MAX WIETHE: Hello, everyone, and welcome to a special Ask Me Anything Real Vision Pro that we're calling "Afterhours with Raoul." Now, Raoul, I know that this is something new and unique that you're adding to the pro level membership tier. What is it that you were thinking for this special "Afterhours" today?
RAOUL PAL: Well, I notice from the comments section that different people at different levels of understanding of investing, everything from how to build a framework to how to size positions, how to think about portfolios, and also how to understand different peoples' portfolios, time horizons, and all of those things, and how to use it themselves, so it doesn't become so much of a copycat, but it's something that's hugely creative to your own process. So that's what I'm trying to do today.
I'm going to talk through how I come up with investment ideas, how I think of an investment framework, and then how to implement those, how to know when to take trades off, what strategies to use to put trades on. So there's a lot to go through. It's a bit free form, so there's plenty of mopping up with questions that you'll do afterwards, Max, from the audience because I know everyone's got a lot of questions for themselves so that they get a good understanding.
MAX WIETHE: All right. Well, with that being said, I think the phrase that jumped out to me which is a natural place to start is idea generation. That's where all trades and investment start. It's from taking a look at the data at the price action, whatever it is that you're focused on to come up with an idea. So why don't we start there?
RAOUL PAL: OK. So I trade macro. What is macro? And why do I use the word "investor"? Now, the reason macro is basically the macroeconomic impact on asset prices and dislocations create asset prices by the movements in the economy. By definition, economic data generally comes monthly or quarterly. Yes, there's some high frequency data.
So when you've got a few data points, your time horizon has to be reasonably long, which many people don't understand with pure macro investing. That's old school-style macro. It's all based around that longer-term narrative.
So when I look at macro, I start with the secular trends. I try and get an understanding of where the world is and where it's going in the longer term. And for things like that, these things build up over time.
But if anybody's starting into macro, firstly, take out charts of every asset price and look at them over 50 years, long time horizons. What are they doing? Are they going up or down?
So the secular trend in equities has been up. The secular trend in bond yields has been down. Currencies move in bands. Gold tends to rise over time, so certain understandings of that. So that gives you a framework. And that's trend, but within that is macro because you need to understand why those things are happening.
And those things happen because of secular trends in the background, whether it's demographics-- so demographics is the biggest driver of all because as the Baby Boomers have put record amounts of money into the equity market, into their pension plans, they have done two things. They've driven up equity valuations over time, so i.e. equities have got relatively more expensive versus the economy as a whole. And you can see that, let's say, in market cap to GDP. That's a good way of looking at that particular structure, or the rise in PEs over time.
On the other side, it's driven down inflation because as people get older, their spending habits tend to be less inflationary because there's less marginal consumption. It tends to be they already have. It's stop to flow. They've already got most of their stuff and so you're not buying much.
But if you were, Max, to furnish the apartment that's behind you or the house that's behind you, that's a lot of spending. If you own it, you replace the light bulb and you change the sofa once every 10 years, your marginal spending is less. And that is deflationary.
Additionally, the older you get, the more likely you have to fixed income investments, and you drive down bond yields. The other thing, the other big trend of our time is debt. We've seen a huge rise in debt. So that, I would say, is a secular trend.
How does that impact asset prices? Well we've seen, for example, that companies have issued debt to buy back stock, so that's part of the equation of why the equity market's done this. But also more and more debt makes it harder to raise interest rates, and therefore the absolute interest rates overall fall over time because of the debt burden.
So these are big macro pictures. These are the ones most people look at. But there are other ones as well, and other people will have their own views on what the secular themes are.
Clearly, the rise of technology and the SaaS business model is a huge one that Stan Druckenmiller talks about. It's not one that I have been playing in because it's more equity specific than my comfort zone. I do look, for example, at the fantastic demographics and low debts of the countries around the Indian Ocean, which I call the monsoon countries. That's a secular investment opportunity that you'd know you'd rather be a buyer of India or the Middle East, et cetera, into large sell-offs or bear markets, which come along. It gives you a bias towards your investments.
I also look at the trend of commodities. Are you in the boom/bust cycle? Commodities tend to have these 20-, 30-year trends. And we had the peak trend as China came into the world, and that peak trend falling as we go through the commodity bust.
Why the commodity bust? It's the age-old excess capacity that builds up over time. And then there's too much capacity, and the price of commodities falls.
That's also linked with the US dollar. The dollar tends to be a driver and inversely correlated to that particular mechanism. We look at the global state of debt.
So all of these build a narrative, and that narrative is something that I'm always testing. I'm trying to say, am I right? Am I wrong? What is going on that changes that?
