Andy Constan on Investing Through Bubbles | First Principles Episode 1

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[00:00:30] Wir sind bereit zu sehen, die neuen Podcasts zu vermitteln. Wir haben ja auch eine neue Podcast mit Andi Constan. Da gibt es ein paar Shows auf die Aufmerksamkeit. Aber das ist ein paar Worte, die Sie über die Aufmerksamkeit sind, was zu gehen. Aber das ist ein paar Worte. Wir wollen die Aufmerksamkeit und die Aufmerksamkeit sein, was zu erinnern. Das ist ein bisschen zu erinnern. Wir können alle verstehen, was das eigentlich die Verwärts und die Ökonomie machen. Das ist eine gute Idee, mehr über die Aufmerksamkeit. In der ersten Folge, wir diskutieren Andy's Lehrens von Investing Through Bubbles und was er can teach uns über AI today. Wenn Sie sich über die nächsten Mal über 2,99 Euro bekommen, dann wieder auf 1,99 Euro. Wenn Sie auf 1,99 Euro bekommen, dann wieder zu erinnern.

[00:00:59] just a general market, but an actual bubble? That's the holy grail. I mean, nobody can, you can't find the holy grail. It doesn't exist. The reason why a bubble regime is so difficult is because it plays precisely on human nature. You see your neighbor up 100% on some semiconductor stock? It matters to you. Not only did they cut, but they did surprise cuts.

[00:01:31] And this is from the same guy who, you know, 40% ago had used the term irrational exuberance to describe the stock market. He was cutting into a stock market that was up 40% from when he made those comments. There's the root conditions, which don't have to be a bubble, but root conditions can become a bubble. Then there's the escalation events. And then there's the peaking.

[00:01:58] And I think we're in that phase right now. Welcome to the first episode of First Pinchables with Andy Constan. Andy, thank you so much for doing this with us. We're excited for you to be here with us today. Yeah, I'm excited too. It's going to be interesting. There are a lot of shows out there that give people opinions on what's going on in the markets. And we're going to do some of that on this show. But I think the overarching goal, what we hope to accomplish here, is to have a discussion that goes deeper on a lot of different subjects.

[00:02:28] And what we really want to do is focus on lessons and frameworks behind what is happening in the market so we can help our listeners and our audience develop a better understanding of what actually it is that drives the things in the markets and drives the economy. And so it's going to be less about what to think and more about how to think. And we couldn't think of a better person to launch this show with than Andy. So it's going to be fun. It's going to be exciting.

[00:02:54] It's going to be informative and appreciate people watching and supporting our guests like Andy. We're going to use your first or a recent Substack post that you did where you were talking about bubbles. And it's a very, I think, timely post. I think it's on a lot of investors' minds in the current market today. Are there bubbles forming around us or are there not? But I think, you know, today's discussion is going to be about talking about what bubbles are

[00:03:23] from your perspective, how they form, how investors can recognize them, and how kind of we see things playing out in the current market and what, how investors might be, you know, trying to or thinking about things. So that's the topic of today's discussion. That's the first sort of topic of the show. And yeah, so let's just get into it, Andy. How do you, when you think about defining a bubble, I mean, in retrospect, it's always everybody's like, oh yeah, it was obvious we were in a bubble and, you know, we all should have seen it

[00:03:53] or we did see it. But, you know, how do you define a bubble and how do you think we can see it maybe in real time? Right. So I don't think you can. I don't think it's well easily defined in foresight. It's incredibly easy to define in retrospect. And I think that when people hear that term, particularly in this day and age where everyone wants to know,

[00:04:21] are you a buyer or a seller? Are you long or are you short? And those are important, very important things, obviously. But when you talk about a bubble, it's hard enough to appreciate what's different in a bubble-like regime versus, that's hard. It's impossible to determine when a bubble's going to pop.

[00:04:50] And so I want to, this conversation has to be about, you know, what is different in a bubble regime, not, hey, the bubble's about to pop. Like, that's a call. As a trader, as an investor, I'm going to change my portfolio if I think I see something that indicates the bubble is popped or is about to pop. But I will tell you, that's like the holy grail of investing. Being able to pick the top,

[00:05:18] not only of just a general market, but an actual bubble, that's the holy grail. I mean, nobody can, you can't find the holy grail. It doesn't exist. How do you think you would separate a market that is expensive and maybe over-owned by investors from one that is actually seeing bubble-like, I guess, characteristics, but that's being defined

[00:05:48] or influenced by a real technological breakthrough? Because that's kind of where we are today, right? I mean, the market's expensive. A lot of people are owning these AI-related stocks. They're all baked into the Mag7 to some extent in terms of, but, you know, then you have this AI breakthrough that's happening. So how should an investor sort of grapple between those two things, do you think? Well, I mean, the first thing you said is something that you hear a lot about in markets, overbought, expensive.

