Jp Morgans Michael Cembalest On The Impending Treasury Bust

TITLE: EOsRcN82lh0 CHANNEL: Unknown DATE: ---TRANSCRIPT--- There’s a crisis coming in the US. 100% of government revenues in the United States uh federal tax revenues will be required to pay interest on the debt and entitlements. I’m going to wait until the clouds clear. You can do it if you want. You know, I’m not going to invest until I start to see the unemployment rates come down or some other lagging indicator. Everyone that’s trying to understand whether or not this makes any sense is dealing with very preliminary information. The next best thing you can do is to look for future opportunity. You know, very rough measures of the share of companies willing to pay actual hard money for AI services. So, Michael, I always start by saying I’ve really been looking forward to this conversation. But this I have really been looking forward to this conversation because we’re doing this in the JP Morgan headquarters are pretty spectacular in New York. And you’ve started at JP Morgan in October 1987. Straight after the crash. So, must have been a scary time. What made you choose the stock market? Well, I didn’t. Um uh I first of all, I started in the beginning of October. So, I was I I had been working there for 2 weeks before the crash and I I remember thinking like gee, I wonder or not if this job’s going to stick because uh you know, the stock market just dropped 35% 2 weeks after I joined. Um I was a French and Russian literature major um in college. Didn’t know anything about finance or economics. And I got a job working in essentially what was a back office accounting and data monitoring function when I joined JP Morgan. And uh it took me probably 2 3 years to kind of work my way more towards a front office position that was markets related. And when you started, it’s a long time ago, did you have a PC on your desk?

No. Because younger audience will find that really rem- remarkable. I was very excited when I got my first computer. It had two disk drives, no hard drive storage, and a little rack for putting the 5 and 1/4 diskettes for the data and yeah, that was uh and then when you traveled, you had a little a compact 286 computer and the thing weighed like 50 lb. [laughter] So, we’ve come a long way. And you spent decades studying markets, writing Eye on the Market reports. What is there anything that’s the same as it was when you started out? Yeah, a lot of things have I mean, a lot of things have changed, a lot of things are the same. I mean, a lot of markets are expanded. Uh the credit markets in particular have undergone a massive shift. When I joined JP Morgan, JP Morgan was a AAA bank lending its balance sheet to other AAA entities. And so, the biggest transformation, the first one that happened was that business went away because the capital markets started providing capital to to high-quality companies at cheaper rates than the banks could lend through commercial paper and bonds. And And that’s when the banks had to kind of reinvent themselves and become merchant banks and get into M&A and trading and things like that. So, that was a pretty big transition. Some of the themes that are the same though are have to do with the psychology of markets and chasing returns and you know, after a correction is probably the best time to look at something. And I mean, after the devaluation of the Mexican peso in 1994, everything that was Mexican was left for dead. And then that was the best-performing emerging market over the last few years. I mean, those those cycles repeat themselves again and again and again. And your reports are available free of charge. Is that I mean, I think that’s a bit ridiculous. They’re better than 90% of the sell-side research that people pay for. But talk a little bit about what’s the process behind Eye on the Market. I mean, how do you decide what topics deserve a deep dive? And And who do you write it for? Okay, so the Eye on the Markets, I’m the chief investment officer of the asset management business, but for a while I was the chief investment officer just for the private bank itself. And the purpose of the Eye on the Market was the private bank used to be kind of more of a small, intimate business, you know, 20 years ago. And then it started to grow. And it’s it’s inconsistent to have the people running the money also dealing with clients. So, the notion was I would sit at my desk, focus mostly on investing client assets, and instead of having to travel around and explain what we’re doing to clients, I would write the Eye on the Market as a way of explaining to our private clients what we were doing in portfolios. Now, we wouldn’t be disclosing individual positions and we would usually give it some seasoning time before after we made an asset allocation shift before we’d start to write about it. But that’s where the Eye on the Market started in 2005 as a method of of explaining to clients, this is why we’re investing in the following countries, what do we think about growth versus value, what’s our duration position, currencies, commodities, infrastructure, hedge funds, things like that. And it’s it started out very much as a bread and butter portfolio allocation thing. And then it started to drift into other topics, particularly after the financial crisis. And you do like really deep research. How do you manage to keep detached and keep that 50,000-ft view when you’re spending so much time down in the weeds? Is that difficult? Well, you the clients force it on you, right? Because you you have to do some pretty intense research in order to decide. Like for instance, let me give you an example. Last year, healthcare multiples were trading at the lowest they’ve been in 25 years relative to the market. And you in order