The Market Illusion: Mike Green on Inflation, Geopolitics and the Hidden Recession

[00:00:00] Every indication we have is that actually the system is, you know, the conditions are much worse for the average American than we think they are. Nobody wants to open up the Wall Street Journal or turn on CNBC and have like a deep, thoughtful conversation about this sort of stuff. Well, behind the eight ball actually conveys that you're aware the eight ball is there. My description of the market is largely a mechanical creature at this point. Ironically, the CPI is probably too high because it has such a huge

[00:00:29] emphasis on imputed costs. Now, a more contemporary measure that was introduced by the Cleveland Fed was called the Cleveland New Tenant Rent Index. It would suggest that PCE over the last year was already around 1.25%. Welcome to Excess Returns, where we focus on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long term investor. Hi, Mike. Welcome back to Excess Returns. Pleasure to be here, Justin. We always love having you on.

[00:01:01] Our audience always appreciates your insights and thoughts. And today we're going to talk about the markets, the economy, get your thoughts on all the things that are happening at the White House with the changes Trump is making. See where that conversation takes us, which I think is going to be a very interesting one. And, you know, just overall, get your get your thoughts on how you're thinking about things in markets. But before we get into that, I do have one just quick. I was talking. We get a lot of comments on YouTube.

[00:01:30] There's a lot of comments, obviously, as the channel has grown. And there's this one consistent commenter. It doesn't matter what video it is. He's just like, follow Mike Green's thoughts. So it could be about anything. Follow Mike Green's research. That's all this guy says. So that's fantastic. I'll have to pay my son a little bit more. Nice. There you go. So but anyway, so thanks, Mike. I really appreciate it. You're always so generous with your time.

[00:02:00] So, OK, let's start out with wanted to, you know, last time we had you on, which it was maybe mid last year, you know, there was some concerns about. You know, possible heightened recession risks for the U.S. economy. Has your mind changed at all on that or what are you thinking? No, you know, it's funny. I was talking with some friends earlier today. I'll show you actually just very quickly an interesting chart.

[00:02:26] So the Chicago Fed National Activity Index came out today. Right. And the CFNA has historically been a fantastic predictor of the GDP level. And so I just want to share that relationship here. So what I'm showing here is a Z score of the CFNA on a one year average and GDP. Right. And part of what's been so fascinating about what's occurred is is overall, with the exception of the period around COVID, which obviously created exceptional variation in those in those components.

[00:02:53] It's been a really, really good proxy for what GDP is. So I'll share with you an X, Y chart that basically shows GDP on the Y axis, CFNA on the on the X axis, the relationship between the two. CFNA explains somewhere around 80 to 85 percent of the volatility around GDP. And what's been really remarkable about that is how that relationship has broken down.

[00:03:19] I'll show the same chart to you in a law in a line form where you can see the extraordinary deviation that has effectively occurred over, you know, a. Over the past two years right now, the irony is, is that the CFNA is largely focused on the cyclical components of the economy. That's why it has been a reasonable proxy for tracking GDP.

[00:03:45] And under almost any model that you look at, it would have suggested that what we actually saw was a recession. And I think people who have been following the manufacturing sector or the interest rate sector, sensitive sector, would argue that we that that's exactly what we saw. We saw an increase in unemployment that triggered the SOM rule that triggered the the the I'm blanking on the the other guys, the McKelvey rule, etc.

[00:04:10] All of which would have historically suggested that we saw a retreat in the economy that was consistent with the recession, albeit a relatively mild one. Now, the bullwhip effect has snuck in to a certain extent, right? As you draw down inventories, as you reduce production of automobiles, as you reduce the production of homes, etc. All of that manifests itself effectively and inventories being reduced and production ultimately has to catch up.

[00:04:36] We've seen some indications that there's been a reacceleration in that segment of the economy. At the same time, unfortunately, exactly as I've been concerned about, we are now seeing more issues in the services sector and in the spending that's coming from wealthy individuals. A lot of people think that this is tied, you know, that the increase in spending from wealthy individuals, wealthy households is tied to the wealth effect. Stock markets are higher. Home prices are higher, etc.

[00:05:03] The problem with that is, is that spending off of the wealth effect is tiny. It's about 2% of the increase in wealth. So if we think about the implications that that has, it's actually quite small. If instead you focus it on the interest payments to the economy, this is, I think, something I've emphasized with both of you in the past. The propensity to spend out of interest income is about 70%. So about 70 cents on every dollar of increased interest income gets spent.

[00:05:30] So when the Fed hiked interest rates because of the low component of variable debt, variable rate debt on the liability side of the equation, relative to the asset side of the equation, the most obvious one being things like CDs or money market funds, etc., it actually led to a surge in interest income. And that's really what's powered the spending component. So the Fed hiking rates didn't have the effect that many people thought it would in terms of

[00:05:57] slowing the economy or causing the stock market to decline meaningfully. Instead, what we actually saw was an increase in interest income that largely benefited those who had cash on the balance sheet. One of the things that I've sort of seen in my career, and it's always easy to see it like in hindsight, but with the recessions we've been through since 2000, you see these like cracks in the labor market with companies, you know, starting to lay off people.

