A Crude Reality for Stocks? With Darius Dale

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0:39A crude reality for stocks. Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Darius Dale, founder of 42 Macro. Hi, Darius. Hope you had a good holiday weekend. I had an excellent holiday weekend. Something like Coach Prime out there in Colorado. Exactly. We were talking a little football before we came on. It was something for everybody this weekend. It's going to be a lot of fun. But I don't know. We would hope it would carry over to the investment landscape, I'm not so sure, though. Stocks kind of kicking off this shortened trading week on a mixed note down. S &P looked like they were going to close lower.

1:16I'm not sure exactly where they are right now. And NASDAQ looked like they were hanging in there maybe flat. Actually, that dipped in the red as well. Bond yields higher, so were crude prices. Oil hit a 10-month high after Saudi Arabia and Russia said they would extend those voluntary supply cuts. That seemed to cast a cloud over as people were kind of looking at the economic forecast. What's top of mind for you as we kick off this new month for all means and purposes? Yeah, I appreciate that, Maggie. Thanks again for having me, everyone. It's good to be back. So, you know, what's top of mind for me is always the same.

1:49We're always executing our process on a daily basis. So I figured it might just be a great place to start, Brian, with our macro weather model to get a sense of what's happening in the real economy, what's happening in the financial economy, and how those two factors are sort of contributing to the outlook for asset markets. So we'll start on the left side of this table. So we refresh this model every day for our 42 macro subscribers. It really helps us kind of navigate kind of all the cross currents that we've experienced in financial markets this year. So we'll start with growth at the top left.

2:17It's accelerating. It's expected to decelerate over the next 12 months. Inflation is decelerating on a trend basis. It's expected to continue decelerating on a trend basis over the next 12 months. The unemployment rate inflected to a positive trend recently. It's expected to continue that positive trend over the next 12 months. Corporate profits, if you look at sales and EPS growth rates, those are trending lower for the S &P 500. The sovereign fiscal balance as a percentage GDP has been trending lower. It's been budget deficits that has been widening. We got a record non-war, non-recession budget deficit in the U.S.

2:46economy. The real effective exchange rate is trending higher despite that. And that's obviously created some headwinds from a liquidity standpoint when you look to the top right on this chart. Our 42 macro net liquidity model, that's the Fed balance sheet, TGA, RRP. You know, that number's been trending lower. Our global liquidity proxy, which I find to be a much better model for explaining asset market performance in terms of the dispersion that it produces in the back test. That number's been trending lower. And our global liquidity proxy is the global centric balance sheet plus global broad money supply plus global FX reserves minus gold.

3:16Credits trending lower if you look at broad money supply, both domestically and globally. The policy rate is trending higher. The two-year nominal yield spread relative to the policy rate is trending lower, so markets are expecting some easing over the medium term. In terms of fear, we aggregate U.S. dollar positioning across all major currencies in gold. That is minus 12 % in terms of non-commercial net length as a percent of total open interest. That's a neutral signal. We aggregate U.S. rates across the Treasury curve at minus 19 % of non-commercial net length. That's a percent of total open interest.

3:45That is an extreme bearish signal. And then in terms of greed, we aggregate commodities across the CRB index. That's an extreme bearish signal at plus 6%. And aggregate U.S. equity instruments, that's a neutral signal at minus 3 % in terms of that net short position that we still see in asset markets. And so when you put all those 20 factors together, they all contribute independently to each of those asset class forecasts. We got a neutral three-month outlook for stocks and bonds, a bearish three-month outlook for the dollar, commodities, and Bitcoin. And we're currently in a Goldilocks regime with a medium conviction.

4:13Yeah. So a lot of information there. When you first were describing it, I was thinking, okay, growth and inflation moderating. This sounds like, when you're talking about the labor market, it kind of sounds soft landing-ish, maybe nothing too terrible, maybe just cooling off enough for the Fed. But then the second part sounded bad, liquidity, and that sounded worrying, and the bearish indicators. So, I mean, no greens, I noticed, right? So sort of yellow and red. It's a yucky time to be taking risk in financial markets. And that's what the model is saying, is that stocks and bonds are likely to be experiencing sort of baseline returns relative to the historical sample, relative to historical trends.

4:55Whereas the U.S. dollar commodities and Bitcoin are likely to experience below median returns over the next three months. And according to all this, it's just not a great environment. It hasn't really been a great environment all year. But one thing that we've been, I think, you know, we take some credit for, we've been very right on this, you know, positive inflection and growth in terms of not only the direction, but also the resiliency of the economy throughout. And ultimately, that's something that we expect to persist into the second half of the year and may continue to insulate this, you know, very narrow U.S.

