Christian Mueller-Glissmann on Bonds, AI CapEx, and 60/40 | U Got Options with Cem Karsan

Welcome back to You Got Options from the SIBO floor brought to you by Top Traders Unplugged and Kaiwa. Today we get to talk to Christian Mueller Glyman from Goldman Sachs. Incredible wide ranging conversation dealing with everything from are we in a bubble? Are the earnings real and sustainable in the market? Do do valuations on a bond basis make sense at this point? What's the role of volatility in a portfolio? And are we likely at this point to need to look at ball a little bit more than we had been in pre previous periods? Lastly, where are we going with the bond market and the speed limit of 6040? Is this a time to be watchful and prepared for debasement? I think you're going to really enjoy this one. [music] The game gang gang [music] [music] >> Welcome to another episode of You Got Options here at the SIBO floor. Today I get Christian Mueller Glistman from Goldman Sachs. He's the head of asset allocation research there. Uh we have talked once before quite quite a while ago. Incredible conversation last time. Can't wait to chat again today. Uh welcome Christian. >> Thanks for having me Cham. Looking forward as well. >> So I want to start out today um with a couple concepts you have uh very recently kind of been talking about which is how the bond market um has really been kind of is becoming the speed limit of uh the equity market. and this concept of broadly kind of innovation versus inflation. There's really this tension between these the bond market and the stock market and what's happening. If you wouldn't mind maybe take us through a little bit of of kind of how you're thinking about this moment we're in in terms of uh growth versus inflation etc. and and I'd love to hear a little bit um kind of about how you see asset allocation at this time in history. >> Yeah, sure. I mean, listen, I think this macro regime that we have since the beginning of the year is very different to what most people expected coming into the year. like at at the beginning of the year like you had unemployment rates that were low, profit margins were high, equity valuations were elevated, policy rates were somewhat high and the best people were hoping for was some type of goldilocks market where you get a bit of inflation relief coupled with maybe some regulatory and and fiscal kind of help from policy makers, but instead you got this enormous AI capex boom that really pushed the business cycle to some extent back into a midcycle acceleration. um like you create this enormous releveraging and and you have to consider that the only thing that didn't look very late cycle at the end of last year was private sector leverage like the private sector didn't look particularly leveraged and and now you get a major releveraging here with the AI capex boom and and this AI capex boom has created this nominal growth acceleration and that already feeds into the bond market because if you get like nominal growth accelerate that usually is good for equities, it's bad for bonds, and equities are usually supported by better earnings growth. And we've seen some of that for sure, even though it's been very narrowly driven, but we've had significant upward revisions to earnings growth. Um, and then obviously on the bond side, you have the issue that often such an acceleration um can drive inflation. And I think this time around, a lot of the inflation has actually maybe not even been driven by the AI capex boom. some of it. Um but but I think the bigger driver of inflation has been the Middle East war. Um so the Middle East war pushing up energy prices has then boosted inflation and now the bond market essentially has to adjust to this new macro regime. Equities have already kind of to some extent reaped some of the benefits because you had the earnings growth really boosting equities but I think the bond market is still trying to find its new equilibrium and as you were saying the risk you're facing is a bit as the earnings tailwinds for equities are kind of moderating a bit because they've been really enormous um for the first half of the year. the rates headwinds are starting to bite a bit and they're starting to weigh on equities a bit especially certain parts of equities and I guess that's the speed limit that you're talking about this the speed of the bond selloff coupled with the fact that the earnings tailwinds have been moderating has meant that equities have have started to consolidate a bit >> so I wanted to unpack this uh two parts of this and kind of separate them well first I want to talk about the innovation part and then I want to get to the bond kind of uh the speed limit part. Um you know Carlile wrote a recent report which you may have kind of read uh which I was came out a couple weeks ago which really uh kind of unpacks the earnings growth and talks about where is it coming from? Is it sustainable? Should we be looking at this as as real earnings growth that's uh sustainable kind of uh real earnings growth and and again I suggest people go read the report but it really uh you know speaks to two parts. One how much of the earnings is being is just asset appreciation that's happening under the hood right that's just a function of anthropic going from 380 billion to two trillion and all these stocks appreciating and then being marked as earnings. That's one. Wow. But two uh they then go into okay because of this boom in and underlying liquidity that's coming into the market specifically narrowly to this part of the market which is then one to one going into capex right how much of that capex is now being depreciated forward how much of it is actual real earnings uh as opposed to kind of the sugar rush I want you to kind of think talk through that how do you think about it again they came out on the side of it's really just a sugar rush that is not sustainable I'd like to hear your thoughts if you believe that so much of it gets painted as uh AI is causing all of these productivity gains that are driving this earnings boom right that's really kind of what you hear in the media most of the time obviously uh understand that view I use AI day in day out clearly I think it's why the media everybody is so uh enamored with this view that we're in this productivity boom but I'd love to hear your thoughts do you think that's true and if so why and do you have any data that maybe backs that up on your end >> yeah no I think you're right Like the problem about every technology kind of revolution is it goes in phases like the first phase is like the investment phase and we've seen a lot of that I think AI capex um boosting semiconductor and kind of AI capex beneficiary earnings and the problem is you cannot extrapolate the investment phase for too long like uh this this kind of investment phase might be one of the largest and and longest we've seen uh in history with regards to how much it is as a proportion of GDP growth. But but nevertheless the market is already to your point starting to question a bit how much you should extrapolate the type of level of earnings and the type of earnings growth that you've been generating linked to investment. So the second phase is then uh the kind of application phase where the applications really get rolled out and that leads into the adoption phase and the big problem is that often you have this J curve where the actual productivity um uh the productivity growth and the benefits um take a long time. So you have this J curve and I would say that um we are probably still at the early part of the J curve. we need to be honest like um it's it's pretty early in terms of saying that we can really see the productivity benefits in corporate earnings in kind of like uh broader macro measures like of productivity um but but I think there's some early signs I mean you have occasionally like CEOs potentially quantifying cost savings um you obviously have all of us using AI in our work and and in our lives and there's definitely some benefits to it. But I would agree with you, you with regards to the AI boom, you're entering now a phase that's potentially less tangible. Like I think what was really quite