00:00 Well, look, the dot-com bust produced a 50% drawdown in the S&P 500 over 2 years. Great financial crisis produced a 50% drawdown in about 18 months. Most of the damage came within 9 months. I suspect we'll have a 40 to 50% drawdown once it's all said and done. The Fed will do what it normally does.
00:24 It'll do massive amounts of QE and money printing, and then we'll have another attempt at another re-inflation. But first the damage has to come, then you'll see a fiscal and a monetary response, but only after the damage is done. >> Hey everyone, my name's Anthony Fatseas and welcome to another episode of the What the Finance Podcast.
00:51 On this episode I have the pleasure of welcoming back a very popular guest, Ed Dowd. So, Ed, thanks so much for coming back on the podcast. >> Anthony, great to be here. Good to see you again. >> Yeah, looking forward to conversation. We spoke about 3 months ago and a lot's definitely happened since. So, really interested to hear, what are you currently looking at? What's your high-level view of what we're seeing in the economy and markets? >> Yeah, the high-level view is the same as we issued in our US economic
01:13 report at the beginning of 2026. Three pillars of risk. The AI bubble, the housing market in the US, and China's economic acute crisis that's unfolding. Then we had, February 28th of this year, the beginnings of the Iran war, which added another element on top of that, potentially causing an energy — It did cause an energy price shock, and that's also now a problem.
01:49 That's only going to pull forward all our risk outcomes that we predicted. >> Yeah, even just in here, you're talking about how you think it's sort of at the precipice potentially of the business models aren't working. Even if revenues are growing, it's not growing fast enough.
02:05 So, yeah, what are you currently seeing there? >> So, there's a couple signposts that I watch. I watch what the players are doing. So, at the end of last year, we're going to remember OpenAI, Sam Altman and the CFO, Sarah Friar, floated the idea of government financing. And why did they do that? That's because the engines of financing were starting to crack a little bit.
02:31 Private credit, which was a big source of funds for the AI buildout, started to freeze because of other issues and it's the end of the credit cycle. So, they started to indicate that they needed some help. So, that was salvo number one. Then as we rolled forward, OpenAI has a lot of people on the inside leaving.
02:56 That suggests that things aren't going so well internally. Then we have notable dignitaries in the finance world starting to question this whole thing. Recently, the head of Apollo said that it appears that most of the revenues coming from the AI complex is coming from investors, not end customers.
03:21 Well, that's been well known to those of us studying this for a long time. This is a classic CapEx buildout. Investors come in, they build out the infrastructure. There was some end customer growth that was parabolic, but a lot of it was just people kicking the tires and trying it out.
03:40 But that seems to have slowed. Token pricing is coming down. And we have private credit continuing to struggle. And every time one of these companies comes to market with more bonds, the spreads go a little bit wider. And then of course what I watch is the semiconductor complex. That kind of peaked in June of this year.
04:02 On tremendous orders and good fundamentals, but the stocks peaked in June 26th of this year, had a sell-off. Now we're trying to attempt a rally and that rally seems to be rolling over. So, we're kind of at the beginning phases of the market starting to realize that. And then let's also not forget there's not enough power to plug all these data center build-outs that have been hyped into the grid.
04:35 So, this thing's going to slow one of two ways. The credit markets are going to shut it down by getting too expensive and/or there's just not enough power to plug these things into. So, the CapEx cycle is going to slow. When it slows, it's going to cause the current beneficiaries, the pick and shovel guys, the semiconductor companies, the power generators, all the people that have been getting these orders, it's going to start to slow and then their stocks will go down and then it becomes kind of
05:03 a reflexive problem. >> Yeah, I guess it's a challenge cuz all these companies have sort of pledged trillions of dollars basically if you add it all up, but they haven't invested it yet. So, it's easy for them to sort of pull back on that CapEx if the business as you said when they see the business models aren't working, when they see the demand's not there, they're just going to stop it and then all those companies are screwed basically.
