Political Impact and Final Outlook

skin The unhedge podcast is on the road and we have a live audience. live audience, say hello We have been allowed out of our sad gray audio studios and come here instead to a fancy kind of loft space in New York City for the FT weeekend festival. Behind us is a huge window with a skyline of New York and patches of sky as blue as the Lincoln Memorial Pool was before the Antifa algae turned up Hi I amm Katie Martin. I'm a markets colonnist at the FT in London. I amm joined by Mrter Robert Armstrong. Rob, say Hello. Hello I want to say a special thank you to everyone in the audience for not going to the wine tasting. Yeah, I don't know what it says about us that our colleagues who I previously thought were friends put us for this session alongside the wine tasting session. anyyway, We'll quiz them about that later Luckily, we've got some brains on board. FT readers will be familiar with him. It's Rashia Sharama, who is chair of the Rockefeller International and author of What Went Wong with Capitalism. It's a long book. Rashia, it's so great for you to come and do this. Thanks so much for joining us. Well thanks, Katie Rob's been obsessed with how many people we have in the room. So we've done o. pretty good turnout. Yeah, this is good. So far so good. This is the hard core. So look, this is an opportunity, I think this session to kind of st step back and take the temperature of what is going on in markets, right? It's a mistake to think of markets as people. They don't want to do anything. They just do what they do. They really want to go up, right at the moment. Stock markets really want to go up There's a kind of feeding frenzy vibe in stocks at the moment. There's almost a kind of last days of Rome sort of feeling about stocks you know like that kind of crypto mindset, but it just seems to have settled in across sort of traditional Markets. So like Rashia, you've been bobbing around markets for a long time. How weird is this current environment to you? Well, I'd say it's not that weird because of the fact that we have seen bubbles in the past And this has all the trademarks of one. And if you look at the long history of markets, which I love studying is that The bigger the technological breakthrough, the bigger tends to be the financial bubble which is that because there's so much excitement around that. So The whole idea that bubbles are based on nothing is obviously not true. They're based on something very real. So the real thing is that This is a huge technological breakthrough that we have seen. So the technology is for real every time we see something like this happen for the last three hundred years, you end up seeing a very big financial bubble which accompanies that. Yeah. And the thing about The probleblem for us in markets is that there is no science behind these things, which is that how do you define a bubble? What is a bubble And I think that What you can do, I mean, I've tried to come up with a framework that how do you define a bubble using four O's, which is you typically get overvaluation, get O investment, you get over ownership and you get over leverage. Those are four defining payines T toooo much debt in the market on that last one. Yeah. That's right. But can I just interrupt for a second One thing that is strange or maybe it's not strange about this particular bubble for me is that everybody has been worried about it being a bubble from the very beginning I think so many people in financial markets are like myself in that the two thousand seven, two thousand eight crash was like a formative experience in my life. It one of the major things it's like getet married, have kids two thousand eight buubble. You know, those are the big in my life, right? So can you have a bubble in the classic sense when everybody's like, is this a bubble? Is this a bubble? Is this a bubble? right? Because usually a bubble su something supposed to sneak up on you. But this will be the most predicted one in the history of bubbles, maybe. Maybe I'm wrong. Exactly. I mean, if I can say so, because I looked at all the literature going back to nineteen ninety nine. and what were people saying in nineteen ninety nine as an example? And I'll find you enough evidence there where people were whyed sick that this was a bubble. There's a letter that a whole bunch of economists wrote to the Fed I think this was in March of nineteen ninety nine, telling the Fed that we are in the midst of a bubble and something needs to be done about this. So the whole idea that this you know that The bubble will only be formed when no one talks about it, I think is not entirely true. because and even the other bubbles I've seen, you know the Chinese equity market bubble, Japan in nineteen eighty nine. Now what's true is that the timing is so uncertain And there's only one factor. So I tell people, which is that there know this old line on Wall Street, which is that The fools may be dancing, but the bigger fools are watching Right? So that's exactly how you feel about where we are currently. So I'd reg So you've got your four O's.. But the reality is there isn't a dictionary definition of a bubble, but it's a bit like pornography, right? I know it when I see it. And when you've got this situation where Elon Musk has listed this Boondogle company that does a bit of AI and a bit of rockets and a bit of satellites for the thick end of two trillion dollars and The financial industry has managed to engineer itself so that that gets hooked directly into the central nervous system of passive