Larry McDonald: Trump Needs a Recession to Fix the Economy

Larry McDonald, founder of The Bear Traps Report and also author, well, of your newest book, How to Listen When Markets Speak, Risks, Myths, and Investment Opportunities in a Radically Reshaped Economy. And certainly a friend of this show. It has been way too long. We haven't had you on since your book came out last year, but gosh, Larry, I feel like now is the time. So it's great to see you. Thank you so much for taking the time to join us. This is going to air as a weekend special, so I can't think of a better guest to have right now, given everything happening in the economy and the markets. Great to see you. Great. Thanks for having me. It's been an incredible year. The thesis of the book is starting to play out with more sustained, elevated inflation and a move over toward value and toward hard assets with gold outperforming the Nasdaq. So I'm relieved that it's playing out. Yeah. Well, the timing is perfect. Again, like I said, I can't think of a better guest. So since it's been a while since we had you and we've certainly grown this channel a lot since then as well. Some folks might be new to getting to hear you speak for the first time, and I'm excited for them to get to know you as well. But let's step back. Let's do the big picture, that framework. Where are we today? Maybe a bit more of your outlook. But Larry, as you know, take all the time you need to set the table, and then we'll start to pull on some of these threads and themes that come up. Okay. So what we talk about in our book, How to Listen When Markets Speak, is around the fiscal and monetary response to Lehman Brothers was about $4 trillion. And the fiscal and monetary response to COVID, the regional bank crisis of 2023, and the election, right? So you had a lot of fiscal juicing into the election, another 1.9 trillion of stimulus last year. And then in the first quarter on the way out the door, the Biden team did another 800 billion of spending, deficit spending now, deficit. So that's like, if you add it up, it's basically in the last five quarters, you're 1.9 trillion of deficit spending, and then another 800 billion. And so what they've done is, because they were trying to prevent a nasty recession in an election year, they created a lot of sustained inflationary forces that are now kind of rearing their ugly head, so to speak. And now Trump is forced to try to bring this down through all kinds of what we call financial repression. And we can get into that. But at the end of the day, the wealthy people are doing great because you've got higher interest rates, they're earning a lot of money on their savings. Here's an incredible stat. This is the most important stat of the week. The top 10% of consumers, top 10% are responsible now for 60% of consumption. So the top 10% of consumers are now responsible for 60% of consumption because the bottom 60% of consumers have been absolutely hammered. And you can see this across so many different companies. There's mountains and mountains of evidence of this. So the wealthy people are doing great because they're earning 300 basis points more on their money market funds. They've had a huge standard of living increase with asset prices. But what Greenspan talked about in the old days, in the 90s, was the wealth effect. And this is the week that we need to talk about the wealth effect. Because essentially what's happening is, because that consumption, those top 10% of consumers are consuming 60% of consumption, it's almost impossible to bring interest rates and inflation down without pushing asset prices down. So at the end of the day, I think what the Trump team's trying to do with this tariff and all these threats is they're literally trying to push interest rates down. And by doing that, they're trying to push asset prices down. Okay. Great frame up to the conversation here. I did not know that. I must have missed that stat, but the top 10% of consumers responsible for 60% of consumption. Wow. That kind of signals to me just how distorted the economic picture is. Like when you talk about those who've really benefited from these policies versus those who haven't. So when we talk about the economy, some folks will say, no, the economy's fine or whatnot. I imagine when you start to just kind of look at like, well, what's really making up the economy, maybe it's not such a rosy picture, if you will. Yeah. Well, if you look at like Dollar Tree stores, Dollar General, any company that faces Macy's, that faces the bottom 60% of consumers, just about every single company is in pretty rough shape. Whereas companies that face, especially look at the airline. Airlines have been ripping all year. Any company that faces American Express, any company that faces like the top consumers is doing really well. And I think what's happening is interest on the debt, Julia, interest on the debt. If interest rates stay here, it's going to be 1.2 to 1.3 trillion next year. And that's much more than defense spending. So they need to get