigger me. I've got the whole rant on that. So what happened, to narrowly answer that, what happened after Silicon Valley Bank, right, the Fed stopped doing QT. Right. And they, right, so that's that answer. And I think they will, they want the market to be really shaky and a lot of volatility, and they're ready to get involved in a short-term basis. But to your point before, they generally want to pull back. commercial banks. Since the financial crisis, the government said, I do not want commercial banks lending to businesses and individuals. I want you buying the 10-year, right? So they doubled their

holdings of the 10-year. And the only way for small business and individuals ultimately to get credit is through alternative credit funds, right? So how are the banks going to make money? And then now with apps and financial apps, you can move your deposits around in a second. So they're squeezing the deposit base, and then they're squeezing what they can do with that deposit base. And so you get things like SVB, Bank of America is in a world of hurt, right, because they've lost a ton of money in the 10 years. Stock looks horrendous. Oh, my God. So my take, when you get a normalized yield curve, some of these banks are going to be a buy.

It's hard for us to imagine a normalized yield curve environment, but it's been true for 90% of our careers. What do you want to buy then? And I think investors should put together their shopping list. We're going to get to private credit a little bit later in the show. In order for them to resume QE, I think people are missing the point that they're only going to do so if something breaks. And if you're rooting for that. That was my interpretation of SCB, right? Because they want things to break, right? They want, ever since early 2022 or late 2021, they don't want anything big to break. They want the rolling recessions. Well, the housing market broke.

That's pretty big. But they want things that are containable. The problem with SVB is their team broke. The Fed, they also don't want to be known as the guys who broke the damn banking system by raising rates too fast. So that's why I think, again, I'm not an expert in this area, but that's why I think once SVB and the regional banks start to go down, that's when they basically essentially allowed them, stepped and basically to cover the deposit issue and step in but but they do want You know, they're gonna want some Uncertainty in the high-yield bond market They're gonna want zombie companies to struggle over time because the more the more as you say price discovery that there is the more the impact of higher real yields Takes a bite out of some of the excesses of the 2010s.

As long as it's done as a controlled demolition, that helps them in their cause. Are either of you worried about the unrealized losses that giant banks are sitting on with the bonds that are classified as health and maturity? I mean, these are, are we hundreds of billions of dollars at this point? I assume so.

I haven't looked at it myself. Is it much ado about nothing or or is there a there there? I don't think they are now looking at the capital ratios at the banks, right? Because that's what killed SVB. It's not that they're losing money. They're losing money. I mean, mark to market, the whole book, they're all kind of addict. They're all bankrupt, basically.

But I think after SVB, the bank regulators are all over the capital calculation. And it's so obvious because they can check it out every quarter, right, with the quarterly earnings. So they know now, we'll know in a couple of weeks. But to me, again, the big theme of there's no buyers, commercial banks doubled their holdings of treasuries in the last 10 years because they couldn't do anything else. And they're not coming back, Michael. My point is, they may not have to sell, but they're not going to be out there going, ooh, juicy, 4.7% on the 10-year, I'm all in. I just think they're like, wow, that blew up SVB.

It's hurting B of A. It's hurting B of A for three to five years, God knows how long. I am playing that game, right? I'm taking duration risk. So how is the fix at 17? Like, just nothing's happening. Well, I mean, look, the S&P, through this 5% raise,

hike in rates, the S&P is up a little bit. And the median stock is flat. People are acting as if that's bad. Are you kidding me? 500 basis points of rate hikes and the median stock is flat? Oh, no. No, no, that's what I mean. As we've had this, that's what I mean about the economy sidestepping things. Again, I don't think there's a person, an economist in the world who

would have said two years ago, you can have 500 racist points of hikes. The S&P would be up and nothing major had broken. It's incredible. It's incredible. Yeah. And so the question is, does that then, is there a feedback loop in that? So for instance, the government doesn't seem very eager to stop spending as much money as they are. They're spending, right? You've got a $2 trillion deficit or something close to it this year. That has an impact on spending.

It has a, and so, you know, in a normal, people used to worry about this. I don't see them worrying about it in the same way that they used to. I'm glad you mentioned that, the spending. So John, chart on please. Wall Street Journal did a big piece on this. Already, more than $1.76 trillion of treasuries has been issued on a net basis through September, higher than in any full year in the past decade, excluding 2020 pandemic surge. Uh, and of course they're doing so at much higher rates. Does this, does the deficit,

I'm not smart. Does it just not matter? Look, I can tell you macro hedge fund guys think we are walking straight into a propeller. That there is, this is, you know, people, the problems, people have been, Cassandra's have been talking about this with great fear since the 1980s, right? I mean, the budget deficits people were running in the 1980s, they thought it was going to crowd out all private sector lending. I mean, people have warned about this for a very, very long period of time. And so there's an assumption that we're not sure how we're going to come out of it, but of course, we've always come out of it,

so that's a natural conclusion. Really serious hedge fund guys who spend 30 or 40 years thinking about these issues think that these are intractable problems that will break in a very, very big way at some point. How it plays out, I don't know. I don't think they know. Well, so, I mean, the US dollar is still the safe haven.

It just is. When shit hits the fan, people buy dollars, people buy treasuries. I mean, maybe that changes. I don't know what would do it. Yeah, I mean, listen, I think we're in a different regime now and we're transitioning to it, but I agree.

