How Excessive Leverage brought down Wall Street’s Golden Boy

0:06Welcome everybody to the Art of Investing Summer Edition brought to you by IG, the Global Investing platform. That's right. We're on our summer holidays. You can see Spice in his super yacht in Saint-Tropez and CJ down in his shed in Skegness. Yeah, it's quiet here, Rich. Very quiet. So today we're going to bring you Leopold and his leverage. That's right. By the end of today's episode, you're going to know how to run your own hedge fund and how not to. But before we get into that, we're going to have a look at this week's portfolio performance. It's a good one. Your capital is at risk. The value of your shares, ETFs and ETCs can fall as well as rise, which could mean getting back less than you originally put in.

0:49This content is for information purposes only and is not investment advice. Past performance is not an indication of future results. So we got a week on week performance of up 4.2%. We got year to date up 13%. And now since inception, that number growing to up 25.5. This is the last week of the first year of the portfolio. So quite a stellar performance. We'll come back to that later, though, because we want to hear why those performances have come about. Let's go to the Spice Market update. Thanks, Rich. Quite an interesting week. Very interesting, in fact. And we're going to debate about why the big moves have happened later on.

1:27But basically, you've seen another outbreak of peace or semi-peace in the Middle East. So Iran and Oman looked like they'd done some sort of deal in the background to semi-open the Straits of Hormuz. So the bombs paused. Stock markets rallied a huge amount. Oil fell 10%. Some people might say it might be down to Kevin Walsh's weak statement as the Federal Reserve chairman last week. But net-net, the US dollar had one of its biggest falls in the last year or so, down 1.6%. Commodities all had a great run, up sort of between 5 % and 10%. And you saw a huge swing back from the value companies back into growth companies.

2:09Remember, we talked in last week's podcast about how value had had a very good sort of run for the last couple of months. Obviously, saw quite a big reversal of that this week. That was led by the U.S. markets and those that are heavily skewed to technology and growth companies. So we saw all new time highs again in the main US markets, the S &P, the Dow, the S &P, equal weighted, the Russell 2000. NASDAQ had probably the best week of all of them, but still below its all-time high because it had been hit, if you remember, by about 12%, 13 % in the last couple of months. It had gone into correction phase, as we mentioned last week, which is one of the reasons we went in and bought a little bit in our portfolio.

2:51And obviously, that's done as well on a one-week view anyway. let's not get short term. In Asia, you saw Korea have its biggest ever one-day rise. It was up 17 % in one day. And that was led by all the usual stocks like SK Hinex and Samsung. It's only got two stocks, doesn't it, Spice? Yeah, but who cares if they're two good ones? Is that right? Two stocks make up nearly 50 % of the index, I think? Yeah, that's about right. Absolutely. I think it's 55, actually. But no, I say if they're good ones, we don't mind if they were bad ones then we would worry and what we'd give to have some of those in the UK market it was new highs also in the UK market I'm just saying that I'm just getting that in there because you're trying to you're trying to gloss over the FTSE 250 new high and new highs in the FTSE 100 well I was going to mention that in the in the market report when we talk about the portfolio because we obviously added to our sort of FTSE 250 last week which is again like the nasdaq ad has done has done us good and we added to japan as well if you remember which didn't make any all-time high but had a very big bounce so it a lot of it is being driven by some fantastic corporate results that are coming out all around the world particularly in the u.s but now we're on track for our seventh quarter in a row of double digit earnings growth around the world and particularly in the u.s and we're running a mid-20s percent growth in the u.s Even in the UK, we've managed some good results.

4:24Persimmon, the house builder, was up 4%. WPP, which is a big marketing company, used to be run by a guy called Martin Sorrell, who was considered one of the gurus of marketing. Their shares are up 25 % today. While not so good, Whiz Air, unfortunately down 4%, but suffering like many companies in that space and tourism or airlines because of the high oil price, and they're still suffering from that. So their shares are down 4%. back into the tech world, which has been the main driver of these big rallies back up. We've seen Western Digital and SanDisk, two big sort of memory companies in America, actually had fantastic results.

5:01But the shares, both their shares fell very heavily, actually. Western Digital were down 14%. SanDisk were down 9%. But let's give you some perspective there. Western Digital is still up 200 % year to date. And SanDisk is up 500 % year to date. So although you've had a small drawdown, Sandisk is still the best performing S &P 500 stock this year. And I think this gives us a good chance to talk about our main topic of the day, and that is Leopold and his leverage. Because everything that Spice has mentioned so far all ties into this one story, a 24-year-old called Leopold Aschenbrenner. Eschenbrenner.

5:40Now, Leopold came from working for OpenAI, where allegedly he was sacked for giving ideas across to Anthropic. But he latterly is known for running a$45 billion hedge fund at the age of 24, with huge positions in SK Hynix, in Samsung, in all the AI names. And that has really been pushing these names around for the past few months, but it all came to a head last week where Leopold was effectively stopped out. And we're going to go through all the implications of that for the market today. And we're going to educate everybody on what leverage is and the dangers of it when it goes wrong. So that's coming up soon in our main topic of the day.