05:24 >> Well, there's also double ordering going on. This happens in every CapEx build-out. Somebody on X put out — Somebody did a survey of a lot of the players in the AI CapEx infrastructure build-out and they did a survey and 50% of the respondents said they were double ordering. What is double ordering? Double ordering is when, during the build-out phase, there's not enough capacity.
05:49 So, your XYZ company wanting to buy some chips. And you get told, sorry, you asked for a million in chips. I'm just using an example. They say, oh, we can only give you 500. So, 50% of what you want. So, the next time you come to the table, you say, oh, I need a million, but I'm going to tell them I want two.
06:16 So, then you get your million. And so the backlog looks very robust, but a lot of the backlog is double ordering. And that's how these cycles end. There's a lot of people double ordering because it's a game theory. I need my 500. I need my million. You tell me I can only get 500.
06:35 So, when I come back to you next, I say, I need 2 million. So, that's how this works. And we're seeing the beginnings of double ordering. And from what I understand, there's rumors that a lot of Nvidia chips are sitting in warehouses getting ready to get plugged into data centers that have yet to be built.
06:53 So, there's probably shadow inventory of these chips all over the place. They've been using chips as collateral in some of these deals, which is insanity to me. There was recently about a week or two ago, Nvidia announced 500 billion in financing from Blackstone, some of the investment banks.
07:15 But what people need to understand was a memorandum of understanding, which is not a contract. So, it can just vaporize overnight. It's not a real commitment until the contracts are written. Same thing happened on the Stargate. And there's a big announcement in the beginning of Trump administration, Stargate 500 billion.
07:34 That's still yet to get funded. That was a memorandum of understanding. So, there's a lot of announcements, a lot of hype, and I don't think a lot of this stuff's ever going to get deployed because A, there's not enough power to plug the stuff into and B, the credit markets may revolt here soon. And I think they're already beginning.
07:51 >> Yeah, it does just seem like a house of cards and somehow it's — Have you been surprised that it's sort of kept going for as long as it has? >> What was the big surprise was, coming into the year, the markets were starting to discount trouble in the economy and even with AI and private credit, the 10-year yield went below 4%.
08:19 Then Iran war started and yields and oil spiked and then people kind of lost interest in focusing on those fundamentals and all the fundamentals focused on the headlines around the war and then Trump announced an MOU and the market ripped and semiconductors led that rip. And it was a very narrow rally that took us to new highs.
08:42 It was all AI or AI adjacent and that all peaked, the semiconductor index peaked in June and we're not there yet. I'm not calling a top, but I'm watching the structure of the semiconductor complex and if they start to really underperform and go to new lows, the bubble may have already burst, but people won't realize that until a couple months from now.
09:05 >> And how bad would this be cuz it seems like there's so much more leverage in the system as other infrastructure plays, the percentage of GDP that's been invested in this is extremely large especially with since we are so much more financialized than I guess historically. >> Yeah, the real economy is already weak.
09:20 Without the AI buildout that's been going on the last year and a half two years that really accelerated last year into this year, the GDP would be a lot weaker. We may even already be in a recession. The economy is in a recession in that the average consumer is struggling mightily.
09:42 Walmart has reported its quarter. They had some issues regarding some drug pricing, but underneath the cover their same-store sales was the weakest it's been in 6 years and they said the consumer is struggling. So Joe Sixpack, 80% of the country is not doing well and eventually you can't have 10, 20% of the consumer supporting the rest of the economy.
10:07 The housing market slowly rolling over. So it's all conspiring to be a very nasty recession and stock valuations are at the highest and we're at dot com level valuations. If you look forward on 10-year projected returns versus bonds, if you took a million dollars and put it in the SPY ETF, you're projected to earn 0% over 10 years, which implies a huge drawdown.
10:36 So we're going to get it. The question is when and when you have an index that's 40 to 50% AI and AI adjacent, that concentration risk always ends badly. Always. >> Do you see cuz I guess the thing that we currently say is a hyperscaler is they do have produced lots of cash flows.