5:22equity asset class relative to the rest of the world that looks to be breaking down from a quantitative standpoint. Yeah. So better than others. But it sounds it's interesting because nothing's everything's either difficult or just flat out bearish. We don't have anything that seems to be doing well, you know, so except, I guess, cash. Yeah, I mean, that's been the case. I mean, really, I mean, a lot of returns have been concentrated, too, not only in terms of the actual factors, you know, U.S. equities. You know, you maybe had Bitcoin in the beginning of the year, but it's also been concentrated in time, whether you saw, you know, a big thrust higher in U.S.

5:57equities in January. If you certainly if you weren't there then, if you weren't there from between May and let's call it mid-July, mid to late July, you know, you really weren't there at all. And so you go look across global equities, global credit, digital assets. But again, a lot of the gains have been very, very concentrated, both again in terms of factors and also in terms of time. So it has been a very yucky year to put on risk. But this is why we think it's been very instructive and very helpful for our clients in terms of our systematic approach. There's been a very easy year to get swung around and whipped around based on macro narratives.

6:30But the reality is most of those macro narratives have really failed to come to fruition. For everybody, right? For both camps. Totally, totally. It's been so frustrating. This is why we run a systematic portfolio construction process. I have plenty of macro netters that failed to come to fruition, less than the average investor this year. But certainly not everything we thought would come to fruition has really come to fruition. But the reality is none of that impacts our portfolio recommendations and asset allocation recommendations. The only thing that matters to there is all the connotative signals that we produce for our clients.

6:59Yeah. And that's why whenever we talk to you and to others, we're always talking about having that framework, right? Having that system in place so that you can pay attention to what's in front of you as opposed to just sort of going on a gut intuition. I want to talk a little bit about the labor market. Friday's jobs numbers came out. Whenever it's a Friday until a holiday weekend, it always gets a little bit buried. It looked like we did see some moderation. Wondering what you're thinking about wages because you couldn't help but notice if you've sort of opened up anything to read on your phone or had the TV on.

7:33We have a big United Auto Workers union contract ending. We've seen this sort of steady drumbeat of unions lobbying for higher wages and contracts. I mean, the UAW is asking for a 46 % pay increase. What's happening on the wage front, and how do you think that filters into the Fed? Yeah, great question, Maggie. So, Brian, if you throw us to slide four in terms of our breakdown of the August jobs report. So the second panel in that chart, actually, I'll just go through each of the panels. So the first panel will show private sector employment. The blue bars represent the three-month annualized rate of change.

8:07The red line represents the year-view rate of change for these statistics. So free in time you see a chart like this from us, that's what you're looking at. So in terms of private sector employment, that accelerated modestly to 2.3 % on a three-month annualized basis. Wages, to your point, private sector average hourly earnings, decelerated to 3.9 % on a three-month annualized basis. That number is right around the long-term trend. you know, the pre-COVID trend. So we're kind of back to normal levels of wage growth, at least with respect to the private sector. The third panel there, private sector average weekly hours accelerated to 0.0%.

8:37That's the highest number we've seen really since going back to March. And then, you know, when you productize those three features, you wind up with private sector labor income, which is the broadest measure of wages and salaries that we get from the labor market. And that number accelerated to 6.2%, but it accelerated in the most positive way possible, which is we actually had employment growth and ours worked accelerate while we had wages actually decelerate to a more trend level. So this is why we have the view that the labor market is sort of back into this Goldilocks state, which is it's not too hot in terms of activating the Fed, but it's not too cold in terms of activating recession fears.

9:12And so I do believe we can persist in a state like this for several months, which ultimately creates a more right-tail risk in the equity market. Yeah. And it's interesting because everyone was so skeptical. The Fed has been sort of saying all along, listen, we're trying to land this soft landing. We have a terrible track record of doing it. But so far, it seems like they're getting awfully close. Does it seem like they might defy the odds this time around? I think the probability of a soft landing, this is something we've been talking to our clients about for several months now, which is the distribution of probable economic outcomes is relatively flat relative to, you know, kind of historical tightening cycles in terms of where we'd be for now.

9:54But more importantly, I think it's getting flatter at the margins. And so we do believe we still have, you know, going back to November of last year, we put out a forecast that we would likely enter recession in the U.S. economy sometime between November of 2023 and April of 2024, that six-month interval. Currently today, I happen to think it is going to be the latter part of that six-month interval as opposed to the early part of that six-month interval. But to answer your question with respect to a soft landing, Brian, if you put up slide six, I do believe a soft landing is very much possible.

10:22And the share of the distribution between recession, soft landing, and hard landing right now, I think the share of the distribution continues to seed itself towards soft landing away from hard landing now or recession kind of six to nine months out. And so what I'm showing in this chart here, the top two panels show the total labor force. As you can see, we have not regained the trend line in labor force, the size of the labor force. But the second panel shows that we have regained the trend line in terms of gross domestic income. And why that matters is that we have a ton of cash floating around the economy that can support goods and services consumption.

