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

Summary

Odd Lots — "Citi's Dirk Willer on How You Know When the Bubble Is Over"

Air Date: November 15, 2025
Hosts: Joe Weisenthal (C), Tracy Alloway (D)
Guest: Dirk Willer (E), Head of Global Macro Strategy at Citi

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Overview

This episode features Citi’s Dirk Willer, a macro strategist and EM veteran, for an in-depth exploration of bubble dynamics, the state of current markets (particularly AI and US equities), parallels to past bubbles, and actionable signals for investors navigating risky market terrain. Willer brings both a practitioner’s quantitative rigor and memorable storytelling.

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Key Themes & Discussion Points

1. Current Market Volatility and Context

• Mixed Signals in Markets (02:00–04:00)
  • S&P 500 experiencing pronounced swings.
  • Gold and Bitcoin dropping along with equities—a sign of risk aversion.
  • Traditional safe havens like bonds also failing to rally, compounding unease.
• Fed Uncertainty (03:45–04:30)
  • Expectations of rate cuts have sharply diminished.
  • Data scarcity and ambiguity make forecasting harder than ever.

2. AI Bubble: Sentiment and Seasonality

• Bearishness Disappearing (05:40)
  • Willer observes "the bears that we found disappeared over the last few weeks. So maybe just at the wrong time, you might argue, but that’s how it goes, right?” — E, [06:14]
• Measuring Sentiment (06:25)
  • Citi uses the "pulse indicator" based on positioning and surveys.
  • “...it’s really very rare to find one [indicator] that tells you, you know what, this is in line with what we’ve seen at other market tops.” — E, [08:16]
  • Institutional investors were never as bullish as price moves suggested.

3. Lessons from Historic Bubbles (Dotcom & Others)

• Analogy to 2000 Dotcom Bubble (11:36–13:52)
  • Nasdaq’s 50% gain in a single quarter cited as a starker excess than today.
  • Willer recounts colorful stories: “...don’t worry that we need more than 100% cell phone penetration in the world because pets will wear cellphones.” — E, [11:53]
  • No single “top” event, excesses can always get “weirder.”
• On Picking the Reference Point (13:32)
  • “What gives me sleepless nights is actually that the 2000 episode is not the right benchmark...not every bubble has to get as crazy as the 2000 one.” — E, [13:32]
  • Other bubbles (1929, market manias in history) offer perspective.

4. Bubble Definition and Signals

• Quantitative Bubble Definition (21:16–23:13)
  • Citi’s rule: If prices move >2 standard deviations above trend in real terms = Bubble.
  • Once a big selloff occurs, clock resets; the bubble must re-form.
• Duration and Dynamics
  • On average: 2 years of above-average returns after entering bubble territory, then below-average returns for years.
• Market Narrowness as Warning (24:22)
  • “The generals framework”: Bubble leadership becomes thinner—monitor the top stocks.
  • “If three of the top seven [leaders] break down, meaning they fall below the 200-day moving average, that’s a really dangerous sign.” — E, [24:50]

5. Role of the Fed & Market Crosswinds

• Fed Policy’s Influence (17:22–18:46)
  • Bullish scenario was predicated on Fed rate cuts into the bubble—a rarity historically.
  • Doubts about cuts now fueling market wobble.
  • Job market data and ambiguous government stats central to rate cut debate.
• Fundamental Weakness Lags Technical Peaks
  • In 2000, fundamentals only rolled over months after the first tech breakdown.

6. Hedging and Safe Havens (or Lack Thereof)

• Gold’s Complex Story (26:43–30:14)
  • First leg up: Central bank buying, driven by Russia, then China.
  • Second leg: “Debasement fears” among retail investors, meme-stock-like behavior.
  • “You saw people lining around the RBA in Australia trying to get physical gold out of the vault. So it became a meme stock almost for a while.” — E, [29:16]
  • No current bubble in gold per Citi’s framework, but risk is elevated.
• Bonds & Credit (30:14–32:20)
  • Traditional hedges (put spreads, bonds) don’t work as well in a bubble blowoff.
  • Credit exposure may offer some protection if the US economy falls through a “trapdoor.”