[00:06:26] And just this morning I saw it. Now, these aren't big numbers by any means, but, you know, and you can always kind of see it like in hindsight. So it's easy to talk to it. But like Starbucks is, you know, laying off, I don't know, maybe a thousand or fifteen hundred workers. And then obviously you have Doge and stuff that's happening with people being let go. And we'll talk about that maybe a little bit more in a few minutes. But I'm just wondering, do you think that any of the things that you're talking about or seeing and any of the things that I'm seeing now

[00:06:55] sort of changes the calculus of what the Fed does here? Well, I think that there's a variety of factors that'll change the calculus of what the Fed does. I think the most important one so far actually is something I'd flagged last September in that the seasonality, the residual seasonality in CPI, which had been very favorable in the summer of last year,

[00:07:20] turns unfavorable or turned unfavorable in the third quarter, towards the end of the third quarter, into the fourth quarter, and then for the first quarter of this year. You remember hearing Jerome Powell say seasonality is over an entire year. We have to equal it out, et cetera. Residual seasonality is a different issue. It's when you introduce basically a shock to the system that changes a seasonal pattern of price setting and consumption. And that in turn then means that your seasonal adjustment factors get thrown off.

[00:07:49] And so you see price decreases where you had expected to see increases. An easy example of that is the Russian invasion in the summer of 2022. They caused gasoline prices to spike to an extraordinary degree, caused a renewal of some forms of supply disruptions, et cetera. That set a stage for normal pricing behavior over the course of the summer to seem like very low pricing. And if you remember, we actually had a couple, we had at least one month in which inflation printed negative in the summer of 2024.

[00:08:19] The reverse of that is now happening because you have to use those seasonal factors to spread it out over the course of the year. And so inflation is coming in hotter than people had anticipated. And you're largely seeing that in the market's reaction to it, right? But what it created is uncertainty for the Fed about its path of rate cutting. Once again, as we come into the summer, we'll start to see that seasonality work in our favor.

[00:08:44] It should cause CPI and PCE to be lower than it actually is. I just want to emphasize that. And as a result, you'll likely see a renewed call or a renewed confidence that the Fed can cut more over the course of the year. The activities of the Trump administration, whether they are tariffs, which the Fed should look through, or whether it is indicated they will look through, or whether it is because of the concerns around increasing unemployment uncertainty or employment uncertainty,

[00:09:13] to me just reinforces those underlying components. The Fed is exceptionally focused on unemployment claims. And I think that's a strategic error. I think that's a misunderstanding of how the data exists today. We can talk about that for a second. But that's what they're going to be following very closely. So if you're correct that the increase in job cuts, whether they're coming from Doge or whether they're coming from corporate sector,

[00:09:41] are likely to cause that to rise modestly or could cause that to rise, that in turn will then create conditions that the Fed has to respond to it. The problem with that is the dramatic rise in the gig economy has changed the nature of unemployment claims. That combined with a couple of other factors. One is we haven't inflation adjusted unemployment insurance levels for nearly a decade in many situations.

[00:10:08] California is still paying the same levels that they were paying in, I think it was 2017. You know, perversely, that makes unemployment claims far less attractive. And at the same time, we have a tool for avoiding unemployment called Uber that has emerged dramatically since the global financial crisis. There's an incredible amount of uncertainty about how big this system is and how many people are employed in gig economy type jobs

[00:10:37] that effectively allow them not to apply for unemployment insurance, right? If you lose your job and you drove for Uber to make extra money and you continue to drive for Uber, well, guess what? You're not unemployed, right? You are ineligible for unemployment claims. And that became even more true in the aftermath of the COVID cycle in which there was an extraordinary amount of unemployment claim fraud that occurred. And as a result, all the states tightened up their claim standards.

[00:11:06] And so it's much harder to apply for unemployment insurance today than it was in the past. That means that the unemployment insurance data that we're getting is in traditional terms, bunk, right? Yes, you lost your job. Yes, you are unemployed in every metric that you as an individual would think about. But because you are driving for Uber, you are not eligible for unemployment insurance.

[00:11:28] And on a cash basis, driving for Uber is infinitely more attractive than the, I think the technical term is shitty compensation that you would get if you filed for unemployment. In addition, unemployment insurance requires you to effectively report to a parole officer, right? What did you do to find a job? Did you go to this ridiculous job opportunity or interview that was available to you? I know you're a mechanical engineer, but there's a job available as a security guard.

[00:11:58] Why aren't you actively exploring that? If you aren't actively exploring those types of jobs, then you are no longer eligible for unemployment claims. And so people have largely voted with their feet to not participate in the unemployment insurance program. That in turn has led to the rise in part-time employment. Are you working part-time because of economic reasons? Well, no, I was driving for Uber beforehand. So it's not actually economic reasons that I'm working part-time. It's that I lost my job.

[00:12:27] Well, you're not unemployed, right? So therefore, you didn't actually lose your job. The rates of hiring in the economy are consistent with much higher levels of unemployment. The rates of consumer distress are much higher than would be associated with traditional levels of unemployment. And so almost every indication we have is that actually the system is, you know, the conditions are much worse for the average American than we think they are.

[00:12:55] And again, that's largely being covered by, as the Wall Street Journal reported today, an increasing fraction of spending that's coming from the wealthiest households facilitated, ironically, by the Fed hiking interest rates. Yeah, I saw that headline that was talking about how much the wealthy actually spend. But just let's bring that like one step further. So that basically means that what the Fed is looking at in terms of unemployment, they're like behind the eight ball effectively.

[00:13:22] Well, behind the eight ball actually conveys that you're aware the eight ball is there. I guess you're right. And so I think the real issue is, and this is very common, right? You rise to a level of success in which you are lifted above the humdrum and mundane existence of people like me who actually try to dig into the data to understand it.

[00:13:46] And as a result, you know, you kind of operate under the, well, this historical system did a pretty good job of telling us what was going on and therefore we're going to rely on it. Sure, I get that things might have changed a little bit, but how much could it have really changed? And I just want to highlight for people like the COVID recession was truly unique. We never had anything quite like it. The GFC is our last experience with a significant level of unemployment and you couldn't drive for Uber then. Right? It didn't exist.