to take a stab at something like that, particularly given the collapse in managed care and some components of healthcare, you really had to know what was going on. So, we do some deep research. And then the question is how do we convey that to the the diaspora of our clients in ways they can understand. And one of the things I’ve learned to do by force of our clients is to is to explain things in ways they can understand. I don’t want to say the name of the firm, but I I digest a lot of research. Mhm. And I’m always amazed. Sometimes I’ll call somebody and say, “Look, I’ve been in this business for over 35 years. And you’ve got a guy there who writes something and I don’t understand more than 30% of it every single time.” Right? So, that’s a problem for you. That’s not a problem for me. That’s a problem for you. And so So, I give a lot of feedback to the people that I get research from because I expect them to be able to to write in a vernacular, understandable style the same way that I do. Yeah, well, it’s really brilliant stuff. And you’re overweight US equities and you highlight that US companies are better quality and deserve a PE premium, which is fair enough. But I mean, it’s almost 2/3 of global market cap. Isn’t that a bit much? Yes, it is. So, we started with the global overweight to the US in 2009. We had just been coming out of a period of of a massive surge of construction and other investment in in Southern Europe, in Spain and Portugal and Italy. And there was an a European outperformance boom both economically and in the stock market that took place during that period before the European balance of payments crisis. And it struck us that without that impetus, that Europe was going to underperform. And we were also looking at at some ongoing deflationary trends in in Japan. So, the actual position that we had for the better part of 15 year was overweight United States and a small amount of overweight to emerging markets and underweight Europe and Japan. That thing kind of paid consistent dividends year after year after year. And it every single year, I would see some brave strategist say, “Okay, this is the year. This is the year that Europe finally comes back.” And they were just consistently wrong. And we had our rationale, but my experience as an investor led me to say, “You know what? This thing just keeps going. It started out with multiples close to each other and we got to the point by the end of 2024 that uh the rest of the world was trading at almost a 40% PE multiple discount to the US.” So, at that point, you know, you never know where the bottom is. Some people thought it was 15, 20, 25, 30. It keeps going. 35, 40. When it got to 40%, we said, “Okay. Like let’s watch it from here because we’ve never seen this kind of multiple discount before.” And we started evening out the positions in the portfolio and heading into this year, our strategy was more balanced, closer to MSCI benchmark weights for the better lack of better word of a way to explain it. So, yes, the the irony is that the the America First president coming in was the end of America First outperformance. I keep hearing about US exceptionalism. I want to ask you if you think it’s structural or cyclical. And I mean, US has got a lot going for it. I mean, you know, when I come here, it really strikes me, you know, how powerful the country is. And you’ve got energy independence, technology leadership, deep capital markets, better demographics than Europe or in China. And the culture is really business-oriented, right? So, you’ve got fewer holidays. Everybody’s got success mentality. But my perception, I don’t know if you agree with this, but my perception is a lot of wealth has been created by buoyant stock markets, very generous bonus programs. And I’m just wondering, can all this continue at the same rate because the valuation start higher and other countries may start to catch up in some of your Yes, and last year was a big catch-up year. Right? Last year in the equity markets, last year was a big catch-up year for emerging markets, for Europe, for Japan. Um other than India, the US was the lowest Now, the US equity markets did fine last year, but they were the lowest-performing equity market of the major ones other than India. So, last year was a catch-up year to be sure. And now, just to put some rough numbers on it, the US the the discount for the rest of the world to the US is about 30% instead of 40%. I don’t think that goes back to parity. Right? No, no. I think a a 20% discount is as good as it gets. So, there’s still some more room for outperformance versus the rest of the world. But if you want to look, if you want a diagnosis of how the US differs from the rest of the world, I will point you to another European. Read the Draghi report. Everything in there is exactly what’s wrong with Europe or what he sees as wrong with Europe in terms of productivity, growth, efficiency, labor mobility, capital mobility, um energy security. He goes into the whole thing. Yeah, and I know it has got a lot of weaknesses, but just looking at the US, almost half of consumer spending, which is a big driver of society, is from the top 1% and the top 1% is all about the stock market. And it looks very circular to me. So, if you had a big correction in the stock market Yeah. Absolutely. Absolutely. massive unwinding. Isn’t that a really big risk? Yes, it it is. It’s a big risk, but but I think a short-term one, right? I mean, if you had some kind of correction, you know, most of the corrections that are value-based corrections kind of repair themselves reasonably quickly. But yeah, look a lot is riding on the AI sector because that’s where those large valuations are. The high valuations are in the tech space. We’ve already seen what can