6:25Other tech companies, Apple, we had sort of talked about, had become the biggest company in the world again last week overtaking Nvidia. Well, it lost its crown this week. The shares fell 9 % after their results. And we'd sort of mentioned that Arm, who make chips that go into mobile phones, and Qualcomm, one of the biggest suppliers in memory chips into phones, had had bad results last week. And that actually fed through to Apple. Apple were struggling to get supplies into their phones. And that basically saw their shares down 9%. Still had a good year. Amazon, on the other hand, and this certainly helped boost the AI trade and the people who are worried about the big cap expense, Amazon shares were up 12 % on their results, about 22 % since last week.

7:12And they upped their capital expenditure by about 10%. But the management very clear, they said they think they can now get a three-year payback on any capital expenditure. So if you spend$100 billion building a new data center, they think they can get that$100 billion back in three years. So the proof is going to be in the pudding, but those results were exceptionally good. And that helped, obviously, some of the tech names around the world. That's interesting. I had a wonderfully entertaining evening listening to the SpaceX conference call a couple of nights ago. And Elon said roughly the same thing, three to four-year payback on all this CapEx.

7:53they're spending. The market would like that if that was the truth, wouldn't it? So as you say, Rich, that, you know, if you can get your return on that capital investment within three or four years, that's as good as any industrial company that's making widgets will probably look to get as well. You know, you buy a new machine to make the widgets and you want that money back within three years to four years. That's a standard accounting return. So that's pretty good and what makes the world think a lot more positively. Now we need more evidence. Amazon is the first company to say that. As you say, SpaceX had their results this week.

8:23Their shares were disappointing. Their shares went down 12 % on the back of the results, but they had been rising very heavily on the back of the Amazon results before that. Net-net, they end the week about down 2%. But what happens today is there's another 900 or so million new shares come into the market and the market's been anticipating that. One of the reasons that SpaceX shares are trading so far below their IPO price. They're trading about$112 a share this morning against$135 when they floated on their IPO a few weeks ago. It'll be interesting, Spice, won't it? Because the market is short 25 % of that initial free flow, knowing that all these new shares are coming to market.

9:03But these are people that believe in Elon, they believe in SpaceX. And what if they don't sell? What if the market is so short, these things, waiting for people to sell and it just doesn't happen? It's going to be one almighty short squeeze. Dream on, Rich. Dream on. The bulls are back in town. It's now, you know, we can do all this AI in three years. You know, everybody's short. It's all going to go up forever. Let's just watch and see what happens. Well, I think it's, to be fair to Rich, one of his old favorites, Palantir, on the bear side, as in he'd like to short it. Their shares were up 30 % this week on the day of their results.

9:44Again, a company that's very heavily shorted. So we've talked before many times about the pain that can come if you're short of a stock. They come in better than expected. You get very, very squeezed. And like I say, you see these huge moves. To be fair, the time to be short was at 200. That's when we were speaking about it. At 125 as it was got into these results. I'm not sure it was so well shorted. Palantir is trading$158. The high was over$200. So here's a stock where you're saying everything's brilliant, it's fantastic, it's trading 25 % less than where it was trading. And the same is true of things like SpaceX and all these things.

10:22We've got to be very careful here that these aren't just bounces in bearish trends because there was so much built into them. So, yeah, I'm comfortable with things, but let's have a bit more of a rigorous fact check around what we're talking about rather than just trying to, you know, sort of talk the good news the whole time. Oh, you can tell you're a bond investor. Correct. So blooming busy. I'm a bond man. Can I talk about bonds, please? Because they were really exciting this week. Oh, three basis point move. So bonds this week did nothing. They were absolutely tedious. In fairness to them, they actually rallied a very small amount.

11:01And if you remember, we were talking last week about the Fed chairman and his disappointing news conference. That really put a foot on the neck of the equity market. The equity market was very worried with the sharp move in bond yields are higher. With those bond yields rallying a little bit, that was another factor, I think, which helped the equity market recover and go, oh, well, things aren't as bad as we were thinking. So there's a bit of a relief around here. So that, I think, is important. And I'm just going to go back to one other thing, which I know will upset Mark quite greatly, which is the FTSE 250.

11:37And the only reason I go back to the FTSE 250 is people like me have been talking about it for years and years and years and have basically fallen asleep thinking about it. It actually took out its high this week, the high that's been there for five years, it took out. So we should mark that and say, well done. The fact it's underperformed every other market by anywhere between 50 % and 100 % is, I'm afraid, putting that in perspective in the same way as I said, we need to talk about perspective around the other things. But well done. Take out the high. We've got a decent position. See what happens next.

12:09Great things always have to start somewhere, CJ. They certainly do. And, you know, I think, to be fair, as I say, part of it is we're seeing, and we've talked about this numerous times in previous podcasts, is that the economic growth we're seeing and the benefits of AI in terms of better margins, more efficiency, etc., is beginning to spread out from the very biggest companies. And that's one of the reasons we've got a big position in the Russell 2000, one of the reasons we've got a big, big position in the FTSE 250, which is the middle school size companies in the UK. So as I say, we're in the seventh quarter in a row, a very, very good earnings growth out of America.

12:44That is spreading into other regions. At 10 of the 11 sectors in America, those companies increase their margins quite substantially. And that's very unusual to have all these sectors improving at the same time. And JP Morgan have done a bit of research that say that they identified that companies who have adopted AI early and are using it efficiently are now getting about 1 % extra margin in their profits, which is huge, by the way, given that most companies will struggle to maybe make 10 % margins net net. So that's 10 % more than you were getting if you add another 1 % to that and get 11%. And that increases your cash generation, profitability, and helps the valuation.