investment, right? of really easy investment flows And then within a couple of weeks of listing, He's already doing acquisitions and talking about issuing twenty billion dollars worth of debt, which looks like it's going to get an investment grade rating, right? which is basically shorthanded markets but this stuff is safe. What k is small This movie we've seen before, this happens in every single bubble, including ninety nine is the most studied one, but Japan in ' eighty nine and you know like the housing bubble in two thousand eight, all these things happen. And these things can keep inflating. And my point is that in three hundred year history of looking at bubbles, there's only one factor which deflates a bubble On one Which is what moment silence. Yeah Which is when interest rates go up. Until interest rates go up, the bubble will keep on inflating So that's what, I mean, so you're going to make up your mind as to what do you want to do, which is that And the smart hedge funds, they're all, they're all saying that listen, you know We have to play this Yeah it all in but it all Doesn't this make it too easy, though, right? I just sit there until rates start to rise And then when they do, I sell and I've top tip, top ticked it, and now I'm rich. Yeah but you don't know what extent of that rate increase maybe. Back in nineteen ninety, it took one hundred and fif thousand two hundred basis points Like one and a half Yeah, likeike one a half to two percentage point increase in interest rates for that bubble to burst in like Japan, also it took something like that in nineteen eighty nine. This time I think is that because of the amount of the real weakness in this system currently has to do with the finances of the American government. And this is what makes it so difficult because if you look at the past bubbles, all the excesses were built on either the household balance sheet or the corporate balance sheet This time, all the excesses are on the government's balance sheet. The government of America is running a deficit of six percent of GDP in the midst of a massive economic expansion. Yeah. That is unprecedented. That's not happened before. And a away as we haveve discussed in the past, it's a transfer of income going on. away from the Government They're almost giving money to the households and the and the pushing money in tax in the corporate system. And that's what happened even in the first half of this year that why were Why was American consumer able to once again withstand the oil shock, partartly it was because They were getting massive tax refunds And also the corporate sector was benefiting from the bill. the the tax cuts. Tax cuts. Yeah ye. know, so the American government's ability to keep on financing the deficit is incredible That for me is really what I'd say that it's something which really surprised me over the years, it's that that America's ability to finance its deficit and the consequences of that and how it is inflating asset prices and everything, I think that is what it comes down to. Well let me ask you about something. Obviously like the lion's share of what we've seen in stock markets and the predominant reason why they've done so well recently is the AI trade. Anything that's got a whiff of AI about it is doing incredibly well and that's pulling the rest of the markets up with it So there was a story in the FT the other day, which was about how Companies are reining in their use of AI tools and their staff use of AI tools because once they get the bill for these things, they're saying How much So Explain to me the economics of that. How is this monetizable? Because surely if markets are sort of balancing on this very narrow pinhead that is AI, but actually it's very difficult to make any money out of that AI, then surely the rest of what we see in stock markets doesn't make any sense No, but I think what's happening with AI like in all fairness is that the adoption rates and even the monetization have been much quicker compared to past technological adoption, includluding what happened in ninety nine two thousand So it took many years to monetize anything on the net That way the Chges that companies are being able to know take and the adoption rates have been much quicker than past technological revolutions. Gady We got a giveift to the AI phenomenon That it's been much quicker than anything you've seen in the past. Let's take a little step back then. How much should it worry us? and this is something I've written about and have not come to any a very satisfactory conclusion, The market being what they call so narrow that most stocks are doing are having like a flat year. s, everything AI contributing all the gains in our stock markets. And by the way, not just the stock market in America, but across world, Ewhere, it's global. and everything else is kind of flat to down for the year. Is that Is that necessarily unhealthy? Well, I think that Once again, this happens, right? So if you look at the world today, what we have today is what I call a new AI driven world order which is that if you look at the world today and all the countries. You can bucket them into three categories. You have the the winners The followers and the losers. So who are the winners It's clearly America Parts of China.. partarts of Japan. you know, where the leading companies now are all AI based companies Korea Taiwan possibly Israel. So these are and you know what's common in all these countries Tch spending is a share of GDP is very high about, you know, anywhere between threecent to six percent So They're