interest rates down. They desperately, they're panicking. And the way to do that, if they can get interest rates down 1%, they're going to save close to $400 billion of interest next year. And Janet Yellen, last year, she was the treasury secretary. In an election year, she didn't want a lot of bond volatility. So what she did was she issued two standard deviations more, two standard deviations more T-bills than longer dated bonds. And when you issue T-bills, they don't move. So imagine like you have to borrow $5 trillion. So you and I have to borrow $5 trillion. And if you issue those $5 trillion of T-bills, they won't move at all, right? Because they mature within one year. If you issue $5 trillion of longer dated bonds, they would move like this, right? And this is what gets back to beset and Trump and the recession. They know they have to term out the debt. The Trump administration and a lot of the people that are close with him were criticizing Yellen for issuing so many T-bills. And it's really like two standard deviations more T-bills were issued in the last couple of years than under normal conditions. And so we have a lot of debt that's basically in the very short term. That's something that emerging market countries do, right? So they were criticizing Yellen, but guess what? So far, they haven't started to term out the debt yet. And all that means is issuing 10-year bonds, issuing 20-year bonds. But guess what? They want to get rates down before they do that. They want to get rates down. So that's why they're trying to talk the market down with these tariff threats. Every time the market goes higher, Trump's out there, it's almost like he's got more dry powder to get harder on tariffs, right? And that's what's going on. They need to get rates down 100 basis points so they can term out the debt. And then they'll save about 400 billion in interest. That's interesting. Okay. So let's talk about tariffs as the mechanism for doing that. I just want to hear more on this. And yeah, let's just start there. Tariffs as a mechanism for getting those rates down. Yeah. So tariffs are... There's an inflation element to them, but there's also a massive economic contraction element to them in the short haul because you're creating all kinds of uncertainty. And then there's the... It's not just the tariffs. These ice raids are extremely upsetting to the labor market. Imagine if you're a company and you work with migrant labor, immigration. I mean, you work with your ice threats of raids, these raids. So you've got the ice raids where they're kind of rounding up migrants and that's taking labor out of the economy. That's inflationary, but it's also contractionary in the sense that companies can't operate the same way as efficiently. And then on the tariffs, when you threaten tariffs on China, when you threaten tariffs on all these countries, that slows down the economy because CFOs can't make decisions. No CFO right now with that uncertainty of tariffs, they can't really make decisions. And so they have to start cutting back on labor, on hiring. And that's why you're starting to see this week, weekly jobless claims were up another 20,000, one of the biggest jumps in years. So do you think we're on a path now? Do you think we're on a path for maybe some sort of negative growth surprise? Do you think we could be headed on a path toward recession? How are you thinking about more of the economic outlook? Yeah. So if they can slow down the economy, remember Stan Drunkenmiller, one of my favorite investors of all time, his point is no inflation cycle that got above 6% has ever been killed without five, six, 8% unemployment. You can't kill inflation with massive fiscal spending. You just can't do it. And that's what the Biden team tried to do. And it just hurts the little guy because the bottom part of consumers get absolutely crushed with inflation. And so the Trump team knows this. So they need to get a recession. They need to cause a recession in order to get rates down and term out the debt. And that would even the playing field because if inflation comes down, that's going to actually be better for the bottom 60% of consumers, right? And so they would get inflation down. And so that's what they're trying to do. They're trying to basically do a slow walk toward a recession. That's why the market's acting so weird this week because everybody's digesting this. 