Citi's Dirk Willer on How You Know When the Bubble Is Over

According to Dirk Willer, the Global Head of Macro Strategy at Citigroup, we are definitely in bubble territory. Per his research, the stock market has been in a bubble since May. Unlike many people, whose definitions of bubbles are a bit more vague or a bit more based on sentiment, Dirk's work focuses on precise timing and price indicators that distinguish bubbles from mere booms. Furthermore, he argues that when the bubble first forms, the correct move historically is to buy into it and then just accept that you'll never nail the top perfectly. On this episode, we talk about his overall approach as well as the signs of when the bubble has come to an end. We also talk about current parallels to the dotcom bubble, why gold has had such a monster year, and the signs from the Treasury market that make the US look increasingly like an emerging market. Read more:Stock Bounce Wanes on Fed Angst as Bitcoin Plunges: Markets WrapGold ‘Trading Like a Meme Stock’ Sets Up Miners as Levered Bet Only Bloomberg - Business News, Stock Markets, Finance, Breaking & World News subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlots Join the conversation: discord.gg/oddlotsSee omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Joe Weisenthal?

  There are some market stories where you want every detail. Tracy and I have made quite a few podcasts on that basis, but sometimes you've only got 10 minutes and need to know what's moving markets and why. That's the Barclays Brief Podcast. Every week, experts from Barclays Markets and research get you up to speed on what matters and what to watch next. About the time it takes to grab a coffee, so search Barclays Brief wherever you get your podcasts.

• 0:26Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs, and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 1:07Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at chatgpt.com.

• 1:48Speaker 02

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• 2:23Speaker 02

  Bloomberg Audio Studios. Podcasts, radio, news.

• 2:39Joe Weisenthal?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Joe Weisenthal.

• 2:43Tracy Alloway?

  And I'm Tracy Alloway.

• 2:44Joe Weisenthal?

  Tracy, markets getting interesting again.

• 2:47Tracy Alloway?

  I love interesting markets.

• 2:49Joe Weisenthal?

  We do. We always say we're long volatility.

• 2:51Tracy Alloway?

  That's right.

• 2:52Joe Weisenthal?

  Here at the Odd Lots Podcast. All financial journalists are long volatility, I guess.

• 2:56Tracy Alloway?

  Yes. I mean, you can actually see it in the listener and readership numbers.

• 3:00Joe Weisenthal?

  Totally.

• 3:01Tracy Alloway?

  Our traffic follows the VIX.

• 3:02Joe Weisenthal?

  There are some bad incentives.

• 3:04Tracy Alloway?

  Yeah.

• 3:04Joe Weisenthal?

  Perhaps.

• 3:05Tracy Alloway?

  Perhaps.

• 3:06Joe Weisenthal?

  Yeah.

• 3:06Tracy Alloway?

  But.

• 3:07Joe Weisenthal?

  If it bleeds, it leads. I mean, they've been saying this about the news forever.

• 3:09Tracy Alloway?

  Yeah. So at the moment, we are recording this on Friday, November 14.

• 3:14Joe Weisenthal?

  At 10:07 a.m.

• 3:15Tracy Alloway?

  Yeah, we have to say that. We have to be very specific because things are changing so fast. At the moment, the S and P 500 is down like 0.7%, but it was down more than 1% earlier. And then yesterday it fell, you know, 1.8%. So this is a pretty substantial slide. And of course, it comes at a time when people were already worried about things like tech valuations and the possibility of an AI bubble.

• 3:41Joe Weisenthal?

  Totally. The US stock market's had a phenomenal year. And this is all kind of minor in the grand scheme of things. But some of the moves haven't been that minor for some big things. It is some of the most volatile period since April, really. I mean, it's kind of been a smooth ride up since the end of April or the middle of April, whenever that bottomed. There are just a lot going on, questions about the Fed. Gold, interestingly, had a massive year and it also is selling off. So that sort of raises the question about what's been driving gold. Bitcoin getting absolutely clobbered, of course. You know, it's sort of a glorified tech stock and the way it trades. So many interesting things, so many market winners fading a little bit.

• 4:21Tracy Alloway?

  You know what was really interesting this morning? For a second, bonds weren't really doing anything. They weren't rallying. And so if you can't go into gold, if you can't go into bonds, if everything's selling off at the same time, that seems kind of worrying.

• 4:33Joe Weisenthal?

  Well, this is really interesting and probably needs to be discussed more. But you're absolutely right. I think yields on the tenure were actually up yesterday, November 13th. In the last week, I was looking at the work function on the Bloomberg Terminal. Odds of a December rate cut have come in quite a bit. It's closer to a coin flip. A week ago is 66%. There have been some speeches from some of the FOMC members talking about, you know, they're uncertain. And part of the reason we're uncertain because we've had so little data. I guess we're going to start getting data again now that the government.

• 5:04Tracy Alloway?

  Although it's still going to be messy.

• 5:05Joe Weisenthal?

  It's still going to be super messy. You know, understanding the economy in real time is hard in the best of times. It's really hard when there's no data. And then it's really hard when the data that does come out is going to be driven by the lack of government employment, which then make the data even more ambiguous. So a million questions, very interesting moment in a very interesting year for markets. We've sort of got to get a better understanding of what's going on.

