#985 - What's Coming for Markets in March? with Andy Constan

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0:56What's coming in markets in March? Welcome to Real Vision Daily Briefing. It's Friday, March 1, 2024. I'm Ash Bennington. Our guest today is Andy Constant, CEO of Damp Spring Advisors. Andy, welcome back to Real Vision. Hey, thanks, Ash. Pleasure to be here. Boy, we drew an interesting day here from the market gods. Let's see, it looks like NASDAQ at an intraday high right now, closing out. We'll see if it sticks as a close on the high. Some action in the Treasury markets, lots to talk about. Andy, where do you want to begin? Sure. I mean, I think we should talk about what happened this week and what, and I think March has, as you said, has a lot of very important news coming out.

1:36So, you know, this week was actually a fairly low data week.

1:45The, you know, the notable, there were no auctions. There was limited except early in the week. And by the end of the week, all we were doing was dealing with month-end pressures. But today, we had a fairly radical move in markets. And it wasn't just stocks. It was stocks, short-term bonds, long-term bonds, gold, oil, everything rallied. And when something like that happens, you have to think that this is some idea that money just became suddenly easier. And so animal spirits just bought all assets. And, you know, I look at the news and, you know, we woke up with Dell earnings, which certainly excited the semis.

2:38But we also started the day with fairly weak bond tape and the PCE, which everyone had been interested in the prior day, which really was fairly expected, really had had no meaningful impact. And then we had a PMI data that came out pretty warm. But that all changed, I think, triggered by the ISM data, which was weak across the board. Now, both of this data is survey data, but it certainly spurred a rally in every asset. Let me just bring folks up to speed on ISM if they didn't catch this number. It fell 1.3 % month over month, 47.8%. By the way, for folks who aren't following this as closely as you are, Andy, it's been in contraction, meaning below 50 on the oscillator.

3:31since late 2022? Yeah, the ISA, you know, survey data is, has become not much of a signal, frankly. It's, as you said, has been, what ASH means is that when it's below 50, that says the economy is in contraction. Now, the PMI, which is a similar survey, shows the economy in an expansion. But that, along with prices paid, which is an inflationary number, you know, got people thinking that the Fed was going to stay at three rate cuts for 2024. And right now we're priced. And so two year notes and shorter dated interest rate product rallied 10 basis points. We can bring up that chart. As a matter of fact, this is the five day chart on two year yield.

4:23Yeah. And that chart shows that we saw a substantial rally in the morning on the two-year. And that's because it had been the case for a number of pieces of data that the, and going back to December, where we had seven rate cuts priced into the two-year note, that had reversed to just about three, a little over three, but just about three. And so now we're pricing a little more than three, closer to four rate cuts in 2024. And so the question is, has the data, the ISM data, convinced markets that the Fed is going to at least stay the course on three rate heights? And by the way, if you're looking at that chart right there, what you're seeing is the two-year Treasury expressed in a yield basis.

5:22Obviously, prices move inversely to yield. So if you see that drop there in the morning, that is the increase in price. Right. So when you look at all those things, at that point, it was a bit off to the races. Long-term bonds started to rally. Stocks extended their already juiced rally on the Dell earnings, but gold and oil also took off. So let's talk a little bit about that. Is that the expectation of seeing those cuts and potential inflation? Is it a hedge play? Yeah, I mean, in terms of gold, yeah, I mean, I guess the idea is that when conditions are going to get easier, when the Fed is going to engineer an easier environment, it doesn't matter what asset you buy, you want to buy all of them.

6:21And you want to buy them because you don't know whether there's going to be more inflation or less. And so you buy some gold, but you also buy some bonds, which should go give you diversification. And that was really the pressure. If we had seen inflation being the driver, you would have seen a different reaction in which gold might have rallied and bonds might have sold off. So I think it was more about people thinking interest rates are going to be cut and that's going to be supportive of all assets. So the question is, you know, what evidence do they have that the Fed is going to change? And that talks, that speaks to what's happening in March.

6:57The first thing, noticeable thing that occurs is next week in front of the House Financial Services Committee and the Senate Banking Committee, Chair Powell will give his speech. And, you know, he can make news if he chooses to, or he could just wait until he has the CPI data and the PPI data from the following week. But that data will really dictate what will happen in the FOMC meeting the following week, which the announcement will happen on March 20th. And the important bit of that, so that's the rolling news that we're going to see through March 20th. And on March 20th, we're going to see what it all means.

7:44And the Fed isn't going to cut rates. That's out of the question for March. And the press conference can guide however it's going to guide. But the most important data that's coming out on the March call will be the quarterly refresh of the summary of economic projections, the so-called dot plot, that the Fed uses to, you know, just say what each member, each of the 19 members, think about the economy, think its direction is both over 2024, 2025, and over the long term. And I think everyone agrees that inflation has been behaving extremely well, coming down as supply shocks have gone away, and yet also agree that employment is very strong, and probably until maybe today thought the GDP was strong.