happen when things unravel. The software space has gotten clobbered this year, down 20 to 30%. Um and from high multiples and software is a good example of what could happen to the broader market if those profit fundamentals come under siege as well. And just on AI, I mean, we first met or started talking when we’re about the hyperscaler capex and we’re seeing huge commitments there. I mean, is this another tech bubble or is it something more durable? You know, whenever I see Google explain what they’re doing, it makes perfect sense to me. Whenever I listen to Meta saying what they’re doing, it doesn’t, right? I mean, Meta is spending 70 to 80% of its revenues on capital spending, which which is a number that’s unheard of in the entire history of corporate finance. Yeah. The average S&P company spends 20% of revenues on capital spending and R&D and maybe 20% for the average technology company. So, when you look at at Google and Amazon and Microsoft at 30 to 35% and Meta at like make up a number, um this is the bet of the century, right? On on AI technology and data centers and GPUs and processing and all that kind of stuff. Um we’re really early, unfortunately, right now. Everyone that’s trying to understand whether or not this makes any sense is is dealing with very preliminary information. Abstract accounting firm surveys of corporate AI adoption. Um you know, very rough measures of the share of companies willing to pay actual hard money for AI services. Um you you know, an estimate from Microsoft as to how much their agentic AI investments are paying off. It’s very tea leafy right now. Um and and and there’s not a lot of hard data on it. The hard data we have is how much being spent. Yeah. We don’t have a a lot of hard data on how much is being earned. But yeah. I’m sorry. And we do know that the free cash flow margins of those big hyperscalers are starting to come down. Going down very rapidly. Yes, through the third quarter of last year, they were stable, which meant that they were spending a lot of money out of corporate cash flow and at a reasonable pace that wasn’t degrading their overall free cash flow margins. Just the last two quarters have started to see those numbers roll over pretty fast. And of course, we’re seeing all the off-balance sheet stuff. I just wanted to pick up. You you said you’ve got good numbers on the outflows, bad numbers and the benefits. How do you try and measure that in an organization like this? Well, Is it it’s fundamental have tons of information, right? And and again, you know, it there was this internet meme a few years ago, what color is this dress? I don’t know if you remember it, but was the gold dress? Was it was it gold? Was it blue? It was whatever you wanted it to be. And it turns out it was a function of lighting and things like that. If you want to really amp yourself up on corporate adoption of AI and what they think of it, read a report from Wharton. If you if you are looking for something more depressing, read a report from MIT, right? I mean, it’s it again, we’re at a stage where it’s a bunch of surveys and very abstract analysis that people are using to explain where we are. And um you know, I try to digest all of the possible information I can get my hands on to to make an assessment of of where we are in this whole thing. But even when I look at JP Morgan internally, the firm is making a massive bet. Um uh some of those efforts are yielding pretty attractive productivity results and some aren’t. And it’s it’s you know, unfortunately, it’s just really early to assess how this is going to play out in the long run. Are people going to be I mean, the end and what’s happening with software and Claude co-work, I think is a microcosm, right? I mean, how much are people willing to transform the way their lives function to save money? That’s what is behind a lot of this stuff. Mhm. And uh and I don’t think we know. And how are you using it personally? Uh me, sparingly. Um my investment process is like yeah, I’ve I’ve been spending the last 48 hours preparing a special piece for tomorrow on the Iraq war on the Iran war and the implications for energy prices, commodity investments. That’s there’s very little AI related assistance that I need. Um I will you me personally, I will use AI for things like a Google overview is perfectly fine for me. What’s the best Bloomberg ticker for global sulfur and helium prices, okay? That’s a I’ll get a I most of the time I’ll get a pretty good solution from AI overview. By the way, I’ll type it in and either works or it doesn’t work. So, I have immediate feedback whether or not it’s told me the right thing. I’m not going to ask it like, what was the reason for the decline in the average size of nuclear plants, which is something that happened. There was a blip in the 1990s where the size of the plants went down for a year for ramping up. Like that I have to do that work myself. I’m I’m not going to rely on Sure. it’s stitching together a bunch of different factoids that it finds. And just going back to Meta, how concerned you think we should be about the fact that it’s being quite aggressive in its accounting. You know, my background is as an accountant Right. and and when I see them putting assets off-balance sheet and committing more capital as a consequence of that. So, spending money to Right. give a false impression. When I see them extending the depreciation lives, there’s a significant impact on on their earnings. Yeah. How worried are you? You know, look, again, I having joined the firm in 1987, there have been many many cycles where companies have paid deliberately paid a higher cost of capital in order to obscure or transform the way things look to investors. When people they may when people first started doing it, it worked