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Prepare your portfolio for “big picture” paradigm shifts reshaping the U.S. economy.

Real Vision co-founder Raoul Pal discusses significant global growth developments and big investment themes with Hedgeye Demography analyst and renowned generational theorist Neil Howe.

Below we’ve transcribed key excerpts from this webcast. Watch the entire hour-long discussion in the video above.

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Neil Howe: Good afternoon. I’m Neil Howe. We’ve got a wonderful show prepared for you today. I’m joined by the one and only Raoul Pal. As many of you know, Raoul is the CEO and co-founder of Real Vision. He’s a Goldman Sachs alumnus and former hedge fund manager. Raoul, thank you for being here.

Raoul Pal: It’s great to be here, Neil. We finally get to meet. You’ve been on Real Vision a few times.

Howe: We have so much to cover. You’ve done a recent Real Vision series on the Retirement Crisis. I’ve talked about some of the same things. For this conversation, I’d like to go through the long-term fundamentals like population, employment and productivity. These are the long-term constraints on where the economy is going. From there, we can go to the business cycle, when is this expansion going to break? Then I’d look to move on to the financial cycle. And finally, my favorite topic, the political cycle.

So I’ll send it back to you to get us rolling.

Pal: Great. Thanks. This is a good framework because I look at the long-term, secular trends and then the shorter-term cyclical trends and how that impacts markets. Long-term, as I laid out in the retirement crisis video, we’re close to the end of a secular cycle in debt and equity ownership.

I think much of where we are today and the secular imbalances as being driven by this Baby Boomer population acting within rational thought. This was the largest generation of all time that had no offsetting generation so they walked into their first house, first car with incremental consumption that caused price dislocation. This caused inflation in the late 70s, early 80s. It was these generations starting to buy.

This next part of my cycle thesis is very influenced by your thinking. After this generation got into their 30s, they started saving for retirement because they were finally earning income. Around this time that was the advent of the 401k and the decline of the defined-benefit contribution system. The onus started to shift to the individual to save for retirement so money piled into the stock market. This accelerated with the advent of the index fund leading into 2000. The Baby Boomer generation created a huge speculative equity portfolio unprepared for a recession. As ever the recession comes along and wipes 50% out of the stock market.

Now, back then, Boomers were young enough to buy the dip but the mentality changed to ‘The equity market is not the safe bet I had from 1980 to 2000. This is something different.’

They then did the rational thing and said ‘How do I save for retirement now?’ The thinking went, ‘Well, property is relatively cheap’ and interest rates were so low so they piled into that. The madness of crowds exacerbated this dynamic and household debt exploded. That bubble burst and household debt has unwound partly.

Now we’re in a situation where this generation doesn’t invest in the stock market but the pension system does. That’s the last part of this demographic bubble. It’s the credit bubble in the U.S., where corporations issue debt to pension funds who are giving it to the savers and corporations use the proceeds to buy back their own shares. These pension fund managers are also taking excessive risk to close the funding hole made by those two recessions. All of these things have come together at a specific point.

Howe: That’s a great overview and before we get to the business cycle dynamics, I want to talk about the demographic constraints on the long-term. This is what I call the generation-long slowdown in the working age population. We’re in a period of incredible decline. We’re reaching absolute zero by 2021. It’s the consequence of Baby Boomers retiring.

Look around the world. You can see that the United States is not particularly bad but how about Russia, Europe, Japan and China, which shows the biggest delta. What’s driving it? It’s not longevity. It’s falling fertility. I’m curious to hear what you think of all this Raoul.

Pal: I think it’s no surprise that the Japanese stock market topped out in 1990. Europe topped out in 2000. Now we’re coming to the average Baby Boomer retiring in the U.S. I think that’s significant. Over time as the population changes, the growth rate to GDP falls alongside it. That’s why we’re seeing bond yields fall globally as well.

[WEBCAST REPLAY] Raoul Pal & Neil Howe: A Sobering U.S. Economic Reality Check  - demographic1

[WEBCAST REPLAY] Raoul Pal & Neil Howe: A Sobering U.S. Economic Reality Check  - demographic2

Howe: So that’s the long-term picture. Let’s talk about the business cycle.