nice in the AI capex boom um uh is that it was very earnings driven and it was to some extent quartertoquarter the market could kind of pay for those earnings. Um whereas now I think you're right like you're going a bit away from the earnings linkage. um maybe a bit more towards understanding what applications potential could be in the future. So you have like companies launch applications and then the market needs to make an assessment how successful these applications can be, what revenue, what profit they can bring and also who are the losers and the winners. So like more dispersion to some extent um uh within tech but also within the broader economy. But I think our kind of macro team's forecasts um with regards to u productivity growth benefits in the next decade or so are still material. There's still a lot a lot up for grabs. The challenge is just that in the very near term I would agree with you. We cannot really see it. >> Yeah. And honestly like uh I think people naturally see those earnings numbers and they assume this is kind of some operational earnings growth and it really isn't operational earnings growth. Actually cash flows uh from these hyperscalers is falling out of bet right meanwhile they are the primary contributor to these earnings growth. Right? When you when you look at it, it's almost if you look at a chart of the two, they are uh normally highly correlated, right? You'd imagine cash flow getting kicked off from earnings. And yet the two are could not be more apart. And the amount of debt that is being taken on as you know, and the credit issues that come with it, as you've already highlighted, are very structural and it's hard to look at that. And uh yes, we can gloss over and say, "Yeah, earnings growth makes this these current valuations maybe worthwhile." Um, but it's hard to kind of believe that if you really dig more than kind of, you know, 3 feet under underground. >> Hey everybody, >> I think that's important what you mentioned. >> Is that your view too or do you think we're in a bit of a bubble in that sense? I mean, >> I would say um it's important what you mentioned there in the sense that the market agrees with you. I think most investors we speak to, they're already discounting those earnings quite a bit. And this is important like if you look at the kind of valuations of the semiconductor companies, if you look in general of valuations of the tech complex, they've derated a lot year to date. What you actually will find is the 12 month forward PE ratio um for like the MCR world will have come down 15% or so year to date. So that shows you the market doesn't completely pay for the earnings and the earnings growth and and for the S&P 500 I think when we came into the year 12 month forward PE ratio was 23 times. Now you're at 19 times. So I would agree the market is already um to some extent discounting uh some of these highly cyclical earnings because um you're absolutely right the business models that are generating currently a large amount of the earnings are very cyclical businesses and that's to some extent what you have to be a bit careful with um because just like earnings can go up a lot they can also come down a lot but what I would say though is that some of these um kind of data center construction uh construction and compute contracts, they're quite long date. It's quite unusual. So that's why to some extent you have a bit more visibility than normal and and that's why investors are are to some extent not worried yet. But I agree with you at some point there's two major questions um that you have to ask. How much compute do we need and what's the price for it um based on the capacity and the type of technology advances that we will find. I think as of now um like our team both in the technology um equity research but also all strategists they've been looking at this and they find that because you're going from these um kind of like LLM uh development compute demands like frontier models to applications there's a good chance that the demand for compute in the near term is still going to remain quite high and until that that that really changes it's very difficult to say um uh what the right price for some of those earnings are. We would say we're certainly not in a valuation bubble. We are more likely to be a bit in an earnings bubble, at least in some of these parts of the market. But it's important because a valuation bubble can burst very quickly, whereas an earnings bubble can take a long time to deflate. And that's a bit like um the comfort you can take right now because yes, you're right. The the hyperscalers, their free cash flows negative. They have spent a lot and and over time that capex needs to be depreciated but that depreciation is spread over multiple years and they can at the same time try to obviously make revenue from their investments. And if you look at some very high frequency um indication of um AI monetization like cloud computing and all of these things, they actually starting to to see revenue come in. And this will I think be a key focus for the Q3 earning season that these companies will actually illustrate further how they will start to monetize that capex because if they don't I agree these negative free cash flow yields and these future depreciation um uh kind of headwinds they they need to be reflected further in valuations because profitability will come down. Mat telling you that >> I think um your distinction between an earnings bubble and a valuation bubble is very interesting. I'd like to kind of dig a little bit deeper in that before we get over to bonds here, which is I mean how how is it that you can argue this is an evaluation I'd like you to kind of expound on that a little bit evaluation bubble when we're looking at you know Schiller price to earnings ratios adjusted for bond yields right that are um almost at all-time highs right u especially with the ascent as we talked about with bonds right uh you know the price earnings ratios even year forward right um are increase, but >> like it's hard to argue there's not a valuation bubble, right? It's the second biggest, if not the biggest in history relative to bonds. So, I'd love for you to kind of expound upon why you think it's not a valuation bubble. >> Yeah. So like Schiller PE ratios are using the 10-year rolling earnings average and by extension when earnings significantly shift above the average like they have really in the last 5 years since co they've massively accelerated versus the long run average you start to see this gap between um the the Schiller PE which is like in the 40s and similar to tech bubble levels and like the 12 month forward PE ratio which actually has a bit more weight on the more decent earnings. So now you might say but wait a second that's why we do a shell we do an average to understand what the trend earnings are what what the average earnings are. So, so then it comes down to understanding how much of the recent increase in the last few years of earnings is cyclical relative to how much is structural. And I would say when you look at the return on equity of the S&P 500 right now, you're like at 24 times. Like only 5 years ago, we were still below 20. So some of the profitability of the companies has actually gone up significantly. And that was even before the AI capex boom like the hyperscalers they were actually having return on equity in the 40s even before and the S&P 500 as well. So I would say the key question you got to ask yourself is where corporate profitability will settle in the next few years and and in terms of return on equity and then we can understand um what the right measure of valuation is. But what I would say is um even if the return on equity starts trending down in function of depreciation in function of some maybe disappointing investing uh investments in the in the AI capex like it will probably be a relatively slow process. It will not be like during a tech bubble where you have like really sharp declines in equities. It will be much more specific. There will be winners and there will be losers. And I would say before we actually see more evidence of that, it's not so easy to make that call. And I