because the tools were so poor that some of those obligations were hidden from investors. The amazing thing to me now is that Meta is willing to pay another 100 basis points to keep an obligation off-balance sheet and every single analyst in the world is loading that back into their metrics when they do their Meta analysis because it’s it they know that it’s the full faith and credit of Meta. Irrespective of the fact that they diluted some like you know, accounting firm and a law firm into describing it as off-balance sheet obligation. So, I you know, I I find it kind of strange that people are willing to pay real cash money to change the perception of something when the information abundance now is clear to everybody that’s doing serious work that that should be added into Meta’s overall debt load. So, but yeah, they’re still doing it and and the reason I’m a little less worried is because when I talk to any Meta analyst or any software analyst any analyst anywhere and our own team, that Meta Blue Owl JV obligation is part of our Meta metrics. It’s not hidden from anybody. No. Except for them in their own minds. Behind the Balance Sheet is an investment training consultancy. We help professional investors up their game in financial analysis and we have an online school. Over a thousand students, professional and amateur, have taken our courses. Our flagship Analyst Academy helped one young analyst land a dream job as a partner of a major London hedge fund and helped another a successful entrepreneur improve his investing confidence. He made a seven-figure sum in year one. Check out the school on our website behindthebalancesheet.com where you can also find the show notes to this podcast. And while you’re there, don’t forget, sign up for our popular and free weekly Substack. Hit the sign up button on the top right of the homepage. I like to take a quiet moment for myself first thing in the morning. Get myself right on the inside before, you know, [music] the chaos begins. Venture capital is an extremely competitive business. So, if you’re not playing to win, why be here? We’re investing across the frontier, aerospace, deep tech, industrials, manufacturing and AI. I have to get familiar and dangerous with new industries and technologies daily. That’s really where AlphaSense comes in. I spend a lot of time wearing down the control F button on my keyboard [music] searching through individual documents. What I love about AlphaSense is the document Q&A is huge for understanding what key insights are quickly. But I think what it’s really saving me is peace of mind [music] knowing that these are trusted sources. I’m not starting from scratch. There’s a lot of noise out there and AlphaSense gets me the signal. [music] [music] Just talk a little bit about bonds. I mean, bonds offer real yields again for the first time in a while. And US bonds have actually been pretty stable in spite of the deficit when the economies are going gangbusters and you’ve got a big deficit. Um how do you think about the long-term outlook for treasuries? You know, the the rewards of being the world’s reserve currency are substantial. No, I don’t think any other country in the world would be able to sustain the kind of fiscal policy and debt burden that the United States has and see so little reaction to bond markets. So, a lot’s riding on the the um this whole issue of the res- of the dollar being the world’s reserve currency. One of the favorite positions of of some analysts out there is that that is changing. We track six or seven different measures of of the dollar’s standing as the world reserve currency and and its share of foreign exchange trading, its share of global reserve assets, its share of global Swift payments, uh its share of the denomination of new debt and equity issuance um of offshore entities. We don’t see it changing that much. So, in the near term I don’t really see anything catastrophic happening with the dollar. I know there’s a lot of people that feel that that the sanctions and the tariffs and things like that are going to be changing, but we don’t on the ground we don’t see it really shifting. If that reserve currency status ever did change, the US is in a world of trouble. Yeah. Uh because they would have to start to monetize the debt that other entities didn’t want to hold. This administration is is doing as much as any to tear down the fundamental supports for that reserve currency system uh that supports the dollar. And um you know, we’ve got another 3 years of them. So, we’ll have to see what happens. Um certainly the war in Iran uh is is another blow against it because it’s another it’s going to cost somewhere between 15 200 billion. And um which is money that the US doesn’t really have. So, um I’m my view is that that there is a crisis coming in the US. A bond market crisis in probably 3 to 4 years. And it’s a pretty nasty one and I’m I’m the First, I I’m going to be retired by then. And so, I’m I am seriously extremely pleased that I won’t have to work through it because it’s going to be a very unpleasant period. And it looks like this. At some point around 2030 or 2031 100% of government revenues in the United States uh tax revenues federal tax revenues will be required to pay interest on the debt and entitlements. There won’t be a penny left for anything else. That is obviously a completely unsustainable unsustainable situation. Heading into that maybe by a year or a year and a half, the rating agencies will probably tell the United States like if you don’t do anything about this, we’re going to downgrade you. And then you start seeing Abu Dhabi and the GIC and Temasek and some of the large sovereign wealth funds not necessarily selling dollars, but no longer buying new ones in the auctions. That then