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Peter Sheer of Academy Securities writing, the end of free money has been a major factor in the recent downturn and could weigh on the economy and markets going forward. I think the economy is at a greater risk than we've seen in some time.
Peter joins us. Now, Peter, great to see you, see you too.
This seems to be echoing what we heard from Neil Dotta yesterday of Renaissance Macro, where he said that he thinks the train may have already left the station when it comes to FED rate cuts and the potential damage that has been foisted upon the economy.
Why are you so negative as well.
So what I'm seeing, I think is what we're calling the end of free money and kind of being a bit cavalier about that. But there was a time, right if you announced you were spending x billion on data centers or AI, your stock went up two x And all of a sudden, now you're seeing people question that. You're seeing stories emerged about ooh, which technology should we use?
So I think we're going through this breather right.
A year ago at this time, if you didn't have an AI strategy, you were ridiculed as a CEO. Your stock was going to suffer. So there was spend, spend, spend. There was this kind of real rush to spend, spend, spend. Now I think everyone's sitting back, Okay, what do we want to spend on?
What is the best value?
And the hyperscalers Right, all of a sudden, you can't just say you're going to build more and your stock goes up.
So this is kind of this first time.
I think we might see a bit of an AI diet where people are like, Okay, how do we be cautious on this? Where do we spend? What do we spend on? What technology is emerging. We haven't talked about anything out of China yet that could derail some of our stocks.
So I think this is where we get a bit of a slowdown.
Right now, before we get into the details of the AI trade, you said the end.
Of free money.
I don't want to dive into that because yesterday we were talking about tightening liquidity conditions. Now a lot of people attributed that to the sell off that we saw in things like bitcoin and also the big tech names. Why is this now the end of free money with the federers are of cutting rates and ending quantitative tightening.
Well, you've also seen coming back to some of the crypto you had the dacos or the digital asseid treasury companies. Some are very sophisticated, some do a lot of things, some simply buy the underlying And there was a period of time right if you bought x amount of ether, your stock went up two x.
All of a sudden, that's not happening.
So all these trades that we're kind of self perpetuating are falling down, and you're having a bit less liquidity come through this and everything I hear and see when we're talking whether it's consumers, corporate, I feel there's belt tightening.
Going on everywhere.
I think people are going to be a little bit surprised where as they go through the budgeting process that companies are actually shrinking their budgets rather than growing full scale.
What do you think the administration does in this? Because we were speaking with the Commerce Secretary yesterday who was beating the drum saying AI has been such a boon for our economy. David Sacks, the cryptos are, which also has an ear to the administration, was putting on x yesterday that it is an AI related investment accounts that half of GDP in a reversal.
Would risk recession.
Is this an administration that would see the sector as too big to fail? As Sam Altman has hinted at to the ugarn of others at open AI.
You know what I think they are doing, I think it's rightfully to do, is investing heavily in electricity and energy production. Right we are putting money into nuclear, We're putting money into everything. That's that's really the bottleneck right now is this electricity. And supposedly that's one of the arguments with the TPUs versus the GPUs is lower electricity US so I think electricity is actually a bottleneck. I see the government spending a lot of time on that,
which fits very much. I know you're sick of hearing it. But production for security or prosec I think they are trying to figure out mark. I think these are the things that the government's trying to make sure goes along. I think it's gonna be hard for them to intervene directly in a But yes, if we get this AI slow down, unless other parts of the economy really pick up, we are going to see this potential maybe not a recession, but.
A slow down. And that's why I'm concerned. How does the WELFERFI to play into that?
At least it has been talking about how just more of everyday people of household's own equities at this point, and a lot of the gains and equities have been tied to AI. If AI starts to take a breather, what overall wealth effect does that come back and have on the consumer we I think.
We've already seen a big hit to crypto right Bitcoin itself is down six hundred and fifty.
Billion, and it seems to track very well.