would say that investors are already having an element of that pessimism. Like no investors we speak to don't worry to some extent about how high Schiller PE are or how much our earnings above uh how much earnings are above trend which is kind of the same phenomenon. No. >> Yeah. Definitely not easy and I hear you. there are uh people are more aware this time around. I would hope that like uh after the you know tech bubble and everything else we've learned a bit and people uh although I the correlary to what you said about the 10ear lag like earnings uh you know acceleration recently and the slower earnings affecting I think you make the same argument on bonds right bonds are at zero for a big part of the last decade right and so the 10-year kind of valuation difference there based on what is maybe normal I think that's easier to predict than whether the earnings themselves are sustainable or Not the other correlary, you know, I'd give to that which I think is an important rebuttal to what you're saying is is that what we've seen in other past bubbles is not that earnings kind of has gotten to this new high and then it just slows down. We see actually mean reversion in earnings dramatically, right? So when when you are we're right now you see about a you know 100redyear 6% real kind of uh you know earnings growth um over u over the long term. um we're now 50% above that uh structurally on a rolling basis. And whenever we see that in history, the mean reversion is not just to the mean. It's well beyond the mean to the other side for the next several 2 3 4 5 years. Um and there's an argument to be made. A lot of this is a sugar rush. It's the capex that's coming in that's pushing earnings. It's not something that I would say is is structurally per se at higher earnings. The other benefit that we've seen the last five years is lower tax rates, right? these these regulatory kind of supply side response has driven a very very kind of if if it stays there forever and then yeah but you're not going to get more of that earnings growth from lower and lower taxes I would argue from this point and if anything with populism where it is those types of things can revert the other way which then becomes sudden headwinds from tailwinds so there's a lot of things that have been structural tailwinds that could very quickly and this is what we have seen historically pendulum swing and then they swing back. It's not like they swing and because they've swung they now have gotten to a high new this time is different higher structural level. Um you know historically we actually see more mean reversion um than we do kind of structural new uh growth booms uh that drive in terms of earnings and we seem structural growth booms in technology like like we saw as the launch of the internet but that translating to a structural earnings higher level of of of earnings I think um is is more debatable. Anyway, uh any any response to that before we move on to bonds? Any other uh thoughts? Yeah, I mean I would say it really comes down to um kind of like recession risk because what you're describing there like the pendulum swings in earnings um have been very much linked to cyclicality and recessions and and I think if you have something specific to the tech sector um I think where it's about depreciation and it's about like um managing the drag from depreciation it could be a bit more gradual. That's what I'm saying. And at the same time, you might actually generate some structural um tailwinds from the new technology. But I'm with you, the phase that we're entering in now is is more difficult because the tailwinds you get from the AI capex for earnings are peaking um because like AI capex is peaking. So the second derivative is to some extent less favorable. Um and and you know these new sources of revenue and earnings are more uncertain like this whole adoption application phase of every technology revolution is more uncertain for all kinds of reasons because there might be overinvestment there might be technological pro progress there might be winners and losers. So I'm with you that the uncertainty is is picking up a bit but I would still say that even before AI came about like Schiller PE were already um a bit elevated. So it tells me um that there was an element of um earnings pickup really in the last uh kind of like 5 years some of it I think has the potential to be more structural. Um it's the the rise of the platform companies, the technology adoption, some of the uh peripheral technologies that have come about in the last few years like cloud computing um and and all of those things. They're highly profitable and they're already up and running. And yes, the free cash flow yield for the hyperscalers is negative right now, but but that's because of the AI capex. if you would take the AI capex out um they would be incredibly profitable and and a lot of this profitability is not linked to cyclical businesses. Um so so I would I would say that the truth is in the middle. Um I I would definitely agree that there is some type of mean reversion in earnings um ahead of us in the coming years. Um but there's some of that earnings um growth that we've seen in the last 5 years that probably will stick. Yeah, makes sense. Um, so I will highlight you said it depends on recession, right? It's on which is itself. Um, I think I want to highlight this. I know you know this, but a lot of viewers may not fully appreciate how much, you know, we used to we still talk about the economy as if it's uh separate from the market. You know, it used to be that markets themselves were a ticker, right? like they were a kind of a a printout of the what was happening in the economy. They were like a reflex like a reflection of of some type of uh real world happening that then uh reflected kind of output. You know most people don't realize how much the roles have really reversed. Markets themselves are arguably the biggest driver of the economy period. um you know we have a 300 give or take you know give or take 50 trillion dollars of equities now in the world between public equities in the US public international private combined all being indicated off of a S&P 500 broad level uh you know when we get a 20% appreciation in the market like we saw in April and May of this year in just two months we went from a 250 give or take trillion dollars to 300 trillion of collateral. Collateral that's not even including all the debt and everything else, right? And so think about that. That is a $50 trillion increase of liquidity. Compare that to the $10 trillion of QE that was done by the Fed in response to CO right which this is something that just happened in two months in April and May. So where is that capex coming from? And this is part of what the Carile report talks about. It's coming from markets going up. Markets go up so you get capex you know and then they report earnings which then is a reflexive reason to the market reflects that as a potential and it's true if the market keeps going up the earnings will continue and then we will internalize them until the market goes down and then the pendulum will swing. And so you're right, it does depend on ultimately this is why it's so hard this reflexive loop of liquidity, >> right? And and what how reliable is that liquidity in markets? >> Yeah. No, I think this you make a great point there and and this is probably more important now than it's been ever in history because if you look at the value of equity holdings for US households as a proportion of their wealth, you're at the highest level ever. you're actually at higher levels than during the tech bubble, during the COVID recovery. And more importantly, the the spread to um to the value of residential real estate as a proportion of net wealth is the widest ever. like every time when you're in the middle of a long equity bull market like in the 50s and 60s in the '9s up until the tech bubble um post the global financial crisis like you tend to get drift where your assets like if you're a household um your assets shift a bit more towards equity because they're just doing really well and that's the wealth effect that you were mentioning there and they get