#945 - Consolidation or Something More? With Michael Gayed

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0:58Consolidation or something more. Hi, everyone. Welcome to the Real Vision Daily Briefing. with me today is Michael Guyad, Portfolio Manager at Title Financial Group and publisher of the LEED Lag Report. Hi, Michael. It's great to see you. Happy New Year to everybody but the bulls, apparently. Exactly. That is what the theme has been so far in this first trading week of the year. It's another rough session for US stocks. NASDAQ, we're just settling, but it looks like the NASDAQ is going to be down over 1%. The big loser of the day, though, and these losses really accelerated here in the last half hour is the Russell down 2.5%.

1:34We saw the 10-year yields creep up above 4 % briefly. It's back down there again, but the dollar moved higher. As you look across the action, Michael, what do you make of the markets right now? What's your read on what's happening? Well, so you mentioned the most important part of the market, which is the real market, which is small caps, not the auto bid, large cap, market cap, magnificent seven names. That's not the market, folks. The market is the vast majority of stocks beneath that. So look, since mid-November, I've continuously been saying on social media, small caps hold the key in a dramatic way.

2:10And I keep repeating that pretty much every single day. Why am I saying that? Because the reality is, you have this refinancing tsunami of debt that's coming starting this year. And a lot of small cap companies are going to have a real risk in terms of them being ongoing concerns against rates, given where they are. If you think about what happened coming off of that November low, small caps were the biggest beneficiary because as rates collapsed, it gave them a lifeline, at least for a moment in time, in terms of the perception that small caps would be okay. The fact that you're seeing to start the year, small caps break down so substantially.

2:50The fact that you're seeing at the start of the year, utilities, the most defensive sector of the stock market outperforming so substantially, healthcare outperforming so substantially, consumer staples outperforming so substantially. All that confirms the idea that despite this move lower in rates, guess what? It's probably not enough for smaller cap companies, which by the way, people forget at the end of October of last year, broke the October low of October 2022, before this huge run up that got everybody so pulled up. I look at the market today, I say to myself, this is all consistent with what I've been arguing for some time.

3:26And I know this is going to sound crazy. I still believe we are in a bear market. I'm sure that does sound crazy to some people because they say, look at what happened at the end of last year, the last two months. It was powerful. It broadened. You had more participation. Is that just a rally within what you consider a bear market? So I think it's important to distinguish two things. One is, how do you define what a bull market is? A bull market can only be known with hindsight and is only when you've taken out the prior, after inflation, real high from 2021. So everyone looks at the NASDAQ, made new highs, made new highs.

4:09OK, did we forget about inflation from 2021? Did we forget that the actual high is a lot more? You're still technically in the drawdown from peak to trough after inflation basis. So you can argue that we're still in that drawdown, which means we don't know just yet if it's a bull market. But let's go back to small caps. Small caps are getting rejected from their nominal all-time high. Small caps went sideways for the bulk of last year. The simplest answer is the right one. Why? Because of the headwind around higher rates. You have what looks like a breakout, and now it's getting reversed. By the way, in 2021, small caps also went sideways for the bulk of the year, had a false breakout towards in November, and then collapsed into the bear market of 2022.

4:48I look at all that, and then there's another dynamic, which I think you have one of these charts on the screen. I've shown this a few times. Bear markets tend to end with a bang, and bear markets tend to end with a flight to safety sequence where credit spreads widen and treasuries do well. If you were to look at the top 20 largest drawdowns for the Russell 2000 going back to 1979. You can see that on this chart that I think is on the screen here in gray. In every single instance for a major decline for the Russell 2000, long duration treasuries, which is what's in purple, basically TLT as your proxy, but looking at the index data, outperforms except for one time, which was what we saw from the 2021 bear market to 2022, or 2023 rather, because again, they broke the October lows of last year.

5:36OK, so anybody looking at this chart would say, OK, that was the first time ever treasuries, in quotes, failed as a safe haven risk off trade in a major drawdown for small caps, for equities. Except that we don't know if the drawdown's over, which goes back to we don't know if it's a bull market yet because you haven't taken out the prior inflation adjusted high. So that's one distinction. The other distinction with this is whether it's a bull market or bear market doesn't really matter for traders. It does matter for investors, though, because if you characterize something as a bull market, it gives people a false sense of overconfidence that they can allocate even more to equities.

6:11And they probably then do so at the wrong time. So my message is very simple. Most declines tend to occur where treasuries outperform on a relative basis. You have not seen that yet. Most declines end with credit spreads blowing out at a VIX spike. You have not seen that yet. I was very loud last year arguing for a credit event. I was obviously wrong in my timing, but we're still in the lagged window of the fastest rate hike cycle in history. And I don't know about you, Maggie, but when I look on social media and I see the overconfidence by bulls, given how well they, in quotes, performed last year, which, by the way, was purely because of a stick save from the Fed in the last two months, because most stocks were down entering November on a year-to-day basis.