[00:06:18] I think the first thing one I do as an investor is just respect the fact that the current market prices are the current market prices and that they're neither expensive nor cheap. They're neither overbought or oversold. I mean, just even those words, like overbought or oversold, it's just not the way I think about things in general. And the reason is, is because at this very moment, every single investor on Earth

[00:06:49] has, by and large, like, I mean, I guess maybe somebody's about to trade, but by and large, every single investor on Earth, no matter what their horizon, has exactly what they want to own. If they're short, they have exactly what they want to short. They have the leverage they want. They have the cash they want. Everybody's at equilibrium. And so there is no such thing as overbought or overowned or oversold. It's just sometimes

[00:07:17] various cohorts are doing things in markets that appear unsustainable. And so the idea is that when people use the term overbought, they mean some them, whoever they are, have bought more than they should have and are likely going to have to liquidate. That's a classic definition of a robot.

[00:07:47] So firstly, I just humbly say that when I look out at investing, I think no one really knows that the best thing to do is to recognize that you don't know which way the markets or the economy or technology or anything else is going to go. And so you just own a passive, well-diversified investment set of investments and just go about your life. So that's the number one principle when I think about all this stuff. But

[00:08:17] I think there are differences significant, assuming every market price is accurate, there are still differences in the sort of regimes that exist. And a bubble regime is what I think we have entered into. And so let me get to that. So what does that mean? Well, bubble regimes have certain

[00:08:47] root causes and certain sets of characteristics that you can loosely define as bubble-like. and again, it's not a precise thing. Like, no one can predict that we're actually in a bubble until after the fact. But for me, I've seen a number of and I've studied even more. I'll only cover the things that I've actually seen in my real career.

[00:09:16] But I've studied a lot of other things. The environment today looks very similar to other bubble environments. And I look at more of them that we've had in my career. The first one was really kicked off in 1981, 1982, and persisted through the crash of 1987. And it wasn't a bubble the whole time, but it was a regime that ultimately delivered a bubble.

[00:09:47] Similarly, the tech, the internet bubble, which started, I like to say it kicked off when Netscape Navigator was invented in 1995. And many, we all became aware of how the power of connectivity. And that wasn't really a bubble for a number of years and then became a bubble. 2006 to 2005

[00:10:16] to 2008 didn't really start as a bubble, became a bubble. Then we go into things that are not risky equity or credit assets, but our bonds. Government bonds after the GFC, where short-term interest rates were set to zero globally, went in one direction

[00:10:45] for an extended period of time. They rallied for an extended period of time. And then ultimately, when COVID hit, they became a bubble. Rapidly accelerated to basically zero interest rates. And that bubble resolved in the following year. So, and then today, a lot of the things that I look at are bubble-like. We started a, and so let me get back to how I think about those.

[00:11:15] So those are the five cases I'd like to sort of think about. So let's get started with, these types of environments typically start with something new. And something new in the internet boom and the, and if we're in a bubble today, the AI boom was technology, was some new thing.

[00:11:45] And you can look back to, and again, before my time, you can look back to a variety of, of industrial revolution, technological advancements. You can look to the, to China, where they took, made a huge productivity move, bringing people from the farms to the factories. You can look at major productivity changes as it tends to lead to some sort

[00:12:14] of bubble-like equity outcome. economy. So there's a new thing that's technology. In 1982 through 87, the new technology, it wasn't, it wasn't really new technology. We just had ended a major inflationary episode. We, the United States deregulated the financial industry, in particular, the savings and loan industry. there was a small technology advancement, which was the invention of

[00:12:44] Lotus 1-2-3, which allowed people to easily scenario analyze companies. And there was the innovation of, of Mike Melkin, in terms of creating a market for high-yield debt. And that kicked off the thing that was really new to the markets, and that was the LBO. And so, when I think of the 1987 crash, I think it was impacted by lots

