Forward Guidance: Why This Economy Refuses To Break | David Cervantes

Sourced by podcast-ingest on 2026-06-03. Auto-transcribed via AssemblyAI (universal-2, en). Speakers identified by AssemblyAI Speaker Identification using the per-podcast host/regulars hints; the resulting label→name mapping is in the frontmatter. Duration: 46m. Episode page: (not provided). Audio: https://traffic.megaphone.fm/BWG8671318478.mp3.

Show notes (from RSS)

While investors wait for a recession that never comes, AI spending and fiscal stimulus keep pouring fuel on the expansion.

David Cervantes of Pinebrook Capital joins to explain how AI spending is reshaping the economy, profits, and traditional market dynamics.

We also discuss productivity gains, consumer resilience, inflation risks, Fed policy, bond market reactions, energy markets, and David’s favorite international trade. Enjoy!

TIMESTAMPS:

00:00 Intro

01:59 AI Buildout Is Driving Macro

06:01 Profit Margins And Productivity

09:58 Supply Chains Shift To Resilience

13:13 Consumer Resilience Mystery

19:19 What Funds The Consumer?

22:44 Why The Recession Never Comes

25:55 The Fed Rethinking Hikes

32:19 Warsh Inheriting Inflation Fight

38:07 Bonds, Equities And Rates

41:17 Can Stocks Ignore Rates?

44:21 The Korea Trade

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Transcript

David Cervantes: The biggest macro driver right now is the AI buildout simply just because of the numbers involved. I mean, we've got basically a trillion in capex and that number just seems to keep going up between the government deficits and the AI build. I mean, it's just a pile of money gushing through the economy. It find it very hard to see how an economy goes into recession. Those kinds of numbers. Public deficits are private sector surpluses. So one way or another, that money is finding its way through the economy as well. Right. The inflationary impulse was broadening and expanding even before the oil shock. I don't see how hikes don't happen or at least talk of hikes when they get priced and don't happen.

Jack Farley: Nothing said on for guidance is a recommendation to buy or sell any investments or products. This podcast is for informational purposes only and the views expressed by anyone on the show are solely their opinions, not financial advice or necessarily the views of Blockworks. Our hosts, guests and the Blockworks team may hold positions in the company's funds or projects discussed. As always, investments in blockchain technology involve risk. Terms and conditions apply. Do your own research. All right, everybody, welcome back to another episode of Forward Guidance. And joining me this week is a repeat guest, David Cervantes of Pine Brook Capital. David, always great to have you on the show. What's going on?

David Cervantes: Hey, Felix, glad to be back. It's been, it's been a few months or it's been a while, but good to be back. A lot. A lot's changed in our world since we last chatted. Yeah, we're at war, among other things. But yeah, lot going on.

Jack Farley: Yeah, yeah, it's a constant oscillation between it's so over and we're so back. It feels like both in the economy and markets, and regardless, markets still keeping going higher and everybody's pulling their, their hair out trying to figure out what the hell's going on and what's driving this thing. So hopefully in the next hour or so we can start to answer that question. Um, yeah, let's just start from the top line. Like what's your, what's your overall macro framework right now? What do you think is most important? What are you most excited about and interested at?

David Cervantes: I would say the, the biggest macro driver right now is the AI build out. And that's just because, simply just because of the numbers involved. I mean, we've got basically a trillion in, you know, Capex, and that number just seems to keep going up and up and, you know, now that now we're, you know, Google tapping the capital markets to fund its next chapter of its own AI build out is just kind of sign of the times. I wouldn't say it's anywhere it's a peak, but things are moving and it can't be ignored. It is just so big. And then you kind of combine that with our still large government deficits. Between the government deficits and the AI build, I mean, it's just a pile of money gushing through the economy and it just keeps getting bigger and bigger.

Jack Farley: Yeah. And it feels like the second, if you just think about the trajectory of that AI build out and the hyperscalers of the last couple years, the first phase has been mostly just funded from their free cash flow that they had that. Okay. Instead of throwing it into buybacks, we're going to use that for capital expenditure and people, okay, now we're, now we're at the end of that rope and okay, we've used up all that free cash flow. So, okay, now we're going to start to tap the debt markets. And that was happening back in, you know, December, January, February, and that was going on. And then, you know, you had a lot of prognosticators thinking, okay, well, you know, that'll be it. You know, we're getting to the point now we're issuing debt and that becomes a lot more sensitive to how sustainable it is. And then to your point, yesterday we get news on the tape that Google is actually issuing this $80 billion equity raise. So now we're talking about equity dilution and issuing of shares to raise capital for this build out. Yeah. I'm curious, like, how do you, how do you think about that? Like, how large of a signal is that? And especially in relation to equity valuation, I mean, if Google's issuing shares and diluting their stock, I imagine that means that their, their equity value is pretty rich. How do you think about that?