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It has been quite a like, I mean, you could even throw in like crypto in there as well. I saw Bitcoin, Bitcoin's down massively as well. What is the market trying to say? Well, we're going from, think about the last like four years, right? You've had three different moves. So if you look at the Bank of America survey, a month ago, the probability of a hard landing was less than 3%, right? In 2022, it was almost 40%, it was 35%. And then in early 23, it was under four or 5% again. So we're talking about the probability of a hard landing in the mind of investors in the Bank of America survey. And so this has gone back and forth like a tennis ball the last three, four years. And so what happened three weeks ago, four weeks ago, is the expectations for growth, for earnings was really sky high because you had a market-friendly president candidate coming in, winning the election. And it was just the market was pricing in a lot of growth and the curve steepened on the yield curve. So if you look at the two-year bond versus the 10s, we really steepened when Trump won the election. And that's a sign of a market that's looking for growth, high growth. At the end of the day, the Trump team behind the scenes knows about these structural problems with the treasury market. We have to term out the debt. We've got massive inequality with inflation hurting the bottom 60% of consumers. So that's where the market now is just trying to digest this shift from massive growth expectations, steeper curve, to now the curve is flattening dramatically. Recession risk is being priced in the silver market. So if you look at interest rates, futures, and we're going from really a massive expectation of say five, 6% GDP to a possible contraction. Steve Cohen last week said this and last Friday, basically he went out and said, listen, we were thinking four or 5% GDP. Now he's looking at 1% GDP growth. That's 0.72's chief investment officer, famous hedge fund manager, and one of the most respected investors of all time. I love Bill Ackman, your friend, and Bill does a great job on this show. But Cohen is really, for him to come out and tell you that, first of all, it tells you that, number one, it tells you that he's set up. This is one of the greatest investors of the last 30 years. It tells you that he's set up bearish. He's basically betting on a recession. Yeah. And Steve Cohen does not do that many public talks either. He would be a dream interview. I would love to get him on the show one of these days. I'll put it out into the universe. But you're right. He doesn't often come out and say those things, and he is one of the greatest traders of all time. Okay. You mentioned the yield curve, a lot of talk too about the reinversion. What do you make of what's happening as it relates to the yield curve? Is that also one of these recessionary signals out there? Yes. We have a model, and anybody that wants to reach out to us, it's tatianathebeartrashandfort.com. We have a capitulation model, but we also have a model that measures the rate of change on the curve, on oil prices. And we also look at the transports, for example. So if you look the last three, four weeks, whenever you see the transports dramatically underperforming, and then at the same time, the staples, consumer staples, which are recession-proof stocks, dramatically outperforming consumer discretionary. And at the same time, you have a pretty violent move in bond yields lower, flattening of the curve. And at the same time, you have oil moving lower. Those four together, if you measure the rate of change, which our model does, you can get a signal that's very powerful because the last time we saw this type of signal was February of 2020. And we talk about this in our book where the market has an incredible sniffer. And in late February, 2020, the Nasdaq was ripping, but the transports were rolling over hard, and they're economically sensitive companies. Bonds were rallying viciously. Oil was coming down. And the staples, the consumer staples, which are those recession-proof stocks like soap and cosmetics, things that you need, alcohol, the XLP was dramatically outperforming the XLY, which is consumer discretionary stocks. So when those four things line up together and are going the same way with a fast rate of change, that tells you the beast in the market. Markets are speaking, they're telling us something every day. And that serpent inside the market is telling us that the probability of recession is screaming higher. Okay. And you mentioned capitulation too. I would love to hear more on that too. Are we starting to see the capitulation or are we gearing up for more of it? Well, some parts are in pretty nasty capitulation, like the copper names are down a lot. If you think of this, I'll give you a sexy trade, right? Yeah, we love that. If you think of a sexy trade, copper has been beaten down because think about it, cognitive dissonance, right? All that means is when you have two opposite beliefs, right? So the market, the Mr. Market is a person, right? The last like 40 years, whenever we've had an economic slowdown, copper has been absolutely annihilated. It happened with Lehman, COVID. And so investors watching us right now all have experiences, bad experiences with copper when the economy slows down. But this time it's extremely different because number one, the amount of copper mines on earth, major mines relative to the last three decades are down probably 70% in terms of new copper mines coming online. So we have a massive supply problem because we're massively, massively underinvested. But that's just a part of it. Think of right now, think