πŸ”΄ A Recession Bet - Interest Rates Going to Zero | Recession Watch

πŸ”΄ A Recession Bet - Interest Rates Going to Zero | Recession Watch

I'm Alex kerkovich the founder and CEO of Hunter investments and I'm delighted to have as our guest today John Burbank the founder of passport Capital He found a passport capital, I believe in the year 2000. Mm-hmm and it's been very successful and very well known in the notes during the times leading up to the financial crisis, very Successful fund but I'm particularly excited to have John here because not only we're in a closed space in this building, but we're also in a Closed intellectual space I believe occupy similar intellectual space don't we trade different products for me? It is important that like myself he's engaged in long horizon thinking and trying to understand what things really are and seeing forests behind the trees and trying to understand that regardless of current market noise a current perception where certain price or asset is likely to be two years from now not By this afternoon at the close And that's why I think we can speak the same language, even when we talk about different products Mm-hmm When you end up being a contrarian you're against 90 percent of the market and yet you sit there 95 percent sure that you're right while 90 percent of smart people are on in 2004 I said One should buy every deferred arrival contract of any maturity if it trades below 100 Hmm.

So basically in 2004, I made a statement that European interest rates will be zero negative in perpetuity, which was probably ten years before its time. I Don't think that was as much a brilliant. It was some kind of mixture of a brain inside and some luck I was just frustrated with an efficiency of European Union. That's really what was speaking of me. I didn't have that Strong perception how near will really play out, but I said it and it carried some weight back then mmm now what I would like to kind of open up with asking John is like what are the instances maybe bring up some historical examples from your career sure when you could really nail it and how would you attribute some of it to Locke and some of It to what it is that really you – nail it So probably the best thing to start with is that I started in January 96 at a small hedge fund here in San Francisco Doing emerging markets and emerging markets or a relatively new asset class.

And so there's a lot of excitement about it But I'm sitting in San Francisco doing emerging markets and our fund went up every month into from January 96th, October 97 and then iam collapsed and people did not predict that and The u.s. Kept doing well it Bottoms in 98, you know about a year later and then the US went up to a bubble and they'll be pretty do that so I guess early in my career in the 97 98 99 In 2000 period what I saw was two things a 90% crash and e/m and a year in dollars in a huge bubble and Things that you know didn't make any financial sense what I saw was It's possible for liquidity To take prices very quickly to places nobody ever predicted and I came up with this view that maybe financial markets aren't nearly as smart on a longer term basis as you think and that the you know The very improbable or impossible happens on a regular basis. And so what I like to think my father's this was Maybe you can actually identify places that would create You know that asymmetrical or high leverage situations? but they had to be things that had never happened before I think because essentially people look backwards and extrapolate forward they look at a chart backwards and they think oh, you know, It's it's gonna go if it's down it's gonna go up.

It's up it's gonna go down they regress to the mean basically, but the world moves forward the world progresses and Essentially the other other principle is that I like these I'd like to say prices of lire meaning if if the massive liquidity has moved so much to one direction and It's pricing in something but it's not actually true or it's not going to be true in a month a year Two years the liquidity is gonna change directions And therefore you're going to have a chain to either make or lose lose a lot of money So what I've tried to do is to understand many different asset classes many different markets to put together an understanding of where Prices are where liquidity is and then match it to the fundamental changes in industries and companies and perspectives, so if you go back to 2000 Right, August of 2000 is when I started just before the US market rolled over we've had You know, the world has changed immensely China wasn't even understood to be a demand driver for commodities until 2003 Tech was this bubble it was forecasting incredible promise But that promise didn't really become I think just kind of in markets until 2013 when growth stocks really started out performing You know price is really just the balancing of liquidity.

It is not the proper discounting of the future So the question is where is the quiddity now relative where it liquidity is going to be in the future for fundamental structural? reasons and So I use One way I'll use it as go back five years Five years is a long time in the financial markets So go back five years in this case 2014 middle of 2014 and think about what the world thought was gonna happen And compare it to where it is now go back five years before that 2009 right and to think about what you thought about the world then versus where it was in 2014 I mean five years is a long long time because liquidity has a chance to move, you know dramatically to one place or another and I'd say markets are more efficient now, I think you know The most powerful dominant companies in the world are generally us some Chinese Internet companies and I don't see a lot of Vulnerability there and I think the liquidity of the S&P the governance to the S&P which is incredibly different than it was 10 years ago Is reassuring to people but now we have a difference a big difference in the perspective of us Fed governors and Long-term structural trends that I think creates a you know an unusual once in a 10-year You know bet that I can that we can anyone can make which has really got my you know, my focus so I think the origin of the idea for this interview was Started possibly with a conversation we had about six months ago.

It actually it was exactly six months ago It had to be first week of January. Mm-hmm Yeah, I remember I was in vacation, huh in Hawaii and you reached out to me to discuss calls on your a dollar future. Yes And the interesting situation was then we just that was when the market just went through this liquidity squeeze and a risk of scenario of fourth-quarter 2018 fixed income market got out of pricing imminent tightening cycle and but once we rebounded from the absolute lows of the stock market stock market strongly bounced last few years of to few days of 2018 it continued to rally into early 2019 We went into this Environment that is basically on hold for the rest of the year and as far as I remember their volatile 'ti Implied volatility on you at all the futures by the way for listeners who are not familiar with them those are contracts on forward interest rates and Basically, those are the easiest to trade contracts which reflect future Federal Reserve policy The volatility was extremely low were close to like record low early lows for quite a while implying very low likelihood of any kind of action and we started talking about this and I think we were both over strong opinion that Rates were actually going to be cut this year and there was an opportunity there and So this is a good segue into discussing why you were so convinced why you think and also why you think that you are so convinced while a lot of people Are still either? Calling for felon hold or even expecting of the dust settles for hikes.

