macroeconomics

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• Why is risk control so important? Legendary traders Bill Eckhardt and Rob Sorrentino explain its role in systematic trading and why it should (almost always) take precedence over prediction.
• Most traders fail because of natural bias. To succeed in the market, you’ve got to learn to overcome these basic instincts
• Despite ongoing changes in the marketplace, trend-following is far from dead. But traders should be careful not to rely too much on following the crowd and getting caught up in shiny, distracting strategies with weak foundations.

What do turtles and trading have in common?

The man to answer that question is Bill Eckhardt — a name synonymous with systematic trading. As co-creator of the famous Turtle Trading experiment, Bill has spent decades refining trading strategies that blend rigorous research with a deep understanding of human psychology.

While markets never stop evolving, old traditions — like following trends — remain popular. They have their place, but traders should adopt these strategies with care. After all, human instinct can often be the main cause behind a trader’s downfall in the market.

The key to long-term market survival is risk control

Bill has a surprising take on market success: Traders who stay in the game succeed not because they’re great at predicting markets but because they’re great at managing risk. In fact, his guiding principle is clear: “Put 10 times as much emphasis on risk control as you do on trying to predict where the market’s going.”

For Bill, trying to consistently predict market movements is close to impossible. “You almost never know better than about 51 or 52% which way the market’s going,” he explains. Instead, he advocates focusing on what you can control: your risk exposure. This approach — which is deeply embedded in Eckhardt Trading Company’s (ETC) strategies — is grounded in utility theory.

Using this rigorous mathematical framework, traders optimize their decision-making under uncertainty. Utility theory is no abstract concept. It’s a practical tool that unsure traders can lean on. “You can’t predict where the market’s going,” Bill says. “You have to know what you’re going to do when the market goes anywhere.”

Overcoming human nature: Why most traders fail

Human psychology is often a trader’s worst enemy. Bill explains that the natural human inclination is to seek comfort, which can lead to poor trading decisions.Opt for “normal human reflexes [and] reactions, and you'll be losing,” Bill highlights. Successful traders aren’t superhuman. They just resist the urge to follow their instincts.

“Trading, by nature, doesn’t feel good,” Bill explains. “If you’re enjoying it too much, you’re likely doing something wrong.” The key to success is emotional discipline and resisting the human impulse to chase profits or hold onto losing trades for too long after it’s time to let go. It’s called loss aversion.

Letting profits run and cutting losses early is a central mantra for systematic traders, and accounts for much of ETC’s success.

From turtle trades to the modern era

From where did ETC originally emanate? Richard Dennis — once dubbed the “Prince of the Pit” — worked alongside Bill in the 1980s to come up with the Turtle Trading experiment, which sought to answer whether trading could be taught.

While the experiment was wildly successful, those days are long gone. The market’s changed, and so too has ETC’s trading approach.

“The Turtle systems were largely disclosed,” Bill says — referencing an original Turtle leak of its proprietary trading manual. Bill wasted no time in strategizing for the future: “Even while the Turtles were still in operation, I was already developing systems as different from the Turtle systems as I could make them.”

Following the “betrayal”, Bill quickly moved beyond the simple trend-following breakout techniques of the Turtle program, adopting more sophisticated risk management and research-driven strategies.

Trend-following is still alive and well, as expected. But staying ahead in the market means nonstop innovation and adaptation to endlessly shifting realities.

Why trend-following isn’t dead (with a caveat)

Despite increasing competition and changes in the marketplace, Bill remains confident in the longevity of trend-following. While some have proclaimed its death over the years, he believes it still holds a significant place in systematic trading.

“Trend following isn’t dead,” Bill asserts. The key is continuous research and adaptation. As markets evolve, traders need to innovate to stay ahead, but the fundamental principles of trend following — like identifying long-term trends and controlling risk — remain as relevant as ever.

Bill’s advice for modern traders? “Run as fast as you can just to stay where you are.” Constant improvement is what maintains an edge in today’s cutthroat environment.

Beware replication

Be mindful of trends, and even follow them if you must, but be wary of overusing replication techniques — especially those relying on historical market data to mirror the performance of broad indices like the SG CTA INDEX. While they might sound appealing, they often overlook critical risk factors, particularly the emotional and discretionary aspects of trading.

“Replication can give you a fitting portfolio based on the past, but it’s almost an invitation to overfit,” he says. This is especially dangerous because futures markets are notoriously non-normal and subject to unpredictable tail events, which traditional statistical techniques don’t account for.

Replication strategies often fail to effectively manage risk effectively — kryptonite for traders — in the face of high volatility periods or sharp market reversals. Bill advocates for a more robust, research-driven approach that adapts to changing market conditions and emphasizes risk management over blind replication.

Prioritize research, but avoid overfitting and underfitting

Research is at the core of ETC’s trading strategy. “We’re a research lab first and foremost,” Bill says, noting that this focus on research allows ETC to constantly improve its systems and stay ahead of market changes.

One of the major challenges ETC faces is balancing overfitting and underfitting. Overfitting occurs when a model is too closely tailored to historical data, making it less effective in real-time markets. ETC’s in-house techniques for controlling overfitting are unique. “We’ve really decreased the extent to which we’ve overfit,” Bill says, emphasizing that finding the right balance between using enough data without over-relying on past patterns is crucial.

However, underfitting — where a model doesn’t extrapolate enough useful data from datasets — is just as dangerous. To avoid it, ETC runs its models across multiple market environments and timeframes. Using decades of historical data, ETC ensures it’s versatile enough to recognize longer-term patterns that might otherwise go unnoticed. “We make sure we’re capturing all the relevant information markets provide,” Rob says.

Leverage volatility for better trading signals

Pay attention to volatility: It’s a key input in trading signals. ETC integrates volatility into multiple facets of their trading systems — using it to size trades, measure price changes and (of course) manage risk.

Volatility is both an opportunity and a risk. “Increased volatility often helps us, and we don't want to restrain that,” Rob adds. The goal is to harness it to improve the effectiveness of trading systems while mitigating the downside risks it can bring through overreliance on volatility metrics.

“We don't target portfolio volatility,” Bill says. However by incorporating volatility into multiple aspects of their strategy, ETC is able to capitalize on market fluctuations while staying mindful of the increased risk they bring.

In this way, ETC leverages volatility as both a signal for opportunity and a key tool in risk management — ensuring it remains adaptable across varying market environments.

Diversify, forever

If effective volatility and risk control are critical for market success, diversification is a natural bedfellow.

“Diversification was the greatest financial idea of the 20th century,” Bill states. Spreading risk across multiple markets gives traders as much reassurance as they could hope for amid any chaos. ETC trades around 70 markets, providing a broad base of diversification.

But beware: Not all markets are suitable for trading. “Alternative markets” can appear more profitable on paper but suffer from liquidity issues and high trade slippage — eroding profits in practice. “Alternative markets might appear better, but in practice, they’re actually worse,” Bill cautions.

Is short-term trading a risky business?

While ETC is best known for its long-term systematic strategy, short-term trading also plays a vital role in managing risk. “We try to cover the short, medium, and long-term perspectives,” Bill explains, emphasizing that their approach isn’t limited to any one time frame.

With flexibility critical to the company’s overall risk control philosophy, Bill notes that “Our systems are designed to be dynamic — responding to market changes across different time horizons.” As such, ETC manages to effectively navigate volatile periods.

“The shorter-term systems allow us to get in and out of trades quicker, especially when there’s an unexpected market shift,” Bill points out, underscoring how these systems help ETC limit drawdowns and manage volatility.

Although the business focuses primarily on longer-term trends, this short-term strategy provides an extra layer of protection allowing the firm to react swiftly to market changes. A combination of diverse timeframes gives ETC its balanced portfolio — reducing over-exposure to any single market condition.

The Gauntlet: Stress-testing trading systems

If you’ve got a trading strategy you think is the one to rule them all, consider running it through ETC’s rigorous stress-testing process: the Gauntlet.

“We’ve had people call us just to have their systems run through the Gauntlet,” Rob says. “It’s an intensive barrage of tests to tear apart a system and see where it might fail.”

The Gauntlet doesn’t just test the systems themselves, but also evaluates the software running those systems: “It can find very subtle glitches in the program that otherwise would be nearly impossible to find,” Bill says. This level of detail means that any system that runs the Gauntlet successfully should be robust enough to withstand different market environments.

What’s more is that the Gauntlet helps eliminate emotional bias from trading decisions. As Rob explains, “Bill has taught us to be as scientific as possible and eliminate the emotion from decision-making.”

By rigorously evaluating each system and eliminating the potential for overfitting or underfitting, ETC ensures that only the most resilient strategies make it to live trading, safeguarding client capital and long-term performance.

Keep your eyes on the prize — and the danger — to stay ahead

ETC leadership offers a clear roadmap for navigating the complexities of modern trading. From emphasizing risk control over market prediction to recognizing the critical role of research and innovation in systematic trading.

“The structure of the market is that the money flows from the many to the few,” Bill says. “So you have to be among the few, not among the many.” By focusing on risk, overcoming human instinct, and continuously improving trading systems, investors can easily position themselves as the chosen few who rise above the lagging many.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• Activist treasury issuance is a hidden tool that is quietly impacting markets and the economy.
• The labor market isn't as weak as headlines suggest; slowing hiring doesn't always signal a recession.
• The US dollar's dominance endures despite geopolitical tensions and the rise of alternative assets.

When we talk about the resilience of markets and the U.S. economy, most discussions revolve around the Federal Reserve’s monetary policy. We analyze interest rate hikes, quantitative easing, and the elusive neutral rate. But what about the other levers influencing the economy? “Activist treasury issuance has had a profound impact on markets and, through markets, the economy,” says Stephen Miran, a Senior Strategist at Hudson Bay Capital and a Fellow at the Manhattan Institute.

Stephen brings a unique perspective to the table, blending academic expertise with practical market experience. He's not just a theorist; he's a seasoned market participant, having previously served as a senior advisor for economic policy at the U.S. Department of the Treasury and managed portfolios at firms like Sovarnum Capital and Fidelity Investments. His recent paper, co-authored with Nouriel Roubini, on activist treasury issuance has garnered significant attention in the financial world. Stephen also contributes to leading publications like the Wall Street Journal, Barron's, and Bloomberg.

In this blog post, we’ll explore Stephen's analysis of several key macroeconomic themes, including activist treasury issuance, the current labor market dynamics, the debate around the neutral interest rate, and the looming concerns about fiscal policy and geopolitical risks. His perspectives offer valuable context for understanding the intricate forces shaping the global economy.

Activist treasury issuance and its impact

One of the most intriguing aspects of Stephen’s analysis centers on activist treasury issuance (ATI). So, what exactly is ATI? In essence, it involves the Treasury strategically managing the issuance of government debt, favoring short-term bills over longer-term bonds.

“The way ATI works,” Stephen explains, “is it limits the creation of interest rate risk-bearing, duration-bearing, notes and bonds and instead gives them more bills.” This approach mimics the effects of quantitative easing by injecting liquidity into the market and lowering long-term yields.

Stephen emphasizes that ATI, while impactful, is not a magic bullet. He estimates its impact to be “about a one-point cut to the Fed funds rate,” acknowledging that other factors contribute to market buoyancy. However, he strongly believes that the Treasury's shift towards bill issuance has significantly influenced market behavior and economic growth.

Why is the Treasury engaging in ATI even though it deviates from traditional Treasury policy, which prioritizes minimizing long-term borrowing costs? Stephen suggests that the motivation behind ATI may stem from a desire to mitigate upward pressure on long-term yields and maintain favorable financing conditions. However, this tactical approach comes with its own set of risks.

The increased reliance on short-term debt raises concerns about future refinancing challenges.. “You eventually have to undo it,” he cautions, “and if you eventually undo it, then you know you're going to be raising yields at a time that might be very inopportune.”

The labor market paradox

Turning to the labor market, Stephen identifies a puzzling disconnect between GDP growth and slowing hiring rates. While acknowledging that the labor market has weakened from its peak, he doesn't see signs of a precipitous decline. Instead, he offers a nuanced perspective, challenging the conventional narrative that a slowing hiring rate automatically signals an impending recession.

Stephen observes that the initial increase in unemployment earlier this year was primarily driven by new entrants and re-entrants to the labor market, particularly younger demographics. These individuals may have benchmarked their salary expectations to the exceptionally strong labor market of 2021-2022, leading to a temporary mismatch between their reservation wages and available opportunities.

Furthermore, Stephen draws an analogy between the labor market and inventory cycles, suggesting that companies may be experiencing a bullwhip effect. “Everyone hired everyone they could,” he explains, and now, with growth moderating, they're slowing down hiring to “wait for their revenues to grow into their headcount rather than reducing headcount now.”

He emphasizes, “The reduced hiring rate is the number one concerning thing about the labor market, But the reduced hiring rate is not indicative of a sharp decline in aggregate demand as would normally be the case.” This nuanced view offers a more optimistic interpretation of current labor market trends.