I don't think what we have is any evidence that the market is worried as much as these old hedge fund guys. And Michael, the chart I like, the statistic I like the most are CDS, so credit default swaps on U.S. government debt. So does the market, and that's a free market, does the market think there's a chance

that we default on their debt? And the numbers have crept up this year. They're kind of not as bad as they were during the global financial crisis, but they're ticked up a little bit, but not nearly to the extent that the global macro hedge fund guys are really apocalyptic, I'll call it, about the budget deficit. And listen, I think it's by far the biggest risk in the market. It's just your question, Michael, the timing. My God, we could be here in 30 years. Literally. No, literally. And we'll, you know. Listen, just not knowing anything, it seems alarming, right? Well, I mean, think about it. You're issuing a lot of debt. Your interest rate is higher. Like just the math is, if you go with this out on a linear basis over the next 10 years,

a lot of your money and more and more and more of your money is going to servicing debt, not doing anything productive with it. Our interest costs are the size of our defense or spending or something crazy like that. So, I mean, when you put it into context,

it sounds alarming. The great Warren Pies, who has a research firm called 314, has a chart that you're going to like, Jan. He said, the shift in buyers for 10-year treasuries is not complete. The Fed, commercial banks, and foreign central banks are all out. Private buyers need a term premium over short-term rates. U.S. fiscal hold unlikely to be addressed in 24. The 10-year yield needs to be attractive enough to pull buyers in, plus short-term

rates have stopped rising and are more likely to fall than anything. So, okay. So, this chart that we're looking at, since 2018, U 2018, US debt has increased by $9 trillion and the main buyers have been the Fed at 2.32 billion. And you could see they're buying less and less. And matter of fact, individuals have stepped up in a big way. These are households on the bottom blue line,

which is, but is that, are households enough to plug the Fed stepping away? I mean, they're still a giant hole. At the right price. At the right price. Stupid yield curve. And the question giant hole. At the right price. At the right price. Steeping the yield curve. And the question is, what is the right price?

And do you get a negative feedback loop? No one knows. So let's get to some of the stuff that Andrew put in, in terms of the ramifications for people that are thinking about their portfolio, stocks, bonds. All right, Andrew, we'll throw your first shot on this. Can I ask you a question before we get there? What do you think the risk is?

Federal budget deficit. Like, is that a 1% like, wow, whatever, I don't care? I think it's catastrophic. I don't know how to quantify it. How much do you worry about it? It's not something, I mean, I think there are more important things to worry about. I think it's probably the biggest risk,

but I don't know how to quantify it. I don't know how to position your portfolio in the event that people step away from the US treasury market. I think that if we do, the world looks completely different and it's not really a world that I want to think about. What would you look at?

VIX, CDS? Do you like CDS spreads on government debt? No. That's not for me. What I do know is that I look at spreads all the time as a sense of, okay, people say the bond market is smart money. People are pricing in risk. And credit spreads are just not going anywhere. And so maybe I'm

being a little bit hoodwinked, but I take a little bit of comfort in the fact that that's happening. That's not happening. The spreads aren't blowing out. Yeah. Yeah. Okay. Thanks. Okay. So stocks and bonds correlations are usually positive. The 2000s and 2010s were weird, Andrew says you. So explain to us this chart that we're looking at, which is the three-year trailing multi-stock bond correlation. Sure. So basically, look, the modern wealth management industry was built in a period where stock and bond correlations were negative, right? And when stock and bond

correlations are negative, it tends to happen when interest rates are lower. It tends to happen when inflation is lower, if you look at it statistically over time. And it's great from a portfolio perspective, because one of the great innovations in the wealth management space was trying to get clients to invest in model portfolios, right? We don't want them to focus on all these individual line items, because that helps them also to remain invested through the inevitable periods of ups and downs of the markets. But one of the underlying assumptions is that if you just start with a simple 60-40 portfolio, that they're going to hedge each other over time. And because most people have had a historical perspective on this, it goes back to 2000s

of the 2000s, that's always been true until the past couple of years. And the thing is that what this chart is basically designed to show is actually that's not normal. What's normal is actually in most periods of time, you actually do have a positive correlation between stocks and bonds. And that has very, very significant implications because if a client went into a portfolio in 2015 expecting the smoothness of the ride that you were getting in 2015 in a 60-40 portfolio, their world may be very different over the next 10 years. I think the risk that you're describing already happened. 2022 was really, really rough. Now, assuming that 2022, first of all, okay, I'm going to say assuming 2022 wasn't your first year in your market, but if it was, who cares, right? If you're a young

person entering the market, who cares? If you're an older person that has been invested, not who cares, but I think you were blessed with a wonderful decade of stock market returns of 15% compounded. Yeah, bonds didn't give you anything, but stocks gave you everything. And so the fears that you're describing actually came to reality in 2022. The S&P 500 fell, I don't know,

what did it fall last year? Was it 17%? Whatever it was. And then not only did bonds not help you, they were the cause of the risk, right? Interest rates going up, bond prices going up, going down, pushed stock prices lower. So I think that we already lived through that. From my point of view, as somebody who helps manage portfolios for individuals, this is a wonderful thing. The fact that we actually finally have some income in the fixed

income portion of our portfolio is tremendous. And the risk from here until the next 100 basis point of increases at the long end or whatever it is, we have a buffer. That buffer was zero. I mean, quite literally, it was zero. It was all duration risk, right? When the 10-year was at 60 basis points, there was nothing to protect you from the decrease in principal. So we took about 18 steps back, right? Now we're taking some more steps forward. But the risk from here forward, in my estimation, is not nearly as large as it was. And in fact, I think it's a gift compared to where we were for the last decade. Well, look, I mean, bonds, a great hedge fund manager said that bonds were

uninvestable three years ago, right? I mean, you're buying, I mean, who in their right mind was buying one and a half percent 10-year paper in doubly-rated credits in the US? But people had to do it, right? Because they had portfolios. And they had to fill the various buckets in their portfolios. And the thing is, most 60-40 portfolios and most diversified portfolios had a low-rates bet embedded throughout their portfolios.

Everything was anchored to rates R. So my point is just simply that there is a single underlying risk that you and I are talking about that did hit in 2022. Now, the question is, how does that affect portfolios on a going forward basis? Because I think what, like, if you look at today, right, I mean, stocks and bonds were up in the morning. Then they're down in September. Everything was down. January, everything was up.

February, everything was down. So just as a fundamental, it's not a criticism. Bonds are unequivocally more attractive today than they were. It's rather that the portfolio construction process may look very, very different in that having 60-40, when you're basically taking the same bet, if we go into a taper, that's going to be great for both stocks and bonds. If we have an unexpected rise in rates from here, that's going to be very bad for both stocks and bonds. And so the hedging feature that underpins a lot of portfolios, including much more complicated, every pension plan portfolio, people are going to have to struggle with how they want to build their

portfolios in the next 10 years to address that. I thought in the prior decades, 70-30, even 80-20 was 60-40, right? The 40 part of it was really difficult. I think now you actually can make a really compelling case for a 60-40 portfolio, even if right now, not only are bonds not hedging the risk, but we are in this weird dynamic today, this will not be the case forever, where risk-off, meaning lower yields, actually leads to risk-on because you have higher bond prices as a result, and stocks are rallying in a risk-off tape. It's an unusual environment that we're in today. Bad news is great right now. Bad news is great. But it's great on both sides of your portfolio. The point of diversification, though, is you're supposed to love what's happening in one part of your portfolio and hate what's happening in the other part of your portfolio and wish, oh, I wish I had it all on that side.

