Develop Your Personal Investing Strategy with Itay Vinik

Yeah, I think that's actually one of the bigger myths out there. The stock market is really an instrument of mass psychology. It's not necessarily an instrument of the economy itself, and it could diverge from the real economy for extended periods of time. So the easiest way I like to think about it is the stock market is what people believe the economy is going to do versus what the economy is actually doing. One of the phenomena that I've uncovered, for example, is ahead of a recession, people typically think that it's not going to end in a recession. There's a lot of soft landing type of hopes, which I think is actually what we're seeing right now. We've seen that as well in 2007, 2008. We've seen that in 2000 before these big recessions. So when the economy starts to decelerate, the Fed says we're done hiking or they stop hiking, the, for example, the stock market reacts positively to that. We've seen that over the last few days, a few weeks. But again, we've seen the same thing in 2007. The market initially cheers for bad economic data because they think the Fed's going to lower rates and they think that that's going to actually prevent a recession from happening. But history shows that when the Fed actually starts cutting rates, it's doing that because we're already in a recession. So it's kind of too late.

Happy New Year, everyone. Today on Upstream, we have an episode devoted to helping our listeners understand the macro environment, the role of the Federal Reserve, poke holes at myths about the markets, and develop a strong investing strategy. I'm joined by Itay Vinik, who is the co-founder of Equi, an alternative investment platform. The interview ahead contains both theory and tactical advice, and we drill down to mental models that should help you better understand the direction of the economy and your personal investing. Here's our conversation.

Let's start with the basics. Even before we get into portfolio construction, why don't you just give a brief background of how you got obsessed with this stuff and what's kind of the evolution of your interest and investing style, so to speak?

So I'm happy, happy to talk about that kind of like a career evaluation, you know. So I started my career— now it was a little bit ago— but, uh, at UBS Wealth. So I got exposed to some of the ways in which very wealthy individuals manage their portfolio. We had a lot of people with both real estate concentration as well as kind of single stock concentration, and I was recommending how to hedge that and things like that to kind of preserve and grow. I later left UBS to start my own advisory business. It was a registered advisory business in California as well. And where we basically built portfolios for high net worth and ultra high net worth individuals. And that's when I really realized how I would say the industry was skewed in a way that made it very difficult to invest in alternatives. So going back into that, it made me really obsessed to think about markets in the way of return drivers and what drives these returns over the long run. And how do you put that together? So I became very, very obsessed about that, and it became clear to me that stocks and bonds were not the only way to invest your money. And then I got exposed to a variety of different strategies that led me to actually launch a hedge fund as well. And then later on, I started investing in real estate. So, you know, I've really learned all about the alternative asset world throughout my career, and I realized that, you know, more people should know about it and should invest in it because it's a great way to kind of diversify your return stream.

And why don't you say more about that exactly? Like, what do people not fully get about it? Or what do they not appreciate? Or what information do you have that if they received, they would take it more seriously?

Yeah, so the way to think about it is stocks, for example, are a single return driver. They have their characteristic, right? Like, either go up a certain amount of money in the long run, stocks go up 7-8% a year, you know, over the last 100 years or so. But often with tremendous amount of volatility. So stocks is one thing, fixed income or bonds are another, and most people just have those 2. But then there's a variety of other investments that could be anything from venture capital to collecting wine and rare cars to having hedge funds. And why is that so important? Because every time you add one of these return drivers— let's take it one step back, actually. So imagine you just have 2 perfect Zero correlation investment. One can produce 20% a year but can lose 20% a year, and one can do the exact same thing but they have no correlation. So you're cutting in half the risk that both of them are having that loss or that volatility in one given year. So imagine the more of these uncorrelated return drivers you add in, you can still get the same return, but you're really shifting that risk to the left. So you're just taking substantially less risk. And that's what I think people you know, underestimate or kind of fail to realize that by adding more uncorrelated investments, they can still make the same return, but they can continuously reduce risk. And that's, that's one of the, one of the big advantages of alts.

Is it true that institutions used to recommend 60/40 in terms of stock bond split, but now that recommendation doesn't necessarily make sense in a new world?

Yeah, so let's go back into why is that even the case, right? So The 60/40 portfolio, I look at it as the kind of like perfect indexing portfolio. You probably heard the Warren Buffett bet with that hedge fund was a decade ago or something like that, that it's like, oh, if I just invest in the index, the S&P, there's no way you're going to beat it. You know, most managers fail to beat the S&P 500. Fact, right? So you don't want to mess with active management. All you got to do is just buy a Vanguard fund. look at it and come back in 20 years, right? That's— you probably heard a version of that one way or another. Another way they call it, don't time the market, it's time in the market, right? Those are all the things the wealth industry kind of likes to tell us, but it's not necessarily true. What is true is that it works really well when interest rates are declining. When interest rates are declining, both bonds go up in value, but also equities tend to have a higher valuation because as the cost of capital decreases, the multiples tend to expand as well. So between 1982 and 2020, 2021, we were in a cyclical declining interest rate environment where rates have peaked around 1981, '82, somewhere in the mid-teens, which is crazy to think about 10-year Treasury in the mid-teens, right? they've been gradually going down towards zero. And as that happened, the 60/40 had an incredibly strong period of time. But now it's quite different because interest rates have risen very sharply. There's a lot of uncertainty regarding inflation and kind of future returns. And a lot of that plays into that narrative. As a result of that, institutions that were allocated primarily to stocks and bonds in the 1980s started shifting that allocation towards towards a much heavier alternative component where a lot of these big institutions are now more 50/50 between alts and public markets. Some family offices are even 70/80 in alts, where the average individual investor just has about 3 to 4% in alternatives today.

Wow. From 50 to 80% to 3 to 4%, that's pretty crazy. And of the institutions that have such a big focus on alts, what is the right way to think about portfolio construction even within alts? Like, where is that divided or split usually?

Alts is a massive category, right? So when we talk about alts, it could be literally anything from a real estate holding. So an alt would be, I own an Airbnb and I rent it out. It could be, I own this, you know, Porsche collection, uh, by the way, I've done very, very well, uh, all the way through hedge funds and, um, more traditional alternatives. So what you see in a lot of institutions is hedge funds, managed futures. So those are kind of the liquid alt side, private equity, uh, and venture capital. Typically, um, they usually would not venture into some of the more esoteric, uh, tech alternatives, even though some of them have done very well.

Makes sense. So just to summarize, uncorrelated portfolios are important to think about so you can spread your, your risk a bit and still have the chances of getting good, good return even if one of them, you know, doesn't, doesn't do well. What are the attributes of whether an asset is uncorrelated or not, or portfolio is uncorrelated? Like, what makes something uncorrelated?

