#946 - Restrictive for Longer? With Tavi Costa

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0:57Is bond volatility here to stay? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Tavi Costa, macro strategist at Crestcat Capital. Hi, Tavi. It's great to see you. Hi, Maggie. Happy New Year. Thanks for having me again. Yeah, absolutely. Happy New Year to you, too. A little bit of a rough start for the market, so mixed bag for stocks. We have the Dow and Russell up at NASDAQ and S &P lower once again. I think it's going on five for the NASDAQ now. The 10-year flirting with that 4 % level again, and the dollar gave up some ground. As we look across, I don't think this stock pullback is surprising to anyone, Tavi, but what's your thesis as we head into 2024?

1:37How are you thinking about these markets? No, it's interesting. The folks that were absolutely nailed in 2022 are also the same people that got everything almost completely wrong in 2023. And the opposite goes to the crowd that got it completely wrong in 2022 and now got it right in 2023. And the question is, which year was the right one. If you ask me, I really think that the market structure that we had in 2022 is likely to be repeating itself over time. I find it highly unlikely that value stocks will not be performing better than growth stocks. I think that the Treasury market will continue to be not only at a higher volatility, but also with higher yields overall across the entire structure of the yield curve.

2:27I think there's a lot of interesting things to be looking at in the markets for 2024. The steepening of the yield curve is one main probably positioning that I believe that that could potentially work in terms of, in average, we tend to see two versus 10 spreads steepen for about 300 basis points. I think that's highly likely, especially if we have more of a stagflationary crisis or even more of a deflationary one. That's the beauty of the trade is really betting on a hard lending scenario. And potentially, if the hard lending doesn't happen yet, that's the way you can be wrong in that trade. It's not my view.

3:10And the profusion of macro indicators that we have that are really showing and suggesting that the likelihood of a recession ahead. And risky assets, particularly, I would say that the Mag 7, the Magnificent 7, have completely ignored those things. And I don't think that that's the right approach here for an investor. So that hasn't changed. I don't see the point of really buying technology stocks and all those things that are so expensive while you have a whole realm of hard assets and things that are linked to hard assets that can offer not only a much better value proposition, but also the likelihood of entering secular moves that can change the whole environment in a large way.

3:56So I remain very focused in some niche areas of the market. I think metals and mining can do very well. I continue to say this because I continue to find a lot of distressed opportunities in that part of the market. And those are the ones that get me excited on my daily basis because I don't find a lot of those things in such a frothy environment. And another one that I think is going to be a very important chart or even idea for 2024 is emerging markets overall. Emerging markets have been so resilient despite all the things that have been happening, even the tightening of monetary conditions and all sorts of things.

4:39And still, you look at emerging markets, particularly the ones that have resource exposure, have been doing so well. I think that's a real trend. And emerging market currencies are so close from breaking out from a major declining trend. And I think that that's going to be an important part of our aspect of 2024 as we enter the year. A lot of great stuff in there. Let's unpack some of it. So is the resource play, the hard asset play, contingent upon the fact that we will see a recession? I don't think necessarily. I mean, the situation that we had in the last month is a great example of why it shouldn't.

5:18Although it is my view that we will in my base case, I don't think you have to have a recession. I mean, if we have what I call a banana republic type of market where central banks just go back to easing very, very ultra easing policies to save the economy, the market can do well. And if that's the case, it wouldn't surprise me if hard assets not only outperform financial assets, but may get into more of a bubble territory in five to 10 years. That's my opinion. I think there's much more of a potential for that to happen than the continuation of us valuing businesses that are already expensive at crazy levels just because inflation is running really hot.

6:06The reason for that is because at some point you have to discount things according to the cost of capital. If this environment I just presented to you would likely drive cost of capital much higher, which is what we saw in 2022. too. So my view is, I think that that part of the market is kind of, why even bother with that? So it's a relative performance. If we have a recession, you like the safe haven play of natural resources. If the economy is doing well, interest rates will be higher and the cost of cattle will be higher. So you just like the valuations of some of the names? I do. And you don't find distressed opportunities in technology.

6:54Let's start it that way. There are no distressed opportunities there. So, no, I like things not to be contrarian for contrarian sake, but if there's enough reasons, macro reasons to really support a thesis to take contrarian view, I love those things. And I think that hard assets certainly is one of them. And you may say, well, I've seen other people talk about hard assets. Yeah. But you look at pension funds, for instance, they have basically zero allocation to hard assets today. What if they change? Central banks. Central banks used to own hard assets, gold specifically, used to make up about 80 % of their balance sheet.

