Eric Peters and Nicole Lapin Discuss Bitcoin, FTX, Inflation and his Wknd Notes Newsletter

Full Transcript:

Nicole Lapin: Welcome to Magnifi+, where we help you invest with intelligence. Which means with Magnifi, you can now do more than just trade stocks. You can search, you can discover and invest in the ideas and values that are most important to you using our revolutionary machine learning software. I'm Nicole Lapin, former CNBC, CNN, and Bloomberg anchor and your host for today. Today's guest is Eric Peters, the founder, CEO and CIO of One River Asset Management and its subsidiary, One River Digital Asset Management. Prior to founding One River, Eric served as chairman of Grant Capital Partners, a one and a quarter billion dollar discretionary global macro hedge fund. Eric has also held various positions over the years, including portfolio manager for Peloton Partners, proprietary trader for both Lehman Brothers and Credit Suisse. And he was also the founder and chief executive officer of a TH Lee Putnam funded technology firm. Welcome, Eric.

Eric Peters: Thanks, Nicole. Thanks for the intro. It's great to be here.

Nicole Lapin: It's great to have you here for many reasons. First being, I know you don't make these appearances very often, so it is a real treat for our audience. You are one of the first to create an inflation hedged portfolio three years ago and one of the first institutional investors in the crypto space. So, I would love to start with the crypto space, if we could double-click there. The crypto market extremely, extremely volatile in the last few years, of course, and more so in the last few months. Is crypto in trouble?

Eric Peters: No. Look, number one, it's a fascinating market. All markets are right now. I've been a macro trader for, boy, it's been 33 years at this stage. I'd say the last few years have been the most interesting of that entire period, and there've been quite a few really interesting periods. Crypto's been part of that story. So we entered crypto space with the largest institutional allocation in November of 2020, and that was really driven by the macro backdrop at the time, which I think continues to play out. And that macro backdrop was one where it seemed apparent that we were in a period where central bankers needed to debase currencies in order to relieve economies from the large debts that they had incurred.

That process really, it started through the pandemic in earnest and then accelerated through 2021, which is when you saw the really big gains in crypto, just really massive gains. And this year has been a year where central bankers have started to try to have to pull the reigns in, and they've obviously raised interest rates far higher than would've expected. They've been quantitatively tightening, and that has had a really dramatic impact on the crypto markets, much of which was... While I think there's some really firm fundamental underpinnings to the market, there had just been so much froth because that big macro driver had really captivated people's imaginations. And so, we've seen similar dynamics in the tech stocks, just like I don't think technology is over, I don't think crypto is over as well.

Nicole Lapin: Seems like you avoided the FTX disaster. Did you ever meet with Sam Bankman-Fried? Did he ever pitch you anything? Did you see signs of this coming?

Eric Peters: I have spoken with Sam a number of times and we've been spoken at the same conferences. We never did any business with FTX. I think our approach to crypto has been pretty conservative. I say that we took very large risk earlier on, we actually made very substantial profits from our early investments. We more or less tripled our money and exited almost all that risk and returned that capital to our investors. So that was pretty exciting. That kind of happened through 2021, but we took the opportunity to build out a range of institutional asset management products in this space. And our approach has been very conservative in the sense that we believed that DeFi represented risks that were mispriced in that the returns...

Even though some of the returns that some of these investment or in lending products generated seemed really attractive at 20% or so relative to the risk, we didn't think that they were commensurate and we thought that there were real regulatory risks so we stayed away from DeFi, which meant we didn't touch Luna. And that's something that really suffered profoundly. We didn't do anything with Celsius, which also suffered, and we didn't touch FTX or their token FTT. And we're obviously grateful for that. You're always a little hesitant to say things like that because it's not as if we don't ever make mistakes, and I'm sure we'll make some poor trades out in the future, but through this crypto bear market, given that we returned almost all of our capital, we've had really light exposure.

And now I think we're at that stage in the cycle where big things are breaking. I think when the FTX news hit, I told our team that I think this marks the beginning of the end of this bear market, that didn't mean that it would end on the day, but it's when big things like this, big frauds happen, they don't happen at the highs, they happen more or less in the range of the lows. So yeah, thankfully we didn't have any exposure, our investors didn't have any exposure. The lending strategy that we did have through that bear market returned all of its capital plus interest. So, I felt there were times where, and people asked, did you feel FOMO as all these other firms were printing these huge yields? And to a degree we did, but I've just been in the game long enough to know when something looks too good to be true, it typically is. And I'm grateful that it wasn't just me, we've got a phenomenal team and the team evaluated those risks and we just didn't touch those things.

Nicole Lapin: So let's double-click on that some more. You came across SBF. Did your spidey sense just go off or was it really just that you guys had this philosophy against DeFi, so you didn't invest there? But did you have a sketchy, weird feeling about him? Did he strike you as a Madoff type character? Can you tell us some more?