I can actually share a few examples of things we've invested in, if that makes sense. So you can really kind of understand and dig into what truly makes an investment uncorrelated. So one fund we invested in does commodity-backed financing, and I thought that was pretty fascinating. But just so you understand, like, it will not correlate to the economic cycle, right? So that's one important thing to think about. So the up and down of the economy, stock market does not correlate into, but it also does not correlate into the cycle of interest rates, which is very important. As we've seen, the bond market is now on its path to a 3rd losing year, which is the first time in the history of the United States where the long-term treasury markets are about to experience 3 down years in a row. So very important to be uncorrelated to these types of factors. Give you an idea. Commodity-backed financing. Imagine there's a mine somewhere in the world. Let's say it's in Australia. Australia is a big country that mines a lot of things. And this mine mines for copper. So a huge industrial mine can extract maybe $1 billion worth of copper out of the ground in a given year. So it turns out when you dig stuff out of the ground, you're going to find other things you didn't intend on finding. So let's say you find $10 million worth of cobalt out of a billion-dollar mine. It's a fractional amount for such a big industrial mine. What did they do with that cobalt? Well, it's kind of a little-known secret in that industry that if you come and get it, they'll sell it to you for maybe 50 cents on the dollar for what the world price is. So there's this industry that developed of middlemen that will come to this mine and they're going to buy the cobalt from them for 50 cents on the dollar. Then they're going to aggregate 3, 4, 5 other places. They're going to ship it to one centralized location, then they're going to sell it at the world price and make an arbitrage. So we found a fund that's the bank for these middlemen. So what they'll do, they'll lend them 70% LTV or so against these commodities, but not at the world price, the price they buy it in. So they're massively overcollateralized. In the event that they can't pay the loan, they get a hold of the commodity at a massive discount. And then when it moves from one part of the world to another, it's actually insured by Lloyd's of London. So the portfolio manager was joking with me and saying, I hope the ship drowns because if it doesn't, I'm getting a big markup on the book because it's insured at the world price. So that's kind of a 1% a month type of strategy, kind of regardless of what's happening. So now you understand, you know, when you understand that strategy, you understand why it could be so uncorrelated. So you can have multiple strategies like that.

It's just Maybe zooming back a little bit, you mentioned now that interest rates have risen up, so things have changed a little bit. Why don't you talk about how exactly things have changed in terms of what investment strategies make sense in a low interest rate environment versus what makes sense in a much higher rate?

So let's talk about that past 15 years, or I call it the era of free money. People are expecting to go back to that. I don't know if that's necessarily going to happen. But first, we have to understand that this period of time where rates were so low for so long was truly an historical abnormality. Based on some research I've read, I don't know how they can even go back that far, but it's been the lowest interest rate in the history of humanity going back almost 5,000 years to the days of the pyramids and the Babylonians. There's never been a period of time— and why am I saying that? It's because up until now, you would think that the low end of interest rates, it's a zero line. But central bankers have been able to prove that was not the case. We actually went into the era of negative interest rates. So in Germany, for example, the European Union, and Japan, and a variety of other places, rates went negative in the mid-teens. And imagine you're lending money to the German government and you have to pay for that. So it just creates a ton of perverse incentives and an accumulation of debt. So if you are a real estate owner or developer, your incentive is to borrow as much money as humanly possible because you're not paying anything for it. And the rent would likely cover a very, very large payment. If you're a corporation, you're going to borrow as much money as you possibly can as well. So the incentives of any rational player during a low interest period of time is to lever up. And in a high interest rate environment, that's not necessarily the case. There is this concept in the low interest rate period of time that was usually justifying why is the market going up for so— why are we having such high returns? Why is tech moving so rapidly? It was called TINA, and TINA just means there is no alternative. You're going to make 0% in the bond market. You're going to make 0% in the bank. You're barely going to get 1% or 2% in treasuries if you lock it in for 10 years. You have no choice but to buy the stock market. And TINA is no longer the case because there are actually a lot of alternatives now. You can get 5% a year risk-free in the Treasury market. And that's the biggest difference between what we've seen in the low interest rate period and now. And it's a completely different environment that I don't think has been digested by the markets yet.

That makes sense. Why don't we just zoom up a bit more broadly, which is to say, which macroeconomic indicators are commonly analyzed by portfolio managers And then I wanna get into which ones do you think are good to analyze and which ones are red herrings.

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Well, that's a huge topic, right? There's a million different indicators that people use. Zooming out, one of the major important things to understand here is where in the business cycle are we, right? That's kind of the most important part. And one of the ways to analyze it, there's really 4 parts of the business cycle that we all know, the kind of the quadrants that we follow. So are we in an expansion? Are we in a contraction? Is this a stagflation? Is this Goldilocks? You use that with a variety of different data. So you have data that's lagging, you have data that's leading, And you have data that is basically concurrent. What I think a lot of people do is overly focus on lagging data and lagging information, which the biggest one in my opinion is actually the jobs numbers or the non-farm payroll, because that's giving us information that's already happened versus trying to focus on things that may be leading these numbers, such as the JOLTS data, which gives you the total number of job openings. Versus the actual job employment data that's coming in a lag. Other things like leading economic indicators that are based on things like the yield curves and others kind of give you a picture of what could come based on demand for different goods and services that are needed to make investments. So yeah, in my opinion, most are focusing on things that tend to be lagging. For example, right now you're probably hearing a lot of calls for soft landing. A lot of these calls are based on lagging economic indicators.

Let's go a bit deeper here. What should people have in mind or do a bit differently here?

So I think the main focus is actually understanding liquidity. You know, we can talk macro all day, which is important, but at the end of the day, a lot of the macro factors themselves are driven by liquidity. For example, in early 2020s, the market was falling apart due to COVID, the economy was shutting down, supply chains issue, etc. But then the market had a massive V-shaped rebound. Why did it have a massive V-shaped rebound? Because the Fed injected unprecedented amounts of liquidity into the system in the form of both the quantitative easing programs that I think are really important to understand, lowering interest rates, and other factors they were doing in order to just pump this liquidity. So the macro factors themselves get influenced by liquidity, and then liquidity is typically influenced by the central bank. So I don't think enough people have a thorough, deep understanding of what the central bank actually does. And getting that understanding, I think, would help a lot of people making— make better decisions regarding macro and portfolio management.

What do people not fully understand about how the central bank works, or what's important for people to understand as it relates to informing their investing?

Well, first off is what are the Fed mandates and what is the Fed trying to accomplish? That's really important, especially understanding what's happening right now and understanding the Fed's reaction to different historical crises. We can go back all the way in history. I mean, it's a huge topic. We can talk about this all day. And then the question goes back into, is the Fed even correct in what they're doing? Is the Fed able to actually steer the economy or is the Fed just reacting to it, which is another big question. but also what the market thinks about what the Fed does. It's actually quite a fascinating topic where I can go into each one of these topics if you want to go into that specifically. But basically, in its core, the Fed has 2 mandates. And these mandates are price stability, which is the idea that inflation needs to be around 2%. Why 2%? Because we live in a debt-based economy, and therefore there has to be some type of inflating of the debt away. Imagine you take a mortgage on a million-dollar home and that mortgage, if inflation doesn't happen, is still worth a million dollars. So you're still paying the same amount of money, but in 10 years, the value of the dollar itself is going to decline. So the value of your debt is going to diminish. And when we live in a debt-based economy, that's just a given. And then the other one, of course, is the full employment where the Fed doesn't want to have mass unemployment type of situation on its hands. What's really interesting in that is that when you got these 2 mandates, they're supposed to be one against the other, which means that theoretically, if you have a period of high unemployment, you theoretically should not get inflation. Because if people are not working, they can't spend, prices typically fall, and vice versa, which is why that mandate was formed in the way it is. The idea is that the Fed wants to kind of use all the tools in their, uh, discretion in order to steer the economy to get low inflation and low unemployment as much as possible. Are they successful at doing that? That's a totally different discussion.

