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The End of Risk Parity: Bonds, Stocks, and the U.S. Dollar (w/ Raoul Pal & Dan Tapiero) - YouTube
Channel: Real Vision Finance
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DAN TAPIERO: You can really say that they
really even haven't begun a wholesale easing
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process, that they've stopped the rot for
now.
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That makes me think, and we've talked about
this before, but that makes me think that
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the government bond curve does come all the
way down and maybe it's 20 basis points flat
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all the way up to 30 years, or maybe it's
10 basis points.
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Now, I don't think for an institution that's
a great bet to buy bonds at 60 bps for a move
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to 30 or 20 or zero.
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I think in that environment, they're going
to need more protection, a different type
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of hedge than just government bonds.
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I mentioned this and I get into this now because
I think we're beginning-- there's a new narrative
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that maybe just developing, which is that
government bonds as an asset class are losing
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their efficiency or productivity.
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Once we get down to zero, I think it gets
very hard for bonds in the portfolio to act
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as the hedge and I'm thinking again, for portfolios
that are 70/30, 65/35 and that I think there
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begins to be a little bit of a possible transition
towards gold, which doesn't have a cap on
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it.
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It has unlimited upside in a period where
the authorities are going to be adding stimulus
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for a long time.
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RAOUL PAL: Make sense because bonds just don't
offer the-- there's no capital gains now.
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All it does is act like cash.
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Well, fine, you'd use cash then, there's no
point having a bond market.
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You're right, you need something that can
offset with gains to create that all-weather
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style portfolio or a portfolio hedge of some
sort because it's no bones.
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DAN TAPIERO: Just think about since 1980,
every time we've had the downdraft in the
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periods we were discussing before, there were
massive gains in bonds.
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You and I both in early 2000, I was loaded
up on two years, the whole year was made on
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US 2-year notes.
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That goes for every time we had one of those
periods and so that would offset the losses
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on the acid side of your portfolio.
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We don't have that now.
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I think if there's an existential crisis,
from an investor standpoint, again, putting
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aside the virus and the oil and all of that
is that in the next five years, what can replace
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bonds?
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RAOUL PAL: Well, if you're a pension fund
manager, and I know you sit on an Advisory
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Board of endowments, or whatever it is, these
are real meaningful questions now that everybody's
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going to have to have is, and I don't know
the answer, we should think about this because
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Europe and Japan have gone through this.
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How did their pension system cope, and what
did they do?
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DAN TAPIERO: Well, they've gotten killed.
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I know German insurance companies, they have
to put their money into negative bunds, and
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they have to pay out what they have to pay
out based on their policy.
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I don't know, maybe the central bank is supporting
that industry.
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I really don't know.
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RAOUL PAL: It makes me think that most people
just leave the equity market.
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Because if you don't have a way of taking
intelligent balanced risk over a long term
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time horizon, and if I look at the European
stock markets and the Japanese stock markets,
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they obviously never recovered again.
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Which is one of my core thesis that I don't
think the US market recovers for an extraordinary
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time until the demographic blows through.
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Because they're part of this.
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How do you run intelligent risk in an equity
portfolio for a pension?
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Now, it's difficult.
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DAN TAPIERO: Where does it go then?
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This is the common refrain.
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If you pull from the equity, are you putting
it into commercial real estate and hoping
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that you'll make some return?
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RAOUL PAL: Or do you get the government guarantee
the pension system and you just put it into
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cash?
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It's all going to end up in the government
balance sheet and the central bank balance
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sheet in the end, whichever way you cut it.
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DAN TAPIERO: It could.
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It could.
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I also think that's a very long term thing,
that doesn't happen overnight.
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For the equity market to become not a place
where you can have exposure to the asset side,
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to assets into growth in the economy, I don't
know even what's what liquid enough to replace
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it.
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I understand what you're saying.
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You would need the government and also industry
and business to say the equity markets don't
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work for us, we need it all guaranteed.
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That's really, you're very close to the socialist,
a socialist system.
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RAOUL PAL: They're buying their bond market
because it's on the books of the pension funds
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and the life insurance companies.
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DAN TAPIERO: I missed that.
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You said Europeans?
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RAOUL PAL: Sorry, the Japanese.
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DAN TAPIERO: Oh, the Japanese.
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RAOUL PAL: ETFs, which are basically the equity
portfolios and the life insurances and the
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pension funds to try and prop up returns because
there's no bond return.
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It becomes a very complicated world because
we've all made promises we actually can't
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match because all promises the entire pension
system is built on never once assume that
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bond yields are zero in the point that you're
raising.