10:56 So they can actually keep investing maybe on the level they are, we've seen them do quite interesting mechanisms to raise capital such as placements and selling equity and other avenues, but they can continue to invest into this. So it's not something that would I guess instantly stop unless we get this overarching build out which is too large.
11:17 >> You don't need it to stop. You just need it to slow. It's a second derivative question and semiconductors are the classic canary in the coal mine. It's when the second derivative slows, the valuations of those stocks goes down quite a bit. If you look at what's going on in South Korea, they have an index that was 50% comprised of two stocks, SK Hynix and Samsung, which are basically part of the AI semiconductor build-out story. That index peaked in June
11:49 and it's down 30, 35% trying to rally. If that goes to new lows, I think we have the answer that the second derivative is shifting and the valuations of these stocks can't support a second derivative slowing. It's classic growth stock investing 101. I was a growth stock investor at BlackRock and in growth stock land, especially in very hyper growth stocks, second derivative does not bode well for valuations.
12:19 >> Yeah, it's a great point, but how bad do you think it would get if all these things were to roll over? >> Well, look, the dot-com bust produced a 50% drawdown in the S&P 500 over 2 years. Great Financial Crisis produced a 50% drawdown in about 18 months. Most of the damage came within 9 months.
12:44 I suspect we'll have a 40 to 50% drawdown once it's all said and done. The Fed will do what it normally does. It'll do massive amounts of QE and money printing and then we'll have another attempt at another re-inflation. But first the damage has to come. Then you'll see a fiscal and a monetary response, but only after the damage is done.
13:07 >> Yeah, okay, makes a lot of sense. As you said, it seems like the rest of the economy is quite weak as well. So, it's not as if there's anything else that could really come in and support the economy once this rolls over. This is really the only thing that's keeping growth going.
13:21 >> Yeah, we're updating our real estate reports and it's a slow roll over. So, the housing price declines have occurred in the Southeast near the southern border. The blue cities are still holding up, but the second derivative is shifting there. And we have a ginormous affordability problem.
13:42 We have the largest amount of homes for sale versus home sold gap on record, meaning the market is frozen. So, there's a buyer's strike and there's a buyer's strike because we've done the math and they're about 30% overvalued. And 60% of the homes for sale are from older boomers and the buyers are typically millennials trying to start families.
14:08 And so, until that clears and the only way you clear that is through price, there's going to continue to be no activity in the real estate market. People going to remember the '07, '08, '09 great financial crisis. By the time people were aware there was a real estate bubble nationally and it made the headlines, most of the damage had already been done.
14:34 These things start — the rollover starts way before and the genesis of this rollover started in 2022 where new permits peaked and have been declining ever since. So, by the time people are aware there's a real estate problem, we're going to be getting more bullish on the economy and what have you because once prices do readjust, that's the beginning, that's the green shoots you need to see the economy recover.
14:58 We're not there yet. I mean, we need home prices to go down quite a bit. And people forget housing is 20% of the economy. And that's now struggling and going in the wrong direction. That helps support a lot of construction activity, a lot of ancillary financial activity. There's a lot of purchases of new furniture.
15:19 So, housing generates a lot of back end economic activity and when it goes through a down cycle, it usually directs us into a recession and traditionally has. >> And do you see this as any normal cycle in the housing market or you mentioned some quite strong demographic shifts and I guess secular shifts that we could see as well.
15:38 So do you see this only as more maybe a longer term potential reversal similar to what we've seen in the bond market? >> Well, I think what the demographic suggests is once prices adjust homes are not going to be treated — you shouldn't look at a home as an investment for a long long time. You don't have a demographic tailwind.
15:55 It's a place to live. And so I think it's going to create a recovery on the other side, but real estate's not going to take off. It's not going to have — because of the demographic headwind, it's not going to have — as the boomers age out and die, it's just not going to be what it was.
16:15 I mean, the boomers were the python in the snake. They really supported the housing market over the last 30 40 years. >> Yeah, do you see this sort of similar to Japan where they could get lots of sort of abandoned houses and not much movement? >> Yeah, it's similar to that, but not as bad. I mean, we're not as bad as Japan.