• 5:27Tracy Alloway?

  Can I say one more thing before we get to our guest? Which is, I think part of the discussion at the Fed, we're kind of getting very circular here because I suspect what's happening is, yes, the Fed is worried about inflation. So some FOMC members are getting a little bit more hawkish in their speech. I think they're worried about AI bubble possibilities and valuations as well. And the longer they keep rates low, the longer this goes on. And then maybe the mess is even bigger when they eventually have to clean it up.

• 5:54Joe Weisenthal?

  Totally. All kinds of crosswinds, so to speak. Well, anyway, I'm very excited to say that we do indeed have the perfect guest, someone we've never had on the show before, but very excited to talk to him. We're going to be speaking with Dirk Villa. He is the head of global macro strategy at Citi. He brought us a book too, that he co-authored, Trading Fixed Income and FX in Emerging Markets.

• 6:14Tracy Alloway?

  It's going to be useful in the US.

• 6:16Joe Weisenthal?

  I know, that's the thing. It's like suddenly all these EM veterans, like, let me just tell you how some of these things really work. So Dirk, thank you so much for coming on the podcast.

• 6:24Speaker 04

  Great to be here. Thanks for the invite.

• 6:26Joe Weisenthal?

  Let me ask you a question. If you went back, say, a month ago or month and a half ago. You're talking to clients, etc. Did you ever encounter a single bear?

• 6:36Speaker 04

  I mean, I'm trafficking more among the macro people than the equity folks.

• 6:39Joe Weisenthal?

  Sure.

• 6:39Speaker 04

  And the macro guys are always half class empty.

• 6:41Joe Weisenthal?

  Okay, right, right.

• 6:42Speaker 04

  So you did find some bears. And I would say, actually, only a few weeks ago that disappeared because there was a really strong buy-in into the center, really. Right, so meaning November and December have exceptionally positive seasonality always.

• 6:56Joe Weisenthal?

  Okay.

• 6:57Speaker 04

  And they have even better seasonality.

• 6:58Joe Weisenthal?

  We're talking risk, in risk.

• 7:00Speaker 04

  In risk, in the S and P, exactly. So, so I think the bears that we found disappeared over the last few weeks. So maybe just at the wrong time, you might argue, but, but that's how it goes, right?

• 7:10Joe Weisenthal?

  Yeah.

• 7:10Tracy Alloway?

  How do you officially measure sentiment in this market? I'm always curious because obviously everyone has different methodologies, but sentiment seems quite key when you're talking about a bull run that's really driven by tech stocks and this AI narrative, the story becomes so important.

• 7:27Speaker 04

  It's actually really key to this because if you were to say, listen, this is the top of a bubble or something, you would have to see really, really into the asset sentiment. And we never quite saw that. My favorite indicator is, we call it the pulse indicator, it stands for positioning and various other things. And that is something that we put out and that worked really, really well this year and actually the last five years for that matter. And that never went into territory that really told us to be cautious. We do a bunch of surveys, so we survey all the big asset allocators worth a few trillion in asset under management. And they never got as bullish on, on US equities because after April, there was a big move outside of US equities, as you know.

• 8:11Speaker 04

  And they never really fully jumped into the US equity market as much as they went outside of the US. So we always thought, you know what? There are certain stories here that definitely remind us of 2000 and of a bubble. And on our definition, actually, it is a bubble, but it's not close to the end of it. And one missing component was really the sentiment that never got as extreme on, on our measures.

• 8:36Tracy Alloway?

  We're definitely going to get more into the bubbles, especially the 2000s. But before that, I want to ask, how do you square, I guess, non-frenzied sentiment with the amount of announcements that we're getting from companies? We're joking on the podcast that every day while we're recording this in studio, we get a new headline that Anthropic is going to spend 50 billion on data centers, or someone else is going to spend 100 billion. It just goes on and on.

• 9:01Speaker 04

  Yes, that is, it's very true. I mean, I think the market is starting to question those numbers a little bit. When the Oracle deal came out, for example, the stock jumped. Guess what? We're back to where we were before the deal was announced. So I think there is a certain sense of skepticism party because some people think they've seen all that before, right? And people are bullish. I'm not telling you they're bearish. I'm just telling you they're not as excited as you might have expected just watching the price action. I think that is more the north here. And then actually, none of the indicators suggest that. I mean, I'm sure everyone has their own favorite, but it's really very rare to find one that tells you, you know what? This is in line with what we've seen at other market tops.

• 9:42Joe Weisenthal?

  You know what? Since we've never had you on the podcast before, and you're the author of a book on EM, and you have a great job, Global Head of Macro Strategy at Citi. Why don't you give us the 60-second background of what you do and how you got here? Like, what's your job?

• 9:54Speaker 04

  Yeah, okay.

• 9:55Joe Weisenthal?

  How'd you land here?

• 9:57Speaker 04

  Yeah, I came over to the US in 99, essentially joining a macro hedge fund. We traded back then. And again, right now, actually, I think it's all about the bubble. It's the single biggest call. Everything else will fall into place. Whenever the bubble bursts, the dollar weakens, the Fed rates will go to zero, or maybe not quite to zero, but you get aggressive. So everything, that's what you have to focus on. And so even though I joined the hedge fund back then as an EM specialist, very quickly I looked into companies because we really had to figure out, when is this dot com bubble over? And then we traded very successfully, actually, the run-up and the run-down, although I would say it's very, very hard to trade a bear market, right? Because these bear market values are really quite vicious.