13:28Yeah, I think the average margin for S &P 500 is 14%. So yeah, definitely a big number there. But earnings season as a whole, So we're 66 % of the way through at the end of this week. 28.8 % growth in earnings versus expected 23%. So I've got to say, it's very, very hard to fight that. Now that we've got the leverage problem out of the way, which we're going to come to shortly, the earnings are really printing and S &P 500, it's hard to see it not going upwards towards 8 ,000. So, I mean, the valuation is slightly less than 20 times forward earnings, which, by the way, isn't massively out of kilter with history.

14:11Even Nasdaq's down at 21 times. And that, as you say, is this delivery of all these earnings coming through from the biggest and the best companies. So, you know, that bodes well, as you say. We don't want to get ahead of ourselves, but nice to see things like the S &P and some of those broader indices, including the FTSE 250 CJ, taking out their all-time highs this week. Okay, so let's get that beautiful portfolio back up on screen then. As you can see, a fantastic week, especially in mining world. We had the BlackRock World Mining Trust up 10.4%, shortly followed by Japan, the Nikkei, some intervention there, which Spice is going to talk about in a moment, up 9.5%.

14:53MSCI Emerging Markets, as we mentioned, Korea helping that up 6.5 % in the week, and the NASDAQ up 5.9%. Spice, this is your fantasy, isn't it? It's your dream week. Absolutely. I mean, what a week. You know, BlackRock World Mining, you say, it's basically these commodity prices. But also, BlackRock World Mining don't just own the underlying commodity. They also own shares that make the miners, if you like, in that area. and those mining companies tend to go up or down more than or less than the underlying commodity. So as I mentioned earlier on, gold and silver up 5 % and sort of 8%, 9 % and copper up 5%.

15:32And yet the companies, the gold mining companies and silver mining companies all done better than that. And BlackRock World Mining own a lot of those. So they've benefited from that. So they've risen by more than the underlying commodity prices this week. Japan, as Rich mentioned, We've seen a really interesting intervention this week. So last Friday, we had the Bank of Japan very early hours in the morning. Bank of Japan had their meeting, their interest rate setting meeting, and they didn't change interest rates. Well, that was as expected. So, you know, that was a good thing for equity markets.

16:04But interestingly, within the next 24 hours or so, it turns out that the Bank of Japan, along with the American authorities, had intervened in their currency market to support the Japanese yen, which was weakening very heavily. And, you know, there was 163 yen against the dollar for a very brief moment. And it's back at 157 now. So that intervention worked. Absolute classic as well. So Scott Besant, the Treasury Secretary in the US, was caught on camera, somebody taking a picture of his notepad with a to-do list, buy Japanese yen. How about that? You couldn't write it. Brilliant. Brilliant. Absolutely brilliant.

16:49The other interesting thing was they didn't sell treasuries. They sold euros. And so there's lots of chatter going on in the markets that this is actually undermining the US dollar, and they're worried about undermining the US dollar, then causing people to sell treasuries. so that the big worry is that the central banks of the world would be selling dollars to say by yen or selling dollars to buy something else and in order to you know raise those dollars to sell they have to sell their treasury holdings and so they don't want them to sell their treasury holdings so the u.s sold euros not dollars the japanese have a law that they've got in japan where they can borrow against their treasury holdings they can borrow dollars they can then sell those dollars, but they don't have to sell the actual underlying bonds.

17:46So there's a big worry here that Besant's actually pretty concerned about the US bond market. And that's why he's doing it the way he's doing it. Now, clearly, everyone's making up the story that suits them. Last week, the Federal Reserve statement was worrying to everybody. And so they're a bit worried about what that means for bonds. Are people going to buy those bonds? What's going to happen. But I don't think the game's over here. I think we should watch this quite carefully, what's going on in the end, because it may be identifying a little bit of concern about the US Treasury market. So CJ, you're trying to say that Scott percent so worried about the long end of the yield curve that he phoned up the Bank of Japan and said, sorry, Bank of Japan, stop selling treasuries to support your own currency.

18:33I'll come and help you and do it for you. Surely that would It never happened. It's what happens in the new world we're in now. It's either that or tariffs. I think they prefer doing that than tariffs, but that's the other way of playing it. As we know from our friend Voldemort, we need to make sure that if it's not him, it's somebody else trying to do something, and that's what I think was going on. So it'll be very interesting to see how things develop. Remember, this is quiet. For people who haven't been in markets a lot, August is a quiet month. Not much happens in August. And they always say the B team of the people left at the desks, anybody at the desks who are listening to this, I'm not really being rude to you.

19:15But the B team at the desk is the A team are on the holes. And therefore, markets can move in fairly exaggerated fashion. And you can argue that with the AI trades this week, maybe. You can argue that in the dollar-yen as well, which has moved significantly from where it was trading. We will only see what the truth is when we get to the other end of August. And of course, it wasn't just the yen that benefited from, if you like, that dollar intervention. Sterling sort of rallied about 1%, as did the euro against the dollar. And this weaker dollar, as I mentioned, is the biggest fall for over 12 months, 1.7 % in the week, give or take, has basically helped fuel this commodity rally.