16:34 Japan is actually going through another demographic decline re-accelerating. China's going through a huge demographic decline. China has 20 to 30 years of housing inventory. It's a disaster and their internal consumption is falling off a cliff. We just looked at some of the Chinese numbers and they're grim and we'll be talking about that once we release our reports.
17:00 Our thesis is rolling out just fine. You're not going to hear about China in the Western news, but in the Asian news, it's recognized that China is struggling because people in Japan and in South Korea rely on Chinese exports and imports to keep themselves going.
17:19 So, Asia has a big problem right now. And if you look at what's going on with Japan, that's part of the problem with the Japanese yen is that the Asian economies are rolling over and so that's why Japan's having such a problem. >> Yeah, okay. That's super interesting. So, what is happening in China? It'd be good to delve deeper into the problems cuz as you said, their growth rate is decreasing despite the fact that the government's spending more and more and trying to pump it up.
17:46 >> So, it's a little history lesson. So, after the great financial crisis, China really stepped up to help save the world and they went on a huge infrastructure build-out. And people talk about how China's the greatest planners on the planet and they think in 100-year blocks.
18:05 Well, if they did think in 100-year blocks, they would have realized — cuz the math is there. This is not rocket science. We've done the math. Their population demographically was going to plateau in 2015. So, they started huge infrastructure builds right after the great financial crisis and built all these cities, all these infrastructure projects.
18:24 And they overbuilt well beyond the capability of their population to absorb it and kept going. And they did that because they probably had no alternatives. They had to keep their economy and their lights on. Then they plateaued in 2015. They started their decline in 2020 right around when COVID hit and they're losing about 150 million people in prime working age.
18:48 They're aging out and becoming retirees and the spending profile of that consumer changes dramatically. And that's what's going on in China and that's when the real estate crisis started was in 2021 when Evergrande went bankrupt and — I think there's something called countrywide or whatever.
19:04 They had a real estate problem beginning. So, that started declining and new permits are down like 70%. It's a disaster in China. The good news for them was they had some long life projects, so construction really didn't start rolling over into the last 2 years. It was only down 20% about 2 years ago, but that's accelerating lower because those projects are completing.
19:24 And their net fixed investment, which is their overall investment in factories and what have you, went negative at the end of last year. Year-over-year growth went negative. They had a little infrastructure stimulus that they tried to stop it. It went up a little bit in January, February, March, but now it's rolling over again. It's at new lows.
19:45 The most recent month, year-over-year growth in net fixed investments minus 9 and 1/2%. That's going to be in our report. So, it's re-accelerating. So, what did China do to offset their internal consumption bust, their real estate bust? They started exporting more, and that's why we had trade wars with China.
20:05 They tried to dump all their cheap goods on the world. And so they're struggling already on their own. If we go into a recession, the exports from China will collapse and they'll be even worse and worse shape. So, it's kind of this feedback loop. And China's one of the China's biggest fears is their own population.
20:25 People need to remember there's only about 7 million card-carrying members of the CCP. They're the ruling class of the party. 7 million people controlling billions. They fear their own people, and so that's why they constantly need to keep figuring out a way to keep people employed. >> Do you think that's why they're investing so much into robots to sort of support this aging population and the manufacturing workforce, so almost to replace them, or is it something else? >> Oh, there's a bunch of reasons for it. I
20:57 mean, it's military. It's what you said, to replace people. The problem is the technology is not ready for prime time. I know there's a lot of TikTok videos of all this amazing stuff going on, but the energy requirements and maintenance and upkeep of a robot are huge.
21:20 If you look at the energy requirements of a human, it's way lower than the energy requirements of a robot. Unless we come up with some new energy source like free energy or localized fusion, the math doesn't work. Humans are still the cheapest way to get something done. >> Yeah, that's interesting.
21:42 And when you're talking about, I guess, 150 million people retiring, it's not something I thought about to do with consumption cuz there's been talk about China trying to move their economy to more consumption-led and but people are really saving. And the reason they're saving is cuz they're probably approaching retirement and there's not really any pension or anything. So, yeah.