precipitates a bond market crisis, which I would define as an increase in the 10-year of let’s call it 150 to 200 basis points over a short period of time. Now you have a legitimate bond market crisis on your hands, equities are down 15% and then a lot depends upon what happens. I you know, I’m holding open the hope and the potential that that kind of a crisis will give US policy makers kind of like the second the second tarp bill vote in 2009 that that the politicians faced with that kind of crisis will have will have the cover of the crisis that they can use in order to justify some painful decisions about taxes and spending. So, that’s that’s one avenue. If that happens, that’s great news for the bond markets and equity markets cuz you take this tough medicine you’re correcting some of the imbalances and you move on. If instead they take the easy way out and just having the Fed monetize the debt, then that’s that’s that’s the problematic outcome. So, in that circumstance, I mean, what do you do today to protect clients’ portfolios? I mean, does that affect your view of the 60/40 portfolio? Well, one of one of the most important things to not do is is prepare portfolios for things that are happening outside the time horizon over your investments. Um what I just told you was a risk 7 years ago. And a lot of the Cassandras and the Roubinis of the world would have recommended preparing for it then and would have been fired long since you know, long before today. So, part of the skill of money management and every hedge fund manager and every private equity firm is like what’s my timeline and when do I need to prepare for certain things and when is it too soon to start shifting my portfolio around because I’m giving up too much return. Ultimately, a lot of investments in markets are are war chest strategies which is you you need to make as much money as you can cuz at some point you know you’re going to give some of it back and you may not be able to anticipate it. And uh you know, in I’ll give you a little bit of an example which is the Indian rupee is a classic example. Indian interest rates have always been higher and if you buy you a rupee-based asset, you’ll make money make money make money and then boom there’s a there’s a devaluation uh or depreciation of the rupee, you give some of it back and then it starts to go up again. And investors that generally accept this cycle instead of constantly trying to game it have actually turned out to do better over the long run because they’re not shortcutting the gains they make before you have those corrections. So, some corrections are easy to anticipate, some of them are really hard. Yeah, I mean, this one just seems um quite obvious. I I don’t know I mean, do you have a view about private credit? I mean, should we be worried? There seem to be quite a lot of nasty indicators out there. I think the underwriting over the last 2 years specifically has been pretty bad. Before then the broadly syndicated loan underwriting was bad, but the private credit underwriting was better, which then led to a flood of assets going into private credit and then their underwriting collapsed. One of the things about credit markets though is the the dumbest chart, you know, I I I have these in my head. I have these you know, there’s there’s like 10 of the charts that I would categorize as as the dumbest charts I’ve seen in finance, right? One of them, maybe number one is a chart that people plot of high yield spreads and they draw a horizontal line at about 600 basis points and it says average, right? Except it’s never at 600 basis points. It’s always either much higher or much lower cuz you’re either in an economic expansion or you’re in contraction. And so, in an economic expansion default rates are low, they’re 1 to 2%. The return on private credit and other extended credit is generally good. And when a recession comes along then it spreads go to 1,000, you take some write-offs, whatever. So, it’s a it’s another example of a war chest strategy because high yield is just not liquid enough for someone to for an institution to amass a large position and trade it in and out of it. So, you have to kind of accept that the recessionary pullbacks are part of what you’re going to experience. Um and private credit is in the same boat. Um and and yes, when private credit was was generally offering 3% over over high yield that was enough. Now the spreads are tighter and you know, the value proposition’s not nearly as good and you’re starting to see some cracks. I had some private credit people tell me they thought that the software holdings they had were the bedrock and safest parts of their portfolio. And how long ago was that? Uh November. Right around the time that Claude co-work and some of these other things were were just being released and you know, it was an external shock to the software space that a lot of people were caught completely blindsided, myself included. And what are they saying now, those people? No, well, you know, they’re hard to find. I think they’re they’re all dealing with their portfolio issues, right? Yeah, so over the last 2 years, I mean, and I and I wrote this 2 years ago. I said I it feels like the ground is shifting on private credit. I think that people should slow down their allocations because the underwriting is deteriorating. And you can track it as a credit guy, you would love these metrics, right? You can track EBITDA add-backs, right? I don’t know if your audience knows what those are. And if I explain them, they’re going to think they’re insane, right? But here’s what they are. You you start out as a lender saying, well, I’m only going to lend towards a certain number of coverage of earnings. But the borrower will say, yeah, but I’m going to make all