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

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1:43Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal. And I'm Tracy Alloway. Tracy, markets getting interesting again. I love interesting markets. We do. We always say we're long volatility. That's right. Here at the Odd Lots podcast. All financial journalists are long volatility, I guess. Yes. I mean, you can actually see it in the listener and readership numbers. Our traffic follows the VIX. Those are bad incentives. Yeah. Perhaps. Perhaps. Yeah. But. If it bleeds, it leads. I mean, they've been saying this about the news forever. Yeah. So at the moment, we are recording this on Friday, November 14th.

2:18At 10.07 a.m. Yeah, we have to say that. We have to be very specific because things are changing so fast. At the moment, the S &P 500 is down like 0.7 percent, but it was down more than 1 percent earlier. And then yesterday it fell, you know, 1.8 percent. So this is a pretty substantial slide. And of course, it comes at a time when people were already worried about things like tech valuations and the possibility of an AI bubble. Totally. The U.S. stock market has had a phenomenal year. And this is all kind of minor in the grand scheme of things. But some of the moves haven't been that minor for some big things.

2:56It is some of the most volatile period since April, really. I mean, it's kind of been a smooth ride up since the end of April or the middle of April, whenever that bottomed. There's just a lot going on. Questions about the Fed. Gold, interestingly, had a massive year and it also is selling off. So that sort of raises the question about what's been driving gold. Bitcoin getting absolutely clobbered, of course. You know, it's sort of a glorified tech stock and the way it trades. So many interesting things. So many market winners fading a little bit. You know what was really interesting this morning?

3:27For a second, bonds weren't really doing anything. They weren't rallying. And so if you can't go into gold, if you can't go into bonds, if everything's selling off at the same time, that seems kind of worrying. Well, this is really interesting and probably needs to be discussed more. But you're absolutely right. I think yields on the 10-year were actually up yesterday, November 13th. In the last week, I was looking at the work function on the Bloomberg terminal. Odds of a December rate cut have come in quite a bit. It's closer to a coin flip. A week ago, it was 66%. There have been some speeches from some of the FOMC members talking about, you know, they're uncertain.

4:02And part of the reason we're uncertain, because we've had so little data, I guess we're going to start getting data again now that the government— Although it's still going to be messy. It's still going to be super messy. You know, understanding the economy in real time is harder than the best of times. It's really hard when there's no data. And then it's really hard when the data that does come out is going to be driven by the lack of government employment, which then make the data even more ambiguous. So a million questions, very interesting moment in a very interesting year for markets. We sort of got to get a better understanding of what's going on.

4:31Can I say one more thing before we get to our guest, which is I think part of the discussion at the Fed, we're kind of getting very circular here because I suspect what's happening is, yes, the Fed is worried about inflation. So some FOMC members are getting a little bit more hawkish in their speech. I think they're worried about AI bubble possibilities and valuations as well. And the longer they keep rates low, the longer this goes on. And then maybe the mess is even bigger when they eventually have to clean it up. Totally. All kinds of crosswinds, so to speak. Well, anyway, I'm very excited to say that we do indeed have the perfect guest, someone we've never had on the show before, but very excited to talk to him.

5:07We're going to be speaking with Dirk Villa. He is the head of global macro strategy at Citi. He brought us a book, too, that he co-authored, Trading Fixed Income and FX in Emerging Markets. It's going to be useful in the U.S. I know. That's the thing. It's like suddenly all these EM veterans like, let's tell you how some of these things really work. So, Dirk, thank you so much for coming on the podcast. Great to be here. Thanks for the invite. Let me ask you a question. If you went back, say, a month ago or a month and a half ago, you were talking to clients, et cetera. Did you ever encounter a single bear?

5:39I mean, I'm trafficking more among the macro people than the equity folks. Sure. And the macro guys are always half glass empty, right? Okay, right, right. So you did find some bears. And I would say, actually, only a few weeks ago that disappeared because there was a really strong buy-in into the center rally, right? So meaning November and December have exceptionally positive seasonality always. And they have even better seasonality. We're talking risk and risk. In risk and the S &P, exactly. So I think the bears that we found disappeared over the last few weeks. So maybe just at the wrong time, you might argue, but that's how it goes, right?

6:14Yeah. How do you officially measure sentiment in this market? I'm always curious because obviously everyone has different methodologies, but sentiment seems quite key when you're talking about a bull run that's really driven by tech stocks and this AI narrative, the story becomes so important. It's actually really key to this because if you were to say, listen, this is the top of a bubble or something, you'd have to see really, really enthusiastic sentiment. And we never quite saw that. My favorite indicator is, we call it the Pulse indicator. It stands for positioning and various other things.