• 10:40Speaker 04

  And so in the end, all the money was made being long fixed income rather than being short equities. But broadly speaking, that was a Me shifting from emerging markets to global macro, if you like. But then I went back to the buy side, partly because, you know, the particular hedge fund never became as bullish again on the bull market, having been successfully bearish for a long time.

• 10:58Joe Weisenthal?

  Many, many people are cursed by good luck getting bear markets right and then

• 11:03Speaker 04

  They're rare.

• 11:03Joe Weisenthal?

  Are haunted by that for the rest of their careers.

• 11:06Speaker 04

  They're very rare, they're very rare. But yeah, so at Citibank, I, I covered emerging markets for a long, long time and switched back to global macro a few years ago. And, and as you can imagine, it's mostly speaking to hedge fund clients, to some real money clients, some corporates. What we do a bit differently is that I have a big quant team. So essentially we back test everything under the sun, at least to get your price right. Things are always slightly different, but I think it's very important to have the right price. And that's what the back tests give you. So we have a big quant effort. We are very trade, sort of aggressive and putting a lot of trades out and, and monitoring them carefully. And, and I have a bigger emerging market angle than most, which I still think is extremely helpful in this environment.

• 11:50Tracy Alloway?

  So since you've been around for a while, let's talk about the 2000s dot com bubble or 1999, 2000 dot com bubble. Obviously people are using that as an analogy for this period of time, but we had someone in our Discord, actually, shout out to Burr Flyer, asking, yeah, asking whether or not people were talking about dot com stocks, tech stocks being in a bubble, the way people are talking about AI stocks, tech stocks being in a bubble now. What's your experience, you know, more than 20 years ago?

• 12:22Speaker 04

  Back then it was even clearer than now. I mean, if you remember Nasdaq went up 50% in Q4.

• 12:28Joe Weisenthal?

  Yeah, I pulled up that chart recently, it's crazy.

• 12:30Speaker 04

  And, and I remember some stories, we had some analyst pitches all the time. So there was an analyst for Nokia who said, don't worry that we need more than 100% cellphone penetration in the world because pets will wear cellphone like. They were kind of right. It wasn't wrong, but. They're kind of right. So you, or you got, my favorite pitch was for Akamai where, when analysts said, you know what? The, the reason why the company There are only three people who understand the formula that's that's basically at the base of it and all three work for Akamai, so don't worry.

• 13:05Tracy Alloway?

  Don't worry about it. We know it's good.

• 13:07Joe Weisenthal?

  It's literally, there's just no one who could ever replicate this technology. There's only three people who could build it and they all got it. Amazing. I never heard that one.

• 13:15Speaker 04

  These type of things happened back then. And of course, not to pick on Akamai, but it, you know, it went up from, I don't know, thirty to three hundred after the IPO and back to one.

• 13:25Joe Weisenthal?

  Yeah, yeah.

• 13:26Speaker 04

  These type of things happened, which

• 13:28Joe Weisenthal?

  And that was one of the more legit companies.

• 13:30Speaker 04

  Yeah, no, they exist. I don't, I'm not covering them or anything, so I don't comment. But yeah.

• 13:35Joe Weisenthal?

  Yeah, yeah.

• 13:36Tracy Alloway?

  This reminds me of what you always say, Joe. Things can always get crazier, right?

• 13:40Joe Weisenthal?

  Yeah. Yeah, it really does feel like you see some event, you know, like there was that, you know, I was thinking about when Jensen Huang, I think it was about a year ago now, maybe nine months ago. Remember, he signed a woman's bra, right? Remember? And everyone's like, oh, this has got to be the top. Right? Because that's just one of those things, like, oh, the CEO of a semiconductor.

• 13:59Tracy Alloway?

  A top being signed.

• 14:01Joe Weisenthal?

  That's right. You know, it's like, oh, why a CEO of a semiconductor company getting like legit rock star treatment? And how much is Nvidia up since then? Setting aside some of the recent wobbles, there is no point where you can definitively say, oh, this is the peak of the media, right? There's always, it could always get weirder.

• 14:18Speaker 04

  Yeah. You know what gives me sleepless nights is actually that the 2000 episode is not the right benchmark, right? Because if you use 2000, you could say

• 14:25Joe Weisenthal?

  Everything's fine.

• 14:26Speaker 04

  Yeah, everything's fine. But of course, not every bubble has to get as crazy as the 2000 one. You know, I mean, it wasn't extreme even by bubble standards. So that is a bit of a risk if you if you focus too much on that one.

• 14:37Tracy Alloway?

  Do you have a preferred historical analogy for our current period?

• 14:41Speaker 04

  And I do think 2000 is probably the closest, just because it was also very tech-heavy. And it had a big CapEx build out attached to it. So that makes it good. I mean, the 1929 one is of all the, the mother of all bubbles, if you like. And that was about, you know, like cars and electrification and consumer gadgets and appliances, rather. So you could use that. And that is actually the one that people used in 2000. So you always go one bubble back, if you like, to make your case and to argue maybe why things can go very crazy. But I think here there are many things that rhyme.