The neutral rate debate and Fed policy

Neutral interest rate — the rate that neither stimulates nor restricts economic growth — is central to monetary policy discussions. Stephen weighs in on this debate, expressing skepticism about the Fed's current assessment of where neutral lies. “I'm willing to say with confidence that it's above where the Fed thinks it is,” he asserts, pointing to the continued robust GDP growth despite the Fed's insistence on restrictive policy.

Stephen argues that the Fed's recent rate cut was a misstep fueled by a misreading of labor market signals and an overemphasis on short-term data fluctuations. He advocates for a less interventionist approach, suggesting that the Fed should avoid micromanaging the economy and instead focus on responding to more significant and sustained trends. Excessive focus on minor data wiggles can lead to policy errors and exacerbate market volatility.

Stephen questions the Fed’s framework for determining the neutral rate, highlighting the inherent difficulty in accurately measuring both inflation and the neutral rate itself. The significant measurement error in these crucial economic variables should encourage greater policy humility and a less reactive approach to monetary policy adjustments.

He points out that the bond market, specifically the five-year/five-year forward TIPS rate, provides a reasonable guess for estimating the longer-term neutral rate. Stephen encourages a more cautious and data-driven approach to monetary policy, emphasizing the limitations of current economic models and the importance of avoiding overreactions to short-term market fluctuations.

Fiscal policy and deficit concerns

Looking beyond monetary policy, Stephen expresses significant concerns about the trajectory of U.S. fiscal policy. He emphasizes the importance of addressing the growing national debt and its potential implications for long-term market stability. “I’m worried about the bond market on a medium-term basis,” he admits, “unless we start to address the deficits.”

Stephen argues that the current fiscal path is unsustainable and that rising deficits will ultimately weigh on bond markets and potentially destabilize government finances. The impending exhaustion of the Social Security and Medicare trust funds are looming fiscal challenges that demand proactive solutions.

While acknowledging that immediate action isn't necessarily required, Stephen emphasizes the urgency of developing a long-term plan to address these fiscal imbalances. Delaying these difficult decisions will only exacerbate the problem and increase the risks to the economy. He advocates for a responsible fiscal approach that balances necessary spending with measures to control the growth of the national debt.

Geopolitical risks and the dollar's future

Geopolitical risks play an increasingly important role in shaping macroeconomics. Stephen acknowledges these complexities but downplays concerns about the U.S. dollar losing its global dominance, at least for the foreseeable future. He argues that the dollar's status as a safe haven asset, combined with the lack of viable alternatives, ensures its continued reign in international finance.

“There’s not really a good alternative,” Stephen observes, noting that other potential reserve currencies lack the liquidity, depth, and stability of the U.S. treasury market. While other countries may desire to reduce their reliance on the dollar, they are stuck due to the absence of a compelling substitute.

Even the rise of cryptocurrencies, Stephen argues, does not pose a significant threat to the dollar's dominance. The deflationary nature of many crypto assets makes them unsuitable for supporting the growing transaction and savings needs of the global economy.

Macro insights that matter

Don't just react to market headlines — understand the underlying forces at play. Stephen reveals the hidden impact of activist treasury issuance, challenges conventional narratives about the labor market, and reinforces the dollar's enduring strength, giving investors a crucial edge in uncertain times. This isn't just about understanding the present; it's about anticipating the future.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• Inflation’s impact just won’t let up, and the Fed has its work cut out for it in trying to tame it. There’s a tightrope walk between maintaining economic stability and lurking recession.
• A soft landing is more likely than it was a year ago, but recession risks remain real: Any economic shock — be it from labor market disruptions or unexpected global events — could still send the economy into a tailspin.
• Meanwhile, the growing U.S. deficit heightens the pressure: While not yet at crisis point, it’s far from sustainable long-term. Fiscal policy and political gridlock could expand the deficit, driving up bond yields and exacerbating the Fed’s challenge to maintain inflation and growth.

Jason Furman, Harvard professor and former Chair of the Council of Economic Advisors, is no stranger to navigating economic uncertainty. And boy, is he the man for the hour.

As one of the most respected voices in modern economics, Furman is primed to share insights on persistent inflation, the Federal Reserve (Fed)’s complex balancing act, and the long-term risks of rising government debt.

At a time when central banks are struggling to rein in inflation without derailing economic growth, Furman gives a sober analysis of why traditional monetary tools may not be enough. Just look at the inflation data: “When we have a bad month, it’s really bad,”Furman says. Headline numbers show improvement, but underlying pressures remain uncomfortably high. Recession risk and inflationary pressure together paint a picture of an economy caught between a rock and a hard place.

And he knows how precarious the Fed’s current strategy really is. If it’s forced to keep interest rates higher for longer than markets expect — despite the growing calls for rate cuts — it’ll be clear why. And while Furman acknowledges the potential for a soft landing, he’s wary of a bumpy ride.

As if inflation and interest rates weren’t enough to worry about, Furman gives us one more thing: the looming threat of unsustainable government debt. Expect higher deficits as a result of rising borrowing costs and political gridlock, as fiscal policy causes headaches for both investors and policymakers.

Furman’s most crucial insights — from why inflation is proving so stubborn to how China’s economic recovery could send shockwaves through global markets — follow.

Inflation: Something’s gotta give, but it just ain’t letting go

Inflation’s decline has been slower and more erratic than expected. While some headlines celebrated the drop in inflation to its lowest levels since the pandemic, Furman cautions that core inflation — a key metric for predicting future inflation trends — is proving to be more resilient.

“The headlines were talking about the lowest inflation rate of the whole inflationary period. But every hundredth of a miss is a tenth of a miss at an annual rate,” Furman says. Even a slight deviation in the core inflation rate could amplify the problem big time, potentially complicating the Fed’s path forward.

The core issue? Inflation is “stickier” than many analysts expected, Furman explains. Labor markets are looser than they were pre-pandemic, but they continue to apply upward pressure on prices, preventing inflation from falling back to pre-crisis levels. “When we have a bad month, it’s really bad. When we have a good month, it’s just normal,” he says.

Labor market’s influence on inflation

One of the reasons inflation has been slow to decline is the continued strength in the U.S. labor market. While wage growth has slowed compared to the height of the post-pandemic recovery, it’s still robust enough to support consumer spending, which in turn is keeping prices elevated.

“The labor market is looser than it was in 2019 by a variety of different measures,” Furman says, but he cautions that this doesn’t mean inflation will drop quickly. The key issue is that while labor markets have eased, they haven’t weakened to the point where they put substantial downward pressure on prices. As a result, inflation could remain higher than the Fed’s target for longer than expected.

A heckuva dilemma

One of the most pressing macroeconomic questions is how the Fed plans to balance the twin risks of inflation and economic recession. There’s a very fine tightrope walk between maintaining credibility and managing inflation without triggering a recession.

The Fed may well be forced to cut interest rates more slowly than markets anticipate, with a faster decline reigniting inflationary pressures. “The neutral rate is a real thing,” Furman says, “but we don’t quite observe it. We don’t quite know what it is.” Such uncertainty makes the Fed’s task even more complicated, as it tries to gauge the impact of each rate decision.

But if the Fed moves too aggressively with its rate-cutting exercise, inflation may morph into a real threat: “There’s just this big question that we don’t know the answer to, which is what is the neutral rate today?”

Mission: Fed transparency

As it walks such a fine line, the Fed focuses on what it can control: its communication strategy.  Furman acknowledges that it’s recently moved towards greater transparency in a bid to manage market expectations and anchor inflation expectations. But even if it helps to be open, is it now too open? Furman reckons it may have gone too far, sometimes causing market volatility.

“Everyone I know is just so negative about the Fed’s transparency,” Furman highlights. While it’s a strategy designed to build credibility, it can lead to overreactions in the market. Investors hang on every word from Fed officials, sometimes misinterpreting short-term data shifts as signals for long-term policy moves. Furman’s take? “You know, a lot of people are profiting off it,” but that doesn’t mean the volatility is desirable.

However, he acknowledges that the Fed’s transparency is more good than bad overall, particularly in anchoring inflation expectations. It could just do with dampening the noise from time to time to regain some clarity. “They don’t know what the neutral rate is. They don’t know how many percentage points above neutral you should be,” he says. But it’s always difficult to give precise guidance in an uncertain environment.

Data dependence shapes policy decisions

One of the hallmarks of recent Fed policy has been its data-dependent approach. The idea behind data dependence is that the Fed will adjust its policy based on the latest economic data, rather than sticking to a preset path. While this allows the Fed to react to real-time developments, Furman points out that this can sometimes lead to increased volatility as markets respond to every new data point.

“We’ve had revisions to employment and GDP data: you get a slightly different picture than if you were basing policy just on the actual release,” Furman explains. He suggests that while data-driven policy is crucial, it requires a steady hand, and over-reliance on short-term numbers can create more noise than signal.

Furman advocates for a broader perspective, arguing that while data revisions are normal, the Fed should focus on long-term trends rather than reacting too quickly to minor data fluctuations. “Look at the 10-year rate: It moves around a lot,” he says. “These data points come out, and it can move up 5, 10, or 15 basis points — or down by the same amount.

The point underscores the challenge of balancing short-term reactivity with long-term stability.

Debt just keeps on growing and growing

Meanwhile, the long-term risk of growing U.S. government debt is ever-present. While he doesn’t see an immediate crisis, Furman points out that rising interest rates are already putting pressure on the federal budget, and this pressure could increase significantly in the coming years.

“When the 10-year yield is around 4%, it doesn’t really send me off panicking,” Furman notes, but adds that the growing debt is still unsustainable in the long term. He anticipates that future administrations — especially with rocketing debt-servicing costs — will need to bite the bullet once and for all.

Political gridlock might not help either: “Divided government can do plenty,” he says. “You get your stuff in exchange for me getting my stuff, and the union of everyone’s stuff might even be bigger.” Furman’s view is that fiscal policy could end up being even more expansive in the coming years, exacerbating existing challenges around inflation and debt management.

It’s ultimately all about the deficit

Furman stresses that the U.S. federal deficit will play a critical role in shaping financial markets in the coming years. He notes that while deficits have long been a concern, the current fiscal outlook is more worrisome due to the combination of these high debt levels and rising interest rates.

“We’re getting more manufacturing structures built,” Furman says, “but that’s because of the nature of fiscal policy.” The issue, however, is that this increased spending could crowd out other investments and eventually put upward pressure on interest rates. This would create a feedback loop where higher rates increase the cost of borrowing, leading to further fiscal strain.

The angle from the East: Global economic repercussions

Don’t forget to look to China, and how its economic recovery could affect the global economy. Furman argues that while the behemoth’s stimulus efforts are a welcome development, they won’t fully solve the country’s deeper structural challenges.

A ripple effect on global markets is likely, particularly in commodities. “China should stimulate, and now they’re finally doing it,” he notes. But while global commodity prices in the short term will send commodity prices up, the stimulus doesn’t address the long-term demographic and productivity issues that China faces.

Global investors should be wary of volatility in commodity prices and additional inflationary pressures in markets heavily reliant on Chinese demand.

Geopolitics and the future of the U.S. dollar

Amid rising geopolitical tensions, Furman also touches on the role of the U.S. dollar in global markets. He suggests that while the dollar remains dominant, its future as the world’s reserve currency isn’t guaranteed.As countries like China and Russia explore alternatives to the dollar in global trade, the U.S. could face increasing pressure to maintain its currency’s status.

“The dollar is the denominator of most global trades and FX transactions in the world,” Furman explains. But as the global economy becomes more fragmented, Furman warns that transitioning away from the dollar won’t be an orderly process. This shift could introduce significant volatility in currency markets and create new challenges for global investors.

Prepare for uncertainty…and anything

The economy continues to stumble between continued inflation and an outright downturn — with any number of factors potentially throwing it off balance.

“We’re probably having a soft landing,” Furman says, “but we’re not all the way there yet.” The Fed continues to weigh the risk of tightening too much against the risk of doing too little. The buzzword of the moment is uncertainty.

Investors and policymakers alike need to be prepared for multiple potential outcomes — from higher-than-expected inflation and increased geopolitical tension disrupting global markets to further Fed rate hikes or cuts.

“There’s still plenty that could go wrong,” Furman says. “Investors need to stay nimble.”

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• China's recent stimulus measures are more than a “kitchen sink” reaction; they signal a strategic shift with global implications.
• A Trump victory in the U.S. election could trigger a weaker dollar and a surge in emerging markets.
• Europe's economic challenges run deep, with misguided energy policies and declining productivity undermining its future prospects.

Global markets are on edge. From persistent inflation and rising interest rates to geopolitical uncertainty and concerns about a slowdown in China, investors are grappling with a complex and unpredictable landscape. Amid this turbulence, however, contrarian voices are emerging, challenging the prevailing doom-and-gloom narrative.