all being rewarded for having created a tech stack then you have what I call the followers. These are countries which don't have too much of great technology of their own, but they're building data centers and other things to feed the ecosystem Malaysia, even Mexico Thailand, Singapore, these countries. And then you have AI losers. Every time there's a technological revolution Europe is always in the AI losers basket, right? So that's what happens. with the only notable exception being the Dutch because of one company. ASML. Yeah,SML. And then there is the rare losers And this is how quickly narratives can flip and this is something we to all keep in mind India, for example, Right? Like this was the big celebrated country to even a couple of years ago on a high. It was the hottest stock market in the world? the hottest mark market in the world, The the only market keeping pace with America. All of a sudden last two years in dollar terms about the worst performing stock market among the major markets in the world, because not only Don't they have any of the AI hardware, which is what like is driving markets today. But they also have industries like IT services, which are seen to be the wrong end of the AI wrecking ball. So Philippines, Indonesia, India, all these markets, noobbody wants to touch them. They're tech outsourcing markets. Tch outsourcing markets. Yeah, yeah. I think that what we have is this AI world order, you know like in the world But once again, I look this point about narrowowness, dispersion, ninety nine, it was even worse R In terms of what happened in the last six months, last nine months, the dispersion, the narrowowness of the markets, what was driving it was even more extreme in some cases. So that's where you have it. yet Bubbles, you know, like feel best like at the end because The NASDAQ the guys you know, in October of nineteen ninety nine Until March of two thousand I was only four years old ye. But I' gonna ask. I can tell you the history. I lived there that it doubled in value in that time period, doubled in value. So that's what happens with these things. And it feels like we're in one of those spikes. It feels like that until interest rates go up, I just don't see this party ending Yeah Regrettably, I was not four years old, but you're still not allowed to whoever lau over there is in trouble is it? So Rob, the other day we did a thing called Ask the experperts on ft dot coma which makes me feel quite awkward because if we're the experts, then we really are in we're a lot of trouble. But people were like asking, okay, I get all that. I get everything you're saying about AI being narrow and about the world being kind of predicated on one trade and how it doesn't matter if you go to South Korea or Japan or where you go, you're still betting on AI. get that this is all a problem. and I get that SpaceX is kind of symptomatic of a broader problem But what am I supposed to do? What am I supposed to buy? And my reply to one of those queries, it's kind of an askk me anythingthing thing, this ask the quote unquotes experts. And I said, lookook, I'm not here to give financial advice And if I did, it would be terrible. But it's still very difficult to come to any conclusion other than Ride this thing for as long as you can by a diversified bucket of stocks Do it passively, do it cheaply, and just sit on it tntill it goes wrong. I mean, it's hard to come to Any of I think you're right. you know, with the proviso, the old cliche, which is not an old cliche in my case, it's reality in my case is that more money is lost Uh getting out before the bubble than is lost in the popping of the bubble And so the worst the worst thing that happened to me in my life as an investor is that I got The two thousand eight crash, just about right. And so I had all my money out of the market and down the market goes And I had the fatal thought that I understood markets as a result. And over the ensuing decade, I set more money on fire thinking that I understood how markets worked than I had saved in the first place by a factor of two or three. right? So you can't Like it's just not a strategy to not participate becausecause then, you know, as Jeremy Grantham likes to point out, you have to make the decision about when to get back in. And you're going to screw that decision up too. Yeah. So I agree with you. You have to be in. We have a you know, we have a genuine expert here, but you do need kind of sleep at night. capital Right? You need cash enough cash in your account where you're not Reading the financial Times in a state of emotional hysteria. If you had all of your money in US stocks and you'd gone into a coma in march twenty twenty five. And you'd missed Liberation Day and you'd missed the war in Iran. and you woke up today You're up about thirty percent. Yeah. happappy days. W What're doing here, worrying about all this stuff. But so Rashir, you spend a good portion of your life, you know advising the rich and powerful on what to do with their money. We are obviously all in this room very rich and very powerful. I can tell just looking at you. Look at them, look at these people What's your advice? Is it the same as mine, which just buy a diversified bucket of stocks and forget about it Well I seem have to be a bit more specific if I can say so that. So in fact, I remember writing this This is why he does what he does I do what I do. You know, So let me just break it down because this is a question I get like all the time, which is that if you look at the world today, there are about eight thousand