Are Bulls and Bears Both in for a Beating? w/ Darius Dale

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1:24And now to the top analysis of today's markets.

1:35Are the bulls and bears both screwed? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Darius Dale, founder of 42 Macro. Hi, Darius. Hey, Maggie. It's a pleasure to be here. How are you? Great to see you. And we're asking that question specifically for you because you tweeted last Friday and it caught our eye and you are worried that both the bulls and the bears may be at risk here. Walk us through what your thinking is. Yeah. Yeah, so it really starts with kind of where market positioning and market consensus are. If you look at the bond market, particularly short-term forward rate spreads, whether you look at the Fed's near-term forward spread or you look at other forward spreads, whether it be the 12-month forward T-bill minus the spot T-bill yield, they're pricing in a very significant amount of Fed easing over the next 12 to 18 months.

2:22And if you look at Fed Fund's futures, that easing is likely to start, or at least what's currently priced into the market in November of this year. That's actually changed since September over the last week or so. And so what we're looking at in terms of both liquidity and factors in the real economy could actually see some of that pricing kind of come out of the market in terms of bond market volatility in the coming months, at least a couple of quarters before we get into the kind of recessionary phase of this business cycle. So I have a couple of charts that I'd like to share with that on that topic.

2:55First chart, Brian, if you can throw that up, where we show the U.S. consumer looking at the PCE report. In the top panel, we show real personal consumption expenditures, which are 70 % of the U.S. economy, are growing and compounding on a three-month annualized basis at 4.3%. That's basically double the pre-COVID trend. No one's talking about this because everyone keeps talking about recession. But you're seeing housing data pick up in recent months. Obviously, the consumer is remaining resilient because we have a significant amount of real income growth. That's at 7.6 % in terms of disposable personal income.

3:28So we do have a resilient consumer, but the issue as it relates to the bond market is slide two, Brian, if you could throw that up on the screen, where I circled the top panel and the bottom panel. We got core CPI still compounding at 5 % on a three-month annualized basis. But more importantly than compounding at 5 % is the fact that it is in the same place that it was five months ago. So we have a lot of disinflation on a year-over-year basis, but that disinflation is going to stop in the coming months if we don't start to see these sequential time series break down. And at the bottom panel on that chart there, we show Supercore CPI compounding at 4%.

4:03That's 4.1%. That's twice the preferred target, and it's in the same place that we were four months ago. So I'm not sure we're out of the woods from the perspective of bond market volatility, purely from the perspective of the recession being delayed relative to investor consensus. Yeah, I want to get to why. So that's why the bears are potentially in trouble. But I want to get to the bulls. But just before that, I want to bring up something that we got a comment right before we came on from Jim saying, and we asked him to clarify, but he's saying, doesn't anybody remember the Fed said that, that they wanted inflation for longer to make up the period where they couldn't get it to 2 percent?

4:42And that's true, but did they want this kind of inflation? I don't think so, right? They wanted sort of trend inflation, not disinflation, but this is way above what they're comfortable with, isn't it? Yeah, you're absolutely right. In fact, they scrapped their average inflation target, which is what the viewers kind of alluding to, back in the fall of 2021. If you mentioned, if you hear the price stability target, their target is 2%. They have not said anything about an average of 2 % really since the fall of 2021. So I don't believe that the Fed is operating under that framework. That was the kind of maximum and inclusive employment framework, the average inflation targeting framework, when they thought inflation was transitory.

5:24I don't think anyone at the FOMC thinks inflation is transitory at this particular juncture. So I don't think that we have to worry about that as investors. But there are a lot of other things we need to worry about. Yeah, yeah. And by the way, if anyone wants to hear, for those of you who missed it, Fridays are tough. We had an extended with Dennis Lockhart, who was the former Atlanta Fed president, sat around a lot of Fed meetings. He had some really, really interesting things to say. Fed officials are usually really kind of closed up, and he is former. But he was very interesting in talking about the thinking.

5:51And he talked about kind of that recency bias from when they were stuck in that environment where they couldn't get inflation to move. And, you know, having to adjust to the prospect that maybe they're in a new macro regime. and they're just like everyone else, right, trying to figure it out. Very interesting kind of digging into all of that. I mean, we did an extended with them. So if you missed it or if you weren't able to stay for the extended, hop on that QR code and you can get on and see it because I think it was some really interesting nuggets in there. But Darius, okay, so back to your thesis.