But without an investment framework, particularly when you're operating the longer term, you don't have anything to base any hypothesis on. You're basically trading discrete events,
Now, some people that works for, but I don't take discrete events. I tend to lose money if I do because I'm just opportunistically thinking, oh, well, this looks good. I'll have a go at that. If it doesn't fit into a macro framework, then it shouldn't work.
What's key about developing a framework, if you can, is develop some key themes that are not related to the bulk of the framework. So if you listen to Stan Druckenmiller, he's got two themes that he's playing. One is the debt supercycle theme, and the other is the rise of technology and the SaaS business model. Those things he can run at the same time. And guess what that lowers his risk? That comes-- and we'll talk about this later-- portfolio construction.
So now I've got this big picture view. And anybody doing this needs to step back and write down what their big picture views, and put down the evidence for it and the evidence against it. Where am I wrong? Where am I right? What's changed? What hasn't changed?
So everybody screams and shouts all day about bond yields. I don't care because I used the charts of truth. Since 1982, it's told you where it's going unless something changes, and that's not built on that chart. That's built on the whole framework of demographics, the debt cycle, the commodity cycle, all of these. Unless something changes, I don't have to argue otherwise. Can it-- and I'll come up to the cyclical components in a minute, but I'm looking at the secular.
So now I've got that. I then spend a lot of time looking at the big picture charts, really long-term charts. What does the chart of copper look like not this year, not this week, but last month, not last five years, not 10 years, not 20 years, 50 years, or 100 years. I want to see the big patterns. I want to look at them either outright or inflation-adjusted terms, or maybe versus another commodity. I want to understand where we are in all of these.
So, for example, from that is one of the fallouts, is over time, if we'll be getting more bearish on the equity market based on both the economic cycle, the debt cycle, and the demographic cycle, well, it's interesting to see gold is so cheap versus equities over that long-term structure. It gives you a bias there, that you probably want to own gold more than equities, and certainly in certain types environments.
So I look at all the long-term charts from the big emerging market patterns, all the major stock markets, all the major sectors, every major currency, all the currency indices, the commodity indices, the metals, the precious metals, the agricultural commodities. I look at the bond markets around the world. I want to know what Indian bond yields are doing versus US bond yields. I want to know what all of these things look like.
I want to understand the correlations between them. What are the bets that are actually happening here? Because when, for example, you adjust the EURO STOXX-- no, if you were to put the US banking sector into euros, it actually looks like the European banking sector. So actually what we've got is a currency difference, not a banking sector difference, things like this. And that takes time, and it's fun because you're playing around with stuff. And you're just looking at it, trying to get variant observations of what could be going on. So that's a big thing.
MAX WIETHE: So then after you-- you've gotten this big picture view, you have taken not only the arguments for your thesis but the arguments against your thesis. From there. I think the next logical step is looking at-- examining yourself and your own time horizon for any position that you want to put on.
I think a good example is you are somebody who has, I think, come in and out of retirement now multiple times. You've been being fortunate enough to have a very successful career. You have put a lot of your earning is in front or is behind you already, and so you can take these longer-term bets.
Someone like myself, I'm not going to put my money into a savings account and earn nothing, so a lot of my savings is actually in an investment account. But that principle, I'm going to have to tap into that at-- a lot of my large purchases where I'm going to be dipping into my principal are ahead of me. So our time horizons, I don't think, match up. How do you--
RAOUL PAL: I think you're dead wrong.
MAX WIETHE: Really?
RAOUL PAL: Yeah. So I made most money from big picture bets when I was younger. So at the age of 40, I decided I want-- my business was billing in euros. I earned in euros, I lived in euros. But I made one big bet that I'm going to change everything to dollars because I thought, the dollar is going to rise, and it's going to rise for a decade or longer. And I took that bet at $1.48 and a half in the euro.
It is the same bet you take with housing. You make the decision of, what do I think house prices are going to do over an extended period of time? I think anybody who thinks they will get rich from short-term trading hasn't understand how people get rich from investing.
There is virtually no example of one of the richest people in the world that's driven by short-term gains. There are traders who periodically appear in the rich list and then disappear because it's not sustainable. It's a very difficult thing, and I'll come on to leverage all this stuff in a sec. There's a lot to get through.
But the real thing is, is what is your investable time horizon? So if I'm talking about my pension, well, I know that emerging markets are extremely cheap versus developed markets, the second cheapest an all recorded history. So it's telling me, if I'm going to put money in the markets over the next 10 years, I want to be in the emerging markets and not developed markets. I'm going to make more money from that bet than by messing around by buying and selling this. It's not going to happen.