Julia, think about the Ukraine rebuild. Just do a chat GPT search for the amount of structures and buildings that are going to have to be rebuilt in the Ukraine. And then do that for Los Angeles, do that for Gaza, right? And so you get this picture of this incredible rebuild the next five years that's going to require just an incredible amount of copper and metals. Then if you look at data center spending from the Mag 7 companies, Microsoft's, it's like a scene from the Sopranos. They're pointing a gun at each other's head. They're all trying to outspend each other. Microsoft's going to do 80 billion this year, up from 40 billion last year. Meta, Zuckerberg's flexing his muscles with I think 55 billion. If you do the math, they're on like a 2 trillion run rate the next several years. And think of the number one commodity that's used in data center construction is copper. So everybody's long these idiotic AI plays, like everybody was long NVIDIA and all. You should be long the copper names. They're down 30%, 40%. Tech Resources, TECK, Freeport, FCX, COPX, which is the copper ETF. You can buy the copper names here and you're just in a very, very good position because you've suppressed the supply globally of copper for years. So massive underinvestment. One of the things we talked about in our book, if you take the 2010 to 2014 trajectory of capital expenditures for copper and oil and gas, if you took that and put it forth to today, we're like 2.5 to 3 trillion in the hole. We're literally underinvested. And that's because all the CapEx has gone toward AI. So we have a power grid in the United States that's 50 years old in some places, 30 years old in others. So we're going to take all of this capital investment in technology, throw it on an old power grid. The grid's broken. It has to be rebuilt. It's a $2 trillion project. Copper, aluminum, hard assets. This is the trade for the next five to 10 years. Got it. So it's the hard assets that that's what you're favoring these days. That was a theme in the book as well. It sounds to me like from our conversations that we've had, and you kind of framed this up back in the book too, a huge portion of the investing world is misallocated right now, maybe because the world has changed as it was put in the book. A lot of folks who watch this channel, they'll know this reference, but kind of the financial equivalent of a fourth turning, if you will. Can you elaborate a bit more on this idea of a lot of folks are completely misallocated because maybe the world has just changed? Yeah. Well, we took a million jobs or 5 million jobs out of the United States. Moved them around the world. We moved them to India, Bangladesh, China. And so we've raised the standard of living globally dramatically, but we've decimated the rust belt to the point where fathers are going home to their children in the rust belt. They used to have a job that was maybe $150,000 a year, and now they're working in a restaurant for $30,000 or $50,000 a year. And so with this massive structural change in the United States, where we've decimated really lots of working class people through not just inflation, but through exporting jobs, the world now is more of a multipolar world, far more. So the last 20 years, we've been in a unipolar world where the United States was the most powerful country. There were pretty much very few wars. Now we have two wars on the scene right now, and that's supply chains are not working as effectively. Wars are incredibly inflationary. I sat down with Neil Ferguson in our book. I sat down with David Tepper, David Einhorn. One thing they all said to me is wars are incredibly inflationary for many, many years later because of the rebuilds, the reconstruction, the structures in the Ukraine. This is going to be lingering inflation for years. And then because we've decimated the Rust Belt politically, we need to reshore all these jobs and bring them back to the United States. So we're bringing like semiconductor industry jobs back to the United States. When you reshore, it's far, far, far, far more inflationary. So we're set up for a period where interest rates, even if we go into recession, interest rates are going to hang out at high levels. It's very stagflationary. It's very much like from 1968 to 81. The market was essentially flat, but commodities, hard assets, companies that own assets in the ground, that's what protects you from inflation. And if you look at the DCF model, what we call discounted cash flow, a software company is great in a disinflationary environment or technology growth stocks. When you have certainty of disinflation, low inflation, those are the types of stocks that do well. Think of like the 2010 to 2020 portfolio. That was a classic period of disinflation. And it wasn't just disinflation. It was very high certainty of disinflation moving forward. From 2020 on, we've had a much more high trajectory and certainty of inflation. And if you use the discounted cash flow model, it looks at inflation, it mainly looks at interest rates. And