bigger and bigger and and it gets uh to some extent more uh supportive um and and I think we gotten to quite an extreme point which to your point when you get actually a sharp correction in equities. There is probably a negative feedback loop to the economy. there is a negative feedback loop to households and a financial conditions tightening that's to some extent larger you know but the problem you have like in this situation especially in the first instance um you would probably get some central bank response you would probably get um the Fed uh kind of reacting to that and and while we know like once you set things into motion it's not always easy to stabilize things as policy makers but but but I would say that considering the importance of these wealth effects and considering exactly that linkage you were highlighting um there would probably be a bit of a buffer from policy. >> There has to be and you're absolutely right. The market's just gotten too big to fail. So it becomes this uh this loop where we must own equities at higher and higher valuations because they are the driver of the economy which means you have to belong to equities and this becomes a reflexive loop. um you know so so again hard almost impossible to um to call the top of a bubble but almost by definition a bubble is this it is things become very fragile and centered on the equity market itself this is what happened during the tech bubble uh this is because we had 27% earnings growth in 1999 same reasons because of capex right what happened to all of the buildout of all the fiber and everything else well We all know that story, right? And how was earnings growth the next two, three, four, five years? We got the benefits of it. But the the reality is this whole thing markets and the w the reason this is so hard is because the whole thing has become a closed loop. The markets themselves are driving the economy and the economy is uh shows growth when markets are doing incredibly well particularly more and more fragile concentrated into the areas which are getting the appreciation themselves. And so um >> but one thing I would say which is really important to keep in mind when we do these comparisons to the late 1990s is the return on equity right now is more than double than what it was um during the late 1990s. So I think like these valuation comparisons I think they're they're always a bit tricky because like the the the whole build out of tech all the capex at the time coupled with the applications were to some extent much more early stage uh and and and I think the businesses they were all very concentrated and and and in the same kind of arena whereas I I would say like the hyperscalers while it's it's very concentrated as as well. They're like very diversified business models. They they got like a very different kind of stage of of profitability and and a very different stage of operating in terms of balance sheet and and and cash flow generation. But we I think we agree on the risk. There's no doubt about it. I guess where where I would put a bit of a difference is is just like the corporate sector and the economy and and the markets, they don't look as bubbly as as as as it did there. >> Yeah. And I I would argue though the amount of debt which takes us finally to the bond side of the equation that is um that is being taken on right to create that return on capital. you know, it's essentially that leverage that I think I would argue is is maybe um you know, what makes those numbers look a lot better than maybe they did at that period. And so that's something at least pmically to think about. Now, let's switch to the bond side, right? The thing with Schiller is Schiller looks at a 10-year bond level as well. And the reason he does that, uh, you probably didn't think you were going to go hear talk so much about Schiller today, is because quite frankly, bonds work with long and variable lags. Why do they work with long and variable lags? I get this all the time. Why, Jim, you said if bonds go this high that we're going to have eventually a problem in equities? Because it's the speed limit, as you mentioned, to equities, right? But why not yet? >> So, it's pretty simple, right? Like everybody financed at 0% five years ago in 2021 and the average duration of debt is 5 to eight years, right? So nobody cares the the the effect of [clears throat] increasing interest rates doesn't matter fully until the world has to refinance and roll over that debt. And so I would argue and I'd love to hear your thoughts that the bond market um is the reasons we're having the issues in the bond market is not just the straightup hormones. We hear a lot about that and that is true. The inflationary structural effects from that are definitely a major effect. But there are two other major effects. >> I'd say there are three. We could talk about wholesale abandoning of debt from emerging you know the rest of the world but let's put that aside. >> The other two main ones in my opinion is one the rolling over debt large globally as we hit this 5 to 8year window where all of the debt that was taken 0%. Right? Just quite simply, if you took out debt at 1 2% to invest in something that had a 5% uh return per year, now you're refinancing at 7 and a half%. And you either have to liquidate that thing or come back to market and figure out uh how you're going to just hold this debt to manage that hoping that interest rates go lower. This is how why we look at a 10-year, >> you know, yield in in terms of the Schiller index. So, that's one. And then the second one is quite frankly all this debt that I mentioned and the crowding out because it's not just the rollover debt that needs to happen. It's now the dramatic increases of debt that are happening simultaneously that are now looking for financing at exactly the same time. So this is why we have this wave of supply and demand imbalance that even though the administration has done what stable coin act uh you know change the SLR ratios that doing treasury buybacks interventions in the yen that they can't seem to you know the house can't seem to hold things at bay. Um I'd love to hear your thoughts about the bond market. Where do you see it and how do you think anything I've said there that doesn't ring true for you or any other thoughts that you may have? >> No I think I think you had a nice summary there. I think when I think about the world as you know there's always three cycles there's the structural cycle the business cycle and the sentiment cycle and that really impacts all asset markets and and uh there's different drivers here and the structural cycle has just become much less friendly for bonds like you described it innovate I always say the structural cycle is a fight between innovation and inflation so if you have innovation that actually has the potential to boost productivity growth that means longer term real higher real yields but in the near term it has the potential of crowding out the bond market exactly as you said like there's there's obviously investors are happy to hold on to the equities and maybe buy more but there's less demand for bonds and and I think so innovation to some extent structurally is is is already changing a bit um uh the kind of attractiveness of bonds and then you have the inflation which I don't need to go through that um clearly higher inflation volatility and higher inflation isn't great for bonds and it's not easy for central banks to to to have policy as easy as they did before uh the COVID crisis with negative rates and QE all of these things they are they're much more difficult from here and then on top of that you have to consider um fiscal um uh kind of fiscal considerations that GDP ratios concerns so putting it all together the structural cycle has become less friendly for long duration bonds and the market is still trying to find its equilibrium. What is the right level for um a 10-year bond uh in this type of new world? If you look at the 300ear average of the US 10ear yield, it's uh 4.7. Um so if you take out the 70s, it's 4.5. You know, we at 5.3, 5.4. So the question is then this spread, is that correct? um uh compensation for all of what is going