6:48And that is something that we put out and that worked really, really well this year and actually the last five years for that matter. And that never went into territory that really told us to be cautious. We do a bunch of surveys. So we survey all the big asset allocators worth a few trillion in asset under management, and they never got as bullish on US equities because after April, there was a big move outside of US equities, as you know, and they never really fully jumped into the US equity market as much as they went outside of the U.S. So we always thought, you know what, there are certain stories here that definitely remind us of 2000 and of a bubble.

7:28And on our definition, actually, it is a bubble, but it's not close to the end of it. And one missing component was really the sentiment that never got as extreme on our measures. We're definitely going to get more into the bubbles, especially the 2000s. But before that, I want to ask, how do you square, I guess, non-frenzied sentiment with the amount of announcements that we're getting from companies. We're joking on the podcast that every day while we're recording this in studio, we get a new headline that, you know, Anthropic is going to spend 50 billion on data centers or someone else is going to spend 100 billion.

8:04It just goes on and on. Yes, that is very true. I mean, I think the market is starting to question those numbers a little bit, right? When the Oracle deal came out, for example, the stock jumped. Guess what? We're back to where we were before the deal was announced. So I think there is a certain sense of skepticism partly because some people think they've seen all that before, right? And people are bullish. I'm not telling you they're bearish. I'm just telling you they're not as excited as you might have expected just watching the price action. I think that is more the nuance here. And actually, none of the indicators suggest that.

8:36I mean, I'm sure everyone has their own favorite, but it's really very rare to find one that tells you, you know what, this is in line with what we've seen at other market tops. You know what, since we've never had you on the podcast before, and you're the author of a book on EMN, you have a great job, global head of macro strategy, a city. Why don't you give us the 60 second background of what you do and how you got here? Like, what's your job? And how'd you land here? Yeah, I came over to the US in 99, essentially joining a macro hedge fund. We traded back then. And again, right now, actually, I think it's all about the bubble.

9:11That's the single biggest call. Everything else will fall into place. Whenever the bubble bursts, the dollar weakens. The Fed rates will go to zero or maybe not quite to zero, but you get aggressive. So everything, that's what you have to focus on. And so even though I joined the hedge fund back then as an EM specialist, very quickly I looked into companies because we really had to figure out when is this dot-com bubble over. And then we traded very successfully, actually, the run-up and the run-down. Although I would say it's very, very hard to trade a bear market, right, because these bear market rallies are really quite vicious.

9:44And so in the end, all the money was made being long fixed income rather than being short equities. But broadly speaking, that was me shifting from emerging markets to global macro, if you like. But then I went back to the buy side partly because, you know, the particular hedge fund never became as bullish again on the bull market, having been successfully bearish for a long time. Many people are cursed by good luck getting bear markets right. and then are haunted by that for the rest of their careers. They're very rare. They're very rare. But, yeah, so at Citibank, I covered emerging markets for a long, long time and switched back to global macro a few years ago.

10:19And as you can imagine, it's mostly speaking to hedge fund clients, to some real money clients, some corporates. What we do a bit differently is that I have a big quant team. So essentially we backtest everything under the sun, at least to get your price right. Things are always slightly different, but I think it's very important to have the right price, and that's what the back tests give you. So we have a big quant effort. We are very trade sort of aggressive, putting a lot of trades out and monitoring them carefully. And I have a bigger emerging market angle than most, which I still think is extremely helpful in this environment.

10:53So since you've been around for a while, let's talk about the 2000s dot-com bubble or 1999-2000 dot-com bubble. Obviously, people are using that as an analogy for this period of time. But we had someone in our Discord, actually, shout out to Burr Flyer, asking whether or not people were talking about dot-com stocks, tech stocks being in a bubble, the way people are talking about AI stocks, tech stocks being in a bubble now. What's your experience more than 20 years ago? Back then, it was even clearer than now. I mean, if you remember, NASDAQ went up 50 % in Q4. Yeah, I pulled up that chart recently.

11:34It's crazy. And I remember some stories. We had some analyst pitches all the time. So there was an analyst for Nokia who said, don't worry that we need more than 100 % cell phone penetration in the world because pets will wear cell phone-like. They were kind of right. It wasn't wrong. They were kind of right. So you got my favorite pitch was for Akamai when analysts said, you know what? But the reason why the company will do well is there are only three people who understand the formula that's basically at the base of it. And all three work for Akamai. So don't worry. Don't worry about it. We know it's good.

