Bridgewater's Greg Jensen on Why Markets Have Further to Fall

and it wasn't the risk of stagflation. People were talking about, oh, we're in a stagflationary environment, which really bothered me because yes, you know, prices were going up, but economic growth was still relatively strong, and so there was no way you could have said that last year there was stagflation happening. Yeah, I think there's right. Um, you know, people and people say this kind of stuff all the time. People throughout any terms. The seventies, it's the eighties, it's four, it's

two thousand and two. People are always reaching for something. There's no you know, that's like, you know, I guess optimistically say that's what makes a market, right. People have a bunch of different years, this is very true. Well, I have to say, you know, some of the people who were accurately talking about the risks of stagflation, not stagflation actually happening in that particular moment, I feel like they've been sort of borne out by events. And the

US economy is still going relatively strong. It's not shrinking by any means, but with the Federal Reserve raising rates, the question clearly on everyone's mind is whether or not we're going to get a soft landing, whether or not it's possible to have prices start to come down but

also maintain economic growth. Well, what I would say is, for sure, whatever you want to call the environment of this year and sort of the last quarter of last year, the second have of last year, it's been a really toxic brewis so to speak for uh for financial assets, for for asset prices. So you know, the economy is still growing appears, and you know the jobs are still

being added. But this mix that we have right now of very high inflation relative to the last couple of decades or last several years, and concerns about whether it could be brought down without coloboring growth, it's a it's pretty rough for anyone stocks and bonds. Yeah, it is

a tough time for markets. And the other thing I would say is, you know, we hear people talk about these big picture macro ideas like stag inflation or recessionary risk or whatever, but then I feel like we don't actually hear that much about how you translate that into a cohesive trading strategy. So, you know, we've had some commodity specialists come on here and say, obviously, you know, if inflation is going up, commodity rices are going up

by commodities. But beyond that, it's not exactly clear to me how you actually invest in that type of environment, because, as you mentioned, it just feels like it's bad for everything. Yeah, the only thing that really works, he had commodities sort of worked. Holding dollars has worked, ironically, given the level of inflation. But this is an environment where typical portfolio strategies and most assets the people own, whether it's docks

or bonds, really in for a rough rude. Yeah, all right, Well, on that note, we are going to be talking with someone who is basically all about forming a cohesive trading strategy around the macro picture. We're gonna be speaking with Greg Jensen. He is, of course the co c i O of Bridgewater, and we're going to get into it. Let's go, Greg, thanks so much for coming on. All

thoughts great, thanks for having me. Maybe just to begin with, you could give us a short summary of what exactly it is that you do at Bridgewater and what makes Bridgewater I guess different to other types of funds because I feel like Bridgewater you know, you say that name, uh, and it has a little bit of mystique around it. Yeah. Great.

So the you know, I'm one of the three co chief investment officers with Ray Dalio and Bob Prince, and we are focused on working with the team of investors to think through how the global financial system works, to

build that out into algorithms to predict what's next. It starts with really looking at the world and trying to process how all these things, the concepts you guys were talking about before growth, inflation, how those how the money flows into financial markets as a result of those things, and how to predict what's next. And so I am passionate about taking those types of big picture ideas thinking through how you'll translate your thinking about them into rules

that you could apply across time and across countries. And as we developed that, as our our team develops that, we work hard to say, okay, this is how we think this works. If you're talking about the dynamic of stagflation, why would that happen? How does it happen? How do you measure whether it's happening or not? And what do

you do if it does happen? And by you know, it's starting with human intuition and logic, but forcing to discipline of pulling out what's going on in your brain, translating that into rules that you can apply and therefore

stress tests whether they've been true in different types of environments. UM, that's been kind of the magic of Bridgewater is having a community of people that are passionate about that understanding, building up what we call that compound understanding, the algorithms that suggest that, and then constantly thinking about what's changing and what you might be wrong about. Is there a

core like framework that you use? So obviously there are all kinds of inputs when thinking about the global economy. Inflation and energy prices and trade imbalances and domestic savings, are domestic debt or national debt? Like all these different things that are always going up and down. But would you say that Bridgewater and or you have like a core framework that you then put all those factors into, Like what is the sort of like underlying lens through

which you view the economy and therefore financial markets. Yeah, well, I mean starting with the financial markets and then I'll go to the economy, But I'd say on both, the basic picture of the financial markets is that every price is discounting a future, and if you can understand what future that's discounting and compare it to what you think the future will be, which I'll come back to the economy and markets, but um, and then how do you how do you it's really changes in people's perception of

that future that drives changes in asset classes. So that's one framework, and I'll get into that a little bit. But understanding what markets are saying about the likely cash flow of assets and the discounting of those cash flows,

and then how those things are going to change. And the second thing I'd say is that we think a lot in terms of buyers and sellers, essentially knowing how many dollars there are to buy an asset relative to the supply of that asset and that whole world is there's so much in there of understanding why people buy things, what caused them to do that, where the dollars come from to do that, and how different types of things are produced, whether it's a financial assets produced one way,

a real good producer totally different way. But that's the second kind of lens that we're constantly looking at. Do we understand all the buyers in the market, what their motivations are. Do we understand how that assets produced and what the motivations of the producers are. And so those are the two frameworks for which we've spent four or five years building up layers and layers of understanding beneath that.

