#971 - Surfing a Surging Market With Brent Donnelly

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0:56Welcome to Real Vision Daily Briefing. It's Friday, February 9, 2024. I'm Ash Bennington. I'm joined today by Brent Donnelly, president of Spectra Markets and a member of our RV Marketplace. By the way, if you are an RV member and want a discount to Brent's must-read macro newsletter, AMFX, head over to realvision.com forward slash marketplace. That's realvision.com forward slash marketplace. And by the way, just a reminder, this video, subscribe to the YouTube channel. It really helps us out. always a pleasure to have you on brent great to be back with you big picture where are we right now in markets hey ash uh yeah it's pretty interesting time uh i'm in an fx guy and funny enough fx is probably the least interesting asset class right now i mean you look at things like um and and what coco is doing and what stocks are doing nvidia um but i think the most interesting thing really is just like the continuing of the U S economy on cruise control.

1:56And like, you know, people, someone called it the, the Bigfoot recession. Like if you look hard enough at that picture, I think you can see Bigfoot in there, you know, so people, instead of looking at the headline data are trying to like dig through the household survey or whatever, like survey miscellaneous survey data or specific details or private data. But if you just look at the headline data, you look at claims retail sales gdp non-farm payrolls the u.s economy is doing fine and then at the margin the countries where we thought they were kind of going to be toast by now like canada new zealand and sweden for example where there's like very high household debt and like high vulnerability to real estate those countries are like just grinding through like Canada's had no GDP growth on, you know, 10 % or something like 10 % population growth over 10 years.

2:52And in the last like three quarters, there's been no GDP growth. And yet still the jobs market's okay. Like you came out to Canada jobs came out today and there's still jobs everywhere. So that the, this cycle is like no other cycle that we've ever seen. By the way, that was one of the phrases that struck me in speed run this idea that it's just like no other cycle we've ever seen. And by the way, it makes sense if you look at things like CPI, PCE, go and look at employment charts. I mean, there's just nothing like what we saw coming at the 2020 shutdown and then the huge spring back. So it makes perfect sense that we're in unprecedented, uncharted waters here.

3:34So it's great to have you on to get to talk about this. By the way, I should say S &P 500 right now, 5 ,026. So yes, we did hold it for the day as the prices settled down here. Brent, talk a little bit about this idea of this Bigfoot recession. This is coming out of a note that was written by, who was it who wrote this note, Brent? Manoj. Yeah. What does it mean? So I think one of the most fascinating things about this cycle has been the amount of confirmation bias because whatever your view was, especially if you were bearish and you were calling for a recession, there's always something that you could point to that would suggest that it's imminent.

4:18The biggest one to me is the soft data. So the survey data like ISM, NFIB, all the surveys of businesses and consumers showed an incredible amount of pessimism. And in a normal cycle, the soft data turns, and then the hard data follows it. But in this cycle, it's just so completely different because there's two cohorts. So the business cohort tends to lean very Republican, especially NFIB is the most extreme because that's small business. So if you look at the Democrats versus Republicans of CEOs or NFIB, it leans heavily Republican. And there's been a lot of malaise on the Republican side because of Biden.

5:00So if you look at, just ask anyone, what do you think about the economy? And it comes down more to whether they're Democrat or Republican than to what's actually going on in the world. So that split has been huge. And then on the consumer side, essentially people feel real income. So how you feel generally is like, do I have a job and do I have more real money to spend? And when inflation goes up faster than wages, your wages, your real wages are going down. So that has made everyone feel really bad. So that depressed consumer confidence. So politics depressed business confidence and rate hikes, of course, like fear of rate hikes.

5:40And then the consumer confidence was hit by real wages. But now you have inflation coming down. And at the same time, you have the odds of Trump winning going up and also just Trump being in the news and Biden fumbling last night, etc. So my view is that the soft data will actually catch up to the hard data. And if you look at the hard data, like retails, like the ones I listed already, the US economy has been strong, pretty much strong the whole way through. But then like, let's say you're bearish and you're looking for a recession, you can look at the household survey right now, which I could go on for like 20 minutes about that.

6:17But I'm a very strong believer that the household survey is useless. But there's lots of things that you could look at to find bearish stories like or you just look at layoffs. So like layoffs have been going up lately. But then layoffs also were going up at the start of 2023. But that's like looking at expenses going up at a company and saying, oh, that company is screwed. You have to look at income and expenses. So for the jobs market, you have to you can't just look at layoffs. You have to look at hiring. So people are pointing, oh, layoffs are up. But if everyone that gets laid off finds a job the next day, that doesn't the layoffs don't mean anything.