Wait, now I wish I had it all on that side. So look, the point that I was making was just really that I think I spend a lot of time talking about people in the model world, as Jan does, in terms of how do you want to build your portfolio? Because I think we all share the common goal, which is how do we help people to retire with as much money as possible and sleep at night between now and then? The making as much money as possible continues to be intact. The problem is, are you going to sleep at night in the same way? Well, I guess the question is, when you're talking about bonds as a hedge, obviously, it depends. If it's just an environment where yields are grinding higher, stocks are grinding lower, then there really is no hedge there. If it's just an environment where yields are grinding higher, stocks are grinding lower, then there really is no hedge there.

If you're talking about like over a day, a quarter, a month, it depends on your timeframe for when you want this portion of your portfolio, the risk off, to offset it. Because it's not going to do it every day. And it's not going to do it every quarter. And as we learned, it's not going to do it every year.

In 2022, it completely blew up. No, no, I mean, look, I mean, mine was a very narrow point. A 60-40 portfolio has doubled the risks today it had seven years ago. A 60-40 portfolio today has roughly the risk that it had in the height of the GFC when you just look at it. Now, if you have a long-term view, you shouldn't care anyway. Like, they asked Warren Buffett, if you didn't have Berkshire Hathaway, what would you do

with your money? He said, I'd put 95% of it into the S&P 500, 5% in cash, and not look at it. But people look at it. And that's what we're trying to manage. But let me try to state your thesis, which is not throw 60-40 away, but sort of add 10% to alternatives with a low correlation. So it's really his argument is 50-40-10, right? And I love this big picture question because this is what a lot of your listeners have to deal with and my clients have to deal with every day. And the biggest – sorry.

No, finish with it. I'm sorry. So the biggest thing is how do you keep people – the first job of every financial advisor is get your client into the market because you're making 8% very high attractive single-digit returns over a super long time period. They don't want to do that. They're worried about every headline every day in the newspaper. I think the only time where it's acceptable and polite company to talk about getting out of the market is when the Fed's about to raise rates.

That's where you should watch out, right? And they tell you, this is not hard, but it's very hard to do that across your client's books. And so let's leave that aside. I'm with you. I came into this year, I was a 40, 60 person. Again, the Fed had already been raising rates. Keep your clients invested in the market. But at the short end, right? Cash is wonderful, right? And you can make a lot of money there. Maybe we'll talk about it a little bit more, but within that 40% or 60% of your fixed income portfolio, there's really fun things, maybe fun is a relative term, but there's fun things to do. So for the record, I have no problem with alternatives in somebody's portfolio, zero problem with it whatsoever. I do think it's interesting, though,

that alternatives had a really difficult time when Fed funds rates were at zero, right? For a million reasons. Risk-adjusted, absolute, whatever. It was very hard to compete. Of course, the S&P is not the appropriate bogey, but nevertheless, we live in the real world and that's what people look at,

especially when the S&P is up 15% a year. Now we're in a world where you could make the argument that why do you need an alternative when cash is a great alternative at 5.5%? Well, I think I have a bigger problem with the liquid alternatives world probably than you do. I think most of the products never should have been launched. It's been a catastrophe for investors.

It's done somewhere a little bit more than 1% per annum over and over. I was trying to be diplomatic. Well, that's a bad neighborhood. No, look, I mean, these are expensive products that did terribly during a great period for 60-40. The question is what happens now? And I think we are always trapped by looking at history and trying to extrapolate it into the future. And I just think a lot of the lessons is that if you had made an asset allocation decision in 2009, having looked at what happened during the 2000s, you would have missed a great deal of what happened in the 2010s. So there's always going to be on portfolio construction,

there's always going to be this balance between where do you think the world is going to go from here? And what do we know about what happened in the past? And so, you know, so I think the problem is that a lot of the whole hedge funds in mutual fund products were expensive products that were built to be sold to people on promises that never materialized. What happened in the 2010s, 60-40 was the right trade. It was the right trade for a decade. It had a sharp ratio north of one for the most of the decade. That's incredible.

There's no hedge fund manager out there who, I mean, maybe one or two, who had Sharpe ratios north of one for the whole decade. And so you were rewarded for not diversifying out of 60-40. And the problem today is that most of the ways that people did try to diversify were highly correlated either to stocks or bonds. So they were really designed to bolster both sides of the asset allocation stool. You go into private equity, guys, that's equities. It's a different form of equities.

You go into private credit, that's a different form of bonds. It may be better. But so a lot of the diversification strategies were designed to bolster one side of the portfolio. But the real diversification came from the separation of returns between stocks and bonds. I think part of the problem with diversification, let's just talk about managed futures for a second, is it's almost impossible to stick with. So it's not that I have a problem with the underlying investment philosophy, but not even to knock on individual investors, professional investors, especially in a world, and I know this is not going to be repeated, I have no doubt that the next decade will not look like the last decade in terms of the S&P going up 13% a year and managed

futures doing 0% a year with all. I know that's not going to happen again. Nevertheless, it did happen. And sticking with something that does actually provide diversification and does actually provide non-correlated returns, it doesn't provide negative correlation. So it's not as if the stocks are going to go down and you're guaranteed to make money. It's really difficult to actually implement that as a human being unless you just completely say, this is my allocation and I'm just not touching it, which is hard. Let me change the debate. You have, I would argue, the biggest risk in the market. I think we agree, which is the federal budget deficit, right?