[00:13:14] and lots of things, and all bubbles have lots of things going on them. But in 1987, that bubble was driven a lot by a trend toward the LBO. We know what kicked off the something new in 95. In 2005 through 2008, where you had the housing boom, we had a period of time where globalization had essentially ended inflation. And with the end of inflation,

[00:13:44] financial conditions could be left very accommodative with no risk of inflation. And that created a levering up in banks and in the housing market. So the new thing was the end of inflation and globalization. And that was a driver for what ultimately turned into a bubble. And by the way, this is what I think. I could be wrong. This is just how I'm thinking through these things. Now, as I said, ZERP and QE drove a bubble in bonds, which ultimately

[00:14:14] peaked when the economy was shut down during COVID. COVID. And then today we have the chat GPT moment, which I don't remember what you thought about it, but I thought on January 10th of 2023 when Microsoft made its investment in Open AI, you know, for many of us, we'd been playing with the first public version of chat GPT. a new version

[00:14:44] had just come on. And for any of us who have done any sort of statistical analysis through their careers, there's been a slow burn of regressions leading to neural networks, leading to machine learning, all happening as compute power increased. That's been a 40-year slow burn in terms of what ultimately inflected with that pretty much one-off event

[00:15:14] when the AI trade has been one direction since then, basically. And so I like to think of those as the precursor to the bubble behavior, which is either a significant regulatory change, a significant easing, or a significant technological development. Or, lastly, a significant exogenous event, the bubble of the bond bubble would not have

[00:15:44] occurred without COVID. And then you have escalation events. And that happens along the path of that framework, and that's when you go into a bubble. And for me, those things were just an explosion of deals in 1987. In 1998,

[00:16:12] the long-term capital easing ramped and escalated the tech bubble. In 2005, financial engineering, in particular, tranched CDOs, tranched mortgage product, doubled, tripled, xed the leverage, squared the leverage, whatever you might want to call it,

[00:16:42] and escalated the housing bubble. Obviously, the pandemic itself was the final thing that caused the bond bubble to go parabolic. And then, as I said, I think we saw some unnecessary easing of financial conditions. Today, we had a super-hot inflation print. It's been, I don't know, 62 months since inflation

[00:17:12] is above target. And in 2023, and even in early 2020, late 2022, before this whole AI trade got started, the central banks, in particular the Fed, eased to deal with financial stability around the banking crisis, the small banking crisis we saw in the spring of 2023. And they gave up on their inflation mandate, and that escalated

[00:17:41] this thing. So those are the things. There's the root conditions, which don't have to be a bubble, but root conditions can become a bubble. Then there's the escalation events, and then there's the peaking. And I think we're in that phase right now. We're in the peaking phase. Now, how long that can last quite some time. You know, we saw long-term capital got bailed out

[00:18:11] in October of 98. It took almost a year. A year later, you know, the Nasdaq still had enough oomph to rally 60% in six months leading up to the final peak. So it can happen. It can take, you know, some time. So let me take a breath. Anything you want before I... Well, actually, a few different things. One is I would ask you, did you... You were investing through it. Did you have any takeaways from the Japan bubble, like of the 80s?

[00:18:40] So let me be clear. So I worked for Salomon Brothers. Salomon Brothers had a massive presence in all these markets, all that I just mentioned. And as a personal investor, you're highly limited in terms of what you can actually do. But one thing I'd remember doing is buying the Japanese, the Nikkei put warrants that existed in 1989 as the bubble peaked.

[00:19:10] But... You got those cleared with compliance, right? You had to hold them for like some days or something. It wasn't a trading thing. Yeah. I mean, that's... Throughout my whole career on the sell side, you know, you just can't... You just can't play for good reason. You know, you're... For one, it's distracting. I think that's the principal reason why they do it. There's the compliance reason, which is insider trading, market manipulation, getting in front of clients, all that sort

[00:19:39] of nonsense. But I just don't think they want you trading all day in the end. Or at least I thought that initially. In fact, I still do. So, yeah, you can't really do much investing. But I did get to see every other type of investor flowing through the market. But, yeah, I mean, the Japanese bubble has many aspects of those same things. In particular, you know, it was a housing bubble,

[00:20:09] it was an equity bubble, it was an easy money-driven bubble, it was all manner of things. What was interesting to me, like, hearing you go through those, it was 87 because I wasn't investing in 87, but when you typically hear people refer to historical bubbles, like, 87 is one people talk about as a crash, but they don't really talk about it as a bubble. So, it was interesting hearing you talk about the event that led to that. You know, most people don't know that if you bought stocks on January 1st, 1987, 1987,