12:11It's literally, there's just no one who could ever replicate this technology. There's only three people who could build it and they all got it. Amazing. I never heard that one. So these type of things happened back then. And of course, not to pick on Akamai, but it, you know, it went up from, I don't know, 30 to 300 after the IPO and back to one. You know, this is like these type of things happened. And that was one of the more legit companies. Yeah, you know, they exist. Yeah. I don't. Yeah, yeah. I'm not covering them or anything, so I don't comment. But yeah, it's. Yeah, yeah. This reminds me of what you always say, Joe.

12:42Things can always get crazier, right? Yeah. Yeah, it really does feel like you see some event, you know, like there was that, you know, I was thinking about when Jensen Wong. I think it was about a year ago now, maybe nine months ago. Remember, he signed a woman's bra, right? Remember? And everyone's like, oh, this has got to be the top. Right? Because that's just one of those things. Literally a top being signed. That's right. It's like, why is a CEO of a semiconductor company getting like legit rock star treatment? And how much is NVIDIA up since then? Setting aside some of the recent wobbles, there is no point where you can definitively say, oh, this is the peak of a mania, right?

13:20It could always get weirder. Yeah. You know, what gives me sleepless nights is actually that the 2000 episode is not the right benchmark, right? Because if you use 2000, you could say - Everything's fine. Yeah, everything's fine. But of course, not every bubble has to get as crazy as the 2000 one. You know, I mean, it wasn't extreme even by bubble standards. So that is a bit of a risk if you focus too much on that one. Do you have a preferred historical analogy for our current period? And I do think 2000 is probably the closest just because it was also very tech heavy. And it had a big CapEx build out attached to it.

13:53So that makes it good. I mean, the 1929 one is of course the mother of all bubbles, if you like. And that was about, you know, like cars and electrification and consumer gadgets and appliances rather. So you could use that. And that is actually the one that people used in 2000. So you always go one bubble back, if you like, to make your case and to argue maybe why things can go very crazy. But I think here there are many things that rhyme.

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15:55Take financial possession of your apartment by December 31, 2025 and save. Discover more at brightviewseniorliving.com. Equal housing opportunity. So one thing that Tracy brought up in the intro, which is very important, is that rates in the recent days haven't come down that much. Today, they're down a little bit, but by and large, it's not like treasuries have been this great life preserver when the rest of your portfolio isn't working. In fact, actually right now, I'm doing timestamps again. We're back at 4.11. We were down at 4.06 earlier, around nine. So even that once again, we don't see this bid into treasuries, rates are sort of down overall for the year a little bit, but there's not this desire to grab them.

16:38Talk to us about what's going on in that space. I think the reason is that a lot of the bullishness over the last week was based on one simple statement, which is saying, listen, we are building a bubble and the Fed is cutting into that. That never happened before. And obviously in 2000, they hiked by 175 basis points. They hiked 50 basis points after the bubble had already peaked. And they had inflation, so it was not without any reason. But for sure, it's very unusual for the Fed to cut into a bubble. And that was a great bull thesis. And so now we are doubting that a little bit, right? I mean, so we are basically having a Fed that might be more hawkish.

17:14December went to 50-50, essentially. And so if you remove that plank of the argument why you should be all in in equities, it has consequences, right? And so we wobble a little bit for that reason. But, I mean, I would also remember, I mean, they hiked 175 basis points before the bubble peaked in 2000, right? So will it be the end of the equity bull market if the Fed doesn't go? I mean, I doubt it. Talk to us a little bit about these doubts that are creeping in for December. I mean, we're truly in a fog for multiple reasons, because even if we had government data, I'm sure the conditions, plenty of different crosswinds.

17:49We don't have the government data. But like one thing we do seem to know is that hiring has been very weak and so forth in several months. Almost certainly that would be the case for October and November if we had clear indications on it. What is the reluctance right now? Why is it a coin flip? Yeah, I mean, well, I think the single biggest thing is, of course, all the comments we're getting out of the Fed, right? And we had the tweet earlier this week. And so in the end, if you try to forecast the Fed, you better listen to what they're saying. But why are they reluctant, given the weakness? So I think the question is, of course, all about the job.

18:23The reason it's a job market. Inflation, you can argue, maybe telethonflation will not show up. So far, it has been very benign. Some Fed members believe it's still showing up. Some others don't. But I think the main crux of the question is the job market. How weak is it? Now, the Dallas Fed put a paper out arguing that if you get slightly negative net migration, the break-even NFP is 30K. If you get slightly positive net migration, 60K. So that is somewhere the range where these days NFP should come in without there being a problem, right? So if the NFP print, and of course, September we know is somewhat artificially strong, October, if we get it, would be artificially weak due to the government buyouts.