It's just unsustainable if you do the math. So you need a bipartisan deal to fundamentally change that. I think it's doable. Most people don't, but regardless, you're sitting with that risk in your portfolio today. Do you want to have something to be able to talk to clients about and say, you know what, this is your hedge, right? Because if we have a major problem with bonds, like interest rates are going up, your bond market's going to lose another, you know, 20 percent or whatever it is. And equities won't do well in that environment. So what is the answer in that environment?

Well, you know, I don't know if there is an answer. Right. There's there's gold. What are the traditional hedges? I mean, we know what they are. Yeah. So are you willing to have that client conversation? Or conversely, are you going to wish you have had it? Now, let me just go backwards, because I think the last year, the last decade has been even harder for financial advisors, because it hasn't been 60-40. It's been large cap growth and treasuries, right? Most of the equity market, if you did EM, if you did value, most of the equity market,

if you did EM, if you did value, ouch! Yeah. I mean, ouch. And we just have replicated that again this year. Well, if you did anything but large growth.

When you talk about managed futures, I think having any diversification conversation with clients has been a loser for 10, you know, 12 years now. That's the difficulty. Well, look, and I think, look,

I think in general... I'm not piling on, by the way. No, no, no. I want the hedge. No, look, look. So first of all, look, this is the'm not piling on, by the way. No, no, no. I want the hedge. No, look, look. So first of all, look, this is the central problem with managed futures, right? People buy it at the wrong time.

They sell it at the wrong time, right? And I know very, very smart guys who got out in 2020 just before it took off again because they couldn't handle the pain that had happened over that period of time. Now, there are peculiarities. And the pain of their clients leaving. Right. So it's not, it's not, I'm not even talking about the strategy itself. I'm just talking about the aspect of we're all actual human beings that need to believe in the product, stick with the product, convince clients to stick with it. It's really hard. So my mission is actually to take – if you have a statistical brain in your body and you're starting with a normal portfolio of stocks, bonds, and other traditional assets, I believe there is no single better diversifier. I think it has more diversification bang for the buck than managed futures as a strategy. On the other side, it is the worst strategy in the world from a messaging

perspective. You ask me, well, what the hell do you even mean by managed futures? Every other asset class has some great term associated with it, right? Remember when junk bonds were junk bonds? They didn't take off. High yield. Now they're high yield, right? So how do we rebrand managed futures? Oh my God. I don't know. I mean're high yield. Right. So how do we rebrand managed futures? Oh my God, I don't know. I mean, tactical alpha. I'm trying to think of something like, like I haven't come up with it yet. You guys are so smart.

The managed futures people are such intelligent people, but they can't get the name right. You know what? Because they're engineers. Right. Right. They don't, the thing is, I think, I think you're hitting on exactly the point, right?

Which is you can make, when we talk about portfolio diversification, we use language that our clients couldn't care less about at the end of the day. Oh, we're going to raise your efficient frontier. I showed this chart. I was giving a talk in London about managed futures. And I said, over the past 23 years, if you'd invested in managed futures hedge funds, your Sharpe ratio would have gone from 0.4 to 0.45.

Cool. I said, there's not a single client in the Western world who gave their advisor a bear hug for that outcome. It's what matters is, I call the strategy like a beacon of green in a sea of red. In September, it was up a lot when everything else was down. In 2022, it was up a lot when everything else was down. What they don't have is a language that describes why this makes sense, given everything else you have, why it's integrated into your portfolio.

And part of it is a lot of the language, as you and I talked about briefly before, it's a little condescending. It's a little bit, you know, we're just taking advantage of the fact that most people are kind of fools in the way they invest, and they don't think about things as fast as we do. And I think that's absolutely the wrong thing. I think for an advisor, it's got to be, why should this be in your portfolio today, 10 years, and when you retire?

What is it doing that we're not getting from other asset classes? And look, if I'm right, then this will be the path by which you can actually mainstream the strategy. So if you were sitting with an advisor and their client, how would you explain it? So I would say, look, what your advisor is doing is exactly right, right? They are the steady hand of the wheel. They are building you a portfolio that has a lot of different pieces of it that is over the next 10 years. You know, telling you over the next 10 years, we're going to chart the steady path for you through stormy seas. But 20% of the time, the world changes faster than those models can adapt,

But 20% of the time, the world changes faster than those models can adapt. Their job is not to move fast, not to follow the false positive. And they're doing the right thing for you because they want to keep you invested, and they don't want you to get you out at the bottom. But every now and then, like 2022, inflation comes back in a way, Fed rate hikes come back in a way that no strategist anticipated. And when it happens, 95% of investors out there can't move fast. A few hedge funds can and other people can. So take a small part of your portfolio and put it into this. If we end up in a commodity super cycle and that we have no idea how that's going to ripple

across everything else in your portfolio, find a stable long-term allocation to something that's going to behave differently. Because diversification is about not just statistical differences. It's about things that function differently in different environments. And the way that advisors should message it with clients is not about,

I'm worried the world's going to fall apart in the next six months, and I'm going to buy this because I think it's going to go up. You're setting yourself up for failure in that because you're basically, the world's not going to fall apart in the next six months, and I'm going to buy this because I think it's going to go up. But you're setting yourself up for failure in that because you're basically, the world's not going to fall apart in the next six months. And it may fall apart, and these guys may not do well because they may be on the wrong side of it. So there's no certainty. I mean, can you imagine? I can imagine. Look, I mean, managed futures has a terrible decade

in the 2010s. There are reasons for it that I think won't be repeated. Like, we talked about cash yielding 5% today. That's literally just 500 basis points added to the returns in the managed futures space because you're just sitting on cash and then you're trying to make returns on top of it. But what the advisor has to be able to do is how is this going to help you sleep at night? How is this going to help you to remain comfortable at this portfolio? Is an all-weather portfolio for all different market environments. It's just tricky because there's so many years where it doesn't, quote, work. And then the risk that you select the wrong manager that doesn't actually perform when you need it to, and then

you're fired, right? And so you're risking the whole relationship for a very small bet. The risks feel asymmetric. Completely, right? And that's actually what we tried to solve, right? I'm not going to go talk about it, but single manager risk in this space is the single biggest landmine. Because what happens is people, again, advisors get excited about these products. You hear about it. And by the way, if a guy killed it last year, you're going to hear about him in January. Sure. They have large marketing teams who are going to show up on your door, and you're going to hear about it.