You know, I always use ARKK as a proxy for disruptive stocks. Those stocks are down, so you've kind of seen this big move in certain segments of the market. Almost anything momentum related is down. So I think you've already seen a chunk of wealth wiped out for people who would spend that money. So I think we need to see this turnaround or you're going to see everyone. Hey, maybe we've got to be a little bit classes right, everything's going to the moon. Crypto is going to two
hundred thousand, wherever the number is. All of a sudden, you're sitting here at eighty six thousand on bitcoin.
I think it.
Doesn't create this negative wealth effect where people are.
Going to be conservative coming into their spending.
So there are three ways to look at this.
There's one way to look at it saying, Okay, this is going to be a recession next year that no one's expecting, which is typically how it happens, which is what we heard from neal data. Then there's a way of saying that actually there's going to be a rebound early next year because of the tax refunds and other types of stimulative effort, but that there will be sort
of this flagging growth. And then the third way of looking at this is it is going to be morally hazardous for either this administration or the Federal Reserve to allow this market to creter. So you're going to see this bazooka of stimulus coming from quantitative easing, from federrate cuts, and from fiscal that will ultimately propel this market higher.
Where do you fall in?
You know, I do think coming into the midterm elections, we are going to see a huge effort. I think Trump and Trump one point, Oh, learn the pain. If you don't win the midterms, it's really hard to govern your next two years. So I expect a lot of stimulus coming into that, and I have liked, for example, my favorite trade right now has been to be underweight NASDAQ one hundred so QQQ and ETF form and I like the S and P five hundred equal weights, so RSP is one you know ETF that you can use
for that. And I think you're going to get this bit of a rebouncing right. Some of the air is going to leak out of the AI, some of it should be transferring to the rest of the economy. And that's why I like kind of the equal weighted S and P five hundred. I think as we take away investor focus from the AAI to electricity, which is still going to be a part of this, But what else is going on in the economy?
What else are we building? What are we making?
We are going to be trying to build manufacturing plants, We're going to be trying to build mindes. We're going to be trying to build refining and processing companies. So there will be activity, and I think that's the area that's going to shine next year.
If you are defensive, can you go into long term bonds with the expectation that this is an incentivized fed to reserve to ultimately bring down long term costs in whatever type of financial engineering it requires.
Normally I would say yes, but I'm kind of stuck more in the belly of the curve five to seven years. I just think there's going to be some outward pressure on the tens and beyond as people are nervous did we cut too much? Are we being too aggressive? Are we paying attention to inflation? So I think that's going to diminish a bit of the rally there. So I kind of like the belly of the curve. I think you're going to see two ten spreads actually go potentially
to one hundred. So I could see us down at three percent on FED funds, and I could still see a ten year close to four percent.
Are you getting those vibes from the Fed that they are going to be forceful in their cuts. We heard from Chris Waller yesterday saying yes, December, and then it's meeting by meeting, I'll.
Be slightly embarrassing, and honest, I'm not really paying that much attention. I think we are going to get a new administration. The Fed's going to look very different next year. We're going to get to three percent before the middle of the summer. I don't really care whether it's a cut in December or not. That's kind of my base case, right this is the direction we're headed. It's going to come almost hill or high water. So that's kind of
how I'm thinking about it. I'm spending less attention to who's talking today and tomorrow. Look who's going to be talking in the future. We know we're getting these cuts next year.
Peter's share of academy securities is still with us, Mister Prosek, Let's put that hat on because ultimately this really does go down to what is your takeaway. Does this have more consequences potentially for Ukraine, Russia or potentially for Taiwan.
I think probably more for Taiwan. So when we're looking at this, and again I work with thirty retired general's admirals, a couple of CIA people, so we spend a lot of time on where.
This is all playing out.
And I think as we're having conversation with clients, we're reminding one g said he wants his military to be ready by twenty twenty seven.
It's not a sign that.
He's going to do anything in twenty twenty seven. But we've always thought what's going to happen is there's going to be a multiple application of the levers of power. So the levers of power are diplomacy, information, military, and economics. So the DIME framework, I think they are going to put so much pressure on Taiwan that Taiwan may eventually
just say enough's enough. And we are seeing the US pivot a little bit away from the kind of this global policeman of the world to really focused on domestic right north South, the Monroe doctrine seems to be taking place again. Right we move the forward into the aircraft carry into the Caribbean. So there's this big domestic focus. So I think there is some risks that Taiwan feels a little bit maybe left out, a little bit nervous.