Louis-Vincent Gave, founding partner and CEO of Gavekal Research, is one such voice. Known for his sharp insights on Asian markets and global macro trends, Louis-Vincent believes that investors need to broaden their horizons and look beyond the usual suspects, particularly in light of China's recent policy shift.

He argues that the wave of stimulus measures announced by the Chinese government is not simply a desperate attempt to prop up a failing economy, as some have suggested, but a calculated strategy with the potential to trigger a significant shift in global capital flows.

“I think it's definitely the turning point for the Chinese markets,” said Louis-Vincent. While acknowledging the real challenges facing the Chinese economy, particularly in the real estate sector, he emphasized that “markets do anticipate these kinds of things.”

Louis-Vincent's core argument rests on the idea that investors are often overly focused on the magnitude of a problem rather than the direction of change. “Very often, where there’s the most money to be made is when a situation goes from very, very bad to just mediocre,” he explained. “And just in that move from very bad to mediocre, a lot of assets get repriced.”

China’s policy pivot: More than meets the eye

Despite Louis-Vincent's optimism, skepticism abounds. Many market commentators have dismissed China's stimulus efforts as a futile attempt to revive an economy burdened by excessive debt and a slowing property market. However, Louis-Vincent argues that this time is different.

“This isn't going to trigger a new construction boom,” Louis-Vincent asserts. He draws a parallel to Ireland's recovery from its real estate crisis, noting that it took years for construction to meaningfully pick up, even after the initial stimulus measures were implemented.

Louis-Vincent points out that much of China's infrastructure spending in previous cycles focused on building out high-speed rail networks and other large-scale projects, but these are now largely complete. “90% of Chinese people now live within an hour's drive of a high-speed rail station,” he explains. This lack of a need for further infrastructure development, he argues, will dampen demand for commodities like copper and iron ore, even as the government eases fiscal and monetary policy.

Instead of fueling another construction frenzy, Louis-Vincent believes that this stimulus package is designed to address specific vulnerabilities within the Chinese economy. He highlights two key demographics that are currently experiencing economic hardship: millennials in tier 1 and 2 cities who have been impacted by the property market downturn and older demographics in rural areas who have been left behind by China's rapid economic growth.

“If you're the government, you think, ‘Okay, these are the two groups that basically we need to help out because they’ve been screwed over in the past five to ten years,'” Louis-Vincent explains. “So what you do is you do handouts to the guys in the countryside, and this has already been announced. We’re going to send checks to the poorest 15% of the population, which basically is the older folks in the rural areas.”

For millennials in major cities, Louis-Vincent argues that the government is deliberately engineering an equity market boom to bolster their wealth and confidence. This approach, he notes, is evident in the government's decision to cap bonuses for financial professionals, preventing them from profiting excessively from the market upswing. “You crank up the stock market,” he says, “and you make it very obvious to these guys, you say, ‘Look, you guys actually do have some savings. Put them in the stock market, we’ll crank that up, and you’ll make some money.'”

The U.S. election: A Trump victory could spark a global reflationary boom

In the United States, Louis-Vincent sees another potential catalyst for a global reflationary cycle: the upcoming presidential election. While acknowledging that the betting markets currently view the race as a coin flip, he expects a Donald Trump victory.

“I think Trump’s going to win,” Louis-Vincent states, pointing to historical polling data and current trends in key swing states. “So, if we assume that Trump wins,I think the general perception of a lot of investors I talk to is that, if Trump wins, he comes in and he’s very brash, and he’s rude to all the countries, especially China, and that this leads to a further deterioration in the China-U.S. relationship.”

However, Louis-Vincent challenges this assumption, arguing that Trump's current circle of advisors, including figures like Elon Musk and Robert F. Kennedy Jr., suggests a more nuanced approach to foreign policy. “Fast forward to today, and Trump is surrounded by people who are far less abrasive with the rest of the world,” he observes.

He also notes that Trump has been careful to refer to China as a competitor, rather than an enemy, on the campaign trail, suggesting a willingness to find common ground. This, combined with Trump's stated desire to find a solution to the Ukraine war, could lead to a more constructive dialogue between the two superpowers. Louis-Vincent suggests that such a scenario could involve the U.S. easing sanctions on China in exchange for pressure on Russia to agree to a peace deal favorable to Ukraine.

“I think in terms of foreign policy, it could be quite a good thing,” Louis-Vincent contends.

Looking beyond geopolitics, Louis-Vincent believes that a Trump victory could have significant implications for the U.S. dollar and global markets. He suggests that a new “Plaza Accord” scenario, similar to the one enacted in the mid-1980s, could be on the horizon, with the U.S. pushing for a weaker dollar to boost its exports and rebalance global trade. This, he argues, could involve putting pressure on countries like Japan, China, and South Korea to revalue their currencies.

“The possibility of a big new Plaza Accord in which the U.S. dollar is driven down, I think is a distinct possibility if Trump is elected,” he says. “If that does happen, then to be honest, I think most people don’t have enough risk in their portfolios because all risky assets will absolutely rip higher.”

But Louis-Vincent acknowledges that a weaker dollar could lead to a steeper U.S. yield curve, with long-term interest rates rising to 5.5% or 6%. This could create challenges for the U.S. government in financing its already massive debt, particularly given its reliance on foreign investors.

A world of shifting capital flows: Where should investors look?

As China embraces stimulus and the U.S. potentially shifts toward a weaker dollar, Louis-Vincent sees a fundamental realignment taking place in global capital flows. He argues that the U.S., despite representing only 4% of the global population, currently commands a disproportionate share of global capital, accounting for 70% of the MSCI World Index. This, he believes, is unsustainable in the long run, particularly as emerging markets offer more compelling growth opportunities.

“Can you have 70% of the capital allocated to the U.S. when it’s a third of the profits?” Louis-Vincent asks. “There’s a dislocation there.”

He predicts that the coming years will see a significant shift in capital away from the U.S. and towards emerging markets, particularly as China's growth accelerates and the dollar weakens. This doesn't necessarily signal a U.S. recession or a bear market, he clarifies, but rather a period of relative underperformance compared to other markets.

To illustrate his point, Louis-Vincent highlights the example of Microsoft, arguing that the tech giant's high valuation has been driven in part by foreign investors seeking a safe haven for their U.S. dollar holdings. As the dollar weakens and other opportunities emerge, he believes this dynamic could reverse, leading to capital outflows from U.S. equities.

“For me, Microsoft, Apple, Amazon, these guys have been receptacles for the excess dollars in the world,” he says. “And that made sense in a strong dollar world. But I think this is the phase where we’re now going to be entering is people say, ‘you know what, U.S. dollars no longer going up. I don’t need to keep as much U.S. dollar assets and I can let go of my Microsoft now and maybe I buy Tencent that’s a quarter of the value.’”

Expanding on his emerging market thesis, Louis-Vincent argues that the historical drivers of emerging markets (EM) performance are now aligning, creating a compelling opportunity for investors. “For my whole career, EM either played on a weaker dollar, and now all of a sudden, the U.S. dollar seems to be weakening, or it’s a play on China doing better,” he explains. “For my whole career, that’s been it. You buy EM when the dollar is weak, and you buy EM when China’s reaccelerating. And if you have both at the same time, China reaccelerating and the U.S. rolling over, EM [will] do very, very well.”

Louis-Vincent specifically highlights Brazilian bonds as an attractive investment, noting their high real yields and Brazil's embrace of trade with China. He contrasts this with the U.S., which is increasingly rejecting China's deflationary impact through tariffs, potentially leading to higher structural inflation.

This dynamic, he argues, makes emerging markets that are embracing trade with China a more attractive destination for fixed-income investors. He prefers, for example, “a Brazilian tip offering 6.5% real than a U.S. tip offering 1.7% real, at a time when Brazil is embracing trade with China and the U.S. is doing the opposite.”

He also notes that while some emerging markets, such as India, Indonesia, and Malaysia, have performed well even during the recent period of dollar strength, other markets, such as Brazil and Chile, have lagged. However, he believes that these lagging markets are now “dirt cheap” and poised to benefit from China's reacceleration and the potential for a weaker dollar.

The productivity puzzle: Energy policy and Europe's challenges

While Louis-Vincent is optimistic about the prospects for emerging markets, he expresses significant concerns about Europe's economic future. He argues that Europe has made a series of policy missteps over the past two decades, particularly in the areas of energy, industry, and immigration, which have undermined its competitiveness and productivity.

“If you go back 15 years ago, 20 years ago, France had a huge comparative advantage relative to the rest of the world,” Louis-Vincent notes. “We were far ahead of everyone in nuclear energy.” However, he laments, France, along with Germany, has since retreated from nuclear energy, sacrificing its productivity advantage “to please a small minority of greens.”

Louis-Vincent contrasts Europe's struggles with the U.S., which has benefited from the shale boom and the resulting abundance of cheap natural gas. “The U.S. has had one massive comparative advantage, it has been the shale boom,” he observes. “It has been the fact that the price of natural gas has gone from $10 down to $2.” This energy advantage, he argues, has been a key driver of the recent surge in U.S. productivity.

Looking ahead, Louis-Vincent sees some potential for Europe to regain its footing, particularly as the war in Ukraine has highlighted the strategic importance of energy independence. He notes a “big zeitgeist shift on nuclear,” suggesting that there is now greater political will to invest in this technology. However, he remains skeptical that Europe can overcome its deep-seated structural challenges, particularly given the growing burden of its aging population and the political difficulties of reforming its welfare state.

“I hope we’ll see it. I fear we won’t,” Louis-Vincent says of the prospects for Europe to enact meaningful reforms. “And I say this as a Frenchman, I fear we won’t.”

He highlights the link between defense spending and technological innovation, noting that countries with strong defense industries, such as the U.S., Taiwan, South Korea, and Israel, have also been leaders in technological development. Europe, he argues, has fallen behind in this area due to its decades-long decline in defense spending.

“We spent 25 years cutting out defense spending,” Louis-Vincent observes. “Because if you’re in government and you think, ‘okay, I mustn’t have budget deficits and I must reduce my spending, the easiest one to cut is always the army because they don’t complain.’” The result, he argues, is that “we have no more tech sector in Europe.”

While Louis-Vincent acknowledges the suggestions from former European Central Bank President Mario Draghi for greater European coordination on defense spending and energy infrastructure, he remains pessimistic about the likelihood of these proposals being implemented. “There’s no appetite for it today,” he concludes.

A world in transition: Embrace the change

From China's bold policy pivot to the potential for a reflationary wave sparked by a Trump presidency, Louis-Vincent Gave paints a picture of a global economy undergoing a profound transformation. Investors who cling to outdated narratives and fail to recognize these shifts risk missing out on significant opportunities.

As capital flows realign and new growth drivers emerge, it's essential to challenge conventional wisdom and embrace a more nuanced understanding of the forces shaping global markets. The time to adapt is now.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• The shift to digital currencies is inevitable, with cash becoming increasingly obsolete in many parts of the world.
• Private companies and foreign governments are racing to establish dominant digital currencies, potentially threatening national economic sovereignty.
• Government-backed digital currencies, like the proposed “Fed Coin,” could revolutionize finance while preserving democratic control over monetary systems.

When we talk about the future of money, most of us tend to think about credit cards, online banking and maybe even mobile payment apps, digital wallets and cryptocurrencies like Bitcoin.

But cash isn't dead yet, even if it's increasingly rare in our day-to-day transactions.

“What is money going to look like in the coming decades? Who's going to control it? Could it be a private company? Could it be Amazon or Google? Could it be a country like China?” These are the pressing questions posed by economist Richard Holden in his new book, Money in the 21st Century: Cheap, Mobile, and Digital.

Richard is a professor of economics at the University of New South Wales in Sydney. His previous roles include faculty positions at the University of Chicago and MIT, where he honed his expertise in contract theory and its application in finance.

When he's not teaching or researching, Richard writes a column for the Australian Financial Review, where he first proposed the idea of Australia becoming a fully cashless society. This seemingly radical notion sparked a year-long experiment where he lived entirely without cash, proving it was not only possible but surprisingly easy.

Despite the rapid digitization of finance, Richard warns of a looming threat: “You can imagine if Libra had gotten a foothold and controlled this reserve with hundreds of billions or trillions of dollars to allocate between U.S. treasuries, British government securities and so on. They'd be in a position to say, ‘Hey Australia, you make up 5% of the Libra reserve, but we're thinking you've got some quirky government policies. We might need to reduce that allocation.'”

Read on for an in-depth discussion on the future of money, central bank digital currencies, and the potential threats posed by private digital currencies. We explore the case against cash, the looming threat of corporate-controlled money, and why governments need to act fast to maintain control of their monetary systems.

The case against cash

At first glance, the arguments for keeping cash in circulation seem compelling. Proponents often tout its anonymity and reliability during power outages or natural disasters. But Richard, armed with both economic theory and practical experience, systematically dismantles these arguments.