People are going to be on podcasts, whatever, talking about it. So what they do is you don't look at the other 47 guys out there and think about is this sustainable, is this likely to happen? So then you go tell your clients, we found this great area and this guy that can do no wrong. And guess what? There's no persistence of returns in this space. That guy is Icarus. He is going to go down much more than you expect and much more than your clients expect over the next 12 to 24 months. Just, it's absolutely the pattern of the space. That's the worst thing that can happen to you as an advisor. You've sold people on this 5% allocation in your space. It's now taking 30% of your time. You're on the golf course with people trying to explain what, you know, why

these guys who couldn't fail are suddenly- fail are, are, are, are suddenly. Yeah. Why this short corn position blow us up. Yeah. And, and, and again, that's the way people talk about it. You talk to people in the space and they're like, you know, oh, it's a great month for wheat or whatever. No one cares, right? What care, what, what they care about is how do I sleep at night? Does this help me? You know, how does this make my life better? I don't care about sharp ratios. So the answer is, eh, maybe.

Yeah. All right, enough about futures. John, let's talk about, let's talk about, get back to bonds. All right, so Bank of America has this great chart. Everyone is bearish on bonds, but nobody sold. You've got the Treasury's cumulative annual flows. And, you know, most years it's up, some years it's down. And 22

and 23, holy moly, gazoli, completely off the charts. And as a matter of fact, the area, now they're actually, they're probably not into short-term money market treasuries, but the area where money is just being shoveled into the incinerator continuously are long-term treasuries. So Jim Bianco has a great chart. I think he's done really good work on this, showing that from the peak in, I think, in the summer of 2020, TLT, which is long-dated treasuries, are down 46% or so. And yet, $34 billion or $36 billion has gone into them. Are these people that are either, they're like, oh my gosh, rates can't go any higher

and or they're attracted to the current rate and rates may go higher, but that's fine. My income will offset the price declines or and or are there people in here that are saying, you know what? If and when a recession does come, this will be the safe haven. This will be the hedge.

And I'm getting in while I still can. If you look at me, I think it's two-thirds dreamers and one-third maybe hedge funds. So the dreamers are the people, we're in a regime change. We've had zero interest rates for a decade, and we're not going to be there anymore. The Fed has told us that over and over and over again. And so they're just dreaming because they think QE is going to come and save the bond market. I don't know why they think, again, that we're not going to have a normal yield curve, but people still today, I had a really heated argument yesterday about this. Like, oh no, it's higher for longer on the short end, but the long end is going to come down because we're not going to ever – like whatever. Is that consensus?

Yes. Yeah. And so it takes – like why does this take so long, right? I was here a long time ago. You know why? Because it takes – money has to move, which is this chart, and then mentality has to change. So that's two-thirds of it. I think they're just dreaming and they're, oh, my God, I get 4.5% on the 10-year.

What a bargain, right? I forget there's risk associated with it. And then remember just that the way ETFs work, that if you wanted to short the 20 year, right, actually money would go into this fund. So that's the third hedge fund money, not really losing money kind of piece of it. Because it's very liquid. Hedge funds are actually massively net long or net short the long end. Right. And this is a way to get short the long end because you're short TLT. And a couple of months ago when Ackman came out and said he was short in 30, everyone

was like, oh, that's the bottom. And he's been right. He's been right. He nailed it. Yeah. So I would add something else to it. So what we know, people get smarter over time about things. Debatable.

Well, no. But I think, look. Yeah, this is the theory of managed futures, right? It takes a while for the light bulb to go on. Well, see, I would draw sort of a slightly different analogy, which is that people used to get caught flat-footed by drawdowns in the markets, right? 2008. And I mean, I was talking to like family offices who are really sophisticated

investors. And the ones who are really honest were like, yeah, we were selling everything in March of 2009. We thought it was over. The world was done. But what happened was there are a few, a handful of people, you know, Warren Buffett steps in with his iron spine and he buys a railroad company and he does preferred stock with Goldman Stacks and he does, he's the guy who's coming in and he buys a railroad company, and he does preferred stock with Goldman Stacks, and he's the guy who's coming in, and he makes an absolute killing. A handful

of hedge funds, Seth Klarman, the guy that I worked for, they were waiting. And Warren Buffett has this great thing. Every 10 years, the economic storm clouds dark, and it rains bars of gold. And he said, don't go out with a thimble. Go out with a bathtub. So there was a whole handful of guys who were willing to tread water for years, do okay, and then make it all then. And then people learned about it. So in March of 2020, as the world is falling apart, I thought this was going to be another period like the GFC. Everyone was out raising money. And every pension plan thought this was their opportunity. They'll take money from here and we'll throw money at opportunity funds. We're going to buy asset-backed securities at a discount, et cetera. I think that's this.

People learned that the markets didn't go too far in a direction and you want to be the contrarian. You want to buy it. You want to step in. And the whole taper trade, I think, was part hope, but also it was the cool trade among a lot of people. This is how you're going to show you're a contrarian. You're going to bet on it going back down. You're going to be the one who didn't get fooled by continuing to go up. Now, here we are. The year of the bond in January was the obvious trade. We saw people pulling money out of hedge funds to put it in long-dated bonds. They're down. When was this?

In January of this year. You know, it was the obvious trade. Not to Jan. No, no. But it was people thought that you'd have a taper in the second half of the year. Whether it was hopium, whether it was part of their business plan, they had to believe it. Whether it was justification of prior decisions they made, whatever it was. And now they're down for the year.

And it's gotten real quiet. Because people don't talk about when the trades go badly. So now it's the year of cash. And all we talk about is short-term fixed income. So I think, you know, if you're talking about $30 billion going to TLT, again, in the context of $100 trillion of global markets, nothing. Yeah. All right. Let's talk about private credit. So there was an article in the journal, the new kings of Wall Street aren't banks. Private funds fuel corporate America. I feel like this trend has been in place, but that really accelerated with Silicon Valley Bank going under.

And so this has been a huge thing. So there's a chart showing growth in debt outstanding since 2010. It's showing private credit just ballooning, screaming past high-yield bonds, screaming past bank loans. If you look at, they have this really killer visual showing private credit assets under management in 2023 versus 2018. So five years ago, Apollo had $75 billion in private credit.