Eric Peters: Yeah, the reason you have Madoffs is because they don't come across as Madoffs I guess. You know what? More or less, I'd say an investment principle that I've held, maybe I didn't early in my career, but I certainly do at age 56, is that when things look too good to be true, they tend to be, and it's just not an area that's interesting to us. When people make money faster than average or way faster than average, that that's also just something to kind of steer a bit clear of. And so, in the calls that I had, he seemed like a very nice, lovely person, but as I said, we didn't do business with him. There are a lot of lovely nice people in the world. And yeah, we didn't touch that.

Nicole Lapin: Because it just felt off or it smelled weird or something.

Eric Peters: It's not even that. We go through a very thorough due diligence process with all of our counterparties and FTX wasn't a firm that passed our due diligence. And so we didn't end up working with them.

Nicole Lapin: So if you were to invest in crypto now, where would you invest? And do you believe this idea still that Bitcoin is a hedge for inflation?

Eric Peters: I think that right now we're seeing the leverage being just ripped out of this marketplace. It's more or less gone. There's always more bad news that can hit a market but I think the vast majority of that is behind us at this stage. It doesn't mean that the prices go straight back up, but I think one of the things that's happened in this last cycle with Bitcoin and digital asset prices is that it was sufficiently large that it attracted a lot of attention, which resulted in a lot of people getting involved and too much leverage and that's been painful on the unwind. But also the silver lining of that is it got big enough and real enough that it finally pushed institutions to start really investing in blockchain technology, which ultimately we have a very high degree of confidence will provide a new infrastructure foundation for finance.

So we think that over the coming 10, 15 years, just about all trading will be done on blockchain. Trading will be done on blockchain, settlement will be done on blockchain, which just means you'll have digital custodians. Obviously, I've got some terrific ones right now, Coinbase being the leader, but you'll have traditional finance enter that space through time and what you'll end up with is a world where all assets that we trade right now, stocks will be traded as tokens just as Bitcoin is a token or ETH is a token. Bonds will be traded as tokens, commodities will likely be traded as tokens. Funds, what we consider mutual funds and things will be traded as tokens, ETFs as well.

So in that world, Bitcoin will be one of the multitude of tokens that will trade and I think Bitcoin will retain its position as digital gold at a minimum, it could become something bigger than that. So I see in that future world, I think that the price of Bitcoin and a number of these other assets will go up a long way. Many of these assets will be worth zero. Many of them are probably worth zero right now, they just don't quite know it yet but that's the nature of innovation. What you're seeing in this space is these tokens represent ideas and technology just like early stage venture investments would, except that they trade in a real market.

And so if you saw every small tech company that was a venture company trading in real time, they'd be awfully volatile and most of them would be worthless. And I think the same holds true with a lot of these tokens, but there will be a lot of value that will accrue throughout this whole ecosystem. And so, that's really the long-term game. That's what we're playing for as a firm and as representatives for our investors.

Nicole Lapin: That's a really good point. That's obviously why a lot of startups wouldn't want something like that.

Eric Peters: Exactly.

Nicole Lapin: Let's go back for a second and talk about inflation. So Eric, you were very early in recognizing that inflation wasn't going to be transitory despite what the Fed said, and you came up with the strategy about that. Can we talk about it?

Eric Peters: We promoted the thesis that inflation would pick up really kind of more like late 2018, early 2019. And at the time, it was a thesis and it was nothing that had manifested directly in markets. The point or the thesis that we made was that we were at the tail end of a debt super cycle in the US and more or less that was exported globally because the US dollar is a global reserve currency, which means that US monetary policy more or less gets exported to all of our trading partners in one way or another. And so by late '18, early '19, it had been become evident that lower interest rates and QE were no longer as effective as they had been for the years prior. And central bankers were more or less calling out for the need for a big fiscal impulse to make monetary policy effective again.

And so it didn't require rocket science to recognize that the central bankers were right about that. And so what evermore aggressive bouts of monetary policy was really doing was just lifting financial asset prices that was expanding inequality, and that was one of the drivers of lackluster growth. Because the reality is even if you make wealthy people more wealthy by pushing up their asset prices, at a point they're not really going to spend that additional paper wealth. And so monetary policy wasn't working so our view was that, look, there's going to be another recession at the time, it had been the longest economic expansion and bull market in US history. It seemed inevitable that some catalysts would come along to end that cycle.

And when that catalyst hit, we thought there would be a material fiscal expansion. A lot of people were talking about MMT at the time we were talking about that, just recognizing that that politically would provide cover for a big fiscal expansion, meaning just the government borrowing a lot of money and spending it. It happened that it was COVID that was the catalyst. And COVID honestly was as powerful a catalyst as I could have fathom other than a large scale nuclear war. And so it was a very, very powerful catalyst. It hit the market. It allowed Republicans and Democrats to agree that we needed a big expansion that extended beyond our borders and so we had the whole world, anyone who could afford to spend and borrow money did. And so that's why it came about. In terms of how we've expressed that, we've expressed it in a lot of ways. One of the ways is through crypto, as I mentioned, that was the most explosive way that we saw. But in traditional inflation markets, and there are all sorts of ones, they were great or at least good ways of expressing that.