7. Can the US Become an Emerging Market?

• Safe Haven Status Under Scrutiny (34:11–35:26)
  • Willer: EM status in trading terms: “Do your government bonds rally when the VIX goes up or they don’t?”
  • US authorities have more tools than true EMs, but some discomfort as Treasuries fail to behave like classic safe havens in recent volatility.

8. Positioning, Risk, and Behavioral Lessons

• Crowded Trades (37:10–37:45)
  • Many investors crowded into the EM carry trade and gold, both linked to low volatility.
• Lessons from EMs (39:53)
  • “The main issue is really political risk. And we have a lot of elections coming up...I used to say, much much bigger difference than in the US. Although that is more debatable at this stage.” — E, [40:20]
  • US political risk may be rising to “EM-like” relevance.

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Notable Quotes and Moments

• On Peak Mania:
  “There is no point where you can definitively say, oh, this is the peak of a mania. It could always get weirder.” — Joe (C), [13:15]
• On Bubble Tactics:
  “Once you enter bubble territory, you’re supposed to buy it. The only time when that didn’t happen was 1929...” — Dirk Willer (E), [21:53]
• On technical vs. fundamental signals:
  “It will be technical, it will not be, oh, fundamentally this happened and get out.” — E, [25:07]
• On “EM-ification” of US:
  “The strong lesson used to be that don’t assume you get these...well-behaved politics that you get in the US and other countries. But that lesson, of course, is somewhat undermined.” — E, [39:53]
• On the frustration of timing bubbles:
  “The problem with bubbles is you can’t sit them out. If you’re a money manager...your clients are going to be really, really angry if the S&P 500 is going up 20%...everyone wants to get out precisely at the top because we want to maximize our profits.” — Tracy (D), [41:34]
• On lessons from previous market cycles:
  “It’s really quite dangerous to be early in this thing...if you’re late, you can control a little bit more how much money you don’t make.” — E, [23:31]

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Major Timestamps

• Market conditions & volatility context: 02:00–04:41
• Is there a bubble & how to measure sentiment?: 05:08–08:56
• Dotcom bubble stories & analogies: 11:36–13:52
• Defining, timing, and spotting bubbles: 21:16–26:06
• Gold, debasement, and safe havens: 26:43–30:14
• Trading in a “bubble world” & EM lessons: 34:11–41:17

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Episode Flow & Tone

The conversation is both technical and anecdotal, blending empirical backtesting with colorful market war stories. Dirk Willer maintains a rigorous approach, emphasizing rules and signal-driven frameworks but underscores humility and adaptability in an environment full of crosswinds, behavioral traps, and historical parallels that may mislead. Joe and Tracy both press for applicable definitions and draw out Willer’s EM experiences to illuminate risks unique to the present.

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Summary Takeaways

• Bubbles have rules: Citi’s “2 standard deviations” real price move definition is an actionable starting point.
• Sentiment matters but isn’t everything: Institutional positioning was never euphoric in this rally, a divergence from past tops.
• Technical signals > fundamental signals for top-calling: Leadership narrowing (the “Generals Framework”) reveals when it’s time to get defensive.
• Bubbles usually last longer and go further than expected; being early is painful.
• Safe haven status is under review: Recent market moves call into question the classic role of bonds and gold as hedges.
• New EM lessons for developed markets: Political risk and “EM-like” bond behavior are no longer distant threats for US investors.
• You likely can’t time the precise top—set rules, prepare to ride the bubble, and accept some giveback.

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For more actionable insights and the mathematical framework for spotting bubbles, listen to the full episode and check Dirk Willer’s forthcoming book on global macro!

Transcript

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[C]

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

[D]

And I'm Tracy Alloway.

[C]

Tracy, markets getting interesting again.

[D]

I love interesting markets.

[C]

We do. We always say we're long volatility. That's right here at the Odd Lots Podcast. All financial journalists are long volatility, I guess.

[D]

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

[C]

There's some bad incentives, perhaps.

[D]

Perhaps.

[C]

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

[D]

Yeah. So at the moment we are recording this on Friday, November 14th at 10:07am yeah, we have to say that we have to be very specific because things are changing so fast at the moment. The S&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, things like tech valuations and the possibility of an AI bubble.

[C]

Totally. The US stock market has 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's 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.

[D]

You know, it 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.