6:23So bears are stuck. What's the problem with bulls? Why are they at risk? Well, so the problem with bulls is just the time decay of this bearish positioning. Obviously, if you look at dispersion within the equity market, We're actually getting some pretty negative signals that we spoke about in our lead off morning note this morning. But dispersion within the equity market has been trading or trending very negatively, as negatively as it ever has, you know, if you look at the time series over the last kind of 25, 30 years. And so that implies that you have a buy side consensus that is very grossly exposed to the market.

6:52They're really long, they're longs, and they're very short, they're shorts, and they have a lot of gross exposure in the market. And that's based on, you know, this kind of negative economy recession view. And so you kind of roll the clock forward. If we don't go into a recession over the near term, which many investors think, if you look at Bloomberg consensus estimates, they're calling for the first quarter of negative GDP in the second quarter of this year. You look at bottom-up analyst estimates. In fact, Brian, that's slide four. We put up a slide four where we show S &P 500 analyst estimates at the bottom left of that chart for sales and earnings growth.

7:24They're looking for minus 8 % negative earnings growth in the second quarter of this year. Now, what if it comes in at minus two or three, which is kind of where it's been at over the past couple of quarters? And so you could easily see a very big convergence trade kind of snap into those investors. But ultimately, what tends to happen late in the bull market cycle, and this is definitely not a bull market, what tends to happen late in the business cycle is that one-by-one investors have to capitulate to the realization that the recession hasn't started. We've been talking, you and I have been talking on this program about the potentiality of a recession since going back a year ago.

8:00And the yield curve inverted back in October, if you look at 10-year, three-month, or back in June, if you look at 10-year, two-year. So it's been quite a while for a lot of investors to be running around talking about recession. But guess what? I just said the economy is doing, I wouldn't say just fine, but it's hanging in there. And it's likely to continue hanging in there, according to our business cycle timing models, until you get into the fourth quarter or maybe even as late as the first quarter of next year. So you roll the clock forward. That's the same problem that happened in October 2007.

8:28It's the same problem that happened to bears in September of 2000, which is you just capitulate because it's not happening soon enough. And they always capitulate at the right or wrong time. So I could easily see a lot of bond market and stock market volatility in the third quarter for liquidity cycle reasons that could easily rotate it back into kind of a blow off top into the early part of the fourth quarter because bears are just capitulating. And then that's when the movie is likely to start. So basically the timing is screwing everybody because the bears – it'll be delayed enough for the bulls to think they're right and the bears will throw in the hat.

9:01And exactly when the bulls are convinced they're right, it'll happen. The bears have already got out of the trade and the bulls will be stuck in it because they think it's a soft landing. A hundred percent. I mean, go back to that chart. I just put up slide four. Look at the, so go back, look at the farthest right candles on that chart. The blue lines represent, again, S &P 500 earnings growth. Bottom-up analyst consensus is calling for earnings growth of plus 9 % in both Q4 of this year and Q1 of next year. Now, that very much rhymes with the view that sales side consensus had coming into 2023, which is recession first half, recovery second half.

9:36Recession first half, recovery second half. Well, if we don't have a recession in the first half, the recession does not start in the third quarter. We're going to be talking, at least a lot of investors are going to be looking around and saying, maybe that was it. That's paused. Time to go. Time to get long. And that's exactly the right, in our opinion, that'll be the exact wrong opportunity to get long. There's always a couple of things that complicate this, aren't there? One of them is that things are different this time. And we do have this enormous wave of AI. And just today, there were reports out that hedge fund giant Stevie Cohen made comments at a private dinner that he's pretty bullish about the market because of everything AI is going to unleash.

10:15I mean, we're also hearing from voices who say it might wipe out mankind. But another thing for us to worry about. But, you know, you do have this sense that, and you've seen it, NVIDIA, Microsoft meets Supernarrow, but you can see the money sort of piling into that. It makes it hard to figure out whether you can kind of trust some of the others. How are you thinking about that? Yeah, that's a great question. So, I mean, I think we'll, you know, this is something I don't think this time is different. There are, you know, bulls and bears operating financial markets being driven by fear and greed, and the cycle is going to continue the cycle.

10:49Obviously, there's different things in each cycle. But in my opinion, AI is no different than the internet. I mean, put up slide five, Brian, where we show, where we debunk one of the myths that everybody's bearish. Well, if you look at the second panel in this chart on slide five, we're showing household allocation to stocks as a percent of their total assets. And that's at 31 % down from a peak of 36 % in the middle of 2021. That 31 % is just shy of the all-time bubble dot-com high that we saw back in 2000. And so the internet was this awesome thing back in 2000, and everyone was spending, from a corporate perspective, as much money as possible to leverage that opportunity.

