Welcome to Trillions.
I'm Joel Webber and I'm Eric Belchunis.
This is going to be a fun episode, Eric.
Yeah, I've been wanting to do this one for a while a.
While, and we had to jump through them some hoops to make it happen. But it seems like a great moment to put the spotlight on the United States of America. We have President Trump back in the Oval Office. He has signed so many executive orders so far, but underlying it all is sort of like, you know, this attempt to kind of reassert American dominance. When you think about the equity market in particular, USA is always number one.
Right er.
Yeah, And you know, on our team, we have this persistent chat and we've actually it's come down to basically like mocking Europe. It's it's like they're the you know, we just had a full leaders at the Super Bowl. It's like they're the Cleveland Browns or the like, they're just a bad team that just can never get going. And then the index that we specifically are just marvel at is the Nasdaq one hundred. We call it the eighth Wonder of the World. It just keeps on freight
training everything year in, year out. This is the cues, and it kind of captures like that American innovation tech thing even better than the S and P five hundred and so when you compare the cues to like investing in Europe, it's just so night and day. But at some point it's so much cheaper pete price to earnings ratio wise in Europe, everybody's like, oh, it's got to go back, but it never goes back. It might go back for two months, but then people come right back
to the queues. And so I just think that the US stock market in particular, that the Nasdaq stocks and the mag seven are almost like abnormally unusually great where they deserve some kind of a scientific breakdown to analyze what's really behind all this because it almost breaks your brain a little bit.
Well you know who's not a scientist, me or you, But it turns out we work with one. His name is Steve how he's a quantitative research at Bloomberg. He has a PhD. You started talking to him a while ago about America and it's greatness, right, would you learn?
Yeah, because you know, we were looking at tech and innovation in other countries and it's just not. They have it there, but no one cares. Why is it rewarded in the US and not in other countries? And we had an interesting conversation about the culture here, the regulations, the mindset, this sort of like you can do it and who cares if you fall in your butt? Like that doesn't exist everywhere else. Like a lot of people are just like get in line and hammer, you know
what I mean? Like America is a special place, and we don't do everything great. We're not number one and a lot of things, Joel, but when it comes to like the stock market, man.
We kick ass.
The US has four percent of the world's population, twenty percent of the world's GDP, and our stock market is fifty five percent of the whole world. Right, you got to go. I think number two is something like Japan, where Europe is a continent, is like eight percent or something like that.
So joining us on this episode, Steve, how quantitative researcher have Bloomberg in disease? This time on Trillions Captain America. Steve, welcome on Trillions.
Thank you very much for having me finally, and Eric, yeah, good to see you.
So, Steve, Bloomberg is a big place. I work in the news group. Eric works in Bloomberg Intelligence. What is Bloomberg indsease and what's your day job?
So Bloomberg Indisses is part of Bloomberg's data team now and I am a quant researcher for Bloomberg Indices. And we create investible indices or portfolios which can be then licensed by as a managers and as owners to track right. We create investment products and inducees that we license, and then once in a while, if we come up with something that we've seen that we think interesting that's worth expanding a bit more than we then run long form white paper.
Okay, so he's written some white papers. Did you read them?
Yeah, I mean I skimmed them.
Okay, all right, we're gonna we're gonna learn a little bit of.
The pricing power. But you she said, was very good.
Yeah. And the innovation, I mean, they're they're they're very good. And the Index group is obviously mentally in the same ballpark as us because we write passive.
But he sells stuff.
True. Yeah, you're on the revenue side of the building.
Yeah, it's important. There's a disclaimer there, which is, you know, we're not going to turn on the We're not going to talk our own business.
No, No, I'm part of the terminal value add.
So Steve, just big picture what makes America fundamentally with the research that you do, the data that you see, why is American innovation greater than anywhere else in the world?
So h if you so went real this white pipe of because you know, we created a index to try to capture innovation as a factor systematically, right, you know out there there's new people talk about we try to innovation. How do you actually do it? Right? There's the r ETF, which is an activetf F you know would selects them
and you know it does what it does right. And then there's accuse, which is actually, when you think about it, not intentionally innovation index, just as all the companies that happens to be listed on the NAS Exchange, which of course has agglomeration effect, right, everybody sort of congregates that. But so it's not intentional. So how do you actually do it? So we start to actually look into some
systematic accounting attributes. So R and D is a natural place to look, right, Companies spend and report R and D not or always consistently, and they may sort of attribute things a little bit differently, but generally the direction is correct. And people previously have looked at R and D intensity, you know, so normalized by sales so they can compare companies in the cross section. That's one way to do it, but we found actually was even better.