if you have that higher interest rate level with higher inflation, then portfolio managers around the world, they want to own companies like the BHPs, the Rio Tintos, they want to own gold, they want to own assets, they want to own companies that own oil, copper, and those types of stocks in that 1968 to 81 regime, which was high inflation, multipolar world. In that kind of regime, that's where these types of different stocks tend to lead in the 2010 to 2020 portfolio tends to underperform. Okay, so it sounds like inflation might be here to stay. Stagflationary environment, which has historically been one of the most difficult for like all sorts of asset classes, but you want to be allocated to hard assets headed for a recession possibly. What else? In the first stage is mainly like, so we have an inflation problem, we have an inequality problem, they got to get inflation down, they got to get interest rates down. So they need to trigger or slow down, which is what they're trying to do with the tariffs, and that's what they're trying to do with the ice raids. They want as much pain away, like we're very close with our team in Washington. When you talk to people that are close to Trump, Trump or Elon, they want the pain, but they want the pain as far away from the midterms as possible, right? They need the pain to bring down inflation, but that means because inflation gets under the seat cushions, it gets under the carpets, it just doesn't come down that fast. So what that means is you have sticky inflation and a slowdown, that's your 1968 to 81 world, very stagflationary, and it really is starting to trigger right now. Just look at growth stocks versus value stocks. It's been a big move the last three weeks, like Berkshire's crushing the Q's, gold miners are crushing the NASDAQ. Look at Agnico Eagle versus Microsoft the last year. I think it's outperforming by 40%. That hasn't happened since the 80s, right? Agnico Eagle outperforming Microsoft by 38% over the last year. It's absolutely unprecedented since the 80s, and that's why we're going back toward that other world where you need an entirely different portfolio construction. And by the way, maybe it sounds like they need that... Maybe it's the short-term pain for the long-term to solve some of our longer-term challenges? Exactly. And that's what Musk and Trump are trying to accomplish. I mean, what they're trying to do is... I mean, think about what they said this week. What they said is so nuts, and I don't even know if they really meant... They basically told us with high conviction that they're going to have a trillion dollars cut out of it. So right now we're spending $7 trillion a year, and Musk said, well, we got to get that down to six. You can't go in one year from what we call right now the deficit angle is around 7% of GDP, and the developed world is around 3%. So the American exceptionalism, the whole point of American exceptionalism essentially has come down to, oh, we can deficit spend at 7% and the rest of the developed world is at 3%. So that's what's created all this American exceptionalism, this strong economy. But if you go from spending $7 trillion a year total down to six, and you try to do that in one year, you're going to create a very, very nasty recession. And so they're trying to do things that should be done over five to 10 years, because unfortunately, when your fiscal spending is this high and you reverse it that fast, it creates a vicious, vicious cyclical turn that can be really intimidating for the market. Yeah, certainly. You mentioned that we need a different portfolio construction. Could you remind folks, what does that look like? That's not the 60-40 anymore. What is the new portfolio construction from your perspective? Well, yeah, it's 40% stocks, 40% bonds, and 20% commodities, or 35-35. Something like that, where you have a higher portion of commodities. Just remember, from 1968 to 81, when we got through that multipolar world, higher interest rates, higher inflation regime, we had the Vietnam War, all those types of things, from 1968 to 81, at the end of that period, 49% of the S&P 500's composition, 49% was industrials, oil and gas, and materials, 49%. Within the last couple of years, that number got down to 12%. We don't think we're going back to 49, but if you think about industrials, if you look at a chart of industrials versus the NASDAQ, it's been outperforming the last three or four years, and that outperformance is starting to pick up. The VIS ETF, which is the industrials, that's the one you want to look at, that's your industrials. Your oil and gas, that's the XLEOIH, and your materials, that's your XME. So your oil and gas, your materials, and your industrials, in recent years, they've been about 12% of the S&P's composition. All the money's in tech, right? This number is really going to go from 12 to probably 30. So oil and gas, industrials, and materials should move from, say, 12% to 14% of the S&P's composition. And within five years from now, we think that number is going to be close