It's now $270 billion. Blackstone was $65 billion. Now they're $206 billion. I mean, just massive, massive, massive numbers. And then last chart before I throw it over to you guys. They're showing private credit funds, AUM, compared with corporate loans by banks. And it is, I mean, private credit funds, they're coming up the rear, as they say. Is there a world in which private credit funds overtake gigantic banks? And for the benefit of the listeners, gentlemen, can you explain what is private credit?

What is this category? Sure. So it's just a loan made by usually a hedge fund type of structure to a business or an individual. And it's what I was talking about before. When I was talking about how the US regulators are trying to kill the commercial banking system and make it unrecognizable, this is the trend. This is a manifestation of it. And so what's shocking about this, because I've been hearing about alternative credit for a decade, is how much runway they have.

And a friend of mine yesterday, Ram Alwale, was pointing this out. There's $20 trillion in bank deposits. There's only $1.5 trillion in alternative credit funds. We could be here in five years. Alternative credit could be $5 trillion. That was sort of the gist of the article. Yeah. But it's crazy.

They could get to $10 trillion easy, and that would only be half a bank deposit. We should start an alternative credit fund. I look at this and I think, what was I thinking in 2000? What are we doing in futures for? Commodities in greater China. So look, this is what happens when an asset class goes mainstream. And the question is why. And what Jan is basically pointing out was that, particularly after the GFC, there were guys who were doing this in the 2000s.

And they were doing rough stuff, hard money lending. I did a deal where Fortress came in. And they were scary to work with. So one of the things is you talk about the bond market being smart money. There's this assumption. I haven't seen it personally. Like when you're particularly on the corporate credit side, if you're running a corporate bond mutual fund, you've got to put out money no matter what. You're just trying to pick your worst outcomes.

But in the 2010s, remember, people were getting rid of covenants that would have protected investors. Again, you didn't have somebody on the other side because people were in the business of basically just putting out money. You didn't have somebody on the other side who was basically saying, how do we make sure we're protected? These guys are stone cold killers, right? These guys are going to, if they come in and you're borrowing money from them because the banks have walked out, you are going to be agreeing to things with these guys that you never would have agreed to in the old world. And so they're actually, they're stepping in and they're serving a very, very valuable market function in that they're providing credit now to areas where the banks have pulled out. Now, query whether it made sense for the government to make it so difficult for these guys, for commercial banks, because trust me, commercial banks would do it for a lot cheaper than the private credit funds would do.

So there's a quote in the article, investors wanted yield and the government wanted credit risk away from the taxpayer. This is Joshua Easterly. He works at Sixth Street, a private credit firm. They created the environment for this market to mature. And I was reminded of a line in Jurassic Park. Your scientists were so preoccupied with whether or not they could, they didn't stop to think if they should. Are these structures, while attractive for investors, you mentioned that you don't want to f*** with these guys. They're getting paid back. So maybe good for the investors.

Maybe good for these private equity companies. How about for the businesses? Are the covenants so strict and the terms so onerous that especially in an environment where these are, I don't know if these are floating rate, but they're short term, right? And they need to get rolled over. When the 10-year is nearing 5%, how do these companies service that debt? Well, just before I say that, one of the things to also remember, these guys are completely shocked by the growth in their businesses. Who's the private equity firms? The private credit firms, right?

There's not a single firm there in 2005 who thought you'd see this geometric growth. They can't believe their good luck. But it's the same thing with the LPO business, right? Back in when I- With what business? The private equity business, what used to be called the leverage buyout business. LBO, okay. That's an LPO. Yeah. So, I mean, look, you raised a $500 million LBO fund in the early 1990s. You were a big player of the space. Now people raise $25 billion funds and put it to work in eight months or a year, right? So when these asset classes go, they seem big at the time,

and they take off in a geometric way. Look, in terms of what these companies are doing, remember, a lot of these companies are also going to be lending to companies that have private equity guys on the other side of the table, who themselves are also tough and hardened. So I don't know how it's going to play out. The interesting thing about, you know, when I was at business school, they used to talk about over-leveraged companies having a cost of financial distress.

And so the expectation would be all private equity companies have a lot of leverage. Therefore, they're likely to go bankrupt at a very, very high rate. And it didn't happen. And part of the reason it didn't happen is because a firm like Apollo is buying companies with equity, borrowing money from other people. When things go bad, they've also got a credit fund that can step in and buy the debt. So it's now gotten really – the institutionalization of the private equity and the private credit business has created a very, very different dynamic in these markets. And it could probably be great for certain companies in providing capital that they otherwise couldn't get.

On the other hand, if things go badly, my guess is they're not going to have a hard time. There's so much money out there. You saw the stories last week about Goldman launching a fund to invest in distressed private equity funds. I mean, it's almost like comical at this point, right? Like the illiquidity, like what are we even doing? But there's still, there's so much money out there.

Yeah, and look, and I think these guys, look, the guys, guys in the private credit business are incredibly smart. Guys in the LBO business are incredibly smart. The LBO business, I think made, or private equity business made money for a long time because they were borrowing from lenders who had no leverage, right? These guys had to make loans. You had bank loans. People had to make bank loans. They had to, they had to, you know, they could go to wall street and issue bonds whenever interest rates dropped and keep refinancing at lower rates. I mean it's incredible there haven't been more bankruptcies. But in that's – in part, this was the most telegraphed risk that people had was that rates would go up.

And so everyone, whether it was buying a house and locking in a 30-year mortgage or companies trying to lock in long-term rates when things were artificially low, they were taking money from bond investors, taking money from banks who were issuing mortgages at 3% for 30 years and basically locking it in today. And so back to your point about this is going to cascade through. There are other people in the trades who are not going to do well. We've already seen that playing out. So who do you think that is? The equity investors in these companies? It's going to depend company by company and where they are. I mean, a lot of companies will get restructured because you've got smart, tough guys on either side.