these changes and I’m going to make earnings better. So, when you do your covenants let’s add 20% to my earnings as if it’s those synergies already happened. Those EBITDA add-backs didn’t used to exist in private credit, the lenders wouldn’t allow them. Uh they only existed in the broadly syndicated loan market. Now the private credit lenders allow them. It used to be that if you had borrowed money from a private credit lender and you sold a subsidiary, you’d have to take 100% of the proceeds and pay down the loan. You know, then you could do whatever the hell you want. That’s changing, too. You only have to pay some of those proceeds, the rest of it you can do what you want, right? And those are all indications of of a relaxation in terms and conditions, which is a reflection of more negotiating power on the part of the private equity firms borrowing the money than the private credit firms lending the money. And you know, as a loan investor, those are not that’s not a good transition for you. Will the balance of power change, do you think? Yeah, yes, it will. You know, it but it usually takes a recession or a or a a substantial contraction in the supply of liquidity and we’re not in anywhere near there yet. Well, we could be quite quickly, I suppose, but Uh no, I mean, like yes, we’re starting to see some cracks in the system, yeah, but there are still so many people willing to lend at those concessionary terms, right? I mean, what has to happen as what we’re looking for to start deploying more money in the space is a real sign that the lenders have fled and that the private equity firms are are are willing to negotiate the terms and conditions which are or are better value for lenders. We’re nowhere near there. No, there’s there’s just too much capital around. I’ve written actually about the bad backs because bad backs are just I mean, astonishingly and loosely structured. In your end of the year piece, you talked about OpenAI being the weak link in the whole AI edifice. Now, I wonder if we would just talk a little bit about that. I mean, it seems to me that people have assumed that it’s the winner and the leader. And all the evidence suggests to me that it this is a commodity. Is that unfair? Well, I mean, to when I described OpenAI as the weak link, it’s because to me, there’s two key bridges they have to cross before justifying the valuations that they’ve they’ve been getting. Um number one relates to energy and number two relates to the way they make money. Um let me do the second one first. So, right now, they are you know, they don’t have really have an advertising revenue model. And and it’s they don’t really have a really robust corporate revenue model. It’s a lot of subscription-based stuff. It seems like that’s going to have to change, right? It seems like they’re going to have to develop more institutional ways of making money, including advertising. And second, they have made over a trillion dollars of commitments for certain build-out and they’re going to require something like 30 gigawatts, which is the equivalent of 30 nuclear power plants in order to make good on all of the commitments that they have. And that gets into a whole hornet’s nest of how the United States and other countries are going to be able to add all of that generation capacity at meaningfully attractive levels over the next few years. And those To me, those are two huge question marks about how OpenAI gets from where they are now to where they need to get to in the future. And there’s just a lot of questions there for me. You talked about an internal memo that Sam Altman had written forecasting a need for 250 gigawatts of power by 2033. I mean, that sounds like mad to me because it’s I mean, that’s just No, I think sometimes some of the you know, they you know, the the Silicon Valley crowd like to speak in hyperbole because they would say, “Well, okay, fine. It’s hyperbole, but at least I’m kind of bringing people towards these higher goals.” And I don’t think that some of those numbers are meant meant to be taken seriously. When our chairman says, “This is how much we’re spending on technology and this is what we’re play This is where we think we can get in terms of market share in the European, you know, commercial banking business.” Those are hard targets that have been developed by project teams, vetted by the board and and other people involved and right. But, I think when Sam Altman talks, it’s it’s meant to be more allegorical. But, even in an allegorical framework, that number was shocking, which is why I included it. Yeah, well, I I was shocked by And were you surprised that he managed to raise 110 billion dollars from Nvidia and Masayoshi Son or Masayoshi No, I mean, as first of all, you have a lot of entities that have raised money and need to deploy it. And they they can’t SoftBank can’t be making small investments. They have too much money. There are a lot of investors out there looking for big tickets. So, that’s number one. Number two, a lot of money gets raised at times based on the vibe and based on, you know, perceptions of where things are heading. Last year was a phenomenal year for stocks linked to small modular nuclear reactors, even though not a single one of them is actually under construction and there are absolutely zero accomplishment targets that you can say have been reached. I mean, it’s it was 100% a vibe-based rally based on the perception that, “Well, the world’s are going to need these things and, you know, you got a lot of smart people working on it.” And I mean, it’s it was all it’s all kind of allegory and anecdote. So, I I think part of you know, a lot of the companies raising money are raising money based on the perception that we’re in this massively transformative world. And you know, part