#969 - U.S. Economy: Half Full or Half Empty? With Michael Kao

0:00Whether you're a crypto newbie, an established investor, or operating a business in Web3, tax season can be an absolute headache, but it doesn't have to be a nightmare. That's where Crypto Tax Calculator comes in, the software platform founded in 2018 by brothers Shane and Tim Burnett, crypto fanatics who were fed up with the complexity of doing their taxes. As Coinbase's official global tax partner, CTC focuses on simplifying complex transactions, supporting over 300 ,000 currencies across Ethereum, Arbitrum, Optimism, as well as 1 ,000 other integrations. Sign up at realvision.com forward slash CTC and get an exclusive 30 % discount with the code RV30 at checkout.

0:54out. Is U.S. economy half full or half empty? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Michael Kau, CEO of Akinthos Capital Management, co-host of the podcast Chaos Theory. Hey, Michael, how are you? Hey, great to be back. See, it's great to have you Also goes on Twitter. Many of you know him as Urban Cowboy, which is one of the best handles ever. I love it every time I see it. We haven't talked in a while. So just bring me up to date. What's top of mind for you? What are you focused on these days? Well, I guess your byline is a good way to start, right? Like, is the economy half full or half empty?

1:35And let me just say that I think it depends on who you ask. And that goes to the heart of some of the thoughts that have been percolating with me, which is, I've been saying for a while that we have this vodka Red Bull economy, right? where you've got Janet Yellen and the various legislations that are pouring on the fiscal stimulus, even as the Fed has been pouring on the monetary depressant. And so the problem is when you have two mixologists in the room, you start making a pretty nasty tasting cocktail eventually. And so, yeah, so I think that's the issue here because when you talk about The bifurcation and who are the haves and have-nots?

2:28Well, the haves, in the U.S. economy at least, are those that are asset owners generally with little to no leverage. I think a lot of the reason why the MAG-7 or maybe the MAG-6 now have done so well is that they generally are free cash flow machines with unlevered balance sheets. But the have-nots clearly are those sectors that have high leverage, high floating rate leverage, which would include some of the lower to middle class consumers that are living hand to mouth and have a lot of floating rate credit card debt. So I think that's the internal bifurcation that you're seeing in the U.S. But the other thing that I think makes for a very confusing macro backdrop is we've been in this, if you visualize a sort of two-by-two matrix of inflation versus unemployment, we've been in this low inflation, low unemployment utopia, call it since the mid-90s.

3:39And I think that that's due to a combination of high productivity growth and a once-in-a-lifetime demographic dividend coming out of China in terms of it exporting its labor deflation to the world, right? We've had these twin tailwinds that have fueled Fed policy, etc. etc. Essentially, recessions became an endangered species, right? Because every recession was fixable by monetary easing with no inflationary consequences. Now, here's what I think presents some food for thought. I think that even though technology-enabled productivity growth is probably going to continue, right? Maybe in the decade or decades ahead, it becomes a push against the reversal of that once in a lifetime demographic dividend coming out of China.

4:36And so I don't think it's unreasonable to consider that we might be out of that low inflation, low unemployment utopia quadrant and migrating towards another not so great quadrant, which is the higher inflation, higher unemployment dystopian quadrant. And I note that when you hear the various folks clamoring for immediate rate cuts, they're almost always the folks that are in that that high leverage bucket that are having problems, like obviously like commercial real estate, et cetera. But I'll note that since 2008, right, we've been in what I call this YOLO period of extremely low real rates.

5:30And now that real rates are just mildly restrictive at 1.69%, The markets extrapolated three dovish dots from the December FOMC into six to eight cuts at peak, right? Even though the Fed just really hasn't even been presented this dilemma of having to choose between its dual mandates of fighting inflation and maintaining low unemployment yet. So I'm writing a piece that I'm going to put out this weekend. And I'm basically saying that, you know, those ripping dots are going to become dipping dots. Because I think that the, I think it's with core inflation still running at an annualized 3.9%. And granted, if you, you know, there are various economists that are saying, oh, you, you know, why look at the 12 month?

6:25Why, if you look at the three or the six month, we're already at the 2 % target, et cetera. I like to think that I'm trying to explore under the hood a little bit deeper. Last year, I wrote a piece in May, I think. I called it the Four Horsemen of U.S. Economic Resilience. And those four horsemen are, one, you have a – they're intrinsic to the U.S. There are some structural demographic factors that might be causing sticky inflation on the labor and shelter side of things. The second horseman is this massive fiscal tailwind. And I always like to remind people that between the three bills, the recent bills, the Bipartisan Infrastructure Act, the CHIPS Act, and the Inflation Reduction Act, that's a combined total of$2.2 trillion of fiscal earmarks slated to be spent between the next five to 10 years.