Richard points out that this feature disproportionately benefits bad actors. “The flip side of that is cash provides anonymity for drug dealers and child traffickers and tax evaders and stuff,” he explains. “And I, to be honest, think that's much more of a problem than it is for people who are cheating on their wives or freaking out about government unnecessarily.”

As for emergencies, Richard challenges the notion that cash is essential. “If there's a big blackout, if there's a tsunami, you're probably not out buying coffee, right? You are probably scrambling for higher ground.” He argues that in major crises, businesses are likely to shut down regardless of payment method, rendering the cash-in-hand argument moot.

The surprising ease of cashless living

Richard's year-long experiment living cashless revealed an unexpected truth: “To be honest, it was the easiest bet ever to win. And I get it that I live in a major capital city, and I'm kind of a bit more digitally engaged than your average 80-year-old retiree, but it was the easiest thing ever.” This experiment wasn't just a personal challenge; it was a response to skeptics who doubted the feasibility of a cashless life.

This ease of cashless living isn't just anecdotal. Countries like Sweden and Australia are far along the path to becoming predominantly cashless societies. The infrastructure for digital payments is already in place, from tap-to-pay cards to smartphone apps, making the transition smoother than many might expect.

The hidden costs of cash and the digital advantage

Richard argues that clinging to cash is not just unnecessary but also potentially harmful. It slows down the adoption of more efficient payment systems and hampers the development of innovative financial technologies. As he puts it, “When the system is set up well, as it is in countries like Sweden and other European countries, Australia, New Zealand, and a bunch of other countries, it's very easy to go without using cash. And that has a whole lot of benefits for consumers and for businesses themselves.”

Interestingly, recent events have shown that digital payments can be more resilient than cash in certain situations. During a recent global software glitch, Richard observed that many businesses could only accept card payments, not cash, due to their reliance on digital systems.

But who will control this new financial frontier?

The looming threat: Private digital currencies

As we move away from cash, a new contender emerges in the battle for financial control: private digital currencies. These aren't your run-of-the-mill cryptocurrencies like Bitcoin or Ethereum. Instead, we're talking about digital currencies potentially issued by tech giants like Amazon, Google or Facebook. Richard argues that this scenario is a looming threat that governments need to take seriously.

Facebook's attempt to launch its digital currency, initially called Libra and later rebranded as Diem, came alarmingly close to becoming a reality. Richard recounts, “Facebook had gotten really far down the curve on getting this established. They'd got Visa and Mastercard to agree to be part of the consortium. They got a whole lot of really big vendors and kind of quasi financial institutions or financial institutions to sign up to it.”

The appeal of such a currency is clear. Facebook “basically said, we're going to bank the unbanked, and we're going to make this better, and we're going to solve the problems with some of the existing digital coins where you worry about how well-backed they are,” Richard explains.

The power and peril of private money

The implications of a private company controlling a global currency are profound. Richard argues that it would give these companies unprecedented leverage to negotiate with governments on issues ranging from tax treatment to regulatory policies.

The power of network effects could rapidly entrench such a currency. Richard draws a parallel with the rise of ride-sharing apps: “Think about Uber, and if you're a rider on Uber, it's good when there are lots of drivers because you don't have to wait very long to get picked up.” He argues that a similar dynamic could quickly establish a private digital currency as the dominant form of money in many transactions.

The global race for digital currency dominance

This scenario presents a clear challenge to government monetary policy and economic sovereignty. “I worry a lot about a private company having that kind of leverage,” Richard admits, “So it's not like I'm anti-business, but I think handing business that kind of power would be pretty troubling.”

The threat isn't just from private companies. China is already far along in implementing its central bank digital currency, the e-CNY. “There are hundreds and hundreds of millions of people in China who are using a government digital currency on a daily basis, and they are very clearly moving towards eliminating cash in China and making everything digital,” Richard notes.

As private companies and other nations race ahead, the question becomes: How should democratic governments respond? According to Richard, the answer lies in a proactive approach—one that could reshape the very nature of money as we know it.

The solution: A government-backed digital currency

In the face of threats from both private companies and foreign governments, Richard proposes a bold solution: the creation of a government-backed digital currency, which he dubs “Fed Coin.” This isn't just a defensive move; it's an opportunity to revolutionize our financial system and unlock new economic possibilities.

What is Fed Coin?

Fed Coin, as Richard envisions it, would be a central bank digital currency (CBDC) issued and managed by the Federal Reserve. Unlike cryptocurrencies like Bitcoin, Fed Coin would use a centralized ledger, leveraging the existing trust in the Federal Reserve system.

The mechanics of Fed Coin would be surprisingly familiar to most users. “You'd basically just have an app on your phone,” Richard says. “And your bank account would tell you you've got this many U.S. dollars. It will look exactly the same, but everything would transact digitally, and there'd be no paper currency sloshing around.”

Richard draws an interesting parallel to illustrate the existing trust in centralized systems: “Even the crazy libertarian guys, they still trust the Fed to the degree that they're willing to hold US dollar banknotes, right? And so there is already a lot of trust in the Federal Reserve.”

The benefits of Fed Coin

Fed Coin isn't just about replacing cash; it's about creating a more efficient and innovative financial system. Richard argues that it could unlock the potential of Web3 and smart contracts, areas currently hampered by the volatility and complexity of existing cryptocurrencies.

“Create a coin that's got all these programmable money features and you can smart contract with, but that doesn't have the downside of the anonymity of the blockchain,” Richard proposes. This would enable a wide range of new financial products and services while maintaining regulatory oversight.

Richard elaborates on the potential of smart contracts: “I can write a computer script that's kind of self-executing. We don't need a court of law to adjudicate the contract; we don't need to adduce evidence about whether you performed your bit of it.”

He gives an example: “If I want to write, for instance, an insurance contract on a weather event that's verifiable by stuff that's in the public domain. What was the wind speed of a cyclone? How much did it rain in Boise on a particular day? These contracts happen all the time for kind of risk sharing purposes and so on.”

Moreover, Fed Coin could promote financial inclusion and stability. By providing a digital alternative to cash that's backed by the full faith and credit of the U.S. government, it could bring more people into the formal financial system and reduce reliance on costly alternative financial services.

Challenges and considerations

Of course, implementing Fed Coin isn't without challenges. Richard acknowledges that there would be significant political hurdles, particularly given the distrust some segments of the population have toward government institutions.

There's also the question of how Fed Coin would affect commercial banks. “Commercial banks would be in a different position here,” Richard notes. While banks would still play a crucial role in financial intermediation, their ability to create money through lending would be curtailed.

Despite these challenges, Richard argues that the benefits far outweigh the costs. “I think administrations of both political persuasions have a rationale for being concerned about the threat from China, which I think is very real and, in another way, the threat from private providers.”

The urgency of action

Richard emphasizes that time is of the essence. The longer democratic governments wait to implement their own digital currencies, the more ground they cede to private companies and potentially adversarial foreign powers.

“I think the answer here is to compete — not to try and negotiate,” Richard asserts. He believes that U.S. leadership in this area is crucial, not just for America's economic interests, but for the global financial system as a whole.

Interestingly, Richard sees the potential for smaller countries to lead the way: “Inflation targeting came out of New Zealand, and it's probably the most important practical thing that's happened in macroeconomics in half a century.” He suggests that a similar pioneering role could be played when it comes to central bank digital currencies.

As we stand at this monetary crossroads, the choices we make now will shape the future of finance for generations to come. Fed Coin, or something like it, may well be the key to ensuring that our financial system remains stable, innovative, and most importantly, under democratic control.

Digital money's watershed moment

The financial world stands on the precipice of a revolution. The call for urgent action, particularly from democratic governments, isn't merely about preserving economic sovereignty—it's about crafting a financial system that upholds democratic values and serves the public interest. While implementing a government-backed digital currency presents challenges, the potential benefits are transformative, promising a new era of financial innovation and inclusion.

The next chapter in the story of money is being written today. Our choices now will determine whether it's a tale of progress for all or profit for a few.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• Pension fund managers face a constant challenge: building a portfolio that can deliver consistent returns while withstanding inevitable market fluctuations.
• Strategic partnerships with external asset managers can provide access to specialized expertise and unique investment strategies, enhancing portfolio diversification and resilience.
• A long-term vision, meticulous due diligence, and a commitment to enduring relationships are key ingredients in crafting a successful external portfolio management strategy.

Imagine a portfolio built not just for today's market, but for whatever storms the future might hold. One that can withstand volatility, leverage specialized expertise, and deliver consistent returns over the long term.

This is the power of a strategic approach to external portfolio management — a philosophy that goes beyond simply chasing returns to build true resilience and enduring value.

“Our external portfolio management team is providing a return profile that is a little bit different. It is absolute return-focused and has more consistent volatility than some of the long strategies,” says Amy Flikerski, Head of External Portfolio Management at CPP Investments, one of the world's largest and most respected pension funds with over C$600 billion in assets.

Since 2012, Amy has navigated the turbulent waters of global markets at CPP Investments, building a career spanning both direct investing and fund allocation. She leads a global team of 40 investment professionals who oversee a vast and diverse external portfolio encompassing a range of strategies: from fundamental equity and credit investments to discretionary macro, quantitative strategies and even commodities.

This global reach is essential to CPP Investments' “completion exposure” philosophy which focuses on a hands-on, collaborative approach to partner selection. “We endeavor to give direct quick feedback if it’s not the right fit or we prefer to monitor,” says Amy  “And then similarly, if it’s of interest, we start to progress in terms of triaging around the strategy and the people and the kind of the vision.”

CPP Investments' EPM philosophy

The “completion exposure” philosophy is put into practice through a carefully crafted external portfolio. CPP Investments' external allocations represent around 20% of the fund's total assets, encompassing diverse strategies and geographies. “As part of our private equity efforts, we have a large private equity funds program as well as venture investing,” Amy explains. “So, collectively, those two external programs are about 20% of the total fund.”

But it's not just about adding different investment flavors to the mix. CPP Investments takes a deliberate approach, meticulously selecting external managers who bring unique capabilities to the table. This also helps keep fund expenses down.

This strategic selection process is guided by a clear understanding of where external expertise can truly add value. “Externally we would probably look at more event-driven, catalyst-driven types of fundamental managers, with probably shorter duration investment horizon, whereas our internal active equities colleagues are looking with the longer horizon, larger positions,” Amy points out.

This approach not only diversifies the overall portfolio but also allows CPP Investments to tap into specialized knowledge, gain access to diverse investment strategies, and carefully manage costs. It's a strategic partnership model, leveraging the strengths of both internal and external teams to achieve long-term investment success.

The changing dynamics of the hedge fund industry

The hedge fund world is marked by innovation, disruption, and, as Amy puts it, “a creative destruction element.” Over her 20 years in the industry, she's witnessed these shifts firsthand, observing how managers adapt, strategies emerge and fade, and new players reshape the competitive terrain.

One of the most significant trends in recent years has been the rise of multi-manager platforms, often referred to as “pods.” These firms have attracted significant assets and talent, offering portfolio managers infrastructure, resources, and often lucrative compensation packages.

However, Amy notes that “the bar is very high for us when it comes to the pods, just because of the pass-through.” She says it's difficult to achieve true transparency into the underlying strategies and performance drivers within these complex structures, particularly in a “higher-rate environment where cash is pretty competitive.”

Beyond the rise of platforms, Amy also observes a trend toward the “commoditization” of certain hedge fund strategies. This can lead to increased competition, fee pressure, and potentially diminishing returns for investors.

CPP Investments, however, remains agile, constantly evaluating and adapting its approach to manager selection and strategy allocation. As Amy explains, “There are lots of changes all the time, and seemingly, they come in different waves, depending on the market environment and where we’re at.”

Building a portfolio for the long term: Manager selection and partnerships

At CPP Investments, the process of building a resilient external portfolio is as much about nurturing relationships as it is about selecting top-performing managers. Amy emphasizes a philosophy she describes as “mile deep, inch wide,” prioritizing specialized expertise over broad market coverage. “We really are very deep specialists in the hedge fund field,” Amy explains. “And that’s supported by the large team and the global breadth.”

This means diving deep into specific strategies, understanding the nuances of different approaches and seeking out managers who are true masters of their craft. “So we look at managers of all kinds, and not just through the emerging manager, even on our core funds, portfolio exposures,” Amy says. “Sometimes these are groups that people may not be as familiar with. They’re not necessarily always going to be the household brand name from a hedge fund perspective.”

This commitment to specialized expertise extends to CPP Investments' unique approach to emerging managers. Recognizing that the next generation of talent often requires support and capital to flourish, they've established a dedicated emerging manager program, which allows them to invest early in talent.

This program not only helps promising managers get off the ground but also positions CPP Investments to benefit from their potential long-term success. Importantly, CPP Investments structures these partnerships for longevity. “We think of this as investing early in order to secure future capacity rights and early-stage performance,” Amy says. “So, it’s very much a complement to the core fund managers in which we invest.”