Nicole Lapin: Do you think it's too late to invest or profit from an inflation protected portfolio?

Eric Peters: I think it's harder. So, moving from a regime of very low and stable inflation, which is really what we had for a decade or more and arguably we'd had kind of low and declining inflation or disinflation for a few decades, but transitioning from that to a higher inflationary world is kind of more of a direct directional bet. I think now it gets more difficult. But I think that that theme is with us because I think what a lot of people miss is that what we are living through right now is a policy choice, meaning the US and all really Western or developed economies have accumulated extremely large levels of debt and entitlement obligations over the last few decades.

Now we have an aging populations across the developed markets for the most part, some places worse than others, even China, by the way, is now aging and has a shrinking workforce. So, you now have an environment where you have shrinking workforces, very high entitlement obligations and a lot of debt. And so in an environment like that, you either need to have a huge productivity boom, which hopefully we have over the next 10 or 20 years. It's just not obvious what that will be right now. And in the absence of that, you need to figure out how to restructure those debts in some way so that you can honor those obligations, those entitlements, and you probably need to restructure those entitlements.

You can do that through just a big reorg, which means you have to tell a lot of old people that you're not going to take care of them in their retirement, that doesn't work well in a democracy. You can default on your debt. That doesn't work very well. I think there's no appetite for that post Lehman. So the only option left is to create what's called financial repression. So create an environment where you have reasonably high levels of inflation relative to interest rates, and over time you grow your way out of those big debts.

And it all gets a little murky and it's not a perfect solution, but it's the best solution out of a few really poor choices so, it's important to remember this, what we're living through right now is a policy choice. Now, it is true that the Fed is trying to reduce inflation. It's highly unlikely in our opinion that it gets anywhere down near to 2% sustainably, we're probably moving to an environment where inflation is between three, four, 5%, sometimes it goes a bit higher, sometimes it goes a little bit lower. But when you look at previous periods of higher inflation, they also have a lot of inflation volatility. So, that's what we need to live through right now.

Nicole Lapin: And where do you think fed fund rates are going to go above 5% or higher? And what do you make of the business news media's obsession with exactly when rates are going to go up or not or the timing of it? Do you think that's even relevant?

Eric Peters: That's a great question, Nicole, because I find a lot of this stuff laughable. It is important if you're trading Fed funds futures to know where the Fed funds rate is going to be at a particular date and time. Right now, the market by the way is pricing Fed funds to top out the middle of next year at 5%. That's what the market says. And then by the end of next year, Fed funds should be between four and a half and four and three quarters being priced right now. But these things move around really dramatically in this type of environment. By the way, the beginning of this year, the Fed funds were priced to be about 110 basis points in the middle of 2023 so now it used to be 110 base points, now it's 5%. So, I think we'll see a lot more of these big swings, maybe not that traumatic.

I don't think it really big picture. If you're looking at medium to longer term equity investments, commodity investments, even bond investments, I don't think it really matters whether fed funds top out at four and three quarters or five or five and a quarter, it matters if they're going to top out at six and a half or seven or it matters if the economy breaks in some way and they have to get slashed down to 3%. But people tend to parse Fed statements for every little word change that takes place and that I used to care a lot early in my career, I care a lot less right now. I think the bigger observation is that there are drivers in place that are going to keep inflation higher for longer and more volatile for longer. And I don't think it's whether Fed funds go an extra 25 basis points up or down, it's not going to change that paradigm in the least, I don't believe.

Nicole Lapin: So. What do you think overall 2023 is going to bring? Are we going to have a soft landing, a hard landing, a medium landing? Tell us more about the landing and what do you think the outlook for stocks and bonds are for the next year?

Eric Peters: Yeah, that's always the trick and we think a few things are going to unfold over the course of 2023. We think inflation is in the process of moving lower, and we think that will continue in the early part of 2023. It doesn't matter that we think that the market's already priced for that there's no... The markets are really for quite benign inflation so if you look at say a 10-year break even inflation, which is just kind of a fancy way for saying what the market is pricing for inflation to average over the next 10 years, it's really kind of 2.3%, which is really quite low, which pre-pandemic, that was a number that you'd often see. So the market's priced for real return to normal. If you look at where that equivalent inflation rate is priced at the end of next year for the following year, that's also right around 2.3%.