7:27That's huge. And then the third horseman is relative rate insensitivity, which goes back to the haves versus have-nots, right? Because this presents yet another bifurcation. The U.S. consumer and the U.S. corporation are far less floating rate sensitive than the rest of the world. So this second bifurcation I'm talking about is between the intrinsic risks to the U.S. economy versus the extrinsic risks to the rest of the world. I think the rest of the world is far more exposed to floating rates from that standpoint. So that's the third horseman. The fourth horseman, of course, is relative U.S. energy independence, although that's becoming less of an issue now that oil prices are coming down.

8:27So to round this whole idea out, and the reason why I think the ripping dots will become the dipping dots, meaning that I really think that at the end of the day, the Fed has a much higher bogey for easing this time. Because when you think about the signal embedded in that first cut, it's not just cutting 25 basis points. It's a package deal because most people expect that once they cut, it's going to be part of the start of an easing cycle that at least encompasses three to four more cuts, right? So the Fed has got to consider that package deal going in. And do they have enough confidence that with all of those, what I call structurally inflationary dry tender factors in place, do they have the confidence that a cut now will not restoke that dry tender, that inflationary dry tender?

9:33I have some serious doubts that they'll be able to control inflation if they cut this early. So I completely poo-pooed the idea of the March cuts even before this recent FOMC. FOMC. At this point, I even think that, you know, not only will the Fed likely disappoint the market from the standpoint of the six to eight cuts, I think they could even disappoint from the standpoint of the three dots that they presented thus far. We'll see. Hey, everyone, we're going to take a quick break right now 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.

10:47Plus 500 gives you access to a wide range of instruments, S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, Forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus 500. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus.

11:25So I just want to say that that is such a great, I mean, Ralph just in the chat just dropped, his core argument is cogent, concise, and believable. And I think that's right. And I would just add that a lot of times when you talk to people in the inflation camp, there's something that doesn't stick together. There's this 1970s spiking energy situation that just seems like it's easy to take the other side of that and just say, well, the demographics aren't there and retrace it back. What you just walked us through, Michael, I think was a much more nuanced, interesting explanation of why we might be in a different regime.

12:10and you brought up some points that we haven't heard a lot before. We haven't heard them put together before. So thank you for that. That was amazing. And I think everyone agrees that's listening. It just gives us a lot to talk about. The first thing I want to ask you is, do you think we might be in a situation where we get no rate cuts this year? Is that possible based on what you're seeing in the economy? You know, I do think that's a possibility. I think there's at least a 10 % probability of something like that happening. because, and that's totally out of consensus, right? Even, I mean, because when you consider what the Fed is saying, they're all saying that, you know, there's almost unanimity in the idea that they're going to start the easing cycle this year.

12:58But, you know, I have yet to, you know, with all of those four horsemen factors aside, we have yet to even talk about two key things that I've been thinking about, which are one, okay, so when I talk, when you go back to my dry tinder sort of mental model, all these structural factors that might be in place that could get reignited, well, what could those sparks be? Well, in 2021, one of the sparks was resurgent oil inflation. We had that spark and that's kind of, I was very, very bullish at the beginning of 2021 in oil and turned bearish. probably around April of 22, I still remain bearish, although less so than when oil was in the 90s and close to 100.

13:47But other sparks remain, right? What about the spiking freight rates right now? Which, yes, that's an extrinsic geopolitical shock, but that's a real shock. What about, and this is something that no FOMC meeting has yet talked about, which is shocking to me. What about all of those strikes? that have led to all of these much higher wages that have been locked into many, many sectors of the economy. It wasn't just Hollywood. It was basically in the healthcare space, in the airlines, in the autos. So there are all these factors that make me wonder, okay, especially when you consider the bogey of, remember I said it's a package deal.

14:35It's not just cutting 25 basis points. The signal quality of cutting means that they're about to embark on a cycle, right? So do they have the confidence that they're not going to restoke that dry tinder by ushering in this new regime that the market's going to? I mean, look, when you go back to just the December rhetorical pivot alone, you think about the power of the signaling and just a mere introduction of three dovish dots, what that did to the market, it created one of the largest easings of financial conditions ever. Yeah, they just flew right from the mention of it to factoring in six.