on. But then you have to start to go to the business cycle [snorts] like um that's only the structural cycle discussion. The business cycle discussion is very much linked to what we discussed earlier. You're in this nominal growth boom. Um and this nominal growth boom is um kind of pulling some of that capital competition forward and and it's very difficult uh for central banks right now to to step off the pedal with regards to to tightening policy because the concern is always that the longerdated bond yields just unanchor um too quickly and and and you essentially um yeah you you get like negative feedback loops to to equities to the economy. So from that perspective, the business cycle and the sentiment cycle are also currently very difficult to to stabilize the bond market. So to your question now, what's the interaction with equity? And that's the interesting one because to some extent um equity starting to consolidate and maybe get more volatile that that can stabilize bond yields. No. But it can also to some extent bring back the diversification benefits between equities and bonds which have been absent for a long time now. Um and we've been talking about this last time I remember Cham like on 6040 and all of this and and certainly what we were discussing at the time that that certainly came true and I would say that I'm still not in the camp that 6040 portfolios will come back and be what they were before co but you can have a short-term period where maybe the equity bond linkage um becomes a bit more friendly in the sense that um the the the kind of interaction between rising bond yields and equities to me always depends on three factors. The level, the speed and the source of bondier increases. Level you already mentioned um is a moving target. It's a moving target like um it used to be that at 5% you really get worried. Um but then you're not in a world where there's innovation and capital competition, you know, and equities have this underlying earnings tailwind. So you've been going through the 5% and you've been dealing with it at least for now. Um, but I think then the question is if you go above five, do you start to hurt some of the parts of the S&P 500 that don't have those earnings tailwinds? And we actually start to see that a bit underneath the surface like you see small and midcaps have come under pressure. Real estate, home builders, um, uh, rate sensitive parts, um, selective financials. So, so you start to see that to your point um there is damage um like the higher bond yields are causing damage. So, I think levelwise we are definitely getting closer and we we historically we like to look also at the speed. So, usually when bond yields increase over like a 3month window by more than two standard deviations um that's when you start to see indigestion. We we went past that level um at 5.1 5.1 to 5.2 two uh we are more than two standard deviations now over three months and then we come to the source and the source if it's driven by growth rather than inflation and policy equities can deal a bit a bit better with it but I would say that um the kind of growth news flow since the summer has been a bit more muted like I think you've seen macro data especially consumer related data um actually starting to weaken and also the earnings tailwinds as we discussed just before like we didn't have an earning season. Um so so so you didn't get any incremental information and people are to some extent skeptical. Um and and this is why the upcoming earning season is so important. Like if the corporate sector has another quarter where they can convince that the AI capex boom is still going and is also still there's some signs of AI monetization of the spenders as well. Like you need to have like some of the spenders give plans of how they're planning to make revenue. Maybe you will still have that growth source that will make it easier for equities to digest the higher bond yields. But the problem is as you would you you were saying as well the the the drivers so far have been real yields and front-end real yields. So it's a lot linked to policy and that's normally not friendly for equity. Um so so I think you need to really follow through with growth in the next few weeks and months in order to keep equities um uh to to help equities digest these higher bond yields. But the way that earnings growth continues is more and more debt for hyperscalers and meanwhile we're seeing CDS break out. So even if they do >> we do see another >> good quarter, right? How sustainable is this? It's just driven by more and more debt >> which is crowding out the long end of the market. It's a bit of a circle, isn't it? I mean, at the end of the day, you know, to continue the earnings growth, we they need to borrow more, which is going to crowd out the long end of the curve more. This is a death loop, right? At some point that doesn't that's not sustainable. It's just not sustainable. I mean, yes, you can it can continue for quarters, but can it continue for years? I mean you kind of need to the best case you know to happen which is really the innovation like the the benefits of this being adopted and the earnings that are structurally coming out of it that are non-capex related to start booming all of a sudden and that could happen. I'm not dismissing like not saying it's not possible. It's but to to make that your base case which is where we are at this point in terms of market pricing I think is is really hard to do. >> I think I think you're right. um the AI capex tailwinds are definitely being discounted more and and I think that's not really which which can give us the relief or the kind of comfort that we probably need in the coming months to deal with higher rates and and and to generally deal with the uncertainties that we have. So this is why I think this earning season will be really important to understand what are also the exactly as you said the adopters doing. Are you starting to see more announcements from companies in the S&P 500 and globally using AI and having use cases that actually start to illustrate productivity? I mean like our US strategy team, they've done some really interesting work on looking at how much S&P 500 companies are spending currently on AI, like literally spending via subscriptions, etc. on on token use. And it's like I think the statistic was to me sounding much too low but it's 0.1% of goods good goods sold cost of goods sold. So that's very small. So there's a large amount of potential spend from the corporates and they're already using it. It's probably that they are not paying for it fully and and so you need to bridge that gap. um where you start to talk about monetizing AI and if you leave it too long, I agree with you, the risk you're having is that it remains incredibly narrow in terms of the earnings drivers and the market is not willing to pay for that anymore because they know that they it comes with risks. It comes with risks with regards to cyclicality of those earnings and it comes with potentially increasing credit risk in the whole AI ecosystem. Yeah, couldn't agree more. And I'll highlight that CDS are starting to break out as we've seen. We haven't seen in a long time. The move index or in other words, the volatility of bond obviously is starting to break out, but the VIX continues to just, you know, hoham. Nothing nothing to see here. Um, any thoughts? I know you started your career in the derivative space as well that we share that in common here. I'd love to hear your thoughts on volatility. Obviously, I have a few views there, but I'd love to hear your views on volatility. Um, if you see this kind of uh these jaws uh kind of uh coming together now that you're starting to see the move in CDS breakout, what are your thoughts on volatility and and uh maybe not just today, but 3 months, 6 months, nine months forward here? >> Yeah, I think equity volatility is a bit cheap here. Um, no doubt. I think you highlighted it. if you benchmark it to credit spreads to rates volatility to commodity volatility I think it it does look a bit cheap and I think there's multiple convexities that equities can offer you right now I mean part of that is what I mentioned