8:40And so the question is, is the dot plot going to reflect three hikes or two hikes? Sorry, cuts. Three cuts or two cuts. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing. Join over 5 ,000 attendees for the largest AI event in Asia at Super AI Singapore, June 5th and 6th, 2024. Raoul Pal, Benedict Evans, Balaji Srinivasan, Edward Snowden, and over 150 others will join the industry's most influential to explore and unveil the next wave of transformative AI technologies. Singapore will become a vibrant AI hub for a week from June 3rd through June 9th with over 150 side events that will make for unparalleled networking opportunities.

9:32Visit www.realvision.com forward slash super AI for 20 % off tickets with the code realvision or click below. you can be forgiven for that because we said that for like decades right we were in that mode um so is it going to reflect three cuts or two cuts and it's a very interesting thing because the way it works is you have a voting committee and you have 19 members submitting their dot plot and you take the medium and all it'll take to go from three cuts to two cuts on this dot plot is two of the members who are currently at three height cuts flipping to two cuts. And so we're really on a razor's edge in terms of what the March meeting will signal.

10:27And so I think that creates a lot of opportunity in markets at this stage. By the way, I'm going to give you guys a free cheat. The pros are looking at something called WORP, the World Interest Rate Probability, on their Bloomberg terminals. But if you don't have $2 ,000 a month to spend, you can go over to the Atlanta Fed that has the three-month expected average SOFR path that will give you a trajectory that's really close to what we're talking about here. And I think we're going to try and bring you that chart in just a second. But if you're down from about 525 to 550, down to about 350 basis points heading out to call it fall of 2026.

11:06This is the interest rate normalization path that everyone has been looking for since the beginning of these, well, just extraordinary accommodative position in rates from the Fed for many, many years now. Yep. So that'll be the big news of March. And so the question is, what will it signal? As I said, the markets are expecting continued, easy conditions, while the Fed regularly will come out and say they believe that conditions are restrictive. And so it's an interesting dynamic to see crypto making new all-time highs, equities making new all-time highs, bond yields still restrained in terms of their yield, not high, and credit spreads in particular at their post-COVID lows, you know, there's a fair amount of optimism regarding the ability to what has been, you know, the metaphor is land the economy softly with inflation returning to target and growth, you know, allowing jobs to remain fairly firm.

12:35And that's what they're trying an engineer. And right now, markets are certainly after today are very much believing it. Yeah, Andy, literally, as you're speaking at closing numbers here, about 10 after four, S &P 500 closing over 5 ,100 for the first time, 5 ,137. Looks like up about eight-tenths of 1 % on the day. NASDAQ taking out the 2021 high, 16 ,274, up over one percentage point on the day. Russell, 2 ,000, over 2 ,000, closing out the day, over 1 % up on a day basis. So obviously, this trend that you're talking about here, red, red hot. Absolutely. Markets are doing extremely well. Yeah, NASDAQ 100, I don't have it on my screen.

13:21I'll bring it up in just a second. But year to date, well, here it is. Year to date, NASDAQ 100 up almost 11%, trailing 12 months. NASDAQ 100 up 52%. percent. Sure is. Yep. AI miracle is driving a lot of that, of course. Does it concern you? I mean, how fast it's moved, how far it's moved, maybe something about the concentration in a few mega cap tech names in terms of where these gains are coming from. Any concerns there? Or do you think that this is a trend that is likely, more likely at least, than not to continue? The way I describe it is, you know, the promise of AI is in the future, and who knows what it will be like, and what the big implications are.

14:09But when you look at all of the various stocks, all that have extremely great legacy businesses that deserve a fairly an above market P.E., and then you add some more future earnings onto each one of those, the valuation of each individual stock doesn't seem crazy. However, and I think this is the bigger point, the AI pie, that future revenue that all of these companies are vying for probably doesn't accommodate each of those companies' ambitions, meaning there's a certain amount of pie. It's big. Let's assume it's big. It has to be big to support the prices. But Amazon needs its share. Microsoft needs its share.

15:07NVIDIA needs its share. AMD needs its share. Google needs its share. Apple has sort of decided now to go after a share. And all of these stocks are priced as if they're going to get their share and that their legacy business is not going to be undermined by the share. So I find it interesting to think about each individual AI stock. You know, I can't argue if they get if they get their share of the pie, it's probably they're probably OK value. But I do wonder about the absolute size of the pie, which I think has its limits with legitimate macro concerns about how quickly the overall GDP pie can grow and how much of that GDP can be sent to revenues for these stocks.