19:55Remember, we've talked before that the lower the dollar, the lower the US dollar, because their commodities are all priced in dollars, the higher the commodity prices tend to go. But that also helped emerging markets. We've talked before, a lot of emerging markets have to borrow money in US dollars. So if the dollar goes down, their interest charge that they have to pay on that effectively goes down too. That's one of the reasons perhaps why the MSCI Emerging Markets was our third best performing asset in our portfolio this week. You know, all those things coming together along with this AI bounce also helped undoubtedly.

20:26So we can group everything together in the worst performers on the week and our fourth place best performer, which is the Nasdaq 100 up 5.9%. Now, what has been happening, now we know the real story for the past few weeks, is that the Nasdaq and especially those AI names have been getting absolutely hammered. So SKINIX came to market a few weeks ago. And ever since then, the AI trade has been really, really struggling. And you've been seeing a rotation that we've mentioned many times on the podcast before. So money has been coming out of the AI names, out of the NASDAQ and into defensive areas, which has helped our Indian position.

21:10And it's helped FTSE 100 as well. It's also helped a lot of software stocks. So stocks you might have heard of like Adobe and ServiceNow. And the overwhelming huge position in the market had been long AI and short or underweight software. And as that reversed and money came out of tech, it had to go somewhere. So it went into the FTSE 100 and went into India. Now, because of Leopold Ashenbrenner, that all reversed last week. Literally from when we were recording the podcast last week, about 11 a.m. on Thursday morning, the story came out that this big hedge fund had had to be bailed out by Citadel.

21:56So that meant that the money could flow back into tech. And that's what we saw this week with the big outperformance from Nasdaq and the underperformance in our least best performance of the week, which is FTSE 100, pretty much flat in the week and India only up 1.3. Okay, Rich, that was really clear about the underperformers and the underperformers turned into the overperformers this week and what's been going on the market. But you mentioned a new name there, a chap called Leopold Aschenbrenner. And to a lot of people listening to this podcast, they're going to wonder who the hell that is. Is it some politician in Bavaria or something?

22:33But no, it's clearly something very relevant to what happened in the financial markets last week. So it will help us to introduce our topic of the week, which is going to be leverage. Why don't you tell us a bit about Leopold Ashenbräller and his story? So poor old Leopold has come from obscurity to one of the most talked about names globally in the financial world. this week, and all on the weekend of his wedding as well. And that's part of the story. So Leopold Ashenbrenner has just married the assistant to the head of OpenAI. It's of course the big AI name behind ChatGPT. Now Ashenbrenner used to work there and he was a very talented programmer in the AI world.

23:21And there is a story that he was let go from OpenAI because he's been accused of sending ideas to Anthropic, which of course is the big competition. So he left OpenAI and he wrote a thesis called Situational Awareness. And the basically underlying theme was AI is going to take over the world. It's going to be the best investments that you could possibly ever dream of going up 10x, 20x, and that he really believes that he can choose which names are going to benefit and just as importantly, which companies are really going to suffer from AI. So there was four investors that thought, well, this kid really sounds like he knows what he's talking about.

24:06He's only 22 years old, but they were really impressed and they seeded him with$250 million to start his own hedge fund. Now, since then, in the 18 months subsequently, his performance has been absolutely incredible. Until the start of July, this 24-year-old was up 420%. That's right, 420 % in six months, slightly better than our own portfolio. But there was one main reason for that, Mr. Fellingham. And what is it? Well, I'm afraid, Rich, it's our old friends, one we have seen on many different occasions in many different guises, but it's always the same and it's leverage. He wasn't just putting that money to work in the market.

24:54He was borrowing a load of money from the banks to buy more of those things. So he had bigger exposure. Why don't you talk to us about a bit about leverage, Rich, and then me and Spice will think of some examples for label. So leverage is basically when you borrow money to potentially increase investment returns. You might have heard it before, every now and again, it rears its ugly head. But if you want to think about it in a simple way, it can magnify both your profits and your losses. So when it is accelerating those profits or making those losses even worse, then that's where risk management becomes so important and the discipline and the people that you surround yourself with, especially if you're running a fund of up to$45 billion like Ashenbrenner was, you have to have the system in place to absorb when markets turn lower.

25:54So of course, leverage isn't just for rocket scientists and 24-year-old hedge fund geniuses. We also all use it in our daily life. spice. What kind of example would you give where people at home might have used leverage as well? The most obvious example, obviously, Rich, is mortgages. And, you know, it's a well-known sort of fact that you can get a mortgage against an asset. Most of the time, banks are pretty conservative about how much they'll lend you against it. But from time to time, they increase that. They give you extra leverage. So back in 1986, when the housing market was bubbling away very, very strongly.

26:32They decided that they were going to give you more than 100 % of the value of the house with no deposit. And they would let you borrow maybe five or six times your salary in order to borrow the money to buy the house. And they gave you the extra money so you could buy a sofa and bed and all the other stuff you need when you move into a new house. And they were particularly generous to first-time buyers. Now, when the credit crunch came along, those lending criteria, instead of lending you five or six times your salary, they cut it right back down to three times your salary. And I think it's just nudging up again now towards the sort of four times first-time buyers.