So the market's already priced for real return to where we were in the past. We think that that's not going to play out. So, we think that we're going to see in the early part of the year inflation heading in the direction of the consensus, and that's going to make people feel pretty good about it but we don't think that we'll sustain at those levels. We think we're going to end up with a materially higher inflation rate. And a lot of that is just because we've had high enough inflation for long enough that we're starting to react... Things are starting to happen in the economy that will sustain higher inflation. We're starting to see wage hikes, we're seeing greater union power, we're starting to see the things happen that you would actually want to see from a policymaker perspective, and I think my personal perspective to see inequality start tightening.

So we're seeing some of those dynamics happening. I think those are good dynamics by the way, I think that'll ultimately create a healthier society and a healthier economy to have less inequality, greater equality. But I think next year is the year where we're going to start coming to terms with the fact that this old paradigm, which is what is currently priced into the market next year is past us, we think that that's gone. We think we're entering a very interesting new market paradigm, and that's going to become more apparent over the course of the next year. And the tricky thing, or the interesting thing will be in terms of basically how does the Fed begin to act in that world? So it's fine. The Fed has so far been winning because it's looking at these flawed inflation measures and saying the market's pricing in 2.3% over the next 10 years. There's nothing wrong with that.

Everything that we're doing is great. Well, if inflation starts bottoming out next year at 4% and not really coming lower, the Fed will be pushed into going, "Okay. Well, now what's the real economic pain we're willing to inflict on the economy in order to actually push inflation back down to those levels?" I think that they probably will start doing that. They'll try to do that and then we'll have a pretty decent market disruption on the back of that.

Nicole Lapin: And if it does, I'm sure you will write about it because your Wknd Notes are one of the most read Sunday wrap-ups among, rumors have it, the biggest hedge funds in the world as well as some major central bankers. I mean, you probably have a distribution list that I would love to dig into and somebody could only dream of. What are you focused on right now? What are your readers focused on? How do you decide what to write about every week?

Eric Peters: Well, my litmus test is I write about things that I find interesting, and my view is if I find them interesting, hopefully at least one other person will, and that's my litmus test. One of the challenges is there's so many interesting things happening right now. I think the big picture like when I'm sitting with our clients, which we've done a lot of recently, is they think about 2023 and beyond is, I think the big question that people have is, are we really in some type of new investment and economic and political paradigm or have we just experienced this weird blip on the back of COVID and actually things aren't very different? And what's interesting is that as we were just talking about, the inflation markets are kind of priced for return to, I don't want to say the good old days, but the old days. And I think that we're actually in a very, very different world.

And so some of the big features of that world, I would say that appear to be unfolding right now is de-globalization. So we spent the last 30 years of my career and all of our careers I suppose, in this world of ever deeper global integration, that process is at a minimum shifting. It may be that there's still plenty of globalization, but we're shifting from China more toward India and other trading partners or more regional partners like Mexico and Canada, which are already our biggest trading partners. But it's likely that there's going to be a lot of consolidation in our key partners. It's likely that we're moving toward a more bipolar world as opposed to unipolar world. It seems evident that we're moving in the direction where we need to improve the redundancy of our economies.

And so you look at things like the Nord 2 pipeline that blew up, it's forcing governments around the world to look at their critical infrastructure and say, "Are we happy in a less peaceful world with how secure our key infrastructure is?" And so all of those things are beginning to shift and ripple their way through economies. What we think you're going to end up with is a world where there is a lot more reshoring. Economies throughout the world look to secure natural resources, they look for more redundant supplies of all the things that are critical to them, that's going to create really lower productivity, higher wages, different inflationary dynamic.

And so we think that those things have only just begun. Incidentally, I think part of that is just the policy choices that we're making, and that policy choice will narrow inequality. Hopefully, it won't narrow inequality through just making wealthy people a lot less wealthy and poor people, more or less the same, hopefully we're kind of lifting the lower income segment up, but it's also like we can observe the super wealthy like Mark Zuckerberg is a lot less wealthy than he used to be, but I think that that will ripple through all the layers of the upper income and kind of compressed there, and hopefully we kind of build up from the bottom. I think a lot of our investors are thinking about that because everything I just described creates the need for a different portfolio than what has been the portfolio that's been really successful for the last 10 or 20 years.

Nicole Lapin: I'm sure you can't disclose your distribution list, but can you tell us one really cool person that you were in awe was a subscriber of yours?

Eric Peters: All my heroes. All my heroes. I never name names, but all my kind of great hedge fund and investment heroes are on a list right now, which is really fun. It's super gratifying for me. It's a lot of pressure to produce something on a weekly basis for such a strong readership, but it keeps me sharp, and I'm grateful to have that opportunity.

Nicole Lapin: Well, we are grateful to have the opportunity to speak with you about it. Eric, thank you so much for sharing all of your insights on what's going on in markets and where investors shall look to invest next.

Eric Peters: Wonderful. Nicole, thank you so much. I appreciate it. Nice to see you.