The Increasing Importance of Politics in Investing (w/ Larry McDonald and Raoul Pal)
RAOUL PAL: Larry, great to finally meet. I can't believe we haven't met before, and we've got so many friends in common. And for you come here from Panama to the Cayman Islands, so one Caribbean paradise to another. It's great to finally meet and get you on camera. LARRY MCDONALD: Now I know why more people come here in the wintertime. They love Grand Cayman in February. God bless it. RAOUL PAL: Yeah, exactly. Who wants to be in New York? So look, I'd love for you-- people have seen you on Real Vision and seen you express some of your ideas, but I'm not sure they know who you are and some of your story. So I'd love you to give some of the story of what makes Larry Larry and where you've come from in your career. LARRY MCDONALD: Well, I grew up Cape Cod. And just before that, it was up toward outside of Boston, Bolton, Massachusetts, and a very tough divorce I went through as a child, my parents. I think we were in probably six or seven schools in eight years. And then finally we went from very countryside living to living in a housing project through the divorces. And as a young man, I really learned how to appreciate money, hard work, and finally made it into UMass. Kind of came up through the bootstraps, the public-school systems, and started off my career that way, and it's been very challenging. But I got our first break years later, which we can get into. RAOUL PAL: Yeah, you told me about this off camera earlier. So you graduate, and then you want to go to Wall Street. LARRY MCDONALD: Want to get into Wall Street. And I think I had 155 nos from every single-- RAOUL PAL: Yeah, I there too. We talked about it. I've got a drawer still full of them. LARRY MCDONALD: A drawer full. And the motivation-- and to me, life is about really that burning desire to break through those walls. Nothing's given to you, and you have to go get it, and you have to really have that burning desire and vision every day. And I couldn't figure out a way, but there's always a way. "If you can't get through the door, you got to climb in through the back window" Doyle Brunson used to say. And I tried to get into Merrill Lynch. After like the seventh no, I snuck my way in dressed as the pizza delivery man. RAOUL PAL: For real? LARRY MCDONALD: Yeah, in Philadelphia. In Boston I'd struck out so many times, so I tried Philly. And I was thrown out of the building. On the way out, one of the senior producers of the firm, Gary Begnaud, grabbed me and brought me back. He brought me into a room with five or six big producers. And they said, Larry, we'll give you a job. You've got to go sell something for six months, prove that you can build relationships with people. And I'm like, what am I going to sell? The guy said, pork chops. And so I went back to the Cape and Massachusetts, five, six months, put up some decent numbers. And next thing you know, they gave me a job. RAOUL PAL: Selling pork chops. LARRY MCDONALD: Selling pork chops. RAOUL PAL: How did you start selling pork chops? LARRY MCDONALD: I just worked my way into one of these-- I think I was American Frozen Foods. And it was during the S&L crisis. We're talking about trying to get a job in finance coming out of school with hundreds-- Bank of New England went out of business. Bank of Boston was on the verge of filing. So the whole area of New England was really near depression. And so I just made my way through the back door. RAOUL PAL: So then after Merrill, where did your career go from there? LARRY MCDONALD: I was on the retail side for a couple of years and really always wanted to be into that major league. To me, I wanted to get into New York and work on the institutional side of the business, and that just fascinated me. My good friend Steve Seefeld, he and I were talking about a vision for bringing convertible bonds to the web, and this is like in the mid '90s. And we started a website called convertbond.com. We were lucky enough to have CNBC do a couple of segments on us. RAOUL PAL: That was very early for websites. LARRY MCDONALD: Yeah, it was late '95, '96. That was just the early construction of it. But by the time we sold it to Morgan Stanley, it was October of '99. We sold the company. This was the largest, most successful convertible-bond research, potentially trading platform in the world. And Morgan Stanley bought us in October of '99. And I often say if we had waited for the next bid, we never would have gotten it because the market collapsed in 2000, and God bless Morgan Stanley. RAOUL PAL: Yeah, top tick in the market because it had a dot com at the end of it. So after that, so after you sell convertiblebond.com, what happens? LARRY MCDONALD: Well, I stayed there. It was a very nice quality of light. I'm in Connecticut and New York running the convertible sales. I'm running really the website for Morgan Stanley. I probably stayed there one or two extra years. It was very comfortable. But always wanted to make onto the trading side, and to me that was really where I wanted to be. And once again, if you can't get through the front door, you've got to come in through the back door or the window, and I convinced Larry McCarthy and the team at Lehman to give me a job trading convertible bonds, high-yield bonds, distressed bonds. That was my big break, making it from kind of on the sales side, research side into trading, and that was probably the biggest break in my career. RAOUL PAL: And so what kind of convertible bonds? So you're now in New York trading. What kind of strategies are you looking at? LARRY MCDONALD: Well, it was really distressed converts, high-yield converts because what we realized is that the businesses on-- when you work on a big bank, you have the equity division and you have got the fixed-income division. And most people don't realize that a lot of these divisions don't like each other, and so back then there was a lot of miscommunication between divisions across the street. And so my job was to really work with both sides and help bring convertiblebond markets to clients around the world but also make sure that our teams on all the different floors in high yield, distressed, and equities were on the same vision. RAOUL PAL: So explain to people-- because some people won't understand what a convert bond is because, you know, it's the hybrid nature. And when you think distressed, convertible bonds, you've got multiple hybrids here. So explain to people what that is. LARRY MCDONALD: Well, I say in the book-- and I wrote the New York Times best seller about Lehman. It's now published in 12 languages. And one of the parts of the book is about converts. And there's a convertible indicator. If you look throughout the history of corporate capital markets and financing, the repeat entries to the convertible markets are oftentimes the most likely companies to file bankruptcy, whether it be