27:10But those multiples have been set in stone for a long time, but they flex depending on what the banks think about the risk of the underlying market is. Now, back in 1986, the housing market blew up. Eventually, having gone up, I bought my first house in 1986 and basically, it went up very quickly. Right at the top. Absolutely. It went up literally 50%. I'm sitting there going, happy days. I'm a very wealthy man and I've borrowed all this money. All the money I borrowed, I'm going to get back because my house value's gone up. No, no, no. The housing market blew up, as we know. And the next thing I had to hand back about £20 ,000 on an£80 ,000 purchase to get myself out of that property.

27:52And that was because I borrowed 105 % on my mortgage, very naively. So, you know, kids out there, don't get sucked into these things. Be sensible, make sure you can afford the payments, even if the interest rates double and double again, because that's what happened back in 1986-87. Okay, Spice, good example. But I'm going to talk more about the financial example, because that I think is more relevant to our dear hedge fund friend. And that is, how does leverage work in the financial markets? Let's say I want to buy shares in company A and the share price is a dollar and I have a hundred dollars.

28:32Now, I can just go and buy a hundred shares at a dollar each. That's my hundred dollars. That's fine. But hey, that's not the fun. That's not what leverage is about. What I can do is I negotiate show my broker and I say, look, if I want to borrow some money, how much do I have to put down of that money as collateral? What's my margin, it's called. And he says, well, Chris, you're a good credit. I'm going to let you have an initial margin, stop laughing, guys, of 50%. So therefore, I don't buy 100 shares. I can now buy 200 shares and I only have to deposit still my$100 because he has lent me the money to buy the other shares.

29:18So I've now got 200 shares. So clearly, if my idea is right, I'm going to make twice the money I would otherwise have made and I'll be just as successful and happy as every hedge fund manager in the land. The problem you need to understand though, is if the stock price goes down, the collateral now is not at margin of 50%. I've probably only given collateral now 40%, let's say. I've got to find some more money to put into my account or my broker will say to me, I'm sorry, guys, but I'm going to foreclose on you. It's called a margin call. He says to me, put some more money in or you're going to be bankrupted by me.

30:03I've got to then find some money to put in. I've now got a problem. What happens if I haven't got that money? I've got to sell something else. And that's what happens when that leverage cycle moves against you. Right. So let me take this one step further. And let me explain how hedge funds work to everybody. Because if you can understand how a hedge fund works, you'll understand why stocks move and can be as volatile as they are. and it might really help you understand what we talk about week after week after week. So going with Chris's example, same kind of idea. I'm a new hedge fund and I'll keep the numbers round so everybody can get a grasp, maybe even write it down.

30:47I've got$10 million of capital. So Chris and Spice have given me$5 million each because they believe in my cautious approach to investing. So just like the mortgage, when you put your deposit down, I go to an investment bank, okay? I probably wouldn't go to Goldman Sachs, I'll be honest. Maybe I'll go to JP Morgan. Now, JP Morgan Prime Services, okay? So that's the part of the investment bank that deals with hedge funds. So Prime Broker or Prime Services. And I deposit my$10 million there. Now, they very kindly offer to give me three times leverage. What does that mean? It doesn't mean that I can go and buy$30 million of stocks or commodities or bonds, like in CJ's example.

31:38What it means, I now have$30 million of a gross book. Now that, remember, is split between longs and shorts. Shorts is when you put on a position and you sell shares before you've even bought them. So in a long position, you buy shares and you want them to go up. In a short position, you sell shares, you want them to go down and then you buy them back. So with my$30 million, if I was running a flat book, I'd be long 15 and short 15. So if the market crashed, everything would go down together and I might not lose any money. Or if the market rallies, they all go up and I might not make any money.

32:23What I want to do is choose stocks that I think would go up and bet against stocks I think would go down. And that's exactly what Ashton Brenner was trying to do. He bought all the AI stocks. So everything we talk about each week, the NVIDIAs, the Microns, the SK Hynix, Samsung and SanDisk. and anything with exposure, AMD, all the stocks in the NASDAQ 100 and some smaller ones as well that would go up with AI. And he bet against all the industries that would suffer as AI came in and disturbed that market. So you've seen software stocks in particular, information services like Relics in the UK, ServiceNow in the US.

33:18Even Palantir was one of these software stocks as Oracle as well. So what he perhaps didn't take into account is that when you want AI stocks to go up and you want anti-AI stocks to go down, you've only really got one single trade on. So instead of having 15 long and 15 short, you've got$30 million of assets, or in his case,$45 billion of assets. And they actually are all one trade. When it started to go wrong, it started to go really wrong. And his AI stocks were down 40 % and his software stocks were up 25 % in just two weeks. And CJ, you're going to cringe at this because his assets under management have dropped from 45 billion to under 10 billion in two weeks.

34:19And at what happens at that point, the prime broker comes calling. And that's what closes him down and means that he has to find an exit. And the press was full of the stories at the end of last week that he'd sold his positions on to another hedge fund. And in doing so, had seen his numbers go from, as you say,$44 billion of assets down to$6 billion of assets. And this is where it gets really interesting because there was rumors around ever since the SK Hynix IPO, because Ashton Brenner was asked to be a cornerstone investor, so a large investor into this IPO. And it went wrong and SK Hynix started to drop.