And when we look at trade negotiations right now, the two things that I think China has some power over us are still the processed and refined rarest and critical minerals. So on pro sac, I think we are trying to do a lot of that. I am convinced that this administration from some talks as well. One we want to produce the rarest and critical minerals, but really we want to make sure we can process and refine them to break that lock that China has us on us. We
control the chips, we control the best quality chips. Again, maybe now we throw the TPUs into that. Those are things China wants. At the same time, China controls a little bit the ability for Taiwan to ship things. So far China has not done anything, but they do have this very very large maritime militia. They've used it in the past and little incidents, but they could put this to work.
It's largely shipping vessels.
They have larger vessels within that and they would just disperse themselves in such a way that it would slow shipping down.
They would throw.
Logs off back, they would throw knits nets trying to foul propellers, so they could do a lot if they really wanted to push on us against Taiwan. So I don't know where this is all headed, but it feels a little bit Parson Parcel where we're focusing a little bit more north south Monroe doctrine, and maybe China has a little bit more control in that region.
Where does that leave someone like Japan, who has been leading on the US alliance in their current height intentions with China after the Prime Minister made those off the cuff marks that they would support or take action if China had military action against Taiwan.
I think it leaves everyone a little bit questioning what is our mission? Right?
The Biden administration is very clear that we would support Taiwan. Trump has not been clear so far, And our official doctrine before Biden has always been ambiguity, right, Strategic ambiguity has been a part of this. The one thing to me, it comes back and we've been talking to clients about this for four years and people used to kind of roll their eyes at us, and now I think they're listening. Is shipping you have to diversify your supply chains along
shipping routes. You cannot be dependent on one shipping lane. So Thailand and Vietnam, you're not diversified. They're going through the same place, maybe even South Korea. So I think this is kind of a huge wake up call that everyone has to look at shipping as a bigger risk than we ever have in the past and say, hey, what happens if and maybe it never happens, Maybe we go on living peacefully and we have these great economic
deals that allow it. I think we have to prepare for more and more deglobalization and more and more risk.
That's so interesting you say that, because I've had conversations with private equity executives who have companies, lots of them that need to deal with supply chain issues, and they said, we've done such a good job since Trump came in as present, because we've de risked from China and now we're in South Asia.
To your point, we're in Vietnam, We're.
In these places that still might feel blowback should there be a larger scale conflict.
Are there other options?
Is the supply chain resilient enough to completely move away from that region even if it's not China?
No, But I think you can diversify, you can have some there, you can have some other reasons because you are going to want to try and sell into that region.
Right.
India is a huge growth story. There's all sorts of opportunities, so you want to be there. But I think you want to look at South and Central America. What's going on there right? Whatever happens, you know, how do we do better with Brazil? So far Brazil has been tough.
We are working closely, I think with Argentina. So I think there's going to be a lot of opportunities in that North South and again, you know, keep coming back and lots of things I've learned not being military, but you know they talk about at academy security is the tyranny of distance. So in war, it is really hard to fight a war if you're far away. If you look at where Guam is relative to Taipei or Taiwan,
it is a very far distance. It's going to be hard for us even when we try and do something to support that relative to what China. They have the same problem when you look at Central and South America. And let's not forget the first place Mark rule Rubio went was the Panama Canal. That has never really happened in our history. Right the you know Secretary of Defense to or sorry secretary almost always goes to the UK. He went to Panama Canal. So there is something shifting
in this. So I have pay close attention to that. And if you want to be where the US government's going to protect you and do the most, I think it's pretty clear to me you want to be edging or favoring North and Central and South America over Asia.
Five years ago, when the pandemic was raging, everyone was talking about the deglobalization and this idea that you had to build in sort of inefficiency in your supply chain to create redundancies.
It was going to be inflationary.
Now we're not talking about inflation, we're talking about disinflation from artificial intelligence. Even as we see an acceleration of this trend of being more regional, is there still an inflationary overlay to this that's the reverse of what globalization provided.