6:53I look at that. I go back to what I always say. opportunity always exists when the crowd thinks it knows an unknowable future. Future bear markets humble us all, just not all at once. I think you said something so important in there. And we talk about this a lot. And this is education month, so it's perfect to bring this up. The difference between traders and investors, knowing which one you are is really, really important. And I think when you said people are going to think I'm crazy, but I think we're still in a bear market, But that chasing of performance that happened as a result of the last two months of last year and the fact that there were plenty of traders and managers of money that were behind, that thought tech was overvalued, they weren't invested in tech, and they're all now dealing with the consequences of that.

7:45That's really hard to stay on your thesis when you're watching these markets rip and you're not participating, isn't it? Well, it depends on how you're executing, which is why I'm the first one to loudly say, don't short, don't go into cash, because that's market timing, doesn't work. And shorting, the problem is if you're wrong, you lose money one for one. Good example is, my own funds are risk on, risk off. They go risk on equities or high yield in case of my JoJo, bond ETF, or treasuries. They're long only. You can be bearish and long. You can be bearish and long. So even this year, if you're bearish entering the year and you're long only and you're in utilities as a way of being bearish, or healthcare, or consumer staples, you're making money as things are breaking down.

8:26If you were bearish entering November as I was, when I thought we were at risk of an imminent credit event, and you were in long-duration treasuries, people seem to somehow just totally are disregarding the fact that long-duration treasuries, TLT, are outperforming the S &P 500 now for the last six months. It's already happening, this transition back into duration, back into some kind of a normalization of the flight to safety dynamic. So I do think it's important for people to recognize you can be bearish on long. Shorting doesn't work. It's OK to lower your beta. It's OK to play treasuries. And you can still make money even if you're wrong in the direction of the broader stock market.

9:05But it's hard for, I think, for a retail audience to really understand that, because every single time I come across as being particularly bearish in a particular moment in time, the response is always the same. Show us your puts. Show us your short positions. But I know that doesn't work because I back-tested it. Show me any single rich short seller. Show me any other than the occasional moments like Michael Burry, right, when you get the housing crisis right. You can get it right, but then over time, that really doesn't work. It's not a repeatable approach. Yeah. And I think that talking about people getting sucked in when you're talking about a bull market and reallocating at the wrong time is so dangerous.

9:49And we always want to avoid that, the people being the last ones in. So we're talking about rates and the danger. We have some questions coming in. We're going to get to them because they're awesome. So I want to rope them in right away. But we had the Fed minutes out today from the December meeting. And they showed, and I'm quoting here, they talked about an unusually elevated degree of uncertainty about the path of policy. Great. But I think mirroring what a lot of other people think, because we had a lot of division on our air and in our conversations on Real Vision last year, and that is absolutely carried over to this year.

10:25But it's sort of the minutes, the impression, at least initially, seemed to be in the markets that it was a bit more hawkish than maybe Jay Powell was and restrictive for longer is the kind of phrase people are walking away with. Do investors need to dial back their rate cut expectations? How are you thinking about the interest rate outlook as we start to move into this year? I think everybody should ask themselves the question. Why is it the Fed wants to pivot? After talking for the last year and a half about higher for longer, what changed? I go back to the simplest answer to the right one. They're probably worried about credit events.

11:08they're probably worried about this debt tsunami that's coming. They have to lower rates in advance of all these small cap and zombie companies that have to roll over into higher rates. They have to make sure they're low enough so that these companies can be ongoing concerns. Now, it gets to be tricky, though, because you want to lower rates, but you don't want animal spirits to get out of control because that might reignite inflation. I think they are in a really tough spot. I really do. On the one hand, you're still in that window of the lag effects, which can create the event or can create a bigger drawdown.

11:42It's like everyone's cheering rate cuts. The vast majority of time when the Fed starts to cut rates, the drawdown is about to get much worse for equities. We've all seen these charts. It is mind-blowing how people are forgetting the why the Fed cuts rates. But they don't want to do it, I think, just yet until credit spreads really, really widen aggressively. The Fed does not respond to the stock market. The Fed responds to credit spreads. The Fed will respond to default risks getting repriced. So they have this dilemma. They might see that there's a risk that spreads blow out, but spreads are very tight.