19:05November is a really interesting one. That might have a bit of an impact from the shutdown and so forth. So the really clean one may have to wait even longer. But let's say we take November as good as it gets for now. So if that is below 30, there'll be a cut, right? If it's below 60, there'll be probably no cut. If there's something in between, they'll fight it out. But without that data, it's just hard to reassure the market, yes, there'll be a cut or no, there won't be. So the job market data will be very, very important. We got a lot of alternative data sources, of course, in the meantime, but we're waiting.

19:39They were a bit on the weakish side. So that's why the city call is actually for a cut. I mean, the noises out of there from sea were certainly a little bit all over the place. So it's not that obvious. Yeah. And a lot can still change between now and the meeting. OK, so if everyone I mean, I realize not everyone agrees it's a bubble, but for the sake of this argument, let's say we all know it's a bubble. It seems like one of the things that happened, especially since the financial crisis, is people stopped running away from bubbles and started running into them. Right. And so everyone wants to make money very, very quickly.

20:13So if you see the line continuously going up, you just join the party. and everyone assumes that they are smart enough to time the top of the bubble and get out at the right point. What's your take on how long this is actually going to go on for? And what are you looking at in terms of actually spotting that top other than sentiment, which we spoke a bit about? Yeah. It's a big question, even inside Citi, our US equity strategist does not believe me that it's a bubble, but we have a definition. So I feel we can actually do something with it. So the definition for us is it's a little bit like the GMO one, which is essentially saying if something goes up more than two standard deviations against the long-term trend in real terms, we call it a bubble.

20:55And then whenever you have a big sell-off, we restart the clock because when you have a big sell-off, you essentially, the sentiment goes to zero and so you have to rebuild it. And on that framework, we entered bubble territory sort of, I guess, in May, June of this year. And when you do that, the interesting thing about it is, as you point out, it goes up. So once you enter bubble territory, you're supposed to buy it. And the only time when that didn't happen was 1929. It went straight down. And I think the reason for that is a little bit that the way people define what a bubble is, they use 1929, right?

21:27And we did that too. And so therefore, that's the only one, all the other episodes, you go straight up. So you buy it when you enter. But the interesting thing is, and clients ask me, well, if that is true, what's the difference between a bull market and a bubble? You tell me it's going up. And the difference is that if you buy it when it enters a bubble, you will give it back eventually, most of it. Most of the in-bubble gains will be given back. So it will end badly, right? And so that, I mean, you don't necessarily give back everything all the time, but in most episodes, you give back most of it.

21:56And so that makes it an important definition. Now, unfortunately, when you study that, it's not that clear how long they last. I mean, on average, I can tell you that two years of above average returns, followed by below average returns and on a 10-year time horizon, you have a low average return. But it can vary a fair amount. And so that makes it hard. I would say if you look at 2000, again, as a template, it will certainly not help you to look at fundamentals, right? I mean, so what happened was NASDAQ broke in March and everything's still fine. Which year are we talking about? Sorry, 2000.

22:33Okay. So, and when that happened, fundamentals rolled over in September. So there was a six to seven month period where fundamentals still look just the way that it had looked before. I guess because everyone was spending so much money on CapEx and it takes a while for that to roll off. Yes, exactly. And of course, it's highly circular. People spend on CapEx while the equity is going up. So equity stops going up. They start to reconsider. What do we do next? So then everything rolls over. So if you look at fundamentals, you'll probably not capture it, which means it will be a highly technical thing if you want to call the top and it would be helpful if you get a blow off top like you know if you get do the 50 percent in one quarter you know you probably have a bigger chance to get it right but I think it's really quite dangerous to be early in this thing because well you will not hit it precisely on the day you either early either or you're late right and I think if you're late you can control a little bit more how much money you don't make in a sense, right?

23:35And so one framework that we have, we call it the generals framework, because what happens in this bubble is the generals. The generals, right. Because it becomes very narrow. And that's a feature of the bubble. It's not an exception, right? And so this narrowness means that if the leaders start to break down, it's a real warning sign. And so what we look at, and we just looked at the top seven leaders because people are excited about MAX 7, but it could be 10. know, basically on our numbers, if three of the top seven break down, meaning they fall below the 20-day moving average, that's a really dangerous sign.