6:52And that's what's been happening. So I don't like to use extrapolation as a forecasting tool. So I'm not saying that this is going to go on forever. But what I think you can do is take the most timely data and look at the hard data and make your assessment from that. And I think the more that you slice and dice, especially in this day and age, because like in the 90s, there was basically all the headline data and that was it, right? Now you have like 15 different private numbers, Like for jobs, you've got jolts. For real estate, you got Zillow. For inflation, you got truflation. There's all these alternate data sources.

7:26So if you have a strong view that we're going into recession and you have confirmation bias, you can always find something that's going to confirm what you've already seen. So for me, it's Occam's razor. You look at the headline, the key data, and have an open mind to the future that this data might not hold up forever. but to me for example claims comes out every week it's not revised that much it's kind of the aggregate of hiring and firing because you don't apply for unemployment insurance unless you've been laid off and you didn't find another job so i don't know i feel like occam's razor is the way just pick the simple approach look at what's actually going on and don't go too far into the weeds because the weeds are people say the devil's in the details and i think in this case that's true but the devil has been calling for a recession for 18 months.

8:17Yeah. Okay. So Occam's razor, this is the idea that the simplest explanation is probably the correct one. I won't try and pronounce it in Latin, but let me ask you this, Brent. What does it mean when you do try to take this Occamist interpretation? What is the simplest story? And I think you're so right about the just overwhelming abundance of data that we have out there. You can craft a narrative that agrees with whatever view you have, because there are just so many data sources that you can pluck from here in 2024. So let me ask you this. What is the overwhelming, compelling story that you see when you look at this from the perspective of trying to simplify and come up with the most likely scenario going forward?

8:55What does it look like? You mentioned the election, which is always a wild card. We have an election year, particularly one that's as politically contentious as of this one. What does it mean for you? What's the base case based on the data you see? so to me the baseline is we were in secular stagnation covid happened they put five trillion into the economy and now we've kind of normalized to this like secular stagnation plus kind of thing so yes the rate of change of a lot of variables is slowing but that's because we were in this hyper cycle that was like a massively overheated economy where restaurants were shutting because they didn't have enough employees.

9:34So to expect that to continue makes no sense. Like the 2021 economy was not sustainable. So to me, now we're coming back down. And then the tricky thing, of course, is that if you go from like overheated to recession, you're going to pass through some kind of middle equilibrium. But I think we're going to find stability at this middle equilibrium, which is kind of like what the economy was, say, in like 17, 18, like 2017, 2018, but probably with a little bit more inflation and a little bit more confidence, because to me, being at the zero bound in monetary policy was bad, not good. So in some ways, normalization is actually good.

10:18It gets money moving around. A lot of people actually are getting more money because cost of living adjustments to pensioners are up. People that have money in the bank are making interest. Obviously, stocks are going up. Housing's still at the highs. So the idea that the money just disappears after you put it into the economy is not really right. I think we're kind of finding a new equilibrium, which is a more stable equilibrium as well, because we were in a very unstable, overheated equilibrium or non-equilibrium in 2021. And I think now we're kind of finding our happy place. And that doesn't mean it's going to last forever, but nothing lasts forever, right?

10:56So like the clocks that are stopped are correct twice a day kind of thing. So to me, one of the hardest things though, is that the soft landing thing that I'm kind of describing, it's kind of priced in now. So markets-wise, that makes it a lot harder. 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. 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.

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13:34let's shift gears here and talk a little bit about asset prices let's take the macro and superimpose it on what you see happening in markets you had two great charts earlier out on twitter and if we can bring them up on the screen the first one is the s &p sector weights so looking at this chart and this goes back this goes back accustomed to 1990s this goes back some 35 years it's a really interesting and compelling chart when you just see the massive outperformance of infotech and comms relative to everything else in the market. It's just leaving it behind. So essentially what that chart showing, and that one speaks to me because I was trading in 1999 and I grew up in Ottawa, which is where Nortel was based.

14:21And the big obvious tell in the dot-com bubble in Canada was that Nortel became 40 % of the entire Toronto stock exchange. So there's a limit, obviously, to how much things can become as part of the economy. Like Infotech can't be 102 % of the stock market. So there is some kind of upper limit, which is obviously 100%, which it can't get to. And so like trees don't grow to the sky at some point, you have to start wondering like, okay, does this make any sense? And so the chart shows that infotech is getting close to 40 % of the S &P, which was, I think it peaked at 42 in 1999. So that red line shows percentage of S &P that's information technology.

15:07Okay. And you can see, actually, interestingly, we peaked up there at the top of the hypercycle as well in the meme, stock mania and all that. But we're getting back up there. So, but then if you - And you can still see the 2000 spike on that as well. Yeah, yeah. So that shows the percentage that Infotech is of the entire stock market, which people know like Mag7 and all that is big. But then if you go to the other chart, it shows operating margins. And so one big tell in the dot-com bubble was price to sales is what people used. And the guy from Sun Microsystems has a famous quote that said something like, we would have to grow at 25 % for 100 years to make the stock go to where people have priced it kind of thing.