12:18So can they thread that needle of trying to keep spreads fairly contained just as the lag effects of those rate hikes are kicking in? And that's why I think you have this kind of back and forth confusion. That, by the way, is probably exactly why long duration treasuries can return to their flight to safety dynamic as that hedge to credit spreads, as that hedge to volatility. And if I'm right about that, then the phoenix is going to rise and all these arguments around treasuries are no longer a hedge go away just in the same way that narrative always follows price. Hey, everyone, we're going to take a quick break right now to hear a word from our partners.

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14:03So G. Blackburn asking, what needs to happen for credit stress to materialize? We waited all last year. Yeah, and that's been one of the more perplexing things because you look at Chapter 11 filings, they're going up a lot. You look at small caps again, doing what they're doing. It has to be the case that the reason small caps have not participated anywhere near as much as large caps and are still below their nominal peak, it has to be the case that it's because of credit stress that is anticipated to come, which is serving as a headwind for small cap companies. It has to be the reason. There's literally no way that that has to be a connection.

14:41It has to be around higher rates. Sometimes the only way that this gets resolved is just through time. I was early in the argument. I don't think I'm wrong about the idea that a credit event is still out there because of the lagged effect. So maybe it's starting now for all I know. I mean, the reality is junk debt didn't do that well. Treasuries did well. Okay, that's at the margin, a little bit of a widening. But you're coming off of major lows on that compression. So it would take some time to move. But everything is screaming the same message as far as play defense. Why would you play defense unless credit spreads are widening?

15:16We're going to widen soon. So I think time is really the answer. I have to tell you, because everyone is so short-term in their thinking, and because everyone seems to only want to chase, to your point, Maggie. They're just letting the chart dictate their thinking and their views and their risk tolerance. They're letting charts determine their risk tolerance.

15:38Again, bear markets make fools of bulls and bears. It made a fool of me, and I still think we're in a bear market. If you have a credit event, yeah, the bulls are next. So Robert asking, what are the likely credit events you foresee specifically? Is there an area that you're worried about? What does that credit event look like, even if we're still working on the timing? You have the lag of interest rates, but you also, as we talked about many times last year, have the lag of the enormous amount of stimulus that was put into the system. What is it specifically that you're worried about, or what area are you most concerned about?

16:17It's hard to know what the exact catalyst would be. I flagged Japan as being potentially where the fire gets or the match gets lit under this reverse carry trade concept. But it could be any number of things that sparks it. I mean, that's the thing about, you know, black swans. Nobody's supposed to be able to predict what the black swan is. Some might see it as a gray swan, but for most, it's a black swan. So I don't know. But all I know is that when you typically see these types of divergences of the private economy against the public markets, of small caps against large caps, of defensive sectors against offensive sectors, of breadth, which, by the way, everyone talks about breadth is improving, breadth is improving, breadth is improving.

16:59OK, there are many more small cap names than large cap names. Breadth is connected to small caps. So you can't say breadth is improving and it's positive, but who cares about small caps, which is the vast majority of the actual stock market? It was like improving from seven to a larger number, but not. 13, 14. OK, so what? I mean, that doesn't mean anything, right? And by the way, let me just make this very clear. I'm not a perma bear. It drives me crazy when people say, how long have you been saying that? How many years have you been saying credit event? I was very clear at the start of last year.

17:27I said it's a melt-up year because pre-election years tend to be the strongest in the cycle. But that towards the end of the year, the conditions would be there for a credit event. From August to October, you had a severe breakdown. Small caps did break the lows. And then you had this enormous rally. And the sentiment got stupid in terms of everyone now saying, look how wrong the bears were. The bear porn is silly. Don't listen to these guys. It's like all these people are making the same assumption the bears were making at the end of October. It's a recency bias. And I always go back to the biggest returns don't come from the middle of the trend.

18:02the biggest returns come from the turn, which means you have to go beyond a chart and beyond a squiggly line and think about the conditions that might favor a turn. And from an intermarket perspective, today was by far one of the most classic risk-off days you could imagine. Again, with Treasuries actually strengthening, they reversed their yield spike by end of day. Yes, they did. That was interesting because we had been seeing a lot of correlation I've got to ask this question from Randy because he was the first one to pop it in. First question, ask him what he would say to somebody who owns NVIDIA.

18:42I will hold back on my wording on that because I've been very colorful on social media. Look, I'm not against NVIDIA. I'm against narratives that don't make sense. First of all, NVIDIA has gone nowhere for six months. AI has only improved. The stock's largely gone nowhere for six months. So I go back to it's like the lagged effect of narratives also on price behavior. Obviously, I was wrong in saying NVIDIA is using the colorful word that I use on social media quite a bit, which is a persona. But here's the thing, if AI is so powerful, if NVIDIA is a true signal of what's to come, we can agree that AI is disinflationary.