11:29But that didn't stop the market from getting cut in half. And so in my opinion, just because you have a fundamental tailwind, if it meets the wrong part of the macro cycle, particularly if it meets the wrong part of the liquidity cycle, which I very much think it will in the third quarter and in the first half of next year, you're going to have a lot of a lot of a it's going to be a lot of questions to answer about where this AI stuff is coming from. 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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13:03Darius, that was a very painful truth you just laid on us there, because if you think about that, I mean, it is true if you look back. And by the way, that did lay the groundwork for enormous societal changes. But you're right, in that can be a lot of froth, especially when people are trying to sort of just throwing money where they're not sure what's going to work or they're not sure if there's going to be a standard or a winner. I mean, this is what we're all talking about all the time. So it's scary, but really excellent point to bring up that comparison to 2000. We're going to be talking a lot more about that, I suspect.

13:36The other thing that comes up all the time, and we're going to play a clip from an interview, because this is the other sort of argument, I think, that comes up. So Harry Melandry spoke with Tom Caddick, managing director at Ned Group Investments, in the latest installment of The Next Big Trade. Now, they were talking all about commercial real estate, but Tom did sort of discuss his overall macro outlook. Let's have a listen to that and we'll talk on the other side. Your view has to be built on some kind of broader macro view about the likely recession risks we're facing and the intensity and duration of any of the coming recession.

14:11Or if there is even a recession, because obviously if the Fed raises rates some more, you might not necessarily be so bullish of real estate. And also if recession is sufficiently intense, that could also put you off real estate as well. So what sort of recession risks have you built into that view? So our base case, our base case is that we will start to, we've already seen peaking inflation, certainly in the US. We start to see peak inflation in UK and Europe. And we will continue to see a slowing but continued upward cycle in terms of base rates. But that is slowing, and we will start to see that moderate and move to a more dovish or more accommodative environment from central banks.

15:00So looking towards the end of this year to start to see evidence of that. So clearly some continued headwinds, but a lot of that is already priced in. You just need to look at the yield curve to see that. Just that's a little snippet of what was a really interesting conversation about commercial real estate. I know a lot of you have been asking about that. So if you're interested to see what Tom's big trade idea is around that, you can go check out the full interview on our platform. If you're not already a member, scan the QR code so you can hear all of the episodes of the next big trade. We love that show.

15:38So, Darius, when he said that, this sort of reminded me of what we hear a lot, and that's, okay, there's going to be a recession, but most of the bad news is already telegraphed. The markets are forward discounting mechanism, and a lot of the bad news is already priced in. What do you think about that? Is the timing issue going to create a problem with that idea? So, one, I would disagree with the view that markets are forward-looking. I think we've back-tested asset markets as well as anyone on the sales side, and I say that very politely. And when we construct those back-tests, we're looking at very sophisticated statistics like expected return, sharp ratios, covariance, all that stuff.

16:20What you really quickly find is that the markets really look more than kind of two to three months ahead. Once you get into the four to five months ahead timeframe, there is almost no correlation between the market and things that you would think to drive markets like earnings, GDP growth. Thank you for that, because I always feel like it's more reactive than predictive. It's much more reactive. And the reason why, Maggie, Brian, if you throw up slide six, particularly in the post-crisis era, I would argue markets are probably a lot more forward-looking prior to the GFC. But post-GFC, liquidity has been the dominant driver.

16:50Raoul's been all over this in recent months in terms of talking about his model. So in this chart here on slide six, we show our global liquidity proxy, which the sum of the G6 central banks, the G6 economy, or the largest six economies in their narrow money supply, as well as world FX reserves minus gold. And that blue line, that sum of those three factors has a 0.94 R-squared to global equity market cap and a 0.95 R-squared to the S &P since 2009. And so if you're telling me that markets are forward-looking, you're basically saying that liquidity is not the driver of markets, which I think you'd have to exit most rooms on the buy side when you make those kinds of comments.

17:29But one thing I would call out, particularly in terms of the headline of this chart, which is there's been a lot of talk around on Twitter and in the kind of financial ecosystem about kind of global liquidity and how it's improving and it's going to continue to improve. And that's really got a lot of people trapped at 31 ,000 in Bitcoin, got a lot of folks trapped at 4 ,200 in S &P terms, in our opinion, because the improvement in the global liquidity cycle has not been linear. As you can see in those max drawdown studies, middle panel and the bottom panel of this chart, the recovery in asset markets, which is the bottom panel of the S &P, the recovery in the S &P off the October lows has been somewhat linear.