You're later in 2019 I mean a lot of people were still calling for hikes in the second half of 2019 which of course in hindsight looks preposterous But interesting thing that it looks looked preposterous for you in me back then yeah So what is that that sure allowed you to outmaneuver people? And what was the trade and what does it allowed you to mature people? So so the starting in at January 96, I've seen a few different cycles for all different reasons, you know the the procyclical capex bubble of the internet build-out in the late 90s and Then the Greenspan created credit bubble and the wall street you know leveraging of the investment banks right and all the banks with a crappy product of subprime and that blew apart And we have a different situation because the world moves forward so much, you know in ten years and so we have a different situation Which was also not believed which is more like we're talking about the the Rye bar bet which is rates in the developed world outside the US or Zero to negative and the disc the demographics are supporting that idea, right and Finally, we also have I think the probably the biggest thing although not it's certainly not the only thing is we have this trade war which is essentially the crystallization of a long term structural bet by the world on globalization 2016 we had brexit in June and then Trump election in November So in my opinion those you should put together because it's finally a group of people who I think have been hurt by globalization Were identify were well in Britain's case? They didn't realize that was going to be the result but in Trump's case, I think he identified that and they barely Elected Trump and he has supported that platform so in my opinion that is the crystallization of a multi-decade process and if you want to see a Really good forecast of this should see on the Charlie Rose show Jimmy Goldsmith in 1994 Campaigning against the GATT treaty saying that all I was going to do was put out of work a huge number of people in developed markets and Despite being a libertarian billionaire, although it was an MP of Europe He accurately forecasted what was going to happen in 1984 and the world went forward in franchise You know e/m labor.

She was very very cheap it did incredible things for e/m, and it ultimately though misled a large group of My guests did say the middle class in the developed world and so 22 years later in 2016 you had brexit and the Trump election and in my opinion that Was the crystallization of and the backlash to globalization The trade war with China is as the next step of that so I look at this as a this has never happened before we've never lived through a Fracturing of the world, I guess since World War two I suppose cold war.

It was a most basically the outcome of you know a Separation a fracture but this is we don't know how serious this is and the market I'd say has consistently underpriced The result of that trade war they keep thinking there's going to be a truce just like the Trump I don't know what Trump exactly thought he was accomplishing at the g20, but nice This is as big a thing as there exists. This is a war. This is a this is a Tipping point of recognition now Trump brought this from his base but now there's bipartisan agreement essentially that the US has to partition China essentially to limit China's power and ambitions How much how many bigger things are there to suddenly occur? So I'd say these things that haven't happened before are Difficult for a group of people or individuals to properly discount into the future yet It's consistent with this demographic this slowing trend this disinflationary trend that you can see if you just look at the 10-year Treasury Over the last 20-30 years this demographic trend You know low birth rates in the developed world And essentially if globalization was good for growth the fracturing of globalization The limiting of globalization has to be bad for growth, right? It has to be unless it's met with with a massive fiscal stimulus I guess which is temporary and inefficient but also do you think the globe their breakdown in globalization is also Deflationary or is it possible to be inflationary? Well terms of its interest on interest rates So right now I think it's deflationary because there's a pulling back By by companies and corporates because they see This their confidence level has dropped tremendously So they're spending their plans to spend I think have been reduced until there's more clarity So I think we're at this point where? Companies are pulling back more and more.

We're seeing it in Copper we're seeing it oil. We're seeing it in how rates are trading We're seeing in the PM eyes of China Peak first than Europe peaked then the u.s. Peaked So the question is when will this be transferred to the consumer which I think it is but it point is I don't know What's going to happen? All I'm saying is this isn't a temporary event This is a structural event born out of last, you know, 20 30 years and finally there was a Identification of a group of people who have been disadvantaged it's now spread around the world, right? So just three years from that some people I just don't see it's going to get put back together.

This this is a Partitioning so it's it's right now. It's deflationary. I Think on a nominal basis, it could be inflationary because of the less efficient means of production and cost etc But in it, I think if that if that's the case, it's bad for real growth You know without some massive fiscal stimulus So in essence I end up with it's deflationary and there's going to have to be some you know much greater policy Actions to support this we've gotten used to in the last ten years We've gotten used to it Congress doing very little and almost nothing after the first two years of Obama administration was done And the Fed doing everything so rates were 0 for 7 years Another thing to think about is the first two years of the Trump administration Is different than the second two years Like Obama had the benefit of the Democrats having both the House and Senate. He passed the healthcare Deal and nothing else really got passed in or did he really try to do a lot for business? Trump's first two years Promised to do a lot of things and I think the animal spirits lift in the US Was was there he also accomplished the tax cut which was pretty pretty stimulative So I think the first years of Trump with the Republicans having House and Senate he got something significantly, you know Done for for for Americans and corporates and there was stimulus and there was burst of enthusiasm But now the second two years The Republicans don't control you know the house and There's a huge backlash.

