00:00:05:22 - 00:00:49:16

Hello and welcome to our latest video #MacroMemo. There is, as always, quite a lot to cover.

We'll talk a bit about fizzy markets in the context of concerns about bubbles and different corners of financial markets.

We'll take a peek at the U.S. government shutdown, which continues, at least as I'm recording these words.

We'll talk tariffs. Tariff developments have been substantial recently.

We'll also dig into a few thematic topics. One is the K-shaped economy, specifically the consumer economy. We'll talk about Chinese deflation and why that's happening and what it might mean or not for the rest of the world.

We'll give you a quick peek at a new economic index we've built, which looks at economic momentum for emerging market economies.

And I'll give you some quick hits at the end, including some central banks. And so that's our plan.

00:00:49:16 - 00:02:24:15

Let's circle around to the top and let's begin with those fizzy markets. And so as I mentioned, there have been some recent concerns expressed about bubbles, maybe three in particular.

One is just the U.S. stock market in general. Valuations.

Another one is the amount of artificial intelligence cap ex (capital expenditures) and whether it's sustainable and whether it represents good or mal-investment.

And also the state of the private credit market in the U.S. and whether there are problems there or not.

And let me emphasize, this is not final word on those things. In fact, you’re hearing from an economist, not from a market strategist. Nevertheless, I can say a few things.

So it's not obvious that these things are bubbles. The U.S. stock market is certainly lofty and skewed toward mega-cap tech in particular. So a lot does count on those companies continuing to thrive. But equally, it does look quite different than, let's say, the late 1990s, which was, of course, the tech bubble of the time.

Very different valuations. Profoundly different earnings as well. These are profitable companies. The AI pursuits in particular are a portion of what they do, not the entirety.

Even after the ‘irrational exuberance’ declaration by then Fed Chair Greenspan, in 1996, markets kept rising for another three years or so. The S&P 500 doubled. The NASDAQ, I believe, tripled over that period of time. And so even if you did figure out that there was a bubble, timing is important and early proclamations are just that. They tend to be quite early.

And so for the moment, we are of the view that markets are more likely to go up than down, but we have reduced our exposure a little bit to the U.S. market, just given how far that it has come.

 00:02:24:15 - 00:03:41:17

On the subject of AI cap ex, all this spending in the AI space – I should say done by some of those corporate champions in the stock market – it is a remarkable amount of money being spent. And so it's $373 billion on track for just from the Magnificent Seven, just in 2025, just on AI. We do think the rate of growth will slow in the future.

And so the rate of growth might be half as fast in 2026 as 2025. But equally, the sum of money should be even larger. And it is still a very much an open question whether this is mal-investment or not. Is this money well spent, or is this money poorly spent? There are just a lot of unknowable questions right now.

How fast does demand for AI grow? Does it grow at 10% a year? Does it grow at 100% a year? Those are both possible over the span of the next decade.

How fast do the very expensive computer chips depreciate? If it's over three years, that could be a problem. If it's over 5 or 6 years, it could be a very wise investment to invest in these data centers.

How profoundly does AI improve over this period of time? Right now, it's really good at summarizing the internet. Does it start to generate new insight of its own? That would, of course, create much greater demand and much greater value.

On the private credit side of things, so concerns there. It is, by its nature, an opaque market.

00:03:41:17 - 00:04:57:07

It does sound as though lenders and private credit have become somewhat less discerning over the years, perhaps because a lot of money has flown in and they need to find a home for that money. But equally, when we look at an admittedly broader definition, which is just non-bank lending – so lending of entities that are not heavily regulated, like banks, certainly would include private credit – non-bank lending hasn't actually risen as a share of GDP.

In fact, it's down over the last five years. It's up over the prior 10 or 15 years. But, if you go back to the early 1990s, the non-bank lending share of GDP wasn't that much lower than it is today. And so it's not quite as clear as you would think that this has become a systemic issue.

Do note that for private credit, there's a lot of complaint about the lack of liquidity. But that lack of liquidity is a strength. It means that there can't be an easy run on private credit of the way that we saw perhaps during the global financial crisis in some public markets.

There have been some recent prominent bankruptcies in the space, in shadow finance. It does seem significantly idiosyncratic to us as opposed to systemic reflecting fundamental problems in that space.

And so, I guess the point here across all three of those concerns is, I think that it’s right to be watching these areas. There is right to have some concern. It's not automatic in our eyes, at least, that a bubble or bubbles are brewing.