David Cervantes: Yeah, I think what's backing out a little bit, it's not just the equity value, it's what's driving the equity value. And unlike other episodes of exuberance, I hate to use the word bubble, but exuberance, there was a lot of PE expansion and now we have earnings expectation expansion. I mean, the earnings are solid, don't get me wrong. But you know, there's talk about there's a bubble in, in earnings expectations and, and whether or not those expectations are realistic and you know, whether or not they'll pan out. Not only will they question do they, will they pan out, but will they Pan out in time to fund the next step of the AI build out. Meaning, you know, there's obsolescence that's kind of factored, factored into these plans. Right. And you know, look, I'm not tech person, but I'm hearing, I'm hearing numbers like five years thrown around. So not only, you know, is this build out happening, but as time passes, things become obsolete, upgrades need to happen. And you know, is, is the earnings capture going to be take place at a fast enough clip to, you know, to weather the replacement cycle? You know, are we still going to be, you know, financing things that are functionally obsolete? That's, I think that's the bigger question that's to be seen. You know, that's, that, that's a couple years out. I think we're still there earlier innings of the AI build out. So that's kind of tomorrow's problem. But I would say that's kind of the big thing I would be looking at is, you know, at what rate do these earnings come in and do they come in in time to, to, you know, stay in line with the replacement cycle?

Jack Farley: Yeah. I want to double click on the second order effects there of this AI build out and specifically two things. One which is these earnings that have been coming in this last quarter just saw a huge acceleration in earnings growth. And even on those lofty expectations we were still beating left, right and center. It was a pretty exceptional quarter. We're seeing corporate profit margins accelerate too. So I'm curious, how do you think about that? And then the second one as well is this AI data build out. How do you think about that in terms of impacting like the manufacturing sector? Because you know, just yesterday we got the manufacturing PMI numbers 54. And so we're, we're accelerating further. The past few months have been really meaningful expansion and I'm trying to figure out what's driving that. Is that just a direct beneficiary of this ADA AI data center build out? So yeah, just curious, how do you think about the, the earnings acceleration and then what it's doing to the, to the manufacturing sector in the U.S. yeah,

David Cervantes: so I think the, you know, the bigger thing I'm focused on versus earnings is profit margin expansion. That is, you know, we're at, you know, we, we keep raising the ceiling on profit, profit margins and profit margin expectations. And that's something I kind of started writing about two years ago when I was looking at the incoming productivity boom. This is, this is the first pro cyclical productivity boom that we've had since the 90s. I think you and I covered it a couple of sessions back. But the thesis still holds. And that thesis is, you know, we have kind of the, the, the perfect storm of things, positive things that are giving us this, this productivity boom. And we're seeing it manifested in profit margins. So I think as long as, you know, the profit margins keep expanding or at minimum, you know, hold, hold their own, then this trade is still on. Because ultimately the profit margins reflect the underlying economics of the enterprise and of what they're doing with the AI buildout. So instead of looking at top line growth or bottom line growth, I think that the profit margin has more signal versus those other metrics for the forward look. So in terms of the second round effects on manufacturing, I think a lot of people have been assuming that the AI build out is going to kind of force this re industrialization or manufacturing renaissance. And we've been seeing that. But I don't think the driver is the AI build out. And the reason is somewhat supply constrained on the things that it takes to do the AI build out. What's been driving the industrial manufacturing renaissance or impulse growth, impulse is really a restocking cycle that is an echo of the prior supply chain shock from COVID So we had a lot of inventory bullwhips where because of uncertainty, you know, firms would restock and then they'd have to, you know, wear down their inventories. And it was this kind of bullwhip type effect through the economy. And I think we kind of got, finally got through the last of the inventory drawdowns. And this is really more a manufacturing restocking across the board. So I think part of that is also, you know, on top of COVID then we had the tariff, the thing of the tariffs. And I know a lot of that's been walked back and there's still a lot of distortions that remain in the economy. And I think the manufacturing impulse is trying to catch up, so to speak, and restock and try to get a level foot on the economy.