[00:14:15] It didn't emerge until 2009. And more importantly, the lift process in which you as an individual could use your personal car to drive a car that Uber then copied into Uber X and it's been exploited by DoorDash and everything else. That really didn't exist. And we've never seen what that looks like during a period of recession. Now I want to emphasize, like, it's a good thing that people have access to that additional income.

[00:14:41] But if you're somebody who was already driving part-time for Uber to gain extra income, your financial condition has deteriorated sharply. And, you know, unfortunately, we're largely ignoring that. We are in the data exploration mode. The Fed has announced initiatives to try to better understand the gig economy.

[00:15:03] But to just put scale on it, the estimates are anywhere from 5% of the employee of employment is tied to gig to 30% of employment is now tied to gig. That gives you some idea of how, you know, far away, you know, or how wide the barn is that we're trying to hit here. Like, we have no idea what this thing actually looks like. And that sort of condition, I think, is part of the reason why people feel so poorly served by what's happening in the economy. Let's talk about inflation specifically inside this.

[00:15:34] Beyond eggs, when we start to think about the subcomponent parts, we think about everything else. How do we actually think about the way these numbers are getting tracked just in the raw products and services that we're using right now? Well, this is something that Powell and echoed by Waller, which suggests that it was introduced to Powell by Waller, have emphasized. And something I've made a sincere effort to highlight to people.

[00:15:55] Powell's introduction of the idea of market-based prices as compared to imputed prices, which he introduced at the December Fed meeting, I think is really critical. Because people tend to think about CPI or PC as an extension of it as, you know, oh, it's all a bunch of bullshit. There's, you know, various forms of imputed measures, and it tells me the quality of things. It's quality adjusted. And so, you know, the CPI number is obviously too low.

[00:16:22] So, ironically, the CPI is probably too high because it has such a huge emphasis on imputed costs. Now, the single most famous of these is the owner's equivalent rent component as compared to what does it actually cost you to own your home? That was misunderstood in 2021. Famously, Bill Ackman went on and said, oh, it's based on a question you're supposed to answer. You know, how much would your house rent for? Not understanding how that was actually being used.

[00:16:50] But what it's really tied to is rent metrics, and it uses a slow-moving average of effectively four separate pools of six-month periods. And so it's using a two-year rolling average for housing costs that represents about 35% to 40% of the CPI and about 25% of PCE. That means that the shelter component that we're getting is giving us all sorts of information about what happened two years ago.

[00:17:15] And you actually hear the Fed addressing this as they talk about the fact that we are seeing slower rates of mobility and lease turnover and home change that is actually slowing that process even further, right? So it's extending the time period that people are in these lease arrangements. That means that the data sets are moving more slowly to correct than what we ultimately think.

[00:17:36] If you replace that owner's equivalent rent with a more contemporary measure that was introduced by the Cleveland Fed, what's called the Cleveland New Tenant Rent Index, it would suggest that PCE over the last year was already around 1.25%. So on my metrics, we're already below the Fed's target of 2%. I think that's telling you in part that real rates are way too high. We see that in the recurring weakness in the housing sector. We see that in the recurring weakness in the auto sector.

[00:18:05] That interest rates are simply too high for the vast majority of consumers who would like to buy those products but are barred from doing so because of the cost of servicing the data associated with it. So by and large, inflation by that definition seems to be decelerating and that seems to be the trend that's continuing here? That would certainly be the implications. Now, I mean, look, if we introduce 50% tariffs on China, you will see an impact.

[00:18:30] But a big chunk of that impact is actually just going to be companies with pricing power having the ability to push that through. But if you look at any number of metrics, true inflation as well, and that I like to point people to, et cetera, you see this huge surge of inflation that basically ended around June of 2022 and largely has been flat since. It's been interesting, and I just want to make sure we point people towards it. We can show it.

[00:18:57] You've shared it in the blog about seasonality, the parts of inflation that are hot and all the different ways this rolls over. Do you want to just take a second just to unpack how you track this and the chart you shared on your blog? Sure. So the chart I shared on the blog actually highlights this seasonal component, and you can actually see the traditional behavior versus what's happened post-pandemic.

[00:19:21] And effectively, those two, you can pull the chart off of my substack, but you can see how those two measures diverged, right? Now, what's happening is the BLS uses a five-year rolling average to calculate seasonality. And so as the post-pandemic period now dominates that, it appears as if we think seasonality is a function of what happened over that five-year period.

[00:19:46] As we return to a more normal pattern, it manifests itself in the function that I described, which is inflation in the summer seems unnaturally low, and inflation in the winter seems unnaturally high. There is absolutely inflation in areas where, let me rephrase that, there are absolutely price increases in things like eggs.

[00:20:09] But the reason why there are price increases in things like eggs is because of idiosyncratic factors tied to eggs and bird flu. We basically decided to slaughter a sizable fraction of our egg-laying chicken population. I kind of wonder if we should identify them as chickens that lay eggs as compared to hens. But that is the sort of idiosyncratic factor that you run into all the time, right?

[00:20:37] Cocoa prices have surged. Why? Because the actual input of cocoa into that box of Hershey's cocoa that you get is about five cents, right? You buy it for $5. It costs five cents worth of cocoa. Sugar makes up the vast majority of your cocoa mix, by the way. And as a result, you demand the cocoa as a Western consumer, whatever price. Doesn't matter if the price quintuples.

[00:21:07] Fine, it's now 25 cents, right? Who cares? The impact on the end product is actually remarkably small, but cocoa is grown on trees. And believe it or not, trees take time to grow to maturity. And so all we're doing is setting ourselves up for a fantastic cocoa oversupply at some point in the future as systems respond naturally to the dramatically higher prices. And farmers across the world are planting more and more cocoa plants that will do absolutely nothing for us for give or take three to five years.