to 25% to 30% of the S&P 500 composition. And that's where you need a whole new portfolio construction. Larry, I've got to say, I always love having you on the show. It's been way, way too long. And again, like I said, what a great week to have you. And I know the folks are going to enjoy this as a weekend special. Before we wrap here, a couple of things. Everybody go pick up Larry's book. I've seen you on the book tour, like on my social media. But if you all have not read it, if you have not read this book, please go pick it up, How to Listen When Markets Speak. I told you, Larry, I did the audio version, which was really cool because I particularly love that dialogue that you capture in the book so nicely. But let folks know, obviously plug the book, let them know more about the bear traps report. I know you have a great community there. And then some final parting thoughts. What would you like to leave this audience to think about? The floor is all yours. Well, thank you, Julia. What I'm proud of is I started off in the retail side of the business. We wrote a New York Times bestseller about Lehman Brothers. It's now been published in 12 languages. And what I realized is you make a lot more money, you make about 10 times more on the speaking tour than you do writing the book because the publishers make so much money. But the best part is meeting people. And so we've been to London six times in the last decade, been to Toronto five or six times, Boston, New York, Miami. We just got back from Zurich, Geneva. And what we've done is we've built this Bloomberg chat. And it's kind of like crowdsourcing information from really intelligent investors. These are hedge funds, mutual funds, and pension funds. And what we do is we crowdsource that information. We create a lens for you as an investor on a buy side conversation. And all that means is what are the billionaire professional investors talking about this week looking at? And so we run the Bloomberg chat every week with the institutional investors. And we recap that in the Bear Traps Report. So it's not a newsletter. It's not some guy sitting by the lake in Michigan. This is crowdsourcing information with the best investors in the world. We want to democratize information and share that with smaller investors. Tatiana at thebeartrapsreport.com, tatianaatthebeartrapsreport.com, put you on a free trial. And I think overall, in closing, I just got back from the Vale Symposium. Dick Strong hosted it. It was a great group. And it had some very interesting people there, Zoltan Posar, Jim Bianco. And what's great was a lot of really good speakers that were on the strategy side, but also a lot of famous fund managers. So it was a mix of strategists and fund managers. And everybody spoke for 40 minutes. And the intelligence gathering that I got from that meeting, as well as doing our... We have these ideas dinners and lunches around the world where we just did ideas dinners in Miami and New York. And what we're doing is we're talking to investors and we're finding out what they really think about the scent and the agenda. And at first, like in the, say, September, October, we know the scent, the treasury secretary was meeting with all these different hedge funds, but it was a very cloudy picture. Now it's very clear the road that they're heading down is what's called financial repression. They want to massage interest rates below the rate of inflation by massaging interest rates, getting them down either through talking to our trading partners, hey, Canada, Mexico, or more so Japan, Germany. You're going to have to own more treasuries at lower interest rates. And you're going to be our friend. And if you want to be on our team, that's what you're going to have to do. Oh, by the way, go to the banking regulators, force the US banks to own more treasuries, financial repression, try to suppress interest rates below the rate of inflation. That's how you get out of a $36, $37 trillion debt hole. There's no way out besides default or what we call a debt jubilee. And there's many stories we talk about that, but that goes back to the Bible. Or financial repression, massaging interest rates over time below the rate of inflation, then you'll inflate your way up. And that's the agenda of, I think, the Trump treasury. And I think that's what the Fed wants as well. Wow. Thank you so much, Larry. Seriously, I feel like in this half hour, I learned a lot from you. And I know this audience certainly will too. And you're always welcome on this channel anytime. We love having you on. So, Larry McDonald, founder of the Bear Traps Report, author of, well, multiple books, but How to Listen When Markets Speak, and A Colossal Failure of Common Sense, which was your New York Times bestseller about Lehman, which is a fantastic book. And I learned so much about you in that book. But Larry, thank you so much for taking the time. Always a pleasure. Really appreciate you. I hope you have a wonderful weekend. And until next time, be well. Thanks, Julie. Have a great weekend.