is uh linked to earnings part of it is linked to the applications part of it is linked to reaction to bonds and that creates convexities in both directions so I do think that um currently the wall is a bit cheap why um I think it has a lot to do um with dispersion. I think there's a huge amount of divergence underneath the surface as I mentioned and and the tech space and this is also important is currently harvesting annualized 30% earnings growth. So if you're flat, that actually means you you you're derating by 30% over over a year. And and and when you have such strong earnings growth, um like it's very difficult to generate a lot of downside uh volatility without the earnings growth showing the second derivative decline which we've discussed earlier. So clearly if the earning season uh delivers this catalyst which is not our house view not our baseline view um then there's a lot of downside convexity that that you would potentially generate. Um I think I'm leaning more towards the upside convexity being cheap um into year end and it can be very attractive to to own slightly longerdated calls to to kind of run your equity exposure right now. maybe also longer dated calls um in the tech space because since the summer the tech volatility has really reset um you remember like uh when before the momentum unwind in in the summer you had a lot of the singer stock vaults around the hyperscalers trade very very expensive and I think it seems like since the summer when you had that momentum unwind like these walls have really come down so so I'm leaning in this camp equity wall is cheap um a bit to your point as well with with with a long variable lags or or the linkages to bonds. I think we're definitely building up a wall of worry right now. The wall of worry is linked to the midterms. It's linked to the Middle East war. It's linked to the bond selloff. Um it's linked to maybe some of the things we discussed on the AI uh earnings. But this wall of worry um can essentially be climbed eventually um or it can drive eventually some type of capitulation where the market just says all right that's too much we need to put more risk premium into equities. I'm leaning to the slightly more optimistic side um eventually, but I agree in the very near term um the potential for the negative spillover from rates, the potential for uncertainty on AI. We have like um obviously uh kind of several catalysts uh linked to kind of some of the large companies in the AI space linked to the earnings releases. I think the the potential for the market putting more risk premium in like they do in the credits is is definitely there. I think the point you make about dispersion I just want to for viewers kind of we've had this conversation before but so much uh so many people take kind of the dispersion as the lead kind of like similar to that idea that the economy used to drive the ticker that was the market right similarly here um you know people think oh well different stocks are moving differently that's why volatility is low um I want to be clear index volatility compression which has been happening because of increases in structured products and all of the structural selling of all that happens is pinning the index relative to the constituents which is forcing that dispersion. We know that and I think we can say the word no because if you look at 120 years of history realized uh dispersion of the indexes right is within a very solid band and we've been that includes World War II that includes all kinds of crazy macro events where things structurally move differently because of all kinds of different outcomes. But what we've seen since 2017 is a dramatic increased structure of dispersion. Right. And that higher level of dispersion that and increase almost one to one correlates with the selling of ball at the index level like that's the one thing that you can map against this that that driving this um outcome. Go ahead. But the the interesting question you got to ask there as well is that um is that the causality or is is the causality is it just that those two things move together and there's an underlying fundamental causality and I think the truth is possibly in the middle because the earnings dispersion that we currently have is probably one of the largest on record as well. Like that's that's that's really kind of like one way I find this underlying dispersion argument a bit more fundamentally supplemented is and we discussed this before as well when you look at the proportion of stocks in the S&P 500 that have a negative beta like that's quite remarkable like in the generally a negative beta stock like if you believe in the capital asset pricing model is quite unusual maybe that indicates in the long run that it should have a negative return, you know, um, like quite unusual. And, and nevertheless, if you look over the last 3 months, nearly 40% within the S&P 500, 40% of stocks had a negative beta to the S&P 500. If you look over the last year, it's kind of something like 25 to 20 to 25%. So, that is actually that has never happened. Um, and and and and the last time we saw something similar was during a tech bubble. Um, which is why some of the comparisons we're making here, they're very preient. I mean, they're very much what you want to discuss. But what I want to say is when you look then at these 40% negative beta stocks, who are those companies? Which are those companies? So, it's essentially exactly what we discussed earlier, rate sensitive companies that have suffered from the higher rates but didn't have the earnings tailwinds to actually keep up with the S&P 500. It is kind of like bond proxy type assets. It's low volatility stocks. It's high dividend yield stocks. And and just to be clear, >> I [snorts] would probably say that some of those stocks um they're going to be a fantastic diversifier um later down the road if something goes wrong with AI, but right now it kind of makes sense that they're negatively correlated. And you could also link it to the fundamentals with regards to AI because AI will create a lot of winners and losers and that also fundamentally can drive a bit more dispersion. So now if you have this dispersion, it attracts the index of all sellers and and and and we certainly have seen that with our client base where there's more kind of interest in dispersion carry because to your point um you you kind of realize that incredibly low dispersion. So there's a bit of a chicken and egg problem. Um I I I would say but I would certainly agree with you that it's very unusual what we're seeing in terms of dispersion levels. >> So I want to connect those two things because I think you're absolutely right. And then by no means am I saying that because uh VA is compressed um you know that has caused tech to exclusively go up and other parts of the market to go down. What it does by definition this is ma mathematically so I know you understand this. I'm really talking more to the viewer is that idiosyncratic risk still exists. Like I said, like >> and if you hold something at place that includes everything inside of it and what you're pointing to is that some of that idiosyncratic risk drives uh a positive outcome for something. By definition, the other things have to go down and that's what that negative data is. You are holding this thing at bay, right? And meanwhile uh you have some uh idio idiosyncratic growth some some some growth in part of the market which is driving growth which is forcing everything away from each other. Now next level up from that thesis. So they don't you're right it's chicken or the egg there's multiple different forces that are interacting on this that are forcing this dispersion. But then as that begins to happen momentum effects kick in right all the passive flows everything that everybody else knows about. And the other major momentum factor is the thing we just talked about. If numbers go up, it's more earnings. This is the whole Carlilele thing which then drives more momentum in that name that drives more dispersion. >> Wow. >> But at the end of the day, the compression at the VA level is structural and critical to this allocation and this breakdown underneath