10:56But we don't necessarily have as many bodies in the economy to produce that. And when you go into the third panel here, we show the blue line shows labor demand, which is household survey employment, plus Joe's total job openings and labor supply, which is, again, that total labor force. And as you can see, there's about a 2.7 or 2.5 million person spread between those two figures. And why that matters is because that spread has historically tracked the private sector, the year-over-year rate of change of the private sector employment cost index, which we show on the fourth panel. So we sort of peaked out at around 6 million in terms of that imbalance between labor supply and labor demand at the beginning of last year.

11:33And we've trended lower. And why that's mattered and why this is really important in terms of inflating the probability of a soft landing is because you look at the bottom panel there, the thing that's causing the labor market to sort of build slack at the margins and alleviate the supply-demand imbalance that's been creating higher and higher wages is the fact that we've seen a reduction in total job openings, but no reduction in total employment. And so if we continue to see that reduction in total job openings, which is the red line in the bottom panel there, with the blue line continuing to accelerate, albeit at a more modest pace, then what you're ultimately going to see is the blue line in that fourth panel right above it continue to trend lower alongside the imbalance between labor and supply and labor demand.

12:12So all I'm basically trying to say is if what's currently happening in the data and has been happening in the data for the past four or five quarters continues to happen over the next four to five quarters, we will be having a soft landing in the U.S. economy. And this is exactly what Jay Powell outlined at the beginning of the tightening cycle. So if we do soft land this plane, he's going to be very deserving of a big standing ovation. And I will certainly give him one. 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.

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13:47Yeah, yeah, because, I mean, I can't remember the exact. It's like 10 out of 13. They're really in the minority, the times, the conditions line up, and they're able to do something like that. So Fed Governor Christopher Waller seemed to suggest today when he was speaking publicly that the Fed can afford to take their time and wait for more data. Consensus seems to be building that they're on hold for September, and maybe if they go again, November looks more likely. Is that what you think? Yeah, they should take their time. I mean, I think, you know, so there's I think Powell's absolutely nailed this in terms of we're now in the phase of just allowing the economy to catch down to the level of interest rates in terms of the policy tightening.

14:28You know, they don't really know our star. They can debate our star as far as the cows can come home and to the cows come home. But the reality is no one actually knows what our star is, certainly not in real time. And so, you know, to use that as a policy setting, you know, tool is kind of is very fraught with, you know, error. And so I think what Powell is electing to do instead of that is just saying, hey, we think we're around our star. Let's just wait and see if things break or not, which is to make a lot more sense than saying, well, inflation isn't doing exactly what I want right now, so let me hike again.

14:57And to me, I think that it's a much more appropriate path to take because, again, we are getting positive outcomes. Wages are coming down. The imbalance between the labor market supply and demand is coming down. And obviously, inflation is coming down. So why not just allow time for the economy to continue those trends? If those trends are discontinued, and obviously, we have the OPEC production cut throwing a wrench in the inflation picture potentially in the coming months. If the plan discontinues, then they can obviously continue to hike again and go from being paused and not being paused. But at the end of the day, I do believe they're pursuing the best action of policy.

15:31Yeah. Our star is that sweet spot, right? That rate where the economy is growing but inflation is not. And there's a lot of moving parts to figure that out right now. Do you see anything breaking, Darius? You mentioned liquidity on your dashboard that you're watching. We're going to be doing a deep dive into that coming up, and I'll let you all know about it soon. But what's happening on that front? Any reason to be concerned? Yeah, absolutely. So, in fact, if you go to number eight, I think we talk about this chart every time. Oh, is this the resilient, the reason the economy is resilient? Our famous resilient U.S.

16:08economy theme. By the way, for those who haven't seen this, this is from last summer. We've been accumulating reasons why the U.S. economy has been resilient. And one of the reasons that's kept us on the right side of this U.S. economic call the entire time. But a few things in this chart, some of these things are more structural and they aren't going to go away. But some of these things are cyclical and will ultimately kind of give way, which is limited credit cycle vulnerabilities. That's something that could change with the passage of time in terms of the longer and longer variable lags. Yes, they are longer, but they are eventually will catch up.

16:40And with that, you mean people will eventually have to pony up and get a new car, reset their business loan at these higher rates, right? Bingo. So it's taking longer because, again, you have not record, but very high levels of duration in terms of mortgages in the mortgage market and also in the corporate credit market. And so that's limiting borrowers' need to refinance. And also their desire to refinance is actually crushed in terms of the spread between the coupons and the market rate. But that stuff will eventually hit the economy, likely in the next two, three years. It's going to take some time.