Jack Farley: That restocking dynamic. I'm curious if you've thought about how it, how it presents itself during a secular inflationary regime like we're in these days. I mean, we haven't been at the 2% target in a lot of years. Now you keep having these supply shocks that keep happening that I, I imagine these, these managers who are making these decisions are like, well, I'm going to err on the side of caution and, and pull forward my inventories because I one, I don't even know if the inventory is going to be there in six months. And I don't know what the price of that inventory is going to be like in six months. We know we could have this random new shock. So okay, I'm just going to pull forward demand because I feel like with these rolling, you know, even during the, I think Powell's last meeting or maybe the second last one, they kept asking him like, look, like we keep having these rolling supply shocks that keep happening. It's like we don't even know. We don't even have a normal baseline anymore. It sort of feels like. So I imagine that has like a pretty sensitive impact on the manufacturing sector where it's just like we need to keep pulling forward demand and it keeps, it keeps the economy strong because you know, we keep seeing these, restocking these other dynamics. What do you think about that?

David Cervantes: Yeah, so I think that's now a feature, not a bug. And something I wrote about a few months ago where for the past 20 plus years our supply chains have been defined by optimization. We wanted to optimize everything just in time. Inventory. You don't want to be tying up working capital and holding large inventories. Now with these shocks that just seem to never stop. Now there's a shift from optimization to resiliency. So if you're an operations manager, what you're looking to do is not just make sure that you have access to materials for your, your inputs, you, you have buffer stocks, you need to have extra and that raises working capital demands, that raises, you know, inventory requirements and on and on. So yeah, there's an element of pulling forward, but I think it's kind of a, for now a permanent thing because this, this shift into, from optimization to resiliency, it, it doesn't, you just, it doesn't happen overnight, you know, and, and you can't put a lot of money into the, into doing this and then shift on a dime. I, I think there is a transitional period that we're going through and resiliency isn't going to factor in more into how firms manage their, their supply chain.

Jack Farley: Yeah, I totally agree. Go ahead.

David Cervantes: I was just, I was just going to add that, that, that does, you know, that does have long term impacts on, on productivity, profit margins. Right. If you're, if you have working capital tied up and you know, you're not, you're not optimizing your capital structure because of these, of these persistent shocks, then that will lead into profitability. But I don't think it's, it's we're at the scale where, you know, we're be running red, you know, super redundant operational, you know, efforts. So it's just something to watch. But that, I think that that's a new, that's a new feature, not a bug.

Jack Farley: Yeah, 100%. So yeah, obviously we've characterized that the corporations are extremely resilient and, and navigating these supply shocks. Let's talk about how the consumers navigating it, because when I see something like gasoline skyrocketing over the last couple months like it has been, I imagine there's some pretty meaningful second order impacts on, on the average consumer. But, you know, American exceptionalism is, is still long and strong. I mean, you write about this a lot and I'm just curious to hear about how you're thinking about just that, that consumer resilience to navigate something like this and still be out there spending every week. Like, how is that working?