Six Flags or Fannie and Freddie. There's so many different companies-- WorldCom, Adelphia. The multiple convertible issuer, it's really the last saloon. So a convertible bond is a obligation of the company. So you sell the bond, maybe a 5- or 10- year bond, a thousand face bond, and it may be a five-year term, but you also have a conversion ratio, a certain amount of shares of stock. And what happens throughout the evolution of some companies is they get too much in debt, companies like Calpine. Calpine had seven convertible bonds before they filed bankruptcy. It's really what we call the last saloon, that bar at 2 o'clock in the morning when you have to get that last drink. It's the place where a lot of companies can go and finance. And lo and behold, guess who the new multiple issuer is in the markets? It's now looking like Tesla. RAOUL PAL: Oh right, interesting. So again, sorry, just to explain a bit about convertible bonds, so as you say, it's a bond, but it has an equity component. How does that work, just so people can understand truly how it works. LARRY MCDONALD: So you have $1,000 face bond, and there's a certain bond floor in there potentially because it's an obligation of the company, but you'll have a certain number of shares of stock that the bond converts into. So if the stock takes off, you can have $1,000 bond go to $3,000 or $4,000 or $5,000. In the dot-com era, there were convertible bonds that went from $1,000 face-- so you have a bond that's $1,000. It matures in five years at $1,000, but you have a potential of turning that $1,000 face into $5,000 or $10,000. RAOUL PAL: Because there's a call option on the equity. LARRY MCDONALD: Yeah, call option, that's a good way of putting it. It's a certain amount of shares, but essentially it's an embedded call. RAOUL PAL: And it has a strike price like a call-- LARRY MCDONALD: Yes, it has a strike price. RAOUL PAL: --of which you can convert-- LARRY MCDONALD: And if you're Buffett, you negotiate the very lowest strike phrase. Buffett's famous for converts. He convinced Goldman and General Electric during the financial crisis to structure him a private convertible bond that he has between them. It's an obligation between him and the company. He loans the company money, but he wanted that income component, that coupon. That's your income. But you also have a low-- in his case, he negotiated a low conversion price. So let's just say the stock is $80. His convert might convert at, say, $85 or $86. But in the case of other converts that are issued, a lot of times there's a bigger spread. So it's like when does that bond get in the money is the question. When can he convert? And Buffett's the classic in that regard. RAOUL PAL: So you're know at Lehman. You're trading. Talk me through that trading at Lehman. LARRY MCDONALD: Well, our big break was we had Jane Castle. Jane's now at Avenue Capital with Marc Lasry. And Jane was one of our leading distressed analysts at time, really an up-andcoming star. And Delta Airlines went into bankruptcy. So we're on the desk, and we were making markets for clients. And I'll never forget the day Delta filed. I started making bonds at $0.16 bid, $0.17 offer, $0.16, $0.16 and 1/2-- back then, pretty decent spreads. And by late in the afternoon, late maybe toward 4 or 5 o'clock, we started to get hit down at $0.12 on the dollar because there was a lot of global competition coming in with price pressure on airlines. There was strikes threatened. The unions were extremely strong back then with the airlines. And so we're trading the bonds, and lo and behold over the course of the next year, year and a half, we built up, at Lehman, a $780 million position between the four of us, four traders, in Delta Airlines bonds. RAOUL PAL: How many bonds were in issuance? LARRY MCDONALD: I think they probably had $3 or $4 billion in debt, so we owned a good chunk of them. So what we would do is we would make the markets for the clients, and so we had a sales force that would make the markets for the clients. But back then, Wall Street banks were allowed to hold large amounts of inventory of bonds. So we had a number of bonds that we were able to-- what we call proprietary trading. RAOUL PAL: And so then in this whole story, you end up writing a book about Lehman. What was the book called, and why did you write it, and what happened, the timing of writing that book? LARRY MCDONALD: Well, to me, Lehman was never rotten at the core. That's where all the beauty was. She was rotten at the head. To me Lehman was 24,992 people making money and eight guys losing it. And it was really about watching some of the people I loved and cared about lives' destroyed that inspired Me. But in the summer of 2008, thank God I had the vision to pitch a good friend of mine, and old family friend-- I think he has place here in the Caymans. Patrick Robinson had just written Lone Survivor, which was a number-one New York Times bestseller. Became a movie with Mark Wahlberg and it was about the American hero Marcus Luttrell from Texas. And Marcus was one of four Navy SEALs in Afghanistan that finally survived, an incredible tale of heroism and surviving and inspiration. And I read that book, and in the summer of 2008 we were up on Cape Cod. It's a beautiful night, 4th of July. The fireworks had just gone off. We're sitting at a table with eight or nine people, and I started to pitch very gently Patrick on thinking about a Lehman book. And the whole table starts laughing. I was the laughing stock of the table because I quickly learned that at the summers on the Cape, everybody pitches Patrick a book idea. This happens every night. And he said, "Larry, please don't disturb me." He said, "I've been working on Shimon Peres' memoirs." He says, "I'm booked until--" remember, this is summer 2008. He goes, "I'm booked solid until 2010." And as the old salesman in me, you never take no for an answer. There's always a way. There's always a way to find and get that direction to what you want in life. So I said, "Patrick, do you understand something?" And the whole table's quiet. I said, "If this bank goes down, it'll be bigger than Enron, WorldCom, Adelphia, and even General Motors combined." And I'll never it. He had that Chivas Regal on the rocks. He held it there for maybe three or four seconds. It felt like an eternity. And he said by the stroke of midnight 2008, "Lawrence," he says, "if that bank goes down, you have a deal." And sure enough, here we are September 15-- RAOUL PAL: Not long afterwards. LARRY MCDONALD: Yeah, September 15, 2008. Lehman goes down. That night, I woke up about 2:00 in the morning. As a former distressed trader, I tiptoed over to the computer. And as a former distressed trader, high-yield bond trader, a lot of times through my career when I went over to that computer in the middle of the night, I'm looking for the bad news. RAOUL PAL: So were you working at