[C]

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.

[D]

Although it's still going to be messy.

[C]

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 and a very interesting year for markets. We sort of got to get a better understanding of what's going on.

[D]

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.

[C]

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.

[D]

It's going to be useful in the us.

[C]

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

[E]

Great to be here. Thanks for the invite.

[C]

Let me ask you a question. If you went back, say a month ago or a month and a half ago, you were talking to clients, et cetera, did you ever encounter a single bear?

[E]

I mean, I'm trafficking more among the macro people than the equity folks and the macro guys are always half glass empty. 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 rally. Right. So meaning November and December have exceptionally positive seasonality.

[C]

Always.

[E]

And they have even better seasonality.

[C]

We're talking more strong in risk.

[E]

In risk. In S and P. Exactly. 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 that's how it goes, right?

[C]

Yeah.

[D]

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.

[E]

It's actually really key to this because if you were to say, listen, this is the top of a bubble or something, you'd have to see really, really enthusiastic sentiment. And we never quite saw 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 US equities because after April there was a big move outside of US equities, as you know, 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 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 our measures.

[D]

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, you know, 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.

[E]

Yes, that is very true. I mean, I think the market is starting to question those numbers a little bit. Right. When the Oracle deal came out, for example, the stock jumped, guess what? We are back to where we were before the deal was announced. So I think there is a certain sense of skepticism, partly 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 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.

[C]

You know what, since we've never had you on the podcast before and you know 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 62nd background of what you do and how you got here. Like what's your job? And yeah, okay. How'd you land here?

[E]

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. That'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, maybe not quite to zero, but you get a grass effect. So everything, that's what you have to focus on. And so even though I joined the hedge fund back then as a EM specialist, very quickly I looked into companies because we really had to figure when is this.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 because these bear market rallies are really quite vicious. And so in the end, all the money was made being long fixed income rather than being short equities. But broadly speaking, that was me shifting from emerging markets to global macro, if you like. But then I went back to the buy side party because, you know, the particular hedge fund never became as bullish again on the bull market, having been successfully bearish for a long time.

[C]

Many people are cursed by good luck getting bear markets right and then are haunted by that for the rest of their careers.

[E]

They're very rare. They're very rare. But yeah. So at Citibank I covered emerging markets for a long, long time and switched back to global macro a few years ago. 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 backtest 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 monitoring them carefully. And I have a bigger emerging market angle than most, which I still think is extremely helpful in this environment.

[D]

So since you've been around for a while, let's Talk about the 2000.com bubble or 1999 2000.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. Yeah, Asking whether or not people were talking about.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.

[E]

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

[C]

Yeah, I pulled up that chart recently.

[E]

And, and I remember Some stories. We had some analyst pictures all the time. So there was an analyst for Nokia who said, don't worry that we need more than 100% cell phone penetration in the world because pets will wear cell phone. Like, they were kind of right. It wasn't wr.

[C]

Kind of right.

[E]

So you. Or you got. My favorite pitch was for Akamai, where when analysts said, you know what? The reason why the company will do well is there are only three people who understand the formula that's basically at the base of it. And all three work for Akamai. So don't worry.

[D]

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

[C]

Literally, there's just no one who could ever replicate this technology because there are only three people who could build it, and they all got it.

[E]

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, 30 to 300 after the IPO and back to one.

[C]

Yeah, yeah.

[E]

These type of things happened. Which.

[C]

That was one of the more legit companies.

[E]

Yeah. No, they exist. Yeah. I don't.

[C]

Yeah.

[E]

I'm not covering them or anything, so I don't comment. But, yeah, it's.

[C]

Yeah, yeah.

[D]

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

[C]

Yeah.

[A]

Yeah.

[C]

It really does feel like you see some event, you know, like there was that. You know what I was thinking about when Jensen Wong, 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, literally, of a semiconductor.

[D]

A top being signed.

[C]

That's right. You know, it's like, why a CEO of a semiconductor company getting, like, legit rockstar 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 a mania. Right. It could always get weirder.

[E]

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, everything's fine. Yeah, everything. But of course, not every bubble has to get as crazy as the 2001. You know, I mean, it wasn't extreme even by bubble standards. So that is a bit of a risk if you focus too much on that one.