00:04:57:07 - 00:06:34:09

Let's keep watching these areas. Certainly not a time to be taking extreme investment risks, but neither is disaster assured.

Okay, let's move forward. Government shut down. Just a quick touch, we've talked about this at great length in the past.

As I'm recording this, we are on day 35. That is tying the all-time record. The longest such shutdown was in 2019. We are on the cusp of setting a new record. There was seemingly still no political compromise available.

Betting markets are suggesting that a deal could be struck, perhaps around the middle of the month, or perhaps by the end of November. But that's the sort of timeframe. We've been assuming mid-November in terms of our own work. But it is a bit of a moving target.

Pressure, though, is rising, and I think this is going to be the key determinant of when a deal gets done. And so, you see, essential workers getting grumpy that they're not being paid.  They will be paid later. They're not being paid yet though.

And so air traffic controllers, TSA agents, starting to slow down. We're seeing more airport backlogs. You can imagine things like this mounting in a way that causes the public to put pressure on politicians. And that could then yield something of a deal.

Food stamps also not being paid or being given out. I should say that there have been some efforts recently, including a court ruling to partially distribute, but it does seem as though it's partial.

So that's going to be a pressure point. You have more than 10 million Americans who receive food stamps and are not receiving their normal allotment, which is a significant problem.

And as the shutdown persists, the economy is about 1% smaller than it would have been at any one point in time. With our assumption that the shutdown is resolved around the middle of November, we subtracted about a percentage point off Q4 annualized GDP growth.

00:06:34:09 - 00:08:00:11

You would then expect, though, faster growth in the first quarter of 2026, as a rebound of sorts occurs.

Okay. Let's talk tariffs for a moment. And so, tariff developments would be there had been some real friction between the U.S. and China. There has now been a fairly small Chinese deal. The deal includes reducing tariffs on China by about 10%.

And so it takes, we think, the average Chinese tariff rate from about 42% to about 32%. There were smaller deals with Korea and Japan. Maybe I shouldn't say smaller for South Korea, as they did negotiate a ten-percentage point cut in their own tariffs as well, but also some investment agreements and clarification.

Do note very imminently, at least as I'm recording these words, the U.S. Supreme Court is set to hear a challenge for the IEEPA tariffs. These are broadly the tariffs used to hit a country with one blanket tariff.

And there is a fair chance those get overturned by the end of the year, which could create some chaos but we've said for some time we do think there are other means by which the White House can impose other types of tariffs. So we’re not thinking that this is a permanent constraint on the tariffs.

U.S.-Canada have been squabbling and so negotiations have been cut off for the time being over an ad. We think that there will be a return to negotiations. There can be a steel and aluminum deal, which they had been talking about. But the big question for Canada is the USMCA deal, and probably not resolved until 2026.

The other consideration is that there are some new sector tariffs. Forestry tariffs for the world came on in mid-October. Medium and heavy truck tariffs came on as of November 1st.

00:08:00:11 - 00:09:14:19

Let’s talk about the K-shaped economy for a moment. The idea here is that you've got a portion of the economy that's doing well and angling higher, as per the shape of the letter. Another portion of the economy that's angling down again as per the shape of the letter.

And so the idea is that wealthier households are doing well. Poorer households are doing worse to some extent. There's a universal truth to that. But this is more of a comment on the direction of travel.

And so wealthier households have done well by recent policy decisions. The tax cuts were very beneficial. They actually hurt the lowest decile incomes because of cuts to Medicaid and cuts to food stamps.

For tariffs, every decile of Americans is hurt. But lower income Americans are hurt more because they are more oriented towards consumer goods, which are what are being tariffed.

Similarly, wealthier households benefiting from higher stock markets. And so the wealth effect is more positive for them. And so consumption right now is heavily dependent on high-income consumers. For the moment they seem up to the task, but it is a pretty heavy burden on a fairly narrow set of shoulders.

And so you do have to be a little bit nervous that consumer spending in the U.S., the growth rate, slows, perhaps as the wealthiest households are incapable of continuing to drive their spending quite as quickly as they have.

00:09:14:19 - 00:10:51:18

Let’s spend a moment on China. China has been in deflation for some time. And so producer prices have fallen, though not irregularly over the years. And that does reflect manufacturing and innovation and competition, and undercutting the rest of the world and so on.

But consumer prices are actually falling in China right now as well. And so the question is why, and what it means, perhaps, for the rest of the world.

And I would say the drivers are a mix of two things. And one is there is just some excess capacity, some economic slack in China. And so that is putting some downward pressure. The classic weak economy equals lower inflation.