David Cervantes: Yeah, so there's, there's, there's a couple of things to consider. One is, I wrote about it this like just last week is the idea that, you know, the boomer cohort of consumers are funding a lot of their adult children's lifestyles and expenses. So whether it's things like, you know, the family vacation, you go on a cruise on a cruise liner, or you take that trip to Italy and France or whatever, a lot of, you know, a lot of cases, especially at the upper K part of the economy as they call it, you know, you have that phenomenon of, you know, someone else is paying for the big ticket vacation. And then more prosaically, you know, you have things like, you know, boomers helping out with the child care, you know, one of a lot of lot, yeah, your big expense buckets. When you're saying, you know, you're early to mid-30s starting family, you know, it's your, your, obviously your, your mortgage, your housing. But another big expense, and I can say this, I went through it myself, is child care. Child care is crazy expensive. And if you got them like in a Montessori school or whatever, forget about it. It's, it's, it's really expensive. And I think a lot of, a lot of boomer parents are helping their kids out with things like that. And that kind of frees up the, the income statement for other things like, you know, you know, the increase in gas or, or whatever. So I, I think that's, that's, you know, we all focus on, or there's a lot of talk about how the upper K, the upper K part of the Consumer segment's fine. Everybody else is struggling. But I think what's neglected in that discourse is this kind of stealth and very hard to document wealth transfer. And, and, you know, it's, it's, it's hard to document because, you know, no one's, there's tax implications, right? If you, if you're gifting money to your, to your adult kids, then there's tax implications. I think it's 13,000 is the max. So if you're, if you're spending, you know, decent money on all these other things, then you got tax implications. No one's going to report this stuff, but you hear about it and you, and you see it. And then I think that's also going back to, you know, what's keeping the American consumer afloat is, you know, I forgot what the percentage is, but it's a pretty high percentage of people that don't even have a mortgage anymore. I mean, think about that. You know, more. You're, you held your mortgage. You know, your mortgage was kind of, you're defining, you know, life expense. And when you've got 40 or 60, I don't know where the number is. It's somewhere, I know it's somewhere between 40 and 60%. Well, you've got, you know, a large part of the population that doesn't have a mortgage that frees up spending for other things, and not just other things, but also for the adult, for the adult children or for the, you know, for, for whatever. So there is that element to consider. And finally, you know, there's a core, there's a relationship between, you know, savings rate and wealth effects. So, you know, we've had this effectively. I mean, outside of COVID the US has been in an economic expansion since 2009, and the stock market's down to what, 300% since 2009 on the S and P? Probably higher for the NASDAQ qqqs. So as people have gotten wealthier through the stock market and their 401ks, et cetera, et cetera, I think a lot of the commentary about the fall in spending rate is, I think it's misplaced because it doesn't consider this huge rise in wealth that's been created and distributed. Now, the distributional. Does the bottom 50% own stock? Not a lot, if any at all. But for the upper 50%, that's a different story. And whether or not it's in direct equity holdings or retirement accounts, it really doesn't matter. It's still the same pie. It's still your Net worth, your wealth. And when people feel wealthier, they're going to save less and spend more. So I think we've got these kind of this three legged barstool of that that's pro consumption. Whether it's the boomer parents helping out, it's the wealth effect. And a lot of people just don't have a mortgage anymore. They paid off their houses. And those are separate conversations. But at the same time they are all relevant to how, how the consumption expenditure is being funded regardless of, you know, because of inflation, there's been a decline in real wages. You know, there's all these offsets to consider and I think those three big ones I just mentioned are really driving it. I mean you see things like, you know, higher end consumption, you know, experiential, experiential providers. For example, sphere, you know the sphere in Las Vegas, the concert venue. Right. You know this, this is a premium product. There's only, they have, they have a monopoly. There's only one sphere in the world. And you know, you try to go to a show there, it's three or four hundred bucks pop, if that maybe be much higher depending on the act. But you know, people are paying for things like that. Some there is a group of people that you know, can afford to do that. They go to Las Vegas and they spend a lot of money on things like the sphere. And that's across the economy. It's not just unique to Las Vegas but so somewhat spending and it's coming from somewhere. And I think that somewhere is those three things I mentioned.

Jack Farley: Yeah, that's really interesting because yeah, like last week we got this PCA PCE data that seemed to have set ablaze fintwit in terms of discourse. And yeah it's, I want to characterize it a bit better and further too because during that data, okay we saw the savings rate hit like a, I don't know if it was a multi decade low, but very, very low. Like below 3%. Income growth was very lackluster. Consumption was above incomes. So you know, there's some sort of dynamic there that's going on that isn't being entirely captured in terms of what's funding that higher consumption. It sounds like you think it's those buckets that you just mentioned that don't get characterized as well in that data. But at the same time, you know, you have, I saw some, some data points about just like credit card delinquency rates are accelerating pretty meaningfully. And so I just have this question, I'd love to for you to unpack further, which is that, okay, are you saying that in light of the fact that income growth is pretty lackluster, these other buckets are just so strong. Like to your point about wealth, and you know, it's not so much the flow of income, but rather just this wealth that has been built up by boomers that has been passed over and you know, just how rich they feel because their equity asset portfolio is going up higher, maybe they can take loans off of it and then that sort of thing. But you're saying those dynamics are just so much more overpowering than something like lackluster income, that it still leads to a confident consumer even though it looks on the surface like it may not be sustainable? Is that what you're saying?

David Cervantes: Yeah, I mean, I mean, think about it. I mean, I mean, someone is spending the money, right? And, and you know, it's coming from somewhere. And I think because, you know, the, the main one that I mentioned about the, you know, the, the stealth boomer wealth transfer, that that's really outside of an actual, you know, liquidity or event where, you know, an elderly parent dies and there's an estate transfer. Outside of that, it's, it's really hard to get data on that, right? Because I said no one's, no one's going to report how much money they're spending on their kid, on their adult kids. So that it's, it's. So there's an element of conjecture. I don't have a lot of data

Jack Farley: to back it up.

David Cervantes: But, but, you know, anecdotally, I think it's there. We see it, you know, you know, on social media, you see a lot of, there's a, it's, it's kind of a thing now, right, to, to, you know, be in your 40s and still be going on vacation with your parents or your in laws or whatever. You know, when I was growing up, I was kind of like, no, I don't want to go, I don't want to be an adult, go on vacation with my parents. And now it's kind of, there's a shift in cultural attitudes and I'm sure part of that's driven by the funding aspect. Hey, free vacation, why not? You know, so, but yeah, you know, but, but, and not only that though, but if you think about the, when going back to, I mentioned about, you know, the AI spend as well as the federal deficits, you know, public deficits are private sector surpluses. So one way or another that money is finding its way through the economy as well, right, the government's spending it. There's, you know, it's, it's making its way to the private economy. You know, of course there's distributional issues and who gets what, but that's from a macro aggregate standpoint, it's really irrelevant. The distributional issues are more political economy. But in terms of pure economy, it doesn't really matter. Those numbers are there and they're massive. They're huge.