But those things we think, and you can go in any economy, whether it's in the Soviet Union and the you know, in the eighties, or in China today or um, you know, or in Latin America in hyper inflations. Those frameworks work, you know, they're they're what we call timeless universal. Now, the inputs of the frameworks change, but the basic frameworks do and um. And so that's that's kind of this starting point. And now in terms of the economy, that

understanding what's going to happen next to cash thowse. We think a lot in terms of the transactions that drive the economy. How does it actually work, Where does the money come from when somebody buys something or somebody sells something, the understanding the bottom line mechanics of that and all the incentives that run through the process at the simple level of interest rates and monetary policy, but other types

of incentives, tax policy, etcetera that affect those outcomes. And so again we've been building that model of saying, okay, well, who are all the buyers and sellers in the real economy and what's motivating them? And what's the ability to produce and where is the demand coming from? Those types

of questions. That's the framework that we're doing, and then just constantly thinking about what's going on and what we're then going to do about that systematically, So we're always because we're predicting two hundred different markets and economic stats and hundreds of different things, there's always the feedback loop of missing stuff which you then go through and say, okay,

well what am I missing? How am I dealing with is As an example today, the deglobalization is a huge deal over the last four years we really haven't been dealing with you know, and now you've got to deal with it. You've got to have a perspective on how to think about supply chains differently and the rebuilding of

them and all of these questions. And because we have a good process that we're building from the base on, we could spend all our time on the things we think we're missing and then try to add them into that understanding. So I definitely want to get into deglobalization and what you're seeing with supply chains and things like that, but just before we do, just so we understand the

framework a little bit better. I'm curious how machine learning and artificial intelligence fits into all of this, because, on the one hand, I can understand if you're looking at economic data points trying to find signs of where things are going, or looking at the market trying to figure out whether or not things are under or overvalued, that

machine learning could play a role in that. But when you talk about things like incentives, I tend to think of that as much more of a you know, a human emotion, what's actually driving people to do this, And I don't necessarily automatically think of that as something that lends itself to modeling or machine learning and things like that. So could you maybe talk a little bit more of

that aspect of your strategy. Yeah, great, so artificial intelligence of them very passionate about it, but it's a broad category of things for which machine learning is a subset. So let me start at the artificial intelligence level. The thing that Bridgewater has been doing for forty years is one of the most unique laboratories of is what would be considered old style artificial intelligence, which is an expert system. So everything that we're doing in markets is happening through

algorithms that we've produced. We produced them and what was the original thought of how AI would work, which is experts thinking about what's going on, writing down what they're learning, what, writing down what their rules are. And because we've invested massively in that process and we've been doing it for a long time and have great expertise that we're able to execute trades across two in our markets are twenty four hours a day, all of those things algorithmically reflecting

everything that we've learned. So we have this big AI process that's like humans and machines, where the humans are looking at the machines, think about what's wrong, but keep programming that in and over time there's more and we're done with computers and now machine learning, you know, comes along over the last decade and is helpful in that process as well. But it's also a tool and that

you have to be very careful. And to your point on what what machine learning can help with and what it can't, at least in the current situation, is that when the data that you can plug into a machine learning model is representative of the data in the future, it can be very helpful. You have to have a lot of it, and you have to have but it has to be representative of the data in the future.

What's so interesting about economies and markets is it never works that way because even just the existence of machine learning itself changes the future so that the future data points aren't gonna be like the past data points because machine learning exists. And and this is a game of in which the players are affected by the tools. It's not like physics. It's not it's not something physical where

it doesn't matter if you're watching it. It matters completely that people are using machine learning techniques make machine learning techniques themselves dangerous. If they're using data from the premachine learning era as an example, and so a understanding that. Right. So there's a lot that machine learning can be helpful on data cleansing other things, but it's wrong to think of it as a landscape that's actually good for machine learning.

You have to be super careful because the data from the past is not like the data from the future, and almost by definition, any anything like this changes the future relative to the past. More generally, there's so little sample size in global economies. We have a couple of debt cycles over the last hundred years. We have a world that was, as we're saying, globalizing. The last fourty years is one big cycle of lower and lower interest

rates and declining inflation. So you have to be incredibly careful to use those techniques that are so valuable in certain ways in the economy and other things in our industry because of those challenges. Now, over time, I mean, I'm optimistic that machine learning can take great strides, and as we do, we're working on different ways to use machine learning to help researchers and other things. And I think that over time, computers will keep doing more and

more that humans can do. But handling that in a knowledgeable way and not using the fanciest optimizer of the day, which today machine learning is the fanciest optimizer of the day. But all through history optimizers have in markets have have failed for the same reason, which is the past. If you don't understand it extremely well, isn't going to be the way to get the data. The data itself doesn't tell the story. You have to actually understand the human