[00:20:39] and you sold them on January 1st, 1988, you broke even. That the crash of 1987 just brought back, just gave away your 1987 returns. The peak of the equity market ahead of the crash was up, I don't know, I think 31, 31.5% ahead of the crash, and all it did is give back. So, I think you can't look at the 1987

[00:21:09] crash without looking at the first nine months of 1987, which looked bubbly. But I do agree, not many people talk about that as a bubble. I talk about it because I find there's an interesting market mechanism dynamic there regarding portfolio insurance that maybe for a later time we'll talk about, but portfolio insurance and zero DTE options right now, rhyme. And those

[00:21:39] had a very big impact on the ramping pre-crash and then had a massive impact on the crash itself. So it's just an interesting, to me, interesting dynamic. that was going to be my question because I think that was probably the most mechanical, right, of the bubbles you would describe it maybe? Yeah. Yeah, there's an aspect of every bubble that has sort of normal mechanical activity. How do you think about having gone through these? I've gone

[00:22:09] through a few myself and I always question am I any better at this or do I still get wrapped up in the whole thing? Right now I'm talking about AI as a transformative technology so it's different than other things. Do you feel like you get better as you go through these or do you feel like there's a human nature to this that it's just very hard to learn the lessons of the past ones? Well, the problem is most people's careers are relatively short and so we don't get to have many, many lessons over time. But what

[00:22:39] I would say is without a doubt human nature across these bubbles doesn't change. Like guys who were my age back then may have seen bubbles before and may or may not have participated in the bubbles that we've seen when we were in the younger part of our career. But the people today that haven't had any experience, they're not well equipped to understand what it's like and the bubble

[00:23:07] is perfect. It's a perfect, the reason why a bubble regime is so difficult is because it plays precisely on human nature. You know, you see your neighbor up a hundred percent on some semiconductor stock. It matters to you. You are affected by that. You are not affected by them up,

[00:23:37] you know, 60%, I don't know, 15% on their S&P when you've been in cash. But if they're getting enormously and suddenly rich, which is unique to bubbles, like, like, we all, I mean, not unique. Of course, there are people that sometimes get lucky. But when not only this neighbor, but this neighbor and this neighbor are getting enormously rich suddenly, that only

[00:24:07] happens in a bubble. And it's incredibly compelling. I don't see how, honestly, I don't see as humans how we can combat that without incredible discipline or, you know, just, well, I don't think we can. I think it's one of those human nature things that there's just bubbles baguette behavior. That's the point.

[00:24:38] I remember the same thing, like, you know, eight, because I knew some people who were buying, you know, three and four houses on, like, these stated income loans with nothing down, and they were just making a killing, like, at least on paper, the houses were going like crazy and it's like, why am I not doing this? Why am I not buying these houses? Yeah, I missed, so I have to admit, I did not see that part, like, the housing bubble per se. Yeah, I saw, it just didn't affect my neighborhood or my community, my friends and my other investors.

[00:25:08] That said, credit investing and the way to make money using the securities that came out of that was highly speculative. How do you think, can you talk a little bit about the late 90s again? Because you wrote the piece about the analog between that and you talked about the 94 bond market crisis and Greenspan's pivot. Can you talk a little bit more about the late 90s and the analog you see today? Right, you know, again, I think you start with conditions

[00:25:37] and the conditions are we had right before Netscape Navigator came out, which, again, I'm just putting, pinning that as being at the time was a big deal. Like, it was a sudden wake up to the rest of the world. One year prior to that, the central bank had basically bankrupt the mortgage market,

[00:26:07] bankrupt the Orange County pension fund, and created a massacre in the bond market and then pivoted. And when they pivoted, they eased financial conditions in a meaningful way. So that money, the money creation, the credit availability, the price of money started ahead of this 95 technological event, very easy.

[00:26:37] So that's a good start. And so then you have this period of time between 95 and really 97 where people thought, wow, this is going to be a big deal, and we're going to need all manner of capital investment. And that capital investment started being funded and started flowing through to market prices and deals were getting done and so on. And that was a period of time in

[00:27:05] which we all know what was happening, but at the same time there was no sort of like euphoria. It was just, this is going to be a big deal.