35:06So Ashen Brenner was under pressure. Now, a week past Saturday, people started to talk about it at their holiday homes in the Hamptons, talking to the press. And they started to hear that he was in trouble. Now, Spice, what happens when the market hears that somebody's in trouble? So they just accentuate those positions. So they know that you are short of something that's going up. they'll buy more of that position to make it go up even more to make it hurt twice as much and likewise all the things you long of that you're hoping it go up they'll be pushing them down on the other side so you'll have had some other hedge funds doing exactly the opposite positions to him in order to make it so painful that eventually he has to close out and as you say citadel came along and you know taking him out of those positions i'm sure that citadel and And some of the other people have followed Citadel doing exactly that and bounced them back the other way.

36:03And a lot of people would have made a lot of money, but he would have lost an absolute shed load, as we know. So to me, there's two things here that's important. One is he's got leverage, and he hasn't really managed his risk positions. He hasn't realized he's only got one bet on. But secondly, when he realized he got a problem, he then told too many people he got a problem and asked them to help him. And the last thing you want to do is do that. I've actually got personal experience of exactly this happening. I was the CIO at a business, which I shan't mention because it's embarrassing. And Mark was actually working with me at the time.

36:44We had a fixed income product which had$4 billion under management. It was a really successful product, grown really strongly. It was levered 10 times. So we had$4 billion of money in, and we had$40 billion of assets, which we were managing the risk of. Are you Leopold in disguise? Well, the good news was the risk control was excellent. Basically, I did that. So I've got to say that, haven't I? I've got to say that. But we had a disaster. And the disaster was the team who'd done brilliantly, performed fantastically, decided they would leave. Another one of our competitive organizations came along and said, look how well this team have done.

37:31Let's offer them a huge amount of money so they can do this for us. And they took Judas's coin and let us all down. And so suddenly I'm faced one weekend with traveling up to Glasgow, which gives you a hint as to which organization it was, and having to spend the next three weeks up there sorting out the mess of this team leaving. And what we had to do was think, well, hold on a minute. We've got 40 billion of exposure. If the clients find out this team have left, they will quickly want to redeem their money. But every dollar they redeemed was$10 that we had to get out of the market. So we had to move quickly.

38:12So first of all, I got the team to sign a confidentiality clause. So they couldn't tell anybody for a period. And then me, Spice, and a few others liquidated all the positions. But what we had to do was do it in a way that the market didn't guess what we were up to, because if it had, it would have then run those positions against us. Let's just say that we'd been around for a long time. And we've got some very good contacts. So we managed to get out of all our positions. We lost 1 % doing it, which in a bond fund, which is looking to make 6 % a year, is a fair amount of outperformance. But at least we got out of it, got our leverage down.

38:52The market found out. The market realized what was going on, but fortunately, too late to hurt us. And we live to fight another day. But a perfect example, sleepless nights, worry, concern, trying to tell people trying to find out trying to keep people in the dark as to what we were doing really really really tough if anybody wants to watch a movie on this the movie margin call is exactly what chris has been through there except it's the the lehman brothers situation so well well worth a watch i was going to say that actually it's important to realize that that fund was doing nothing wrong it was acting within the guidelines it was allowed to so it was allowed to have that 10 times leverage that had been agreed with the regulator so maybe the regulators that fought when sometimes in by letting people have too much leverage on these things but they were in within the limits that they were allowed and they'd done nothing wrong and as chris said we had to work very hard and very fast without the market realizing what was happening i think it probably i think on the off the top of my head chris probably took four or five days business days before suddenly they sussed it out and worked out what was happening.

40:07And then suddenly all the things we were left with trying to get us out of, funny enough, went to sell prices you didn't want to do that. And so we just held our nerve and went until they bounced a bit and then started doing the same thing again. It was a very, very interesting and educational time for all of us, I think. And it shows you what happens in times of stress as well, because as we said on our example, everybody wants to buy good stocks. So hedge funds are generally long, good performers and great companies. And they're short of bad companies because they believe they're going to go down.

40:43So in times of stress, when people start to lose money, then it can snowball sometimes and you get this, you can only sell what you own and therefore you're selling all the best companies in the world and you're buying all the worst companies in the world and every hedge fund's got on the same positions and it gets really ugly very quickly. And that's why when we talk about volatility going, if volatility gets to a certain point, then you've got a good chance it goes even further. People might ask listening to this, why are we talking about it? And we're talking about it because leverage is always there or thereabouts when accidents happen in the financial markets.

41:26We need to talk about this with respect to a book I was reading, extremely good books, a book that people should read on their summer holidays called 1929. And it's by Andrew Ross Sorkin, who wrote a number of the books about the financial crash. And what he's done is he's accessed a lot of extra material, which was available from that time, Fed chairmen's private diaries, bank's chairman's diaries, chief executive's diaries, those sorts of things, to try to piece together what happened in 1929. And for those people on this podcast who've never heard of the stock market crash in 29 and what happened, essentially, the market fell very, very heavily.

42:12And then that brought about a depression that lasted for nigh on 10 years. So when the stock market went in 29, it was a proper, proper destruction. Who were you working for then, CJ? Thank you very much. I wasn't working. Funnily enough, not even I'm that old. But if I was, I'd have been working for one of those firms, I've got no doubt, because it was exactly the same sort of markets as we have. Also, there are many similarities to the markets that we have today. And this is what I found so interesting about this book, that if you look at what it says was the cause of the Wall Street crash, I mean, what he says, it's clearly an opinion.