I think there is as it comes online, there is going to be some pressure on commodity prices if we really start building these factories, if we build out the energy production that we need, or electricity production, we are going to see levels of inflation that have been higher. I think it's persistent, say that two and a half to three and nine percent. It's not going to get out of control. But over time, we've also built a much more secure system. I think costs will go down
over time. Right if you're not shipping things long ways? Can I just keep coming back to I really believe this kind of concept of production for security is going to replace kind of EESG. When we're thinking about sustainability. It's going to be much more like what do we need at the base? And this is going to sound wonky, but you know, I look at Maso's hierarchy of needs. I always think that's probably the most useful course I took with psych.
One oh one.
But it talks about you basically need shelter, you need food, and all those things before you can move up to self actualization. And we're kind of at the self actualization. What we would like, well, I'd love to do this, I'd like to do these things, and then we realized we had to our base.
It erodent. We cannot produce the things that we need.
How can you be safe for sustainable if you're not making some level of your basic necessities. So I think that's where we are headed. I think the government's the first to see it. I think capital is already starting to flow into it. So capital is going to be second. Corporation is going to adopt it, and I think Europe's
going to start falling. I think Europe's going to fight out a bit more tooth and nail, but ultimately they're going to get dragged into this where you have to produce your basic necessities or some portion of it yourself, and work with close allies because you cannot just rely on China to be your friend.
Stay with us.
Multile inpex Devinance coming up off.
To this, I'd always say me of Columbia thread noodle casting doubt. I'm a so called productivity boom. Writing AI will lead to an acceleration and automation, which has been a central feature of economic growth. AI will have no impact an aggregate economic productivity. It joins us now at that bold statement, ed, why do you think that that's the case?
Given the fact that so many people are saying.
That is when this will start to pay off, that is when this will be disinflationary and not necessarily just the investment in nuts and bolts in the physical world.
Yeah.
Absolutely, Look, we've seen these waves before. The point I wanted to make is it's really difficult to translate technological innovation, which we've seen pretty much continuously over the course of the past forty years, into aggregate economic productivity. That's extraordinarily difficult. It really requires us to reorganize how we make economic widgets.
So at this point, you're saying that there are implications for the fixed income world in terms of the ultimate payoff, right, because it comes to not only the corporate debt market that's been fueling a funding a lot of this, but.
Also it goes down to the expected inflation.
Right, just what kind of growth you can see on the heels of AI. So where do you think the biggest misunderstanding really is right now?
Yeah, I mean part of the problem is with channeling an extraordinary amount of savings now into the AI thematic, it's going to cannibalize to some extent the capital that's available to other parts of the economy, including the treasury market. When in the early stages of this the AI theme has just come to the investment grade market wholesale. It will be with us for a number of years, no doubt.
Well.
One of the risks is it starts to lift yields across the ward and starts to make the cost of capital more expensive for other companies. That ultimately could be a drag on growth down the line.
This is a real crowding out because not only in capital, but in manufacturing the way that energy is used to So wouldn't that be a healthy thing. If all of a sudden we've decided we've gone so too far and AI backs up and the spending on AI backsup, does that open up other parts of the economy to make use of this capital, make use of the energy, make use of America's manufacturing capacity.
Yeah, eventually that could very well be the story. We've seen this happen in other parts of the world. China as a fantastic example of this.
It's gone too far.
We're now seeing deflation, outright deflation because of that capacity in China. It's very early in the story, But one of the risks is we've invested an extraordinary amount of capital, some starting with a te at this point in the AI thematic, and some of that capital either depreciates rapidly or is stranded and doesn't contribute to economic growth.
What happens to private asset players who've all started to pour money in this. A lot of the conversation there is we're not taking AI risk, We're taking meta risk. We're taking oracle credit risk. If what you're talking about that corporate bond markets also start to feel some of the pain. What does that due to this entire ecosystem of funding.
Yeah, it's quite vulnerable.
Let me say this.
The good news is we're starting with corporate balance sheets that are extraordinarily strong.
These are high quality, high grade issuers.