15:21So I think you're absolutely right. And the Fed certainly must have guessed that it would be something like that. But now they know for sure that if they go for that first rate cut and that at a time when there's already six priced in. So, you know, we're it's very hard to see how they're going to be as measured and cautious as the Fed keeps imploring everyone to be. And one more thing I'll mention is that, look, what changes my mind on all of this is if there is credit contagion. This brings us to a question that a smart viewer already asked, and that was also on my mind. But one of the things I love is you've created a picture of this sort of structural conditions that are likely not going to change.

16:04And then we have to look at more temporary ones that you say are either going to help or hurt, ignite or dampen this situation. But being aware of the terra firma you're on now is really important if you're thinking about that. That's how I'm thinking when you're explaining this. This is the macro sort of ground foundation that you're looking at. And now we have to look at what are these factors. So we talked about what could ignite it. The other flip side of that seems to be some kind of credit situation. And Macro Butler is asking, Michael, do you think we will see a wave of bank failure over the next few weeks and that the Fed will be forced to continue the BTFP or another alphabet soup shadow liquidity injection rather than cut rates?

16:50Or even if it'll force their hand to cut rates. I'll just add on to that. Yeah, well, so look, back in March, I basically said that I thought that this, there were, during the depths of the fears of during that whole Silicon Valley Bank crisis, there are all these comparisons to, oh, is this going to be like another 2008 type of contagion type situation? and I and I said you know I don't think so it doesn't the signs are not there for a contagion and that I felt that the introduction of the BTFP corroborated my feet my own feeling that it was going to be a a precision surgical tool a rifle shot uh way of dealing with this as opposed to a shotgun bazooka a way of approaching it right which that that part turned out to be uh turned out to be correct.

17:45So the question is, what would change online now? And is there another credit contagion in the cards? To answer that specific question, I have no idea whether or not there's going to be another domino effect with regional banks. If it does, I think that they will probably bring back that rifle shot approach. There definitely does not seem to be any sort of broad-based credit deterioration. There's definite, like again, that wouldn't go back to that bifurcation I talked about, right? There are definite signs of stress in amongst the highly leveraged sectors of the economy, as you would expect, and those that are exposed to floating rate risk.

18:25But this is by no means a contagion. And some interesting data points that I got from some conversations last week. I was talking to one of the largest managers of CLO equity out there. As you probably know, collateralized loan obligations own about half of the outstanding senior secured leverage loans out there. They have to keep tabs on default rates, etc. The last 12 months, leveraged loan default rates, which are at the top of the capital stack, right? Senior secured leveraged loan default rates are still at one and a half percent, which is roughly half a long-term average. That's extremely denying.

19:10I mean, knock on wood, right? The other thing that's interesting with this, you always hear about private credit. Private credit is now a, I was shocked to hear this, but it's now a$1.6 trillion market with only about$1 trillion deployed. There's still$600 billion of sidelined cash, I guess, or dry powder waiting to refinance zombie capital stacks. In my piece that I'm writing this weekend, I said, Look, I mean, you already have this horseman number three of relatively less rate sensitive U.S. consumers and U.S. corporations. But when you add on top of that horseman number two, which is that fiscal tailwind that's lifting kind of almost all ships, and this situation where in the credit markets we've got this huge amount of private credit waiting in the wings to refinance, even poorly positioned capital structures, I don't see, at least right now, I don't see any of the conditions for a broad-based credit contagion.

20:29And so I don't see the Fed necessarily jumping up and down to want to start an aggressive easing cycle. And I think the other thing to consider is that what would happen to their credibility if they did cut and therefore signaled the beginning of an easing cycle only to see core inflation reignite and then three or six months down the line having to hike again? 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.

21:13well he said he said a million times they don't want he's not the arthur burns right he's he's he's invoked that and and to go from a lot of soft data and all of a sudden we had this streak the end of last week beginning of this week of re what looks to be strong data now you can argue some of it may be lagging but i mean that's enough to probably put the fear in them that that that's the worst case scenario so that would presumably have reinforced that that instinct to be very cautious when they go, which they've all been sent out to tell the markets in the last four or five days. I mean, they've all been singing off the same song sheet.