So what you're saying is, if I understand correctly, it's important to understand how the Fed works because ultimately they're determining and influencing interest rates, uh, inflation, and other indicators that will inform our, uh, our investing approach. Is that accurate or how would you characterize that?

No, that's very accurate. I mean, I think the Fed is the most powerful body. It's the most powerful government body, hands down. Like, they control money itself. It's even more important to understand they control debt because, I mean, debt— I think people actually don't understand debt correctly either. Debt is money. The vast majority of money is debt. Over 90% of all money out there is debt. So by By being able to price the debt, they're able to control the circulation of money itself.

Let's say that you become confident that interest rates are either going to rise significantly or going to lower significantly. Give us more examples of trades or decisions you would make based on that, on those beliefs.

Well, there's a few different things you could do. The most simple one is to make bets on interest rates themselves using the bond market. So The way bonds work is that you have more volatility the more duration you have, and kind of works like a seesaw where the price of the bond is inversely correlated with the yield on the bond. Easiest way to think about it is let's say you hold a bond for 10 years, and if rates now went from 1% to 2%, the price of the bond needs to go down by an amount that reflects That difference. So you're missing 1% per year for 10 years if you were to buy the bond at the old price, right? Which means that roughly the bond price will fall by 10% to reflect that. So at maturity, you're gonna be able to get whatever it is that that difference was, if that makes sense. If rates go higher, you, you would sell short that bond because as yields go higher, the price of the bond would go, go down. Which is something, for example, we've actually done in 2022 as rates were, were going higher.

Mm-hmm.

we were confident that the Fed will continue to increase interest rates. Now, having said that, there is not a direct— I mean, there's a correlation, but it's not a direct relationship between, let's say, the Fed funds rate itself and the longer bonds. This is a really complicated relationship that is measured by what's called the yield curve, where this yield curve is the spread between short-term bond prices or basically the Fed funds rate and let's say longer duration assets like 10-year Treasury, 30-year Treasury, and there's a spread between them. And that spread could tell you a lot about the economy based on how that's trading.

And can you say, say more about what that spread tells us about the economy?

Yeah, absolutely. So this is one of the key, uh, leading economic indicators that we track, uh, in fact, which is what we call the yield curve. Uh, and this yield curve can be either flat Which means that the spread between, let's say, the 2— so let's just give a concrete example to make this make sense. Let's say you have a 2-year Treasury and you have a 10-year Treasury. The spread between those 2 is referred to as that yield curve spread. And then let's say the 2-year Treasury in a normal situation would always be lower than a 10-year Treasury, right? Because Why would you lock your money for 10 years unless you're getting a bigger coupon? You're not going to lock your money for 10 years at, let's say, 4% if you can lock your money for 2 years at 5%, right? So most of the time, the, the curve would look like this, which is normal. The longer the, the time you're locking your capital, the more yield you're going to get. But sometimes that, that curve can invert, could be the other way around. And that's when we pay extra attention to that, which means that when yields on the short end are actually higher than the ones on the long end, that means the market is typically anticipating a recession. And historically speaking, the wider that curve is, or the bigger that spread is, and the longer that lasts, the more severe the recession becomes. And throughout 2023, we've actually seen these conditions unfold. So we've seen a very big yield curve inversion that is one of the things that typically happens ahead of a recession. Really all year we've seen that as well as in some parts of 2022.

Say more about the other leading indicators that you— or the key ones that you spend the most time on.

Yeah, so the yield curve is definitely one of them. And then there's what we call the LEI, Leading Economic Indicator, which is really a barometer of a variety of different indicators that are being measured by the Confidence Board. So LEI, just to give you an example, they've been in contraction, I believe, for 18 or 19 straight months. Now it's actually the longest period of time they have been contracting since, I think, since '08. This is the longer, the longest term. So really what it, what it is, it's combination of what we call the financial components. So that could be credit index, so we're measuring the lending that banks are doing. Are they lending a lot? Are they not? And right now they're definitely not. Stock prices are a part of it, which have been relatively okay. Then we're looking at that interest rate spread, which we're looking at the 10-year Treasury minus the Fed funds rate. That's still been indicating a recession. And now we have non-financial components. They could be what consumers are expecting business conditions. That's been pretty negative. We're looking at new orders, uh, ISM. So that's basically how many businesses are making new orders because they're expecting better business conditions. That's been declining as well. We're looking at building permits, we're looking at average weekly earning hours for work, we're looking at manufacturing new orders, um, which is capital goods, we're looking at initial claims for unemployment as well. And then we put it all together to get an idea of what's the kind of like LEI component looks like.

Can you say more about how you track the yield curve, but how exactly does it inform investing decisions? Like, what do you do as a result of that, you know, based on where the yield curve is?

When you look at that yield curve going back to the post-war period, every recession was followed by an inversion of the yield curve. Now, not every inversion led to a recession. Some of them were relatively mild, but most of them did. And it just makes us more defensive. We are less likely to be investing in high-beta things. We're less likely to be investing aggressively in the stock market, for example. We're more going to be looking for these type of low-correlation opportunities and building a portfolio of diversified alternatives that share very little correlation with the economy than we would with, let's say, the beginning of a new cycle. That plus LEIs is is making it very, very likely that we are going to experience some form of a recession. And it's really hard to say in advance how difficult it's going to be. You have to realize that we are in the fastest cycle of interest rate increases in a few decades, and no one's felt it yet because since the early 1980s, rates have not gone up this quickly. And everyone is still living in the free money era, in my opinion, right? People have not felt the consequences of the higher rates. And I'll give you an example. You know, do you have a mortgage? You own a home?

I do not. No, I rent.

You do not.

Okay.

You rent, which is now a smart idea, right? But let's say you did own a mortgage. A lot of people in early 2020 refinanced those mortgages, and that was an historic low in interest rates. And most people that I know have rates in the 3%, right? And when you have interest rates at 3%, you're not moving anywhere, you're not doing anything, which is why the housing market's frozen right now because new mortgages are priced at 8 to 9%. So as a result of that, this is the idea of how monetary policy works in a lag, in a big lag. As a result of that, no one's moving. And the only people that are taking on new mortgages is because they literally don't have a choice. So let's say you get a And then you have to sell and then you have to move somewhere or some kind of other life event that makes you take a mortgage at 8 or 9%. Other than that, we're seeing the worst housing activity in decades. I think going back to 1994, actually worse even than the GFC, the Global Financial Crisis. And it's going to take a long time for that spillover effect of higher rates to actually fill in into the economy because No one's going to, no one's going to move away with their low interest rates. So that's why it takes a long time for that to actually happen and why a lot of the effects have not been felt yet.

If you anticipate that a recession is going to occur, what is the proper strategy against that?