The corporate bond market, particularly the investment grade market, was practically invented for this. It's there to fund these themes. So it's going to be a while until we get to a point where it starts to degrade and we see whether it has an impact on earnings. But the fact that the story is so deeply interconnected is definitely vulnerability. That's not a new theme, but it's going to be with us for some time.
So how much of a liability do you think this is for the treasure market.
A little bit?
And again the good news is we're sort of focused on the narcissism of small differences. What is the fad going to do in a couple of weeks. The AI theme doesn't affect that in any meaningful way. One of the core questions for the Fed in the next couple of years is should we assume, the way Greenspan did in the mid nineties, that productivity is rising. That's a license to keep monetary policy tighter than it would have been otherwise. If they make a mistake, and look, Greenspan,
god lucky and he got it right. But if we make a mistake that leads to lower growth, that leads to tighter policy, that leads to lower inflation in the coming years, And that's going to be a really, really interesting debate in both twenty twenty six and beyond.
If this does lead to greater weakness and potentially overly tight financial conditions at least for the rest of America or the rest of corporate America that hasn't experienced the AI boom, Are you expecting this to be essentially disinflationary for the wrong reasons, right, the idea that they could actually slow growth and end up in a situation where the corporate debt issuance really suffers because the growth just isn't there to really fuel the returns and the profits in an ongoing way.
Yeah, let me start with the second other questions. So, if productivity does not materialize, in other words, productivity is very concentrated in parts of the economy that potentially deliver earnings to these companies, it's fine. If productivity becomes more diffuse and the economy as a whole starts to lift, that's a license for again higher interest rates across the board.
That's a license for a healthier growth story. That's something we saw in the mid nineties through the mid two thousands, great outcomes in terms of inflation, fiscal interest rates, stability, and so on. The challenge for the FED is, again, if we make the wrong assumption in the short term and we put that higher productivity story into our strategy at the moment, you could make a much stronger case for tighter policy, and that would be a mistake of the stage.
So, if that's the case, what's yours conviction right now? Heading into your end into twenty twenty six.
With respect to interest rates, Look, I think we have a starting level if really yields inflation adjusted yields across the board that are still quite healthy. At the same time, when you look at the corporate debt market where we're financing and underwriting this AI story, corporate spreads are extraordinarily tight.
There's a lot more room for those spreads to widen, and there's a lot more room for real interest rate inflation adjusted yields to come down in the course of the next twelve to eighteen months.
What would it take for spreads to widen though, because this is a market that's flush with cash looking to put it to work, and it feels like every single auction, every single debt issue, once that there is so much demand that spreads, even when they widen, are widening to like, I don't know, seventy bases like nothing crazy still even when you do see widening.
Absolutely And the appropriate answer is I have no idea. All I know is at the moment, investors are not being compensated for a lot of the risks that they are taking, particularly in weaker balance sheets. How quickly those balance sheets degrade ultimately is going to be the key part of that narrative for next year. And then, most importantly, we need a shock to our beliefs. That's what always happens. There are deep stories that are embedded in the way
we price these spreads. There are deep stories around the AI thematic, for example, that are being embedded in how we price assets in the economy. Shocks to stories like that ultimately are what we orient at credits right.
Stay with US multile Impex Savana's coming up off to this.
Former senior White House Trade advisor Kelly and Shaw writing, the daytant between the US and China is continuing to hold, and I expected to through new years.
I am increasingly.
Skeptical about the durability of the US EU trade deal. Kelly An joins us. Now, thank you so much for being with us. Kelly An, Let's just first talk about what you make of the idea of negotiating a deal for the EU and the US that supposedly was already set in stone.
Yeah, good morning, Thanks so much for having me on. This is why I'm so skeptical about this deal and frankly watching it very very closely. The United States and Europe announced back in July that they had agreed on a package of mutual concessions, including tariff cuts going both ways. The US implemented that going all the.
Way back to August.
First, the EU has only introduced its legislation with no real hope of even passing it in the short term. So the EU has yet to cut a single tariff line.
Now the US is in.