It's actually to look at persistence of R and D spending, right, companies that grow their R and D spending three consecutive years year and year right, so, and by screening for these such as gets expensive. Yes, that gets expensive, but but more than that, it also means that there's a highly grow of persistence that needs to be funded by
internally generated cash flow. On top of it, you probably soft indicative of the skills that you have the confidence in your own ability to convert right R and D activities, which is inherently very expensive and on certain into valuable intentionibal capital.
I want to go even deeper and just okay, you grew up in I grew up in America. I basically was raised outside. I went down played with people like droll down the street. We got into football games in the backyard. Then I entered little league games, had to get along with teammates from all over the place. There was also a feeling of optimism in the in my upbringing at all times pretty much it was like anything's possible.
And then you go to high school and college and you're frequently grouped with people to work on tasks and as a team try new things, and.
I break breakdown problems.
Breakdown problems, and there's also credit from being the one that does the good thing, like there's a number one winner kind of celebrated here. Not to mention the bankruptcy laws and the regulatory environment, it just seems like, I'm not sure how you replicate that.
I think recently there was a very good interview that Jeff Bezos gave at the Old Book. You know, he mentioned that one of the biggest, you know, I think reasons why America manages to have such a vibrant tach sector innovative industry is because of the presence of a risk capital market, which is different from a banking market,
right financial markets. You know, if you think about landing right banks land Europe has a very good banking industry, but the ability to have risk capital venture right to invest in things that has one hundred chunds or even less to work out. That's gonna when it pays off, pays out one to to one hundred and one to one thousand. That is the type of risk taking that
comes with I think both culturally and also past dependence. Right, some of it has to do with cultural this idea of being encouraged as a child to try things and not be told that you likely will not succeed, but
to be told just try it. Right. Then, there was also the fact that Americas happened to have succeeded in the tech industry, a bunch of people succeeded by concentrated entrepreneurship and equity appreciating, giving them the confidence of saying, yeah, I can take a risk investing in in venture.
But if you take venture capitalists could invest in the European I mean they're not like just legally allowed to invest in the US like they they if they thought Europe was the better odds to get that like Unicorn, they would go there, right.
So, like, well, part of it I think to be fair to Europe is that Europe. When I recently, I've taken a few trips business trips to Europe to try to understand how to actually get European clients to buy stocks, and one we've noticed that there's just such a huge amount of fragmentation of markets. It's impossible to get a huge market right because everyone little country still has its own language, you know, own regulation and just customs, and
it's impossible to scale what product. So if you're an airbnb, right, you can have the entire US market. If you succeed here, you become this behemoth and then go overseas. Everybody is lightweight, you know. So I think it's a combination of issues. I think cultural, you know, sort of is certainly at the core of it, but you know, there are other sort of institutional factors.
This idea of international also is something Bogel I wrote a piece about a month ago, and I was like, Bogel was kind of right about international. In ninety three is the first time he had written, you don't really need international. The US has all the capitalism you need. If you had followed his advice, man you would have
really benefitted by not going international. So a lot of people that I know, advisors and portfolio managers, they're always in this dilemma of whether to rotate internationally, but it just doesn't ever pan out. And I think that's part of why this matters now is that we got big valuations here, low valuations in Europe. But does Europe have to go up just because it's due?
Well, so, the one thing is that if you recall a post dot com bubble in the early few thousands, you know that was a period when a bunch of sort of things that we are not used to. How did it happen?
Right?
International, I'll perform the US right, Europe, I'll perform the US EM I'll perform the US value, I'll perform growth right, and bones actually outperform stocks, you know, for many years until things sort of then resumed. It's long run trajectory and you have to triumph of the optimists. But you know there are conditions in which you know.