of that is fueled by the incredible speed with which OpenAI has reached the 10 to 20 billion dollar, you know, faster than any other company in history. So, I mean, they actually have certain metrics that look kind of remarkable. But, part of it is also the statements that are being made by Anthropic about how about, you know, what’s going to happen to the labor market. And by Jensen Huang saying recently that Open Claw is the most important software release of all time. And I told our people internally, to me, I mean, I I think Nvidia is obviously one of the best companies of all time and Jensen belongs in the pantheon of great CEOs. That particular statement sounded to me like the chairman of Saudi Aramco saying that the Hummer is the most important vehicle that’s ever been sold to the public, right? Cuz there are times when these guys say things that are oriented towards policy and and, you know, how the world is changing. And then there are other comments that are mercenarily linked to their own fortunes and shareholders. And so, you know, I think people sometimes look at everything that Sam Altman and Jensen and and Tim Cook say and assume that all of it is meant as part of kind of a debate about the future and sometimes it’s it’s less than that. The 110 billion dollars won’t last Sam very long, right? Because he’s spending a lot of money and so, he’s he’s going to need another round. At some point, he’s going to have to come to public market. I mean, I was quite surprised he managed to raise 110 billion dollars at that valuation. Well, remember, a lot of people are working backwards and saying, “Okay, when and if this thing goes public, I’m going to want to have a market weight position. I’m not going to be able to get a full allocation in the IPO, so I might as well participate on this thing because this cap this pre-IPO capital raise because I’m building towards a market weight position, right? So, you I think some people view these rounds in that regard. Well, that’s interesting because I was wondering if he came to the stock market this year to raise 200 billion dollars, I wonder if he could do it. I don’t know, but again, we’re we’re talking at a time that there’s a lot of volatility in capital markets conditions because of, you know, changing monetary policy, the war, volatile commodity prices, right? I mean, I know of some entities that have put in orders for these and intend to keep doing it in the pre-IPO market because they’re trying to build to what they think will eventually be a standard market weight position in the company. As a public entity. Because they’re too scared to be have a zero weight in a company. Yeah, I mean, a lot a lot of institutional money and certain endowments and foundation money would say, “Yeah, we we want to start out with a market weight position in any stock.” Now, most companies you don’t have to worry about that because by the time they go to IPO, it’s it’s 26 basis points of the S&P 500. Here, it’s it’s going to be more than that. Now, the the IPO may not be oversubscribed, but what if it is, right? So, that’s I think a lot of the thought process. And this this is a a big issue, isn’t it? Because we’ve got SpaceX probably coming. There’s a bunch of very large tech companies that have stayed private for periods that we’ve never seen before. them tapping the equity markets in in in as IPOs or what about Google last quarter in the fourth quarter of last year out of nowhere for the first time in years borrowing money to finance data centers. So, between the equity market and cap and debt capital market, um you know, there there’s been a shock to the system here. Now, there’s plenty there’s plenty of investor capital that’s willing to take it on now, but it’s it is a little bit of a shock to the system to see all of that potential supply coming. And have you looked at all I mean, I did a a study a few weeks few months ago of if all these big private companies who came to the market, tech would be like huge I mean, it’s already very significant in the US market, but even more significant and we kind of all have to be tech analysts. Yeah, yeah, yeah, yeah, yes, but the United States is somewhat of a victim of its own success because the United States has historically been the most liquid market, the most diversified market that that people use as the benchmark for all equity investing. If you look at other countries, you see very high concentra if you do the top 10 company market share, um the US is not at the top. Other countries are similar or higher. Um both on top 10 stock concentration of the overall market or sector concentrations, right? A lot of a smaller countries are very concentrated in terms of their sector weights in public markets. It’s just that the US never used to be. The the US used to be this beautifully diversified market where as a where if you had anywhere in the world if you made money, you could put it in the S&P 500 with the knowledge that you were getting utilities and health care and staples and and and consumer discretionary and energy and basic materials and tech and software. And and so, yeah, now those numbers are starting to drift up in the same way that the financial sector numbers drifted up before the financial. It’s becoming more skewed, but in that regard is kind of looking like a lot of other markets and less like it what it used to be, which is unfortunate. And and a reason why we’re looking to diversify our exposures and not just be too concentrated in the US going forward from here. But, it’s really important to recognize that this the tech sector of today is a lot more profitable, at least for now, than the tech sector of 20 years ago when there were no profits associated with it. And less cyclical, of course. Yeah. So, I