Historically speaking, owning treasuries would be a really good idea at the beginning of a recession because what typically happens in a recession is that yields come down because the Fed would react to it by lowering interest rates in one way or another. Why that is a little bit of uncertainty today is because we're still seeing persistent inflation at the same time as the Fed has raised rates quite a bit. We've seen some evidence that inflation has eased, but it's still far above— it's 3% plus, still far above the Fed mandate of 2%. So in the 1970s, for example, treasuries were not a great idea because rates were staying higher for a long period of time and actually going higher into the 1980s. But in a classic recession like '08, owning long-term treasuries have done exceptionally well. A more sophisticated trade is what we call yield curve steepeners, something we've put on. So that's the idea that the yield curve, when it inverts, is going to normalize and come back above zero to a normal situation. So, you know, that's one thing you can make a lot of money off of. Of course, you know, you don't need to take as much risk in the stock market as you would, because if you're making 5% risk-free, the dividend yield on the S&P is less than 2%. You don't need to necessarily take that stock market risk when there's a lot of other alternatives out there. Another thing that we've looked at is real estate investment trusts, which can give you a good amount of yield, and they typically do poorly when rates rise and they do better when rates fall. And putting that in a portfolio while rates fall could be a Could be an interesting idea as well, but it's not without risk, obviously, because they can get hit in a recession as well. So you need to really do your diligence and work when you're looking at these.

One of the myths that you highlight is this idea that stocks and bonds are always inversely correlated. Can you talk about that a bit?

The whole wealth industry is almost predicated on that, right? The 60/40 portfolio concept is the idea that bonds, particularly with US Treasuries, long-dated Treasuries are going to go up when the stock market goes down because there's going to be a flight to safety in there. And that has been the case during a declining rate period. So again, the 1982 through 2021 period, that has been the case. So when inflation is falling, that typically has been the case. '08, we've seen that happen. In COVID, we've seen that happen. But since the end of '21, correlation between stocks and bonds has actually picked up, that they're both moving together. So throughout the entirety of 2022, as the stock market has fallen by 25% or so, the bond market's fallen massively with it, and they've really fallen tick for tick together. And this year, we've seen that correlation continue to stay pretty strong. And that's really been an issue for the 60/40 portfolio and why it hasn't performed very well over the last couple of years. And in order to really dig into that, you have to realize a 60/40 portfolio just does well when inflation is low or falling, and it doesn't do very well when inflation is high or going up. 1970s and '60s, another great illustration where bond-stock correlation was positive. So we can't rely on this idea that bonds and stocks are actually always inversely correlated, and it's one of the reasons I lean so heavily into building a portfolio with more alternatives, realizing that that correlation could break and turn positive, which would hurt portfolios long-term.

Let's also get into the myth that stock market always reflects the real economy. Why don't you unpack exactly what's going on there?

Yeah, I think that's actually one of the bigger myths out there. The stock market is really an instrument of mass psychology. It's not necessarily an instrument of the economy itself, and it could diverge from the real economy for extended periods of time. So the easiest way I like to think about it is the stock market is what people believe the economy is going to do versus what the economy is actually doing. One of the phenomena that I've uncovered, for example, is ahead of a recession, people typically think that it's not going to end in a recession. There's a lot of soft landing type of hopes, which I think is actually what we're seeing right now. We've seen that as well in 2007, 2008. We've seen that in 2000. Before these big recessions. So when the economy starts to decelerate, the Fed says we're done hiking, or they stop hiking, the— for example, the stock market reacts positively to that. We've seen that over the last few days, a few weeks. But again, we've seen the same thing in 2007. The market initially cheers for bad economic data because they think the Fed's going to lower rates and they think that that's going to actually prevent a recession from happening. But history shows that when the Fed actually starts cutting rates, it's doing that because we're already in a recession. So it's kind of too late. And then the market has fallen sharply. I can show you, there are some really interesting charts about that. You can really see how in '08, for example, as the Fed was cutting rates to zero, the market was just crashing, which is exactly against what you would expect. So there are periods of time when the market psychology and valuations can massively disconnect from reality, even though in the long run, it does tend to reflect the general economic conditions, but definitely not in the short run.

Would you feel comfortable getting more into your own portfolio construction and how you've thought about, you know, how you allocate to each, even within alts, and depending on the different macro situations and how your portfolio evolves accordingly?

Yeah, so, you know, there's some tactical component to that where we would allocate based on where we think we are in the cycle, but there's also a large component of that that is designed to be all-weather. So we think of 4 different environments that are out there. These environments basically are expansion, so that's when a new cycle starts, things are booming. Think of '09, 2010, 2011 as early expansion. We have contraction, which classically could be '08, could be 2001, 2002. Then you have stagflation. So stagflation is something we've seen in '22, something we've seen in the 1970s. And then you have Goldilocks, which has been the condition throughout the majority of the 2010s. So I don't think I really need to dig into expansion and contraction because those are pretty self-explanatory, but stagflation is something to really understand. That's something where we're seeing prices go up, so we're seeing inflation, but we're also seeing economic deterioration. So we're seeing less demand. Typically, we're also seeing higher unemployment, but in '22, for example, we didn't see that, but we've seen stirring economic data in some cases. Definitely in the 1970s. And then Goldilocks. What's Goldilocks? It's when it's not too hot, so you don't really have inflation that's causing an issue, but it's also not too cold, so rates are low, lowish, higher valuations can be supported, and it typically results in just a gradual grind up in the value of stocks as well as bonds. So Goldilocks, typically the easiest time for kind of investment. So What we're trying to do is find most strategies that would do well under all these conditions together. When we think of the portfolio, we want to have a core of anywhere between 50% and 70% of really stable return drivers. So these are managers and strategies that are going to return 7%, 8%, 9% per year regardless of what's happening in the world. So think of the commodity lending-backed fund as an example of that. That's one of our kind of slow and steady core allocations. And then we have allocation to different strategies and alternatives that will take more risk, be more volatile, but also produce greater returns. And that's how we put them together. And we do use some discretion of where we believe we are in the macro cycle for that 30% to 40% piece. For example, if we think we're coming out of the recession, we may do a distressed fund that specializes in buying distressed assets at a time where easier monetary conditions are going to come in and they're going to be able to participate in the recovery. We're not there yet, but we're starting to look at some of those funds in the event that we're We're gonna see a deeper recession in 2024.

What are the factors you're looking at the most right now to determine whether, whether we are going to go into a deeper recession or not?

The biggest one is we're waiting for— so we're seeing signs the consumer is really starting to get tapped out. We've been following discretionary saving for a long time. Talked, you know, we talked about liquidity, we talked about a lot of different things, but we didn't actually talk about the consumer yet. Consumption is the biggest factor in the US economy, really. 70% of the US economy is based on the consumer and consumption. And recently we've seen a lot of bad earnings from the Walmarts of the world and a lot of retailers really showing that the consumer is starting to get strapped out, especially with the resumption of student loan payments that happened in October. We've also seen a lot of excess saving after COVID. There's some really good charts about that that really show the stimulus checks and all these kind of things created a pretty big excess saving that hasn't been the case for a while. That's all gone. So that's been fully depleted. So we're in a pretty, I would say, fragile position because unemployment is still relatively low, but we're seeing the beginning of leading indicators on that showing that number of open positions are falling sharply. temporary job is falling as well. So we're seeing some evidence that unemployment rate might go up in the next few months. Combine that with the inflation period that we've been through, consumers strapped out, credit card debt reaching all-time highs, and you could get a situation where consumption is just going to drop sharply, which would lead to worse earnings, which would likely roll us into, into a recession. Also, the Fed's track record at engineering a rate hike cycle without a recession is very poor. They've only been able to do that in 1994 from all the historical rate hike cycles.