motivations on the other side of markets. So in five hundred years, maybe Bridgewater will have a machine learning algorithms that have seen twenty great financial crazies and twenty big dead cycles and twenty high inflationary periods. But as you note here in two, there just haven't been that much data yet. Hard to get out of sample data for

some of this stuff. But what do you know, let's talk about right now for a moment, and thinking about what you just said, like we are experiencing it appears or reversal of a forty year pattern in interest rates. It does appear that we're certainly experiencing inflation the likes of which we haven't seen in several decades. So how do you adjust this new a new thing emerges or maybe it's de globalization. How do you what is the process by which you sort of acknowledge or recognize that

say this is something different. Yeah, well, I think are going back to our frameworks right that you can look at. So why did the why did the inflation? And now let's say slow in your oath with inflation. I agree with you, I don't want to get should agree what you're saying in the introduction of getting stuck in the words place these different things, but the basic picture is if you turn back the clock to COVID, COVID accelerated something that we expected to happen over a decade, which

was this combination of fiscal and monetary policy. We thought that would happen because it's necessary monetary policy. Quantitative easing by itself was getting stuck in assets, was was worsening the wealth divide. Eventually that in order to turn around some of the economic ills that had been stretched over that four to year period, that you would need to

combine fiscal and monetary policy. That happened in in warp speed during the COVID crisis, and it showed the power of it that that printing money and getting that money into the hands of people that would spend it in the real economy worked massively well. It was way more effective way to ease policy than anything that had been tried before, lowering your interest rates or quantitative easing. But

what it did was instantly create demand without creating supply. Normally, when the economy is strong, the demand is coming at the same time the supply is coming in the sense that somebody gets hired and they're supplying o good at the same time they're getting paid in demanding a good. So you've got demand without supply instantly. In terms of COVID, Now, it took a little while to play out because the lockdowns and other things related to COVID, but that that

had this huge inflationary effect. Right, And if you just think about the framework I was saying before, if you just look at, well, how many dollars are available to spend relative to the supply of whether that was the supply of meme stocks or the supply of used cars, right, nothing kept up in that phase that the demand rose so quickly the supply of assets and didn't keep up. Now, as time goes, assets that are easy to print, meme stocks,

et cetera, the supply of those increased quickly. The things that are harder to supply are still lagging that demand shot, and so you get this inflation. And now the inflation becomes sticky when you end up in where I think we are, which is now this wage price combo, because wages are now the thing that we're most short on in the United States is actually labor at this point, and wages are rising and goods prices are rising, and

they cycle on each other. The wages drive up goods prices and they drive up the demand for goods because because incomes are rising as a result of the wages. And so you've got that cycle, and that we think that cycles pretty sticky, although we'll see that's certainly the place you'd be looking is whether that cycle turns out not to be sticky. But that then so we're measuring that phenomenon, right, And if you try to do that statistically with so little sample, and you looked at the

last four years, you almost never see that spot. You have to go back to other periods in history, so statistically you will you would be looking for inflation to revert because the last fourty years it mostly has. Now in this case that we think that if you measure that dynamics at a physics level and you look at what's happening to incomes as a result of the wage inflation and what that means for spending and where action and other things will be, we think you're stuck in

a more stubborn inflation spiral. Now that's all coming from algorithms that we've produced, but they're not the same as the algorithms that would be produced through a machine learning process, particularly if it waited the last fourty years significantly. And that's the difference. Knowing that difference being able to tune your algorithms in the way that you think things work rather than the way that they've worked over most of

the history. And that's the freedom you have as a human to look at that history and understand it and therefore say, well, I haven't seen this before, but I know the physics of how it would work, and you get you get different answers as a result. Now, I don't think that's impossible that you could imagine someday, uh machine learning capable of seeing those differences and whatever, but

it's extremely difficult. And so in any event, that's where the expertise comes in to understand those different types of situations, which when you're in and tune your algorithms and you're thinking to your systematic process in that way. So you mentioned the potential stickiness of inflation as we get this sort of wage price spiral, and obviously this is something that is concerning to the Federal Reserve and that's why

we're seeing them hike interest rates at the moment. Could you walk us through exactly how you see interest rate hikes impacting inflation at the moment, Like when when you walk through that as a as a trading strategy or when you're trying to gauge the impact of what that could be on the economy and on broader markets, what exactly are you seeing? Yeah, so this is a great

example of coming back to the framework. Right, So we look at if the Fed raised a short term interest rates, how much will that cut the dollar spent on goods and services? If you're trying to estimate inflation relative to what's going to happen to the production of those goods

and services. And when you look at that, this is the tough thing for the Fed that if you take the last decade, what the FED did was drove up asset prices so much more than the economy itself, so that there's a huge gap between asset prices and the cash flows available to those assets in the real economy. And that gap is an unsustainable gaps. Somehow you have to pay for the assets with cash flows generated in