Pal: This is where I spend most of my time because long-term secular trend don’t change that much decade to decade. So the business cycle is the key driver of asset prices.

Where are we now? This is the longest business cycle in U.S. recorded history. Of the indicators I look at, the most basic one is ISM, which is around 50, suggesting we should be growing around 1% GDP growth. Forward looking indicators – like the JOLTs survey or classically the yield curve – suggest we are at the point of recession or close to it.

Now, recessions come from a slowdown in the business cycle but they are actually crystallized by a larger event. I think the tariffs broke supply chains around the world. The Coronavirus on top of that really doesn’t help. My view is that we’re going into a recession this year. There might be some euphoria around the election as both parties spend a lot of money on fiscal stimulus.

You can see this playing out in bond yields. They’re falling daily. I’ve been a part of this trade for a long time. I’ve also been very interested in the dollar because as the world slows down and world trade slows down there is a global demand for dollars. The BIS put the dollar shortage at around $13 trillion. That’s driving the dollar higher.

We’ve got this issue that the U.S. Dollar is driving up because of debt dynamics and regulatory issues. That in itself lowers global growth, lowers bond yields, inverts the yield curve and the Fed has started to stop cutting. Everyone else globally is thinking about stimulating. The reality is at some point the equity market is the final leg of this. All of this dovetails exactly when the bulk of Baby Boomers hit retirement age.

Howe: And you remind people that financial markets don’t always bounce back from these issues. Look at Japan. Look at Europe.

Pal: Neil, this is a key thing. Look at the cult of equity. The cult of equity is dead. If you look at individual households, they don’t own equities. Yes, they own it in their pension plans but as you said it’s only the super-rich holding equities. So you’re killing the cult of equity off.

Much of the activity is corporates buying back their own shares. What is it that allows corporates to buy shares? Cash flow. Cash flow is correlated to the business cycle. When the business cycle goes negative, cash flow goes negative. We’re already seeing that in many companies already.

The other question is who’s buying all the debt being issued by companies that ultimately fund all this buy back activity? It’s the pension system. That’s also driven by corporate tax receipts and again, that’s driven by the business cycle. So tax receipts go negative, the buying of corporate bonds stops and corporations stop buying back their shares. So you end up with a situation where the two most widely held assets by the entire pension system come to a halt as soon as the business cycle goes negative. That’s a really key issue.

Howe: The last part of the equation is how all this influences the elections. If we are reaching a turning point in the business cycle you look ahead and people are voting.

Pal: We’ve talked about the debt cycle and corporate debt is probably the big issue here. The central bank bubble is at its peak. The business cycle is finishing. And you’ve got a shift from productive workers to net divestors. You couldn’t ask for a better Neil Howe tick list to create a Fourth Turning. That’s a recipe for polarization.

You now have a mighty polarized country and you have a potential for an political upset yet again. In your framework, the upset could potentially be Sanders teaming up with Elizabeth Warren and the whole progressive movement. That would change almost everything we know today.

Howe: I constantly remind Republicans of how delighted Hillary Clinton and the Democrats were when Trump was nominated. Do you remember that? They thought the election was going to be a cake walk. ‘Trump believes in protectionism and isolationism. He couldn’t possibly win in a modern day and age.’ I see all these Republicans saying similar things like, ‘Who’s going to vote for a Socialist?’ And then you look at head-to-head polls where Sanders is beating Trump. I think Sanders is a lock-up for the nomination.

It’s going to be a fascinating contest. Trump, himself, doesn’t want to run against Sanders. He would much rather run against Bloomberg. Trump says it all the time, ‘Bloomberg bought himself into the election.’ Bernie Sanders has real supporters. That’s the world Trump knows, a polarized nation with real supporters.

Pal: It’s easy for Trump to attack Bloomberg because of the zeitgeist out there now. Bloomberg is a centrist and an East Coast billionaire. Sanders looks more like Trump in many respects in his appeal.

Howe: Exactly. Sanders is the post-modern candidate for the Left. Trump is already the post-modern candidate for the right.