16:07And then there's the how many slices does each guy get? And so I think there's going to be some accidents on a number of the stocks, but also some winners in that group. And so picking that is going to be the challenge, I think, when you're thinking about the AI space. Boy, that's such a great framework to think about it in this idea that at the scale that you're at, you need GDP growth. There's just no other way to get growth in the revenue at this scale without GDP growth. And then you have the question about the allocation, the winners and losers among those divvying up the pie of this projected GDP growth to come in the future.

16:47Yeah, I mean, if you look at GDP, it isn't spent on tech. You know, the six biggest companies that we've been talking about, you know, have increased their share of GDP in terms of revenues from 3 % to 6 % over the last five years. And they've actually flatlined at 6 % of GDP for the last year. But you have to understand, it's not like that 94 % is addressable market. You know, people still teach, eat, buy their car, drive their car, spend on military, all the various factors that aren't going to be parts of the GDP pie that AI can start to take. And the GDP only grows 5 % a year on a nominal basis, assuming inflation is what it is.

17:46And so that's about$500 billion of pie for the whole pie. And prior to that, prior to this year, you know, the pie that these companies ate was 300, was 6 % of that. And so when you look at those sort of numbers, sorry, 1.25 trillion is the increase, and the 6 % is like 75 billion. So they really have to both get the GDP pie to grow and the share of that GDP. And it's unclear to me where it's going to come from. So when I look at that, I just say, OK, these are huge companies delivering a great product, but they're priced to take a significant portion of more GDP. And the funny thing is, you know, companies like NVIDIA, 40 % of their sales are to the big four hyperscalers.

18:53And those four hyperscalers are not planning on growing their investment in GPUs anywhere near as quickly in 2025 as they did in 2024. So, you know, I look at it from that framework and think that these are great companies and many of them are going to be winners, but not all.

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20:15Boy, Andy, we could do a three-hour show on just that chat. It's funny. I don't know anything about this. Well, you know what I was thinking? And look, there's obviously room for debate on a lot of these points. But the point that you just made there, at least my key takeaway from it is, when you're talking about numbers at this scale, when you're talking about revenue and market cap at this scale, it has a clear macroeconomic impact. You have to grow GDP in order to grow revenue because it's just so large. That's not the case if you're talking about a, I don't know, a micro cap fashion company, right?

20:44But what's also really interesting when we talk about macro is to think about, obviously, what we're talking about here is the potential for productivity growth. Here's an interesting thing. You know, you think about it, revenue and wages are the flip side of the same coin, right? Real Vision's wages, Real Vision's revenue are my wages. And if NVIDIA and Google come up with an AI avatar to replace me, I don't work. So you start coming up with these questions about what happens in terms of wages, revenue shifting from essentially from wages to capital, the potential impact of things like marginal propensity to consume versus marginal propensity to save.

21:22Who's getting this revenue? What are the macroeconomic impacts of it. These are real material questions that I think we're probably in the infancy of figuring out. Absolutely. Yeah. Those are hard to predict and we'll see how that plays out. But I think that's the promise of future deflationary productivity increases. But it also has to be thought of in the context of where does the revenue come from for people and the lost wages, how are those repaired? So it's a complex thing. Maybe we can bring it back to QT with Waller's speech today. Yes. So I think it's important to recognize that for about three months now, there's been, ever since the, well, two months, ever since the minutes from the December Fed meeting, there's been a discussion around slowing down the quantitative tightening program.

22:24And I saw people that had extrapolated that minutes question moments later into the reverse repo program going to zero by March and QT having to end by June. And I think since then, the Fed officials that talked about it are now pushing back. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing.

22:58Can you just explain the significance of some of that? Because I know that when it comes to the mechanics of monetary policy, lots of retail investors get a little bit overwhelmed. First, unpack reverse repo markets, what role they play, and talk a little bit about where we are in terms of the cycle of quantitative tightening, just to set the stage for people who don't follow this as closely as you do. Sure. You know, I think let's step up to the high level, which is the government spent, provided the economy with a tremendous amount of stimulus in 2020 and early 2021. And that stimulus got spent and saved and remains in the financial system.

23:40It's not spent anymore. It's now mostly saved. And so that savings is largely in banks, in their bank deposits, earning, you know, some people get interest, but most don't. And the rest is held in money market funds where people have been moving money to get interest. and that money needs to be invested. And banks could pay interest, often don't, but they have an account, they take that cash and put it in account, and it's roughly this, put it in the account at the Fed that pays interest to the banks. And the banks conceptually pass it on to their clients. Money market funds also need interest for the cash they got from their fund investors.