So if we didn't have a recession, it would be a rare instance given what we've seen historically, right?

That's correct. It would be highly unlikely. The Fed has a horrible track record of being able to engineer a soft landing. It's just A soft landing is kind of a myth. It did happen in 1994, but there were external factors in 1994 that were not Fed-related that caused this supercycle of boom primarily. And it's not even tech. People think it's tech and the '90s dot-com bubble that did it. I actually think it was just a part of it. It was mainly the fall of the Soviet Union in 1991. So it's a new era of globalization. All these borders fall. There's a ton of exports happening, money's flowing everywhere, and there's all this growth from parts of the world that didn't see that before. And that really led to a really strong economic cycle in the 1990s, which can explain why the 1994 rate hike cycle did not end in a recession. But other than that, other instances of Fed increasing rate, whether it's 1999 to 2000, 2007, 2006, 1980s, '81, '82, '70s, etc., they all end in a recession. So typically something breaks as rates go up. And the issue I'm seeing today is that we have a higher debt load to both GDP and corporate than ever before because we've been in a 15-year period of time where rates were effectively zero. So the incentive was to accumulate as much debt as possible. And it's really hard for me to believe that raising rates so much, so quickly, and even more so doing quantitative tightening, which we can discuss separately because that's another thing the Fed is doing to reduce liquidity out of the system, is very likely to end in a recession. Very, very likely.

I would think our internal models are showing around a 90% chance that this does end Why don't you get into both quantitative easing and quantitative tightening and a few examples of when they've been used so we better understand the levers that the Fed has at its disposal?

The Fed can really do a few different things. Up until 2008, 2009, the main lever they were pulling was just interest rates. They were basically either reducing rates, which stimulates lending, right? Because when When rates are lower, it's easier to borrow money, mortgages are cheaper, etc. So it puts more liquidity in the system. And if things were getting too hot, we're getting too much inflation, they would raise interest rates and reduce the amount of liquidity because there's just less loan demand, etc., etc. There's another thing they can do which is less known, which is manipulating what's called RRR. And that's not pirates here, that's the required reserve ratio. What that means is that they can control how much money the banks need to hold in reserves versus what they lend. So that's another way to control liquidity. So imagine they tell the bank for every— because we have a fractional banking system, which means that when you put your money in the bank, what the bank actually does is take your money and lend it to somebody else, and they don't actually have your money in the bank. Which is what we've seen with Silicon Valley Bank, right? Everybody's coming to get their money out. There's no money in the bank. So what the Fed actually does is that they require banks to have a certain amount of the money from their deposits actually held in the bank. So let's say the RRR is at 10%. For every million dollars that you have in deposits, you need $100,000 of actual cash that you have in the bank. Now, the Fed can reduce that amount. In order to increase liquidity, and they have done that in the past. They can also increase that amount to steer it and make it stronger, but the Fed has less used that tool since they've done quantitative easing, quantitative tightening. So '08-'09 is the big game changer here because rates were already zero and the economy was still falling off a cliff, and there were still a ton of issues and banks were falling. And they realized that the zero lower bound, which was the first time they've done, you know, they've cut rates to actual zero, is just not enough. So what do you do? Well, you can print money out of thin air. And the way the Fed prints money is quite interesting because yes, they click a button and they create it out of thin air, but where does it go to? Quantitative easing was used to buy US Treasury bonds. And mortgage-backed securities. So they would basically just fund the federal government's debt. The federal government just could create a bunch of bonds, Fed's going to buy them. And the result is that it's actually creating that demand for the bonds, just reduces the rate in the long end. So if we talk about the Fed fund rate going to zero, that doesn't mean that the 10-year Treasury is going to zero. It doesn't mean the 30-year Treasury is going to zero. But the Fed can create money out of thin air and buy those bonds. That means they're lowering rates in the long end, and that stimulates more of the economy because now mortgages are not tied to the Fed fund rate, they're tied to the 10-year and the 30-year Treasuries. So then you're able to create just more money in the economy and you're creating easier conditions. So Fed did QE for the first time, '08, '09, and then they stopped it for, you know, minute or so in 2010. Stock market crashes 20%. They do QE2. Stock market crashes again in 2011. They do another round of QE. And then in 2013, they just started doing QE indefinitely. It was QE3, but technically it didn't have an end date. And they were printing $85 billion a month just buying US securities. And they did that for a while. And then they stopped doing that. raise interest rates a little bit, uh, and then in 2020, they massively did QE to, to the massive, massive trillions of dollars, uh, to the point that between 2020 and end of, you know, end of 2021, I believe something like 28 cents on every US dollar was created out of thin air just during that period of time. So that's a brief history of QE.

Uh, some people said that crypto was a— the term liquidity sponge, i.e., there was just a lot of excess cash and people were looking for different ways, you know, sort of things that they thought were uncorrelated to put it in. They thought maybe crypto was uncorrelated. Is that the right characterization? And are you sympathetic with that assertion?

I am not, actually. So we did a lot of studies on crypto, and crypto does seem to be a risk asset, right? So in 2022, when crypto went from $65K, $67K all the way to $16K, that was in response to quantitative tightening and falling So crypto tends to do very well when liquidity is abundant and when rates come down and when the Fed is printing money. So maybe it's a good hedge against inflation, it's a good hedge against money printing and easy money policies, but I don't necessarily know if that's kind of like uncorrelated to the stock market. If the stock market fell 50% next year, I would not believe that crypto would go up under those conditions. Those conditions. You know, we've seen that pretty correlated with the stock market. It's just like a higher beta version of it.

Let's get into quantitative tightening.

Quantitative tightening is just the exact opposite. And by the way, the Fed is doing that now. They are reducing almost $100 billion a month. They're basically clicking the delete button and making it go away. So what happens is that during QE, the Fed buys the bonds from the US government. During quantitative tightening, it's doing the exact opposite. So what it's doing is the Fed owned a bunch of bonds, they're getting interest payments on these bonds, and then when the bonds mature, they get the principal back. So when they get their principal back, instead of like being like everybody else and taking the money and either putting it somewhere else or, you know, spending it or whatever, the Fed just clicks the delete button and just makes it go away from circulation. And this is a problem now because the US government is spending money like it's a drunken sailor, I would say, without any other— the fiscal situation is really insane. The deficits are massive. And in order to fund these deficits, the US government needs to continue to create new bonds all the time. If the Fed is not buying those bonds and actually selling bonds or making— it's not necessarily actively selling, but every time the Fed has maturity, they just make it go away and they don't reinvest it. There's been a lot less demand for US bonds than there has been historically, which has made that market far less stable. And knowing where the debt and deficits are going, given this high interest rate environment, that's a really, really challenging situation. I'll give you one more. 30% of US bonds are due to mature next year. And if rates stay where they are now, we're going to be spending more on interest payments for the US government than almost any other line item. We're already spending about $1 trillion in interest payments, which is more than national defense and almost as much as Social Security. So it's on its way to becoming the largest line item. So yeah, there's a really strong relationship between what the Fed itself is doing and how kind of like US government is handling its debt situation. And this is the first time that spending, fiscal spending, is this high while rates are going up, while actually it's becoming more expensive to do so.