Transparency, meticulous due diligence, and a collaborative approach to portfolio construction are also central to CPP Investments' strategy. They're not just looking for short-term gains but for enduring partnerships built on trust, alignment, and a shared vision for the future.

Navigating volatility and drawdowns

Even with meticulous manager selection and robust portfolio construction, volatility is an inherent part of the investment landscape. Market swings, unexpected events, and periods of underperformance are inevitable.

The key, according to Amy, is to approach these challenges with a calm and considered perspective, guided by a long-term investment horizon. “We’re definitely longer hold investors,” Amy says, describing CPP Investments' approach. “So one way I like to describe it is we’re near-term monitoring. We’re really on top of what’s happening with markets or in the marketplace or with the managers themselves.”

This “near-term monitoring” involves staying informed about market trends, manager performance, and potential risks. CPP Investment's team conducts quarterly portfolio reviews, analyzing data and engaging in deep discussions about each manager. However, monitoring doesn't translate to impulsive reactions.

Instead, CPP Investments favors a more deliberate and patient approach, particularly when faced with drawdowns. She acknowledges that while they have moved quickly on occasion, “on balance, we tend to give up more time rather than less for the managers to work out either performance or team issues or strategy, especially [since] some strategies kind of find themselves out of favor.”

This commitment to working through challenges, rather than making hasty decisions, reflects a belief in the power of long-term partnerships and a deep understanding of the cyclical nature of markets. It also demonstrates a level of trust in their managers, recognizing that even the most skilled investors can experience periods of underperformance. “We have managers in the program who’ve been in there for over a decade,” Amy points out.

The art of enduring partnerships

Building a resilient investment portfolio for the long term requires a strategic blend of vision, expertise, and enduring partnerships. It means embracing a “completion exposure” philosophy, seeking external managers who complement internal capabilities and offer specialized knowledge. It demands a commitment to nurturing emerging talent and recognizing the potential for future growth and innovation. It necessitates a patient, deliberate approach to navigating market volatility, favoring thoughtful analysis and strategic collaboration over impulsive reactions. In a world where short-term gains often overshadow long-term value, a steadfast focus on building strong, aligned partnerships can pave the path to sustainable investment success. True portfolio strength is built on a foundation of enduring relationships.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• The carry trade, a popular strategy for generating steady returns, is facing unprecedented challenges.
• The era of “easy carry” may be ending, as rising interest rates and geopolitical shifts disrupt traditional strategies.
• How should investors adapt to the new carry trade landscape and manage the evolving risks.

The sharp unwinding of the Japanese Yen carry trade in August 2024 served as a stark reminder of the inherent risks of carry trades. Much like the sudden market crash triggered by the COVID-19 pandemic in 2020, the Yen's volatility revealed the precarious foundation upon which carry trades are built.

But are these recent tremors merely isolated incidents, or are they harbingers of a more profound shift in the global financial order — an end to the “Carry Trade Regime?”

“Taking a step back, carry is a trade that makes money if nothing happens,” explains Kevin Coldiron, co-author of The Rise of Carry. At its core, a carry trade involves borrowing in a low-interest-rate currency and investing that borrowed money into an asset with a higher yield.

Investors often use leverage to magnify these potential returns, making the strategy particularly attractive in periods of market calm. Think of it as a bet on stability and predictability. But as Kevin emphasizes, the inherent risk lies in that “something” happening to disrupt this carefully balanced equation.

Familiar examples of carry trades include the classic Yen carry trade, where investors borrow in Japanese Yen at ultra-low rates and invest in higher-yielding assets in other countries. However, the carry trade phenomenon extends beyond currencies. “Financial markets really behave as a kind of giant carry trade,” Kevin points out, noting that even broad market indices, like the S&P 500, exhibit characteristics of this leveraged, stability-dependent strategy.

Read on to gain a deeper understanding of the carry trade's past, present, and uncertain future.

The rise and evolution of carry

Kevin began by painting a picture of the carry trade's evolution over the past few decades. He described a period he calls the “Carry Regime,” characterized by the remarkable growth and expansion of these strategies across all corners of the financial markets.

“Carry trades over the last 30 to 40 years have grown from being niche strategies mainly applied in the currency market and commodity markets to strategies we see everywhere,” Kevin explained.

What was once a specialized tactic employed by a select group of traders has become a pervasive force shaping global market behavior. This rise of carry, Kevin argues, has profoundly impacted the financial system, contributing to a surge in leverage and interconnectedness.

“They’ve grown in size and scale to the point where financial markets, the global market, really behave as a kind of — if not a giant carry trade, they have the characteristics of a carry trade,” he observed.

This widespread adoption of carry-like strategies, with their inherent reliance on leverage and stable market conditions, has created a system that is both remarkably efficient in generating returns during calm periods and highly vulnerable to sudden shifts in sentiment or unexpected economic shocks.

Kevin highlighted the inherent fragility of this system, pointing to the COVID-19 crash of 2020 as a prime example of how rapidly leveraged carry trades can unravel when confronted with unexpected volatility. “The [COVID] crash, some might say, has got nothing to do with carry. That was a global pandemic,” Kevin acknowledges. “In this case, the trigger was ‘fundamental’, right? There was a fundamental reason for markets to fall, but once they started falling, these levered carry trades started losing money.”

He suggests that the sheer scale of carry trades today means that any disruption, whether fundamental or technical, could trigger a cascade of unwinding, leading to significant market volatility and potential losses.

The cracks in the carry regime

While carry trades have flourished for decades, Kevin and Alan identified several significant challenges and potential disruptions to this seemingly well-established model.

One of the most prominent shifts has been the changing role of the U.S. dollar. As U.S. interest rates have risen, the dollar has transitioned from being primarily a funding currency for carry trades to more of a recipient currency. This shift has significant implications for carry trade dynamics, ” because this has led to increased reliance on less liquid funding currencies like the Japanese Yen, potentially making carry trades more susceptible to volatility and sudden unwinding.

Adding to the complexity is the challenge of managing carry trade risks in an environment of rising inflation. Central banks, tasked with maintaining financial stability, face a dilemma when market disruptions occur. “In a world where the underlying risk is inflation, then responding with a liquidity injection is a lot riskier,” Kevin cautions.

Silicon Valley Bank's collapse in early 2023 illustrates this dilemma, where the Federal Reserve's intervention to stabilize the banking system occurred against a backdrop of already elevated inflation. This action, while successful in containing the immediate crisis, raised concerns about the potential for moral hazard — encouraging excessive risk-taking in the belief that central banks will always step in to provide a safety net.

Beyond interest rates and inflation, geopolitical fragmentation is casting a shadow over the future of carry trades. Events like the Russia-Ukraine war and China's changing approach to global capital flows are disrupting traditional patterns of investment and potentially reducing the availability of funding for carry trades.

“It's impacted that circular flow of dollars. China [and] the big commodity oil exporters are not recycling those reserves back into treasuries,” Kevin observes. This shift in global capital flows, combined with heightened geopolitical uncertainty, is creating a more complex and unpredictable landscape for carry traders.

Kevin suggests that this new reality might lead to a greater prevalence of capital controls or taxes on short-term capital flows as governments seek to mitigate the destabilizing effects of large-scale carry trade unwinds.

Investing in a world of unwinding carry

Given the evolving challenges facing carry trades, what does this mean for investors? Kevin and Alan offered some valuable insights and practical advice for approaching carry trades in this new environment.

First and foremost, they emphasized the importance of recognizing the inherent fragility of carry trades. While these strategies can deliver consistent returns during periods of stability, they are highly sensitive to unexpected events and market volatility.

“It's very hard to lean against carry,” Kevin cautions. Investors need to be aware of the potential for sudden and significant drawdowns, especially when leverage is involved. He points out that even seemingly unrelated events can trigger a cascade of unwinding in leveraged carry trades, leading to sharp market corrections.

In this context, a keen focus on risk management is critical. Diversification, prudent position sizing, and avoiding excessive leverage are crucial for mitigating potential losses. “I spent most of the early summer thinking about how I could make money from the Yen carry trade unwind,” Kevin admits. “I looked at setting up a bank deposit account where I just moved dollars, but then you’re paying away the carry, right?”

Profiting from carry trade unwinds is challenging even for seasoned investors. Kevin suggests that a more realistic approach might involve setting limit orders at levels below current market prices, essentially waiting for assets to become more attractively priced during an unwind.

Finally, Kevin and Alan stressed the importance of staying informed about global macroeconomic trends, central bank policies, and geopolitical developments that could impact carry trades. The financial landscape is in constant flux, and investors need to be proactive in monitoring these changes to adjust their strategies accordingly.

They highlighted the need to pay close attention to signals like rising real interest rates, which could indicate a shift in the underlying growth potential of the economy and impact the sustainability of carry trades. As Kevin advises, be prepared to “look for vulnerabilities, be willing to step in below the current level and have some cash to be able to do it.”

This proactive and adaptable approach, combined with a deep understanding of the risks, is essential for navigating the complexities of carry trades in a world where “nothing happens” less and less often.

The carry trade is at a crossroads

The “Carry Trade Regime,” once a reliable engine of returns, is now subject to shifting interest rates, rising inflation, geopolitical fragmentation, and the influence of central banks. Investors who embrace a nuanced understanding of these dynamics, prioritize prudent risk management, and remain vigilant in monitoring global trends will be best positioned to navigate the carry trade's uncertain future.

Brace yourself: The era of “easy carry” may be drawing to a close.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• Commodities, often viewed as volatile and unpredictable, are poised for a resurgence, presenting a compelling opportunity for savvy investors.
• Adam Rozencwajg, reveals why commodities are radically undervalued and poised for a potential upswing.
• What are the intricacies of commodity cycles, the factors driving current undervaluation, and the potential catalysts for a resurgence in this asset class today?

When constructing a diversified investment portfolio, most investors gravitate towards familiar territory: stocks, bonds, and real estate. We might consider sprinkling in some gold or perhaps a broad commodity index. But rarely do we delve into commodities like oil, natural gas, copper, and uranium — assets often perceived as volatile and unpredictable.

“Commodities, as we all know deep down, move in these big, long cycles,” says Adam Rozencwajg, Managing Partner at Goehring & Rozencwajg, a firm specializing in natural resource investments.

Adam, with his partner Leigh R. Goehring, has spent decades charting the intricacies of commodity markets, identifying value where others see only risk. Their approach, honed through years of research and analysis, centers on understanding the ebb and flow of these long-term cycles.

Adam's perspective challenges conventional wisdom, suggesting that we may be on the cusp of a significant shift in commodity markets. He points to historical precedents, where major changes in monetary systems triggered commodity bull markets. “We firmly think, looking at history, that this time is going to be no different,” Adam asserts. “I think we're in the right zip code, as they would say in the US, the right neighborhood, for change in the monetary systems, just like we had in those other times. And I suspect that that will be the ultimate catalyst here.”

Cem Karsan and I invited Adam back to a Global Macro edition of Top Traders Unplugged for another fascinating discussion exploring the complex world of commodities. We delve into Adam's big-picture framework, discussing the historical context of commodity cycles, the factors driving current undervaluation, and the potential catalysts for a resurgence. Join us as we unpack the nuances of this intriguing asset class, uncovering valuable insights for investors seeking to diversify their portfolios and capitalize on contrarian opportunities.

Understanding commodity cycles

Adam, a staunch believer in cyclical patterns, emphasizes that commodities are not merely speculative assets subject to the whims of short-term traders. Instead, they are deeply entwined with the fundamental forces of supply and demand, capital expenditure, and investor sentiment. These forces, he explains, create a cycle of booms and busts.

He elaborates on how these cycles play out: “There are periods of time where commodities are in a slight deficit, and prices can rise quite dramatically. Companies, at the time, earn supernormal profits. It’s not uncommon to see them have yearly cash flow returns of 30% or more in the good years. Money, at some point, flows in to chase those returns. Stock performance is very high. And there’s a virtuous cycle there, pushing stock prices higher, attracting more capital. And then it becomes a classic reinforcing cycle.”

This “virtuous cycle,” however, eventually sows the seeds of its undoing. Adam explains, “What eventually happens, though, is too much money comes in and eventually too much supply comes online, and the market slips from deficit into a surplus. Prices collapse and investor returns plummet.”

To grasp the current scenario, it's essential to understand these historical cycles. Adam points to several periods where commodities became radically undervalued relative to financial assets, each triggered by a seismic shift in global monetary systems:

• 1929: The end of the classical gold standard, marked by the reversal of Benjamin Strong's experimental quantitative easing policies, led to a decade of strong outperformance for natural resource equities.
  
• 1968: President Johnson's decision to remove the legislative mandate for the US Dollar to be backed by gold coincided with the bottoming of the commodities-to-equity ratio, paving the way for the commodity boom of the 1970s.
  
