The Coronavirus and the World Economy With Raoul Pal #686

Raoul Pal blog

Bruce Norris is joined this week by Raoul Pal. In the early 90s, Raoul worked at Goldman and Sachs, where he co-managed the hedge fund sales business and equities and equity derivatives in Europe. He then co-managed the GLG Global Macro Fund in London for GLG Partners, one of the world’s largest hedge funds. He retired from managing client money at age 34 in 2004, and since then he has founded Real Vision TV, the world’s first On-Demand TV channel for finance. Raoul has been publishing global macro investors since 2005 to provide original, high quality, quantifiable and easy readable research for the Global Macro Investment Community.

Episode Highlights

  • What does his job as a global macro investor entail?
  • What kind of methods does he use to reach conclusions about the market?
  • Does he believe an impending recession would be global or just in the U.S.?
  • How does he see the coronavirus affecting the global economy?
  • What psychological impact will this have on investors and companies?
  • What was the reaction to the Fed lowering interest rates by half?
  • What is his view on how Bitcoin will play into all this?

Episode Notes

Bruce Norris is joined this week by Raoul Pal. In the early 90s, Raoul worked at Goldman and Sachs, where he co-managed the hedge fund sales business and equities and equity derivatives in Europe. He then co-managed the GLG Global Macro Fund in London for GLG Partners, one of the world’s largest hedge funds. He retired from managing client money at age 34 in 2004, and since then he has founded Real Vision TV, the world’s first On-Demand TV channel for finance. Raoul has been publishing global macro investors since 2005 to provide original, high quality, quantifiable and easy readable research for the Global Macro Investment Community.

Bruce began by asking him what a global macro investor does. Raoul said if you imagine yourself as a real estate investor, that’s your particular expertise. Other people have expertise in credit or stock markets or even sectors of stock markets. As a macro person, he looks at the overall picture that’s driven by the economies, the movements of economies over time and how that affects asset prices. Asset prices could be anything from real estate to equities to bonds to currencies to commodities to credit. He looks at everything across the world, emerging markets and developed countries, and try and piece together the jigsaw puzzle of how movements in those economies will offer opportunities for investment.

One of the things Bruce is most impressed with his he said Raoul has a very honorable process on how he comes to conclusions. He has operated a number of different frameworks. One is a secular framework. What is the big trend? A long term trend. He is talking 10, 20, 30, 40, 50-year trends. So some of those are relatively easy. Demographics is one of the biggest drivers of all. We can follow the demographic wave and understand what that does to asset prices. That was a big driver of real estate, particularly in 2008, as the baby boom generation piled into real estate for their pension plans. It’s the big driver of the cheaper end of the market now as millennials try to find homes that are affordable. It’s the driver of the expensive part of the real estate market, for example, the larger homes where baby boomers want to sell them and there are fewer bids around. That is the long term theme.

We have another big theme within the long term, which is the big global debt bubble, whether that’s at central bank level, corporate level, or whether it’s at the household level. He looks at those things as well. There may be things like the rise of ESG or environmental investing that will probably end up being a secular theme that drives out over a long period of time, or maybe the decline of the oil business. There’s a number of these big things, but the most important thing is the business cycle. That’s the ups and downs of an economy. Generally speaking, economists never forecast the ups and downs of economy. They always extrapolate a linear trend. If you give a small child the graph of GDP in America, it goes up and down. It’s cyclical and we all know that intuitively. BOnce you’re armed with the cyclicality and you also know that asset prices move up and down with the economy, then you know that once the cycle rolls over, it’s likely to be headed down over a few years and that asset prices, once the economy starts going negative, will go negative. On the reverse when we get to the bottom of the cycle coming up, we can extrapolate forwards the returns of certain asset prices.

For over the top with trading and positioning, he uses chart patterns to help him understand human psychology and where we are in the markets themselves. That’s the general framework. Living in the macro world, he has to live in the future. There is no point in trying to assess the markets based on the information you know today because everybody knows it. What you have to do is try and extrapolate out into the future and say, “OK, the business cycle is weakening. Therefore, this will happen.” Right now with the Coronavirus, you have to live in the future and see the probabilities. There are no certainties in anything in the investing game, just a probability. So it’s assessing those probabilities to figure out what the best opportunity is.

Bruce asked him if he has a team of people and practices a version of idea meritocracy or if he meets with himself and battles it out to draw conclusions. He said since he has been doing this a long time, he has his own thought process. He likes to speak to people and is very active on Twitter. He is gathering information and doesn’t read anybody else’s research. The few research pieces he reads now and then he does purposely not to correct his own thinking. Then, he sits down and writes the global macro investor every month, which is about 120 to 130 pages of graphs, some words, and analyses. He lets that flow to try and figure out himself exactly what’s going on. He doesn’t come with a preconception. It’s by looking at all of the data and all of the charts and the narratives that are out there to figure out what’s going on. He has an analyst who helps him put together his database of charts and feeds him some of the information, and himself. That’s it. He has been doing this for 15 years now, and it has just been the two of them.