Jack Farley: All right, so with all that said, pretty clear that if you continue with the fiscal deficits that we have with the AI buildup that's going on, this resilient consumer, recessions are still just a word that has no warrant to be in the vocabulary right now. Is that still your view? Because that's been your view for a long time and you've nailed it during moments where everybody was screaming about recession. I want to make that clear.

David Cervantes: Yeah, no, that's really a big part of it. These are World War II style deficits. I mean, the last time we had deficits this size, I mean, during the Reagan military build out, I think our deficits were like maybe 3 or 4%. And that was kind of like, you know, people were, people were just, you know, a gas at, at that. And you know, now we're looking at 6, 7%. And we haven't had that since World War II. And it's just really hard to put an economy into recession while those kinds of, you know, numbers are being pumped through the economy. It's like, it's like, you know, it's, it's, it's forced, it's force, force, force method to the economy. So to spe, it's just, it's hard. I just don't, I find it very hard to see how can you go into recession. Those kinds of numbers. Now shocks, shocks are a thing, but we've weathered the shocks, you know, relatively well. We weathered the, you know, the rate shock of 22, we weathered the tariff war. Now we're weathering the kinetic war and the, you know, you know, the oil price shock, which isn't even that much, this is going to be even that much of a shock anymore. So yeah, the economy is resilient, the consumer is resilient. And yeah, look, there's always a tipping point at some point, but the labor market, you know, so far has held up. And that's another thing too is, you know, the labor market has been struck because of the President's immigration policies. So you know, with, by shrinking the labor market, you kind of mechanically put downward pressure on the unemployment rate and one of the NBER's National Bureau of Economic Research, you know, they're the business cycle dating people. One of the things that they weigh very heavily is, you know, a decline in the labor, in the labor market. And we just, we just are not going to get a decline in the labor market at a magnitude that would be consistent with recessionary conditions. It's just not there. We're effectively at full employment and there's a good, there's a good chance that employment could get down to 4% by the end of the year, despite what's, everything that's been happening in the economy. So when you put all that together, you know, it's really hard to say, well, wow, we're going into recession, but employment, unemployment's falling. It's just, it's, it's incongruent. You can't have a, you know, we're going to recession, but unemployment's falling 100%. It's just, it's just like. Yeah, sorry. Yeah, go.

Jack Farley: Yeah, no, I, I just wanted to dig into how the, the Fed and the Fed's dual mandate starts to impact that. Because if we rewind back to January, there was a pretty meaningful amount of rate cuts price into the curve. And a lot of that depended on this potential mystery of the labor market. Because of the dynamics that you just mentioned around immigration and everything. You know, we were getting some pretty lackluster job sprints, you know, some negative revisions, all that stuff. And you really had to have a really keen eye to this dynamic of the evolution and the impact of this change in immigration and how that's impacting like the break even rate for the labor market. So at that time there's quite a few rate cuts priced in. Then you have the Iran war, you have that shock. And fast forward to today, we have a meaningfully stronger labor market. We have better clarity on the fact that, okay, we were actually like you just said, probably at maximum or full employment. And now you have an oil shock and accelerating inflation. Suddenly here we are in early June and we have rate hikes priced to the curve. How are you thinking about that?