Lehman Brothers as you left? LARRY MCDONALD: I just left, but I had a lot of what were called restricted stock units. You couldn't sell these. You could try to hedge. We tried to hedge our position, but we had a lot of stock. And it was really a life-changing moment when I saw that Lehman had filed bankruptcy. And I was holding my wife there in the middle of the night in the living room. It was a very tough, dark time. The next morning I called Patrick and I said I had a chip to call in. And I said, Lehman. He said, "Larry, come on over here tomorrow night for dinner." And I said, "You're on the other side of the Atlantic Ocean." He was about an hour and a half outside of London in Berkshire. And the next morning I found myself on the tarmac of Newark Airport. And as the plane is racing down the runway, 50 miles an hour, 60 miles an hour, 80 miles an hour, 100 miles an hour, wheels up, and I'll never forget sitting back thinking, what on earth am I doing? I'm a high-yieldbond salesman. I'm risking everything. I wanted to bring the unvarnished tale of what happened at Lehman to the world, but I was terrified. RAOUL PAL: Why were you terrified, because of your reputation of slinging a bit of mud and stuff like that? LARRY MCDONALD: Yeah, just kind of the change in direction of what I might have to say. I'd never written a book. But as the plane banked toward the northeast-- it had rained that morning and there was some raindrops on the window. And I looked out and I looked down, and there's the green and white of Lehman in Times Square. And I said to myself, it's time to go pick a fight. It was about reaching out to-- because I a high-level executive, so I needed to have the relationships with the senior people around the firm to really figure out what was happening inside. And as you peeled back the onion, if you peel back at the center of the onion, you really get close to the skull and crossbones to see what really happened inside the bank. RAOUL PAL: So how did you get buy-in from the people within Lehman to do this? Well, they were just angry, I guess. LARRY MCDONALD: Well, there was so many of them. And remember, it was a period where a lot of the people were taking some time off and wanted to be with family. So you had that. If the financial crisis didn't exist, then they would have been back to work. So there was there was a group of people, probably like 50, 60 people helped me put it together. At the end of the day, there was this large group of people that were doing so many good things and there was so many great businesses within Lehman that had nothing to do with the failure of Lehman. To me, for every dollar we were making-- there was one point where our group made close to $2 billion on the short side in 2007 as our group. But for every $1.00 we were making, they were losing $8.00 or $9.00 upstairs. RAOUL PAL: Wow. LARRY MCDONALD: So it's really a lot of lessons there, but it allowed me to change my lifestyle quite a bit. RAOUL PAL: So what was the book called? LARRY MCDONALD: A Colossal Failure of Common Sense. I tell my wife once a month. I said, honey, if we sell a million books, we'll break even on our Lehman stock. And I think we're up to about 600,000. RAOUL PAL: That's a lot, right, in books. LARRY MCDONALD: That's a lot in-- RAOUL PAL: Books don't sell a lot. LARRY MCDONALD: --financial books. RAOUL PAL: Yeah, they do not sell a lot. It's interesting. LARRY MCDONALD: And the best part is we've done 140 speeches in 16 countries. And there's certain countries in the world like Canada, Australia that have a large financial component in their economy-- and South Africa. So we've done events around the world, met some very interesting people, and it's been quite rewarding to go from a bank where you're kind of stuck with this nice group of people in a broader group but then to kind of take what you've learned the way you have, which has been so inspiring-- take what you've learned and then bring it out to that wider audience and help people. RAOUL PAL: Yes, you're now writing research. LARRY MCDONALD: Yes. RAOUL PAL: So talk a bit about that, and then we'll dig into some of your ideas and what you're thinking about. LARRY MCDONALD: There's no I in team. So we have a wonderful group of people in Washington that we've been working with since 2010, ACG Analytics. And so we have an institutional business where we help people with the Puerto Rico trade, hedge funds, asset managers, Venezuela. RAOUL PAL: So you mainly looking distressed? LARRY MCDONALD: Well, that's a large component-- event driven. RAOUL PAL: Event driven. LARRY MCDONALD: Event-driven research, but also macro, so things like populism with Europe. We have a nice business there where we've really got a-- we made a really good call on the euro in January in The Bear Traps Report around getting short that euro ahead of the Italian elections. And looking for those kind of-- really taking the trips. A lot of people-- and I'm sure you've seen this on The Street-- the problem with Wall Street research when it comes to Washington and politics, they all try to wing it from New York. They don't take the trips to DC. Now I'm in Washington eight, nine times a year. We'll take the clients around the Hill. We'll do the trips to ACG. During the Greek crisis we did four different trips with ACG Analytics into Athens to meet the potential incoming government. Before Argentina, we did a trip to Argentina to meet with some of the new representatives of the Macri team. Occasionally-- well, not occasionally. Usually once every two or three years there's an election like Brazil. We've been working pretty closely with the Bolsonaro government where you get a game-changing moment that just secular changes all of capitalism in that country. And if you're positioned in the bonds or the equities in the right spots, the profits are just spectacular. RAOUL PAL: So where are you seeing the opportunity now? If you're looking across the world, whether it's right here, right now or coming up, where is a regime shift where it's how a country looks at capitalism? LARRY MCDONALD: Well, we're still in the early stages in Brazil. We did a Bear Traps Report in September which we put up on the Real Vision platform. It was a really nice report. And it got into the amount of capital that's in the public hands when you're taking capital within the government and then privatizing it. So you're in the early stages of privatization in Brazil. At the same time, the Bolsonaro government, most of Wall Street, they were convinced that he was as toxic as Trump-- that was the pitch-- and that he wouldn't be able to get pension reform passed through the legislature in Brazil. And that's turning out to be, I think, not true. And so if they get pension reform done, then you're saving about a trillion in real of interest for the government. So your credit quality goes up dramatically. At the same time, for