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DAN TAPIERO: Right, but how about a different
thought?
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How about, we always talk about all this debt,
et cetera, and I remember in the mid-80s and
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late '80s, people talking about how Reagan
had leveraged up too much, we'd had too much
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debt, and that the US economy, I think there
was a Book Day of Reckoning or something like
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this, it was going to default and all of this
business.
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What ended up happening in the '90s was that
we reflated the asset side of the balance
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sheet, of the country's balance sheet.
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Maybe when we think about what are the models,
the frameworks of the future, maybe they've
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gone unlimited right away.
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Maybe, maybe you're right, maybe the government
is going to support the equity markets to
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a greater degree than we could ever imagine.
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How much pressure is the debt side of the
balance sheet if let's say the S&P doubles
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from here?
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Let's say the next three years, often you
get inflationary episodes after there's a
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panic spike that forces the hands of authorities.
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It's not impossible that we have an inflationary
episode where the risks of the S&P doesn't
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go up, the nominal value of the S&P goes up.
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Also, connected to this, and this is maybe
something contrary to what you've been thinking
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is that, look, Americans only care really
about the equity market.
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No one cares about the value of the currency.
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This is a perfect situation where if the dollar
went down 20%, 30% here, wouldn't be that
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big a deal because especially if it happened
over time?
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I would say most Americans wouldn't care,
wouldn't know, it wouldn't matter I think
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over a five, six-year period, you could probably
have it go down 50%.
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Look, it went down from 2000 to '03, that
was a huge run for macro guys like us, that
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dollar selloff.
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It was because of that dollar selloff that
we could recover from the NASDAQ collapse,
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which really was a gigantic collapse.
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RAOUL PAL: One of my core ideas I'm floating
around my head is the 1920s.
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We've got the US essentially and the UK and
France eventually and Germany out of the troubles
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that they were in was currency devaluation.
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The US were quite late in repayment because
the dollar was very strong.
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They kept accumulating gold reserves, gold
reserves, gold reserves, and eventually, they
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said, listen, even though we're accumulating
reserves, we have to weaken our currency.
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Almost the moment they weakened it, the economy
turned around.
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DAN TAPIERO: Right, and I think it's exactly
the same.
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We're at the place where-- we've discussed
this, look, the dollar in theory, in theory,
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it could still rally a bit, I don't know,
but I think it's late in the game.
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You could have, if we have another episode
where the markets are saying the Fed's not
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adding enough liquidity, the package stimulus
is not getting through enough, the markets
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correct again, let's say in the next few weeks,
and you have another huge dollar up move.
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That's possible.
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I think this is an ending move, but that in--
it may be a few weeks, it may be a few months,
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I don't know.
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I think the next 30%, 40% is to the downside.
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That's because I think that's really the only
thing, also that will get Europe to be more
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aggressive on stimulus because if the Euro
heads up to 135, they're going to have to
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do a lot more.
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Also, China.
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China still has 3% government bond rates,
or 2.75%, or whatever it is, that should be
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down at 1%.
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We have to force China also to be more aggressive.
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If everyone is being more aggressive, because
we're going to either actively intervene in
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the dollar or naturally because of all the
excess stimulus, the dollar heads into a bear
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market.
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I think you could be in a situation that's
like the '20s, where it really is rip roaring.
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I'm just saying this is a model I'm working
with.
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I see you're 1920, the '29 framework where
things could be-- I think that's more likely
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if the authorities give up and don't do the
right thing.
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RAOUL PAL: My view on that is, and again,
we're all holding a lot of different scenarios
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in our heads because we have very unprecedented
times.
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I just think that the probability of a larger
solvency crisis based on slow growth is pretty
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high.
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In that situation, I think it's almost impossible
to stop the dollar.
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I think the dollar is these two windows.
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One is this now period and I agree, I really
don't know whether the Fed are going to do
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enough to stop the dollar rising.
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Maybe if they do, that's it squirts up again.
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They try and smash it back down.
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Okay, fine.
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My fear is actually give us six months' time
in September, October when economic growth
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hasn't really picked up, but we've got this
real debt issue, so you've got negative cash
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flows and negative earnings out of corporations
and debt.
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Like Ford just got downgraded to junk, we
start going through the debt cycle.
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Now, the worst is obviously abroad because
they need dollars, and they don't get access
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to the Fed.
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The borrowers in the US can get access to
the Fed in some way, shape or form, the foreigners
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don't get it.
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That's what drives the dollar.
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My fear is there is still a larger potential
dollar cycle that is even more toxic.
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Who knows?
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