There's a huge separation as we see that I think it's gonna last for 10-15 years between liberals and and and Conservatives but really it's these it was globalist and you know the backlash Trump supporters, but even that has become I think there's a basic agreement that we have to limit China So what I'm left with is for these two years these last two years of Trump. He doesn't have the power to To make things happen the way they did the first two years and we're gonna suffer from the year of your comparisons From those first two years plus we have the outcome of the trade war Plus the all the liquidity that was put into the market in 2016 after a very bad 2015 by Europe and Japan everything That all that everything rose up and now it's been falling as by the p.m ice in China was the first one to peak then Europe as a quarter later, and then the US so I feel like it's kind of like looking at a patient if you're a doctor like If you if you only want to see the good parts, you know, you could say this person is really healthy But if you actually looked at the full patient, you could see a lot of problems and want to prescribe Somehow the Fed, you know the Fed only changed their mind and when the SP fell 20% and If you look at the SP you're being misled as to the health of this patient in a way I could say it's just capital accumulating to the best company's strongest companies in the world the most liquid situation but many of the things in the world are Showing, you know poor health and the the gap of rates From the Fed to the rest of the world is really really large and so the the getting down to the trading question You know, other than that fourth quarter, we're equities fell and then have rebounded How do you hide yourself from this trade war being far worse? Bye-bye-bye You know the the distant flourish disinflationary impulse around the world, you know going to levels that people don't expect That's what you have to guard against and so I guess the the point now is what I've seen in Almost 30 years is that is that every ten years when you get to the end of a cycle a long hiking cycle a long growth cycle and We just made it the longest expansion ever I think just this week you have this opportunity or risk of a quick down cycle and I didn't have the training or understanding about how to use fixed income instruments in in 2001 and and in in 2009 I you know in 2001 I was short a lot of bubble equities and the SP went down and I figured out places to be long that ended up being commodities.

That was a great story, you know 708 you know, you know five identified subprime mortgages as the place to hedge my portfolio It didn't start paying off until February go seven and I held it ended through 2010. I held it a long time But this is different. There's an opportunity now that to head yourself through betting on lower rates and it's entirely different than what I knew before and so the point of this is I think There's there's going to be a lot more policy needed and then the Fed governors around the world think in 2015 Which was the the after-effects of the shocks at the end of QE where the dollar rose? 20% end of 14 and 15 that created a lot of problems so I think this this the second to two years of Trump where he can't do a whole lot this trade war now All these things were not you know forecast very well by the market and yet it's it's not to say that there isn't real reasons to be long you know the best tech companies or tech generally that is just the structural long term trend and So if you look at if you just look at that you say there's no need for rate cuts But if you look at copper negative rates around the world China's deteriorating You know p.m.

Is they have a lot of debt. They have a lot of potential issues You know, and I'm worried about these things going way farther faster than the market Expects and so I started looking at it In I started looking at it in October But I didn't have any expertise in this so that's why I reached out to you in January and I came to the conclusion That if rates have to be cut like the last two cycles, there's a good chance they're going to be cut all the way to zero and Because capital had had masked so confidently on a bet on hikes the Fed was saying three the market was saying to Liquidity had priced something that wasn't going to be true.

And so there was a chance to bet against a well-informed American view yet the rest of the world the rest of the commodities had already started peeking So the way I look at liquidity, the first peak was Bitcoin in December of 17 That was a global phenomenon and obviously not as liquid But that was a that was a sign like a will clearly peaking the second signal Late, January 18 when eeehm peaked and it was a very steep ramp in January it Peaks I think January 26th. It was exactly when the dollar bottoms the dollar essentially what happened We had the and if Kiwi in middle 14 The dollar went up 20% the Fed never thought this was going to happen In 15 all the commodities whole world went down because the dollar rose and then they come in lawless liquidity They they make things rise, but then brexit happens Trump gets elected and suddenly we're in a different You know real environment where voters are calling shots and the Trump election for seven weeks propelled rates high believing there was going to be a lot of action and After seven weeks it peaked and then the dollar fell all during 2017 And the dot the dollar falling means that that that asset prices are likely to go up So 2017 was a great year for assets and Trump really couldn't do much in the first year There's hard to get a lot done in the first year It was January 2018 the dollar bottom DM topped and e/m started falling.

Of course the S&P fell down, too But then it kept rallying So in August of 2018 small caps in the US stopped and then in the very beginning of October Right after commentary by the Fed that they're a long way from neutral the S&P and Nasdaq topped and you had this big correction That's what made the Fed You know change the their policy course but but since then they've been very reluctant to Believe that they're too tight yet. All these fringe asset classes are showing you that look that we're past that point of liquidity so so anyway the what I like about this trade is That we're not betting on unlike where will traders mark gold in a year? We're not saying where will the multiple of SP earnings be? We're not saying, you know, even where will the tenure trade you know? What I like about betting on With euro dollars and betting on fed futures is that we're we're betting on where the actual policy rate is going to settle It's really it's like betting on the earnings like nailing the earnings of an equity But but not having to worry about the multiple, right? it's it's really for someone who's done equities and particularly shorting equities when you know bad things if you have Of guidance, you're you know, you're screwed.

So anyway, that's it's talked a long time but the but the point is we're in this really interesting situation where the world has been fooled in a way that were Normalization is ahead And yet the structural reality of brexit and Trump and a recognition around the world is and and then now this trade war Oh, no, the world is now structurally different it's gone to globalization gone too far hurt too many people and now that backlash I think is a is a long term thing and China is is a Bipartisan now recognition of this so I don't see how we have any kind of you know real Hope of a move back up and to the right yet policymakers seem to think there is this chance which is why they're so reluctant to Acknowledge that they've been too tight so You know anyway that that gets to this trade and and I've learned I've been able to focus a lot of time to learn Eurodollars trade how calls are priced and I've come to the conclusion that Betting in this situation once every ten years get the end of a cycle betting on owning calls particularly with this leverage on a lower rate is Far far superior to any other way to head yourself It's far better than owning out of the money puts it's far better than being, you know owning calls in gold It's really a compelling thing.