42:55You can look then at what's going on today and try to draw an analysis or an analogy of where we are in that situation now. This is what he says, having looked at all this stuff, was the main causes of that terrible crash. Extreme leverage and margin buying. Well, that's what we're talking about in terms of the leverage in the market. Now, it was more than, I mean, people were putting down 10 % deposits and being able to borrow, therefore, 90 % extra. And so they were really, really, really heavily exposed. So that's one. Now, there are similarities today. And I would argue that if you look to things like SK Hynix, you would see some of that behavior.

43:51What do we have today? We have these new vehicles that have been created over the past six, nine months where you can buy a fund that's leveraged three times to either the market going up in a particular stock or the market going down in a particular stock. And people say, great, isn't this fantastic? Well, it is if you get it right. But if you get it wrong, it's a disaster. Let me give you one very quick example. SJ Hynix, there's an exchange-traded product, which is a three times long SK Hynix product. If you bought that on the 22nd of June, which was the peak of these stocks in Korea, it was$35, that was.

44:39Now, what the instrument gives you is three times the return from the date you bought it. So if you bought it on a date, let's say you were smoking the spicy euphoria cigarettes that he is having most of the time. And you say, right, you know what? I've fallen for it. I'm going to buy$35. I'm going to buy it that day. It's going up forever. Would you believe those things trade today at 84 cents? you have lost 97 and a half percent of your money if you had bought those that tells you why our hedge fund friend lost so much money because from that top to that bottom if you levered yourself up at the wrong time that's a terrible absolutely terrible performance it's interesting that sometimes governments get involved to try and take the this sort of euphoria out of markets.

45:34We only talked about it last week or the week before, that the Korean government were doing exactly that. The Korean government are introducing sort of controls now to stop this margin buying, this leverage buying that we've seen. Didn't stop the cost being going up 17 % this week or one day. But nevertheless, they realized how much danger it was happening. And China has done it before in the past. And of course, they encouraged them first. And after encouraging them and getting everybody involved in the casino of what it was, they then try and slow it down. But that's the first one, extreme leverage and margin buy.

46:09Second one, speculative mania around new technology. Now, in those days, it was radio, telecommunications, that sort of thing. Nowadays, we have AI. Ooh, the bells are ringing. The bells are ringing. There's two for you. Right. Third one, So, retailization and democratization of risk. Order investors in those days were courted by bankers, brokers. You could buy on margin, put your money in, you can make a fortune. What do we have these days? After 2020, we have all these people. We've all seen the adverts, all saying, copy what I'm doing. Make 200 % in the next three minutes. And people believe it.

46:50And people give people money on that basis. So, you've got a bit of that going on as well. The next observation was weak or absent guardrails. In those days, there was no regulation. Now, at least these days, we have pretty good regulation from our regulators within each of the individual markets. So I'm going to say that's a plus point. Up till now, I've been saying this pretty similar. That one's a bit of a plus point. Now, this is the one that worries me. Policy errors that turned a crash into a depression. What was the response or what happened around that time? At that time, the Federal Reserve were keeping rates very easy.

47:32The banks who were lending money to all these retail investors were saying, you can't possibly tighten rates. We can't have rates going up. That isn't something we should do. We need rates to be cut. Is there a Donald Trump in the house? At the end of the day, we now have a Fed chairman who is saying, we don't want to raise rates. We're going to do everything we need to do against inflation. We're going to be really aggressive, but actually is doing nothing. That's one of the things that happened there. But it's not just that similarity. They also brought in tariffs in 1930, which then added to the issues.

48:10And we seem to have tariffs as well. Gosh, this is getting a bit scary. The final thing, which isn't similar in my view, is in those days, you had to go down to wall street to know what was trading there was no there was no ticker tape there was no screen with it all on so they would actually go down and queue up which is where you see those big pictures of 1929 where everybody's around wall street they want to know where their stocks are trading has it crashed what's going on and we don't have that problem today but there are are a number of similarities here that make us at least think, are we getting very mature in this bull run that we're in?

48:53And the thing that's worried me most has been the Fed's change of policy and communication. We talked about this last week. The Fed have come out under the chairman and said, we're very keen on keeping inflation down, but we're not actually doing anything about it. And the market's doing the job for us. Now, the problem to me about that is if the market's got to do the job for you and you lose confidence that the Fed will be there if there's a problem, then one of the big anchors of this bull market, which is the Fed will always do what it's needed to keep the stock market in the right place, disappears.

49:31So of all the things that I see there from 29 and reading this great book, and I recommend everybody reads it on the summer holidays it's a great read really really interesting read is do can we rely upon the fed being there to save us if there's a problem which is what we have been able to do for the last 10 years that's the thing that worries me guys what do you all think well isn't it fair to say chris and you've preached this many many times to me the europeans will look after their bond markets because they remember what happened that you know started the war hyperinflation in germany and that's why the Germans that lead the European Central Bank will always try and control inflation very aggressively and therefore you want to be a bond investor in Europe but they don't really care about what happens to equity prices or other asset prices.