21:49So I think this presents an interesting, that other bifurcation I talked about, the first bifurcation I talked about was between the haves and have-nots intrinsic to the US economy, right? But the bigger bifurcation is the bifurcation between intrinsic risks and extrinsic risks. And so basically where my head is at is that because of relative U.S. economic resiliency to all these aforementioned factors, it makes intrinsic risks like big domestic credit blow up less likely, but it increases the chances of an accident in some other part of the world by virtue of our favorite thing the u.s dollar wrecking because right because because if the fed really is forced by the data to stay high for longer i i think that every central bank around the world so far They talk a tough game, but it's getting to the point where the economic divergences are large enough that they need to figure out whether or not they can really afford to follow the Fed or do they need to capitulate before the Fed.

23:05And my thesis for a while now is that there is a potentially stage two to this U.S. dollar wrecking ball. The first stage we saw was in 2022, right, when the Fed embarked on this aggressive hiking cycle and essentially out-hawked the rest of the world, right, sooner and higher than the rest of the world. But stage two, potentially, of the dollar-wrecking ball comes from the rest of the world outdubbing the Fed because they have no choice. So there was a chart today that I retweeted. I thought that was pretty interesting. I mean, if you just look at the relative rates of GDP growth among the G7 nations, I mean, when you look at it, just no other major geography comes close.

23:59And then what's really stark is you see that Germany looks like they're already in recession, and Germany is the largest economy of the EU, right? So I think the chances for an extrinsic problem are greater than an intrinsic problem. Right. But how quickly does that external situation become a problem for the U.S. and the Fed? We know what we saw during the great financial crisis, sort of it emanated here, but it went everywhere. Counterparty risks, credit liquidity started to shut down because everybody's exposed to everybody. Doug asking, what about a collapse in the shadow banking market? Would the Fed be forced to move with a non-bank crisis?

24:39I mean, it's not just U.S. banks that are too big to fail. There is an interconnectedness to the global financial market. You can argue that China's problems can be contained, but you see a big player. We saw that in long-term capital management. There are instances where there's enough counterparty risk and everyone knows now what happens. We've got that ghost of the great financial crisis. Do you worry that the Fed will be forced to take measures because of something externally happening? well um i guess that's the unknown you know i see here this is where geopolitics it's very important to pay attention to geopolitics too because i think that there's a reason why we have uh swap lines to all of our you know allies and friendly countries and there's a reason why we don't have swap lines to the pboc right our greatest geopolitical rival so um so So while, you know, some people are somewhat surprised that, you know, China's economy falling apart haven't really had real repercussions yet to the U.S., but I would argue that, you know, we're – the U.S.

25:49economy is far – we're not big net exporters, first of all. So the collapse of the Chinese consumer actually, in a way, benefits the U.S., right? It sounds kind of heartless to say that, but it actually benefits the U.S. from the standpoint of, well, it brings down commodity prices globally. And that's the other thing I wanted to mention, which is oil. The biggest tell to me that this idea that extrinsic risks are greater than intrinsic risks is when you look at global pro-cyclical commodities like oil and the other industrial-based metals. You know, I've been bearish oil all year and half of last year, and I've been saying that you need to fade every geopolitical risk because not only is there a large amount of overhead spare capacity in that market, the problem is that when you have an overtight Fed transmit its monetary policy by way of a strong dollar to the rest of the world, So all things being equal, you will see demand for global commodities fall.

27:18So I think there are too many oil bulls that are just focused on the strength of the U.S. economy. Well, yes, the U.S. economy accounts for 20 % of global oil demand. But what about the other 80 %? So in other words, a strong 20 % can't make up for a flagging rest of the world's 80 % demand. So you have to pay attention to the globally pro-cyclical commodities because they are a tell on how the rest of the world is doing with respect to our exporting of tight monetary conditions by way of a stronger dollar. Yeah. So against this backdrop, let's talk a little bit about where U.S. markets are, because you paint this really compelling picture and a good argument about why the Fed is not only going to be as cautious as they say, but may actually not deliver the rate cuts that are priced in, the market will have to walk some of them back, if not all of them back, maybe a more hawkish Fed.

28:34What do you make of the fact that U.S. equities, S &P, is knocking on 5 ,000? We're at these record levels. We have bond yields that have moved back up a little bit after those strong data releases, but they're still just above 4%. What would seem sensible for stocks and bonds based on the scenario that you're looking at? Well, so on this regard, I feel torn because on the one hand, you've got these conditions that are strong domestic conditions, right? Right. And and, you know, they are, you know, so in a way you're you're seeing the you're seeing. Those bullish aspects of a of U.S. economic resilience being reflected in, you know, earnings beats and even expanding multiples, et cetera.