[00:21:35] This does a great job of explaining the problem I've had trying to derive the inflation out of my Uber Eats orders for hot cocoa and eggs in the recent past. Yeah, I would suggest that you will save money by not using Uber Eats. But if you're really worried about inflation, there's this thing called a stove and it works remarkably well. We're going to have you back on for cooking tips. But for today, we're going to stick to the straight stuff here. Like what you said right before about the Fed.

[00:22:05] Is the Fed in a good spot coming into where we are or good in air quotes, a flexible position with these new Trump policies that we're all trying to figure out what they mean right now? Well, I think the Fed is genuinely uncertain, as are all of us, about what Trump's true intentions are. I will be honest with you. I think what Trump is doing at this point is largely geopolitical in nature as compared to truly tariff based. And I've had this argument with people on Twitter and elsewhere.

[00:22:36] You know, is Trump a moron? Is Trump a genius, et cetera? What is very clear by all of the actions, including the peace overtures to Russia, is that the Trump administration is very focused on the risk of China, which has always been a key source of my support for Trump in 2016. And then again, Trump in 2024 is the fact that he is that he and his advisors take very seriously the threat that is levied by China.

[00:23:02] And so what he is doing quite successfully is actually interjecting chaos into the relationship between Russia and China in the same way that FDR interjected chaos into the relationship between Russia and Germany following the Molotov-Virbentrop protocol. China and Russia are natural enemies, not allies. They share a large border with each other. They are not aligned politically.

[00:23:27] Obviously, China has made extraordinary inroads into the eastern sphere of Russia, what we call Siberia, you know, repopulating large areas of it. And there's a tremendous debate as to whether or not Russia actually controls that territory or not.

[00:23:43] But by creating overtures to Russia and solving the Ukraine problem, as painful as it is to accept that Ukraine is merely a pawn in this process, you know, he is effectively isolating China and allowing the U.S. by saying to Europe, look, Russia is your problem. You have to spend money to deal with it. And I don't care how offensive I have to be to get you to start to do so.

[00:24:07] Like, if you want to spend money on defense because you think you're going to be fighting the United States because we're a bunch of inveterate assholes, you know, that's your choice. But just spend the money. Right. Get yourselves ready because we have to focus on a much more serious challenge. Now, you don't say that. You just get China. You just get Europe to spend the money. Remember, 10 years ago, Europe looked at us like we were idiots when we said Russia is a problem. Right.

[00:24:34] You should be able to secure your frontier against Russia. You should not be building energy dependence on Russia. Right. They looked at us. They said, oh, you're a bunch of idiots. Right. You Americans with your paranoid delusions. And now, of course, they're saying, how could you abandon us? It's just I mean, it is extraordinarily clear what strategy that is being played here is. And you want to talk about Greenland or Canada. Right. Look at a map of the world.

[00:25:03] Above us is this thing called the Northwest Passage. As global temperatures rise and the Arctic starts to melt, suddenly there is a shipping route out of Russia and China into Europe that is far more efficient than the traditional route that's been taken through the Straits of Malacca. Right. Or through the Panama Canal. Ultimately, we are looking to control all of those points of egress. We're taking over the Panama Canal. We want Greenland. Why?

[00:25:30] Because it actually controls something very similar to the Straits of Malacca in terms of the Northwest Passage. We're tanged Canada. Get your act together or you become our 51st state. Why? Because it's not reasonable to expect Canada to defend the Northwest Passage. They simply don't have the resources to do so. So all of these things are geopolitical in nature and are very clearly quite strategic, even as they feel idiotic to people who are used to a status quo.

[00:25:59] This is one of the things I've loved following along with you on the Substack and some other places because you're parsing apart the geopolitical strategy from the economic strategy. So now tear apart some of the economic strategy that we see coming out and some of the policy implications, whether it's tariffs or trade. Because you look at that, I feel like differently than the geopolitical strategy that you just laid out.

[00:26:21] Well, again, part of the challenge is actually to keep relations with China normalized long enough to allow us to further diversify our supply chains away from China. We have a tremendous advantage versus 2016. We've had, give or take, eight and a half years to begin the process of separating. A significant fraction of production has been moved to places like India, been moved to places like Mexico, to a lesser extent, to Canada. We've friend short a significant quantity of it.

[00:26:49] The idea that the Trump administration is going to meaningfully return manufacturing to the United States, particularly in an environment in which there's very low labor force growth and potentially even negative immigration as we go through the process of expelling people who are here illegally in the United States. You know, it's silly. It's just that I'm sorry, it's just silly, right? We will eventually automate much of that production. We will bring high value added manufacturing back.

[00:27:17] We will rely on lower income countries where labor content is required, but we are friendshoring that process to reduce our exposure, but we can't replace them yet. And so part of the game is to actually maintain relatively good relationships with China while we continue to pressure American companies and those who supply American consumers to diversify the supply chains away. Right. Again, I'm not ascribing unique brilliance to Trump.

[00:27:44] You can love him, you can hate him, whatever, but these are all steps that are required and you don't do it overnight. What about the impact from things like Doge or some of the other stuff that we're seeing inside of the administration here? And I mean, we're at the end of February, so we're early innings on this stuff. What impacts do you see that as having? Yeah. Yeah. I mean, also remember Trump didn't take office until January 20th, right? So when we talk about the end of February, we're now one month in.