But you will make several hundred percent returns to get that single bet right. Basically, long-term bets come down to where is the dollar. That gives you emerging markets versus developed markets, it gives you commodities, it gives you pretty much everything you need to know.
And the other is, where are interest rates and where is the equity market valued at? Those three things will get you future expected returns that are generally quantifiable. Doesn't always work, but it gives probability on your side.
So then when I come down to what the most important thing is, it's then, OK, what is my investment horizon for Real Vision Pro or Global Macro Investor? And that's down to business cycle time horizons. The business cycle time horizon is basically most business cycles, the up cycle tends to last between four and eight years. We've just had the longest one ever. The down cycle tends to be 18 months to 3 and 1/2 years.
OK, that's great. Now you know you're playing with. What you really want to do at a very simple level is buy risk assets at the bottom of the business cycle and hold them all the way. So the easiest way is if the ISM crosses 50 on the way up, for when it's properly formed an economic base-- I would argue that this current situation is not that, but I could be wrong-- you hold risk assets all the way through until it crosses back down to 50. And it's on his way back down again, you've got other indicators of recession. That basic asset allocation will keep you in the game.
Now, you can get cute then. Within that business cycle, is the economy likely to expand or contract over the period of time you're looking at? So right now, I still think we're in the contraction phase. That contraction phase, I think, probably lasts another 18 months because that would be normal. So if I'm biased towards that, then it sets up certain biases within the portfolio.
This is why I don't trade the short side of bonds because my secular thesis is bond yields fall, and my cyclical thesis is bond yields fall. So why would I trade against that? Because it doesn't fit my time horizon.
Somebody else who has a shorter term time horizon would just say, maybe-- I'll come on to short-term time horizons later-- is that sentiment's shifting, and therefore I'll trade the sentiment. That's great, and it works for people.
My way is not everybody's way. It's just how I do things, and it's what's given me the success and the proven track record that I've had over the years is by doing this. And I've taught people at Goldman in the graduate program, OK, this is how you look at markets and this is how you analyze it. This is what you understand with the economy, because most people don't understand what to do with the economy.
They see the data, and they want to trade the data. That's not what we do. The business cycle is all about understanding where it's going, and that is the structure of the business cycle, at what point. So that's why I'm saying, listen, it's most likely that we're not at the bottom of the business cycle right now, and it's driven by the composition of how the ISM number is done, which is versus the previous month.
So if I look at the industrial production cycle or whatever, it looks like we're still very, very negative. So that biases me in certain ways. That biases me towards, for example, my dollar view. My dollar view, in a negative world, where cash flows are reduced globally, in a high debt world-- that's another big picture theme of mine-- in a down cycle, there's going to be less cash flow. And I can prove that by showing S&P cash flows against the ISM. They're the same thing. Or against GDP, even better.
So that tells me that the ability to for people to pay dollars, pay back to their dollar debts or service the dollar debts, is diminished. So it biases me toward the dollar going up. It biases me towards understanding the central banks probably have to lower rates again because that is the only way to continue with the debt cycle at this stage. It biases me to understand that with the secular cycle for commodities is down and the business cycle is down, that any market action commodity prices is likely to be counter trend because the economic trend over my time horizon is down.
So time horizon is crucial to me because I'm using economic data and the movement of economies. Economies are like juggernauts or supertankers. They take forever to turn. You need to understand that.
Now, there are some people who are very good at trading around both time horizons at the shorter term. As Paul Tudor Jones said to me, very importantly, he said, the best investors I've ever seen, and the best traders, have a time horizon that matches that idea horizon.
What that means is, if my horizon is the business cycle, then kind of six to 18 months tends to be the right sweet spot to express the part of the business cycle that we're in. But if you're trading on sentiment, it could be one week. But then you shouldn't care about anything longer term because it's irrelevant to your view. You might just want to say, what trend has the market been in for the last week, month, year? And within that you would understand where you might want to add and reduce your bets.
But for God's sake, don't trade a central bank bubble and all these big narratives and then try the two-week time view because that's just not what you're doing. You're actually trading what goes on over the next two weeks. Then you need to ask yourself, what is happening on the next two weeks that I think I have an edge for? And if I understand that, then trade that. But that's not what I do.
MAX WIETHE: How do you go about determining whether a move that you're seeing is something that's short-term, that should be ignored, or whether it is potentially a shift in one of these longer-term trends?
RAOUL PAL: Everything is potentially a shift, so you need to be endlessly insecure. That's crucial. But then you use the long-term charts. Is this noise? Is this doing anything in the chart structure that's changed? Is the economic data doing something that I would not expect at this point in the