[D]

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

[E]

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 was of course 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.

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[C]

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, 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.

[E]

I think the reason is that a lot of the bullishness over the last weeks was based on one simple statement, which is saying, listen, we are building a bubble and the Fed is cutting into that. 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 are 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, it has consequences. Right? And so we wobble a little bit for that reason. 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.

[C]

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, November, if we had clear indications. I mean, what is the reluctance right now? Why, is it a coin flip?

[E]

Yeah, I mean, well, I think the single biggest thing is of course, all the comments we're getting out of the Fed, right? And we had the tweet earlier this week. And so in the end, if you try to forecast the Fed, you better.

[C]

Listen to what they're saying, but why are they rewarding given the weakness?

[E]

So I think the question is of course all about the reason you cut is a 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 break even NFP is 30k. If you get slightly positive net migration 60k. So that is somewhere the range where these days NFP should come in without there being a problem. Right. So 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 really clean one maybe have to wait even longer. But let's say we take November 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 somewhere in between. They'll find it out. But without that data it's just hard to reassure the market, yes there'll be a cut or no there won't be. So 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 noises out of there from sea were certainly a little bit all over the place. So it's not that obvious.

[D]

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.

[E]

Yeah, it's a big question actually. Even inside Citi, our equity, US equity strategists, it's the question, 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 the 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 your 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. Right. And the only time when that didn't happen was 1929. It went straight down. And I think the reason for that is a little bit that the way people define water 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 the bull market and the 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. I mean, on average, I can tell you there are two years of above average returns followed by below average returns. And on a 10 year time horizon, you're 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.

[C]

Which year are we talking about?

[E]

Sorry, 2000.

[C]

Okay.

[E]

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.

[D]

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

[E]

Yes, exactly. And, and of course it's highly circular. Right. People spend on Capex while their equity is going up. So equity stops going up, they start to reconsider, what do we do next? So then everything falls over. Exactly. 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 if you do the 50% in one quarter, 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, the generals framework because what happens in this bubble?

[C]

The what framework?

[E]

The generals. The generals, because it becomes very narrow and that's a feature of the bubble, it's not an exception. Right. And so 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 looked at the top seven leaders because people are excited about max seven, but it could be 10 or 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.

[C]

The 20 day moving. 200, 200 day. Okay.

[E]

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.

[C]

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 gains are. What is the time frame we're talking about? So you say two standard deviations above the real long term.

[E]

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 much you go by.

[C]

Standard deviations in, in real terms.

[E]

So we deflated because in the 70s a lot happened. Right. Even a bear Market. But was, but is it two standard.

[C]

Deviations in like a certain period of time or like how do.

[E]

Yes, it's a yearly. Okay, got it.

[C]

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. Why is that? Like where did that.

[E]

Yeah, I mean that we just, in a sense we just backtested it, right? We realized, okay, there's something special about these bubbles where the leaders carry the weight for a long time, right. 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 so you leave money on the table and too few signals where 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, once three of them break, it's becoming the odds are not in your favor anymore.

[C]

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's going on there.

[E]

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. He bought Euro, he bought CNY and he boug gold and euro was not a particular promising bet. In the end, CNY was a good bet for him. But obviously China cannot bet on the CNY and that leaves gold for China. And so I think in the very, very big picture, central banks are just very important for the gold market. The gold market bottomed in the 90s when the bank of England was done selling gold. And it will probably peak when the PBOC is done buying gold. 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 the Fed is going to cut and whenever the Fed cuts, 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. And that was roughly the time when Steven and Marion talked about the third mandate for the Fed and things like that. 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, because all the other debasement rates did not work. I mean, the curve did not steepen, break evens, 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. So it became a meme stock almost for a while. And so while it hasn't actually triggered our bubble levels, if we apply the same methodology, it certainly, I think became too dangerous. And so we actually got out of gold a little while ago. Now, the debasement story is an interesting story. It could come back, right? You saw gold consolidated for a while and then When Trump discussed $2,000 for everyone, then gold started to take off again because people started thinking, well, maybe we have to trade the basement again. And that's the way we call. And personally, I think the new FOMC will be more dovish than the old one, right? I mean, why? 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 rather than this year's story. 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 when they will come back, but structurally I think gold is likely still okay. In the short term, we are a bit more cautious.