[00:28:14] One month into actual. Right. It feels like so much longer, doesn't it? There was a headline on the New York Times today that actually finally figures out kind of what's going on, which is Musk has transported his Twitter takeover strategy to Doge. And I think that's really the critical thing to understand. I don't agree with everything that's going on with Doge and I particularly don't agree with the way much of the progress is being communicated.

[00:28:41] I think that almost all of the savings that are being articulated are largely fake at this point. And I think the idea of distributing a fight, I mean, I hit this on Twitter and said, we're not a serious people. You know, when we talk about distributing $5,000 checks to taxpayers to reward them for the savings of Doge, like this is stupid. Right. It really is. It's, but it is a cover for what is really going on, which is the same thing you would do in any corporate takeover.

[00:29:09] The very first thing you do in a corporate takeover is get control of the payment systems. You figure out where the money is going. And a month into it, that looks like exactly what we've done. Now, have we done it in a manner that is non-transparent? And I think the euphemism is lying. There we go. You know, have we misrepresented much of what we're doing? Sure. But again, it is highly strategic in nature and a necessary part of any significant takeover.

[00:29:37] I think that's particularly true and echoes in the context of Trump's 2016 election, which I think he, like most Americans, had assumed when he came in as president that he would be able to direct the regulatory agencies that actually are part of the executive branch and are supposed to follow his edicts, but turned out to actually be a hotbed of resistance. He's correctly going, I mean, I got to purge all these people. Right.

[00:30:02] And, you know, it feels horrible, but like, imagine your company has just been taken over by Apollo or KKR or Elon Musk. And you said at your desk going, man, I am going to sabotage this. He's going to be gone in four years. We're like, you should expect to be fired. Separate for us what's going on in policy driven volatility in markets. So we've seen some bumpy markets in the last month here, too.

[00:30:28] How do we separate thinking about the policy decisions that are driving market volatility and just the underpinning market dynamics that are contributing to market volatility without all this political noise? So, I mean, that is a really tough one, but I would highlight and I've emphasized this in other areas like it. Again, I did it on my blog recently. Like, you know, the S&P 500 has basically been the sole source of gains. If I look at the Russell 2000, it's basically flat since spring of 2021.

[00:30:56] If I look at lower quality companies, those who are interest rate sensitive within that group, it's down somewhere around 25% from that level. Right. This is a secular bear market that is occurring across the majority of stocks. What we are seeing in terms of the behavior of a unique subset happens to be caught in various ways. And I know in your questionnaire, you'd, you'd posited the question of, you know, can we break some of this down in a meaningful way that allows us to think about it differently?

[00:31:25] I think the answer is yes. Right. I mean, so where flows continue to go and when it goes into the S&P 500, an increasing fraction is going into the largest companies. Those largest companies are relatively inelastic and don't suffer from an overweight in the active manager space, which is subject to net redemptions. Right. Right. So what we're seeing in that, in that small cap space is that's where the active managers lie.

[00:31:49] That's where the people who have discretion about what they do are typically allocated because they're trying to add information value to a particular position. And it's far easier to have superior information about a smaller company than it is about the largest companies. Those, again, have been in a secular bear market now for going on four years. And it's amazing to me that people don't see this.

[00:32:18] Mike, let's just go back to tariffs for one second, if you don't mind, because I'm, I'm, and I want to see if you can kind of walk us through. We apply a 25% tariff to steel. So how does that actually like get implemented? Like who pays it? Does it always result in price increases? Could the companies eat it? Where does the money go? Like, what are the details behind that?

[00:32:44] Cause I, as I'm thinking through it, like, and I'm, I'm sure I could, you know, Google it and kind of read, but I'm interested to hear how you would articulate that. Well, steel is an interesting one because it is so strategic in its nature, right? And you saw the opposition to the takeover of U.S. steel. Well, the U.S. government, I think is doing a relatively poor job in that particular area.

[00:33:05] The simple reality is by introducing tariffs, you're trying to create a price umbrella that allows at least a strategic production of U.S. steel where we're not dependent upon allies shipping us that steel. So it's, it's, it's semi-related, but I often retell the story from the 1930s when the FDR administration approached Alcoa and said, hey, we're really worried that there's an, that, that there's a war coming in aluminum.

[00:33:34] Which Alcoa actually was DuPont at the time controlled on a global monopoly that we don't have adequate supplies to build an air force, which we think is going to be the strategic asset in this war. Turned out to be right, of course, um, that we're not going to have the resources and aluminum availability to build the aircraft that we're going to need to build. And, um, Alcoa slash DuPont's response to that is, oh, don't worry. We've got plenty of capacity.

[00:34:01] We can service you out of our plants in Germany, right? Now, obviously that's absurd. And so the FDR administration created Kaiser aluminum and Reynolds aluminum as competitors to Alcoa for precisely that reason. Tariffs on steel are designed to create a price umbrella that attracts new capital and new investment into the U.S. economy.

[00:34:23] Because we are a net, like we're, we're a minor producer of steel at this point, certainly relative to China, which has far too much steel capacity. And the argument is, is that they dump it internationally to offset that strategic production. Um, by introducing tariffs, you know, we are going to have to pay more for it, right? They are the ones that have the capacity. They are the ones that have the pricing power. We need to attract that additional production to the United States.

[00:34:50] I'd much rather see us just bite the bullet and say, hey, we'll fund production of steel in the United States rather than trying to do it inefficiently through tariffs. Yeah. So I guess there's like the tariffs of the strategic importance kind. And then there's some that maybe it's just that they're not always there for like a competitive type of advantage purpose. Um, I, I still think Latin said it best, right? The capitalists will sell us the rope that we use to hang them.