I think the point you're making, though, which is is a good control. Bogo really had very deep wisdom, and he knew US would have bad years. He was going to stay invested. I think if you add international and bonds and this other stuff, when they go up and the US goes down, it gives you comfort and like it helps you hang in there. So if you have a behave, if you're somebody who can't have the intestinal
fortitude to just stick to the US. But the returns I'm talking about are actually inclusive of those bubbles bursting two thousand and eight, two thousand and one, International way lags. But you're right, there's these sections of time that could be years where you're going to underperform. But I think in Bogel's case, he was like, I'm committed to the S and P five hundred. I don't need the feeling that something else in my portfolio is up, which is a level of wisdom that's hard to get to.
Yeah, I mean, part of it is exactly because the US is such a huge economy with such a tremendous complexity that there is everything that's happening right inside of individual countries that's only exposed to oil or banking on and so on and stuff forth. So this national boundary division was always obitring the US place. I never really like the comparison or two lines of a Europe US up performing Europe because it's not the Apple Store comparison.
If you actually compared sort of sector weights adjusted or equity duration adjusted, you will find that the difference, what there is, a premium difference, is not as big as one might have thought.
Or see if I want to bring it back to your your paper and how you think about building in disease that can help capture investment. Right, So you brought up persistent R and D being the data point that is like kind of the north start for the style investing. How do you go about getting that data? By the way, it's all you know, the companies are doing this, but like what do you see when you look at those numbers?
So companies, first of all, that they increase, they are required to you know, sort of disclose their R and D and you know spending expenditures and you know for a long time depending on or coman treatment. If R and D spending is immediately allowed to be expensed, they are actually incentivized, you know, to expand and so they
can reduce their textbook you know income. But more broadly, we're just looking for, you know, in a systematic fashion, metrics that can most succinctly, sort of in the sufficient sufficient statistic way identify companies accurately that fit the profile we're looking for. So in this case, we're looking for innovative companies. You know, what is one metric that really captures companies? You know ability to innovate, and we zoomed in on the R and D spending metric in particular.
We found that more than the intensity is the persistence of R and D spending that really allows you to sort of screen down to the companies that are genuinely innovative.
Well, it's an example of the company that goes that big on R and D but maybe isn't as persistent, and what's that? What's that when that's more persistent?
So like, I don't want to go into an individual company, but more more more likely I think it's one thing is like if you look at, for example, the art portfolio versus the you know, sort of the queues or or in this case, the Bloomberg be invent Index, which which is which we created and it's comfortable to the cues. And here I do want you I want to give credit to my colleague Garl Panzea who who you know,
helped create this this metric. Uh, is that if you go back to compare the rc ETF you know membership, the companies in there spend a tremendous amount of money on R and D. Right, and if you normalize by net sales, the average ratio is perhaps higher in fact than the companies that are contained in this portfolio. But if you compare the performance over time sort of you know, this index is tremendously outperformed the art portfolio over time.
Now why is that. It's because the companies that held in her profile in the portfolio tend not to be consistently profitable. As a result, they don't consistently spend the R and D. They sort of one of those things. They spent one year when they have profits, the next year they spend less, and so on and so forth. So the average is high, but the persistence is not
very high. And as we all know, so those of us who are trying to innovate, it's one of those things where you can't really just you have to get it, sticks, stick to it. You have really you know, persevere through, you know, uh, and that's how you menually make the discovery. And in fact, if you compare the US you know
index and why he has performed Europe. You know, going back to our discussion earlier, the biggest difference between US and Europe is not even the level, right, is actually the percentage of companies that have persistence a high degree of persistence. And we started the millennium actually with the US and Europe being at similar levels of intensity and percent of companies that have uh, sort of three consecutive years R and the growth. And it was over the
last twenty years that difference really diverged, right Uh. And you can so in the in the paper, you have these sort of tables. You can check out these numbers.
That's why, in my opinion, it's not just R and D spending. It's a U S thing. And and I talk to people on Twitter life and they say, well, you can get growth here. You just it's hard to get growth other places. Sometimes there's these speculative bubbles like in China, but pound for pound, you're just you're just going to get more growth here in some of these big companies that are in the US, they're just growing.
But Steve's going to bring it back to persistent R and D being that thing.
And if you go, yeah, but that that that exists in Europe too, but nobody cares.
Like that, not to nearly the same extent right over.
The last time in percent increase, that's right.
