The $600 Billion Loop | Jeff Klingelhofer on AI, the Return of Bonds and the Fed's Third Mandate

**SPEAKER_1** (0:01)
This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome, that's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block, or finally break down that long article you've had open for weeks. Gemini and Chrome is here for it. Ready to make anything online make sense? There's no place like Chrome. Check responses set up required compatibility and availability varies 18 plus.

**SPEAKER_2** (0:26)
When you need to build up your team to handle the growing chaos at work, use Indeed Sponsored Jobs. It gives your job post the boost it needs to be seen, and helps reach people with the right skills, certifications and more. Spend less time searching and more time actually interviewing candidates who check all your boxes. Listeners of this show will get a $75 sponsored job credit at indeed.com/podcast. That's indeed.com/podcast. Terms and conditions apply. Need a hiring hero? This is a job for Indeed Sponsored Jobs.

**Jeff Klingelhofer** (0:56)
It's AI CapEx that's driving the stock market and it's a stock market that's driving that ability of that high end consumer continue to consume, which is all very circular in nature, right? If any one of those links in that chain breaks, it's a very tenuous setup. Part of the reason why we haven't had a classic business cycle is because of all of that Federal Reserve intervention and its direct focus on financial markets. And so I think what it's done is it's lengthened that business cycle. As good business analysts, we try and focus on fundamentals. What's ultimately driving individual companies? How those companies are driving the stock market? But what really drives prices is sentiment.
And what sentiment rolls over? It's tough, right?

**SPEAKER_4** (1:35)
Jeff, welcome to Excess Returns.

**Jeff Klingelhofer** (1:37)
Hi, it's great to see you and great to be here. So I appreciate it.

**SPEAKER_4** (1:41)
You are managing director at Aristotle Pacific and a portfolio manager across several of the firm's fixed income strategies through this role that you currently sit in and prior roles at PIMCO and Thurnberg. You had a front row seat to global fixed income markets through many different regimes, many different credit environments. And today, what we'd like to discuss with you is the current macro environment, Fed policy, credit markets, inflation, and where investors should be looking for opportunities in today's market.
People always say that the fixed income guys are the smartest guys in the room and much smarter than the equity guys. So Jack and I are hoping today that some of this intelligence rubs off on both of us. They would have to do a lot of work to rub off on us, Justin. We've got a lot of work to do. You're right. Well, hopefully Jeff is patient with us as we work through this. You said that the markets are focused on an increasingly set of narrow things that are working and really aren't appropriately waiting some of the headwinds out there. So can you explain where you're coming from with that?
Yeah.

**Jeff Klingelhofer** (2:43)
The way I would describe it is we've all talked about this K-shaped economy for quite some time. And what we are seeing is the economy is humming along, but it is relatively narrow in the sense that there's only a few things that are really working. And even those couple of things that are working are very interrelated. And so what I really mean by that is if we just unpack where GDP is today, if we unpack the reality of higher rates, higher inflation, having pressure on that lower end consumer, that's old news. That started in 2022 with the rising rates. Now it's continued to spread and it's been made notably worse by Iran, increasing oil prices, etc.
And at least for the moment, we've got a temporary reprieve that's helping to alleviate that. But really what's been driving the economy is this incredible AI capex expansion. We've got 600 some odd billion dollars from only a handful of companies. And for the moment, there's lots of questions around ultimately where AI goes, its impact on the consumer, its impact on the broader global economy. But in the build out phase, it's for real. We need real people, real things. We need to be digging in the ground. We need energy, we need copper, we need chips, we need all of these things.
And so that is a massive, massive tailwind to the US economy. It's also been a massive tailwind to equity market returns. And so the more narrow focus that we've been seeing from the consumer is that really, the only part of the consumer that's holding up amongst this massive tailwind is that increasingly high-end consumer. And they're only holding up because they are the ones that are benefited primarily from asset price appreciation, right? House values have gone up, equity markets have done well. And so that higher-end consumer that has a lot of assets continues to spend. They're the ones that are really propelling the economy, that middle and lower end can consume or act in its tracks. We're seeing delinquencies increase.