the real economy. One person's assets is another draw on somebody else's future income, So the incomes and the assets have to align at some point. Now that could take a very long time, but the last decade was extreme. It was one of the most extreme periods of assets doing well relative to the nominal cash flows. Today, the FEDS trying to deal with the aftermath of that. The aftermath of that is we've got a tremendous amount of paper wealth, we got a tremendous amount of demand relative

to the ability of the economy to supply it. And now the FED has two choices. If you said, what is it going to take to get inflation back to target? You know, and it's not I don't want to give the sense of false precision. But if we said, well, how much you have to drop demand change the labor market to get it, you're looking at a tort term interest rate of five and a percent and a recession, a d percession, and a crash probably in financial markets

down if you choose to go that direction. I don't think the FED will do that. I think the FED will instead watch as growth stats. One of the things you were saying, Tracy, and the intro that equippal with a little bit is I think growth is slowing right now. Now it's just starting to show up. But I think you're gonna see you are gonna see negative growth in

the next year. Tube Real growth now different than nominal growth, and so this gets complicated, and nominal growth will be high and real growth will be slow, and that's gonna be a dilemma and how fast the FED deals with that dilemma of do they actually raise rates? Are they serious about two percent inflation or are they gonna kind of way the consequences of bringing inflation down as quickly as markets currently expect against that consequence in the real economy.

That's where we suspect the FED will actually go slower. They're not going to go to five percent, or at least if they do, they're going to go there slowly. And so we think they need to tighten a lot more to get inflation down, but likely they won't choose to bring inflation down because they'll be weighing that trade off and be cautious along the way. But I don't know for sure. That's another good example of why data matching or what is very tough. This is in the

hands of a few policymakers. They're going to make those decisions of how important inflation is to them relative to how important the ramifications of fighting inflation are. Well. So the FED has, you know, in theory, it has a goal of getting uh, you know, inflation back down to two percent, but it's been suggested by others that okay, if inflation gets down maybe four percent or two four percent or three percent, that it could start breathing a little bit, that maybe it doesn't have to go as

aggressively in that last one or two percent. If if the direction is right, is there like a level of either inflationation or either inflation improving or real growth decelerating that you would suspect would be consistent with saying, you know what, the Fed like, we're not going to go as hard as maybe we had planned, Like what level of activity maybe gives them a little bit of comfort reading how Jay Powell and they are gonna, you know, it's not necessary Like, I don't know that I have

any particular insight on that other than that they seem to be lagging and somewhat backward looking. But my if you're asking me if I were in their shoes, I would be wary. Right. I think they're gonna. They're in this dilemma, and it's due to a lot of reasons. It's not the fault of the current Fed per se.

If you go back to the debt bubble prior to two thousand and eight and you're still living the ramifications of that debt bubble, We've gone through transferring that debt to the government, we've gone through inflating it away to a certain degree, and we're in this process that is a long process that normally would with inflation. And so the current Fed is in a very difficult spot, but it's a spot that's been set up over fifteen twenty years and and and so they're making choices between bad

outcomes here. But so the one the outcome, my guess, is they're going to try to carve the middle of that that in the end there's no magic to a two percent inflation target, like you're saying, lower and reasonably stable. Probably four will be a better choice. Now the markets stopped to adjust a lot. If if you're actually gonna have a long term inflation rate of four, the markets have that they're not pricing that in. That's a lot

of adjustment from here. It's particularly bearish for bonds, but somewhat bearish for equities as the disc out rate evolved in that direction. But I think that, like you're saying, the goal would be to get it down a bit while maintaining as much as you can the economy and

reasonable shape. Now that's gonna be very difficult to get and right now, unless they raise interest rates more than expected and hit markets harder, we still think you're gonna be above five in core inflation, you know, going out the next twelve months. So something's got to change even further than it has in order for them to get

that get that down. But to me, I would consider, you know, them getting it down to four and maintaining reasonable you know, very slow economic growth of a big success. And if they try to get more than that, I think they're gonna get They're gonna pay a lot on one side or the other, just on the idea of markets, And you mentioned earlier a lot of what you do is sort of trying to figure out discounted cash flows or trying to figure out what the market is actually

discounting in terms of the future. What are markets seeing right now, because it feels at the moment like people are simultaneously positioned for higher inflation, but also there is this expectation of her session and you know, to the point that Joe was making. At some point you would kind of expect those two to start impacting each other

and potentially cancel each other out. The I'd think the markets are pricing in actually a pretty darn smooth landing here that if you look at the break even inflation curve, the difference between inflation and X bonds and nominal bonds, you see what the markets are expecting for inflation, and they expect inflation to come down over the next eighteen

months to two point seven percent. And at the same time, while equities are down, it can feel like a big thing has happened in in the stock market, not much has actually happened that that stocks have dropped mostly in line with the interest rate rise such that up until the last couple of weeks, cash flows projected in the equity market actually gone up, not down over the period of equity equity weakness, because the cash flows have to

make up for the discount rate increase. So now you're starting to see the market price in less liquidity and the fact that the cash flows are going to be a bit worse. That growth can be slow, but it's still extremely optimistic pricing in the equity market about future

cash flows. So overall, i'd say if you if you track what the markets are saying, they're essentially saying we're going to get the decline inflation, the Fed's gonna tighten to about three and then be done and it's going to flatten out there, and that the economy at that point will be good. And that's kind of that's the betting line. You think about that as the line. Now, if it's better than that, if inflation falls further with

growth being better than that, markets will go up. And if it's worse than that, if inflation is more sticky and you have to hit growth harder, assets are gonna fall from here. And and our view would be on the second that it's going to be much tougher. That is still very optimistic pricing. Even though I can feel like, oh my gosh, stocks are down almost or whatever um from their peak. It feels like our sessions being priced in.