19:20I think we can all agree it's supposed to be productivity enhancing. Why didn't yields drop alongside all the strength in NVIDIA on the long duration side? OK, which by the way, now you're seeing disinflation, maybe even outright deflationary pressure coming in. If NVIDIA is a signal of AI taking over the world, you would think that the productivity gains of all the AI that the NVIDIA chips are bringing to the world, that small caps would be bigger beneficiaries. They'd be more productive. There's a disconnect. It's not my war is not against NVIDIA. My war is against the narrative where you can't just say it applies to NVIDIA alone, while everything else is saying, watch out.

20:04Yeah. I think it's a great point, by the way. It's the same when we have people on who are bullish, right? Like people are not permanently anything, especially people who've been in the markets for some time. They are following their framework and narrative and looking at timing, and the timing may be longer or shorter than someone else. But David Rosenberg will say the same thing when I talk to him, too. He gets accused of being a perma-bearer all the time. And he's not. It just depends on what he's seeing in the market. So it's important for no one to get locked into any narrative that defines you as something.

20:37I wanted to get this one in from Trillion X. And that is, what if a credit event is another bank blowout and the Fed uses its facility or another alphabet solution rather than cut rates? We talked yesterday, we had a guest on who's concerned about the banking system and doesn't think that the banking system is well and is also looking at its exposure, company's exposure to it, the fact that it lends to a lot of small cap, small medium enterprises in the US. What about that? What if we don't see the solution in rates? What if we see it through another mechanism? I'd argue the effect would still be the same.

21:22Because if they're responding to some kind of crisis that is systemic, then long duration yields would drop independent of what the Fed does regardless, probably before the Fed acts. Because again, I go back to the Fed doesn't set policy. The bond market sets policy. The Fed follows bonds. Treasury yields, rates did not rise when the Fed started hiking rates in 2022. Rates started rising in July of 2020. You look at the duration side, that's when TLT topped. So the Fed follows the bond market. So now, having said that, back in March of last year, when the regional bank crisis was coming out, I made it very clear that I didn't think that was a credit event because there are solutions to that.

22:06You can plug the hole. I still maintain this original thesis that if I'm right, that you're in the lag effect window, there's still some kind of a credit event out there. By the way, if you look at European credit spreads on their junk debt relative to their high-quality paper, they are starting to widen. So you are starting to see everything I've been saying now start to actually play out, at least internationally. But if I'm right about that, I think it has to be something outside of the U.S. banking system, which is why I go back to it. It has to be something they can't necessarily front run because the Fed knows what's going on with the banks.

22:36It's not clear if they know what the knock-on effects of Japan hiking rates, which we can debate, would actually be on a highly levered global financial system where everybody's using the yen to fund riskier investments overseas. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing. Hi, on the 5th and 6th of June, 2024, I'll be speaking at the largest AI event in Asia, Super AI in Singapore at the iconic Marina Bay Sands. Alongside brilliant minds like Edward Snowden, Benedict Devon and Balaji Srinivasan, I'll be on a stage exploring the extraordinary potential of AI and the profound change it represents not just for financial markets, but also for the world as we know it.

23:23With over 5 ,000 attendees and over 150 side events, Singapore will become a vibrant hub for a full week from the 3rd and 9th of June. Visit superai.com to register and join me with 20 % off tickets using the code REALVISION. Use the link in the description and I'll see you there. It's going to be incredible. STEPHANIE DESMOND - You're absolutely right. Fed is supervising the banks here. Often, when we see that an event happen, and to your point, Michael, it's not the event itself. It's the unknown second and third effects of that and the counterparty risk that comes with that in a highly connected information global financial system.

24:05That's the concern. We've seen that before. That is true. That's what you have to worry about. Can I answer that real quick? Because I think this is a good point, this counterparty risk. So there is another chart, hopefully we can pull it up, that looks at the VIX relative to credit spreads. Because event, credit event, is just another way of saying VIX spike, which you see on the screen here. So the blue is the VIX. The red is credit spreads. You can see there's a one-for-one relationship. It's very clear that we have volatility spiking, credit spreads widened. Those are events. And again, that's what typically marks the end of bear markets.

24:38So if you look at the far right, we're at all-time lows on that, which again is why the Fed has to be careful. They might be worried about the refinancing risk, but they're worried against spreads which are still very narrow. So they need to probably see some of that really rise before they have ultimate justification to start lowering. But by then, it's probably going to be too late anyway. Yeah, and I think things move so quickly. This is the other lesson from SVB, right? It's like what the Fed was able to do in days or weeks before is just instantaneous now, which is in and of itself another risk.