So that's that's where it took me a while to get to that point I wish I had known this, you know in Oh 708. I wish I'd known this you know 2000 2001 I mean rates fell 500 basis points in those two we only have 230 but 7 basis points to go to 0 well This is a very interesting like because what I hear from you're talking one of the most interesting Threads that you're repeating about how you like how you trade markets to bet on things that have never happened? before how you're looking for those structural shifts and actually willing to put your money on it and It there might be a little different between my approach in your approach to that because that's a very much of your marquee approach Yeah, my tendencies to bet on historical patterns repeating.

Mm-hmm So I like to bet on things that happen before and kind of ignore things that I don't understand so To your point. I Also traded all those cycles and I started an interest rate trader. So I've had Advantage on stumble on the concept or whatever discover independently If you wish the concept risk parrot of risk parity in 2002 and the idea of using interest rate Instruments as a hedge to equity position. So for me, this is a well played scenario. I'm just playing the scenario I played many times over and over as opposed to doing something new What I find is interesting is your strong view on impact of trade wars and D globalisation whereas I am kind of Finding myself. I don't really know what's gonna happen there so I appreciate the fact that you have strong view and I also find myself and I'm Gonna put it to you again a little worried in terms of if you look at it as a known as a hedge But as a pure baton interest rates going to zero I am still worried about for the fiscal impulse.

I am worried about mmt if Trump loses election, I'm worried about if Trump wins election about Infrastructure deal I am worried about fiscal impulse from china Because chinese does need bipartisan support for fiscal impulse Of course, you can have your view but you always so to me those two things that kind of Create this what's the uncertainty? Let's go through those so we are betting on something sam before which is rates going dropping dramatically Correct, right at the end of a cycle.

So that's that's reassuring it's just that the the Evaluation of that possibility has been so limited. We talked to about ten institutions And it became very apparent Right away that they had no interest for all kinds of reasons number one None of their managers were doing it right so number two It was completely contrary to what they had learned the past few years so they thought why why would we need this and third They no longer thought they really needed a hedge a tail hedge they we've been we've learned since oh nine that We're gonna be taken care of by central bank's like things aren't going to get that bad. They're going to go do something What was funny is that I was basically saying yeah, and that's why they're gonna take race to zero when there's a problem So, you know and you can make 10 X 8 10 X on this and they just weren't interested They just they set aside the possibility. It was a lot. It was really like in 506 when it became when it was it was clear that if home prices do not appreciate for three years The sub-prime the trouble visas were going to zero there was no understanding belief that that prices could actually Not go up.

That's about what the the view was among institutions a few months ago about rates it was just abroad and it was very helpful right to talk to the market and see so we got no interest not even a second meeting and who became Clear. Okay, good. That's fine this is This is and you can see it in the in the in the how people were betting they're betting on rate hikes It was really only to whatever, you know, the Fed meeting this recent fed Meaning that it was ratified for everyone or clear to everyone Oh, the Fed actually is probably gonna cut like they made it clear They don't want to cut you know, because they're looking at the healthy part of the patient not the weak part right now So that with with the the race markets are saying June, you know June is really the meet like between now and next twelve months is when rates are going to go down there's not that much more in between June and in January and around January February of 2021 is the but what's perceive is the bottom of the rate cycle So what's but what they're saying in, you know? I think I think the rates market is saying there's a hundred and five basis points of cuts between now in January 22 2021 I look at this and say They're so little to cut and the Fed speaks openly about this and they've talked about what other things would they need? I think when they realize that the patient really is sicker than they think that they're they're gonna want to cut a lot faster and they also know that they have Less than half as much to cut as they did in the previous two cycles So my belief is they don't know it yet because they're really not very good doctors You know about the global patient and they and they don't understand these things that haven't happened before so well Plus, there's no really negative consequences to them if they don't have it, right My bet is I that the rates markets are problem right within the next year There's there's going to come a conclusion that they have to do a lot more But I don't think whatever 100 basis points is nearly enough to get liquidity back again without some other fiscal impulses so Trump I don't see why until there's a crisis why there's going to be an introduction of big fiscal stimulus because we have two sides that don't want to agree on anything so that would argue for After the election, that would be post You know that B's December 2020 may be January 21 is the right time for the bottom But I think there's a better chance at bottom at zero then what a hundred and thirty three basis points Which is what the market is saying China was a concern because it was China's massive stimulus quiet But massive stimulus at the end of 2015 as well.

It basically got commodity prices up and they and they they levered up again I didn't know whether China would just do this again But they decided not to they decided to try to hold themselves together And actually the trade war is hurting China because essentially they for a couple years now, they've put on hold the export of dollars Right leaving the country. They don't have that many dollars really and I think they're just deciding we're gonna hold things together ease policy Try to restrict dollars so that we we don't weaken the currency a lot I think that's really bad for for a world growth and that's what we're seeing in in copper and oil So I don't think China is like this answer unless they were willing to let their currency Go a lot and I don't know what their calculus is about face, and we're you know You know what in their trade war negotiations where currency fits for them, right? I could I can imagine them wanting to hold this, you know, keep it below seven You know to the dollar it doesn't mean later if it's just there's no policy.

They may decide to you know ease Tremendously and let the currency go and really put pressure right on The US and the rest of the world. I don't know. But anyway, I'm not so worried now because with the the house You know Ruled by the Democrats and we're in the election period Trump cared a lot more about the stock market First, you know a couple years he cares about it But the S&P the most liquid best companies in the world are actually, you know, breaking out to new highs. It's everything else It's not looking that great small caps have rebounded but they're not making new highs Copper you know, he doesn't really care but copper is is at risk of really breaking down Towards early 2016 levels oil just hit the 50 inch and a and has sold off That could be squeezed by OPEC But I think people are still looking up when they should be looking down in the US the rest of the world As you said about negative rates and Europe like they're looking down today the 10 euros under 2 percent the 30 years about two and a half percent and the Fed, you know has rates at two and a half Tuna quarter gnf percent and they think hey, I don't want to cut like this things are okay Right like the market is forcing them the market runs ahead What I've seen in the last couple cycles the market runs ahead and it's the euro dollar market.