22:00 >> Yeah, so this is something that needs to be discussed with China. The US needs to negotiate with China. They need to set up a social safety net which they don't have one. So, that's why even when you're a prime working age, you're worried about when I retire. So, they already have a high savings rate even amongst the people in their prime age working earning years.
22:24 So, they save too much. And they've been trying to figure out a way to get a consumption economy going, but they haven't done it because in order to do that they have to give up power cuz they have a mercantilistic system meaning the people at the top make most of the money. And they need to share that with the rest of the people and there doesn't seem to be an appetite to do that.
22:45 So, that's why China has this consumption problem because there's no safety net. >> Do you see it being, I guess, a Plaza Accord 2.0 that is required cuz that's the only way I can think of, if there is a recession, if China's really struggling, then maybe that's the only way they can get out of it where similar to what Japan did in the 1980s to sort of negotiate with the rest of the world so that they can rebalance their economy.
23:05 >> Well, so China would — Japan and China are interesting case studies. In our China report, we talked about Japan. So, when China hit its demographic wall, they were able to export more. That's how they kind of muddled through the lost decades was exported more.
23:28 But Japan is 1/10 the size of China. And so the world was able to accommodate that. The world cannot accommodate China trying to do the Japan model. So, there needs to be a massive restructuring of China, but they have to focus on their own internal consumer. So, but they don't seem to have the appetite to want to do that.
23:49 So, that's why we have these trade wars. And there's going to be global conflict as we roll through time because China's going to need a scapegoat to blame — not going to blame themselves for what's going on in their economy. They'll blame, and that's why there's all this chatter to Taiwan.
24:05 They want to get Taiwan so that they can keep the game rolling. >> Do you see that being a potential risk? And I guess as we have seen geopolitical building up. >> It's a risk out there, and when it goes off, who knows? But it's a risk. And Warren Buffett got out of Taiwan Semiconductor.
24:24 He got out a little early cuz the stock went up a lot cuz of the AI bubble, but one of the reasons he got out of it was because he was worried about war with China and Taiwan. He was early, but when that conflict does start, it'll be a problem. >> Super interesting point.
24:39 So, another challenge, you mentioned the cost of debt at the start of the interview, and it seems like that's something that governments are facing as well. Just bonds rising, rising, rising. Do you see this being a sort of continued risk, or do you think with the recession and potential disinflation that could sort of reverse? >> Yeah, so this is classic.
24:57 Right before the '07, '08, '09 great financial crisis, bond yields were going higher because there was temporary inflation from an oil price spike. People forget during the '07, '08 time frame, oil more than doubled because there was this theme that China had an insatiable appetite for oil.
25:22 So, oil went up to like $149 per barrel into the summer of '08, which created demand destruction, and then yields and everything else rolled over as growth slowed. So, when yields rise like this, they create their own growth slowdown. So, what's going on is there's competition for money to fund all these sovereign bonds, and now we have the AI bubble competing.
25:51 Yields rise to attract capital, but then the yields choke off the economy, the economy slows, and then yields come down, and the Fed has to start cutting. So, the solution to high yields is high yields themselves. The solution to high commodity prices is always high commodity prices because more supply comes online.
26:08 So, the bond market trades on two things: growth and inflation expectations. And right now there's all this talk that yields are going to go a lot higher, and we're going to choke on these high yields. If I'm right on the recession and the AI bubble bursting, yields will come down in the long run. >> Yeah, okay. So, it's interesting.
26:28 And so, you just think that the government debt isn't as much of an issue or is that an overarching thing that's not going to be resolved in the near term? >> It's not going to be resolved in the near term. I mean, long term it's still a problem, and there's already the global sovereign debt crisis, which has been talked about ad infinitum for 10 years.
26:47 I always had the thesis that it would eventually get manifested in the currency markets. That's the release valve, and it's beginning in Japan. Japan is Bank of Japan is case study number one. They have a demographic disaster. Their debt-to-GDP ratio is something like 270% and they are out of choice now where they have to continue to either fund the yen and carry trade or care about their own economy.