Brussels, you have Ambassador greer As while as Secretary Leutnik, who are there talking to their counterparts. What seems to be on the table is a potential deal on steel in exchange for concessions on the Digital Single Market, on the DMA, on some of these digital regulations. But the EU has said that they're not budging on that. So I don't expect the US to budge on steel and aluminum either, which means.
We have an impasse.
And I think as soon as the President starts to connect with the fact that the EU hasn't cut a single tariff line, that's going to spell some serious trouble for this relationship.
That relationship has been afraid for quite a while. There are ongoing questions also about the US and China, and I think that right now more people are focused on that, just simply because of how essential trade is between these two econees, particularly when it comes to rare earth minerals and a couple other products. I'm just wondering what you make of the phone call between President Trump and a President g and this idea of a visit coming in April.
Yeah, this was a really interesting conversation. It wasn't interesting so far as the two leaders spoke. They speak all the time. It's not unusual to follow up with a successful meeting and a deal that is being implemented, to touch base, to talk about the trade issues, to talk about China soybean purchases, WE purchases, and other commitments that are coming due. But what I found so interesting were the competing readouts, and one in which China really rushed
to get out. The President didn't even give his own readout for several hours later. China's was almost exclusively focused on this issue of time Taiwan, on the importance of Taiwan, saying the US had acknowledged the importance talking about its criticality for the post world international order. While the US readout didn't mention Taiwan at all. It was focused on the trade deal focused on Ukraine, and so it's this
he said, she said. What actually happened in this call mystery. Now, of course there are no transcripts available to the public about what happens in these behind the scene phone calls. But what is interesting is the narrative that both sides are laying out. And I think what is clear is what's on China's mind right now. I think the President's
focused on this trade deal. But when the President does go visit President she in April, I have no doubt that Taiwan is likely to be on the agenda, at least from China's perspective.
The fact that Taiwan wasn't mentioned by President Trump Kelly in, does that say anything about the White House's willingness to step in should there be military action from China to Taiwan.
I certainly wouldn't read that into an omission. I think from the US perspective, this call was really about checking in on the trade deal discussions around what's happening in Ukraine. The administration has said several times over the past few months that there's no end to the Ukraine Russia war without China's active participation. So I do think that those are the things that are likely on the administration's mind
right now. I think what is clear, based on what is happening between China and Japan right now, the concern over Taiwan is really this messaging campaign that we're seeing from China. This seemed to me more about a race to win the narrative versus what actually happened in the call, and I think that's why you're seeing the US just not address it.
I was going to say, in terms of competing narratives. You also had the Japanese Prime Minister say that she received a call right after that China US call from the President, but we didn't really hear about it from the side of the US Kelly, and what do you make of that?
Yeah, clearly there is a tremendous amount of tension right now between Japan and China. China's threatening to cut flights, There is a huge diplomatic row right now over the Prime Minister's comments about the existential threat to Japan of any sort of military incursion by China into Taiwan. I think with the United States President showing is solidarity with the prime minister, I think this is about saying that
we are with you, We stand with our ally. I don't think the President needed to issue any sort of statement to make that point. The fact that that phone call happened was the message. And so I do think that the United States and Japan are united. But again, this issue of Taiwan is increasingly on President She's mind, and I think this will be a real point of tension, particularly going into those April meetings, and I expect President She to try to squeeze the President for something on Taiwan.
And that's when we'll see what the US's real position is.
Here, Kelly, and how much is it a tit for tat this idea that if the US does shift away from Taiwan hardcore a rhetoric around Taiwan, that China will help the Russia Ukraine war and potentially bringing it in to it sooner.
Look, I think that China is likely to use all of its leverage points in terms of trying to push issues that are so important to it, and Taiwan is issue number one in terms of the things that President She wants to do.
But look, I do think that the US position is strategic ambiguity.
I don't think that the fact that the President hasn't departed from that, or at least said anything from that indicates a different pivot point in US policy. But again, the robber is really going to meet the road come April, when I fully expect President She to push the President on this issue. And then again we'll see what the result is. But the US position, as far as I'm aware, has not changed. I think strategic ambiguity continues to be the US view.
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