Citi's Dirk Willer on Why You Buy the Bubble | #654

Meb Faber (0:00)

US markets near all-time highs, a lot of AI bubble talk, bubble talk in general. How do you define one? Are we in one?

Dirk Willer (0:07)

We entered bubble territory roughly middle of last year. Our punchline really is, guys, it's great, it's a bubble, let's buy it. What's the difference between a bubble and a bull market? You tell them it's a bubble, let's buy it. And the difference is that you give back a fair chunk of the money that you make while you're in the bubble. In 2000, the market cap of the equity market was a bit more than 100% of GDP, and the bursting bubble gave you a recession. It was a shadow recession, but it was a recession. And now it's at 240% of GDP, so you can expect a bigger recession, and the Fed will react to that. Maybe rates go back to zero.

Meb Faber (0:39)

How would you describe the worst Fed so far?

Dirk Willer (0:41)

We created what we call the worst shadow rate. Right now, it's at the highs. We think that means it's hawkish. The first Fed hike is usually not a problem. The last Fed hike is a problem.

Meb Faber (0:51)

What's on your brain as we look out to next year?

Dirk Willer (0:54)

I really hope the bubble will keep giving for another year. 80% of our efforts should be dedicated to trying to figure out when this baby peaks, because then Fed will change direction rates, or change direction rates could go very, very low levels again. The Fed will probably have to buy the back end of the curve. Gold will go straight up.

Meb Faber (1:13)

What's up, y'all? Today's guest is Dirk Willer, head of global macro asset allocation, emerging market strategy at Citi.

SPEAKER_3 (1:20)

Dirk, welcome to the show.

Dirk Willer (1:21)

Great to be here. Thanks for the invite.

Meb Faber (1:23)

As we wind down through October into Q4, US markets near all-time highs.

People, a lot of AI bubble talk, bubble talk in general. What do you think? How do you define one?

Dirk Willer (1:35)

My favorite topic and hotly debated inside Citi as well. And I, you know, I mean, the word is sort of somewhat loosely used by many. And I have a big quant team as part of my outfit. And so we like to backtest things and for that new definition of a bubble, right? So we came up with the definition or rather didn't, we stole it rather from GMO. And that's essentially saying, you know, if something goes up more than two standard deviations against the long-term trend in real terms, we call it a bubble.

And we get a fair amount of flack for that. And one reason is that it's a price-based definition, not a valuation-based definition, right? And that I think is part of its charm though, because bubbles can show up in earnings too. And some of the gross margins that some of the high-flyers are displaying here and reporting are obviously not sustainable, and therefore, there could be an earnings bubble. The second issue is, of course, when anything is in scarce supply, people order a lot more than they really want. And then on the back of these types of bookings, people project their earnings. So I do think that the price definition of a bubble is great because it doesn't really care whether the bubble is an earnings or a valuation. And if you use that definition, you conclude that we entered bubble territory roughly middle of last year. And by the way, if you really insist on valuation, I mean, if you use Trith or Scape, it's also telling you you're under bubble, right? I mean, if you believe that the earnings projections for the next five years will look like for the last two or three, then probably not. You tell them it's a bubble, but you buy it. And the difference is that you give back a fair chunk of the money that you make while you're in a bubble on average, right? So for us, it's not a reason to be bearish, it's just saying, you know what? Eventually, we could have a fairly severe sort of payback time. How big the payback really depends on how far the bubble inflates first, obviously.

But we could see again, the levels of mid-last year.

And that just means, don't be over levered, have maybe some hatred on the book, be conscious of the fact that it will land badly. I think that is the definition that makes a bubble different than a bull market.

Meb Faber (3:52)

And so how do you think about trading these?