[00:35:17] If you outsource your strategic production to the market, if you believe as Alcoa did, that you can service your aluminum needs from plants in Germany, well, then you make yourself hostage. And so, uh, you know, the unfortunate reality is, is that we are currently hostage to China. This is why it is a credible threat that China says, hey, we'll cut off, you know, um, access to raw materials like rare earths.

[00:35:42] I just want to emphasize, and I, I mean, I've said this so many times and I will keep saying it until I see it repeated everywhere. There is nothing rare about rare earths. Rare earths literally just means slightly unusual dirt. And the, the issue is that when you produce rare earths, you have to refine them. You're effectively taking 5% of the land of the, the dirt that you're digging up and extracting it in various toxic forms.

[00:36:09] When you treat that 95% or a hundred percent of the earth that you've now dug up and only take 5% away, you're left with 95% of poisonous, toxic garbage that you got to figure out where you're going to put it. In the United States, we don't want to do that. Right. We don't want to pollute our environment that way. So what we're really actually saying in rare earths is, you know, it's really rare that somebody would want this in their backyard.

[00:36:34] Do you think that, um, that obviously plays into, uh, you know, what we're, I guess, trying to get out of Ukraine with their minerals and stuff? Yeah. What we want to find is a place that is now shitty enough that they're like, oh, we'll do it back to her. Right. And that's really what's going on. It's not that Ukraine has tons of reserves. It's that Ukraine is basically destroyed. So why not destroy it a little bit more? Again, I understand how offensive that is, but Ukraine is a pawn.

[00:37:03] You sacrifice pawns in a chess game. Okay. And, and, and I'll, I'll try to humanize that in one quick second. Like I also apologize because I understand that Ukrainians are people and I don't want to see this happen to any person, but the simple reality is they are a pawn in a much greater game. Before we move off of Shrump, it was one of the posts on your sub stack, which by the way, I'm always amazed, you know, and I apologize.

[00:37:31] I, you've been writing on sub stack for a while and I, I'm finally following you and I should have been following you for a long time. Um, and that's just at, at Michael, Michael W. Green is his sub stack handle. So people can search that, but I don't know. You had an interesting, it might've been the golden break post.

[00:37:48] So I guess it was maybe the most recent one where you had this, like, and you sort of hit it earlier, this, I guess, dichotomy or explanation of the things that Trump is doing. Like on the one hand, I think, and it kind of plays into that Ben Hunt piece. So there's a lot of good things. There's a lot of uncertainty. There's possibly this like bad. So it just kind of shake out your thought process.

[00:38:18] So I, when I was reading it, I was like, yes, this is what, what I'm feeling, but I have a hard time, like articulating it because like you said, it's, we've moved so fast, so quickly. And he's, it's obviously a delicate situation, depending on who you're talking to. Yeah, I know. And, um, so in my sub stack, which is, yes, I give a fig and you're right. And sub seconds at Michael W. Green. Um, I highlighted that the way I view it is we effectively have a Schrodinger's cat, right?

[00:38:46] So Schrodinger's cat is a quantum physics thought experiment in which you put a cat inside a box. You then have an atomic clock. That on a random basis, because a particle decay will release a poisonous gas into the box. It will eventually happen. If you keep the cat locked in the box forever, the poisonous gas gas will be released and the cat will be dead. Oxygen will probably run up before then. But the, the reality is, is that that cat now exists in an unknown space.

[00:39:15] Are they alive or are they dead? And Trump's behavior is very similar with our Republic and our democratic institutions. Are they alive or are they dead? And we can't know until we open the box and we don't get to open the box until we see what happens after Trump. Right. Do we get elections in four years? Do we actually see a society that has remade itself with a more efficient public sector that is capable of tackling

[00:39:43] the objectives of, you know, resisting the rise of a totalitarian state in the form of China. And I'm sure I just offended, you know, a sizable fraction of the earth's population. But the reality is, is that the actions of China are consistent with prior totalitarian regimes. We don't know. Right. We are genuinely uncertain. As I, this should be clear from the, you know, monologue that I went through a second ago.

[00:40:10] Some of the actions of Trump are extraordinarily strategic and extraordinary. And by the way, I attributed them to those in his administration. Many of whom I know, many of whom I respect that are thinking deeply about these geopolitical issues. Whether that remains the focus or whether what remains is the venality and meanness that is also present in behavior is unclear. Right. Right.

[00:40:36] And so part of what I highlighted in there, I have a son at the U.S. Naval Academy. We know, my wife and I know many young women that serve at the academy who are all amazing individuals, really talented, capable individuals. And with the firing of somebody like Lisa Franchetti, which you can dispute, you can, you know, you can think it's the greatest thing in the world for various reasons. A very simple message has now been conveyed to young women serving in the military. Your position here is uncertain. Right. That's never a good place to be.

[00:41:07] And so, like, we don't know the ramifications of it. The other thing that I emphasize in this substack is, you know, the parallels of history. And history rhymes. It doesn't repeat. But the parallels in history are very, very similar to prior populists who have arisen in response to ineffective governance and a failure to address the needs of society. The fact that the federal reserve is focused on unemployment insurance claims, when I just walked through a long explanation for why they are no longer relevant. Right.

[00:41:37] Is a reason why people view the institutions as unfair and unserving. And as a result, their frustration is growing. They feel disenfranchised. And so the only way that they can react is through mob-like behavior, the elevation of a populist, protests, et cetera. That's how the people express their voice, not through voting for rational government.

[00:41:58] And whether Trump's actions by breaking with the standards of behavior have paved the way for a Caesar or somebody to truly seize power, I think it's somewhat implausible that that's actually Trump. Right. He is an 80-year-old man. He is not going to be here in another 20 years, or at least I hope that, well, I hope for him he is, but I certainly hope for us. But the simple reality is that that's not who builds an empire.