normally finish by asking you to recommend a book, and I know that this is a sensitive topic for you. So, I’m not going to ask you to recommend a book. But, if you were teaching a class for young investors, what would be the three most important economic macro concepts that they should think about? And they should understand. The advice I would give is slightly different. And I talked to lots of young people that come to JP Morgan or at schools or something. The financial industry is extremely jargon intensive, right? I met you because I was reading articles and didn’t understand the jargon. And I found my way to you because I was trying to understand this issue of the depreciation approach for certain components of data center investments having shifted from three to six years, and why did that happen, and you know, what does it mean? And so understanding industry jargon is is really important for young people because if they don’t understand it, they’ll be in a meeting and there’ll be a discussion and they won’t really understand what’s going on. And they’ll leave me I can and I’m so I can I have had analysts forever. I can tell by looking at them whether they can understand what’s being said. And you can tell when someone’s just completely lost. And the the only solution to that is hard work and I tell people you should read the Financial Times every day and you should read Barron’s. And every time you see a word or a phrase you don’t understand, it’s a pain, but you got to circle it. You got to highlight it. You got to print it. You got to save it. You put it in a folder. And then, if you work at a certain kind of organization or if you have friends, have someone explain it to you. There’s no better investment than you can make than that. Because what because a 23-year-old would be perfectly fine reading your really well-researched stuff, but only if they had some kind of working knowledge of the widgets and the terminology involved with the analysis. And so, that I for the young people that want to get into this industry, you have to make that investment. It’s very good lesson for me. Maybe I’m going to be have make sure I’ve got less jargon because I write for the professional investor. And you’re kind of known as the chart man, and you told us what your least favorite chart was. What’s your most favorite chart? My Oh, I I So, this summer there was a 20th anniversary I in the market compilation that was put together. And um so, we had the chance to go back over the last 20 years and pick some of the favorite charts. And my favorite chart is how markets anticipate the future. So, let me give you an example. During the savings and loan crisis in the early ’90s, at one point the bank stocks are down 60 to 70%. Only 20% of the ultimate bank failures have taken place, but that’s when the bank stocks bottomed. And for clients that are like, “Well, wait a minute, Mike. You wanted us to start investing in banks again. Every morning I wake up, there’s another headline about a failed bank.” I have to say then, “Well, yes. But, like the way the financial markets function as a discounting mechanism, by the time the bad news on bank failure stop, the bank stocks will be 150% up. And I have probably 50 versions of that chart in every business cycle across equities and commodities and credit, and it’s it’s the hardest part of this business because you have a crisis of some kind, and then there’s this kind of incessant flow of bad news because the press is trying to explain to you the reason for the thing that just happened. It’s already happened. It’s in the price. And if you say, “I’m going to wait until the clouds clear.” You can do it if you want, but I’m going to wait and see until I You know, I’m not going to invest until I start to see the unemployment rates come down or some other lagging indicator, you’re going to miss all of the upside. So, you know, and if The short takeaway is sometimes we can’t see the things that lead to the crisis. And I’ll give you an example of one. But, once it happens, you then have to start looking forward and say, “Okay, what’s in the price?” And uh for instance, in March 2009, only like 10% of all the mortgage defaults that were going to happen had happened, but that’s when you had the bottom in a lot of housing-related investments. In the summer of 2008, remember um things started to get rattly in the summer. And the preferred stock of the GSEs started to sell already at a pretty substantial discount. Our firm, which is in the center of the global financial system, our firm made a capital investment for our own account of $2 billion in Fannie and Freddie preferreds. And um so, we didn’t even see it coming cuz those went to zero. Three months later, three months after they were purchased, the GSEs went into conservatorship and the preferreds went to zero. So, if we missed it, how bad things were, that’s a signal that sometimes the rot that’s taking place in something is is not even apparent to people that are sitting in the middle of it. And so, you’re not going to be able to anticipate every correction. The The next best thing you can do is have your wits about you after it happens to the extent that you have some liquidity to look for future opportunity. And that was That’s been the unending cycle of my long career. Michael, thank you so much. I’ve so enjoyed the conversation. Thank you for taking the Thank you, Steven. Nice to see you. Behind the Balance Sheet and affiliates and podcast guests may own shares or have an economic interest in securities discussed in this podcast, which is aired for your education and entertainment only. Nothing in this podcast should be construed as investment advice or relied upon in for investment decisions. Always do your own research. [music]