Bruce knew this would be his answer because he does research in his own little world. He has watched Raoul talk, and it’s almost like when he gets in front of a chart, he is part of the chart. If he could get inside that chart, he would see a lot more than most people. Bruce said for someone that does what he does, he gets a big kick out of watching him do that. Raoul said for him a chart is everything because he understands everything that’s gone before and some probabilities of where the future lies. He got taught this by some of the world’s most famous investors who all use charts. It just helps you understand where we could be going. There’s a story in every chart, and that’s amazing. Bruce loves charts too. Sometimes, he will look at one for 20 years, and then a new explanation comes to him. His son Aaron can tell when he is really amped about something. It’s like a new discovery that cleared up a question.

Bruce asked him if he has anyone he bounces off of if he is about to put something in writing that’s pretty outrageous. He said no. He is in an incredibly flattering position where he gets paid very handsomely to think independently for others. He get paid essentially by the world’s most famous hedge fund managers, sovereign wealth funds, family offices, and asset management firms to think independently. That’s what they want from him. They want to see things that they don’t see. He doesn’t do it to shock anybody because it’s a closed circulation business. It’s a very limited number of people allowed the subscription. It’s very expensive. The point is he needs to be unfettered to allow his own thought process to evolve. They may choose to reject it, but they want to hear the counter-arguments to their own existing views. In his world, it’s not the people’s need to slavishly follow him. He has gotten a very good track record over the 15 years, probably one of the best of all of the kind of research businesses. People are happy to tell him if they don’t agree with him. They may be doing the opposite trade, but they really appreciate understanding where their risks lie.

Bruce wanted people to understand that Raoul is not given to outrageous statements. These are very calculated words that he comes up with, and some of these might be scary today. First, there are interesting things going on right now. Six months ago or so ago, he was looking at the charts and came to a conclusion we were probably headed to a recession. Bruce asked if this was just in the United States or a global slowdown. Raoul said it was a global slowdown. The United States pricked the bubble by raising interest rates even though they didn’t go up a lot. People in the real estate market know that it put the squeeze on several people because the rate of change of interest rates was quite high. That started slowing down the economy, then we had trade tariffs. Trade tariffs were a global event, and we also had a strong dollar, which was pressuring global economies. He thought the global economy was already headed into recession. World trade was negative. Before the Coronavirus hit, we already saw German exports and manufacturing falling apart. He could see some elements of some accelerating weakness in the global economy. That’s where he was coming at before all of this.

Bruce asked him what kind of recession he thought would unfold before the coronavirus. He does we don’t know, but his base case was mild with a risk of something bad because we have a large problem with the baby boom generation hitting retirement age. The average age of the baby boomer in the United States is 66. As they go into retirement, they are overweight risk assets, equities and credit. They have to sell those to realize their retirement income. He thought that that was going to create some problems. The other side of the equation was there was an enormous amount of credit issued by corporations that was also held in their pension plans. He thought there was a risk in a recession that credit spreads could widen, or credit was harder to get and that would cause a big problem. He had been shouting from the rooftops about the retirement crisis, trying to get people up to speed on the risks they’re taking and what is likely to come. He feared something bigger than a mild recession. His base case was mild, and his fear was a 2008 style event. Then the Coronavirus came along, and his base case was 2008 or worse events, and his fear with a high probability is actually depression.

China did something dramatic. They saw the virus, and they saw that its rate of spreading its R.O. was incredibly high. They saw that it overwhelmed their medical system, and also the death rate was high enough to offer concern. If you use the framework of the rates of the virus spread, plus the death rate and look back at the Spanish flu and say, “OK, that is what a worst case unconstrained virus looks like.” It would have killed the equivalent of 68 million people this time. China did what they had to do, which was completely shut down the economy to control the virus. As we’ve seen, the virus spread in China has collapsed because they took the hardest measure of all, which was basically to collapse their economic growth, take the maximum economic pain with no output, no consumption and no supply to contain the virus for the sake of society. South Korea and Singapore did similar, but Italy and Iran were too late. Now they’re all shutting down their economies, but this virus has gone to a pandemic.