Do you see a world where that changes, where fiscal goes down or has to go down? Or how do you talk more just in general about how fiscal spending interplays with monetary policy and what that What are the implications of what that means?

Yeah, I mean, in my opinion, it has to. Even Jay Powell talked about it a couple months ago in the Economic Forum. He was saying that we have to get our fiscal house in order because it's completely unsustainable, even though it's technically not their job of doing it. It's actually really, really interesting how these things interplay because it's not very obvious. One of the most interesting dynamics was How come— and I've had that question asked a bunch of times— how come we've been printing a lot of money between 2008 all the way through 2020, but we actually didn't have inflation? And then all of a sudden 2020 happens and we have inflation that forces the Fed to really kind of raise interest rates. I mean, everyone thought in '08 and early '09 that we're going to have massive inflation. And at that time, we didn't really have Bitcoin. I mean, we did actually have Bitcoin. Bitcoin since '08, but almost no one used it. I mean, I wish I did, but unfortunately, I didn't find out about it a few years later. But a lot of people were buying gold and there was this first run-up to 2000 in gold and into 2011. And then turned out inflation never showed up. Gold crashed by half, stock market soared, bond yields fell, and QE was just going and going and going. no one could really understand why come we're not seeing inflation. It's kind of odd, right? You can print $85 billion a month, but you're not seeing any inflation. And the reason is QE alone is money printing for the rich only. That's the main reason, as crazy as that sounds. Because who benefits from QE? Those that own assets, because low interest rates allow you to lever it up your assets even more. The value of stocks go up, the value of bonds go up. People that own those typically are just the top 5-10% in institutions, and they basically get all the benefits from QE. So the QE programs historically just create asset price inflation, but they don't really create real-world inflation. What's changed in 2020 is that the world was shut down, And all the QE that happened in 2020 went to fund these massive fiscal deficits. And for the first time, helicopter money was actually being done. So people were getting checks directly to their hands on a massive scale, both PPP loans, stimulus packages, as well as all the unemployment benefits while the world economy was shut down and there was no supply. So supply chains are shut down. But everybody still gets money. So then everything reopens and everyone wants to spend that money and there's a massive grab for resources and everyone got money. That's the big difference. QE alone is primarily money for the rich. But unfortunately, when you give even a little bit of money for millions and millions and millions of people, it will translate into real-world inflation. That's kind of the difference. QE plus fiscal stimulus, inflation. QE alone, you don't actually get CPI inflation, you get asset price inflation.

You suspect we'll keep doing QT until when?

That's a great question. Right now, it's open-ended. So the Fed doesn't have plans to stop it. And the balance sheet of the Fed has already been reduced quite a bit. I think until you really— until you start getting— until you get a credit crisis. At some point, something is going to break. You know, it's very hard to say what it is. We actually did call the collapse of SVB and Silvergate and a few other ones. It was pretty easy to see. Even Credit Suisse are pretty faultily constructed. But at some point you get a credit crisis, and when you do, the Fed is going to have to support risk assets, and they're probably going to let go of the QT, especially if they don't want to implode the US Treasury market. That next year is going to go through some difficult times with all that refinancing that has to happen. I mean, probably— I mean, I doubt the US government will actually issue longer-dated treasuries next year. If rates are still high, they're probably going to issue bills that are shorter dated. But even with that, the debt load is just going to be massive. So when we get a real crisis, I suspect the Fed is going to A 180 into what exactly? Well, they're going to end QT when that happens, very, very possibly. And the most difficult part here is where is inflation going to be when that happens? Because that's when they're going to get really tested. Because on one hand, one of the biggest mistakes of the 1970s, and they've talked about this, is that they were too quick to cut rates into a recession, and that resulted in a big secondary, second wave of inflation. And historically speaking, when we've seen inflation happen, like what we've seen in 2021, 2022, it hasn't been a single wave of inflation. It hasn't been like a one spike and done type of thing. Historically, it's been between 2 and 3 waves of inflation. So, you know, the conditions are, are there that you could have persistent inflation for a long period of time, could be years to come. So it really depends, like, you know, do you see real-world inflation while that's happening, and are they able to mitigate that or not? How severe the— they're going to get really tested. I'm happy I'm not in their seat, actually.

What is the right way of thinking about the debt? I know that Lyn Alden has a belief that the debt— I think she's kind of challenging Ray Dalio's belief that the— because the debt-to-GDP ratio is so high, I think she said something like, in 51 to 52— out of 52 times when it's been this high, uh, you know, countries and governments have inflated away the debt and, you know, have had kind of persistent inflation, um, to, to get rid of it because the alternative is, is too extreme. I guess paying interest is too expensive perhaps. Is that a right characterization of the trade-off? And what is the right mental model for thinking about the debt and what we do as a result of it?

No, I think she's actually completely right because the alternative is pretty catastrophic. There's 2 ways to deal with that. One is restructuring, which is very deflationary haircut type of thing, austerity. Raising taxes. So raising taxes and cutting spending together. So I know one party says we just raise taxes, the other one says we cut spending, but the reality is you need to do both in order to kind of control this. You actually need to do some kind of combination. I don't see how you have the political power to do it. And the easiest thing to do is to have long-run inflation run running above the level of that debt. Exactly what you're saying, inflated away over the long run. The problem is that inflation is a hidden tax on everyone unless you own assets that tend to appreciate when that happens. But it's a hidden form of tax. It can translate into declining standard of living during a period like this. Either way, it's going to result in a long period of time where kind of standard of living and the trends in growth are going to be below average. That's very likely unless, of course, you get a big technological innovation or revolution that can kind of increase growth faster than this process.

And that could be AI.

That's what people are saying. I mean, that's the only reason the stock market's up in 2023 really, in my opinion, because if you're looking at The difference between the performance of, let's say, the small-cap index that doesn't have the big AI stocks, it's flat to negative for the year. And then you're looking at the NASDAQ and it's up 30%, and then the S&P is somewhere in between. We've never actually seen a period like this with the exception of maybe 1999, which is not a good precedent where such few names have led the market up to this degree. It's kind of It's kind of crazy. And again, that is the narrative. It's like, is AI going to cause a revolution that's as big as the internet itself? And I'm not the expert for that, obviously, but I can tell you that's what a lot of people think. Yeah.

And a lot of people in my world, venture capital, are saying, hey, venture got as big as $300 billion. Some people say it's going to be— that was just as a result of excess liquidity, and as a result, it's going to go down maybe even to $150 180. And people are very bearish on the amount of capital that's going to be in venture capital. And, you know, people's ability to fundraise as easy as they could, both startups and venture alike, as a result of that. Does that make sense, consistent with your sort of macro prognostications over the next few years?

Yeah, it really does. Because a lot of the venture access liquidity, to your point, is a function of TINA. There's an alternative. If I can't make 5, 6, 7% in relatively easy, safe things, I might as well chase a 10x, 50x, 100x return in some of these high-value, high-flying things. And we really have seen what I think is a lot of signs of an asset bubble around 2021 when some of these non-profitable tech companies were trading at just obscene valuations that I think have come down. So again, like, in the long run, this industry is great, but It's probably just what come down to 2017, 2018 normal levels versus what we've seen that valuations— I mean, people were raising crazy seed rounds with a pitch deck and half-baked idea, right?