[00:27:47] So when I think about that, I think about the prelims to what we're involved in now. And the prelims to that were the stock market bottomed in early October, maybe 6th or 7th of 2022 after the Fed had gone through this hiking cycle and announced QT and started doing QT. The bond market had sold off from its bubble.

[00:28:17] And all of a sudden we have the beginning of an easing cycle. And so that set us up to a point, you know, Meta was in the 80s and all the stocks that are now 10x that or 5x that, well, double digit stocks, you know, and now they're all deep into the triple digits. All the Mag7, Nvidia. And then we had October, oh sorry, we had January of

[00:28:46] 2023. 2023. And that was the Netscape Navigator moment. Soon after that we had the SVB crisis. And so we had the next couple of years was a very nice runway for technology. But we hadn't had the escalation, the meaningful escalation. And that brings us back to

[00:29:15] 97 and 98. In 97 and 98, what happened? We had an Asian crisis because all this easy money flowed outside of the United States and went into Indonesian taxi companies and Thai companies and there was a speculative frenzy in Asia that unwound suddenly. causing stocks to U.S.

[00:29:45] stocks to crash and then recover. And then we had the long-term capital crisis in 98. And so when I think of those proxies, I said, hmm, October 97 we had an Asian crisis. October 98 we had a long-term capital crisis. Huh. that's interesting. 2025 we had Liberation Day. 2026 we had the

[00:30:17] war in Iran and we had major sell-offs. Similar timing. So now you have those things. They've been resolved. The financial conditions have been kept easy because they wanted a successful resolution of those things. In 99 and in today, you're having a

[00:30:46] expectations explosion. which, you know, I pointed to something in one of my posts. In March, right in the middle of the Iran war, the chairman of NVIDIA came on and made a very, very aggressive announcement about CapEx. And we all knew CapEx was coming, but it had a

[00:31:16] step change in expectations for semiconductors. The semiconductor stocks ended up falling, but that step change ultimately when the war was resolved immediately got recognized and started a parabolic move in semiconductor stocks that we're still in the midst of. And so you have to look for that step change in

[00:31:45] expectations, a world in which the bubble, the main asset that's in a bubble is flowing through for expectations for earnings that are simply never going to be bad. And you had that in 99 as well. So we're somewhere in that phase where you have massive

[00:32:16] expectations of immediate benefit from the technology that has resulted in a parabolic move in assets. Yeah, and I do wonder, like, when we look back at this, I wonder if we'll look at the announcement of Claude Bitos, because that was very tied to the move in Senis recently. I wonder if we'll look at that as a big event in terms of what ignited a parabolic phase here. Well, I mean, I think that one lines up better with

[00:32:47] but what I see, a lot of the bullishness on semiconductors is the step change in earnings expectations. We already expected 60%, 70% increase year-over-year in earnings. In March, you had a change from 60% to 70% earnings growth for the next couple of years to 100%. I point

[00:33:17] to that, but I think yours lines up better on timing. And that's the way things work. You have this constant what's the right word? You prime the pump with the main thing and then each time you get an accelerant that makes you go the next phase up. Can you talk a little bit more about long-term capital? Because you talked about that in the pieces. What happened in the week of that is

[00:33:46] something that might happen in a like regime? They weren't necessarily directly associated with the bubble. That's an interesting point. There are a couple of things that happen during a bubble. You always look for what I call contagions that could either cause the bubble to extend or

[00:34:16] are consistent with the post bubble world. long-term capital had it's interesting. One of the contagions you can have in a bubble is those who are fighting the bubble being bankrupted.

[00:34:45] But generally those don't have meaningful contagions because whatever they have to dump they dump and whatever unwind there's so much liquidity around there's so much available capital around that losses can be absorbed by the system. So an inflation bubble the period of time when a bubble is

[00:35:15] inflating you rarely have contagion. So I don't think the long-term capital thing was caused by the stock market rally. There's some tweaky little stuff about their vol position that probably had some impact but it's not really there. Long-term capital was over-levered in primarily fixed income instruments and got a margin call.