That is the liquid Form of this and it's saying you have to cut so we know that you know The the the markets forced Powell to change course very, you know in December but the race markets are doing the same thing at the ESPY is not but the race market and They're gonna cut the question is 25 or 50 basis points My view though is that I don't see anything on the horizon in China and Europe and Japan in e/m Unless the dollar were to really really fall.

I don't see anything to stop this And it doesn't mean there's not health and power and liquidity and the best companies in the world. There are But we're every jobs report. There's the risk that it keeps its undershoots and is showing that the corporate you know risk aversion is showing up in you know in unemployment and And with that rising unemployment you're gonna start seeing right falling consumer spending which is you know, The biggest part of our economy and then it may translate to equities, but you know what? I don't even I'm not even trying to be long US equities or short US equities I I don't know what's gonna happen there my wonder and and an appreciation is that I have identified This is the third time I had a chance to you know play Play this cycle with with euro dollars and I missed the first two times because I didn't understand it Well, it seems like you nailed at this time Halfway through it's always possible to lose money But like at least based on market market, you nailed it, you know I want to ask you just for a second yet stay on stock market because you were talking a couple times mention about this idea of the health and Endurance on the strongest companies and that actually a subject I've been thinking a lot recently but there is a lot of people who are talking about the fact how stock multi-pulse and although all those like various measures of Stock market valuation and mean reverting and soon and everything points towards a very massive correction at some point Now I keep thinking and this is going to your point of looking at something that never happened before if the whole world is going To provoke market world going to professionally zero to negative interest rate environment Then it means that any asset with positive yield whatsoever becomes tremendously valuable in Mississippi or larger if you look at lunch cups Which are ongoing concerns? Yeah, like it's very hard to put Google out of business now right Oh name your choosey or whatever They are determinant but but but yes exactly they have positive earnings.

Yes, right So is this possible that we could have yeah possibly even a recession possibly rate going to zero butter a very significant even from this point a price on the value of Positively yielding ongoing concerns why the multiples cannot go several times up more? Yes So that is that is essentially what I think is happening is the I think what happened with? Is the timing of the rate hike and the comments by pal? You know at the end of September beginning of October that at the end of the year caused a really unexpected Selling right and and it was a signal that things were too tight.

levels oil

But I think that's a very you know, Managers were very vulnerable right because it's a it's every year they get you know They rated for that year and then they move to the next year so I think the timing of all that led to this big correction, it was also you know October tends to be often a month of a Poor month or month of bottoms. But anyway, and that was corrected by his Neutrality, but I think you have to look at the ESPY or large cap. Nasdaq, etc And tech these are the a students in the class, you know Like it's it's if you have a choice of where to put your money And to protect yourself you'd rather bet on the most liquid best governed best companies in the world So I'd say I don't know where it's going to trade I can make a case for up or down but But I'd say that the US credit markets are very illiquid now corporate credit They've traded way better than I think they should The Treasury markets was were incredibly liquid are predicting real weakness But I think the market does and we forwarded does learn for myself at the end of 2011 because I'm always trying to think what five years from now structurally is going to be very different and I came to inclusion that the way Tech was was was changing and constantly moving forward Not mean reverting was my paw This is and this was the end of the commodity cycle that I'd played for 10 years my belief Was that human capital the best human capital? the eighth student in the class was actually gaining tremendous value because the cost to start a company or create a you know an Application or whatever was just getting cheaper and cheaper and so I turned my my focus for myself to try to understand I'm not a technologist started investing a lot of startups and early-stage venture and But it was until second quarter of 2013 that the stock market actually took up growth stocks 2012 was it really not a great year for for a cat long/short equity and and and people just didn't want to be long equity 2013 growth stocks finally finally took off to me though.

This is a structural Reality of technology. It's only gonna get cheaper and cheaper to enable, you know the best minds or combination of minds to create something that has value and even greater value because of you know, just because of the ubiquity now of tech in our own lives and in increasingly in In our industries so I could say that multiples in Tekken in a way have never been higher Multiples in the US are very very high you know really maybe the market actually understands like I'm gonna I'm gonna stay I'm saying with my a student that Iam has underperformed the US for eight eight years value has underperform growth for good eight years I don't know when that's ever gonna change like III think this is a structural reality that as as tech only penetrates more and more of our lives gets cheaper and cheaper it in franchises the best in The u.s.

You know Europe's not going to catch up to the u.s. In Technology Japan's not we're partitioning China and China is using technology Actually with the state in a way that we we never have comprehended that's actually a risk for us because they've developed our own ecosystem So I guess I could say that now we're in a very different situation with tech the SP and Nasdaq has become a software company It started as a infrastructure company in the late nineties building the internet, you know and the procyclical Capex phenomenon a freedom for that for the for the country. But now it's a it's actually a it's a it's like low-cost Applications plugging into all that all that infrastructure all that knowledge these ecosystems like I look at this as now structurally the winners win even more and The best human capital round the world will come, you know to the winners and so I developed in 2012 I don't have a very very strong view that San Francisco was a huge real estate was a huge long Tech was a huge long but that's someone that's from someone who not an engineer don't claim to Understand tech better than someone else but structural you made sense and I don't see it mean reverting I I don't I don't see how that's going to mean revert and it led me to actually be negative on am From about 2013 on and I don't think I'm ever gonna want to get long The D students in the class the C and D students in the class I don't see that ever gonna catch up Chinese Internet is different They're gonna there has to win that is winning China, but the state is essentially you know commandeered that and so I think we're in a situation where all industries are now becoming you know tech businesses, I mean they're integrating tech and the demand for the agreement in it the legislation of it This is just what it's just one path I don't see how it means reverts So I can make a case that the SMP just goes to new highs it pays a dividend, you know They're liquid.