Totally. We talked about quantitative easing, we talked about quantitative tightening. Are there any other major levers that either the Fed or governments more broadly have to stabilize the Well, for the Fed, besides—

I mean, the Fed just has their— I mean, there's another one called moral suasion, which is basically just them talking about what they're going to do in order to talk the market in certain things, which, believe it or not, really does work. Sometimes it's really enough for the Fed to just talk to kind of put the animal spirit in there. It's really controlling the required reserve ratio, interest rates, and controlling the money supply through QEQT. There are other things they've done like the special program. So right now they have the special bank lending program in which they've allowed all these small and medium-sized banks to survive by offloading some risk into their balance sheet and get liquidity from the Fed this way. But those are more nuanced type of functions they have. Those are kind of the main ones. For the government itself, obviously they can create as much debt as they want. want in order to fund existing debt. That's what makes it different. But the question is, do other— especially if the Fed is not participating, you need a lot of foreign buyers. We've seen a lot of them step away, especially China and other things. But remember, the US is still in a very different situation than any other country in the world. And that's because the US controls the global reserve currency, at least still does. And that puts us in a very different situation because we can create more, much more, both money supply and debt than any other country can because the entire system is just based on— the debt system is just based on the US dollar.

What would need to be true for us to lose that status? Do you see any chance of that happening in the next decade?

Yeah, it's a really great question. I remember when we did our market calls, we did 3 hours just on this topic, really analyzing it from the beginning, how the Dollar Reserve was created, going back into all of these. And people were burying the dollar for a very long time. That's something that's important to understand. Going back to Bretton Woods when the dollar standard was really created, I think we do need to go back there in order to really understand how this narrative plays out. In 1944, the winners of World War II gather and decide that the US dollar is going to be the global reserve currency, and that's going to be backed by gold. And then every other country can convert their currency into US dollars, and that's backed by gold. So it turns out that in the 1960s, the US was creating more dollars than they actually had gold to back it with secretly. And other countries were asking for their— asking for the conversion, and they were starting to take too much gold out. So 1971, the US was like, okay, we're done with this and we're gonna drop the gold standard. At that time, people were really calling for this dollar reserve authority, and it didn't happen. And inflation actually did get— or like, things stabilized in the 1980s. And then sure, we have the QE programs We have other things, but we have to understand that other countries have printed money too. The ECB and the European Union have printed a lot of euros. China's economy is not doing so well either. The BRICS nations are talking about a gold-backed united currency. But in order for you to say, well, there's not going to be a dollar anymore, there's going to be another reserve currency, who is it going to be? What is the alternative to the US dollar today? And I actually don't think it exists. Now, can we go from a single dominated US dollar standard to more of a multipolar world where more things are accepted? That's probably where it's going, but I don't see anything substituting the US dollar today, especially there's so much trade happening in US dollar, including crude oil and commodities trading in US dollar. But there's so much debt that's being financed in the US dollar. So many emerging countries have taken US dollar debt that there's a whole cycle of emerging economies versus the dollar that I don't see it going away in the next decade. It may be less used in more of a multipolar world, but I don't see it going away.

I heard someone say that maybe it would halve from something like 35% to 40% of sort of overall transactions to maybe like 20% or something. Like it would just become a much less dominant. I don't know if those numbers are correct, but does that seem plausible?

Yeah, I, I see that as what's happening. I think it's closer to 60 to 70% is actually happening in US dollar today. So the numbers are still very, very large. And, um, even, you know, let's look at what just happened in Argentina, right? We just had a very libertarian president winning the election there, and one of the things he said to stabilize the country, right, they're having more Horrible inflation. They've had 150% inflation. So imagine our 7-8% inflation versus 150%, where literally where people were spending their paycheck the day they were getting it because they knew that in 2 weeks it's going to be worth 10-15% less. He wants to dollarize the country, so he wants to get rid of the peso and introduce US dollars until they are able to stabilize their economy. Why is he choosing US dollars and not another currency, right?

That makes sense. So we talked about some of the levers that the Fed has. Why don't you talk about its, uh, its sort of skill level or its effectiveness, um, at, uh, at stabilizing the economy? How should we think about the Fed in terms of that?

Great question. Uh, one that I've struggled with quite a bit, whether, you know, do you even need a Fed, right? Can you almost have the free market do the Fed's job, right? Are a few academics sitting in a room better able to steer the economy? So The Fed actually has a pretty terrible track record at being able to steer the economy, both being too lax and keeping easy monetary policy for far too long, creating asset bubbles. Undoubtedly, Alan Greenspan fueled the housing bubble by cutting rates too quickly in the dot-com recession. And similarly, the Fed has kept rates far too too loose in 2021 when it became evident that inflation is not transitory. I don't know if you remember this, but for 6, 7, 8 months, they were continuously saying, oh, this inflation we're having, don't worry about it, it's transitory. Rates were still zero. They were completely reactive. And then all of a sudden they realized, oh my God, inflation's at 7, 8%. We have made a horrible mistake. Now we have to take it from zero all the way to 5.5% in a heartbeat. Very quickly. So historically, the Fed is reactive. Its predictive value is very limited, and they have almost never been able to steer the economy in a soft landing when they do raise rates. And they typically inflated asset bubbles as well by not reacting fast enough when they were created to begin with. They were allowing asset bubbles to happen. So I don't think the Fed has a good track record of doing this, which Makes it also very— Fed is saying, you know, we're going to keep rates higher for longer, etc., etc. I don't know if that's going to end up being true. It may be as transitory as inflation is transitory.

You would think that there's more reflection on the inflation is transitory, but I don't see a ton of apology.

Do you? Never, never. It was like, we're the smartest people in the room. You know, we can control the Don't you worry about that.

Talk more about how globalization in general has affected the Fed and how the Fed responds. We've been talking domestically, but let's talk internationally.

That's a great question, actually. And when I think of the Fed, I don't actually even think of them as the Bank of the United States. They are actually the bank of the world. So if the dollar is the global reserve currency and there's so much international trade happening around it, then in fact, the Fed is dictating monetary policy globally. And we've seen that most recently with Japan, where the Japanese yen has been depreciating massively, going from 100 yen to the dollar to about 150 yen to the dollar. Now, that's a really, really big problem for Japan because they need to import most of their raw materials to produce different things. And if they get A yen that's too weak, that's a problem for them as it becomes more and more expensive to import these raw materials and hurts business profitability, etc. Now Japan also has another problem. Well, they have a lot of problems, but one of their main problems, I think their biggest problem, is their debt problem. Japan has the world's highest debt to GDP by far of any developed economy. It's in the hundreds of percentages to their GDP. And that's actually something that's very worrisome that you can get into this trap of QE and low rates where you get to a point where you do get inflation and you can't raise rates because you just have too much debt. And that's where Japan finds itself. It finds itself when the Fed keeps raising rates. And because the Fed kept raising rates, their yen just gets crushed because they're unable to raise rates. Believe it or not, they're still at the zero lower bound. They actually have negative rates. their equivalent of Fed fund rate. I think it's still negative 0.1 or something like that. So there's a huge divergence between where the Fed is and where Japan is. And then Japan kept pressuring the US Fed, telling them, hey, you can't raise rates because that's killing our yen and that's causing all this economic instability and we have too much debt. We can raise rates to compete with you. So It's one of those things that the Fed has to think about because when they raise rates thinking of the US domestic economy, they also need to consider what it's doing to other countries in the world and how that's translating into just global stability. Because if Japan implodes, it would have massive consequences on the whole global economy, including the United States. I don't know if that's what you mean specifically with globalization, but it definitely is a big factor, which is also why emerging economies have an inverse correlation with the US dollar as well for, for other reasons. But there's a whole cycle where emerging economies, because they take so much dollar-based debt, when the dollar goes up, they tend to suffer quite a bit as well. So, you know, no one really tends to like a really strong dollar outside of the US.