7:30Today, it's about 20%. What if that changes again? And so those are potential for changes in dynamic of capital flows that could be really meaningful for asset classes like mining industry or the energy space or agricultural businesses and other things. And one more point that you asked the question regarding the recession being really a huge part of the thesis on owning hard assets. Now, remember what happened less than a month ago with the FAD changing its policy stance recently and basically now talking about cutting interest rates and other things and shifting away from inflation being a problem to now worry, maybe even employment could be a problem and other things in the labor markets, which to me was a takeaway from the Fed minutes was one of the important sentences there, concern about the labor markets overall.

8:23And if you think about that itself, and the Fed changing their tune right now, to me, everything went up on the back of that shift. And so that could happen again. But I think one important aspect of 2024 that could change from 2023 is maybe this leadership from mega caps. I don't think that's sustainable, but I wish I had the crystal ball to know when it's going to change. But again, why even bother with that? There's better things to do. Yeah. Yeah. Your point about the valuation on some of the techs is something that concerned people all last year, which is why a lot of people were on the sideline and missed that big rally at the end of the year.

9:09I think that kind of haunts people, that kind of defied expectations. Do you think that was just an overshoot for technology? You don't buy the idea that there's sort of, you know, some AI productivity wave and technological changes that are coming that might keep some momentum in these names? Two points. The point of staying on the sidelines and missing an upside in the market is an important one. I was never saying stay on the sidelines. I've been happily invested in things in general and just not invested in tech at all. And some of the things that we invested in mining have done really well.

9:52And the reason for that is not tracking GDX or GDXJ or ETFs, you can buy private businesses trading for one-time free cash flow today. And their businesses did very well in the last year. And so we've been doing a lot of that recently ourselves. The other thing is, personally, I think that the technology space in terms of the the changes in terms of the technology overall are incredible advancements. And I continue to think that way. I just don't understand very well why. Well, I guess I understand partially why the mega caps are doing better than the others. They do have first access to most of those things.

10:38And they've been doing a lot of that. And thinking just about how much growth they have potentially relative to small caps, It, to me, is a no-brainer to own small caps because I don't understand the limited growth potential for most of the large cap names overall. To me, it seems quite limited. And on top of that, one of the things I noticed in 2023, which was a big takeaway for me, has been this dynamics in CapEx. and technology companies were, back in the days, used to be companies that don't spend a lot of capital and have incredible margins and make a ton of money. What changed this year is that if you look at who has spent most of the CapEx in 2023, was actually technology.

11:26And so AI is great and it will make huge changes, but we got to understand that that's capital intensive and most of the mega caps are having to spend more and more capital to generate less and less growth. And so at what point do we see multiples getting re-rated because of that aspect? And anything that requires higher capital to generate growth usually tends to be called cyclical businesses because that's the access for capital is what makes that business more cyclical. And so is that the case? Does that mean technology is becoming more cyclical over time as well? It could be. So yeah, so those are my takeaways from that dynamic.

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13:24That's a really, really interesting point, Tavi. And we are going to be getting those earnings reports this month. The tech is a little bit toward the end of the month. But that's going to be really interesting to hear what they say about that CapEx spending and how investors react to that. Because you're right, it'll be a very different scenario. It's interesting that you're bringing up the CapEx spend because we keep all roads kind of lead back to bonds and bond yields and that volatility that we saw. You mentioned that you do think we're in for increased bond volatility. Ash sat down with Jurian Timmer today, the director of global research at Fidelity Investments.

13:58He also thinks that we're in a sort of new era for bonds when it comes to volatility. Let's have a listen to that. So we had the rare occurrence of not only losses in 2022, but in 2021, sorry, and losses in 2022. And as of October of last year, which was just two months ago, we were on schedule or on track to have a extremely rare, if not unprecedented third year in a row of negative bond returns. But that massive rally at the end of the year kind of saved us from that. So bonds actually ended up returning plus 3 % in 2023. But bonds were at the center of the storm. And I think, in my view, we're going from an era that we would call the great moderation.