24:38And so they can invest it in T-bills, but they also need money overnight that's safe, like a bank deposit, in case their client wants to spend on something or invest in something and withdraws his money. And so the Fed recognized how much money they had provided the system. And so they created essentially a wholesale bank in which they would take money market mutual fund cash and pay interest on it. And that grew to about$2.5 trillion by the end of the whole cycle. And then quantitative tightening was announced and began in May of 2022. And ever since, what happens in quantitative tightening is the government issues bonds to the private sector, and the proceeds aren't spent in the private sector.

25:46they're given back to the Fed for the bonds that are maturing in their portfolio. And so that withdraws some of that excess spending, excess liquidity, excess savings that is in the financial system. And so that's been - And by the way, just for reference for folks, we've gone from about a peak of around$9 trillion in assets held by the Fed to now about$7.5 trillion in assets held by of the Fed, so a significant diminution. Yes, and that's$1.5 trillion less dollars in the financial system. And most of that has actually come from, actually more than all of that has come from the reverse repo programs shrinking from$2.5 trillion to, I think it was like$440 billion today.

26:40And some actually has leaked back into the banking system and is still there. So the banking system actually has even more reserves than they had, even though quantitative tightening, this paying back the Fed, the money they spent on bonds, is supposed to reduce reserves. It hasn't yet. And so the question is, how long will the Fed continue quantitative tightening? And what the speech today said, which I thought was fairly clear and has been what they've been communicating, is they still expect quantitative tightening to run for an extended period of time. Andy, that may be the single best explanation we've had on the relationship between the Fed balance seat in the reverse repo market on Real Vision Daily Briefing.

27:32I'm a little bit of a specialist on that, nerdy as I am. We're going to have to have you back to do like a two-hour deep dive unpacking all of this for our Real Vision members. But I wanted to jump because we've got some questions here that are very specific to what's happening in the bond market, and I'd love to get them to you. The first one comes to us from Marty F. I'm going to go a little bit out of order here, guys. The first one is Marty F. And who wants to know what is Andy's take on tips for the next 12 months? These are the Treasury Inflation Protected Securities for folks who are new to this.

28:05So you don't have to admit the best thing about tips is you don't actually have to make a bet on inflation. A lot of people think when you buy a tip, you're making a bet on inflation. Turns out when you're buying a nominal bond and you're locking in the yield, that's when you're taking a bet on inflation. When you buy a tip, you get whatever inflation is. So you're protected from that inflation. So what you care about is the real yield. And real yields have been peaked in October at what I thought was a very attractive rate of two and a half-ish percent. And, you know, two and a half percent real yields for five, 10, even 30 years is actually a real gift.

29:00And so they're not there now. They're, depending on what maturity, they range from 1.8 to 2.2. They're not quite as attractive as they were. Now, that doesn't mean they aren't attractive, and it doesn't mean that by buying them you are making a bad investment. But the pressures on the bond market with significant amount of supply and the quantitative tightening that is ongoing, to me, means that you don't have to rush into these things. They're perfectly fine as a place to put your cash, certainly the shorter maturity ones. But I think there'll be a better buying opportunity by the end of the year.

29:45And so I'm looking for yields north of two and a half for me to start getting long tips sort of for the long term. Here comes another bond question from Eva D. Any views on TLT short term, Andy? Gracias, she says. And by the way, I should say TLT is the BlackRock iShares 20 plus year treasury bond ETF prices move proportional to price inversely proportional to yield. Yeah, this is a fairly volatile retail way of buying long term bonds. There are more volatile ones. There's also levered versions of these things. But the TLT is sort of a, you know, a generic, highly liquid way of getting long term bond yields, nominal bond yield like returns.

30:33I'm short it, not TLT specifically, but the underlying things that relate to it. Frankly, the bond futures contracts that have similar maturity. And why I'm short it is similar to the reason I don't am not buying tips, is that there's quite a bit of supply of treasuries overhanging the market. And the economy is doing great. Real growth is very strong. Inflation expectations are low enough so that they are not super attractive, meaning that even if inflation continues in its decline, you're not going to get much principal appreciation in TLT. I'm looking below 90 to think about buying TLT. They closed, I don't know, they rallied a little bit today, I think 94-ish.

31:30I'm short them and I'm happy to be short them to get a yield. That to me is when the 30-year bond yield is north of its October highs, so that's somewhere in the five and a quarter range. That's when I'm going to be more interested in TLT on the long side. But right now Now I'm short. Yeah, exactly right. 94 and change closing today. Here's a question from Doug McCurn. Andy, what's your view on DXY here in 2024? This is dollar index. DXY and the dollar more broadly. Yeah, what a bore. DXY has been in such a narrow range. And I don't, you know, I'm a little bit bearish on the dollar, but not, But I don't actually have a position.