[00:35:47] The problem is that the central bank massively overreacted. This is what they did is they arranged for the entire fund which by the way the numbers are laughable how small they are right now. They forced the I believe the number was they forced 13 banks or 11 banks called the consortium to come up with 1.3 billion

[00:36:16] dollars. That's B for billion not T for trillion. That's crazy. Nothing 1.3 billion dollars to buy the positions that long-term capital had and assume their positions. So there was it was nothing. But they still cut significant interest rates significantly to make sure this didn't become a

[00:36:47] financial crisis. It wasn't going to become a financial crisis. It was taken care of. I was that. But they still did these not only did they cut but they did surprise cuts. And this is from the same guy who you know 40% ago had used the term irrational exuberance to

[00:37:17] describe the stock market. He was cutting into a stock market that was up 40% from when he made those comments. And so that was like adding rocket fuel to the bubble.

[00:38:01] One of the was that Cliff Asnes did. Yeah. Yeah. So I'm just wondering how do you think about why that matters? Because that's a really important point. I mean tech was very small going into the beginning of that bubble and now tech is sort of at the beginning of

[00:38:33] I'm going to still want some dominoes or Burger King or whatever. I'm going to go play golf. I'm going to get my hair cut. Whatever. Until tech cuts your hair I guess which is maybe someday that's going to happen.

[00:39:04] I'm require stuff that's not semiconductors. So the share of the economy matters. And so when an industry has no share 4% share and it can grow to 4x well that's you know offers a real significant earnings and stock price upside.

[00:39:34] But if you're already at 15x you can't go to 60x you can't get a 4x because there's not a there's just not a lot you can't there's no some of the pie slices of the economy are claimed they're never going to be tech. So I think that's the point which is once you start if you're starting at a small base you can get a 4x return but you can't get a 4x return on

[00:40:07] already a significant factor in not only in the investments but in literal earnings share of GDP now does that mean that we can't see another 5x 6x 10% share growth in earnings coming from the economy in tech over the next few years we can I don't know where it's going to come from and who's going to

[00:40:37] pay for it and so you know that's sort of when I think about what can you know what the upside for this is I look at it and I've described this as a you know a pie where great new technology and this is true throughout history great new technology increases the size of the GDP pie it does it because people get a new and can generate more output

[00:41:07] with that tool full stop that increases the size of the pie and a majority of that pie increase the increase in that pie can go to the tool maker I got no problem with that it can mostly go to the tool maker and that creates an

[00:41:37] any bit of share that technology takes comes from somebody else and so that speaks to jobs it speaks to incomes if technology is going to take more of the share everything else is going to get less of the share that means everybody's income that is involved in that lesser share is going to fall so

[00:42:07] who's going to be the customer to buy the new GDP from the tech so that's the thing that I think is so it's all about the S curve in the end of the day that's a lot of people describe that you can grow a lot when you're small you

[00:42:43] start again I know don't think it can double from a big base and I do think it can double from a small base so I think that is fundamental does it matter that it's big on the way down sure I guess a little bit in that it can fall harder but that's not I don't I don't think this technology I

[00:43:27] 30 year journey for me to watch things that happen in the world Amazon has been able to anticipate my buying needs for 20 years now they know exactly what I want to buy exactly when I want to do it they didn't call it AI back then but it was AI right so these things have been going on we're not going away from it I don't new version of AI that got people

[00:43:56] excited going to be extra disruptive maybe or maybe it won't work I just I'm a big believer long term in this tool and I do believe technology will continue to be isn't going to shrink so the question is is it going to grow as rapidly as is expected that's really I think the only thing that we're talking about here it's like talking

[00:44:26] they overbuilt fiber now we use every strand so I don't think that's the story here I think it's just a matter of expectations and pricing do you think you've mentioned some policy errors like in previous bubbles what do you think the biggest lessons for policymakers are if you look back through the bubbles you've lived through like what are the biggest lessons for policymakers in terms of the mistakes they've made

[00:44:57] the ability for the government to do anything but steal from the future and to give to the current I guess the you know we had today we had the somebody a senior in the Korean political system suggesting that they are going to tax Korean AI to deliver a

[00:45:27] citizen dividend and so you know that's an interesting thing it's a redistribution it says these are the guys that are making all the money we're going to take it from them and give them to those guys and so governments love to do that stuff they do it all the time and you look at

[00:45:57] housing great example why was housing in a bubble lots and lots of reasons but perhaps the greatest reason is that this country's politicians have always always favored home ownership and created subsidies for cheaper mortgages and so when you do that you have an impact so yeah I mean I think it's it's