But all this really changed is the discount rate on assets, and you're going into a period where the liquidity hole is getting bigger bigger. The Fed's gonna start running down their balance sheet. Banks that were too The FED and banks were the reason there was so much money going around last year. The FED was still buying assets, and the banks were buying bonds at record clips, almost crazy fashion in my mind, because they had so much access deposits.

All that's reversing. They're not buying bonds anymore. The Feds not Fed's actually gonna roll off their thing. Banks aren't because they essentially bought in an excess of bonds and now the market has to clear, and for the bond market to clear with private sector buyers, they need to draw those assets from other assets, and there's so many assets in the US you're seeing this This a lot

of the market action last couple of weeks. The assets that need liquidity the most, that don't themselves have cash flows are getting killed because liquidity is being withdrawn from the aggregate system, and those assets that require kind of pondsi like ongoing purchases to support the assets, are getting hit the hardest. And so I think today's market pricing is still overly optimistic. It's been a small move relative to the secular change that we're actually experiencing. So we're

experiencing a secular change. And look, I would never say in a million years, and I know this that investing or portfolio management is easy, but it is true that you know, in the last decade and maybe before a stocks mostly just went up. And also investor has had the luxury of those other asset class treasuries that sort of acted as a natural hedge. They also end up over time, but they usually on a short term basis.

We're moving inverse relationship to stocks, so that had an effect of volatility smoothing, and so you could buy a bunch of stocks and buy a bunch of bonds and you don't always make money, but both generally went up, and they also sort of canceled each other out in the short term. So I'm curious, like how you're thinking about like portfolio construction, if we're like shifting to a

new regime. If inflay Shin, let's say it comes down, but it still remains for a while above this two goal or target, Like, how do you approach the general problem of building a portfolio? Yeah? Great questions. So I mean you start with, like you're saying that the lessons of the last twenty years, in particular in terms of portfolio construction, you really have to understand the reason for them and then think about whether those reasons exist. So

you made the point about both assets doing great. You know, since the financial crisis, you've had this incredible run where diversification was actually almost always bad. All you wanted was US assets and US equity assets, and everything else was a drag. Now that's not going to go on forever.

It's a kind of obviously true. US equities can't take over everything in the world, um, and yet they were on pace for that, And most portfolios are are still dominated based on what's been great for the last decade. And and like you said, the relationships change as a result of the impacts on the cash flows. Right, So if you why are stocks and bonds gonna be negatively correlated in the future? If they were positively correlated in

the last one of years. Well, and the difference is the cash flows on equities and bonds are affected by both real growth rates but also inflation. Now the real growth rates stocks and bonds act opposite. So if real growth is the dominant factor in inflation, stable stocks and

bonds are gonna be great diversifiers if inflation. Though inflation is bad for bonds and to some extent bad for stocks, although we get into that all of a sudden, they're no longer good diversifires when inflation is more volatile than growth. So if you look at history, hundreds of years of history, stocks and bonds are always negatively correlated, good diversifiers when inflation is stable and low, and they're bad diversifiers when inflation is high. And that's just a function of the

cash flows. And so if you don't think in terms of the correlation, but think in terms of the actual physical cash flows, you can start to see in different types of environments what the good diversifiers are. So if you take today and you say what diversifies stocks and bonds If they're not good diversifiers for each other, well, and that's really you want to be careful and figure out ways to take a view on inflation and break

even inflation. The difference between inflation index bonds and nominal bonds is one way. You mentioned commodities in the intro and commodities is one way. But you need those things, and we think also looking at certain emerging markets that have what the developed world needs. You have a world where your short labor and your short commodities and your deglobalizing. So you've got to look at the emerging market allies essentially that you can reliably provide the things that the

world's missing. Those places are the places to diversify the problem that's going on in the stock and bond market that are more and more correlated rather than diversity. Can you talk a little bit more about the impact of inflation on stocks and why you see stocks is not necessarily outperforming or performing reasonably well in an inflationary environment, because I think this is an ongoing debate in markets

whether or not equities actually have that pricing power. Yeah, so if you look at periods of inflation, right, I mean, stocks can often be better than cash and inflation periods but lose a lot in real terms. And why does that happen a there's stocks are a function of both the cash flows and the way those cash flows are discounted.

So if you take periods of high of high inflation, if you take the seventies as an example, cash flows were decent for companies, but they were hit by a significant rise in the discount rate and the uncertainty essentially a higher uncertainty were supremium when you have higher and more volatile inflation. So cash flows were fine, but ease dropped a lot during the seventies, and that's a function of the higher discount rate and the higher risk premium.