Some of them will get restructured out of court. Some of them will end up in court. You'll have lots of litigations and battles and standoffs and other stuff. But the industry, the structure of owning companies, owning privately held companies, and who's lending you money has changed materially over the past 10 years. Another material change in the market

that I thought is sort of mostly getting cleaned up, but in terms of like, what does this mean? Is this unsustainable? Where does the rubber meet the road? Is unprofitable companies. Goldman had a great chart. John, if you would please. Unprofitable firms and even persistently unprofitable firms have become a larger part of the U.S.

corporate sector over time and have been largely unscathed, excuse me, unscathed by the pandemic economy so far. So the chart on the left, we're looking at the share of all publicly listed firms by profit margins and ones that are very negative, like less than 5% margins. It looks like it's 40% of all publicly traded companies. Now, the good news is in terms of the revenue, I mean, it's a relative drop in the bucket,

but these companies have to be in a world of hurt now, right? Like these companies were given the benefit of the doubt. They were subsidized by venture capitalists for a long time, which was great for the consumer. But in a world where capital has a very real cost, these companies have to be in a world of pain. Look, going back to the hopium thing, right? These guys, you know,

people invested in disruptive tech companies, people invested in anybody who has loans that are going to roll over. Everybody is hoping that we go back to a world that looks a lot more like the 2010s. people invested in disruptive tech companies, people invested in anybody who has loans that are going to roll over. Everybody is hoping that we go back to a world that looks a lot more like the 2010s. And if we don't, you're going to have a series of these rolling train wrecks. It is going to cascade through different markets. We haven't seen it in the housing market. Maybe it gaps down significantly when people actually decide that they're going to move as opposed to staying where they are. Maybe we'll see it in the corporate bond market. But again, I think

the fact that we haven't had a big single impact, which I think was a lot of people's base case scenario, it likely means that you'll see the impact of rates and now positive real rates really for the first time in years cascading through different parts of the market. Now, I said this has been mostly cleaned up. John, next chart, please. So this is the non-earners as a percentage of weight in the Russell 2000. The market took care of this. These companies got absolutely creamed. They were 30 some odd percent of the Russell 2000. These are non-earners and it's now down to, I don't know, 22%. So the market- I like this chart a lot. The market's a care of this in no time.

I think you put your finger on it. I think the profit margins are being squeezed, right? The alternative credit guys. And I think there might be a stickiness to that business, right? If you have a lending relationship with Fortress or whoever it is, fill in the credit fund, they have your financials. You're not going to move around for 20 basis points, I would guess. But I think you're right. They're taking it out of the equity holders, the company's profit margins. And I think profit margins are shrinking a little bit. And I think they're taking a bigger bite of the apple.

And so, yeah, that's another foot on the neck of the small cap investors, right? Yeah, and you mentioned earlier that, in your estimation, the biggest risk to equity investors, or just the biggest risk, is the national deficit. Yeah. And that might be the biggest risk, but it's hard to quantify. It's at a 1% chance.

I think still the thing that I worry about more than that, because we're all f***ed if our debt is no good, is just the economy and earnings, and just not overthinking it. Like, how are corporations doing? How is the consumer doing? And I know that can change on a dime, but for right now, it's okay. And we're coming to earnings season next week. Yeah, look, I think the economy has also changed a lot. You know, when I started in the business, you could look at an industry. I mean, one of the things that I think people have lost sight of is how much better run today the average company is than it was 30 years ago. Absolutely. I mean, when I started as an investment banker in 1990, you know,

they were just introducing PCs. You know, you had people who were like using Lotus 1-2-3 to kind of figure out. And EBITDA wasn't a term that people understood outside of the investment banking world. The tax benefits of leveraging a company and what that would do to your free cash flow, these were all esoteric concepts in the 1980s that then became very, very widespread. And so the average company today thinks about things like average cost, your cost of capital. They generally have independent boards. You know, back in, part of the reason this, you know, people talk about the value factor from 1962 to 1990, as Fama described it, he was describing a world where corporate governance was terrible. You know, people didn't think about cost of capital. You had, you know, you had the competitive dynamics within industries

were much, much slower. And so now you look at the, and so I'm, look, I'm in general an optimist, although maybe it sounds like I'm somewhat cynical, but think about the companies that we have between a Google and a Microsoft. These are, these are the best run companies in the world with, I mean, you know, Warren Buffett said with Google, it's like somebody invented a cash register in San Francisco and anybody, anybody, anytime goes online, anywhere it rings, you know, it's with the smartest, most rapacious capitalists with their own skin in the game. I mean, those are incredible things and I wouldn't bet against them. So I'm with you overall, right? But if you have a steepening yield curve, the winners, of course, the fangs are going to succeed, but the winners might be different. Like value may come in.

So other parts of your portfolio may work. Values outperformed for the past three years, believe it or not. It doesn't feel that way because all we talk about are the fangs, but they've done well. All right, before we get out of here, we got to talk about the trial real quick. Of course, that is the Sam Bankman free trial. All right, we're going to try this out here. Duncan is going to play the role of who is the AUSA. Is that the assistant US district attorney or? I don't, I don't know. All right. Well, that's what the USA is. All right. And I'm going to, I'm going to

play a Kara Ellison. Duncan, are you ready for this? I guess. Okay. So we're going to, we're going to read some transcripts from the trial. Duncan, you go first. Okay. How do you know the defender? At Jane street, then Alameda. We dated for a couple of years. Did you commit crimes? Fraud. With others? Yes. Do you see Sam Bankman-Fried? He's over there. What was his involvement in the crime? He was the head of Alameda, then FTX. He directed me to commit these crimes. What makes you guilty?

Alameda took several billions of dollars from FTX customers and used it for investments. What was the defendant's role? He set up the systems and told What makes you guilty? What was the defendant's role? How much did Alameda take to repay its lenders? How did you defraud Alameda's lenders? Why was there not enough money for customers in November 2022? We had to take it to repay lenders. End scene. Pretty rough.

Very tightly scripted. I mean, it's all going to be about the credibility of the witnesses. So it'll be interesting how that plays. That sounded a little forced. But that was real. No, no, I get it. But I'm just saying, like, that's a very clear—it's almost like the prosecutor wrote the whole script. Like her lawyer coached her, too.