15:52And Cisco was the same. It was like 40 times sales. And if you backtest every large cap stock that has ever got to 40 times sales, it's like the worst EV trade in the world. that like something like 12 out of 15 of them dropped 50 and three of them went up or something like that i was actually just uh telling my younger colleagues about uh cisco and talking about nvidia not that's a direct comparison but look cisco if you look at that chart uh cisco's never regained the highs that it achieved in what whatever the year was 2000 i guess spring of 2000 it's just never ever got parallels too because they're both like the pick and shovel play for the industry, right?

16:31Like Cisco was building the network that people needed to use the internet and NVIDIA providing the chips that people need for AI. And what ended up happening, it was that eventually it was never really like Cisco did anything all that wrong. It's just that everyone bought all the networking equipment they needed. And then there was no networking, there was no more equipment needed because everyone had it. So it basically got, the market got saturated also by competitors. So, but the interesting thing is if you bring up that other chart of price to sales versus operating margins, the big difference now, and like, I'm the last person that will ever say like, Ooh, we're in a new paradigm or this time is different.

17:13Cause they that's, those are crazy words to say, cause they're never, never ended up being true, but there is some truth to it, even though I cringe when I say it and that these companies are not really NVIDIA, but some of the other companies are borderline monopolies or oligopolies that are printing money and their operating margins are so high, right? Like look at the operating margins in 1999 when price to sales was where it is now. And then look at operating margins now. And I think it's a little small, but I think the Y axis is something like 10 and 22 or something. So operating margins are basically double.

17:50And in the end, that's how much cash they're pumping out in theory. I mean, it's a bit more complicated than that. And that's important, right? Like that's, so these companies are just like incomprehensibly big. Like the other day I was comparing Microsoft's net income to the top hundred companies in Canada. And that includes like RBC, TD, Bank of Montreal, like huge companies that, that, and that, again, those are oligopoly companies too. So those are juicy, juicy businesses. And Microsoft makes more than like the top 30 or something. I think you have to add the top 30 or 40 companies in Canada before you get the same net income as Microsoft.

18:27And by the way, such an important comparison, the way that you're doing it, they're basing it on net income. We often hear that with regard to market cap, but actually looking at net income, how much cash are these companies throwing off? Boy, that's a compelling and interesting statistic. Yeah. And it's just absurd how much money these companies are making again not necessarily nvidia yet but um microsoft and and amazon and all that it's just they have really high margins so i don't know my my challenge with these is that to me like 21 was very much more obviously similar to 01 in terms of just like the total hysteria um whereas i feel now there's actually a lot more skepticism than there was in in 99 or in 2021 so it's not as obviously a bubble to me i mean like i said i i it's hard to to say like it's a new paradigm but it can neither be a new paradigm nor a bubble it can just be a bull market right and maybe this is just like a more of a standard bull market and there's always the mistake of saying that every bull market is a bubble and just a lot of bull markets are not are not bubbles like housing in Canada, people have been saying it's a bubble since 2013.

19:41And it's 11 years later, and it's probably doubled since then. So it's risky to call everything a bubble, but then obviously bubbles exist. So it's a tough one. Well, it's the Keynes comment about how markets can remain irrational longer than you can stay solvent. By the way, housing markets generally a little bit different than more liquid asset markets. Obviously, higher transaction fees a little bit slower. When you deal with things like equity bubbles, they can collapse very quickly. when you talk about those days 2000 and maybe some of the skepticism now is that, Brent, folks who are our age actually remembered.

20:12I was working on Wall Street. I was one of the young guys back then. And I remember when that Judge Penfield Jackson decision came out, I guess in the April or May of 2000, I remember I was at Credit Suisse Private Banking and going up to the trading floor and just being like, man, I got to see this and seeing that chaos and that panic. And when you had some of those experiences, boy, it stays with you. One of the great things about finance, one of the few things in this world that we just keep getting better at as you get older, because you just have more models mentally to compare things to greater frame of reference.

20:42Right. You know, it's really interesting. There's a lot of data on this that people are so influenced by their formative experiences, whether it's like if you grew up in the 70s, then you're always worried about high gas prices. If you grew up in the 90s, you're always worried about tech bubbles. If you grew up in or if you came into the business in 08, you're always short because you always think stuff's going to crash. It's an interesting bias that is difficult to get rid of because there's one thing to, I remember talking to Jim Grant about this one time and I said to him, why do you think people just keep stepping on the same rake generation after generation?

21:17And he's like, you can read all the history books you want, but until you actually feel it and you step on the rake and it smashes you in the face, that's when you learn the lesson. You don't learn the lesson from reading like reminiscences of a stock operator. 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.