And what you see is these big divergences and more volatile corporate situations and generally lost productivity as a result of the instability of inflation and the price feature. So so, but basically stocks cut both ways. The cash flows generally stay in line. Profits a little bit less so because margins are hit to a certain degree. But the biggest thing is that the risk premium on the discount rate.

All of a sudden, if you have a risk free rate of government bond yielding fift what are you going to demand out of your equities? And that's been the the history of it is that that and when the FED tries to then battle the inflation, of course that's particularly bad for equities because you get a growth slow down, you get the disinflation effect, and you get this lack of liquidity. So the second point that's making stocks really bad in this inflation here this period over the last

four months, it's the lack of liquidity. The FED had been providing tremendous liquidity up until this calendar year. You see how many stocks needed that liquidity because they needed new buyers. And right now we can calculate about the US equity market can only survive essentially with new buyers entering the market because they're not cash flow generating themselves.

And that's near a historic high. That's like basically right in line with and it exists because because the FED produced liquidity for so long, you're declining real rates high levels of liquidity. You get the reverse and you're seeing that squeeze. The stocks that need that liquidity are getting hit the hardest and um, and that's happening quite quite quickly. You also see that to some extent, you need constantly

new buyers in crypto space as well. Just the removal of macro liquidity is starting to affect the entities everywhere that need the liquidity in the mode. So this is really interesting and that's a stunning stat and it's sort of one of my pet theories, which is that something changed after the two Crisis, which is that in an environment of low growth, people started chasing momentum as a

way to outperform. You just followed wherever the money went, and money going into something basically helped inflate the valuation, and then that attracted more money and so you had this really bad cycle. So two things here, how do you calculate that number exactly? And then secondly, what happens as this starts to reverse as the momentum goes in

the other direction. I mean, for the past ten years or so, it would have been that as the markets were going down, the FED might you know, step in and start easing again, and then that would be the circuit breaker. But what's the circuit breaker on valuations in this environment? I'll start with the first question on how

do we start? And I don't mean to again I worry about false precision where this this all this stuff is rough, but the basic idea is you can there's always in normal times, there's a churn in financial markets. Some people have to sell their financial market assets because they're spending in their economy, they're retiring, whatever the reasons are, and assets inaggregate are going to go up if there's more money available to buy than that constant turn rate

to sell. Many companies provide enough cash flow that they don't require new buyers. They can offset that sound and let's say five percent of holders want to sell on a normal basis every year, Well, you need an asset that has five percent cash flow in order to offset that, either by doing buy backs themselves or dividends or whatever

to create that cash flow that's there. That you can then look at the companies across the market and see how many of them can, essentially through the money they're earning, satisfy the liquidity needs of the rate the basic rate of sellers versus those that need a constant flow of new buyers. And that's how we look at those assets and break them into those that can make it. That are that are subject to what happens in nominal GDP.

They need actually the profits and the cast flows. They need the economy to be okay, but they don't need new liquidity versus the ones that even if the economy is great, they need new liquidity. And that's where that calculation is coming from. The circuit breaker question, like what

actually stops the downward spiral evaluations here exactly. This again a great example of where you'd have to have an incredibly smart machine learning system to recognize the difference between this downturn and the two thousand eight downturn or the two thousand or the COVID downturn or whatever. Where there is a huge difference in downturns when policymakers are unconstrained.

So if you take even two thousand eight, as devastating as that was, policy makers, because inflation was low, they could print much money and spend as much money as they were willing to do, like there wasn't a constraint. Basically, there's three constraints on policy makers if you look through history. They can always create nominal growth if they don't have an inflation problem, if they don't have a currency problem,

and they don't have a bubbles problem. And um, so you take it two thousand eight or the COVID thing, and you see how it works. Right, They did a lot more effectively in COVID, which is print the money, spend the money, and you can off set anything. You could shut down the whole global economy and within a month you could offset that with printing money and spending money. And when we went through that, that's when I I

sort of went through Oh my gosh. You know, it's so obvious policy makers to any deflationary shock can off set it. What you see in history is they always eventually do. It might take a while, whether it's the Great Depression, coming off the gold standard or whatever. It might take a while, but they can do that. But if you look at history and you look at when policy makers are constrained, it's when it's inflationary. Therefore you can't use that unting and spending and you have a

much more difficult thing. So so basically you could buy you'd want to buy DIBs when the central bank is able to essentially be that shock absorber. But when inflation is stubbornly high into weakening assets, um, you can't. If that's not gonna be there, they're they're gonna be. In fact, they want the asset prices to fall to a certain degree. And even if they fall more than they want them to.