the hood. It forces momentum. Uh it forces uh also dramatically different outcomes for different parts of the market. So it concentrates the gains in part of the market which then drives more capex than ever. So these things are interacting in a very very um uh you know in a way that drives extreme outcomes. >> Yeah. >> Right. And those extreme outcomes is is why I call it a bubble really. It's at the end of the day it is dependent on everything maintaining this this direction. But the the reality is those things work in the opposite direction just as strongly. And all it takes is the right a bit of idiosyncratic other side and then all of a sudden there's a long you're you're a long way from Kansas as we say here in the US. So um >> you know this is the what makes it so challenging in a bubble you you can be in a bubble for years. Markets can stay irrational longer than you can say solvent. That doesn't mean you're not in a bubble. We talked about the tech bubble in 98. We were all talking about it. You know, we were talking about the housing bubble in 2005, 2006. Everybody knew about it. It just didn't pop for years. Uh and the popping itself, you it's d it's unsustainable is the point. And and that uh and it's overdone. Now, can it continue? Sure. A, you know, it it can continue. uh but it doesn't mean you're not in in where you are which is in this uh structurally forced outcome that is driving more extreme and more extreme kind of historic as you highlighted kind of outcomes the markets >> but I I I think like you make a good point there I think we all know that we're in a boom and a boom at some point comes to an end I wouldn't call it a bubble as I said let's say a boom for now and I think the the most important thing to keep in mind is that timing the peak of a bull market is incredibly difficult. That was very difficult as you were saying also in the late 1990s. If you were talking about the bubble in the late 1990s and 98, you were two years too early and and I think you would have let a lot of money lie on the table and and possibly uh depending on your institutional or your personal investing setup that could have been very painful. So I think what is the best approach right now is to prepare your portfolio and to in introduce risk management and introduce um kind of uh kind of ways to to to deal with um uh kind of shocks and to deal with potentially more volatility. So one thing you mentioned there which I thought was a very nice explanation of of not only the problem but also the solution. you have like one part of the equity market that's pushing higher and higher and another one that's pushing in the opposite direction. If it reverses then obviously the things that are currently lagging could actually do really well. And I always give the following statistic that surprises some investors. Um during the tech bubble um NASDAQ was down 80% 80 S&P 500 was down 46%. But if you look at uh a simple S&P dividend aristocrats index or like an S&P Loval ETF, it would have been up 10 up. So like the market was down 46%, NASDAQ down 80 and these very boring defensive uh kind of areas of the market that at the time also had a negative beta to take um eventually they actually snapped back and were actually up. So, so what I'm saying is at this point there's always two value ads that you have as an asset allocator. Market timing and diversification. Right now, you need to be very careful about portfolio construction and diversification to manage some of these concentrations and manage some of those risks that come with it. And and factor diversification is a very good example. And maybe the bond market, as we discussed earlier, can be a bit more helpful. Maybe not long duration bonds, maybe a bit more in the belly. um and and and of course um equity volatility as an asset class and and and related trades. I think all of these are tools that can help you um to to to kind of prepare the portfolio. >> I I completely agree with what you said and and couldn't agree more. I I think the thing that works so well I mean I started this business in 98. My first experience in 989 into 2000, the tech bubble boom was actually the best thing to do. The easiest trade was to own out of money calls instead of stocks or just to own longerdated cheap volatility. Um and um I think uh you know particularly longer out in the curve. um you know those those positionings can benefit into a rally but in a bubble markets tend to start moving in kind of a megaphone type patterns and so um you know different set of risk than equities clearly and and markets have changed a lot since that time period but I completely agree with you that there is a place particularly given how um you know relative to the potential distribution of outcomes how cheap some of these uh these equity kind of calls are and volatility is is dramatic. Um so I think that's a wonderful way to play it without necessarily trying to short the market, right? And I think that that is um incredibly desirable. Um also to your point, uh certain certain businesses are really cheap right now. Like if you can go look at a just a discounted cash flow at some businesses, particularly relative to earnings growth, there's a lot of structurally stable that are real solid earnings like that aren't built just on capex or on kind of the market going up. Clearly they will have some blowback just like every other business will if kind of the economic cycle turns a bit but um but they are they can be much more resilient and much more you know money ultimately needs to go somewhere to your point uh can be can be very defensive and and a great um asset in that period. Um all right for the last like five 10 minutes I I want to kind of get into kind of the what I think of what I call the third leg of the stool. We've been talking about macro primarily and we've talked a little bit about market micro structure and flows, right? This pinning of of kind of the reflexive capex that happens and these types of momentum flows. But I really think um important thing that that we're you know the the biggest way that this market has changed in my last 28 years of being in this business is really the last two years of how um aggressive I don't know know how to think of another word. And it's not just pointing the finger at this administration. It's the pressures in the system are forcing particularly for the US dramatic outcomes. And we have an administration that is being aggressive partially because it has to. Um, I'd love to hear your thoughts a little bit about the role and how you are thinking about the uh what the administration is doing in the US uh what globally what China is doing and and how this can dramatically change asset allocation how we should be thinking about those risks and how they're playing a role in market outcomes. >> Yeah. No, I think political uncertainty and geopolitical risk is is very difficult for market participants and asset allocators to take a strong view on and adjust the portfolio and and I think that's the big challenge like what we always say is like um timing geopolitical risk and timing the market response around geopolitical risk is is is is very difficult. So, this comes back to what I said earlier. Um, like there's two value ads you have as an asset allocator. Market timing and diversification. I think you just need to think about how to create a portfolio that's more robust um to potential geopolitical shocks. One of the conclusions we've had with a lot of asset owners um discussions on is real assets, the value of real assets in the portfolio because a lot of policy choices that um uh kind of uh cause volatility in markets often generate inflation and and and real assets are on the one hand delivering stable cash flow growth but also um in real terms. And yes, when the inflation happens, they don't always uh protect you. um certainly not real estate and infrastructure, maybe a bit more commodities, but but but they they over the medium term they have the potential to cushion inflation volatility. The other thing we've noticed in in speaking to global asset allocators is there's a bit more home buyers because of FX risk because the challenge