a number of reasons, inflation in emerging-market countries has come way down. So that takes tremendous pressure off of the Central Bank of Brazil to hike rates. So what's been happening over the last 10 years is every time Brazil's economy gets cooking, inflation picks up, and the government-- the Selic rate, what they call the rate-- a number of rate hikes, vicious, that really knock the fire out of the economy. RAOUL PAL: And there's a lot of credit in Brazil, household credit and-- LARRY MCDONALD: Oh yes. That's another element of it. They're in probably the 1950s where the US in terms of really the development of household credit. There's some household credit, but it's really not as wide as I think in America. So if that household-credit situation expands and improves and works its way through the economy, at the same time you have the central bank that is more in control and not aggressively hiking and at the same time you have this political element, I think Brazil equities could be in next, let's say, five years could be up another 100% from here. RAOUL PAL: Yeah, but I guess it depends on the global cycle. Emerging markets are great when you get the right point of the cycle. The wrong point in the cycle and it's all overwritten. So what else are you looking at on the horizon of the big-picture stuff? And then we can go into some of the more specific opportunities as well. LARRY MCDONALD: Well, the populism is still-- I mean, it's an old trade in some respects. It's had cycles. You had that first cycle in 2016 with Brexit and then the US with Trump, but now the globalists were very empowered by the Macron election because when he was elected, it really looked like populism was going to be at least contained in Europe. RAOUL PAL: He looks like he was the outlier in fact. LARRY MCDONALD: Yes, exactly. And at the time, that's the amazing thing. The Street was lecturing us that this whole movement was dead, this whole populist movement. In the summer of 2000-- RAOUL PAL: Because people wanted it. LARRY MCDONALD: What's that? RAOUL PAL: It's because they were imposing their wants, their desires. LARRY MCDONALD: Exactly. And you've been picking up on this for years is you see these research reports that-- and Trump brought it out in people, and it's very popular around the world today is that research is driven with a political bent where it really warps the reality of the research. And so to us, we want to do trips to Italy, more trips, and meet Salvini and his team. So we'll take clients over there. So I think that the situation with Spain is fascinating because Vox is now-- if you look at Europe, AFD in Germany has gone from 3%, 4%, 5% in the polls to high teens. These guys make Trump look like Mary Poppins in terms of immigration. And then Vox now in Spain is now rising, and in Italy you've got obviously the Lega and Five Star. So the whole thing is coming together and, as you've been talking about, Brexit. RAOUL PAL: But they're all bifurcating as well. So there was an explosion in the left, in the hard left, and an explosion in the hard right, and it's happening everywhere. LARRY MCDONALD: Niall Ferguson has been on top of this. If you look back through the history of capitalism, there are what's called a debt-jubilee period. And there's a number of people that have been starting to-- Ray Dalio is kind of hinting at this. But you're right, the left is rising and the right is rising, and the left, especially, is very anticreditor. So if you're in the left wing in Europe and you're a millennial, you see the baby boomers of Europe have saddled these countries with debt, and these young people are looking at this debt load and saying over time each year that goes by, I don't-- at some point, there's going to be a movement strong enough to walk away from that debt. If you look back through the history of capitalism-- maybe you can explain a little bit too-- in the Bible there's references to debt jubilees. It's a debt reset, and I think that that's what we're heading to in the next-- I think anywhere between two to five years there will be some type of debt jubilee or debt reset. RAOUL PAL: I actually agree with that too. David Zervos has been talking about this as well. I think Japan's going to be the first place to look at it because they're more advanced with this whole debt cycle. And the point being is the central bank already owns and 60 odd percent of the debt. So at what point does the central bank in the next recession just end up owning all of the debt and then saying what debt? It's gone, right? That accounting trick-- LARRY MCDONALD: What do they call it, a coin? You create a coin. RAOUL PAL: Yeah, whichever way it's done, that accounting trick is a debt jubilee, essentially, because you say to the government, OK, that debt's written off. Now the central bank own it. We'll call it quits. There will be, obviously, some repercussions. What that is, it's probably the currency collapses. But it seems to me that we can't get out of the problems we're in, both the political problems or the economic problems we're in, without it. With an aging population, with more debt, there has to be some sort of debt jubilee. What that means, it's terrible to be a creditor. Anybody with savings gets killed. But in the world of the 99% and the 1%, it actually appeases 99% of the entire population when that happens. So it's a really odd situation. As you say, it could easily happen. LARRY MCDONALD: Alexis de Tocqueville-- there's a number of-- his life as, I think, a Brit, and the Scottish, and then through his life, he wrote a lot of works, and there was a number of people like Alexis de Tocqueville in the 1700s, 1800s that talked about the cycles of capitalism where you start off really in a bondage period because you have a period where the US was essentially contained by the UK. Then patriotism, entrepreneurship, and then a flourishing abundance stage, and there are these stages that he talks about. This work is close to 200 years old, but in the end is the apathy stage, and then you're back to bondage because at the end of the day when the voters realize they can vote themselves largess from the public treasury and that kind of left-wing or that right-wing extremists impair the debt-- which we've seen in Venezuela. We've seen it to a large extent in Argentina many times. There's this cycle, and it's pretty clear that, if you look at the US, we're moving into that apathy, those later stages, and so we've moved to the rise of the left in the US. RAOUL PAL: And I think Neil Howe's Fourth Turning also alludes to this kind of thing. There was a phase to this, and I don't know how long this phase lasts, how long the political instability and how extreme it gets because it could get to several forms of war because if the US pulls out, something I've talked a lot about-- if the US pulls out of the world political order, which it seems