They're weighing the inflation picture against that. So all of a sudden, you've got a much bigger dip possibility before you get relief from policy makers. And in fact, the dip has to become disinflationary in order to do that. And so that's why the drawdowns and the loss in real terms in the ninet seventies and early eighties was so much worse than most of those other drawdowns in

terms of the duration over which it lasted. And you see that across economies, that that when policy makers are constrained by inflation or currency, you know, it can take out, it can lead to lost decades. Can we pivot a little bit? So we've been talking about this new regime, the new macro regime, the difficulty of asset prices in higher inflation. But obviously the other big story, and you

mentioned at the beginning, is what's going on geopolitically. And of course there's the concerns about deglobalization between US and China. There's the war that's taking place with Russia's invasion of Ukraine. How does this sort of geopolitical reset, perhaps of the word I don't know the word, how do you incorporate

that into your thinking? Yeah, well, we try to incorporate it in the same way I was describing before, which is what does it mean for the production of goods and services and for the availability of money and credit to purchase those things? And what you see you come back. I kind of lade the intro to the inflation that you had this huge demand shock as you created demand

without creating supply. Supply actually was reasonable post COVID, and a lot of people are blaming the inflation on some fly when it was actually this massive increase in demand that accelerated so much faster than supply could keep up. Then you go into this phase, the phase the Russia UH invading Ukraine, which really put the globalization into fast forward.

That was happening, It was in the background also happening, but now this is in fast forward and on the you know, the front burner of so many companies um and you get a real supply shock. So in the case of the Russia Vasia Ukraine, you have a massive commodity supply shock. Now that's starting to play out. Russia's

commodity supply. While they'll shift, they won't sell the Europe their energy or whatever they'll try to sell to India and China and such, and they'll do that to some degree, but the bigger picture is Rushi's oil production is gonna fall. It needs the Western technology to do that. So you added from a demand shock into a supply shock, and that has big impacts on the essentially the ability to

supply um the global enemy. And right now we're actually in a lull of seeing that because you also have one of the biggest shutdowns of commodity producing economy ever, China shut down, and the impact that has on on um commodity demand is massive, and yet it's not really showing up because you have an offsetting supply shock simultaneously. But the Chinese demand shock will fade in our view anyway, a lot faster than the Russia Ukraine demands a supply

shock will. So we're also i'd expect somewhat of a surge catch up to the supply shock, as if trying to comes out as eventually well out of its COVID zero policies. So hey, that's going on now. Secularly, as you're describing, there's this big trend of the globalization that one of the lessons that US corporations of European corporations have taken is, Wow, we need a much more reliable,

secure supply chain and we need to build that. And that's building for resilient see, rather than building for efficiency. And that's part of the inflation story. If you take the last thirty years, everything in the global economy was built for efficiency. Almost nothing was built for resiliency, and it was part of the disinflation story that now you're going the opposite direction. You've got to build semiconductors in your own economy. You've got to get energy from sources

that you can rely on. You've got to do raw materials production in places that you know you'll be able to access it. And and this is part of the reason that you'll actually have demand for capital expenditures even if the economy starts to turn down. So that's going to create pressure on nominal GDP, even if profits are starting to climb. Normally, capital expenditors go up and down

with profits. But you've got to rebuild an economy. And this is where you have the impact of stranded assets that all of this capacity to export of the world in China and all of the capex that went there. It's got to get replaced over time, and that's costly without creating wealth in a sense, because it's off setting stranded assets and UM. And that's gonna be a big phenomenon.

That is an inflationary phenomenon because it's going to create higher um nominal GDP, but without let's say, creating new wealth. It's offsetting lost wealth and UM. And so those are the that's the cost of the globalization. And we've had this wind at our back for so long that that people even forget it's a wind in a sense UM. And now you've got the wind in your face as you go through the process of unwinding the incredible efficiency of the global economy over the last thirty years and

building something more resilient. And we don't think that's gonna stop. There's the the pressures between the US and China are such that you're almost certainly on a path two too largely separated economies. They'll have an interface in trade and other things, but they won't be so tightly linked uh as they have been, and that's that's a very big deal.

Is there a predictable inflation or growth effect of this or is this like a Okay, there's going to be some period where things have to reset and supply chains are reoriented, but then things settled down, Or is this like a permanent sort of regime shift that then you know, goes into what we talked about in the first half of the discussion about you know, rethinking asset prices. Yeah, I think it's a it's a secular drag the same

way globalization was a secular benefit to asset prices. This benefit asset prices over the last thirty years was it led to lower real interest rates, lead the glut in savings in China and other places came into the US route drove assets up. Those things are changing. You're not gonna have the lower lower the disinflationary impact of tapping into the most efficient pools, and you're not going to have the excess liquidity transfer back to the United States assets.

So as a result of that, I think you see a trend in rising real yields, a end in higher, more stubborn inflation because it's less efficient. Those things I think you get. Now you get some benefits too, because that certainly from a social cohesion perspective, all of a sudden kind of the losers of globalization um get the benefit, that's the higher wages, the So a lot of this discussion is focused on the negatives to the financial markets.