you have is that FX risk um starts to matter because you have like large policy shifts potentially um and and so that means that if you are an asset owner that has a liability or that really has to to to kind of uh uh manage returns in a specific currency that automatically you migrate a bit closer to home. We've certainly seen that in bond markets. Um we are seeing that also increasingly um in equity markets. It's difficult uh because the best opportunities are often like in countries different to your own like you need to be nimble like to find the best opportunities. But home buyers is definitely um uh uh kind of something that we start to see a bit more. And the last thing is of course you really need to focus on risk mitigation in a very different way like when you live in a world where inflation is low and anchored deflation is the bigger concern than inflation and there's fiscal austerity and fiscal consolidation I think the bond market no matter where it is in the world um is is a good uh buffer for your portfolio but in this new world where I think you you you essentially have like fiscal concerns in in in most countries you have a policy uncertainty and political volatility in a lot of countries. I think suddenly the bond market on top of the reasons we discussed earlier is becoming a less reliable partner um in for equities in the portfolio. So so so that completely changes um depending on where you are as well um what you can do with duration. So we've seen a lot more focus on gold like I always say like gold has this very interesting convexity when there is an issue with trust. So like in the 70s um investors didn't trust central banks to bring down inflation from very high levels. um in the global financial crisis um people didn't trust the financial system and and and since the COVID crisis there's a problem with trust towards governments um globally and I feel like that has supported gold and we've been quite constructive on gold as a portfolio diversifier to deal with broad geopolitical risk but timing the day-to-day generations and the day-to-day movements on policy and politics I think that's very difficult for investor tors and anyone to do. So, we're trying to stay away from that. >> Yeah, I think that I agree. It's hard, right? And that that's what makes this so difficult. I used to be able to look at the structural flows and look at the macro forces and then government sitting on the other side of the poker table would be reflexively responding, right? This is they are much more proactive at pushing outcomes. And I do think the greatest risk that is un not talked about enough. I thought more and more people are waking up to it. you know, we've been talking about it for for at least five years is the debasement reality, right? There is no way out of this debt issue in the US. There is no way to deal with that debt issue and simultaneously compete with China and drive the level of growth, the n level of national kind of uh uh investment that needs to be made, right? I would argue without some level of debasement leaning on the exorbitant privilege of the US dollar. uh it has become clear to me and I think one of these things you know we talked two years ago a lot of the things we talked about have come true the thing that I'm going to highlight today is that you know that debasement that people have been talking about for some time is not is no longer two 5 10 years away it's coming in the next year and that debasement when it starts to happen will be a dramatic convex outcome for global markets in very dramatic ways it doesn't mean it's markets go down per se but the effects of that are going to be an earthquake through the system when it comes and I think the other thing people aren't preparing for enough is what goes with that which is that direct investment from government much more of a China model in the US where we are going to start rolling out a sovereign wealth fund at scale Trump accounts at scale because this market quite frankly is too big to fail >> there's autistic >> and so we this next crisis or next whatever downturn that we see which I think is very well uh they you know will be much more managed than usual even um will be uh you know in the words of Hank Pollson the coming Treasury crisis that we're seeing will be met with massive QE as they always are but this time with an a a cap on the long end of the curve which is going to drive a structural inflationary loop and I would argue that's kind of part of the plan because that will allow the roll out of of of direct investment into corporations. So the way this capex bubble keeps going is it takes the next logical step which is no longer being dependent on markets uh you know free markets pushing it higher no longer just uh capex coming from the uh which is softly by the way I I would argue coming from government don't don't forget September 2025 they sat around a table and said you know I'll do 600 billion how about you I'll do 500 billion in capex right but it's going to be direct investment coming into equities from uh the US government and I think this is the thing people are least uh thinking about and least prepared for. The incentives drive those outcomes and the the truth is the incentives um are pointing in such a way that there is no way out other than print money by stocks and as you know Japan did this for 15 years. This will not be the first time in history for this to happen. Um I'd love to hear any any last thoughts and this is why I agree with your asset allocation. You have to own gold. You have to own farmland. You have to try and have debt on your real estate. You know that you want to have the same position broadly that the government has. You The greatest irony is most people think that a mortgage is a risk. It's leverage. Like I need less leverage, but the greatest risk of all might be not being levered enough. Um [clears throat] I'd love to hear your thoughts, final thoughts there related to >> Yeah. No, I think you definitely painted like kind of a really bad picture how it could all end. What I would say is that FX volatility, we talked a lot about equity volatility to me also looks remarkably cheap. Um, when you when you think about it like because you know FX used to be boring. It used to be mean reverting. You didn't have very violent convex moves before the COVID crisis. But really in recent years that has changed. I mean look at just what happened in the last few days um around Europe like some of the moves in the euro some of the moves in the Swiss Frank then obviously before you had the moves in the yen. Um so I I would say that um maybe um FX volatility and expressions linked to FX volatility will also become much more valuable in the portfolio to protect assets outside your home currency. >> I couldn't agree more. Last data point. We've done a study in the 60s and 70s and we can't help but uh see some similarities right obviously with some of these things we're talking about. During that period the volatility of FX and bonds and gold which is essentially currency um dramatically outperform any other period in history. Uh meanwhile counterintuitively uh industrial commodities and equity all dramatically underperform and a lot of that with the equity side is this pushpull of because it's nominal right equities are nominal like inflationary pressures are you know would be good for all assets in theory but on a structural level but at the same time the volatility and risk of of profit margin compression all of the other uh you know the discount rate rising and and the uh multiple contraction that you see those things end up pulling in two directions for equities and as we saw 68 to 82 equity markets went nowhere literally nowhere in nominal uh terms um and that that I think is a dramatic departure from what we've seen otherwise Christian wonderful conversation broad- ranging covered so many important topics such a critical time in history I can't wait to have another conversation with you in a year or so to come back and see kind of more of what we've talked about comes true again but uh always a pleasure uh thanks for your time. >> Likewise. Thanks so much for having me.