Once we get through this recession. There's enough policy. You know, that's where you're gonna want to be Anyway, I just by looking at the rest of the class and and their poor health I'm believing that the Fed is eventually going to recognize this because corporates are global players now, you know They weren't really ten years ago. Now they are the trade war is a huge event and We see slowing in commodities. We see negative rates around the world There's a limited, you know number of policy responses that can happen until we get after the election I believe in the United States So I think the course is to lower rates and very aggressively but we need the Fed We need people need to bet against the Fed finally and win You couldn't do that since the crisis you had to go with the Fed You know that was the only way to win was go with the Fed now you have to change in bet against the Fed to Win because they're not very good analysts They're not very good doctors and I think they're going to realize oh my gosh We have to cut and the ESPE is not the the symptom here to follow It's all these other things.

Well, that gives me a segue to what I wanted to talk about Final section because first of all, I want to recognize that it appears like what you're talking I think you are in some whatever kind of contrarian minority of people thinking that in equity markets or like regional markets think I'm not going to mean the world because I hear so many people saying that how value has to eventually mean the worth with growth how emerging markets have to mean revert with US Markets how small caps and large caps have them in the world and it is interesting? Okay your perspective that you have a very strong opinion that it's not gonna mean revert, which means that For listeners for investors. It's very few variants It doesn't yeah And they may have to get in and continue on a trend which is already very mature might continue and that goes better trade We're discussing because as you mentioned earlier in the talk, how like last year or even earlier this year? Nobody was thinking about betting on rates falling.

I had a similar experience not even as a hedge Yeah, even as a they couldn't they couldn't put it together Yeah, it was like the financial crisis like I was like hey These subprime mortgages are worth zero and they're 30 times leveraged That means there's probably a real problem in the wall street people just never had They couldn't they couldn't imagine it Yeah People cannot trade on anything people can never trade on a pattern which is not happening right now And it was I had a similar experience of 2018 I called my bank coverage and asked to price some floors floors again for listeners. That's a bet on options bet on a falling Falling interest rates and they sent what interesting you're asking for flows. Everyone is asking us for cops We have no floors and floors I was like, yeah I won like hundred basis points out of the money floors and they were like totally dumbfounded. They wanted to ask about that Okay, John's asking for caps, so that was good, but it was Good to have that insight and that conviction at the end of 2018 at the beginning of 2019 Now this conviction already had run quite a bit The trend is on if you were mentioning that you kind of want to focus on the mid 2020 as their interest rate pads now implied LIBOR rate, which is the rate which London interbank offered rate Which is basically driven by the Fed policy at the height of their interest rate hiking craze.

Possibly. It was like three thirty during that time and now it's fallen as low as one-and-a-half percent on that sector So we already run more than assuming that zero is the final destination and it's even not quite zero We're on quite a bit of that. Yes Road if you and you you using options so you could buy call four five six and we could choose your own pick your own Poison what calls what strikes like I can go through some of them.

Yeah, maybe give an example and and see like where they've gone Where they were where they are now and where they might be going sure in your opinion So I have to refer to this sheet. So the question is You know, what's the payoff for you know for various levels, I mean when you're This is this is a this is kind of like betting on a bankruptcy right? It's kind of like betting on Enron You know where it was one of the biggest companies or AIG or whatever you could say It's like betting on Tesla right now Like when a company's got 30 or 40 billion dollars It's hard to imagine it going to zero right even though the debt and Tesla trades I don't know probably in the 80 75 80 cent range the question is for me is is what is the risk how much risk for what kind of multiple and so we've been we've been focused on like 20 20 25 delta calls we've so because the belief is Hey, if this company's gonna you know miss its earnings dramatically and its really levered It's gonna go to zero right the markets eventually gonna realize and take it down fast So I think it's kind of like that.

The economy is not growing at the rate That the Fed thinks that the rest of the world is pulling this down the future Perspective on the trade war and other things is shifting negatively and you have that that risk of downdraft Which is just validating where Treasuries are trading So the question is, you know, when you it's only so often that you can you know confidently find Multiples appreciation, you know? Long something is where you can get multiples, but it's hard. It's hard in a Deteriorating global economy to find that kind of thing I mean if you have this, you know outlier bet, you know, hey This company is not going to miss its earnings The leverage is going to overwhelm the equity and it's gonna have to be you know gonna get price to zero There are bets in fixed income that you can make that hedges out Whatever risk you have on the long side, you know that that would be potentially collateral damage to me You know with those payouts relative to the likelihood, it's funny people kind of agree like if things are bad, they're probably gonna go to zero fast, but they seem to monitor things by you know, Whatever they look at every day like the SMP Like yeah, it's not happening cuz hey these things aren't going down but I don't know anything else that could possibly protect you better than Things yes.

It's just getting to that tipping point of recognition what with a market I guess is probably looking for is the Fed to Now to show we have a whole month, you know the end of this end of July before the Fed actually reaches his verdict and I think the Fed doesn't want to do this. They don't want to be wrong They they don't want to have to go through this They don't want maybe they don't want to have to encounter going back to extreme policies But they do talk about it. And if they do have to do that, I think they're gonna go to zero pretty fast in fact that that would be the choice, right they get there as fast as possible and then discuss, you know negative rates or some other, you know rate targeting or whatever, so So it's one of those things like they either Do have to do this stuff or they don't and if they do, I think they go to zero which case the betting on zero scenario you can make real serious returns and obviously the sooner It happens the better the rates market generally is saying most of the rate cuts are gonna happen by June in the next year But I think they're the ending rate is way too low they're not enough people believe this although it's only been the last couple months that the Exposure to euro dollars is positive.