29:34The question, though, I wonder about is, again, you go back to this vodka Red Bull thesis. If it then manifests in a Fed that is forced to stay higher or high for longer, there necessarily has to be a growth slowdown at some point. And so are the expanded multiples and evaluations appropriate at this stage of the game, especially when you consider the significantly increased cost of capital? Well, I'm torn on this front because the way I run my book is still the way I used to run my hedge fund, which is I feel like I'm trying to make money the hard way, which is I'm trying to find idiosyncratic bets that are either event-driven or value-based types of bets.

30:35but I hedge against macro risks by having, you know, you know, puts up and down the capital stack, for instance. Right. And, you know, these, these having equity puts on today, I just tweeted out. I said, look, when you buy insurance, it always looks like a waste of money when things are going well, but what buying insurance does for you is that it increases your chances of at least having a chair when the music stops. I don't know when the music stops. I really don't. But the tricky part of this is to not let insurance costs eat you alive, right? And so that's easier said than done. Um, um, but, uh, but yeah, I don't, I don't have a good answer for it.

31:25I feel like, geez, I could have, uh, had I not, it's always tempting to go see what performance would have been had I not bought any insurance and embraced, uh, you know, it went balls to the wall levered long, but you know, I, I, that's just not, well, this is why, this is why you sit here in the wisdom of your chair, still speaking to us today, Michael, because you resist that temptation and stick to your framework. I've been through too many cycles to know that nothing lasts forever. And this particular cycle has the earmarks of a combination of the internet bubble era, as well as the lead up to it.

32:10I guess The key question to me that I'm always wondering myself is, is this 1996 or is it 2000? Yeah. And I don't know. That's come up a lot. And I will tell you that many, many have, we've been having this discussion, you know, over the, really since the year started, a lot of people turned the corner hoping for some clarity. And it's just a really, really tough environment. It's a really tough environment to figure out for people like yourself who've been at it forever, you know. But I just want to underscore that I hope all of our listeners really understood what a master class this was in understanding how you have a macro point of view and a framework about what you think might happen, some of the secular trends, some of the structural things that Michael talked about, but then also making sure that you're operating not from the hip.

33:00Right. Like Michael's got a got a system that he uses to make sure he thinks about insurance, uses the option market, all these things that we talk about in the academy so that you live to fight another day. So it's a it's a very complex process. But if you break it down and especially lean on the wisdom of folks like Michael, you know, you can get through it. But it seems like a lot of information coming at people. So it's it's tough. It's tough out there, Michael. Not if you're long in video. That's right, which some people are and are laughing. But you want to keep those profits. We've been touched on Tech and the Mag 7.

33:35We're going to have to leave that for another time because, believe it or not, we're out of time already. But that was just fantastic. It was so fun to have you on the daily briefing. I know you're on other parts of Real Vision with us and are going to be again in the near future. But it was really great to be able to share your views with this broader audience. We appreciate it. Always a pleasure. Great to catch up with you, Michael. Thank you so much. And thanks for the smart questions. Feel free to post in the comments. We look at them. We'll get them to Michael. We'll get the feedback and we'll keep the conversation going because he brought up so many points that we're going to have to touch on.

34:05And we're also going to be talking about why research like the kind Michael does is so important. We're going to do something special on that in the coming weeks. So keep your eyes out for that. Thanks, everybody. It's been a really interesting week. We've had some fun shaking it up on the daily briefing. Hope you're enjoying it. We will be back same time tomorrow. So take care and good luck out there. Whether you're a crypto newbie, an established investor, or operating a business in Web3, tax season can be an absolute headache, but it doesn't have to be a nightmare. That's where CryptoTaxCalculator comes in.

34:34The software platform founded in 2018 by brothers Shane and Tim Brunette, crypto fanatics who were fed up with the complexity of doing their taxes. As Coinbase's official global tax partner, CryptoTaxCalculator focuses on simplifying complex transactions, supporting over 300 ,000 currencies across Ethereum, Arbitrum, Optimism, as well as 1 ,000 other integrations. It's as simple as connecting your wallet, pulling in all your transactions, and following the automated suggestions to quickly and accurately calculate your tax obligations. Finally, 2024 is a year when crypto investors can do their taxes with speed and confidence.