David Cervantes: Yeah, I mean, I've been thinking about that for a while. Back March 1st, I called none and done that. We were not going to have any rate cuts by year end because the inflationary impulse was broadening and expanding even before the oil shock. So you know, right now obviously there's the, the supply chain part, but there's a part of the economy that has a lot of price pressure that has nothing to do with, you know, oil energy. So you know, typical Fed framework is, is, you know, they, they look through oil, I'm sorry, they look through supply chain shocks. They're just like, okay, these, these are one offs. They might raise the price level, but the trajectories is after that one off it's, it's unchanged. So you know, you know, it'll, it'll mean revert and we'll be, you know, happy days again with respect to inflation. But that wasn't happening by late, late winter, I'm sorry, late last year, early January I think January. We came in at 042 month over month. So we started seeing, you know, seeing the inflationary impulse building up, you know, two months before the actual invasion. You know, January is always kind of a, kind of a wild card because there is an element historically of new year new prices, right? So if you're, if you're a vendor and you like, you play the inflation card, you know, you, it's like, hey, it's the new year, I gotta raise prices. So there's an element of that. So I think January, even though it's historically hot, it gets a kind of a pass because of that new year new price phenomena. But then we start getting into February and March and the prints were just, you know, still very strong. And the, you know, issues with the oil price shock had even come into play yet then this is, it's a different bowl of wax. And on top of that, you know, a large part of the disinflationary impulse of 24 and 25 was housing driven. Right? Rents were, you know, slowly coming down. And, and that was really kind of the big driver. We've kind of harvested the low hanging fruit of a decline in rents. Rents still may continue to go down, but not at the same rate that we saw in 24 and 25. So with the low hanging disinflationary fruit picked out a broadening inflationary impulse prior to the war and then the labor market that's actually strengthened between January and now. I think January was 4.5. I think it was 4.4 or 4 point. Whatever it is, the unemployment rate is lower now than it was in January. So how do you no longer have the. Well, we want to prioritize the labor market. Well, how can you prioritize it when inflation's broadening and unemployment's falling in fact actually hurt the labor market? Because that puts pressure on upward pressure on wages. So you know, if you go into the theory of the neu, I think It's a non. Inflationary accelerating whatever, whatever. I forgot to find the acronym, but it's bas it's, it's the basic idea of, you know, at what rate can, you know, wages grow without impacting inflation. We're at risk of running above that level because you know, there's more inflation and there's, you know, the labor market is not rolling over so people are going to demand, you know, people are to, when people negotiate the labor contracts, they say yo, you know, my, my wage from a pirate job isn't cutting it. I need to make more money. So I do think that, you know, another, another nail in the disinflationary coffin is in fact going to become, will be coming from, you know, some pressure upward pressure on, on the wage side. So I just, I just don't understand. I don't see how hikes don't happen or at least talk of hikes when they get priced and don't happen. You know, the, you know, the market front runs these things. So you know, we don't, you actually have to wait for the actual price policy rate hike. The market prices it in and it's already, it's got one priced in and I think that's going to accelerate.

Jack Farley: Yeah. So the super simple way to put it is that look, if this dynamic was actually really just an oil thing, we could maybe fade the rate hikes. But what you're saying is that there's actually some coincidental dynamics underneath the surface of just that that are validating these rate hikes. So we probably don't want to fade it. One, being the labor market's stronger than we thought, two being there's a lot. This is a much broader inflationary reacceleration than just headline oil inflation.

David Cervantes: Absolutely, absolutely. And you see with the, you know, if you look at the ISM numbers too, the if the price is paid component of, of ism that is on fire, I mean really strong numbers that we haven't seen since 2022. So I mean this is not just like you know, gas at the pump and remember core, Core, core excludes that anyway. But there are knock on effects that oil, the oil price shock does eventually infiltrate, you know, the general price equilibrium and raise it. And I think we're, we're kind of entering that area era.

Jack Farley: So this is a fun moment for Kevin Warsh's first ever meeting as Fed chair in June. Coming forth into, you know, when he got nominated there was, there was cuts priced into the curve and now he's sitting in the chair about Dev's first meeting and there's hikes priced into the curve. Any, any thoughts on how that pans out?

David Cervantes: Yeah, I mean, he's coping. He's, he's, he's in a real pickle because his boss, his, you know, he's not independent. Right.

Jack Farley: He's got a boss.