18:04At least it's sought out in the last couple of months, but the improvement in global liquidity has very much not been linear. And that kind of scares me because if you look at the next chart, Brian, where we layer on world equity market cap in the red line and we layer on Bitcoin, both in price terms in that same analysis in those bottom three panels, we show trailing one year Z scores for each of the global liquidity proxy for the world market cap and for Bitcoin. And global liquidity proxy is still trading at a minus 0.6 sigma, whereas world equity market cap is up here at a plus one, Bitcoin is at a plus one sigma.

18:35So they kind of ran up like the recovery in global liquidity was linear, but the recovery in global liquidity is not linear, and it's going to get increasingly not linear once we get into the third quarter or whenever we get past these debt-selling negotiations. I can unpack that as well. Yeah, we certainly want to because we have questions about both, but let me bring one in that is related to Bitcoin since you're mentioning it. Miguel asking, does Darius still see Bitcoin at 10K in the short term? 10K? No, that's not. Yeah, I don't know where it comes from. That's not a comment I've made, ever.

19:12So are you suggesting with the liquidity that it's going to be volatile? I mean, how are you seeing that? I mean, we've probably seen the year-to-date highs. I mean, maybe not the year-to-date highs, but certainly I think we've seen a high for a little while now. I mean, Bitcoin and Ethereum actually just broke to neutral from bullish in terms of our volatility, just a momentum signal this morning. So I would call that out if you're long Bitcoin. You're probably going to be walking into an environment with a lot more volatility than we experienced in recent months. Number two, just in terms of this concept of liquidity, there's a lot of stuff going on.

19:46We've talked about this in the most recent Real Vision New York thing I was on a couple of weeks ago. But when you pass the debt selling, so clearly there's potentiality for a negative market event into the debt selling. The closer we get, the more likely we're going to see something that looks like 2011. I think we can all agree on that. I think the bigger, more structural overhang for asset markets on the other side of the debt ceiling are twofold. One, we've got to take the Treasury General Account balance from$0 to$600 billion, or at least that's what the Treasury has outlined for the end of September or quarter.

20:17And then number two, we're going to return to net coupon issuance. It's going to go from basically zero to something greater than zero, which means quantitative tightening, which has not been draining bank reserves over the past six months, is going to start draining bank reserves again. And so in our opinion, you're dealing with a negative liquidity situation in the U.S. that suggests that the dollar could actually start at the bottom and rise again, which would obviously be a tertiary headwind to global liquidity as well. So the liquidity backdrop in the third quarter is actually quite poor.

20:45You could see asset markets trading much like they did in 2022, which is stocks down, bonds down. But ultimately, if the recession is as delayed as I think it's likely to be, which is Q4 or maybe even Q1 of next year, then you could probably recover from those levels. If we're wrong on the timing of recession and it's Q3 or Q4 of this year, then I think you could easily go from a negative liquidity environment causing volatility in asset markets to a negative economic environment causing capitulation in asset markets. 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.

21:28wow i think that we are going to have to start turning the daily briefing into happy hour because you might need some fortification for for some of these but but information is power right and offense is the best defense and maybe there's another one i can think of but you need to know we need to be thinking about this because as you pointed out earlier a lot of this is not priced in and and that is should make us all a little bit nervous so let's get to the debt ceiling, some questions about that. Scott is saying, how do you feel about longer duration bonds in the context of the debt ceiling?

22:01So our weather model, which is a pretty sophisticated dynamic factor model that guides our asset allocation process, is currently bearish on bonds. Liquidity is quite poor. There are a variety of other metrics in that system that's calling the bond signal to be negative, not the least of which is the fact that investors are actually short rates by an extreme degree. And historically, being short rates has historically been led to negative X and D returns in the bond market. So I don't know that it's a good idea to be getting max long bonds here. Now, we've seen a pretty nasty backup in yields over the past couple of weeks, basically 20 basis points over the past couple of weeks.

22:36So if you're trying to play allocate to the recession playbook, or more importantly, if you're coming from a, I didn't believe the recession is likely to, I now believe Darius, and it's probably going to start in six or nine months, then I do need to start dipping my toe in on bonds, on dips. But from the perspective of our forward-looking models, which are trying to manage the medium term between now and then, I don't think this is the time to be max-long bonds. Because again, you're getting net coupon issuance, you're getting TGA refill, you're getting potentially dollar up, which obviously reduces demand from foreign central banks for US assets.