But it's not all that. In fact, I would say most consumer items in China are rising in price.

It is a few idiosyncratic forces that are contributing to the outright deflation. And so one would be, of course, globally oil prices are down. That's true for China as well.

Another is that China has had a housing bust. So shelter costs are falling. That's a quarter of their price basket. Another one is that food prices are falling in China.

And that's a pretty big chunk of their basket. And I guess I mention these things in part because, again, it's partially a weak economy, but it's even more so some other special forces that are at play. And that's relevant to the rest of the world because you wouldn't think that China would be in a position to export a lot of that deflation.

• The oil is already happening.
• The shelter costs are unique to China, or at least specific to China and not exportable.
• The lower food prices, China is a food importer, not a food exporter.

And so this doesn't mean that the rest of the world is going to enjoy a big deflationary force from China. Equally, if some of these idiosyncratic forces are resolved, it does suggest that Chinese prices can go from mild deflation to mild inflation before too long.

00:10:51:18 - 00:12:14:13

Okay. We built a new economic index, an Emerging Market Economic Momentum Index. The idea here is that we do talk about and think about regularly the medium-term economic outlook for China and India and Southeast Asia, plus other markets. We do that regularly.

We feel, despite what I just said, reasonably good about the Chinese outlook over the next few years, quite good about the Indian outlook, quite good about the Southeast Asian outlook and so on.

But that's the medium-term view. That's the multi-year view. What about the short-term story? Who's doing better than expected right now? Who's slowing down next month? That sort of thing.

And so we've constructed an index just based on some fairly standard indicators, including economic surprises and economic data change indices and what manufacturing purchasing managers are thinking about the present and about the future.

And we've merged those together and just for the moment – recognizing this is a short-term outlook, and so by its very definition that story can change – the macro picture looks strongest right now for India, for South Africa, surprisingly, for Taiwan, for Turkey and Thailand as well. Conversely, at the bottom of our scorecard are Russia, Mexico, Poland, Brazil.

And actually in the very short term, China as well, which has slowed a bit recently. And so again, that can change from one quarter to the next. We do think it could be a useful tool for short-term geographic asset allocation.

Okay. Let me finish just with some quick hits here.

00:12:14:13 - 00:13:07:20

And so a brief mention of central banks. So the Fed cut rates on October 17th. It was a 25 basis point cut. It's reasonable to think more is coming. But there was some dissent. There was a preference by one voter for 50 basis points. There was a preference by another for no rate cutting. Fed Chair Powell emphasized that a December rate cut is not automatic.

All the same, we think it's more likely than not. And I think that there is some more cutting to come over 2026, but maybe not quite as much as the market thinks.

On the Bank of Canada, Bank of Canada also cut rates, also by 25 basis points, also on October 17^th. Bank of Canada was pretty clear that it does not plan to do more cutting. It wasn't just waffling on the subject. It thinks it's done.

Our forecasts are a little bit weaker than the Bank of Canada. And indeed, Canada's latest GDP print was below consensus, perhaps consistent with our view. And so we think that the Bank of Canada maybe does have another cut or even two in store over the next year, but probably not in the extreme near term.

00:13:07:20 - 00:14:11:07

There was an internet outage on October 20^th that spanned the world. It was an Amazon Web Services cloud that went down and the repercussions were amazing. And so I do want to flag this, even though it sounds awfully narrow and technical. And so parts of the world, social media shut down, online retail shut down. Voice assistance, Alexa, didn't work.

Some banks and financial platforms were unable to function. Video games, including Fortnite and Roblox didn't work. Home security was shut down. Some airlines, including United, were unable to function. Sports ticketing was greatly challenged.

In the net, this was resolved within a day. The economic implications were fairly brief, were not perhaps too bad. But it does speak to just this vulnerability.

When so many companies are relying on one cloud, and a very small number of cloud providers, you do have to worry about future outages or worry about cyber-attacks or things that could have a more enduring effect.

And, not clear what the result or what the recommendation is other than to try and make these platforms more resilient and more robust. But there is a real vulnerability here, and it needs to be acknowledged. This is sort of a new way the economy can be interfered with.

00:14:11:07 - 00:14:28:10

Lastly, just on Canada, I mentioned the Bank of Canada. I'll just say, there was a budget due out imminently. It's probably out before you hear this from me. And so I won't go into any great detail, but, it does look as though it should be quite fiscally expansive.

Okay, I'll stop there and say, thanks so much, as always, for your time. I wish you well with your investing, and please tune in again next time.