• 15:30Joe Weisenthal?

  There are some market stories where you want every detail. Tracy and I have made quite a few podcasts on that basis, but sometimes you've only got 10 minutes and need to know what's moving markets and why. That's the Barclays Brief podcast. Every week, experts from Barclays Markets and research get you up to speed on what matters and what to watch next. About the time it takes to grab a coffee, so search Barclays Brief wherever you get your podcasts.

• 15:56Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw, innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting

• 16:38Speaker 01

  and hiring practices, but according to recruiters, advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute, brought to you by ChatGPT. Get started at ChatGPT.com.

• 17:19Joe Weisenthal?

  So one thing that Tracy brought up in the intro, which is very important, is that rates in the recent days haven't come down that much. Today, they're down a little bit, but by and large, it's not like treasuries have been this great life preserver when the rest of your portfolio isn't working. In fact, actually, right now, I'm doing timestamps again, we're back at 4.11. We were down at 4.06 earlier, around 9. So even that, once again, we don't see this bid into treasuries. Rates are sort of down overall for the year a little bit, but there's not this desire to grab them. Talk to us about what's going on in that space.

• 17:54Speaker 04

  Yeah, I think the reason is that a lot of the bullishness over the last week was based on one simple statement, which is saying, listen, we're building a bubble and the Fed is cutting into that. And that never happened before, right? And obviously, in 2000, they hiked by 175 basis points. They hiked 50 basis points after the bubble had already peaked. So I mean, you know, they, and they had inflation, so it was not without any reason. But for sure, it's very unusual for the Fed to cut into a bubble. And that was a great bull thesis. And so now we're doubting that a little bit, right? I mean, so we are basically having a Fed that might be more hawkish. December went to 50/50 essentially. And so if you remove that plank of the argument why you should be all in in equities, it has consequences, right? And so we bobble a little bit for that reason.

• 18:39Speaker 04

  But I mean, I would also remember, I mean, they hiked 175 basis points before the bubble peaked in 2000, right? So will it be the end of the equity bull market if the Fed doesn't go? I mean, I doubt it.

• 18:51Joe Weisenthal?

  Talk to us, talk to us a little bit about these doubts that are creeping in for December. I mean, we're truly in a fog for multiple reasons, because even if we had government data, I'm sure the conditions, plenty of different crosswinds. We don't have the government data, but like, one thing we do seem to know is that hiring has been very weak and so forth in several of the months. Almost certainly, that would be the case for October and November if we had clear indications. I mean, what is the reluctance right now? Why is it a coin flip?

• 19:18Speaker 04

  Yeah, I mean, well, I think the single biggest thing is, of course, all the comments were getting out of the Fed, right? And we had, you know, the tweet earlier this week. And so in the end, if you try to forecast the Fed, you better listen to what they're saying. Yeah, but why are they reluctant, given the weakness? So the, I think the question is, of course, all about the, the reason of cut is the job market. Inflation, you can argue, maybe tariff inflation will not show up. So far, it has been very benign. Some Fed members believe it's still showing up, some others don't. But I think the main crux of the question is the job market, how weak is it? Now, the Dallas Fed put a paper out arguing that if you get slightly negative net migration, the breakeven NFP is 30K. If you get slightly positive net migration, 60K.

• 20:02Speaker 04

  So that is somewhere the range where these days NFP should come in without there being a problem, right? So if you, if the NFP print, and of course, September, we know is somewhat artificially strong. October, if we get it, would be artificially weak due to the government buyouts. November is a really interesting one, even that might have a bit of an impact from the shutdown and so forth. So the may, really clean one, maybe we have to wait even longer. But let's say we take November as, as good as it gets for now. So if that is below 30, there'll be a cut, right? If it's below 60, there'll be probably no cut. If it's somewhere in between, they'll find it out. But without that data, it's just hard to, you know, reassure the market, yes, there will be a cut or no, there won't be.

• 20:45Speaker 04

  So the, the job market data will be very, very important. We got a lot of alternative data sources, of course, in the meantime, but we're waiting. They were a bit on the weakish side, so that's why the city call is actually for a cut. I mean, the noise is out of there from C were certainly a little bit all over the place, so it's not that obvious.

• 21:03Tracy Alloway?

  Yeah, and a lot can still change between now and the meeting. Okay, so if everyone, I mean, I realize not everyone agrees it's a bubble, but for the sake of this argument, let's say, we all know it's a bubble. It seems like one of the things that happened, especially since the financial crisis, is people stopped running away from bubbles and started running into them, right? And so everyone wants to make money very, very quickly. So if you see the line continuously going up, you just join the party. And everyone assumes that they are smart enough to time the top of the bubble and get out at the right point. What's your take on how long this is actually going to go on for? And what are you looking at in terms of actually spotting that top, other than sentiment, which we spoke a bit about?