• 1999: A complete reordering of Southeast Asian and Chinese central bank policies, shifting from a dollar peg to a below-market rate to spur exports, resulted in a subsequent surge in commodity prices.

Adam argues that these historical precedents reveal a crucial insight: major shifts in monetary systems often act as the catalyst for new commodity bull markets.

Uncovering value in commodity markets

The million-dollar question, of course, is: are we on the verge of another such shift? Adam believes we are, and the evidence, he argues, is hidden in plain sight. Despite strong fundamental factors pointing to a commodity upswing, investor positioning remains stubbornly low.

“There’s almost no exposure from these people in the market,” Adam observes. “An easy way to look at it, maybe not the most precise but fairly easy, is that you look at what’s the energy weighting of the S&P 500? The long-term average is 10%, 12%. The bull markets top out at 25% and 30%, and they bottom historically at 5% or 6%. So, in the last four years, the high in the energy weighting in the S&P is more typical of past cycle lows.”

This lack of interest in commodities extends beyond just energy. Adam points to consistent outflows from commodity-focused ETFs, indicating a broad aversion to the asset class. This, he believes, creates a compelling contrarian opportunity. The current underinvestment in commodities, driven by factors like the rise of passive investing and the allure of technology stocks, has led to a disconnect between valuations and underlying fundamentals.

“If all I had to work off of was the underlying data, and the supply and demand figures for the different commodity markets, I would be as excited and as enthusiastic as I’ve ever been,” Adam states. “But instead, when you look at the price action, it certainly has been frustrating. And there, of course, lies the value. The disconnect between the two is that the fundamentals have only gotten better.”

Years of underinvestment in exploration and production have resulted in tight supply conditions across various commodity sectors. This is particularly evident in energy markets, where US shale production has peaked and is now in decline. Simultaneously, emerging markets like India and Indonesia are experiencing rapid economic growth, driving increased demand for commodities like copper and energy.

The ongoing green transition, despite its challenges, is also expected to fuel long-term demand for certain metals and minerals. Adam also points to another critical factor: the precarious state of the current global monetary system. Burdened by excessive debt and sustained by experimental monetary policies, the system is exhibiting signs of instability.

Adam sees this as a potential trigger for a major shift that could propel commodities to the forefront of investor attention. These factors, when viewed collectively, present a compelling narrative of undervaluation and opportunity within commodity markets. However, volatility is an inherent characteristic of this asset class, and understanding its nuances is crucial.

Navigating volatility and risk

A discussion about commodity investing is incomplete without examining the volatility of this asset class. Prices can swing dramatically in response to geopolitical events, weather patterns, economic data and even investor sentiment.

As Cem points out, it’s important to understand not just the direction but also the potential for sharp, unpredictable movements.

“The catalyst that often pushes these things back into line is volatility,” he observes. “It is dislocations. The reason is that people are aware that this cycle is going on, and they are buying. That said, these things can become undervalued and stay undervalued for some time.”

He likens investing in commodity producers to “net selling puts,” a strategy that profits when prices remain above a certain level but carries the risk of significant losses if prices fall sharply. This is a crucial point for investors to grasp, as commodity producers, while offering leverage to rising prices, are also exposed to the downside risks inherent in the underlying commodity.

Adam, while acknowledging the volatile nature of commodities, argues that this very volatility presents opportunities for savvy investors. “I do anticipate that the moves higher will be volatile, they’ll be unfortunately probably chaotic,” he concedes. “You’ll have periods of time where they will undoubtedly have pullbacks, the likes of which we’re in now.”

He advises investors to focus on the long-term fundamentals and resist the temptation to react impulsively to short-term price swings. This requires discipline, patience, and a deep understanding of the underlying forces driving commodity markets.

“The stock market for commodity stocks used to be more of a discounting mechanism than it is today,” Adam reflects. “It used to be more of a future-looking forecasting instrument than it is today.”

Adam argues that this shift highlights the importance of taking a contrarian stance and looking beyond the market's short-term noise. By embracing a disciplined approach and maintaining a long-term perspective, investors can navigate the inherent volatility of commodities and position themselves to capitalize on the potential rewards this asset class offers.

Embracing contrarian opportunities

The world of finance often rewards those who dare to be different, who can see value where others see only risk. Commodity investing, with its inherent complexity and volatility, is a prime example of this principle. Several factors point to a potential resurgence in this asset class, yet the masses remain hesitant, clinging to familiar investments. This presents a compelling opportunity for contrarian investors willing to embrace the challenge.

Adam offers a key piece of advice: “Everyone is a trend follower and a herd investor because, probably, from an evolutionary perspective, it always made much more sense to be in the herd and in the pack and not off on your own saying, ‘oh, actually we should look this way.’ The lion would come and take you out pretty quickly. Leigh and I sometimes joke that we’re very happy that we live when we do and not back in the caveman days, because we would have been picked off a long time ago because we’re really not very comfortable in that herd. We’re much more comfortable, I think, being contrarian and looking at things where other people aren't, because that’s where value is.”

He argues that this contrarian mindset is essential for identifying and capitalizing on opportunities that the herd overlooks. By understanding the long-term cyclical nature of commodities, recognizing the current undervaluation, and embracing the inherent volatility, investors can position themselves for potential outsized returns.

Of course, venturing into any new investment territory requires careful research and due diligence. Understanding the specific dynamics of each commodity sector, the risks involved, and the appropriate investment strategies is crucial.

The key is to remember that fortune favors the bold, especially when the herd is looking the other way.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• The “good macro” era of steady growth and low inflation is over. A new set of economic realities is taking shape.
• Economist Philipp Carlsson-Szlezak, Chief Global Economist at BCG, challenges businesses to rethink their assumptions about “good macro.”
• How to navigate tight labor markets, evolving debt dynamics, and persistent inflation.

If it feels like the news is constantly warning of impending doom, you're not alone. Recession fears, inflation anxieties, geopolitical tensions — it's enough to make any investor feel like they're navigating a minefield.

As Philipp Carlsson-Szlezak puts it, “The airwaves are dominated by doomsayers who predict the end of times regularly.”

As the Chief Global Economist at BCG and the co-author of Shocks, Crises, and False Alarms, he's spent years analyzing economic trends and advising businesses on how to navigate choppy waters.

While Philipp acknowledges the challenges of the current climate, he doesn't buy into the doomsday narrative. He points out that for a while, businesses got comfortable with “good macro” — steady growth, low inflation, and easy access to capital. But that era is shifting.

“Global macro demands more vigilance, demands a lot more engagement by executives and investors,” Philipp says. “But there's lots of good things that are still working well for those operating in the global economy.”

Kevin Coldiron and I invited Philipp to another Ideas Lab edition of Top Traders Unplugged to dig into those “good things” and explore how companies can adjust their strategies to win in an uncertain economy. Here are just a few highlights.

The labor (un)comfort zone

One of the most significant shifts in the “good macro” landscape is the rise of what Philipp calls the “era of tightness.” “The era of tightness refers predominantly to the labor markets,” he explains. “It's when the unemployment rate drops below a so-called neutral rate of unemployment. Essentially, labor is quite scarce.”

This scarcity of labor is creating challenges for many businesses accustomed to easy access to a readily available workforce. But Philipp argues that this “tightness,” while uncomfortable, can actually be a powerful catalyst for innovation and productivity growth. “When firms can't hire the labor they want, they're first nudged and later forced to embrace technology, and that moves their production functions to the frontier.”

He points to the auto industry as a prime example of the dangers of failing to adapt. During the COVID-19 pandemic, many automakers anticipated a prolonged economic downturn and canceled their semiconductor orders. “They went to the back of the line,” Philipp notes, “when instead of a really long recovery time, they got this very aggressive recovery with spiking demand for automobiles.” The result? Crippling semiconductor shortages and production bottlenecks.

A shift towards a more technology-driven approach has the potential to unlock significant productivity gains over the long term. As Philipp points out, there are other benefits to this new era: “[An era of tightness] comes with a lot of good things, including wage growth, particularly at the bottom of the distribution.”

The debt dilemma

Government debt often evokes fear and anxiety, conjuring up images of economic collapse and financial ruin. But is the situation truly as dire as many headlines suggest? Philipp Carlsson urges a more nuanced perspective, drawing on historical context to debunk the prevailing debt anxieties.

“The entire framing of debts in terms of levels is dangerous and tricky,” he cautions. Fixating solely on the size of the debt, without considering other crucial factors, can lead to misguided conclusions. He points out that the trend of stimulating economies through debt has been growing for decades, going as far back as the Reagan era, despite the Republican party's claims of fiscal responsibility. This “culture of stimulus,” as he calls it, has added both fiscal and monetary tools to the mix, with the “Fed put” becoming a classic reaction to even minor economic weakness.

A new fiscal reality

But the economic environment is changing. Philipp draws a crucial distinction between existential stimulus — the necessary measures taken to prevent systemic collapse in times of crisis — and tactical stimulus, which he characterizes as more frivolous attempts to “juice the cycle.”

“Existential stimulus is the ability of policymakers to backstop the system in moments of true peril,” like the 2008 financial crisis or the 2020 pandemic, he explains. And this ability, he argues, isn't going away. Financial markets and political will are likely to support such interventions when truly needed.

However, tactical stimulus, the kind used to address minor economic dips, faces more constraints when inflation is a growing concern. Philipp notes that market forces, sometimes referred to as “bond vigilantes,” may step in to push back against excessive spending and debt accumulation.

He cites the example of Liz Truss's short-lived government in the UK, where plans to boost the economy through borrowing were quickly met with resistance from bond markets. While he believes the U.S. has a higher tolerance for debt due to its reserve currency status, the risk of a market backlash is still greater in an environment of rising inflation.

The R v. G equation

To understand why debt levels alone don't tell the whole story, Philipp introduces a critical concept: the relationship between nominal interest rates (R) and nominal growth rates (G). “The question is: Is it easy or hard to carry that kind of debt level?” he asks. And that comes down to two variables: the nominal rate of interest compared to the nominal rate of growth.”

When the nominal growth rate (G) is higher than the nominal interest rate (R), a country can manage its debt burden more effectively, even at higher levels. “If my nominal rate of growth is higher than my nominal rate of interest, I can carry a very high level of debt,” Philipp explains. “In fact, if the spread is favorable, my debt to GDP ratio will fall.”

To illustrate this point, Philipp points to Japan: “I think about Japan. And you've had economies at much lower levels of debt — like below 70% and 60% — with a sovereign debt default.” Despite having one of the highest debt-to-GDP ratios in the world, Japan has not experienced a debt crisis, thanks in part to a favorable R v. G scenario.

The lesson for investors? Don't get caught up in the debt fearmongering. Instead, focus on understanding the bigger economic picture, including the dynamics of growth and interest rates.

The inflation puzzle

Inflation is a specter haunting boardrooms and household budgets alike. But before we spiral into a panic about runaway prices, it's crucial to understand the nuances of this complex economic phenomenon.

Philipp Carlsson cautions against lumping all inflation together. “We need to differentiate between cyclical and structural inflation,” he emphasizes. “[Much of the commentary] has gone off the rails over the last few years because we weren't willing to differentiate between the two.”

Cyclical v. structural: understanding the difference

Cyclical inflation refers to short-term fluctuations in prices, often driven by temporary shocks to the economy. Think supply chain disruptions during a global pandemic, a sudden surge in energy prices due to geopolitical events, or even a shift in consumer spending patterns as we saw during the COVID-19 lockdowns. Central banks, like the U.S. Federal Reserve, typically address this type of inflation through adjustments to interest rates, aiming to cool down an overheating economy.

Structural inflation, on the other hand, is a more persistent force rooted in the underlying dynamics of the economy. It's influenced by factors like demographics, technological change, and the long-term credibility of monetary policy. Philipp points out that structural inflation is “determined by inflation expectations.” In other words, if businesses and consumers believe that prices will continue to rise in the long term, they're more likely to accept higher prices in the present, creating a self-fulfilling prophecy.

Decoding inflation for business decisions

While cyclical inflation has grabbed headlines in recent years, Philipp argues that structural inflation remains largely under control. “If you look carefully over the last few years, inflation expectations stayed firmly anchored,” he notes. This means that despite the recent price volatility, there's no evidence of a broad-based shift towards a 1970s-style inflationary spiral.

This distinction between cyclical and structural inflation is critical for investors making portfolio decisions. For example, if you believe the current spike in commodity prices is primarily cyclical, you might be hesitant to increase your exposure to commodities, anticipating a potential price correction as supply chain issues ease. However, if you believe we're experiencing a more persistent, structural shift towards higher inflation, increasing your allocation to inflation-hedging assets like commodities or real estate could make sense for a long-term portfolio strategy.