stocks which are listed in the public equity markets, which are what I call investable. I define investable as companies with a market capit of more than a billion dollars, a market value and and somewhat reasonable trading volume. There about eight thousand such stocks out there There is something which is defined as quality And quality is a factor, which is that's you know, like they're about twve hundred such stocks in the world today, which are defined as quality. What is quality exactly? These are definitions which are used by all these indDCs. These are companies which consistently produce very high returns on equity capital have very low leverage, steady earnings, relatively low volatility Boring stocks. Boring Can we call them boring stocks? But you call them boring, but in terms of steady edies over time. Yeah. Yeah. And so of the eight thousand You narrow it down the quality and you get about twelve hundred such stocks in the world today Then you know, what I ended up doing was that let's look at the cheapest of these stocks, these of these, you know, a lot of stocks because you' paying the least for their profit for them. Because if you look at what's happened historically is that in the last twelve months, because of this market we haveve been in, These quality stocks in general have underperformed or done much worse in the market than possibly ever Right Because so many unprofitable, the space ses, etcetera are doing so well. So these companies have all been ignored And they have done very poorly. Give us a couple of names. Right what's a typical Any. So example, let's look at Europe. It could be a volvo, it can be a shell. You look at emerging markets, it can be a bank in Brazil like ITO, It can be a company like Bartietel in India.. You look at, you know like the US, you know, like out here. bunch of energy materials, other companies, including some industrial companies. So my point is that if you backtested this, What I found was that if you bought quality stocks after they've had such a run of underperformance from like they've had, typically give you a return of about fifteen percent annualized dollar for the next Three to five years So my sort of addvice to people is Figure out how much equity risk you want to play the AI and I have no idea as to how early or late in this. It seems we're in the advanced stages of it, but it may still have some to go figure out how much. And if you want to take any more risk Equity risk in your portfolio, stock risk in your portfolio. buy this basket of stocks because I would do this. I'm putting my money behind this and saying for the next five years, If I'm to get fifteen percent annualized returns in dollar terms, I'm going be very happy with it. The problem with that is that sure, at some point they will start making fifteen percent annualized returns, but in the meantime, they're making n percent annualized returns. And ultimately, we're all humans. And so while we're sitting there reeking in all n percent and thinking, ah, but it's going to be fifteen percent soon We've all got some like eighteen year old nephew somewhere who's like, I just put all of my birthday money in SpaceX and I'm aw every you're the loser. takeake the L. So that's why that doesn't happen, right? is that we're just we're people. And for people like you professional investors There's career risk. Yeah In taking the contrarian trade and saying I want neglected high quality companies. you know not you know you're in a position where you're establisedhing your career and maybe you don't have to worry as much. But for a lot of the professional investors, it's a very risky thing to do proession. No. Like as I said, that first figure out how much you want to put in the AI trade And this is what you put as the hedge Yeah. So you know so to speak. That's what I'm trying to say. So I totally agree with you that to be completely out of it if you're a professional investor' very dangerous. Y. But if you have a three to five year time horizon, And you're like, listen, I don't Understand why Spaceics trading at two trillion and all this other stuff I still want to like I still have to make money, right? becausecause in fixed income you're getting close to zero in terms of real return. bond market. Yeah like in a bond market because it's zero. Well the inflation rate is four percent, R I mean here in America. Yeah. and you have the You know, depending what you buy, but anything up to five years is also four percent. Yeah. So it's close to zero. Like I still want to make some money. I don't want to do it in a way where because what do bubbles do? Because bubbles can go up and then like you can be down eighty, ninety percent. Yeah. You know so I won't be surprised if three years from now, Sace six is down eighty percent. That's entirely feasible. It's happened across the world, loads of time. Yeah, loads of time. Well, So America's a giant bet on AI.. And to a large extent that been fed by the fact that the current president is who he is. and sort of the AI the sort of Silicon Valley types have cozied up to the president, and there's been this massive deregulatory agenda and so on and so forth To what extent is the stock market vulnerable to political change. if we have a democratic president next time around, does a lot of this kind of deflate okay, if I can say so, which is that I know we are all obsessed with Trump and rightly so, you know, given what he does But I just feel that we overestimate Trump Because even like on the stock market, the nature of the stock market and the way