50:16The Americans because of the lessons of 1929 and the Great Depression will always try and protect their stock market and so even if interest rates are out of kilter if that you start to see a crash in stock markets they would step in and actually probably cut interest rates, even though that may hurt bonds. They don't care so much about the bond markets, they care more about the equity markets. What I was going to say is that I think that one of the reasons we've had a very good week in equities generally is that equity investors, such as myself, believe the Fed are doing what's called running the economy hot.

50:53They are prepared to live with higher inflation, even though they don't specifically say it in their statements. But at the end of the day, they want to see this growth that is accelerating now continue. And their argument to the flip side is that this can be growth that doesn't bring huge amounts of inflation. Historically, central bankers are worried that if you get too much growth, companies put prices up too much, and therefore you get inflation. And then people ask for higher wages, and you get a whole spiral of prices going up and up and up. This time, I'm not going to say it's different, but in the background, there's an implicit belief from people like Kevin Walsh, and he's been quite public about it, that because the adoption of AI actually brings possibly higher unemployment through youth unemployment, that is a dampener down on things like inflation.

51:46Companies, as I mentioned in the market report, are getting over 1 % more margin through pure profitability if they're adopting AI. So they're getting higher efficiency gains. This is not by them putting up prices. This is by them cutting costs, becoming more efficient, the people working for the companies becoming more productive. And that, I think, is the core argument this time, that this industry change, the adoption of AI, is actually potentially quite disinflationary. And that's what I've argued for this over the last 12 months. If you believe, like me, that AI is going to be adopted, ultimately it can lead to companies being able to, if they want to, become more competitive, try and get bigger market shares by cutting prices, not by putting them up.

52:30And those companies that put prices up are going to suffer because they haven't put the AI in to get the efficiencies to make the difference. And I think that's the big difference this time. So right now, the Fed, in my view, is running the economy hot. Personally, I'm not worried about the inflation side. I think bond markets have moved a long way. But how much further they go before people say, I need to sell equities to buy bonds because the bond yields are so attractive that it makes it a no-brainer bet. And I think that that is some way off still. I think August 27th is going to be so interesting because that is when all the top central bankers meet in Jackson Hole in the US.

53:12And that's when we're going to hear from Kevin Warsh, not as he's forced into at the Fed press meetings and he has to answer questions and stick to the statement. At Jackson Hole, every year, the chairman of the Federal Reserve gets a chance to look longer term and really put down his views and his path towards 2 % inflation, as Mark thinks there that they're running the economy hot and they don't have this 2 % inflation target. Well, we'll actually hear the meat on the bones of what Kevin Warsh plans to do. And I think the path until then, equity markets get excited. They run on this huge earnings growth.

53:55Without Leopold and the leverage, then we've got what I would call a clean and undisturbed market at the moment. A lot of hedge fund managers go off to Saint-Tropez and to the Hamptons, and this is their holiday period. So their books are down, the leverage is down there. The positioning is lower than normal. And I think we see the S &P running to 8 ,000 and I think that will be a very good August. However, then at the end, that last final few days of August, I personally would like to get risked down a little bit because anything can come out of Jackson Hole. I look at the similarities of 29, and I don't think we are there yet.

54:42As the child says in the back of the car, are we there yet? I don't think we are. But there are a number of things that have raised the risk in the market. And the big one to me, as I say, is Walsh. Whilst I accept what Marx says and the view he believes in, that's not really the job of the Federal Reserve Chairman. the Federal Reserve Chairman, is there to give you credibility in what the Fed is doing. And if you don't know what the Fed is doing, and if inflation does not prove to be transient, as they say, remember, they said that in 2021, 2022, and it wasn't. Now they're asking you to believe the same thing.

55:24This inflation is not going to evolve into anything else. It's absolutely safe as houses. The job of the Federal Reserve is to make sure they have credibility. And if the Fed doesn't establish credibility, then there will be a worry. The risk premium must have gone up. It may not go up enormously, but the risk premium must have gone up that there is an error at some stage. So I'm the same as you guys. I don't see anything in the horizon at the moment to worry about the markets continuing to move higher. I think we've got a good position in the markets. And if anybody disagrees, please say. We sold some bonds out last week.

56:02We added some more equities. All those have worked for us and done nicely. But I just think we have to be careful running into Jackson Hole at the end of August. We talked about it last week. Richard's talked about it this week just now. That's when we're going to get a better picture. And if we do have a really good August, we should remember the seasonal patterns that we've talked about before, how in September, it's not normally a good time for equity markets. We said that last year, and we kept it, if those people remember, back to the start of our portfolio, when we first set up the portfolio, we kept a little bit of cash on the sideline and the markets rallied a little bit.

56:43So we were wrong to do that. But there's a seasonal pattern, which means it normally happens. So I suspect it will be right to reduce a little bit of risk in a couple of weeks time, but let's enjoy the ride for the next couple of weeks. So I'm not suggesting any changes to the portfolio this week. I think we stay as we are and wait for the good ride into the end of August before we think about maybe taking a bit of profit. Now talking about enjoying the ride, well, you enjoy your summer holidays as well. No matter where you are, you can find us on Instagram, which is the art of investing pods or on TikTok underscore the art of investing for some behind the scenes footage and the best clips of today as well.

57:27So that's it for today. We hope it's going to be a quiet August. No 1929 style crashes here. Gents, thank you very much for joining us. Goodbye from Chris. Goodbye. And goodbye from Spice. Goodbye, everyone. And it's a goodbye from me. Have a great week.