14:50So So low inflation, falling inflation, low interest rates, low volatility. So the 2000s to 2010s were a period of what we call the great moderation. I think we're now in a period that some people are calling fiscal dominance. And you think about it, you think what the government is doing, the deficits it's running, 6-7 % of GDP during a period of expansion and full employment, more or less, is really not what Keynes had in mind when he came out with Keynesian fiscal policy. You're supposed to run deficits when the economy is in the tank, not when it's at or above capacity. But so this is the order of the day, and I don't see a change in that kind of fiscal dominance anytime soon.

15:43Jaren's not only head of global research of Fidelity, he's also a master chartist. He and Ash covered a lot of ground across both macro and crypto. Really fascinating conversation. You can find the entire chat available for pro members on our website. If you are not a member or you want to upgrade, head over to realvision.com. So, Tavi, how are you thinking about this interest rate environment in terms of the companies you like? Because some of these mining companies, I would think that they are also capital intensive. No? Oh, they are very capital intensive. And I would also point out that they've been terrible businesses for decades.

16:22And the only difference is that there are decades that you want to own them. And the main reason for that is because the underlying security that they sell, a hard asset, usually goes up in prices more than cost during those decades. And so what you got to get it right is that there is really a big shift in the markets towards more of an inflationary environment. So this is why I focus so much on the macro side of why I believe inflation is more structural today, because I don't think the valuation of those companies are not really reflecting this new era that not only our guests commented on, that we also share the same opinion.

17:00And as we see that happening, I think there's going to be a re-rating of those companies in a massive way. particularly from not only from a valuation standpoint, but really from the stress multiples that we have currently. And so, you know, that's to me, that's where the opportunity lies ahead. And I agree with him in a lot of ways. I think inflation is structural because of, I've been saying there's the pillars of inflation. And so it really is the lack of investments in natural resources, which I see it every day in terms of, you know, just running a business that invest in those companies.

17:37It's really struggling to see how we're not seeing new projects and new things come online. And metals and mining and energy takes years for you to develop those projects. And so if not, I should say decades, depending on the project. And so that's a big change. The reckless amount of fiscal spending, which he touched on, and I would say he was even nice about it. I would point out that instead of calling it a 7 % deficit, if you just look at the spending alone, not looking at the revenue, just spending alone, and then take out the interest payments that we're doing, because that's not really inflationary, you're going to find that we're close to 20 plus percent of GDP.

18:18And to look back in history, we've never seen these levels of spending. So that's insane. And not only that, but the labor markets is also another important change, the labor market, what we're seeing, the cost of living being higher. Why are we seeing widespread labor strikes? The reason for that is because people are not getting paid enough. And if you look at the profitability of most companies today, which are nearly at record levels, the reason for that is because they're not paying enough their employees. That trend might change. And I really think it will. And the fourth thing that is even more important than anything I said is deglobalization.

18:56De-globalization is, to me, at the early stages of something a lot worse in terms of geopolitical risk. Even that is not really pricing commodity prices yet. And so all those, the reshoring, the countries and companies really trying to go away from efficiency of cost, but really trying to secure their logistics, those things are very important macro changes that will actually make inflation more structural, in my opinion. Yeah, it's the big battle we're having, right? And it's really hard on the tail end of all that fiscal to figure out those lags and what the real economy is doing. You mentioned that you think that we're going to have higher interest rates, higher bond yields.

19:46We're kind of tipping back over four. We got a payroll. We had stronger than expected payroll data today from private payrolls and weekly jobless claims. We've got a monthly government number tomorrow. If you think yields are moving higher, how much higher? What do you see happening to the 10-year? Well, I think the 10-year bond in general in the US that the Treasury was really overbought, oversold not too long ago. And now it got overbought. I think there is the potential to seeing my trade on steepening of the yield curve. I think the 10-year is going to drive the way, meaning I think long yields could be the one driving the steepening of the yield curve in a very significant manner.

20:34And maybe it's the reemergence of inflation that causes that. Studying inflation throughout history, you've seen the chart that I put out of the waves of inflation. And that is, to me, the most important charts because it's normal to see deceleration of inflation. It's just at some point, given if the forces behind it are really structural, then you'll have a big reacceleration of prices that then causes policymaking to also adjust for that. So as we see those things happening, there's not really, inflation is one side of the problem. The second side of the problem that drives bond yields right now, especially, is the funding issue that we have in the US and other developed economies.