Yeah. Well, she cut a deal with the prosecutors. She spent endless hours with prosecutors and her lawyers scripting this out every step of the way. Do you think her relationship with Sam's over for good? Not good. Andrew, can I read what you put in here? Because this is just a chef's kiss of a quote. Crypto was a global superconducting douchebag magnet. So look, I have no opinion on whether crypto changes the world and it's better.

I mean, a lot of the concepts intrinsically sound interesting. I talked to guys who are far better on the tech side than I do. They think there are all sorts of limitations associated with it. I think you've got an unregulated area. What happens, the way bubbles take off is you have an area where you have something that has exceptional returns or something associated with it. And within that, you're always going to have a spectrum. You're going to have white knights to the black knights, basically. And what happens is the longer it goes on, the white knights think the black knights are going to be punished at some point.

Somebody's going to reach in and do it. And this space in particular just seemed to reward the worst people in it. And if you actually, so I'm not an expert on the space at all, but if you go back to the late 2010s, there were frauds, there were Ponzi schemes. But an interesting thing, I think, is that the political dynamic, and look, conspiracy theorists will tell you it's because of the level of political donations that was coming from it. It was not cool for prosecutors to go after the space for a long time. And then something flipped. You know, maybe it was Celsius, maybe it was other things happening. But at some point, this became a way and Bill Ackman,

actually, who I've known since 1992, and I think is, is can often see things with very clarity. You know, he basically said, look, this is you now have, let's see how this all plays out, because you now have almost stepping the same same SPF's defense, which, you know, is a ruckus. But what he basically said is you've got prosecutors now who it is in their best interest to find the most attractive scalps in this space. That helps them politically. It helps to advance their careers. And so I think what he was basically cautioning people to do is when you look at this,

just understand the dynamics that are at play here. This isn't necessarily just an altruistic search for justice. Everybody has skin in the game on a different outcome here. And I think what Jan was saying is this isn't a natural conversation. This is designed to have a maximum impact on a jury to give them the highest probability of winning. So you guys agree with Michael Lewis, it sounds like. I'm just kidding. Yeah. I wouldn't go that far.

I mean, look, every fad attracts scam artists with PowerPoints and things like that. And Sam was a fast-moving guy and got in front of a lot of money and then obviously started helping himself to it. But you don't think cryptos are fad? I think there's – no, I think there's just some real potential with that. But, you know, there's, yes, I think there's potential to be disruptive on the payment side very specifically. And if people want an example, look at the Visa Solana deal.

If you, the payment structure in America takes 3% of every transaction that uses a credit card. You can disrupt that. That's disruptible. There's tech questions, there's scale disrupt that. That's disruptible. There's tech questions, there's scale questions, but that's disruptible. I just want to be aware of the possibilities there. What I also found interesting about crypto, though, was, and I did some tweets on this, which is it had this sort of religious quality for people. This was their way to challenge the system. This was the way to... And so,

again, I've never had a view that there's anything necessarily bad in crypto. I was just sort of more interested in the dynamics of it. Like, well, how did it become this thing? Oh, we read your quote. Well, that was... But look, I think the question of whether it gets regulated, whether it's useful... I mean, I used to get these when I would say anything that would even question anything. Because remember, people talked about this as it's a non-correlated asset class. And then it was correlated. And then it was, I forget, there was like a whole series of arguments that people made for it.

And as they broke down, an intelligent investor would say, okay, I had five or six reasons why I thought this thing would go mainstream. And, you know, three or four of them had just fallen away. And so I was pointing out just things like that. You know, look, you're moving the goalposts. The narrative is changing. It's a religion. And it was a religion. So people would say like, you know, like this is going to save emerging markets because people are going to, in Venezuela, are going to be able to protect their capital and stuff. And so I think that part of it, I think, was almost unique to

crypto and the fact that it was global and under-regulated in the way that it was. All right, gentlemen, appreciate your time today. Did everybody have fun? I loved this. Thank you so much. All right, we're going to end this show. Can we just quote again? Super conducting douchebag magnet. That's gold.

Did you see the courtroom depictions? The courtroom art? They look about how they always look. Remember the, didn't somebody draw a picture of

Awesome? Allison looks pretty rough. I saw my favorite tweet was Ashley Vance from Bloomberg said, can you sue a courtroom artist for defamation? Didn't they have

Tom Brady looking ugly in one of the pictures? I'm thinking of something else. No idea. Who is that artist? I don't want them anywhere near a portrait with me. Good Lord. All right.

As we always end the show with favorites, Andrew, what have you read, watched, whatever, listened to this week? Well, I was on a plane coming back from Europe, but I was rereading Trillions by Robin Wigglesworth, which I think is a book that anybody who's interested in the asset management industry should read. It basically talks about the growth of the index business and by tangent, the growth of the ETF business. And I just think it's an extraordinary survey of, again, how much has changed in this business over the past 30 years.

Jan, got anything for us? Yeah. Boring history book, How the Scots Created the Modern World. You know, Adam Smith was a Scot and just their influence on the development of the UK, the America, Australia was founded by Scott, like Hong Kong. It was just everywhere. How'd you find that? Well, I don't know. I read a lot of history stuff like you. All right. So last night in bed, I watched, I called it 30 minutes of The Prestige, which I haven't seen. I've seen it a million times, but I haven't seen it in a long time.

I did see it in the theaters in 2006 when it came out. Hell of a movie. Christopher Nolan, listen to this run in the 2000s. From 2000 to 2010. He did Memento in 2000. Two years later, he did Ins 2000. Two years later, he did Insomnia. Three years later, he did Batman Begins. The next

year, he did The Prestige. The year after that, he did The Dark Knight, and then he ended the decade with Inception. Not bad, huh? Not bad. Yeah. Not bad. OG. All right. If you're a young person and 2006 is before your time and you missed The Prestige, cannot recommend it highly enough alright

Duncan Rob Nicole thank you for producing it thank you for watching I was about to

say animalspiritspod.gmail.com where do we send people we don't send people we don't okay

well thank you for listening we'll be back next week Josh will be in the seat we'll see you next time

thanks so much Rob thanks good stuff that was awesome I'm not gonna say it I thought it was not at all I didn't know See you next time. Thanks so much. Good stuff. That was awesome. I didn't know how much I missed the sound. you