27:13 So, they have a Hobbesian choice. The US obviously wants them to continue to not raise interest rates too fast and pull the yen and carry trade, which would cause a deleveraging event. So, this is a tightrope, but when we get the reset, the global recession, yields will come down. If you look at what's going on in China with their bonds, their bond yields have been collapsing because they're in a deflationary disinflationary situation.
27:38 That eventually is going to catch up with the rest of the world. And our yields will be coming down once the markets switch from growth to growth scare. The other thing that we should note is stock valuations are at the point where the yield on the stock market is below that of government bonds.
27:58 So, there'll be an asset allocation decision that will come up, especially as the growth scare comes. It's cheaper on a cash flow basis. It's cheaper to own bonds, and usually stocks trade at a discount to the risk-free rate, meaning the dividend yield is higher on the S&P 500 than it is on bonds.
28:21 That's inverted at the moment, and that usually doesn't last long in history. So, that's how we come to the fact that we can say that valuations at these levels are going to yield you 0% over 10 years. It's because of the relationship between stocks and bonds, and stock yields are below the risk-free rate of the US government.
28:43 And there will be at some point an asset allocation, is over-allocated to stocks and under-allocated to bonds. That'll reverse. >> Okay. >> And once the flows begin, it happens quick. >> Yeah, I can imagine. And another sort of I guess asset that has sort of performed quite well is commodities recently, especially copper.
29:04 Gold and silver have come down a bit, but over the last year they've performed. And energy as well. It sounds like during a recession, the potentially majority of those things could go down as the demand decreases. Is that sort of what you see? And really bonds are the only play in town at that point. >> Yeah, and again, most people think bonds are dead.
29:21 That's — This is a very contrarian call. I think one of the greatest asymmetric trades in the investment universe right now is the long end of the curve. If you're Joe saver, you just want to raise cash in your investments so you can buy cheap assets on the other side of this.
29:41 If you're an institutional player and you want to take a little more risk, you can look at the long end. I think that trade is going to work. It's gone against us recently, but I think once this begins, it'll happen fast. And just like it happened in the great financial crisis and the dot-com bubble, once people realize what's going on, the capital flows will switch and it'll happen pretty quick.
30:06 >> Yeah, really interesting. So, thanks so much for your time today. Really appreciate it. So, my last question is what is one message that you want people to take away from the conversation? >> The big message is valuations are stretched. The bubble is in the process of coming undone, and cash allocations in your portfolio, taking advantage of lower prices, is warranted.
30:32 Do what Warren Buffett's doing. Warren Buffett was early like we were. He's got 40% cash. He's waiting for a fat pitch. David Tepper recently announced in June that he had 40% cash. Paul Tudor Jones, famous hedge fund guy, he even said looking at valuations he wouldn't recommend investing in the S&P 500.
30:57 So, there's a lot of smart people suggesting that you just raise cash. Don't try to short the market, that's a waste of time, because timing is hard on these things. And the last thing I'd like to say that I got a new Substack, Adapt on the Narrative, where you can follow me and see what I'm talking about.
31:16 >> Yeah, perfect. I'll definitely put that in the description. Is there anywhere else people can find the work that you do? >> Yeah, all our economic research that's for sale is at phinancetechnologies.com and I have a personal website at dowd.com and you can also follow me on X at dowdedward.
31:33 >> Okay, I'll put that all in the description later, but thanks again for your time. >> Thank you, Anthony. >> Hey, everyone. Thank you so much for listening. Really appreciate your support and I hope you found amazing value out of this interview. If you really enjoyed it, we'd appreciate if you liked and subscribed or shared.
31:46 It really helps with the podcast. We're still trying to expand, get to more people to help make sure that everyone understands and decode what's really happening in the world of finance, investing, macroeconomics, and geopolitics. If you enjoyed this one, then you might enjoy this other interview as well.
32:00 So, really appreciate it and thank you.