21:17I mean, I think I calculated about$8.2 trillion of treasuries are going to have to be reissued next year. You may say, well, just reissue those in T-bills. Yeah, it's not that simple. It used to be simple like that back in the days. $8.2 trillion is an unprecedented amount of treasuries that are going to be reissued. We have to really think this through. And Druck Miller was recently mocking Janet Yellen about not issuing treasuries on the long end when rates were very low. What do you think Janet Yellen is going to do if rates drop a little further? She's going to issue 10 years and 20 years and 30 year yields probably.

21:58And so what is that going to do with yields? It's going to probably going to drive yields higher. So it is of my view that long-term yields can probably surprise a lot of people to the upside. How long can they go in terms of how far? I don't know, 5.5 % wouldn't surprise me. 6 % wouldn't surprise me at all. I'm not in the market to know where it's going to be, but it's definitely higher than here, in my opinion. So if that's the case. That's a lot higher. That's a lot higher from here, especially at a time when people are pricing in easing, Fed easing. Tavi, you're talking a lot about the funding, and we talked about the problem with the enormous debt burden.

22:38Are bond vigilantes back? Potentially, they could be back. They were dormant. I won't say dead. They were dormant for a really long time. I think people thought maybe that they were a thing of the past. We started talking about it a little bit in the summer, but then all of a sudden, things changed in the second half of the year. Is that something we need to be concerned about? I think you're too nice. I think they were dead. But, no, look, I think that's a good question. I don't know exactly how to even track that. But, no, I do think that that falls into the idea. I mean, just look at the positioning.

23:20Bank of America does a great job looking at positioning of overweight and underweight of financial advisors in general. Rowan, the question the other day was how much commodities are underweight relative to how much overweight was the bond market. And it's astonishing. And where do we go from here? Most likely, it's the same idea of owning hard assets versus financial assets. I just think financial assets overall carry so much risk, unnecessary risk. And I don't understand, again, why buy 150 times earnings of bank stock when you can buy a one to five times free cash flow business in a place like Brazil or even in the US, depending on the industry.

24:10If you find an energy company today trading at levels that we saw back at the very end of the global financial crisis, and they're not going away. There's still going to be business for the next decade or so. Then after that, we can ask questions about the duration of their business. But I still think that there is a lot to go in that front. But if you are, of my view, where yields, and macro is always like this, right? If you talk to a lot of people, and usually there is one thing that is fundamentally different about the way they think. And it usually has to do, in this case, either growth and contraction of the economy or has to do with inflation versus deflation.

24:53And then macro thinkers strap away from that. So in my case, if I'm more in the inflation campaign structural, obviously I have a view about cost of capital being higher. That means I have a bearish view and a lot of things are expensive. That means I also have a bearish view on growth versus value. That means I probably have a very long view about emerging markets versus developed economies. 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.

25:36Alongside 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. With 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. And we have voices in both of those camps that are testing each other's thesis all the time, which is what we like.

26:21That's where you can find the value. And if you are listening and are not familiar with the sort of reign of the bond vigilantes, go on our site and use the AI tools to check it out. It'll give you a really nice explanation. So, Tavi, we've got some questions. We're going to go a couple minutes extra because we came on a couple minutes late. The Macro Butler, I love that handle, says, Tavi, is it time to buy the dip in uranium stocks? Tavi Kassner - You know, I think you, let me explain how I view the commodity space first. I think the commodity space, when do you know you're in the bull market?

26:56And I'll get to uranium. I think you know you're in the bull market when, first of all, things start going up in prices, right? But how does the dynamic work in a commodity space? Usually, it's in a rotation. There's always one commodity that is really surging to the upside. And there's always another commodity that is plunging. And recently was NatGas. NatGas was plunging recently. And now it's starting to maybe show signs of a bottom. The other side has been orange juice, uranium. All those things were surging recently. So uranium could take a little longer for some sort of consolidation. One thing that has been consolidating for a while now is the metal space, the metals, not gold, the other metals.

27:47Gold has been in more of an upward trend recently and trying to break out, which I think will accelerate to the upside in 2024. core and will drive, in my view, other things like silver and copper and platen and palladium and other things that haven't really had a bull market in a while. But pay attention to that rotation that is happening. And uranium just came from the upside and now went to the downside here recently. And the question really is how long it will stay there. Every commodity will be in a different manner. And it depends on positioning. Uranium was a hot commodity recently. and obviously needed to take a break for a bit.