The key takeaway: Don't just react to the headlines. Take the time to understand the forces driving inflation. As Philipp suggests, “In the 2020s, it's quite plausible that more often you're going to be somewhat above [the inflation target], and you're going to have to sort of bring it down.” This means we should expect a more volatile inflation environment, where agility and informed decision-making will be critical to navigating the inflation puzzle.

The new playbook for “good macro”

The economic landscape is changing. The “good macro” environment that many businesses have come to rely on is evolving, presenting both challenges and opportunities.

Labor markets are tight, pushing companies to innovate and embrace new technologies. Debt levels are high, but understanding the dynamics of growth and interest rates is essential to assessing true risk. And while inflation remains a concern, the ability to differentiate between cyclical and structural forces is crucial for making informed strategic decisions.

The future belongs to those who can read the signals, adapt their playbooks, and embrace the new rules of the game.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• Global liquidity is a hidden force that can make or break a tech company's growth trajectory.
• Understanding the interplay of debt, central bank actions, and capital flows is crucial for navigating today's economic currents.
• A weaker dollar cycle could be on the horizon, presenting both challenges and opportunities for tech leaders.

When strategizing for growth, most technology leaders focus on product development, marketing, and sales. They rarely consider a less obvious factor influencing their success — global liquidity. Yet, the ebb and flow of funds through global markets can significantly impact a technology company's ability to secure funding, navigate economic fluctuations, and achieve its growth objectives.

“Debt needs to be refinanced,” explains Michael Howell, Managing Director of CrossBorder Capital, a leading advisory and research firm focused on global liquidity flows. “And in order to refinance, you need balance sheet capacity. And that's what we think of as liquidity.”

Many investors, particularly those focused on equities, may not fully grasp this concept. As Michael points out, “If you have come from a fixed income perspective, you understand that debt is a finite instrument, and it needs to be refinanced.”

Michael's career began at Salomon Brothers in the 1980s, and he's since become a recognized authority on global liquidity. He brings a unique perspective to understanding market cycles, emphasizing the often-overlooked impact of central bank actions, capital flows, and the dynamics of debt refinancing.

We invited Michael to join in another Global Macro edition of Top Traders Unplugged for a deep dive into these critical topics. We discussed inflation, interest rates, the U.S. Dollar, China, and more. Here are just a few highlights.

Liquidity: The unsung hero (and villain) of market cycles

Michael's central thesis revolves around the power of liquidity — the lifeblood of financial markets. He argues that liquidity, or the flow of funds through markets, exerts a more powerful influence on asset prices and economic cycles than many traditional economic indicators. “Broadly speaking,” Michael explains, “credit is extended into markets by the financial sector in a very broad sense. It's not just banks; it's also shadow banks that are important.”

This flow of money, both in the form of central bank actions and cross-border capital flows, creates a ripple effect that determines which assets rise, which fall, and the overall tempo of economic activity.

Michael highlights the interconnectedness of the global financial system, stating that “this has become a global phenomenon and it's facilitated leverage. And there's sort of the whole range of instruments that are available. So it's become a lot more sophisticated, but at the heart, it's really a flow of money or liquidity into markets.”

Understanding this flow is crucial for investors. Michael emphasizes that it's the momentum of liquidity, rather than the stock, that truly drives markets: “I've always come from the school that it's flows that are more important because markets are priced at the margin,” he says. “And so, what you need to look at is the flow of new money coming in or exiting a market. And that is what makes a big difference.”

To illustrate this point, Michael points to recent market volatility, particularly the sharp fluctuations in the Japanese Yen. While many attributed this to the unwinding of the Yen carry trade, Michael suggests a more nuanced explanation.

He believes that the Yen's rapid decline in early 2022 was likely an engineered move, possibly orchestrated to pressure the Chinese financial system. The subsequent rally, he speculates, could signal a “tacit deal done on currencies,” leading to a shift in the dollar's trajectory and a potential easing of monetary policy by the Fed.

The debt dilemma: A looming threat or manageable risk?

While liquidity fuels market cycles, Michael also expresses concern about the increasing mountain of global debt. He warns that this accumulation of debt, driven by factors like aging populations, rising healthcare costs, and increased defense spending, poses a significant risk to long-term economic stability. “The [global financial crisis] increased debt,” Michael observes, “COVID amplified that dramatically, and the aging demographics are rising. Government debt is going to increase significantly.”

The challenge lies in refinancing this massive debt load. As Michael explains, “You've got 350 trillion of debt in the world economy with an average maturity of five years. Which tells us you need to refinance 70 trillion dollars of debt every year — just to stand still.”

This refinancing burden necessitates a continuous injection of liquidity, leading to monetary inflation. He argues that if debt continues to grow at a faster pace than the real economy, as projected by data from the U.S. Congressional Budget Office, global liquidity will need to expand at a similar rate, effectively creating a perpetual cycle of monetary expansion.

He questions the prevailing belief that central banks can smoothly withdraw stimulus without causing market disruptions. Citing China's experience with quantitative tightening (QT) as a cautionary tale, Michael argues that the true impact of QT in the West might be masked by the U.S. Treasury's shift to shorter-term debt issuance.

“There's been no QT in the U.S. for 18 months,” Michael contends. “They've been pushing liquidity into markets.” This, he suggests, could create hidden vulnerabilities as large amounts of debt come due for refinancing in the coming years. He points to record low levels of term premium in the bond markets and the unusually wide spread between U.S. agency mortgages and 10-year bonds as evidence of this potential manipulation.

Furthermore, Michael highlights the potential social consequences of relying on monetary inflation to manage debt. He warns that this approach can exacerbate wealth inequality, as “you're increasing wealth for asset holders and wage earnings are losing out on the wealth.” This dynamic, he suggests, could lead to social unrest and political instability.

The dollar's reign: How long can it last?

The U.S. dollar, long the world's reserve currency, has enjoyed a period of remarkable strength. But Michael believes a weaker dollar cycle could be on the horizon. He sees the potential for a shift in the dollar's trajectory, driven by a combination of factors, including a potential easing of monetary policy by the Federal Reserve and a rebalancing of global economic power.

Michael points to historical parallels, such as the Plaza Accord of 1985, where a coordinated effort among major economies led to a deliberate weakening of the dollar to address trade imbalances. He speculates that a similar dynamic could be at play today, pointing to the recent rally in the Japanese Yen as a possible sign of a tacit deal among global policymakers.

“It could equally be,” Michael suggests, “that there was a deal struck that said enough is enough. We've achieved what we want. The Chinese have basically agreed to something. We don't know what, but it basically means that the dollar now should begin to weaken.” His skepticism about the Yen's rapid moves stems from his extensive experience: “In my experience, I've never seen a move as dramatic as that in a G7 currency.”

He also emphasizes China's crucial role in the global dollar system, highlighting the complex and often counterintuitive relationship between Chinese trade surpluses and the dollar's value. “The more that the Chinese use non-US banks to recycle their funds,” Michael explains, “the less efficient it will be and the lower the elasticity of dollar supply, which underpins, in the medium term, a rising dollar.”

However, he also acknowledges China's efforts to reduce its reliance on the dollar, noting that they've made progress on it. But the question of who wants to hold the Chinese currency remains. He believes that the Yuan's path hinges on whether it starts to appreciate, possibly due to Fed easing, or if China engages in significant money printing.

While Michael believes a weaker dollar is likely, he doesn't anticipate a sudden collapse. He states, “I don't think it's going to be a big inflection because I think there's a lot of factors underpinning the dollar in the medium term.” This suggests a gradual shift rather than a dramatic devaluation.

Riding the liquidity wave

As Michael's insights demonstrate, global liquidity dynamics play a pivotal role in shaping market trends, influencing investment decisions, and driving economic cycles. For technology leaders, understanding these dynamics is no longer optional; it's essential for navigating the complexities of today's interconnected world. By adopting a liquidity lens, tech leaders can anticipate market shifts, identify emerging opportunities, and make strategic decisions that position their companies for sustainable growth.

It comes down to this: adapt to the liquidity current or be swept away by it.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• The stock market is significantly overvalued, setting the stage for a potential recession that may be closer than many think.
• Peter Berezin, Chief Global Strategist at BCA Research, offers a sobering yet insightful perspective on the economic headwinds facing the tech sector.
• Why the AI hype might not translate into real profits for tech companies.

When we talk about the economy, it's easy to get swept up in the day-to-day fluctuations of the market. We obsess over the latest Fed announcements, parse through earnings reports, and scrutinize every new data point that crosses our screens. But what if we stepped back for a moment and looked at the bigger picture? What if, instead of focusing on the trees, we considered the entire forest?

“The stock market is more than 50 percent overvalued right now, the highest level of valuation since August 2000,” warns Peter Berezin, Chief Global Strategist at BCA Research. It's a stark statement, painting a far more precarious picture than the “soft landing” narrative many cling to.

Peter, drawing on his decades of experience analyzing global economic trends, offers a sobering prediction: a recession is coming, and it's closer than many think.

He doesn't mince words when outlining the forces at play: “The excess pandemic savings are gone. More people are faced with higher rate mortgages, and critically, job openings now have sort of normalized to very low levels.” His team at BCA Research, backed by their quantitative model incorporating these leading indicators, recently downgraded stocks. It's a clear signal that the economy is shifting, and tech investors need to be prepared.

Alan and I invited Peter for a candid conversation on the Global Macro edition of Top Traders Unplugged, exploring these critical economic indicators and what they mean for the tech sector. We delved into the AI hype cycle, examining whether the current optimism is justified. We also discussed potential investment opportunities in undervalued markets and strategies for building more resilient businesses in a downturn. Here are a few highlights from our discussion.

Decoding the economic warning signs

Peter doesn't sugarcoat his assessment of the current economic climate. “In my view,” he states, “most scenarios point to recession.” This view, however, runs contrary to the hopes of many. Peter argues that several key indicators point towards a recession.

He points to the housing market as a prime example. “Homebuilder confidence has plunged again,” Peter observes, adding that “the housing market is weakening.” He notes that people simply can't afford to buy new homes at current prices, and existing home sales are at historic lows. This lack of demand is squeezing homebuilders and further weakening the housing market. This weakening in a traditionally strong sector is a cause for concern.

He also points out that while people might feel wealthier due to increased home values, it's difficult to tap into that wealth. The demand for home equity lines of credit (HELOCs) is weak, and banks are tightening lending standards, making it harder for consumers to monetize their home equity.

Moreover, Peter highlights the precarious state of consumer spending. “The savings rate right now is like 3.5%. This is unsustainably low.” This, coupled with the fact that excess pandemic savings are gone, suggests a potential pullback in consumer demand, the engine of the US economy. “People are going to have to save more,” he warns, “and the problem is that if they try to save more in aggregate, what that's going to do is reduce demand across the economy.”

The labor market, while seemingly robust on the surface, also reveals cracks upon closer examination. Peter notes that “job openings now have sort of normalized to very low levels.” This, along with rising credit card delinquency rates, points to a potential rise in unemployment, further impacting consumer spending and overall economic activity. “If labor demand continues to decline,” Peter cautions, “we will have this rising spiral of higher unemployment.”

He emphasizes that the labor force participation rate is already back to pre-pandemic levels, and employment gains are starting to slow. This, combined with slowing wage growth, suggests that income growth will continue to decelerate, further pressuring consumer spending.

Further complicating matters is the government's limited ability to provide fiscal stimulus. “The budget deficit is very, very large,” Peter explains, making it politically and economically challenging to implement counter-cyclical measures to soften the blow of a recession. “It's going to be difficult to do significant counter cyclical fiscal policy next year given the starting point of the deficit and the very unfavorable debt dynamics,” he adds.

Peter's team at BCA Research has incorporated these worrying trends into their quantitative models. Their recent downgrading of stocks reflects this pessimistic outlook, sending a clear signal to investors that the economic tide is turning.

Will AI deliver on its economic promise?

The tech world is abuzz with excitement about artificial intelligence (AI), and understandably so. The rapid advancements in AI, particularly in large language models (LLMs), have opened up a world of possibilities. However, amidst the hype, Peter injects a dose of realism. “It's not so obvious where all the big profits from AI are going to come from,” he cautions.

While acknowledging AI's transformative potential, Peter questions whether the current valuations of AI-related companies are justified. “You're kind of betting on the most favorable outcome,” he observes, pointing out that investors are assuming rapid and substantial returns on AI investments. He draws a parallel to the dot-com bubble, where investors poured money into internet companies with unproven business models, only to see many of them crash and burn.

Peter argues that the competitive landscape for AI is still evolving, and it's unclear which companies will emerge as dominant players. He uses a striking analogy to illustrate his point: “Perhaps these large language models will be more like airlines — very useful but they never make any money.”

Just because a technology is powerful and widely adopted doesn't guarantee profitability. He points out that many AI models are converging in terms of their capabilities, making it difficult for any one company to establish a clear competitive advantage.

He further highlights the limitations of current AI models, particularly in their ability to generate genuine innovation. “If you use ChatGPT or Gemini, the answer often comes back more or less the same. Where's the competitive moat?” he asks.