• 21:48Speaker 04

  Yeah, it's a big question. Actually, even inside Citi, our US equity strategist does not believe me that it's a bubble. But we have a definition. So I feel we can actually do something with it. So the definition for us is it's a little bit like the GMO one, which is essentially saying if something goes up more than two standard deviations against a long-term trend in real terms, we call it a bubble, right? And then whenever you have a big sell-off, you restart the clock. Because when you have a big sell-off, you essentially, sentiment goes to zero and so you have to rebuild it. And on that framework, we entered bubble territory, sort of, I guess, in May, June of this year. And when you do that, the interesting thing about it is, as you point out, it goes up. So once you enter bubble territory, you're supposed to buy it. And the only time when that didn't happen

• 22:33Speaker 04

  was 1929. It went straight down. And I think the reason for that is a little bit that the way people define what a bubble is, they use 1929, right? And so, and we did that too. And so therefore, that's the only one. All the other episodes, you go straight up. So you buy it when you enter. But the interesting thing is, and clients ask me, well, if that is true, what's the difference between a bull market and a bubble? You tell me it's going up. And the difference is that if you buy it when it enters a bubble, you will give it back eventually, most of it. Most of the in-bubble gains will be given back. So it will end badly, right? And so that, I mean, you don't necessarily give back everything all the time, but in most episodes, you give back most of it. And so that makes it an important definition. Now, unfortunately, when you study that, it's not that clear how long they last.

• 23:18Speaker 04

  I mean, on average, I can tell you that two years of above-average returns, followed by below-average returns. And on a 10-year time horizon, you have below-average return. But it can vary a fair amount. And so that makes it hard. I would say, if you look at 2000 again as a template. It will certainly not help you to look at fundamentals, right? I mean, so what happened was Nasdaq broke in March and everything still

• 23:45Joe Weisenthal?

  Which year are we talking about?

• 23:46Speaker 04

  Sorry, 2000.

• 23:47Joe Weisenthal?

  Okay.

• 23:48Speaker 04

  So, and when that happened, fundamentals rolled over in September. So there was a six to seven month period where fundamentals still look just the way that it had looked before.

• 23:59Tracy Alloway?

  I guess because everyone was spending so much money on CapEx and like it takes a while for that to roll off.

• 24:03Speaker 04

  Yes, exactly. And, and of course it's highly circular, right? People spend on CapEx while the equity is going up. So equity stops going up, they start to reconsider, what do we do next? So then everything rolls over.

• 24:15Tracy Alloway?

  Exactly.

• 24:16Speaker 04

  So, so if you look at fundamentals, you probably not capture it, which means it will be a highly technical thing if you want to call the top. And it would be helpful if you get a blow off top, like, you know, if you do the 50% in one quarter, you know, you probably have a bigger chance to get it right. But I think it's really quite dangerous to be early in this thing because, well, you will not hit it precisely on the day. You're either early or you're late, right? And I think if you're late, you can control a little bit more how much money you don't make in a sense, right? And so one framework that we have, we call it the generals framework, because what happens in this bubble.

• 24:54Joe Weisenthal?

  The what framework?

• 24:54Speaker 04

  The generals.

• 24:55Joe Weisenthal?

  The generals, right?

• 24:55Speaker 04

  Because it becomes very narrow and that's a feature of the bubble. It's not an exception, right? And, and so this, this narrowness means that if the leaders start to break down, it's a real warning sign. And so what we look at and we just look at the top seven leaders because people are excited about Mac 7, but it could be 10 or it basically on our numbers. If three of the top seven break down, meaning they fall below the 20 moving average, that's a really dangerous sign.

• 25:23Joe Weisenthal?

  The 20 day moving average?

• 25:23Speaker 04

  200.

• 25:24Joe Weisenthal?

  200 day, okay.

• 25:25Speaker 04

  It, it will not be early, right? Because by the time it triggers, the market is obviously down from the peak. But I think following that has saved us a lot of money on the downside when these things happen. So that is something you can use because it will be technical. It will not be, oh, fundamentally this happened and get out.

• 25:40Joe Weisenthal?

  This is fantastic. So let's just sort of like, just to sort of summarize this because that was excellent. So the bubble condition has emerged when the gain. Are what is the timeframe we're talking about? So you say two standard deviations above the real long term.

• 25:54Speaker 04

  Yeah, exactly. So I mean, the way we measure the long term performance, it's actually rolling windows. It grows every year and it's just a linear trend that you that you put through it. And then you can see how how much you go above it.

• 26:07Joe Weisenthal?

  Two standard deviations in.

• 26:08Speaker 04

  It was the trend in real terms. So we deflated because in the seventies, a lot happened, right? You were in a bear market, but was.

• 26:15Joe Weisenthal?

  But is it two standard deviations in like a certain period of time? Or like, how do?

• 26:19Speaker 04

  Yes, it's a yearly returns.

• 26:21Joe Weisenthal?

  Okay, okay, got it. And then the warning sign. So in your view, you know, if you think about sort of profit maximization or risk minimization or whatever, the thing to look for is when three of the seven leaders break down. Or why is that? And sentiment.