17:17But one by one, borrower by borrower, business by business, household by household, they're eventually going to hit those long and variable lags and reset to a higher level of interest rates. in terms of that perfect storm for new housing development. That's something that could also continue for a while. But until once you start seeing households kind of really get tapped out from a demand perspective, or really the builders, it's really the builders who've been subsidizing the mortgages for incremental new home buying. And if they kind of get tapped out from a balance sheet perspective, then that perfect storm ceases.

17:46Buidonomics is not something that we believe is likely to continue indefinitely. As I mentioned, we have this record non-war, non-recession budget deficit in the U.S. economy. The budget deficit itself is$1.3 trillion larger today than it was last summer. And so that's obviously something that's probably not going to, you know, we're not going to be$1.3 trillion next summer than we are today, right? So that's going to, in terms of Delta, that's going to come down at the margin. And labor hoarding might be something that is persistent. But this is the one thing we don't really know anything about because it's the first time we've really seen it in the data.

18:17But if we do start to see some real degradation margins, and again, we have inflation coming down. And if growth inflects lower, you're going to have a double whammy on margins. And so some of that labor hoarding might come undone. So this is why we still believe a recession is the modal outcome. Again, but that distribution of outcomes is relatively flat. It's not a steep, high kurtosis distribution. It's very, very flat in terms of the probable outcomes in the U.S. economy. Yeah. And the labor hoarding is going to be very interesting because this is where time becomes something we have to watch.

18:46because do they invest in technology so that they replace workers with automated? For anyone who's gone into a supermarket or a fast food restaurant, I'm sure you're either checking yourself out, ordering if you've gone to an airport, you're checking your bags. I mean, there are less and less humans around doing this. So do they solve it that way? And we've got AI coming. So those are all things that are kind of unknowns, unknowables right now. So it's gonna be super interesting to watch that. We have a great question from Russell that I want to get in here. I think it's a perfect time. What's the data saying about inflation over the next three, six, nine, 12 months?

19:23Does Darius have a position on fiscal dominance? Yeah, we definitely have a position on fiscal dominance. We are in a fiscal dominant regime. That's something that we've talked about in terms of our research for really almost two years now. So I don't think that's, the fiscal dominance portion hasn't really changed, but what is likely to change over the next 12 months, as I mentioned, relative to the previous 12 months, is we're not going to get this sort of, sort of lurching forward of the deficit like we did from 2022 to 2023. Don't forget we had the CHIPS Act. What's the other one? Inflation Reduction Act.

19:53You had all these sort of acts that sort of put new ability for private sector agents to really come tap the federal balance sheet and expand that. So I don't think we're going to see that kind of same dynamic. You're still going to have a large budget deficit, but it's not going to grow to the same degree that it grew over the last kind of 12 months. And so that's going to be an issue. And then in terms of where we have inflation over the next 3, 6, and 12 months, our view is that we are still in this immaculate disinflation regime. When you analyze inflation in terms of the sort of shorter-term stochastics like three-month annualized, six-month annualized, those numbers are continuing to lead the year-over-year time series lower.

20:28And we're still accumulating lower and lower levels in terms of the sequential, the month-over-month inflation prints, whether it be headline, core inflation. We're also seeing that in underlying measures of inflation as well, like trim mean, CPI and PCE, et cetera, et cetera. So in core PCE and obviously super core as well. So generally speaking, inflation is likely to continue coming down over the next few months. But where I take offense to kind of the medium term outlook for inflation relative to consensus and certainly relative to the Fed is that they have inflation linearly returning back to their 2 % target without any real hiccups in the economy.

21:01And historically, that's very unlikely to do, very unlikely to occur. You look at sort of something like core PCE, you typically experience most of the reduction in the core PCE rate in and after the year after a recession. You tend not to have core PCE and other measures of inflation like wages break down until you're well into recession. And so it's our view that we're going to get stuck at an awkward level of inflation at some point in the next, let's call it, six to three to six to nine months. I do believe the near terms like inflation is going to be continuing to be very positive, but maybe by year end, particularly if oil continues to move higher, you're going to start to have a different conversation about inflation shifting from an immaculate disinflation narrative to something that's more like a sticky inflation narrative.

21:44And that's probably it for asset markets. Yeah, and that's exactly what I was going to bring up because we did see that hit today. We started the show asking about crude reality, but we had that move again from Saudi Arabia, who's been very aggressive in terms of trying to support prices. and you did see crude move higher. And in fact, some have pointed out while it's not off to the races and spiking higher, to your point about sticky, even with all the weakness we've been hearing out of China, oil has kind of been holding in. It hasn't been collapsing. Yeah, you're right. I mean, to me, the transition from immaculate disinflation to sticky inflation is the number one thing that's going to cause problems in asset markets because it's going to bring back currency volatility.