There was really no reason to believe in lower rates in a hikes hiking cycle, right and It was only until the middle of last year right people are believed in higher rates so this is a huge shift in forward expectations as Evidence by rates markets and the question is is it going to go all the way to zero or not? And if you remember two thousand or two thousand seven or eight you just don't say oh, yeah. It's at zero No, it's like a day by day month by month Valuation process until you get to a bottom and usually the bottom is wave, you know farther than anyone expected I remember in 2008 There was one strategist on Wall Street one who thought we were in a in a terrible scenario one It was David berg of maryland America, he he predicted the espy earnings were going to be about half of what the the average was it was really interesting that that there was a strategist who thought that Until the fed until the fed just declared that they're likely to cut Goldman sachs was saying there was a they believed in hikes They totally didn't believe any of this for whatever reason and there were a few other banks who totally disagreed The fed has now made it clear.

There's a likelihood but there's still a big fight and struggle against this concept So only a trade I was just kind of thinking over there like buying those calls in You're a dollar futures making this long shot bad It's a little bit like if you think of investing like at Google or Amazon at IPO Yes, if you thought several months ago You could invest in those things at IPO and you could already make five or six times your money, right? And now we're at the juncture where? We many investors might be turned off by the fact like oh We already missed hundred eighty various points of the most that's normal.

That's normal behavior. Right? I missed it. Yeah, we missed it But as you mentioned in 2002 you could have very easily said like I miss 200 basis points of the move but there was another 250 to come yes in 2008 the same thing and also would have more information coming in and if you were always like all the trading wisdom says that Yes, most money is made not of the picking the bottoms like going with its middle cycle as the trends established So as your feeling is that that's how investors should be looking at it that you have right now established trend With very high probability takes raise to 0 and people shouldn't look back at when they should have would have done something Regardless where they have position or not.

This is a good flow, right? Yes So I'm not an expert but I've been focusing on this for the last nine months and six months particularly in in the Eurodollar calls and I Am long a number of other markets and things I'm not choosing to be law I'm one a lot of private, you know companies, but I'm not choosing to be long Nasdaq in the SP. I think the multiples are high and there's vulnerability But what turn what started as a hedge is now the trade which was kind of like subprime. I did subprime to protect Because I thought to protect my eeehm and commodity lungs. I thought were very vulnerable to a shock and that became the dominant trade I'm seeing this as the dominant trade and it's it's been Reassuring and reinforcing that people aren't positioned for this. They're now positive So now fun hedge funds etcetera are now positive, but Raul has told me Please and he I trust his view of Canvassing the street that almost nobody has had the trade on that's reassuring to me right because if this is real they're gonna have to the trade on so it's just on positive in terms of exposure and Everyone who was short maybe they believed in inflation.

Maybe they believed in Growth because of policies maybe they believed in who knows they've lost a lot of money now Right, they they're being forced to cover. Its you could also say it's like, you know a stock that there's a heavy short interest and I think of like snapchat where it's like, oh, no, it's gonna it was it was like promising and then it goes down Tremendously and but it's gonna get wiped out and then they changed a few things and suddenly, you know People cover their short and now suddenly it's like triples. We're in this kind of dynamic where people having to realize it wrong They're forced out of it. They're forced into it. And now the Fed has validated Yes, there's so it's easier less controversial to put the trade on I I do worry, of course what could what could change this but when the Fed talks about You know an insurance cut like like 98 Like we're in an entirely different situation than you know that capex cycle you know in the US and the build out of the internet and where we were in the world and you know, it's just Demographically completely different than where we are now.

So I think there's still this opportunity and So, you know I now actually evaluate like I'd rather put money in this trade then almost anything else and the question is how much of Portfolio should have should one have in this trade and I'm waiting for I think that I think that there's a chance we go sideways Into the Fed meeting waiting getting data, etc because we're way above the 50-day moving average now if I've I've looked back the last five six years and often the Eurodollar moves sort of hug they go up and they hug the 50-day cycle until they they break. It's a pretty steep It's a pretty steep chart if you just look at the chart You'd say I want to be along that, you know, that's security like every time it drops. It's it recovers very quickly So my biggest concern is that okay now it's been the news is out Fed is going to cut Question is how much how fast and I think the risk is we go sideways For a while which we decay at about three basis points a month, but I'm trying to make you know hundreds of basis points So I think this is a pretty good trade-off We're gonna get more information and I also know that I can fit it to what my wrists are you know, I believe my wrists are in the long side and but What's happened is it's expanded right is expanded a lot.

And now I'm I have okay, so some money it tastes great It's like this coin you make it a lot of your authority. That's at least 20% of yeah, pretty much I'm very sure that our understanding of this trade will be radically different at the end of the year There is now there's gonna be so much news so much more data it's either gonna be confirming and they're they're gonna totally reevaluate their policies or there's gonna be some reason, you know again, It could be the dollar.

I think we should talk about the dollar the dollar sold off in June, right? When it became clear to the market ahead of the Fed that they are gonna cut So this is after a pretty long build-up. It's not a new highs but the question is do you think the dollar is gonna keep going or is it going to now recover because in a Contracting liquidity environment, it should recover So but if the DA for some reason was going to drop that would help, you know global quiddity I do not believe there's a much of a chance of Trump and in China Fixing things I think we're past that I think there's too much agreement like this, you know Yesterday, you know Rubio Said no.