[D]

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?

[E]

Yeah, very good question. What people typically do which is actually dangerous in a bubble is they just buy some, put spread in there. Some people. 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.

[D]

And we saw Michael Burry, who was like the poster boy for calling the AI bubble close his fund this week.

[E]

Yeah. So I think 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 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 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. What we have actually recommended is to do something in the way I see it. I mean, either the AI bubble continues to move higher and then credit will not benefit very much from it. 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 credit will protect you really well. So credit is something to look at. Good.

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[C]

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 joke in the US is becoming an EM and then it sort of gets a little more oh, ha ha, oh, this is oh. And then suddenly it like feels less and less.

[D]

It's not funny anymore.

[C]

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

[E]

I think people made the case in. First of all, the question is how do you define an em? It's actually a harder question than you think because traditionally people do it just looking at GDP per head. And then obviously MSCI gets paid a.

[D]

Lot of money to do this.

[E]

That's right. But putting that aside, I think for trading, the right definition is a little bit rather your bonds rally when the VIX goes up or they don't. Right. And on that definition, which is a trading centric definition of emerging markets, you actually find China is not the emerging market because CGP is rally when there is a risk off and Korea is an emerging market. So it's a much more sensible definition for traders than the World bank definition.

[C]

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

[E]

Exactly. So and of course the initial headline was for the UK right when the. When the distrust 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 should become a problem. So if you see US rates selling off during risk aversion, maybe because of fiscal voice 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 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. But it's not that they run out of roll in a way in 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 the disposal that they could use, I think.

[D]

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? 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.

[E]

Yeah, no, it's true. I mean there are many crowded trades. I would say. Again, I. Broadly speaking, we never found US equity position all that heavy, but it 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 and that is a bit linked to the volatility trade because it works well when volatility is low. And so that is a very heavily owned trade. It's very hard to forecast volatility spikes. I told you I'd have a quantium. 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 implies are 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? 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 210 implied volume index, EM implied volume index and high yield Spreads. 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. So if the stress comes from US rates and the move index, it will not like it. If it comes from Vix and S& P will also not like it. 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 obviously it could change.

[D]

What's the name of that index?

[E]

We have constructed our own.

[C]

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

[E]

Yeah, exactly.

[C]

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?

[E]

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 the main issue is really political risk. And we have a lot of elections coming up, especially in that time. We have Chile, we have Colombia, we have Brazil. So these things can really, I used to say, much, much bigger difference than in the us Although that is more debatable at this stage.

[C]

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

[E]

The new book is coming soon on the macro. So what's the new book on? It's the same idea, but on global macro rather than em.

[D]

Oh, great.

[C]

Well, we'll read it. Thank you so much, 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. Okay, let's just, just come up with some rules that tell us when these things, what constitutes a bubble and when.

[D]

It'S over, precision is good.

[C]

Yeah.

[D]

I hope Dirk will tell us when the bubbles.

[C]

First he's got to send us an.

[D]

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

[C]

Hopefully we'll see the note.

[D]

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.

[B]

Right.

[D]

Your clients are going to be really, really angry. And if the s and P500 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.

[C]

Yeah.

[D]

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.

[C]

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

[D]

Right. Exactly. And you accept that reality.

[C]

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

[D]

Well, I would add on to that that the companies themselves might be profitable, but but the business itself is as yet not generating positive cash flows and everyone just expects it to at one point, right?

[C]

Or the spending is simply not sustainable and that's another fact. Anyway, super interesting conversation we've had them on. Karthik Senkaran 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 treasuries. I don't love that.

[D]

Nope, not a good sign on that happy note. Shall we leave it there?

[C]

Let's leave it there.

[B]

All right.

[D]

This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

[C]

And I'm Jill Wiesenthal. You can follow me at the Stalwart. Follow our producers Carmen Rodriguez at CarmenArmandasho Bennett at Dashbot and Kale Brooks at Kale Brooks. For more Odd Lots content, go to bloomberg.com oddlots where the Daily newsletter and all of our episodes and you can chat about all of these topics 247 with fellow listeners in our Discord, Discord.

[D]

GG Outlaws 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 podcast and follow the instructions there. Thanks for listening.

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