to be doing now, it leaves an enormous vacuum because the Europeans are too busy trying to sort out their massive problem with the UK pulling out, creating a vacuum there as well. There's kind of vacuums everywhere, and it leaves kind of Russia, China, and other players like Saudi, Iran, and Turkey to kind of figure out what they want to do because who's going to stop them? I mean, Saudi can murder journalists in Turkey and nobody does anything about it. The Chinese are murdering people all the time. They've got concentration camps, but yet nobody will do anything about it. The Russians are killing people in London, yet nobody will do anything about it. So that tells you that everyone's free to do whatever they want, and that worries me because that could lead to war within that. LARRY MCDONALD: And the US really debt sustainability-- I mean, if you look at entitlements and interest, we're up to 62% of the budget. Whereas, say, years ago, defense spending versus entitlements was larger. Now entitlements and interest on the US debt is so much larger than defense. And you have to say if 62% of the US budget is entitlements and interest, defense is going to get crowded out, and I think that's what expresses itself through Trump is starting to see that. Now granted, Trump has definitely increased defense spending. But in terms of the US being, like you said, the global policeman, there's no way that's financially sustainable anymore if your interest costs and your entitlement are already 62% of the debt compared to 50 years ago if both those two combined were 28% or 30% of the debt. RAOUL PAL: So let's pull on the thread a little bit about populism. So I think what you said was interesting is there's a potential between the hard left and hard right to really not care about the creditors somewhere within this. And that leads me on to the European banks, and who's going to save these guys in the end, and how is that going to play out because are they going to have to go into the public sector? Because the Germans, the Italians, and the Spanish I'm really worried about right now, and how is that going to play out? I guess it depends what political party? Are they just going to write them out and just blow everybody up? Are they going to supposedly bail in the creditors, which is what the rule was said? But I don't imagine the Germans are ever going to that with Deutsche Bank. Or are they going to take them over as government entities? How do you see that play out? Because if we're talking credit special situations, that's probably the biggest one in the world I see. LARRY MCDONALD: Well, once again, you think of the cycles of democracy, that bondage to patriotism to abundance and then back to bondage. Well you look right there, Venezuela is in the bondage stage. So Venezuela will probably transfer into, in the next six months to nine months, to a new stage, a new moving out of bondage into maybe that new form of patriotism, kind of where, I guess you could say, where Argentina is right now. But Europe, if you talk to people in the White House-- and I spend a lot of time on the Hill. After Lehman, there was a conversation or two about a real debt jubilee moment. But in the end-- and there was literally conversation in the White House between the Obama people, Treasury, and the Office of Management and Budget. And in the end in that small room in the Oval Office they discussed. And the argument came down, we have to protect the banks because if you let the banks go in the United States and you cram them down because they own all this debt, then you have a depression. But we've already been through this. And to your point, we've been through this in Ireland. So we've been through this in Europe. And now at some point when you go into the second round of the next crisis, that's when the banks probably take more of a hit, and that's what you're getting it. Here's the amazing thing. There are banks in this world in Canada that are trading at 2 and 1/2 times book. And Soc Gen, Societe Generale, BNP are trading at 40% of book. So this is craziness. What is going on in this world? And that's pricing in that credit rating. You look at France. CDS is moving up. It's not crazy because France CDS is substantially wider than Germany compared to where it was, like, six months ago. Something's going on there. So I think, number one, I think the Canadian banks are overpriced, but why do you have this drastic difference, 2, 2 and 1/2 times book versus 0.4 in Soc Gen and BNP? RAOUL PAL: Question is are Soc Gen and BNP even worth 40% of book? LARRY MCDONALD: Well, that's the thing. RAOUL PAL: I don't know. A, I don't know how you value book any longer. And I know Soc Gen as you know Soc Gen. It is an enormous derivative house of which I don't know what the black holes are in that, and so is BNP. They have huge derivative books. LARRY MCDONALD: When you trade as my career in trading distressed and high yield-- and the equity investor watching us right now. So many equity investors don't understand. Like in the case the Deutsche Bank, the equity might be $16 billion, but there's hundreds and hundreds and hundreds of billions of debt, and like you said, off-balance-sheet debt, derivatives. So you're talking about potentially the sliver of equity in Deutsche Bank is this. And people look at the stock. They're like, ooh, I can buy the stock at $12 or $11, but you own this little tiny stick of a pie. You own this little tiny sliver, and all of the rest of the pie is senior to you. And you really, at the end of the day-- like to your point, if its priced to book, it looks cheap at 0.3 times book at Deutsche Bank. It might be 0.2 for Deutsche Bank. Oh, it's cheap. But oh, by the way, look at the pie. RAOUL PAL: Yeah, and what's in that pie? LARRY MCDONALD: What's in that pie. RAOUL PAL: If that pie is toxic as hell, you don't even want a taste of it. So where else is interesting to you or what else is interesting to you? What's on your radar screen right now investmentwise or opportunitywise? LARRY MCDONALD: I'm spending a lot of time on electric vehicles. What I like in cycles is if you look at the dot com, there's this period of any new trend, any new massive social-economic trend, whether it be, say the internet. What happens is the fast-money equity people come in, and they bid everything up. Buffett talks about the three Is, the innovators and then finally the idiots-- so the three Is. And so you have this innovation stage where the money comes in, similar to crypto. And then if you look at Amazon's stock, Amazon priced in 15 years worth of earnings in 1999, 2000. So you had stock went from $100, whatever it is, $100, $150 to, I think, close to a buck and then back to $2,000. So we look around the world, and if you look at electric vehicles, this has already happened to some extent. Not as vicious as, say, the dot com, but you had a lot of companies in that electricvehicle space-- in the mining, lithium, cobalt, these critical, critical commodities that are mathematically unsustainable. We need literally a tremendous-- what I mean is the current amount of them on planet earth is unsustainable relative to the demand of electric vehicles. We're selling a million electric vehicles a year now in China compared to 200,000 five years ago. So the large trends we look for at The Bear Traps Report is, OK, you're coming out of the euphoria stage, and then you're down on impatience. We've seen this so many times in so many different trades. Up on euphoria. 