[00:42:26] And there is no time for him to install Ivanka or any of his children in that role. They may eventually return as George Bush and his nephew did. But the simple reality is that it's highly unlikely that you're going to see an empire formed out of the Trump administration. But the destruction of the norms of behavior, which is also what happened under the Roman Republic, potentially set the path. Right.

[00:42:53] Caesar famously looked at Sulla, who conducted a civil war in this, what was called the social war in Rome with, you know, thousands or millions of people killed. I don't know the exact number. I would be terrified of seeing that happen in the United States, but I think the potential is certainly higher than it has been in the past. You know, Caesar looked at that and said, what an idiot. Why would you give up that power?

[00:43:19] Do you think more of the seeds of what we're talking about come more from the great financial crisis or more from COVID? Or is that not really a fair question? Is it like kind of a continuation of just all of it? I'm just curious. Well, as you know, I actually think the far more important component is, is that we have, as Carl Pogliani, you know, famously warned against, we have made the market our master.

[00:43:47] We look to the market for imputed measures of how the economy is doing rather than more directly measuring it, more directly understanding the behavior of the individuals. We increasingly treat a subset of Americans that are poor as if they are not meritocratic and not worthy of consideration on an economic basis because they've failed at the game of life. And by game of life, I mean something much more akin to the board game we used to play when you were a child, right? Oh, you made the wrong choice.

[00:44:15] You chose to be a sports star as compared to being a banker, right? I think that's a very unfair way to look at the world. And I think it's a particularly unfair way to look at youth who have been very poorly served by the choices that we've made. The younger generation is very poorly prepared relative to prior generations to assume the mantle of leadership. Their awareness of civics, their understanding of why we have a republic relative to a direct democracy is dramatically degraded.

[00:44:44] Their understanding of what capitalism is, is basically non-existent in most situations. Our addiction to electronic devices and the dopamine hits and our addiction to products like marijuana, which we've freely introduced into our population. Have echoes of all sorts of prior social ills. That makes us, you know, we've been very unfair to that generation. And they're understandably frustrated by it.

[00:45:11] And I would argue that, you know, that's what we really should be focusing on much more than a lot of debates around are we sending out checks to dead people? Let's just pivot to equities in the stock market here. What do you think? I mean, the market was up two back-to-back years of 25% plus were positive for the year this year, although it kind of seems like it's cooling off lately.

[00:45:38] But what do you think the market sort of did the market miss something? I mean, what's what do you think was driving a lot of that return? And then I guess as a follow-up question, you know, where where do you see the biggest risk right now and where do you see the biggest opportunities? When you say the market missed something, I just want to be very clear.

[00:46:04] Like my description of the market is largely a mechanical creature at this point. If you participate in a 401k and you are employed and there is employee employer withholding and employer matching of your paycheck and you are contributing that to a target date fund. There is no information content going into that other than the very lagging information that you are currently employed. Right now, the behavior of those dollars, once they enter the market is also pre-programmed.

[00:46:32] You are going to buy based on how old you are, a certain fraction of U.S. equities, international equities, U.S. bonds and international bonds. Does the supply of bonds influence that decision? In other words, if the U.S. has to print more bonds? No. Does the level of interest rates play any role in that decision process? No. Right. And as a result, those flows are purely mechanical in their construct and it becomes a mechanical description of what should happen rather than any thought process to it.

[00:47:03] I'm not implying that there is no thought going into the market. There are still, you know, roughly 50% of activities or aggregate funds that have some degree of discretion associated with them. There are portfolio managers that are trying to say you should buy X and not Y. And on the margin, they're going to influence things. But the key insight that I would argue I contributed to this is the net outflows from that active management space versus the more than 100% of the inflows coming into that passive space.

[00:47:31] Actually, crazily enough, put a negative loading on those insights. You're actually firing the people that are trying to apply thoughtful analysis. Right. And as a result, as Jim Chanos and others have described it, we're in the golden age of fraud in which there is no real thought process to the market in a lot of ways. You know, I realize that doesn't feel like what you hear everywhere else. Right. I get the phone calls from CNBC or Bloomberg, like every other market commentators. What is the market pricing in?

[00:48:01] And my reaction is like, well, do I really want to get into a long conversation about the mechanical nature of flows and passive investments and the multiplier effect across different market capitalizations, etc.? Or do I simply want to say, oh, they're reacting to Trump? Right. Like the reality is, is they want to hear they're reacting to Trump. Because nobody wants to open up the Wall Street Journal or turn on CNBC and have like a deep, thoughtful conversation about this sort of stuff. And I understand that. Don't blame them for that.

[00:48:28] So the rumor is that you've got a book somewhere. I've got thousands of books. But is there one coming out of you? Claim a new country called Greenland just for the namesake? I didn't eat a book. I hope one's not coming. No, I am in the process of writing a book on the impact of passive on markets and the implications that it has for our capital allocation process in our society.

[00:48:59] A lot of people who listen, you know, I am far more sensitive to it than I think many others are. Like I went to, you know, as a young man, I went to Wharton and I studied business and finance and, you know, as a rapacious hedge fund manager, etc. I like to joke that, you know, we've all seen the movie Goodwill Hunting, in particular when you're relatively smart like I am. You watch them and you're like, man, I'm just like Will, right? You know, I'm going to walk into that bar and I'm going to be the guy who's like, well, of course you think that. You're a first year grad student, right?

[00:49:29] But the reality is I'm the first year grad student. And so I spent my entire life thinking I understood something because I was pilfering something from work in Nessex County, page 196, relative to the reality that I got, you know, 30 years later, I'm doing some thinking on my own. I'm looking at the system that has developed and I'm saying, this is really important for people to understand. And if I can help other people get there faster than I did, then maybe I've accomplished something.