[00:46:27] you know you're in a world in which major disrupt so I don't think this is going to be disruptive and I think in many bubbles we've seen disruption what does disruption mean it means people lose their jobs the LBO bubble if you call it that was the hollowing out of the manufacturing sector in the United States that's what we did the LBO were

[00:46:59] socially destructive according to Dan Ruston Kowski who was the house ways and mains chair ultimately a criminal I

[00:47:28] but it was Congress blamed LBOs and decided to target them and so it's very likely that policy makers can by their actions stimulate bubbles and when they try to muck with who gets the benefit of the bubble and try to redistribute that benefit can

[00:47:58] kill the bubble do I see anything on the horizon yeah I do I mean there's no chance that politicians in this country will allow the complete hollowing out of the income potential of a significant portion of possibly a gross majority of the population

[00:48:27] from being able to earn a living to allow shareholders of AI companies to become oligarchs they may allow it for some period of time depending on who's in charge but at some point the country is going to rise up and there's going to be a politician who says give me your money is that something that's going to happen in the year term no but it always happens so you can count you can absolutely count

[00:48:57] on it that at some point they're going to take the money from capital and redistribute it I want to the point you made about the earnings growth revisions and how there was that step up change that they went from I don't know what it was projecting 50% 60% growth to maybe double that for some of these semiconductor and other tech related companies so are you within this bubble regime is it that the earnings growth

[00:49:27] estimates are too optimistic or is it the reaction on the stocks is too optimistic or maybe some combination of both but I just want to kind of flush that out a little bit because maybe if the earnings growth comes through I mean then maybe some of these like price moves can be substantiated but I don't know I'm kind of asking right so so

[00:49:57] there's this idea of valuation which has never been a good metric for understanding markets at all like there's you know we've seen for a number of years some of the usual suspects talking about including myself talking about given assets or equities or whatever are going to be sub normal you

[00:50:28] can't do much with that it doesn't help you to know that to determine whether you're should be buying or selling stocks or whether you're in a bubble or not it comes down to expectations positioning and value has become less to me relevant but for instance semiconductor stocks on a price to forward sales basis

[00:50:58] are extremely elevated on a price to earnings basis nope they're fine they're actually pretty cheap actually so you know you can look at valuations and say does it is our value I think it is a helpful and necessary understanding to a piece of information that contributes to a bubble if valuations are crazy

[00:51:27] but it's not you can have a bubble without valuations being crazy and that's because valuations are based on expectations based on earnings expectations and if you have a step change of 50% earnings growth to

[00:51:57] well more more than that which not only tells you that the expectation the recent expectation for 26 or 27 was higher but all future expectations went up and that to me is indicative of a market that expects semiconductors to continue to grow well past people's normal horizons which to me is

[00:52:27] a bubble indicator when people extrapolate recent historic growth with an order book that's by the way their order books are nuts they're just unbelievably packed with orders so they're going to deliver those earnings I think they're going to deliver their earnings but at some point things don't go to the sky and

[00:53:00] so the question is when people stop extrapolating this sort of earnings growth year over year over year if it delivers listen if we grow semiconductor earnings 100% a year for every year forever just firstly imagine you know what doubling something what happens to something if you double it for 10 years you know it goes from 1 to 1,000 how do things

[00:53:30] possible I mean I guess it's possible but this is where I come back to the point I was making earlier which is where's it coming from for one where's the money coming from to buy all this stuff like where's the money coming from like if we need to buy a thousand chips 10 years from now and we're only buying one to make shitloads of money

[00:54:00] I get that but I'm talking about the customers how are the customers going to make the money to do that because the customers are getting disrupted so if you look from a macro standpoint I think it's very possible and again it's one of those funny things if semiconductor earnings deliver such that their valuations and their so such you can continue to get sizable returns owning semiconductor stocks

[00:54:29] a bunch of other companies are going to be really struggling and so the bubble may stick we may grow into the I don't listen I don't think there's any chance we will just to be clear I'm not timing the market but semiconductors could double fine got it they aren't going to go

[00:54:59] up much more than that and when they stop going unless everything else gets crushed and I don't see how that's possible I don't see how you can have continued semiconductor demand except for one thing massive leverage the only way you can get the rest of the economy to get its share of the pie and semiconductors to get their priced in growth

[00:55:28] is through massive leverage borrowed money from the future so far we haven't seen that and more importantly so far we haven't seen the financing I think one of the things that we miss when we think about all of this is where is the source of the rally from the semiconductors the source is that people