No way is a sentinel our Huawei You know Agreement so I don't see how that's gonna kind of gonna happen So let's talk about the dollar like well That's a long conversation it almost I almost feel like a dollar dessert will deserve like a whole separate review But I do agree with you that dollar is at the heart of things if anything mighty this is that the whole reason while rates have to be cut is not so much because of any kind of Catastrophic situation the US economy, but because if the dollar if you don't cut rates there will be no stopping Catastrophic dollar rally verses currencies which have negative yield? Yes, because dollar and euro have relatively same inflation rates You cannot have real rates different by 3 percent forever.

It'll just blow up the whole global financial system You cannot forever do it because it's not sustainable rates have to contract to like a reasonable range and that's something you all loaded to so I totally Subscribe to this when I see the dollar rally I'm like this trade is gonna work really her great trade is gonna work incredibly Well and in June we had it we had the SP rally a lot and we had the darf all gold went up a lot but to The last few days we've seen the dollar actually today the dollar rallied strongly. We saw copper fall strongly We saw the oil fall strongly. So I think we're At the midst of a recovery a bottoming of the dollar and when it starts moving up, I think accelerates this trade Well, I agree with your dollar view But my last question I want to say like what I want to talk about in conclusion you mentioned that what you can kind of both view this as a trade and you could view it as part of a larger portfolio and portfolio construction as a whole again subject for a whole weather interview You could also talk about gold and how gold plays out on this because that's a whole other subject I do wonder like let's say this is true.

Right? Let's say within the next six months. It's very clear They're going to zero and we know in in rate cuts They they cut every month, right? They don't like wait a quarter cut way to court. That's kind of what the markets saying They're gonna wait a quarter are gonna cut wait a quarter than a cut no I think they're gonna have to cut really fast and even maybe it could be a hundred basis points You know when they realize who knows? But the point is once they get down to zero the question is what do you do next? Right and Gold the question of gold and I've been involving gold for a while time for 15 years The quality of the management's and the miners in the business is likely is not great.

It's really it's really lousy And it's been an 8-year bear market, you know, most commodities have been terrible But I do can imagine that once that happens that what's left for them to do and what's left for them to do particularly because politicians now Particularly on the left think it's okay to like forgive a trillion dollars of student debt or to pile on Like right deficits because the Treasury market doesn't seem to mind so it is it is gold and other inflationary Benefiting assets may have a really big move later after we get through the cycle. We just don't know what actions are gonna play But right now I think the play is that on on where the Fed Funds settles is the trade is your best hedge and And later, we'll see where we go And so the last question when you're like eight a portion of your portfolio to this trade You obviously like you laid out your arguments But we both know that sometimes things don't flare out the way we think are you prepared to say if I'm wrong? This is just gonna go to zero this whole thing is is gonna wipe out of course.

I don't want to like it's delicate I don't ask you about your exact portfolio management. That's your other kind of private internal strategy But in your mentally are you preparing to say I'm making this bad. I'm trying to make five times X a mediocre scenario I'll make two times X but I'm prepared to wipe this money to zero and go on with my other trades and live to fight another day Is that your mentality or do you thinking that you will somehow? Manage out of this trade without losing a hundred percent of premium. Well the good thing is that there's virtually no chance they're gonna hike now, right right, so it's not like it's not like There's gonna be some spike in demand in the world that we don't see coming like a legislative And we're in this second two years of the Trump The we're in a pre-election cycle period where they disagree it's gonna be hard for them to agree to do that stuff so question is would I let this go to over a year we'll probably not I would probably not but it would also mean that a lot of things have happened a recovery in The isn and manufacturing and corporates and you know, it's just that would have to happen So no I'm not I'm not willing to do that or I Would just size it to where I would be a lot would be you know, okay with that What's interesting is is that I always thought that you know equity people we're willing to take more risk You know played for bigger stakes and fixed income people were the opposite right? They're going to be conserved or bond market people Conservative and that you attracted a different, you know kind of kind of personality So what I've talked to people who just do fixed income about this or institutions say, oh, yeah.

I've got that trade on I'm like, what is it trade? Oh, well, I'm long, you know ten years. I'm long five years I'm long two years. And then the question is well, how levered up are you? You know, how confident is bent? Usually they're they were talking about Okay getting a 20% or 30% return in a really good scenario and I'm talking about like getting a you know a 10x return in a scenario and so in in a way I'm like bringing a like a risk seeking mindset to this trade for a lot of people who don't you know aren't used to having this maybe optionality or Aren't seeking this kind of risk. I now believe I now can understand why Druckenmiller could have made so much money, you know in these times right a risk seeking mentality in an incredibly liquid Leverageable, you know area I get it. I get that now and if I had to do my career differently I would have been trained about rates On the sell side earlier in my career.

So I kind of I could have made this part of it as I've Socialized this with other macro guys. I've realized they don't they don't have expertise here either. This is not a normal thing so it's actually been a been a recognition of a separation between equity people and in rates people but you kind of needed to have a macro view point to see to see the disease or the lack of health here and why would be applied the US and and so as belatedly I've you know come to recognize this as An inefficiency you might say in the market But I'm I'm playing with an idea that it's worth playing to try to make 5x here in the next year I don't think I can make 5x or even what you know fifty percent in Most most things and I do actually better in a dislocation.

So right now I'm believing That's the path that if I think it's gonna change That it probably gonna be a parent and and I would reduce my risk Okay. Well, thank you very much for taking your time It was great to have you on the real vision great to have you in this office Always a pleasure to have a good conversation about my kids. Thank you very much. All right, great.

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