What will have to happen is one economy after the other is going to have to shut down entirely. That means no factory output, no demand for goods. We’ve never, ever faced a global demand and supply shock at the same time before. At this point he is not extrapolating to the future. He is talking about what happened yesterday in Italy. They just shut down. Spain will have to follow suit as well as France, Germany, Denmark, and the United States. The United States has been the slowest of all dealing with the spread of the virus, and they have no choice because their voters are baby boomers. This virus is like a nuclear warhead because it kills baby boomers at a higher rate than it kills anybody else. The death rate is much higher for the voting population that happens to own all the wealth. This is why this is an extremely concerning situation.

We are living with hope that maybe the virus dies off in summer, hope that maybe economies can get to grips with this fast enough. But the reality is, it doesn’t look like they are. His fear here is that if they do not get control of this in the next three weeks, then we have something that is a lot longer lasting, a lot more pervasive and a lot more destructive as it starts to unwind the big secular bubbles of debt, the equity bubble, the retirement crisis, and also exacerbate the dollar exploding higher because there’s a huge dollar shortage. His fear is on all of those things.

That’s a lot to consider. We have used that word black swan event, and Bruce wondered if this is the mother of them all. He said it is. He has heard people warn about pandemics before. Bill Gates warned about it. At first, he didn’t get it. However, the moment he saw this, he got it in seconds, luckily from experience. He then extrapolates it out into the future. Nobody would have thought that we’d have a demand and a supply shock at the same time. Throw in an OPEC oil war in the middle of it, trade tariffs, and a U.S. election, this is the worst case possible outcome we could have ever established. We are now praying for a miracle that it doesn’t turn in to the depression and it’s just a two or three-quarter terrible recession like 2008, or a bit worse.

What’s crazy about this is a month ago, this wasn’t even on anybody’s radar. This was because we don’t forget. We had the swine flu, and it was okay. We had the Ebola virus, and we got through that. We had the MERS one. Everyone thought we don’t need to worry about these things. You have one after another. Living in the Caribbean, you know it with hurricanes. People who have lived here long enough get missed by hurricanes every year, and it’s OK. That just means the probability is increasing that you’re going to get another big one soon. People didn’t see that and understand what the risks truly were. This is going to change people’s psyche forever on this stuff.

Bruce said when they closed Italy, that changed his serious outlook of it. That was a shocker right there. Then, when there was no basketball, you really start realizing we have never dealt with anything like this in our lifetime. Raoul has gone back in history and can’t find another time in all history where we have dealt with anything like this. We’ve never taken measures. Nobody’s ever shot economies before, especially rolling shutdowns with one economy after another, city by city. It never happened.

Bruce said when he looks at charts today, naturally he knew the stock market was going to take a hit. Gold, silver, and Bitcoin are also taking a hit. There doesn’t seem to be a a safe haven right at the moment. Even bonds aren’t moving much anymore. Raoul thinks there is a huge liquidation going on from hedge funds, asset management firms. If you think about the standard pension portfolio of 60/40 stocks vs. equities, or 70/30 these days, the idea was the bonds would protect you when equities fell. The problem is the bonds just had a huge rally and they’re almost pricing in zero rates. There’s not much more they can move. You dont get price gains out of bonds. You get a bit more left, maybe, but not much. So no price gains from bonds, that means all the pension plans are holding too much equities. That becomes liquidation events from everybody in this. You see the overlevered hedge funds. There’s a number of players, so they sell anything they can that’s not nailed down to pay margin calls until they sort their portfolios out. That is what is happening to gold and bitcoin.

Bruce next asked what psychological impact this would have on investors and companies and what the ramifications would be. Raoul said to think about it at a societal level. You haven’t yet got it in the US, but very soon everyone’s going to understand that everyone’s going to fear each other. That is truly extraordinary. We’ve only seen that level of fear in the United States in New Orleans with Hurricane Katrina. When people fear each other, that is this kind of scarring. People fear going into public, fear socializing with people, fear going to music concerts or anything like that. That has an ongoing effect.

Also, a lot of this consumption is gone forever. It’s not pent up demand. It just disappears forever. To be able to get through this is very difficult for many people. He feels truly worried for people who own restaurants, shops, and bars and simple things that require people to go and visit them. It’s a catastrophic event because they’re gonna get quarantined. All the staff are going to go home and they’ve got full payroll plus rent to pay and no income. Most businesses probably can’t last two months. That’s what he fears is going to come out the other side of this. If there are a lot of real estate investors listening to this, then they need to understand that the likelihood of people not paying their rent, particularly businesses, is extremely high. People are going to lose jobs, but also people are at home being paid, working from home, and not spending much on other stuff. If you’re renting out apartments, that’s less of an issue. But if you’re renting out to retail, you’ve got a huge problem on your hands.

Bruce started thinking about those dominos last night. He saw a video in Italy, and they were in line for something and they were about five