• 26:38Speaker 04

  Yeah, I mean, that we just, in a sense, we just backtested it. We just, we realized, okay, there's something special about these bubbles where the leaders carry the weight for a long time. And so you have to find out, well, when the leaders break, what is a danger signal that actually works? And it's always a trade off between giving you too many signals where you leave money on the table and too few signals where you you take part in the downside that you want to avoid. And so what we found is if you use that rule for 2000 or for other bubbles that we have in the sample, you know, once three of them break, it's becoming the odds are not in your favor anymore.

• 27:16Joe Weisenthal?

  Can you apply this framework to gold? So this is the interesting thing, which is that we don't typically associate booming stock markets with booming gold, especially because gold is associated with fear and pessimism, et cetera. Talk a little bit about what what's going on there.

• 27:31Speaker 04

  Gold is just very, very interesting. I mean, the first leg up was essentially this whole central bank story, right? If you think about it, it all started really with the Crimea issue and Putin making, in a sense, three bets when he diversified away from the dollar, right? He bought Euro, he bought CNY, and he bought gold. And Euro was not a particularly promising bet in the end. CNY was a good bet for him, but obviously China cannot bet on the CNY. And that is gold for China. And so the, I think, in the very, very big picture. Central banks are just very important for the gold market. The gold market bottomed in the nineties when the Bank of England was done selling gold. And it will probably peak when the PBOC is done buying gold.

• 28:14Speaker 04

  And they still could buy a lot. So that I have no issue with as a structural story, long-term story. What happened this year was not the central bank buying, at least not as far as we can tell from the official data. It was much more this whole debasement fears that crept into gold. And the first leg was very easy for macro guys to understand and participate. And that was just, you know, the Fed is going to cut. And whenever the Fed cuts, you know, the dollar sold off into the first cut. Rates fell into the first cut and gold went up. So that is as it should be. Now then, what happened, if you remember, after the first cut, rates went up, the dollar went up and gold kept going up. Right? And that was roughly the time when Stephen and Marion talked about the third mandate for the Fed and things like that.

• 28:59Speaker 04

  And so the debasement fears became more acute and that propelled gold higher. Now, the interesting issue is that it was really not that much the institutional investors, right? Because all the other debasement trades didn't work. I mean, the curve did not steepen, breakevens did not rise, the dollar did not fall. So it was a retail-driven debasement fear. And you saw people lining around the RBA in Australia, trying to get physical gold out of the vault, right? So it was, it became a meme stock almost for a while. And so, while it hasn't actually triggered our bubble levels, if you apply the same methodology, it certainly, I think, became too dangerous and so we actually got out of gold a little while ago.

• 29:44Speaker 04

  Now, the debasement story is an interesting story. It could come back, right? You saw gold consolidate for a while and then when Trump discussed $2,000 for everyone, then gold started to take off again because people started to think, well, maybe we have to trade the basement again. And that's the way we call it. And personally, I think the new FOMC will be more dovish than the old one, right? I mean, while we don't know quite yet who will be the head of the FOMC, it's likely to happen. And so the debasement story could come back, but you have to time it fairly well because you had a lot of retail in it and it already moved a lot, right? So on the debasement fears. I think it might be next year's story or this year's story.

• 30:28Speaker 04

  The central bank story will come back eventually, but it's, I mean, China loves to buy pullbacks rather than the high. So I'm not quite sure how, when they will come back. But structure, I think gold is likely still OK. In the short term, we are a bit more cautious.

• 30:46Tracy Alloway?

  Well, if gold is off the table for now and bonds, no one really knows what they're going to do. How are people actually hedging and what are you recommending?

• 30:55Speaker 04

  Yeah, very good question. What people typically do, which is actually dangerous in a bubble, is they just buy some put spread in the S and P. Now, the issue is, in a bubble, if you first go up another 30%, the strikes are so far out of the money that it will just not help you.

• 31:11Tracy Alloway?

  And we saw Michael Burry, who was like the poster boy for calling the AI bubble closes fun this week, so.

• 31:18Speaker 04

  Yeah, so I think so the obvious thing actually became harder to do in a bubble. The other issue is, can you use currencies? And that is also very interesting, right? Because the correlation between the dollar and the S and P changed somewhat. And it changed in April. It used to be the case when the S and P sells off, the dollar goes up. That correlation flipped on us in April. And while there is a lot of debate whether the correlation will move back to positive or stay negative, I think if we are talking about a bursting bubble, that would be dollar negative, right? So there are structures that allow you cheap hedges if you're willing to bet on S and P lower and at the same time, dollar weaker, right? So that might work.

• 32:02Speaker 04

  What we have actually recommended is to do something in credit because the way I see it, I mean, either, you know, the AI bubble continues to move higher and then credit will not benefit very much from it. There's no, you know, there's not that much AI-related credit in the indices. And in any case, people start to worry about credit on the AI front and spreads are extremely tight, of course. On the other hand, if the US has a bigger problem than we are thinking and the labor market falls through a trapdoor, and then, you know, credit will protect you really well. So credit is something to look at.

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• 35:09Joe Weisenthal?

  Let's talk about your EM background. This is one of those things that I think, I don't know. Maybe it started as a joke. It's like, you know, people are joking. The US is becoming an EM and then it sort of gets a little bit, oh, ha, ha. Oh, this is, oh. And then suddenly it's like feels less and less.

• 35:25Tracy Alloway?

  It's not funny anymore.