10 years of goodness gets priced in. Down on impatience. And what we look for at The Bear Traps Report is-- RAOUL PAL: I kind of think the cryptocurrency world's in that impatience phase. We had the euphoria. We've now gone into the impatience. It's like, nothing's ever going to happen from this. And then eventually out of this conflict. LARRY MCDONALD: Oh, it's going to explode out, and it will be different players that can survive. RAOUL PAL: And whatever it is, a different format. LARRY MCDONALD: Yeah, it's all blockchain. It'll be like JPMorgan's back office will be completely-- they'll be settling trades in like two minutes 10 years from now, right? How long does it take to settle a bond trade, like, three, four, five days? But over time, with blockchain you'll be able to settle that trade-- like both counterparties will be able to-- RAOUL PAL: Which is the Overstock story. This is what people are interested in. But sorry, I interrupted you there. LARRY MCDONALD: No, what we look for at The Bear Traps Report is that new bull market. And so we did a pretty good job on solar names last year, the year before. We look for that. And this past year, we were doing a lot of work on natural gas. And so we're looking at just the demand for electric vehicles. And nuclear power in the world is just massively-- if China doesn't produce 30 new nuclear power plants, the entire Paris Accord is a complete fraud because it's the dirtiest air on earth. The percentage of electricity that's produced coming out of coal-- That's the thing that drives me crazy about the Davos crowd. There's so much attention on the US. And the dirtiest, most viciously pollutive companies and countries are in India and China, and they get this free pass in Paris. And you can say whatever you ever say about politics, but guess what? There's a trade there because they may have a free pass now, and that's empowered some people politically, but that's mathematically unsustainable. That free pass is over in two years. RAOUL PAL: But I think China would acknowledge that, and India probably also. China are faster. Their whole thing is about renewables and cleanness and everything. They understand that you can't destroy your environment any longer. LARRY MCDONALD: Yes, that's why you need 32 nuclear power plants. And then the trade is your natural gas and uranium, because China and India, the amount of natural gas and uranium, the demand-- we've had this huge amount of natural gas that was found in the US mainly because of the Fed, right? Fed kept interest rates so low for so long. Billions went into the Bakken, and they found all this natural gas. So all of a sudden we're sitting on all this natural gas, no buyers. Now this LNG is changing the world where next 5, 10 years, the floor price for natural gas is going to be maybe 50%, 60%, 70% up higher from here. Same thing with uranium. Both of those sectors and natural gas-- RAOUL PAL: Why would nat gas, when there's so much of it-- I mean, people are just tripping over nat gas everywhere. LARRY MCDONALD: Well, in these other economies, these power plants are going to have to be nat gas, LNG-- LNG, nat-gas fueled. RAOUL PAL: I mean, Russia's got so much of this stuff-- LARRY MCDONALD: It does. RAOUL PAL: --and there's so many places with nat gas. I can't construct a bullish argument for natgas prices outside of supply restrictions that come periodically. Uranium, yes. This has been a big theme for a lot of people I think. LARRY MCDONALD: It's a harder case to make with nat gas, but coal is just so unsustainable. And the other thing is nukes, you still have that political element. The one thing about the Trump administration, they know the US can't compete with Russian natural gas, but they're using NATO as leverage. Look this Nord Stream deal. So that the Germans have this natural-gas deal with Russia. But the US is saying, oh, by the way, we're basically giving Europe this x amount of billions of dollars a year in NATO funding. If we're going to keep that level, you're either going to have to raise your defense spending or buy our natural gas. So in that respect, you're right. There's too much of it. It's uneconomical, but Europe may be forced to buy a lot more. And Poland's already leaning this way. Trump's been over to Poland three or four times. And from what we hear, there's a deal there in natural gas that's actually linked to defense, which is crazy, like 21st century. RAOUL PAL: Wow. LARRY MCDONALD: Animal House-- I mean Animal Farm. RAOUL PAL: So also in the electric vehicles, so where's the opportunity within that? LARRY MCDONALD: Albemarle, the big producers in Latin America. There's this triangle of countries, of regions that really where most of that lithium is coming from. But Albemarle is really an anchor tenant position. There's the ETF, which is the LIT ETF, which is a lithium ETF. There's cobalt companies. There's BYD, the electric-vehicle company that Charlie Munger-- great story. I've got to tell you my Charlie Munger story, but Charlie told me about-- he invited me to Omaha. My book came out in 2008, '09. And 2011, he invited me to Omaha to come see that Berkshire Hathaway annual meeting. And I end up going to a number of those annual meetings. Any investor watching us right now, first week in May, you have to. While these guys are still healthy and just incredibly functioning, you have to get there. So I bring my wife there, and we get off the plane. We do the cocktail parties on Friday night. And the next morning, on Saturday morning, we're in the Qwest Center. There's 32,000 people there. And Buffett and Munger-- now remember, I was a former Lehman trader. Buffett and Munger start answering questions from the audience. And this is going on like an hour, hour and a half. And I look over at my wife. I'm getting the death stare. She's hungry. And I'm like, I shouldn't have brought her on this trip. It's an investor trip. RAOUL PAL: This was for you. LARRY MCDONALD: Yeah. And she's like, "honey, I want to get some lunch." And I leaned over and said, "What would you like for lunch?" She said, "Oh, I'm really in the mood for--" New York gal-- "I'm really in the mood for some sushi." I said, "honey, we're in Omaha, Nebraska." So the next morning we walk through the foyer of the Marriott Hotel. We were supposed