David Cervantes: That boss is the President. Right. Fine. It is what it is, but he's in a pickle. And I think he's trying to navigate it by moving the goalpost. So he's trying to push for a new inflationary metric. Instead of being core pce, he wants to be trimmed. Dallas trimmed mean pce. And the problem with that is the, the Dallas methodology is not symmetric. What does that mean? You know, typically when you, when you trim mean something, you kind of clip off the tails on both sides. The Dallas methodology does it asymmetrically. It cuts off the top 34% of high prices and the bottom 20 something odd percent of low prices. So you've got this kind of asymmetric weaning of the tails, which mechanically favors a lower price. Under that metric, we're looking at around 2.5 PCE, which is just, you know, ask anyone paying for groceries or pupping gas and they say, are you crazy? That, and it's just, it's kind of politically expedient. But, you know, if you're. I think the Cleveland Fed has an alternative trim mean, and don't ask me how I find these things out. The Cleveland Fed has an alternative, a symmetric trim mean, and I think that's close to 3%. So, you know, I think core right now is 3.3 year over year, just the traditional core. The Cleveland is somewhere below, slightly below 3 high 22 nines, and Dallas at 25. So, you know, sounds kind of wonky, but, you know, he's trying to move, move the goalpost, and I think he's going to have a hard time. You know, look, the FOMC is a committee. It's not one person. And the, the, the, the role of the chair is to kind of build consensus and, and cajole and, and, and, and twist some arms behind the scene. You know, tra, you do the proverbial tra, you know, horse training to try to get a unified consensus on paper. And I think he's going to have a hard time doing that. In fact, there's a good chance that there might be kind of a revolt within the institution. A real hard line between doves and hawks, I think Beth Hammock was on the tape yesterday saying look, if these inflationary prints keep coming as they are, the conversation is going to shift. So I'm not, I'm not, I don't know where she sits on the Dove hawk spectrum, but you know, she's, you know, there's, it's a, it's a loud voice, a prominent voice. And yeah, I think that sets up, that sets up for kind of a bonfire advantage within the Fed of you know, a bar fight of who's gonna, who's gonna have the, who's gonna be, you know, who's gonna be the, the intellectual guiding light. Now Waller typically has been the smartest guy in the room. He got the prior inflationary look through mostly right. And I think he's kind of flip or flipping towards hawkish. So that's gonna be something to watch. But yeah, going back to Wash Kevin Warsh, it's gonna be interesting one to watch 100%.

Jack Farley: Um, yeah, I definitely perk up my ears when I hear Waller change his views. And to your point, he had an interesting speech where he definitely shifted gears from being pretty dovish to yeah. Beginning to lay the groundwork for hikes. So it does seem like it's gonna, it's gonna actually happen. Bit of a wonkish or semantics question for you, but I'm curious like, so you have, in this modern day and age of forward guidance from the Fed, like you, you get these hikes priced into the curve and then you know, maybe six months later you get the actual rate hike. I'm curious how much like if you're going to put a percentage on impact on the world or markets or economy or whatever you want to say, how much of it is the impact from the pricing in versus the actual like change in the effective federal funds rate? Because we just had the pivot from cuts to hikes. Like do you think that that's more meaningful than the actual hike that comes at the end of the year?

David Cervantes: Yeah, I mean market, look, markets, you know, they price in they front run and they price in the entire, in net present value of all financial assets. And that you do get more bang from the buck from the expectations front running than you do by the time the actual hike or cut or policy move comes. It's kind of baked in the cake. It's really a non event unless it's surprise. It's a real surprise or the magnitude is greater than expected. For example, I believe it was in September of, was it 25 when they

Jack Farley: did the 50 surprise?

David Cervantes: Yeah, 50 surprise. You know, things like that that'll get Things moving, but for the most part, you know, market's price is centered slowly, slowly, then suddenly and then by the time it's done, it's getting over.

Jack Farley: All right, so I want to, I want to take that framing and ask you about how you view that impacting both the long end of the bond market and equities in the US We've seen a pretty meaningful sell off in the long end of the bonds over the last month or so. It's given back some of, you know, we've rallied a little bit since then. Equities have no issue in rallying. You know, we're setting all time highs every week. So it doesn't seem that they're too concerned. How do you, how do you think about those two asset classes in light of what we just talked about?

David Cervantes: Yeah, so we got to understand, you know, what's driving, you know, what's driving the rate hikes. Is it, you know, real rates? Is it term premium? And I think what we saw in this most recent episode, real rates did go up, but term premium went up more. So what that means is you had kind of, you know, investor fear about these issues. I mentioned at the Fed the big issue that bond investors have with Fed policy. It's not so much, it's not so much the, it's not so much the concept of a raise or a hike. It's really about what are the rules and what is the credibility of the institution enforcing the rules. So what I mean by the rules, what's the policy framework, what's the reaction function? And then the credibility part, is there consensus, is there institutional consensus in getting this done? And I think we got kind of pop and term premiums in part because, you know, we don't know what the rules are. Is it core PCE 2%, is it Dallas trend mean to 2.5% or is it Cleveland fed 3%? So I think as, as markets are trying to make their, make their, make up their mind about what is what, that, that tends to be the bigger risk than just okay, rates are X, Y OR Z. The 10 years at 460 or 460, I think it peaked at 468 about three weeks ago that, you know, figuring out the reaction function and the credibility of the institution enforcing it matters more than just where our rates. That's kind of a secondary issue. Markets will adjust and so you have to look at what the drivers are. And I think, you know, look, we tagged 5% back in October of 2023 and that, you know, after you Know the market was off to the races after that, maybe before that, but also it just continued. So you know, I wouldn't even get concerned with rate 10 year rates at, at, at 5%. You know that's just, you know that's just the bond market doing what the bond market's supposed to do and equities will, will trade off of it, provide it. What's driving, you know, driving it is not something that's harmful to the cycle. So. Yeah. So you know, the two things can coexist. Higher, higher, higher, higher nominal interest rates can coexist with rising, rising markets and vice versa. It really, really depends on the causal factors. Not just, you know, some magic numbers. Is kind of the, the red pill