it's behaving, It has been pretty much this has been a cycle which has been on since two thousand nine And even under Biden includcing, you know, like the years like twenty twenty three, twenty twenty four It was very similar. So I just feel that that we overestimate politics in general, its impact every time. agree. and the impact of these economic forces like AI and stuff are underestimated. So therefore, as a rule that I have for investing is that let's not talk about Trump. Because he because I think that this may be the ultimate insult for him, but he just doesn't matter as much compared to AI. He would be very unhappy to say that. Yeah. But so you keep optimistically batting away Katie's habitual pessimism here But you are worried about one thing Yeah, which is at some point, the price of money increases enough to crack the bubble and we have a big problem. Yeah. That sounds like what you're really worried about is inflation getting out of control. Inflation or the deficit. Yeah those, I would say those are two sides of the same coin may Lic away, but I'm saying that there is a point that if inflation goes up, the Fed doesn't increase rates The long end gets un anchored. Yeah, ye yeah. you know, So its like I keep saying that yeah, and we haveve done some analysis, you know As you all know, that there is no science behind these things. This is art ten year, for example, the ten year yield on government bonds in the U.S were to go up above five percent. That's not as loud a bell as you're going to hear that this is coming to an end. Yeah, It's a terrifying number. but ye it's about In your view of bubbles, it's about inflation getting out of control or inflation starting get out of control. The Fed doesn't respond and the bond market does the work of inflation. Interest rates. I mean three hundred years of bubble history for whatever I can come down to, one factor. C come to me today. What do you think about these massive IP's which are happening? Isn't this sign of froth? What do you think of hedge fund leverage? What do you think of this? What do you think of that? I said we have tested all this None of this really works in explaining But you get me like an interest rate increase of even fifty basis points about half a percent given the amount you have in the system today, and that'll bring this down. Okay, counter example, we had a massive increase in interest rates in twenty twenty one, twenty twenty two. We had the market come down a little bit and then it bounced merrily right back. Is that is not a counterxple to you? No. So firstly, the market did go down twenty percent. Yeah Yeah, yeah, you got to be aar market. But here's the big thing, which is what I think Two things happen which help this one the amount of fiscal stimulus which came on came the other way. Yeah, came the other way. So second two levers in opposite direction. On one hand, like interest rates You jack them up. On the other hand, you keep on spending. and this under Biden as well, right? whichich is that they kept on spending, spending, spending. I mean just to put it like in perspective that America used to run a budget deficit. of three percent of GDP last decade, now it is six percent is the new normal. and that came to be after the pandemic. So that offset it. So that's my point, Robt. it's sort of offset it in terms of it But at this stage, you don't have that room And in fact, The feedback mechanism can easily go the other way. that let's say that America has a downturn Every time America has a downturn, the deficit goes up by four percentage points So we're looking at a nine percent to ten percent deficit of GDP. this time if America has a down. U it already spends more on servicing its debts than on defense on defense. Yeah, that's one statistic which is out there. You can cut this in many ways, but I'm saying so that is the real risk. If somethingomet happens to interest rates, then the feedback mechanism, the feedback loop goes the other way twice as fast. We do a thing on the unheded podcast where at the end We go long short We go long, a thing we love or S short a thing we hate. So in the time that we have remaining, what are we saying? Rob You know, I've been giving a lot to the thought to the financial world as we find it. The numbers are what they are, which is why today I'm going short sharks. ocean swimmer And there was a terrifying article in the Wall Street Journal this week about the incursion of sharks ono the East coast. So however strapped our government is, it needs to do something about the sharks, Katie. And I'm short sharks. Short sharks. Rashir. I'ming short. what are you saying? Well, I'm just going to stick to the theme that I've said today because I get it all the time, which is that buy this basket of quality stocks and just Don't worry about when this AI bubble will burst.ill it Is it a bubble or not It's agnostic to that So, you know, just do that. And you know, just go and, you know, for the next three to five years you know, just be contontent with that, but of course deal with FOO If your you know, your mother in law or your daughter in law, they're coming and saying, we are like up this much on On SpaceX. Yeah, ye I'm going to be long June Normally whenever I come to New York, it's either far too hot or far too cold This is delightful It not bad. This is okay. Maybe you're write about this city. Maybe it's alright. So I'm gonna to be long of this. Rashia, thank you for sharing your brain. Rob, thank you for sharing what's left of your brain. Audience, thank you so much for being here.