to meet one on one meeting Charlie Munger at 9:30. And as we walked through the foyer, there's Bill Gates in one room with the sovereign-wealth funds. There's Buffett in another room with the pension funds. And just this great group of investors in the lobby, and everybody you talk to, it's a lot like this conversation. There's a lot of really incredible people that I respect. Someone that's been into Buffett, Berkshire equity for 20, 30 years, that's a very interesting person. And so we're in the room, and I say to my wife. I said, "Annabella I only have 25, 30 minutes with Mr. Munger, so please just say hi and then just gracefully leave." I didn't want to be too aggressive. So Charlie walks in, and he meets my wife. She's leaving, and he said, "I just want you to know hardship is good for you." And I said, "Mr. Munger, you're one of the richest men in the world. What do you know about hardship?" And he told this story on stage too. Years ago in the 1950s he had a law firm, and one day eight lawyers walked out the front door. And he woke up in the middle night, looked up at the ceiling. He said, "Honey, if I lost everything, would you still love me?" And she said, "I'd love you, but I sure would miss you." And I said, "Mr. Munger, you're one of the richest men in the world. What do you know about hardship?" And he's just the most inspiring man I've ever met. The burning desire of Charlie Munger every day to get up and get smarter is something to behold. And when you live through your whole life-- and I just turned 53-- you realize how much time you have. And as a young person listening to us right now, there's nothing that can stop you if you just keep that burning desire to learn, to break through those walls, and get smarter every day. Get smarter at your focused craft, and that's what Charlie Munger's life is all about, and he's one of most successful investors the world's ever seen. RAOUL PAL: So to loop back in the electric-vehicle thing, he's invested in-- LARRY MCDONALD: In BYD. So around that time he convinced Mr. Buffett, who's not really a big technology fan, even though he's the largest shareholder of Apple now. But it's fascinating to see that vision. They were way out in front. If you look at their cost basis on this BYD equity, I think they own 20% of the equity now, but their cost basis-- I mean, they were in there way early. And within China, it could go really well for BYD because as the Paris Climate Accord gets priced- - as they enforce it in China, the companies with the highest standards or the highest-- the electric vehicles with the best performance and standards are going to get more credits, more receptive and more push from the government. And so I think that's why-- number one, that's not their original thesis, but that's why I think they're very happy with that position because that's an equity that could be 5, 6, 10 bagger from here. RAOUL PAL: So you'd like to be long that and short Tesla? LARRY MCDONALD: Yes. Well, I think the Tesla thing is fascinating because as a former distressed trader, high-yield trader, I've never in my life seen a $50-billion equity market cap. Think about this. I've never seen a $50 to $55, $60-billion equity market cap-- so that's equity-- on an 8% or 7 and 1/2% coupon high-yield bond in the same company. It doesn't make any Sense. So it's just a classic tails, right? So you've got the equity people that are playing this one tail, and the high-yield people, the bond people don't buy it because if they were buying it, the bond would have-- the coupon or the yield on the bonds would be well below 5%. RAOUL PAL: Because the bond guys I think are saying he's managing the companies as if it's still a VC-funded firm. So they're saying but it's a public company, so you're going to run out of cash. The equity guys are saying, yeah, but look at the upside, and they're also thinking like VC guys thinking, yeah, but there could be a 10x here. And I don't think it's possible in the public markets for this to happen. LARRY MCDONALD: I've never seen-- maybe you could point one to me. Typically you don't see $50-billion equity market caps and a coupon that high. RAOUL PAL: Then why is that not the trade then is just to buy the bonds and sell the equity? LARRY MCDONALD: Well, that's why there's the converts. Now the problem is the converts, they're unsecured, and the senior secured, and then there's other pieces of debt that have a claim on Tesla's prized assets, the big property plant that they have on the West Coast and now the assets that they're developing in China. So the converts could be a great play, but it all depends on the recovery risk because the bond's at par. So going back to the convertible bond. The Tesla bond's right around par. That's $1,000. It may go to $6,000. To your point, that's the equity component. But where's your recovery if it's an unsecured convert with all this bank debt and all this other debt on top of it? So maybe you have 50% downside, but net-net you have 600%, 700% upside. That's a lot better deal than the equity. I'd still rather own the Tesla converts, but net-net, I'm negative on the equity. And our work shows that-- we did a beautiful report that that's up on Real Vision, but you're talking about $400 or $500 billion of investments from German engineering-- Volkswagen, BMW-- that are coming at this. RAOUL PAL: I keep writing about this. LARRY MCDONALD: Can you imagine this? RAOUL PAL: When you see what Porsche are launching, what Audi are launching, what BMW are launching, they're really going for this, and they've taken the time to get it right so that the doors actually fit together and the car doesn't break down. LARRY MCDONALD: Best engineers in the world. Literally like 30,000 of the best engineers in the world are coming at Tesla. But guess what? If you spend a little time on the Hill, Elon Musk is a genius politically. He's spent a ton of time on the Hill. He really ingratiated himself with the Obama presidency. And the subsidies-- the American taxpayer, if they saw the subsidies in Tesla through that creation, the average taxpayer would just faint. it's just billions of dollars of subsidies. But guess what? He's very close with Kevin McCarthy. Kevin McCarthy's the House minority leader. And you've got this 232 coming out of the Trump administration now. And they just announced on autos, the auto tariffs. They just announced the plan on February 17, but they haven't given the details. Lo and behold, there'll be some protection for US electric vehicles, I think, coming out of that White House. RAOUL PAL: Really? LARRY MCDONALD: Because think if you're Elon Musk. You know those 20,000 German engineers are coming at you. You know there's $200, $300 billion of investment that's coming at you in the electric-vehicle space coming out of Europe. To your point, the most incredible Porsches are coming out. The only way you can survive is if