[00:56:01] frontier models are demanding compute now are the clients demand of the frontier models demanding compute yes partly but also the frontier model builders are demanding compute because they want to create the next thing which will actually be the thing that changes the world you know as you know LLMs are going to do what they're going to do but it's the next thing that's going to that they need to continue to advance

[00:56:32] so you've got this chain and people like to call it circular financing I don't it's pretty straightforward compute it's all about compute we need a bunch of money to build compute and if you just think of it that simply where's the source of money it can come from revenue from those who already have installed

[00:57:02] compute it can come from revenue that happens from the frontier models or it can come from borrowing and financing and so what do we know about that well the first what do we know we know the capex promises are massive trillion dollar capex year over year which is

[00:57:32] the source of money has mostly there's there's been a little bit of it coming from the frontier guys but most of the source of the money has come from the hyperscalers and they've handed that money to Nvidia who has then handed it to others and I get that but most of the money for the compute build is coming

[00:58:02] and so the first source of funding was okay we've got plenty of cash flow free cash flow that means their customers by giving them profits for their tools allow them to spend that cash flow on instead of just

[00:58:32] businesses they're spent that now they're canceling their buybacks because they had been using cash flow to buy stocks their stock back in meta canceled theirs two quarters ago Google canceled theirs this quarter Amazon doesn't really buy Microsoft has shrunk its buyback for a while now and they'll likely cancel more so that takes a bit out

[00:59:05] and they're issuing corporate debt lots and lots of corporate debt all of those things that lack of stock buybacks that additional corporate issuance all is how this CapEx is going to be funded so you have to ask yourself who's buying the corporate debt do they have the ability to buy that corporate debt to lever up to buy that corporate debt and what about the pricing

[00:59:35] because eventually all happens when the cost of financing is in excess of the return on the CapEx usually happens after it's already crossed over classic business cycle but right now we're in the face of everybody wants to buy compute and everybody needs money to buy it and so

[01:00:04] one of the things that's a potential catalyst for a bubble top is that issuance being a headwind on assets and so you know I'm looking with great curiosity about how the three frontier model guys are going to IPO just their proceeds alone rivals the proceeds of even corrected for inflation etc

[01:00:34] rivals the proceeds for all 400 of the IPOs that happened during the four years of tech all coming in three tranches this year corporate debt exploding higher in terms of issuance that supply to me is the big risk if they get it done if somehow the financial markets lever up and take on that debt

[01:01:04] take on those IPOs take on more risk assets relative to their capital lever up then you get a virtuous circle because the money does get spent on compute and if it works if it delivers the promise the price will pay off as a positive ROI which means everybody will get who invested who lent money to these companies will get a nice return so that there is a very bull case if

[01:01:33] without a hiccup all of these financing all of this capex gets funded by the market and the capex delivers ROI without a hiccup you can have an extremely long that's how you grow out of a bubble like bubbles can bubble and then consolidate for years as earnings grow without ever popping and you can get back to health that does happen it's just very

[01:02:17] first principles under the surface how you should think about this where does the money come from like are they going to get the return on the investment that they think they're going to get all this stuff is very first principle based and the consequences for everybody else right right those are

[01:02:47] things in the future but just to sort of try to sum up if I could explain it back to you you know at a high level a bubble forms when something new comes to the market or the economy whether it's a new technology a new financing sort of scheme or what have you and then that kind of puts us in this possible or potential bubble regime and once you enter

[01:03:18] you have sort of like the FOMO the neighbors over here getting rich you have everybody talking about sort of how they're making money in this bubble and that sort of puts us in this bubble peaking phase which is to your point it's hard to time but there are signals that you can look to that say this looks like we are way do I

[01:03:48] have that rate did I miss anything absolutely and I think the key thing there is we're somewhere along the

[01:04:19] I'm no George Soros and I think I'm late to this being a bubble so I'm not rushing in but as an investor you have to think about whether you want to you know the type of mistakes made during bubbles are the most costly and so and that's the reason why the regime identifying a regime that's a bubble is important because you have to change your behavior you have to

[01:04:48] this with you monthly but I think for this discussion we want to get this out sooner so we'll record that here in a couple days and we'll put these episodes out pretty close to each other this has been a

[01:05:18] can contact us at xsreturnspod at gmail.com no information on this podcast may be holdings of the firms of the hosts or their clients