The share of companies that sort of really remained persistent in R and D spending just dropped, right, and bisector of the sector, you can compare them, Whereas in the US tech sector is you know, sort of over fifty percent. You know, in Europe you're talking about half that and actually peaked in twenty thirteen, and actually it is even
smaller today. In other words, I think it's a kind of a in the American the case is kind of a virtual cycle, right when you have these innovative companies, and I show in the paper that when they invest persistently R and D, it produces intensible capital which then becomes truly valuable, right, and it spins out cash flow.
Right if Apple invents the iPhone, invents the AirPods, if becomes a six of a product, and that cash flow funds R and D. Because R and D is inherently a very opaque, asymmetric information activity, right, you don't really want to erase external financing to fund it because nobody's
going to know how you're spending it. So you want to use internally generated cash flow, which is why what's nice about this metrip we created is that we don't need explicitly even screen for cash flow because these companies that persistently invest in R and D automatically are profitable and general cash flow and they invest in themselves. So which is why today you're seeing the AI race is all the hyperscalers that are investing capacs by the hundreds
of billions themselves. They're not boring, right, So what.
You're describing is effectively a flywheel, right, this is the R and D flywheel that that's what makes me.
Let's say we decided to go into Europe. Europe had an ice run for six months like two years ago. Is that flywheel going to start there and keep getting rewarded? In other words, are the European companies going to spend it as well, our work as hard as in the US, where that R and D is rewarded with these intangible brands and you know, huge, great products that we have.
Yeah, I think that's probably a challenge. I mean, France, I think just announced one hundred billion euro projects try to replicate or to to emulate America Stargate AI project. I think their challenge there is I think again, all these factors that are not pointing in the right direction, right, so they don't have a you know, sort of unified single market. The language is not English. It's hard for
them to draw talent. They have a lot of you know, so well trained French engineers from their cause, but you know, sort of it's hard for them to I think, get your scale. You talk about the work culture, they don't have as much. I think the text code probably makes it, you know, such the people are not as incentivized to work those long hours, sleep on the factory floors and so on. I mean I'm generalizing here. I mean they
are really genuinely creative, ingenious, hardworking people in Europe. Like there's the Mistraw model, AI model that's really I think the state of the art. But I think, what if you're sort of, so to speak, generalizing there is think those factors that work against them?
Okay, So I used to take meetings a number of years ago with Huawei. Do you know what Huawei? The stat that they would point to persist in R and D. Yeah, and it was a big number, and they would like show it how much bigger they spent, how much more money they spent on R and D than American companies. So let's bring China into this. China spins a ton on R and D. What is that? How does that challenge your assumptions.
In so so you got cleary. You know, so this episode is a cuptain in America, right, and the last time years, America is far and away the biggest, most successful you know, spender and creative innovation.
By the way, see you're Captain America. That's that was That was the joke.
Yeah, that was the nickname you got.
That's funny, even though I'm not.
I know it adds to the humans run with it.
So so so if you look in the paper and Fogus figure travel, like I was sort of doing a tabulation of like what percentage of the companies you know, in various national stock markets that are persistent R and D spenders and what market share they take up in the overall stock market. America is you know, obviously number one, right in terms of both accounts, but number two is China.
Right.
They started a decade negligibly low, right close to zero asserted they started the millennium right in the early two thousand when China was much so further behind in terms of economy development. But they caught up in a very spectacular fashion. So if you look at the chart of you know, sort of that pay figure twelve, that that ascend and rise in R and D expenditures and the degree of persistence, you know, almost catching up with America, you know, a sector bisector.
Right when we started talking about this, there was this great email exchange that led into an eventful weekend. I just want to like look back on that for a second. The email that you sent was a couple of weeks ago, January twenty fourth, and you said there should be a fun one with all the hysteria about Chinese AI kneecapping American AI. And then on Monday that was Deep Seek Monday, when everybody woke up and was like, what is Deep Seek?
So you sent that email and I was like, you know, it's great to have that time set stamp because now we're going to go back and revisit it. How does your thesis hold up from before the Deep Seek Monday to the after Deep Seek week.