Jack Farley: or the black pill. I think that's something that is catching a lot of people off guard is. Yeah. In their framing. You know, 5%, 10 year equity's got to go down similar to what happened in 2022 or, or what have. It feels like circling back to some of the dynamics we talked about at the beginning of the show. Corporate profit margins are just up, only earnings are accelerating. Really incredible stuff going on there. We have public sector deficits which are private sector surpluses as you mentioned, that's a tailwind. And then you have the AI data center thing. If it's all being built out that crazy. That's going to be added to the mix as well. It just feels like those factors are so much more powerful than the bond market and especially what the Fed is doing. Is that how you see it as well?

David Cervantes: Yeah, I mean effectively. Yeah. I mean there's just, these are just very powerful, you know, very powerful moves happening underneath. You know, I am a little, look, I am a little concerned about what's happening in the energy space. My thesis was actually pretty bearish a few months ago thinking that you know, once, you know, you know, unless the straits are open by mid summer, things are going to get difficult. But you know, there was some, you know, there was a big, a big force in the market actually a couple of big forces. And that was basically the SPR Strategic Petroleum Reserve spends by both China and the United States. China effectively became a central oil banker in a sense by releasing, they basically cut their imports which freed up imports for other countries and they had a gargantuan SPR release starting in early May that offset a lot of these inventory holes. So that kind of bridged things and surprised a lot of people and I think a lot of people that were expecting, myself included, you know, oil to be above 150 by June. It hasn't happened. But that's, that was kind of the, the, the, you know, the, the invisible hand in the market was the SPR releases. Now that said, Those are finite SPRs, you know, they're not, they are finite resources that at some point do get run down. And that rundown period is looking like late July, maybe early August. So, you know, at some point there still is going to be pressure in physical commodity markets. That was expected around late May, early June. Hasn't happened. Good chance it happens in late July, early August. We just kicked, we were just able to kick the can. Now a lot of things can happen between now and then and right now the market's given in, giving it the benefit of the doubt. But you know, those are still physical realities that need to be dealt with in the, in the upcoming months.

Jack Farley: Yeah, yeah, good points. All right, last question here, but what trade or what mispricing in the market are you most excited or interested about? To wrap up here with something a bit more tactical.

David Cervantes: But.

Jack Farley: Yeah, what are you fired up on right now?

David Cervantes: You know, I'm fired up on the Korea trade. I've been, I've been very bullish at trade since early this year. You know, I was dabbling in and out of it last year and then this year it just got, it just went parabolic. Fortunately, we, you know, in, you know, subscription members were on it. But it's not just, it's not, it's not just limited to Samsung and Hynix Semiconductor. All those, you know, all Those combined are 50% of the index country weight. But there's, the whole economy is on fire and it coincides with, you know, this huge pop in birth rates. They just had, They've been kind of, yeah, they've had, they've had some really bad demographic issues and this year they, we get the sudden pop in birth rates. Then you got Samsung giving out $400,000 bonuses to their employees. I, I think and, and, and the, the, the, the, you know, I think the pe, I mean, it's no longer what it was, but I think back in, shortly after the ceasefire announcement, the PE was looking at six. So you had, you had these, you know, parabolic growth rates and exports and semiconductors and the, it was still trading historically extremely cheap and it's still cheap not as it was before. But that's, that's just, you know, that's, to me, that's just been the. No, no brainer trade has worked out.

Jack Farley: I like that one, man. I was in, I was in Seoul, Korea, last summer. And I was just blown away. This was my first time. I was blown away at how just driven and hungry that economy is. And the average person is there. Like, I can totally see it. They are just, they are they are ready to sell some stuff in the world. Like, it's incredible.

David Cervantes: They just want to make money. So that's yeah. So that's that's really interesting. Yeah.

Jack Farley: Yeah, yeah. 100.

David Cervantes: All right.

Jack Farley: Well, David, always great to have you on the show as usual. Thanks for breaking this all down. Where could folks go if they want to see more of your work?

David Cervantes: Pinebergcap.com Go check it out.

Jack Farley: Amazing. There you go.

David Cervantes: All right.

Jack Farley: Thanks, David. Appreciate it.

David Cervantes: Thank you. Take care. Bye.