[00:49:57] No, Mike, sometimes I wish I had never met you because then I could go to sleep at night. Yeah, exactly. There you go. There's something out there like, yeah. But inside of that, that's important though, because that's the nuance of this. Like you said, CNBC calls, you're not going to give them this, this level. So it feels like it's an important thing to actually try to flesh out. Even if you're that first year grad student, even if you're at the beginning of the journey to say, there's a whole body of thought on this that we don't often take the time to unpack. Yes.

[00:50:27] And it is actually remarkable once you begin unpacking this and you begin understanding things that we have done over the past 50 years in a process of somewhat needed reform against an encroaching bureaucratic state. The reality is, is that we've undone many things that were true insights by our forebears. Right. I would challenge most Americans, like, do you know what a perpetual trust is? Right.

[00:50:55] They were actually made illegal throughout most of history for the very simple reason that the objective of accumulating generational wealth and extending your power and influence beyond the grave was something that was generally accepted as a bad thing. Right. Those rules existed from roughly 1600 until roughly 1986. 1986, we changed them in 1986 with generational skipping trusts.

[00:51:19] And today, the period that throughout 400 plus years was measured as 21 years after your life is today currently 150 years with attempts at legislation to make it infinite. Right. When you create infinite power beyond the grave, what have you done? You've introduced vampires. And in every situation, in every story I've ever read, vampires are not an impoverished class, although they used to be. Right.

[00:51:44] I mean, again, if you go back and you read actual ancient history or ancient fairy tales, vampires were social outcasts who inhabited the forest and you would only encounter them if you were foolish enough to wander off on your own. In, you know, the retelling that exists in today's world, they live amongst us and they're powerful and they're worshipped. True blood taught us that there are sexy vampires. There are sexy vampires. Absolutely. You're right. The mythology has changed.

[00:52:12] So, like, why would we do that? The reality is we lost the lessons of our forebears. We failed to pay attention. We were those first-year grad students enamored of Greenspan and, um, Ian Byn Rand and, you know, the thoughts of, oh, I, I am uniquely meritorious, right? Like, what we've introduced in our society is a degree of Calvinism again. Predestination.

[00:52:38] I was predestined to be successful because my IQ, go on Twitter and see how many posts are now coming out saying that IQ is destiny. I'm sorry to break it to you. That's crap. IQ has a correlation up to a certain point, but people like, as smart as Nassim Taleb, will tell you that it's garbage and there's a very good reason for that. Right? The reality is, is what IQ tells you is a threshold.

[00:53:01] And so if you are incapable of being a surgeon because your IQ is below 115, but you are no better surgeon because your IQ is 185, you're still going to show a very strong positive correlation because effectively there will be no effective surgeons below 115. And our sampling capability beyond that 115 level deteriorates as we get further and further off into the reaches, right? Remember, a 130 IQ is two standard deviations above. Roughly 1% of the population is going to be in that category.

[00:53:31] Right? Right? It's two-tailed distribution. So it's significantly low. We don't do a good job of testing the 1%. We have no idea what that actually means. It's the same thing as the stock market where we're aware there's fat tails, but we have a really hard time deciding what the actual distribution is. Right? Right? So we're allowing ourselves to be, again, governed by mythology, which unfortunately returns me to Carl Sagan's The Demon-Bonded World in 1994, right?

[00:53:56] Which has this unbelievably and terrifying quote, which I, you know, I have a foreboding of an America that returns effectively to its mythology and clings to the darkness and, you know, the candle in the darkness. It saddens me, as you can tell. Here's to the dragons in our garages. Exactly. Justin, you got a closing question for us?

[00:54:18] So, yeah, Mike, we like to ask the question, the closing question, which is, what is the one thing you believe about investing that you think the majority of your peers would disagree with you on? It's a lot harder today, right? Because if you'd asked me eight years ago, this is the same question that I was asked by Peter Thiel in which I introduced the concept of how passive was changing the behavior of markets.

[00:54:47] I honestly think most in investing would actually acknowledge many of the points that I have emphasized and made around that. So, on the investment front, I guess what I would really highlight is an element of Goodhart's law, which is once a metric becomes a measure, once you begin tracking it or attempting to use it, that it no longer becomes an efficient metric.

[00:55:16] You've actually changed it by its participation. And again, I highlighted this in my sub stack. You know, I think Austrian economics is largely bunk, right? I just want to be very clear. I think there's a deep misunderstanding of what money is in Austrian economics. But there is a really important concept in Austrian economics, which is that we are all acting individuals. We are not passive participants in our lives or in the universe that exists around us.

[00:55:41] We tend to look at cycles from an anthropic principle, which is to say the world exists, right? And these cycles have played out through history and therefore they will play out in my lifetime. The reality is those cycles were actually created by the actions of individuals who either resisted the cycles, amplified the cycles, tried to turn the cycles, et cetera. We've become so passive as a society that we're terrified of any attempt at action.

[00:56:07] And as a result, we're passively sitting by and saying, well, the cycle is going to play out. No, if you don't act, the cycle is going to be different and it's probably going to be worse. And so I would just emphasize that we should all be stopping and thinking at every stage in every action that we do. Is it an intentional act to make the world a better place? And I don't think markets tell you that. I think the participants in the markets tell you that. Thank you. Thank you very much, Mike. Really appreciate it. Great conversation.

[00:56:37] As always. I love it as always. Thanks so much for tuning into this episode. If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube or leave a review or a comment. We appreciate it. Jack Forehand is a principal at Validia Capital Management. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients of Validia Capital.