So within the context of what we are talking about today, you know, innovation systematic, you know, innovation factor. I think it is actually ties in perfectly and we'll see later why this entire phenomenon actually ties in very naturally to what we were talking about, the American culture. American culture of innovation. And two the ex time we have this great geopolitical rivalry between US and China. What people don't, I think often appreciate, fully appreciated in America, is that
China is really copies itself in America's mirror image. Right. China, my generation represents a generation where we grew up looking up to America when we when we first grew up, we used to say thing of the world as the West, right, the outside world, that the abroad, and then we realized not all Western countries are born equal.
Right.
There is Europe, which is the Old World, and then there's America, in particular the Silicon Valley. And gradually we have had millions of Chinese students coming over the study in America. They acquired that American sort of can do spirit, the entrepreneurship, the ability to reinvent the wheel and not be afraid, not be laughed in your face. And that's
why shan Zen is China's Silicon Valley. And that's why you as increasingly seeing sort of Chinese Chinese innovation success, which we will talk about how China sort of succeeded sort of by copying America, not just you know, in terms of literally the blueprints, but also more importantly in
a cultural sense. And that's the reason why I think China has Actually it's one of those things where you you know, you can't really catch up overnight, right, you have to sort of practice and practice and practice, just with any sport, right for you to hashman to get get to get onto the game, actually shoot with a high degree of percentage, you know. So I think that's what we are looking at. So America still has a tremendous lead, but China presents a formidable challenge.
So let's bring it back to AI specifically. US has obviously been at the lead of this. The deep seek moment sort of suddenly suggests maybe there's different ways to go about making better AI models. How does that sit with your research?
So to the extent, you know, so my research is well identifying you know, innovative companies, you know, and we indeed actually sort of find the same cuss out of companies that are succeeding here in America through our index and people can look at the membership. And we have also using applied the same methodology to China identified you know, sort of similarly creative and you know it come in
China that are doing well. That with respect to Deep Seak, I think it's actually a very good illustration that, you know, innovation is one of those things where you're sort of paddling upstream, right, you are always sort of persevering and so that so you can make progress and you otherwise you'd be caught up. The Deep Sick moment is really nothing special other than the fact that we are continuing, continuing along the scaling law. Right, you know, sort of
costs of compute has always gotten cheaper. When you guys were first entering, you know, the workforce and computers were much slower, right today computers are tiny and on the phone on the phone much faster. And then there's nothing special about it other than the fact that you have happened to have come from China and further innovation will take place in America. What Deep Sick actually has actually done was not even necessarily novel in the sense of
the invented brand new techniques. Those techniques have actually been already published by Google right a year and a half ago. Google didn't manage to actually make it sort of commercially work as well as Deep Sick did, but generally the idea is that one thing we've learned. Hardware advantage is one thing, but you know, human capital is still ultimately the most valuable.
At the beginning, I mentioned that the US stock market is fifty five percent of the global market cap. Do you see that, you know, growing to sixty seventy. I mean, given how small we make up four percent of the population, that is a big disparity. Obviously, where do you see that number going. Do you see the money consistently rewarding the US like the flywheel, or do you think that the valuations will just get too wide and you just have to go to Europe for like, just because it's cheap.
Well, I think I think of it in the two waysn't fundamentally, I don't think it's an accident. Right, stock market is not magic? Right America? I think, even though has such a tiny population, is one of the world's unique immigration country. Right is the immigration system is a funnel the hye B system, which was much talked about a few weeks ago. Essentially it's a funnel to funnel
for the world's I think, sort of finest talents. Right, So, even though you know the population is very big, you manage to attract the world's brightest, most best educated population that's been excited by other countries' expense. Right, so, whilst that doesn't change, I see in America having a structural advantage. Now where that change, we don't know. Right there are seemed to be some political winds shifting and with respect to whether or not so we can have a stock
market bubble crash, and that's always possible. But this is what happens afterwards when America continue to have that structural advantage with respected the rest of the world. That remains to be seen over the next few years.
Steve Hown, this has been fascinating. Thanks so much for joining us on Trillions.
Thank you very much for having.
Thanks for listening to Trillions. Until next time. You can find us on the Bloomberg Terminal, Bloomberg dot com, Apple Podcasts, Spotify, or wherever else you'd like to listen. We'd love to hear from you. We're on Twitter, I'm at Joel Weber Show, He's at Eric Baltuno's. This episode of Trillions was produced by Magnus Hendrickson. Bye