Which the financial markets benefited massively from globalization, the average worker in the United States did not, and now the reversal will do the same. It's kind of the definancialization of the US, which arguably is good for a social good, but it is a very difficult environment for assets, just offsetting the incredibly great environment assets have had. Those so those things I think are sticky and will play out secularly. Now they could play out very quickly. The Russian Ukraine

type thing creates a shock in that direction. That's a sweakening growth, rising inflation shock. So obviously, if China moves on Taiwan or something like that, you could see the success alerate. But right now, I I'd say it's even if it doesn't accelerate in that rapid way, it will be a constant grind for a decade. One more question

along these lines. You know, this conversation has been very US asset centric, and you say that in the beginning that investors were so bullish on US assets post GFC that they were unpaced to take over everything in the entire world. But as you know that, you know you're not just followut you're following. I think you said two

markets around the world or something like that. Is that assumption, like, should people think more global in this environment when UM If if we're seeing the assumption break that u S stocks can't just take over the entire world, what does this mean for non us SS. Yeah, well, I think that one thing strategically most investors should focus on that hasn't been a big deal over the last decade is diversification. So I think there are issues. You go around the

world and there are big issues. Europe's going into a significant recession, probably worse than the US UM as a result of everything that's going on UM in terms of supply shock there and the war and the impact of that. And at the same time they're gonna have a massive fiscal spending to try to change their infrastructure and rebuild militaries. UM. So you've got stress, significant stress there, and you've got

UM significant stress around the world. Chinese assets, while I think you're they're at a totally different part of the cycle. They have a disinflation they have weak um, a very weak economy, and a central bank and government that's prepared

to stimulate a totally different set of circumstances. And then you had to Japan, and you've got trying to maintain an interest rate backs amazing range of circumstances and opportunities, and I think diversifying across those risks, you've got a huge risk in the United States, is that liquidity that was stuck in the U S assets comes out to US. Most investor will be way better off having a much

more global mix of assets than they currently have. So that would be point one in terms of the short term, short term kind of alpha opportunities. I think it's also that that's right. I think a lot of assets outside of the US are more attractive than the US, although there's risks everywhere, but the pricing is so different. We talk about the pricing of cash flows, the pricing of

cash flows in the US. If you take companies very similar cash flow allocations, you can get them in the rest of the world of those same cash flows for thirty cheaper. That's the issue. The US has done so much better and whatever for so long that it's being extrapolated right. China is the most extreme of that, and for reasons that you can understand, given the regulation, etcetera.

But if you just take the reasonably expected cash flows and you compare that to a similarly situated American company, you're seeing these huge differences. Now, the huge differences can have merit. There's reasons. There's bigger risk premiums in assets in different parts of the world. There's more even more risk and the worst spilling over in Europe. There's China is even more risk of regulator a year, the inability to invest in China, all of those things. So there's reasons.

But on net we think you're you're certainly gonna want a much more diversified portfolio going forward than you have today. Greg, that was a really fascinating conversation, and yeah, we really appreciate you taking the time to come on all thoughts great well, I enjoyed it, so thank you both. Thanks Greg,

that was awesome. So, Joe, that was really interesting, first of all, and secondly, I think it was kind of a good foil to the macro discussion that we had a little while ago with Neil data Um and Luke Kawa as well. So I guess this is sort of I mean, this is pretty bearish, the idea that you could get drop in in the US markets. Yeah, that's

pretty bad. Yeah, No, I mean it's definitely. Yeah, this idea that the market is still even with all the volatility that we've seen pricing in a soft landing was striking. And then of course this idea that like, look, you know, we've had this incredible run for risk assets pro and

the conditions were just right. And I thought Greg laid out a very good, sort of like simple way of thinking not just that the conditions were right, but why the conditions in particular were right for investors buying stocks or bonds. And I think, you know, it's like pretty significant question about whether you know, when all the dust settles on this sort of the pandemic and post pandemic period,

whether those conditions can be returned to absolutely. And also just this idea, and we've discussed it before, I think with with Matt King from City Group on this podcast, but this idea of I mean, it's sort of the flows before prose idea. The idea of flows attract inflows, and that's how you get to these really lofty valuations and when the conditions that sustain those start to turn. To Greg's point, there's not really anything that can or pin them anymore, like to his point that the cash

flows aren't really there. And look, you know, I think we're sort of you know, a conversation you always hear is like, well, okay, what do you buy? What's the right portfolio strategy for this new inflationary environment? What do you what did you we reallocate to? Maybe it's whatever it is, but like I also think, like it's possible that everything is. And I don't know, but like maybe there is not like an optimal portfolio if the conditions deteriorate,

if inflation remains high, real growth decelerates, etcetera. And I don't know if it will, but maybe, like you know, bad news like asset prices aren't going to go up in that environment, and the fascet prices aren't going up, then there's not gonna be some like magic portfolio construction that makes it easy. Yeah, all right, well shall we leave it that. Let's leave it there. This has been another episode of the All Boughts podcast. I'm Tracy Alloway.

You can follow me on Twitter at Tracy Alloway and I'm Joe Wisn'tal. You can follow me on Twitter at the Stalwart. Follow or producer Carmen Rodriguez. She's at Harmon Arman. Follow the Bloomberg head of podcast Francesco Levi at Francesco Today, and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.