you get your boys in Washington to protect you with tariffs for the next two, three, four years. RAOUL PAL: I thought this government was supposed to be antitariffs? LARRY MCDONALD: Oh yeah. I think if you look at 232, it won't be-- and remember, we're talking about the US-auto-tariff agenda that's coming out, and it'll be much more of a sniper fire than a shotgun. We did a report on BMW. The spread between BMW equity and GM is two standard deviations outside the norm going back 10 years. It's never been this cheap to GM, ever. So I think German cars could be a real-- German auto, like BMW, equity could be a real buy here because at the end of the day, it's a lot like Mexican equities. Trump gets elected. He makes all this news on the wall. Mexican equities drop 60%, 50%. We were buying them for clients because the Trump bark a lot of times is worse than the bite, and the media coverage on the bark is so profound that these vicious selloffs occur. And at the end of the day, you've got all this news on auto tariffs, all this negative news on BMW. And if they come up with selected tariffs that won't hurt BMW as much as what's been priced in, you're talking about a stock that could be up 60%, 70%, 100% over the next three or four years. RAOUL PAL: Well, the other way of looking at it is that when I look at car sales around the world, they're collapsing. The US is also slow. Not the end of the world yet, but it seems to be slowing down. What happens if it's just GM that's massively overpriced? LARRY MCDONALD: Well, there's some pretty impressive investors that have stakes in GM. To me, I just love David Einhorn and his career, even though he had a bad year last year. The work that some of these investors have done on GM-- their incoming entrance to electric vehicles in China, the growth, the potential deal with GM and, I think, Amazon. There's all types of disruptive forces that could eventually help GM. But you can make the case that-- we don't really have a strong opinion on GM equity, but I do think though it's-- RAOUL PAL: Because I'm just thinking, again, like we were talking with the Tesla, maybe the smarter thing here to isolate the actual risk and opportunity outside of the macros is to do the long short, the pairs trade. LARRY MCDONALD: Well, yeah. RAOUL PAL: Because if it's two standard deviation mispriced-- LARRY MCDONALD: No, exactly. I see if you're short GM and long BMW, yeah, that's going to normalize. That'll work for sure-- RAOUL PAL: Now whether it happens-- LARRY MCDONALD: --I believe. RAOUL PAL: --that GM share price falls or BMW rallies, what you're taking is the market risk out of it. LARRY MCDONALD: Yeah. There's an HS screen on Bloomberg which you pull it up and you look back, and it's just, we've never seen it. That gets back to-- that's politics. That's why I think the political element of research is so important because whether it be elections or whether it be tariffs or whether it be-- the noise is so loud from the press. And remember, there's a disruptive element of the press. BuzzFeed out of business, right? The New York Times had financing from Carlos Slim which potentially saved the company, and now the company is flourishing. The point is that the US media is being massively disrupted. So the clickbait, the ability to issue a story and get eyeballs on it is now much more important than it ever was before because of these really historic disruptive forces in media. So what that means is there are these trades that get viciously-- and we have a capitulation model that measures capitulation. We look at these different sectors. Is this a category 3 hurricane capitulation? And you can mathematically quantify the capitulation. And what we found, especially with Mexican equities, with Brazil last year ahead of that election, the stories about Bolsonaro and Brazil-- they made this guy-- this guy looked like Darth Vader coming in. And then you had a bunch of things going on in Brazil at the same time with trucker strikes and everything. But the bottom line is the negative narrative because of this media's disruption I think is profoundly expanded more so than it ever existed 5, 10, 15 years ago. So what happens is the capitulation process and this vicious bear market can be so severe and the exiting-- and then sure enough, lo and behold, these produces a fantastic bull market. Brazil equities are up, since October, 30%, 40%, 35%, and the US equities are flat. So you've had 35% outperformance in Brazil versus the US since October, all because of this politicization of information. RAOUL PAL: So just as a final thing, where's the next big political opportunity? LARRY MCDONALD: Well, it's definitely Venezuela, but it won't be tradable for a while. So then we have to look at around the world. RAOUL PAL: What about Europe? Does anything change? LARRY MCDONALD: I think that in Europe, you could have a situation with Merkel where if she exits-- German equities are so cheap to the US. I think if you go back 20 years, they're one of the cheapest they've ever been. What we look at for The Bear Traps Report is multiple levels of capitulation. So you've got a capitulation-- remember, German equities, there's a decent chunk of them that are exposed to autos. So that's part of it. And then you have the potential Merkel exit. You've got all this problems on the periphery. So German equities relative to the US, if you buy German equities now and hold for five years, I think you're going to be in a pretty good spot to some extent. Now the banking situation is an overhang, but it's very well known, and maybe that plays out over a longer period of time, and maybe over the next two years, that could be the real situation because think about it. European equity, especially Germany, has been crushed by this Trump trade drama with China because you're talking about Germany's largest trading partner. And today we just saw manufacturing PMI down with a 47 handle coming out of Germany. I mean, they're in recession. So these stocks are cheap, and the risk reward in German equities-- I mean, they've got a Merkel exit priced in. You've got a China potential recession that's been priced in over the last year into German equities. You've got all this political risk. You've got the Trump trade tariffs. I mean, you're talking about every sane investor's been knocked out of Germany. There's nobody left to sell. RAOUL PAL: Fascinating. Larry, really fascinating conversation. I think people are going to get a lot out of this and hopefully some thinking and some inspiration as well. So just thank you so much-- LARRY MCDONALD: It's a pleasure. RAOUL PAL: --and we look forward to seeing more of you on Real Vision. LARRY MCDONALD: And you've been a great inspiration to so many of us on The Street, and I love your quality of life. RAOUL PAL: Thank you. LARRY MCDONALD: Good to see you. RAOUL PAL: Good to see you. LARRY MCDONALD: Thanks, my friend.