When we accuse China of dumping, what's happening there?

When they're dumping their US Treasuries or when they are basically manipulating their yuan FX rate, Yes. China basically has a policy that they want to be able to fix their yuan rate, uh, so they're able to have relatively competitive exports, which is not new. They've been able to, they've been able to do that for a long period of time. And the yuan is not a free-floating currency, um, in the way that they, they do manipulate and they do able to— they are able to control because they want to be able to Figure out how much exports they have. So it does fluctuate. We're within a band and they're continuously manipulating that. They also manipulate their domestic markets a lot. They have famously what's called a plunge protection team where their stock market goes down too much, they buy it themselves, sometimes effectively, sometimes not. But the idea here is that they have an unfair advantage where if they can artificially lower their currency, they can export more and flood the world with cheap Chinese exports. But it is important to note that China has increased their own domestic economy portion massively in recent years too. So they're no longer as dependent on exports as they used to be. But with that, yes, like for example, other Western nations have a free-floating currency, so they aren't able to directly manipulate it. They manipulate it in other ways. Familiar with their their exchange, with their central bank rates and other things like that. But it's not as direct.

I want to segue into going back into alts. But before we do, can you first address the sort of passive versus active sort of topic? Because there's this widespread belief among certain groups of people that passive actually outperforms active. I know you think that's a myth or Or certainly not nuanced. Why don't you unpack what is the claim and why is it lacking?

Long-term, there's this belief that if you look at a long chart of the stock market going back to, let's say, 1900, stocks look like they do this. So the point is, why do you even try to trade anything? Why do you even need any other strategies? If you just index and passively invest in the market, you're going to do just fine and you're going to you're going to be able to kind of like outperform in the long run. Now, I don't think that's necessarily true because of a couple of reasons. First is that it's true that passive investing has worked really well in a low interest rate environment. So when rates are falling, there just tends to be less volatility and prices for stocks tend to rise better. But active investing has worked much better during rising interest rate environment and persistent inflation and higher rates. So that has tended to be true. But the other factor is that timing actually matters a lot, a lot more than you think. What I mean by that is that the point of time, even over decades, where you buy the stock market is going to have a very material impact on the returns because the market, what it does is Sure, it averages that 7-8% in the long run, but the way it does that, it does it in either a cyclical bull market that can last 10, 15, 20 years. And then once it gives you those excess returns, like think of 2009 through 2021, we were averaging a lot more than 7-8-9%. Some years were up 30%, 15%, more than 10% in most years. But then once it does that, it needs to make up for all that outperformance. by consolidating and reverting to that mean. So we call that phenomenon the lost decades, where you go through a period of cyclical bull market and then you go through a very long period of time where there's just a ton of volatility but nothing happens and you end up not making anything. The most extreme example of that is the 1929 crash. So between World War I and 1929, markets go up. 1929 crash. The market didn't go back to where it was in 1929 until— you won't believe this— but 1954. So imagine buying 1929. That's quite a long period of time to just wait. But it doesn't end there. You know, the post-war stock market booms, etc. It stops in 1968. So 1968 is another cyclical top. If you didn't catch that, the market's not doing anything until 1981, 1982, another very long period of time. Then '82 to 2000, you're up. 2000 to 2013, the market did nothing as well. Dot-com bubble top, global financial market top in '07, another 12, 13 years of nothing. So whether you buy the market in 1982 or you buy the market in 2000 makes a huge impact on your returns. Which is why, you know, we believe you need to diversify, not just rely on the stock market, which, you know, this is one of the kind of dirty little secrets of the wealth industry where they tell you that it doesn't matter, you just buy the market, doesn't matter when you buy the market, but it really does.

Let's go back to alts. And I think what we could do now is give just a little bit of preview of maybe some of the ones that we're going to go in deeper on in future episodes. So, so real estate is the first one. But why don't you kind of list out some of the major alts that you or clients tend to get involved in, and maybe even just like high level of how to think about them, while knowing that in future episodes we'll go much deeper?

Sure. My specific specialty is in the liquid alt space. So here you're talking about quarterly liquidity, we call it, but mainly things like hedge funds, managed futures, and other strategies that tend to use public market or close to public market, sometimes lending, in order to generate returns that are not necessarily correlated with the public market. So those could be macro strategies that would literally attempt to trade different countries and their regime, and, you know, what's happening in Argentina versus what's happening in Brazil is one example of a strategy. So that's kind of the liquid alt space. There is, of course, venture capital, which you probably know a lot better than me, which is the idea of no liquidity for a very long period of time and making bets on companies that may become great companies years down the line. But I guess it depends on what stage you invest in, but it could be anything from, you know, very junior companies all the way to secondaries, I guess, to companies that may go IPO soon. Then you have private equity, which here, um, there's also a variety of different strategies from roll-ups to other types of strategies where they look at businesses that typically are cash flowing positive and they're doing well. And then you have more esoteric type of things, which could be anything from buying Rolexes to Porsches to wine, etc., etc., and then everything in between. And of course you have The number one creator of millionaires in the world, real estate. And believe it or not, more people have been minted out of real estate than any other asset class.

Wow. And why don't you share a little bit more about why that is? And maybe just give a little couple minutes preview almost of what we're going to spend our, you know, deep dive session on real estate talking about?

Yeah, I mean, the reason that is, is because most people buy real estate as a primary residence and they own it for 20, 30 years. Maybe they have another investment property and, you know, it's just the way it works with deflating the debt away over time. It's just very easy to make money in real estate over a long period of time because imagine you buy it on a mortgage, you hold it for 30 years, you have a million-dollar home, you have a $2 million home, you paid the mortgage off over that 30-year time period, and now you have a million and a half, $2 million asset. that you own free and clear. So again, it's not a way to get rich quickly, but it's a way in which a lot of millionaires have been minted over the long run just by just buying a property and living in it for 30 years. That's obviously the simplest way of doing it. And there are obviously times where it's better or worse to buy real estate, just like any other asset class. Today, for example, is one of the most unaffordable— actually, it's the most unaffordable real estate market in history. So I wouldn't necessarily recommend doing about today. But there's a variety of strategies, whether you're investing in industrial and multifamily, you're pursuing different methods. You know, I built a real estate portfolio doing what's called the BRRRR method, where you buy, you rehab, you rent, you refinance, and then you do it again. But again, that strategy works really well in low rates. It's not going to work very well today. But I was able to build a pretty sizable portfolio doing that.

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