• 35:26Joe Weisenthal?

  Yeah, it's not really funny anymore. A, do you like buy this premise that, you know, there is something about EM governance, et cetera, that is applicable to thinking about the US right now?

• 35:38Speaker 04

  I think people made the case in, I mean, it's, first of all, the question is how you define an EM.

• 35:42Joe Weisenthal?

  Yeah.

• 35:42Speaker 04

  It's actually a harder question than you think because traditionally people do it just looking at GDP per head and then obviously, right, it's.

• 35:49Tracy Alloway?

  MSCI gets paid a lot of money to do this.

• 35:51Speaker 04

  That's right. And so the, by putting that aside, I mean, I think for trading, the right definition is a little bit whether your bonds rally.

• 36:02Joe Weisenthal?

  That's right.

• 36:03Speaker 04

  When the VIX goes up or you don't. Right? And on that definition, which is a trading centric definition of emerging markets, you actually find China is not an emerging market because CGB is rarely when there is a risk off and Korea is an emerging market. So it's a much more sensible definition for traders than the sort of world bank definition, right? And so in the end.

• 36:24Joe Weisenthal?

  This is uncomfortable because we're about to get to what the US's bonds have been doing during this volatility spike.

• 36:29Speaker 04

  Exactly. So, and of course, the initial headline was for the UK, right? When the, when the risk trust issue happened and the pound sort of, and then gilt sold off. And so people said, oh yeah, the UK is moving in that direction. And for the US, again, you can argue a little bit. I would say though, that what will likely happen is that if that should become a problem, so if you see US rates selling off during risk aversion, maybe because of fiscal worries or something like that, I do think the Fed will come in and hammer rates back down. And I think they can do that, in a sense, they're physically able to do it, but they

• 37:11Speaker 04

  could, the treasury could phase out the 20-year bond if they wanted to. They could do more buybacks. And yes, it will weaken the dollar for you.

• 37:18Joe Weisenthal?

  Right.

• 37:18Speaker 04

  But it's not that they run out of rope in a way an emerging market would when these things happen, right? Because in a sense, if it happens in Brazil, it's not that the government can control or that the central bank is able to keep the bond yield at a certain level. The US has many tools that they have at their disposal that they could use, I think.

• 37:39Tracy Alloway?

  Since you're in the trading space, or you pay very close attention to it, are you seeing anything in terms of positioning that could make a sell-off either more extreme or unexpected or volatile in the current setting? And the reason I ask is, you know, we had a few episodes about the dispersion trade and people selling volatility. And I was having lunch with someone in the market yesterday, and they were very clear that a lot of people are still doing the dispersion trade, which kind of surprised me.

• 38:09Speaker 04

  You know, it's true. I mean, there are many crowded trades, I would say. Again, broadly speaking, we never found US equity position all that heavy, but it's certainly, and people own it, right? Gold was, on our survey of these asset allocators, gold was for a long time the standout. It came back a little bit. One other trade that people really quite like is the EM carry trade.

• 38:33Tracy Alloway?

  Yeah.

• 38:33Speaker 04

  And that is a bit linked to the volatility trade because it works well when volatility is low, right? And so that is a very heavily owned trade. It's very hard to forecast volatility spikes. I told you I'd have a quant team and we backtest a lot of potential strategies that we think are credible. And we did not find a good rule to say volatility is low enough by volatility, or volatility has been low enough for extremely long time by volatility. On average, you're obviously meant to sell volatility because implied is higher than realized. And yes, they're unpleasantly low right now, I would say, but on average, it's just not right to buy volatility in these circumstances. So what you do about it?

• 39:14Speaker 04

  I think what you can do is you can find rules that essentially tell you, well, volatility has started to move up by X, and it's probably a good idea to get out because when it's positively correlated, right? So if it starts to move, it can move a lot. So we have one particular volatility index that is actually the sort of maximum Z score, if you like, of all the various different volatilities people care about, the move index, VIX index, G10 implied vol index, EM implied vol index, and higher spreads. And but we take the maximum of that, not the average, which is a bit different than other people do it. And the reason is that no matter what goes wrong, EMFX will not like it, right?

• 39:57Speaker 04

  So if the stress comes from US rates and the move index, it will not like it. If it comes from VIX and S and P, it will also not like it. So and that volatility indicator so far is still relatively well behaved. And again, I'm glad you keep mentioning when exactly we're recording this because

• 40:11Joe Weisenthal?

  Yeah, I know, I know.

• 40:12Speaker 04

  It could, it could change quickly.

• 40:14Tracy Alloway?

  What's the name of that index?

• 40:15Speaker 04

  And we have constructed one.

• 40:16Tracy Alloway?

  Oh, OK.

• 40:17Joe Weisenthal?

  OK, well, we'll look for it in your reports. All right, I just have one last question. So I actually, I really like this definite. This is a very useful definition of EM. Do your government bonds rally in a volatility spike? And guess what that implies is are your bonds safe havens or are they credits? Right?

• 40:35Speaker 04

  Yeah, exactly.

• 40:35Joe Weisenthal?

  So you have this experience in EM, et cetera. Are there any other, I don't know, bitter lessons? If all sort of US investors are to some extent increasingly a little bit more trading in an EM space, do you have any lessons for them from the EM world that we should all know about?