21:41It's so true. I remember my grandparents and all of their money just went into real estate because of that visceral. You remember what the 1930s were like. Nope, it's real estate. We'll buy houses, we'll rent them out. Nope, not buying stock. That's probably a decent call. It probably was. Hey, listen, I want to ask you about one other thing. I was actually watching last night, the conversation that you and I had in April of 2023, right after the beginnings of that little mini regional banking crisis that we had. There's some stories going around today, one coming out of Semaphore, an interesting one talking about the risks of CRE, commercial real estate, of course, and the risk that some of these loans are disproportionately skewed to a smaller sector of banks.

22:24I don't know if we can bring that chart up, the chart from Semaphore, but it really is an interesting one. It's a compelling one. Just to bring things full circle, I know this isn't where you spend most of your time, but because we had this conversation the last time you were on in April of 2023, boy, it's interesting that we have this sort of rhyming moment here where we're talking about regional banks again. Again, any thoughts on this and whether or not this could be a place where there is some risk learning? I'll add one more thing here, which is what's happening right now in office space.

22:53I just want to throw this out to get your view on it. My view is that we're probably never going back to the 2019 model of five days a week, 40 hours a week, the madman era, take the train into the city and sit at your desk for eight hours. What are the secular changes that we're looking at? What are the potential risks here? Yeah, there are some parallels to 07, 08. Like, I don't think it's close to being the same because at that time it was the big banks that were over levered and now it's the small banks. So to me, it just seems much less scary, like a cynical take, which, but I, I think an accurate take is that these banks will just get gobbled up.

23:28And I don't know, my personal view is that you don't need 4 ,000 banks in a, in a country of 230 million people. So, you know, we've gone from 10 ,000 to 4 ,000 and we're just going to probably go to 2 ,000. And if you look at these, like the SNL crisis or whatever, these moments, these over-levered moments tend to be when the small banks get gobbled up by the big banks. But there are some interesting parallels. Like there's been some pain in Germany, in German banks as well from US CRE. And to me, that's kind of interesting because a lot of the sort of shockwaves went through like the Barions banks, the hypobanks, whatever in Germany, where they bought the crappiest part of mezzanine stuff on the CDO squared stuff.

24:11So I think it's definitely worth watching and it's interesting, but in the end, I think it's a fade because these banks are not systemic. So as much as like those individual banks, there's probably a lot of single name plays where the banks will go to zero or, or something or get bought for two bucks by JP Morgan. But I just, I don't see it being systemic, but I, the one caveat I would say is like, I'm not an expert on, on the banking system. So I'll be more like, for me, this kind of stuff, because I'm more of a trader, and I tend to have more like, short term time horizons, is this stuff is just like super, super on my radar.

24:50And I'm trying to gather as much information as I can. Because the thing you need to know if you're if you're trading, this is more like for traders, but is what are the names I should be watching. So like, if if there's, if you talk to someone who's a professional that trades regionals, they'll probably tell you like, okay, dude, these are the six banks that you should probably be worrying about. And you should have those six banks up on your screen because one of them is going to drop 18 % in five minutes and you're not going to know why, but you probably want to, you probably want to buy 10 years on that.

25:21You know what I mean? So as a trading thing, I think having these, these themes on your radar and like not even being expert in them, because that's impossible, but having a high enough level of, of awareness of what, what matters and what doesn't, I think is more key than making a forecast of the ultimate impact on the economy. Yeah. We're going to get some questions in just a minute because we've got some good ones coming in from our audience. But first, two quick points. If you're looking at outstanding commercial real estate debt, remember the office space piece of that is only a relatively small component.

25:55There's multifamily housing and some other things in it. A second point, Brent, I guess that if you wanted to play devil's advocate on the small banks question, when you look at the outstanding amounts of the debt outstanding on that chart that showed the loan positioning, I guess one of the risks is if they are large banks, they're easier to repair. You can flow the money to them rather quickly. I imagine when you were talking, you're talking about how does America really need 4 ,000 community banks. There were some community bankers out there with a vein throbbing in their temple who believe that, as many people do, that one of the reasons why we have such a vibrant economy is that we have community banks who are able to lend in more targeted ways, sector by sector, regionally, and some other points.

26:36So with that said, let's move into some of our questions here because we've got some really good ones. First one comes to us from IsThisIt on YouTube. Does Brent have a view on Bitcoin? Is BTC in a halving pump? By the way, Bitcoin right now around$47 ,500, bit of a rip. So I do have a view, but it's kind of boring. My main view is - Bitcoin needs more boring. Give us a boring view. I'd love to hear that. I think we're going to see a slow decline in volatility. There's a couple of reasons. One, or the two main reasons are that market cap and liquidity are correlated to volatility. So the price discovery period for Bitcoin to me is kind of over.