If AI models are primarily synthesizing existing information rather than creating truly novel solutions, their long-term value proposition might be less robust than many assume. “The architecture of these models or the neural nets and the transformers — it's very similar,” Peter notes. “The training sets are basically the same. So are you surprised that the answers are the same?”

Peter also points to the disconnect between revenue and profit when it comes to AI hardware. He uses Nvidia as an example: “Nvidia sells a chip, it books a profit, but when Google buys that chip, that's CapEx.” This distinction is crucial, as significant upfront investments in AI infrastructure might not translate into immediate or sustained profits for companies deploying these technologies.

Peter warns that this capital expenditure on AI hardware could lead to disappointing returns and even losses for tech companies down the line, especially if the promised productivity gains from AI fail to materialize.

This raises a critical question: could the current AI hype, fueled by speculative investments and inflated expectations, exacerbate the impact of a looming recession on the tech sector? It's a question worth pondering as we navigate today's economy.

Turning economic headwinds into tailwinds

While a recession presents undeniable challenges, it also creates opportunities for discerning tech investors and businesses. Peter, amidst his warnings of an economic downturn, offers valuable guidance for navigating this turbulent terrain.

He emphasizes a cautious approach to AI investments. Instead of chasing the hype, focus on companies with clear paths to profitability and robust competitive moats. Look beyond flashy demos and promises of disruption, and carefully assess the underlying business models and potential for sustainable revenue generation.

“It's going to take a long time to make money off these products,” Peter cautions, suggesting that investors with shorter time horizons might be disappointed. He also warns that competition will arise to challenge companies like Nvidia, which currently enjoys high profit margins in the AI chip market.

Peter also suggests exploring opportunities in undervalued markets. He points to Japan, where the yen is significantly undervalued, as a potential area of interest. As other central banks around the world cut interest rates in response to a recession, the Bank of Japan's more stable monetary policy could make the yen an attractive investment.

“The yen remains a very, very cheap currency,” Peter observes. “It's close to 40% undervalued relative to PPP.” He predicts, “Those interest rate differentials are going to move in favor of the yen, and the yen will strengthen.”

Moreover, Peter recommends diversifying portfolios to include defensive assets. Gold, a traditional safe haven during times of economic uncertainty, might provide a hedge against volatility. Bonds, particularly longer-term bonds, could also offer value as yields decline in anticipation of central bank rate cuts. “Our target for the 10-year treasury yield is 3%,” Peter states, suggesting a significant decline from current levels.

For tech businesses, Peter advises prioritizing efficiency and cost-cutting measures. A recession demands a leaner, more agile approach to operations, focusing on core competencies and maximizing resource utilization. He points out that even if the Fed cuts rates, it might not have the desired stimulative effect on the economy, as longer-term bond yields have already priced in a significant amount of easing.

He also suggests exploring alternative funding options, such as private credit, as traditional lending might tighten during a downturn. This proactive approach to securing capital can help businesses weather the economic storm and position themselves for growth when the recovery begins. Peter notes that there was a story in the FT about how a lot of startups are going bust because they're unable to access the credit they need.

Finally, Peter emphasizes the importance of building resilience and adaptability into business models. A recession often accelerates existing trends and exposes vulnerabilities. Tech companies that can anticipate these shifts, adapt their offerings, and embrace a culture of innovation will be better positioned to emerge stronger from the downturn. He cautions that “the average interest rate is going to rise, even if the Fed cuts rates,” due to the high interest rates on existing loans.

Prepare for the storm, position for the future

Peter's economic outlook is a stark reminder that the tech sector, like the broader economy, is cyclical. Periods of rapid growth and innovation are often followed by periods of correction and consolidation. While a recession presents undeniable challenges, it also offers opportunities for those who are prepared. By heeding Peter's insights — approaching AI investments with caution, exploring undervalued markets, prioritizing efficiency, and building resilience — tech investors and businesses can weather the coming storm and position themselves for success in the long term.

As Peter says, “A recession is coming, and preparation is key.”

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes. 

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• Humans are innate tinkerers and technologists, says Mark Mills, who heads up a national energy think tank. Technology makes civilization — including laws, government and politics — possible.
• Even if the convergence of different technology-driven forces isn’t unique, the current convergence of information technology, materials and machines is.
• Will America sovietize its economy? Probably not, and — despite somewhat constrained growth — economists are surprised that the U.S. is surviving the predations of policymakers.

If you’re wondering where productivity boosts are going to come from in the economy, you’re not going to have to wait much longer.

You’re looking at an imminent and brand new Roaring Twenties, says Mark Mills, Executive Director of the National Center for Energy Analytics. Mark is the author of The Cloud Revolution: How the Convergence of New Technologies Will Unleash the Next Economic Boom and A Roaring 2020s. He believes that there are unique opportunities to grasp — so long as America doesn’t hamper itself.

Mark rejoins Kevin Coldiron for a stimulating discussion about the beginning of a roaring period of productivity and economic growth, driven by technological convergence that hasn’t been seen in society for a long time.

In fact, while the concept of technological convergence itself isn’t unique, the current convergence the world is experiencing is. Those who embrace what technology can do for civilization — as well as for markets — are set to gain big time.

These are some of the key takeaways from Mark and Kevin's discussion about where the economy may be headed and the evolution of economic trends in light of his expectations.

To make our future is human

“We’re all forecasters and we’re always forecasting,” Mark says. “It's how we plan and live our lives.” Basically, it’s human nature to think about the future — be it business, government policy or life more generally.

While technology is a special sub-category, it impacts everything. Ten thousand years ago the world couldn’t have looked more different, technologically-speaking, than it does now. And yet, “the same energy forces, materials and nature exist,” Mark explains. “What's different is our knowledge about information and the technology we've developed from that knowledge to manipulate nature — literally manipulate.” To build, we manipulate atoms and molecules. Meanwhile, technological change and progress are different things: The former doesn’t necessarily result in the latter.

To be human is to make: “We’re innate tinkerers and technologists,” Mark says. “Technology is not exogenous to humans: It’s human nature.” Politics, governance and law all matter in making predictions about the future, but it’s “technology that informs and enables everything that makes civilization possible.”

The unique convergence of three forces

Because of the inertia of systems, broad decades-long predictions about the future are “necessarily dictated by what we know how to build today,” Mark says. But what people don’t often realize is that many revolutionary technological changes have histories stemming back decades into the past: Think automobiles, airplanes and computer chips.

“Every entrepreneur will tell you that the overnight success of 20 years of incremental engineering and proven development leads to that inflection point where that new product, technology or service emerges suddenly on the market and in the public conscience,” Mark explains. The apparent leaps and bounds in AI that the world has recently seen are a case in point.

The three forces that lead to a convergence resulting in economic growth are:

1. Information technology including microprocessors
2. Materials such as those from mining
3. Machines that we use to move and make things

The world hasn’t seen such an era-defining convergence in a long time. In the past, when world-changing inventions like the printing press and television converged with radical developments in machinery, there was a bigger revolution than if one of those things had happened individually.

“It happened in the 1920s with air travel, the car, the telephone, and the telegraph, and of course the advent of pharmaceuticals and steel — three revolutions that typify the change and happen simultaneously in different domains,” Mark says. “We have the same thing happening now: The cloud itself as an information tool is the biggest infrastructure ever built by humans,” Mark says, “and combines with AI, which is now maturing to a point of high utility.” Advances in both biological and physical material sciences — along with the development of autonomous robots and machines used to make microprocessors and semiconductors — also converge with these trends.

No surprise that tech results in rising energy consumption

On the subject of developing trends since his first discussion, Mark says there have been “no surprises” — due to the nature of inertia and the velocity of building things, which are well-established laws in physics and engineering. “You get discontinuities over long periods of time, but in a decade they’re very, very rare,” he explains.

When something like AI enters society's consciousness, stock markets react. Witness the Mag 7 stock explosions and the media taking notice of computing power demands. As early as the 19th century, the economist William Stanley Jevons knew that efficiency and production cost reduction increased consumption: Just look at steam, electricity, and compute. “The market response to consume more valuable goods is almost always greater than efficiency gains,” Mark explains.

But AI is painted as a bit of an environmental boogieman. It’s the data centers — essentially warehouse-sized computers, Mark says — that are hoovering up electricity. “Building steel mill-class facilities at 10 times the rate that you build steel mills” will do that, Mark says. AI isn’t blameless though. It accelerates the process in two ways:

1. AI chips use much more electricity than conventional chips, in the same way starting and permanently running something like a power plant rather than episodically like a car will use more energy
2. AI increases the value of conventional data because collecting more data fuels AI

“The global cloud uses twice as much electricity as the country of Japan does for all purposes,” Mark highlights, “and more energy than global aviation — while cloud AI is accelerating faster than global aviation.”

That’s not to say AI chip-makers like Nvidia, AMD, and Intel haven’t already begun improving energy efficiency. But this will lead to more energy consumption — not less.

Nonetheless, constraining AI — via public policy, in a bid to reduce consumption — means constraining the whole economy. Having enough electricity is only a constraint if markets are constrained in supplying electricity. “This is not a size forecast — it's a behavioral forecast,” he explains. It can easily be rectified by building what we know how to build “to fuel the economic revolution that AI offers”

Framing the materials and mines that fuel cloud growth

For materials, Mark takes a realistic perspective. “Numerical framing is important,” he says. “My forecasts are not based on what I'd like to have.”

Mining is at the front and center of his theory: “There is nothing in society — no product or service that exists — that didn't start with a mine somewhere.” The exception is in primitive societies, wherein animal-based materials like bone, sinew, and leather prevailed. And even with some recycling, mining virgin material is impossible to avoid. “Everything costs energy; everything involves waste,” he says.

Starting with mining, the questions become about quantities required and cost of material.  “Making the complex things that we build and operate takes energy,” he says. When they become waste, they're worn out, broken and fall apart — the energy went into their complexity, not just the materials.” It’s Physics 101, Mark says.

Physical automation is also set to improve mining through “robotics, better knowledge of how we can manage materials and more efficient extraction” via enhanced chemical processes. AI-driven supercomputers will improve these processes further. “All that will happen, but it takes time — these are industrial systems,” he says. “They get better measured in decades, not years.”

Finally, framing mining has to start with understanding reality, not wishful thinking. “Mining is not an easy industry,” he says. “The average time to open a new mine is 10 to 20 years,” Mark says. In the U.S. it’s longer due to opposition, so few if any mines have opened for decades, despite there still being mineral resources to mine. “We've chased mining out of the United States,” he says. “It didn't leave voluntarily.”

But there'll have to be more mines for economic growth “Acknowledge that growth is good and requires more materials,” he says. “You want to extract them in the most benign way possible.” Better here than in other countries with more lax labor and environmental laws and protections.

“Once you’ve framed it right, you might arrive at policies that are sensible,” Mark says.

Manufacturing as a service

What brings together the advancement of the three different dimensions is the notion of manufacturing as a service (MaaS). Mark offers two different examples to explain:

1. Nvidia has no manufacturing plants for its AI chips — the MaaS is provided by Taiwan Semiconductor Manufacturing Corporation (TSMC)
2. The prevalence of specialization and internal integration varies between industries, and while its evolution is unavoidable, AI, automation, and cloud technologies accelerate the process

Mark predicts an increasing number of non-semiconductor companies adopting an Nvidia model “where they design, vet, and market things that they don’t actually manufacture.”

Most people have never heard of publicly traded Canadian Magna International, but it manufactures world-class parts for BMW. Likewise, “most vintners don’t grow grapes,” Mark says — they buy them. It’s now easier — and more important — to specialize in manufacturing due to automation and AI.

The economy is resilient

With interest rates up from zero to 5% in 18 months and no economic crash in sight, Mark believes that “we're in a period similar to the 1990s: We can see computers everywhere except in the productivity statistics.” While hard to measure their ultimate effect, it bore out soon enough.Likewise, next-generation technology computing is currently hard to tease out but is already making waves.

“There are data supporting the contention that a lot of the resilience in the economy is in fact coming from AI and cloud technology,” Mark says. This is the beginning.

“The extent to which we can really roar and get big productivity boosts,” he highlights, “is now going to be significantly impacted by policy.” Constrain or unleash: This is the choice facing policymakers. But Mark believes it will happen anyway because markets are unstoppable in the long run.

“I'm hoping and don't believe America will sovietize its economy,” he says. “We have somewhat constrained the growth, but not as much as the partisans on both sides would say or complain. Hence, the economists’ sort of surprise that we're surviving the predations of policymakers.”

Here’s to hoping we continue to survive them.

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This is based on an episode of Top Traders Unplugged, a bi-weekly podcast with the most interesting and experienced investors, economists, traders and thought leaders in the world. Sign up to our Newsletter or Subscribe on your preferred podcast platform so that you don’t miss out on future episodes.