• 40:51Speaker 04

  The strong lesson used to be that don't assume you get these sort of fairly well behaved politics that you get in the US and other countries. But that lesson, of course, is somewhat undermined. But, you know, the main issue is really political risk. And we have a lot of elections coming up, especially in that time, right? We have Chile, we have Colombia, we have Brazil. So so these things can really make, I used to say, much, much bigger difference than in the US, although that is more debatable at this stage.

• 41:18Joe Weisenthal?

  That's interesting. All right, Dirk Villa, thank you so much for coming on Odd Lodge. Thank you for bringing us this book and I'll have to have you back sometime. It's fantastic.

• 41:25Speaker 04

  The new book is coming soon.

• 41:26Joe Weisenthal?

  OK, good.

• 41:27Speaker 04

  So.

• 41:28Tracy Alloway?

  What's the new book on?

• 41:29Speaker 04

  It's the same idea, but on global macro rather than EM.

• 41:31Tracy Alloway?

  Oh, great.

• 41:32Joe Weisenthal?

  Well, we'll read it. Thank you so much.

• 41:33Speaker 04

  Thank you.

• 41:47Joe Weisenthal?

  Tracy, I like getting a sort of mathematical, precise definition of what a bubble is. I find that, look, I mean, obviously, there are aspects of bubbles that are very sentiment driven and I think pop culture driven, just how much people talk about X or Y. And these are useful things to discuss. But it's also nice to think about, OK, let's just come up with some rules that tell us when these things, what constitutes a bubble and when it's over.

• 42:11Tracy Alloway?

  Precision is good.

• 42:12Joe Weisenthal?

  Yeah.

• 42:13Tracy Alloway?

  I hope Dirk will tell us when the bubble's about to burst.

• 42:16Joe Weisenthal?

  He's got to send us an email.

• 42:17Tracy Alloway?

  Or at least tell his clients and then we'll see the note.

• 42:19Joe Weisenthal?

  Hopefully, we'll see the note, yeah.

• 42:20Tracy Alloway?

  I mean, I do think the message. It's a very realistic message in some respects because the problem with bubbles is you can't sit them out if you're a money manager or even if you want to make more money, right? Your clients are going to be really, really angry if the S and P 500 is going up 20% and you've been bearish for two years. And again, Michael Burry has turned into a really good example of this. But on the other hand, everyone wants to get out precisely at the top because we want to maximize our profits as much as possible. And I think when Dirk says like, well, you know, you kind of have to ride the bubble and then you kind of have to wait a little bit for it to start popping. And you just have to kind of figure out how much money or loss you are willing to take.

• 43:05Joe Weisenthal?

  Except that you're not going to time the top perfectly.

• 43:08Tracy Alloway?

  Right, exactly. You accept that reality.

• 43:10Joe Weisenthal?

  Yeah, I think that's sort of an interesting approach to the bubble problem. And so just don't worry about nailing the time, but come up with some rules. And it is interesting, these consistent patterns of the leadership narrows, et cetera. You know, one thing I've been thinking about, we didn't ask about this, but one thing I've been wondering about, you know, people look back at those 2000 analogies all the time. And one of the things that people say is that, well, this isn't a bubble like that because, you know, we don't have the pets dot coms. We don't have like this proliferation of non-profitable tech companies soaring. And I guess that's true. But I think one of the problems I have with these analogies is private markets are so much bigger now.

• 43:51Tracy Alloway?

  Yeah.

• 43:52Joe Weisenthal?

  And so you look at these mega valuations that private companies are raising at, and you know, it feels like there's like momentum trading almost going on in private markets, et cetera.

• 44:01Tracy Alloway?

  Yeah.

• 44:01Joe Weisenthal?

  And it would be nice, and you can't really get an apples to apples comparison because so much of the bubbly activity appears to be happening away from the S and P 500 or away from the NASDAQ. And so these charts about what percentage of companies are or aren't making money that only look at public markets, I think are a little bit unsatisfying right now.

• 44:20Tracy Alloway?

  Well, I would add on to that, that, you know, the companies themselves might be profitable, but the business itself is as yet not generating positive cash flows and everyone just expects it to.

• 44:32Joe Weisenthal?

  Right, or the spending is simply not sustainable, and that's another fact. Anyway, super interesting conversation. We've had him on, Karthik Sankar, and also likes that definition of EM, which is, are your government bonds credits, or are they safe havens? And I don't love how in this recent volatility, we haven't seen more of a bid into treasures. I don't love that.

• 44:53Tracy Alloway?

  Nope, not a good sign. On that happy note, shall we leave it there?

• 44:57Joe Weisenthal?

  Let's leave it there.

• 44:58Tracy Alloway?

  All right, this has been another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

• 45:04Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our producers, Carmen Rodriguez at Carmen Armin, Dashil Bennett at Dashbot, and Cale Brooks at CaleBrooks. For more Odd Lots content, go to Bloomberg.com/oddlots, where we have a daily newsletter and all of our episodes. And you can chat about all of these topics 24/7 with fellow listeners in our Discord, discord.gg/oddlots.

• 45:26Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we talk about whether or not AI is in a bubble, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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