Are Risk Assets at Risk? With Michael Kao

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

1:41Our risk assets at risk. Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Michael Kow, CEO of Akantos Capital Management. I don't know if I'm saying that right, Michael. Hey, how are you? Am I saying it right? Akantos Capital. Akantos. Okay. As I'm looking at it, I'm like, something's off here. But welcome. It's wonderful to see you again. Yeah, it's great to be back. Happy summer. Yes, exactly. The heat is sort of straining everything, including our systems, because I know a few of you had trouble getting on. Sorry about that. We actually started a few minutes late so we could try to work it out.

2:14We're all feeling tired. And the market was feeling tired earlier, Michael. You even tweeted about it. But then all of a sudden, in the last few minutes, we saw US equities close in the green. We had a little surge here at the end. And it's certainly been a winning month for US equities. S &P, Dow up around 3%. NASDAQ up over 3.5%, maybe even closer to 4%. What do you make of this equity market that we're looking at? Yeah, I mean, the ebullience is pretty astounding this late in the game. But yet, if you look at past analogs, whether it's the 1997 period, 2000, 2007, in all three of those cases, you had this big sort of pivot, hopium rally, if you will, that happened essentially before the top was put in.

3:11So I'm not going to say that this time is exactly going to be that time. But I'm hard pressed to see a situation where the Fed doesn't break something. To me, the US consumer is the strongest consumer in the world. I wrote a piece last week as part of this commercial real estate panel that I participated in where I gave a little macro presentation. And I call the Fed, the Ivan Drago Fed, going back to Rocky IV, where he goes to Rocky, I must break you. We remember he was one of the scarier characters. It's funny to watch it now, right? Because I feel like there's so many scary characters. But at the time, that was one tough dude, right?

4:01Yeah. Right. RAOUL PAL So it sounds like there are warning signs blinking for you. I want to get into why and exactly how you see that macro side playing out. But it's interesting because, and I think I've been hearing this a little bit for people, the market's gone further than they thought. Everyone was looking for a turn. People were worried. It felt topy. They were worried about valuations, a whole host of things. And yet, we've been sort of post the last Fed meeting, having the Fed sound like maybe they're getting more comfortable with what's going on, not in terms of equities, but certainly on the inflation front.

4:39Over the weekend, Minneapolis Fed President Neil Kashkari said the U.S. economy continues to surprise with resilience. But a lot of Fed governors have also said they're encouraged about the direction of inflation. And Andreas just dropped his latest steno signals on our platform and sort of pointed out that the Fed seems to be growing more confident that they can engineer a soft landing. Let's have a listen to that. Jay Powell is now much more confident that the Federal Reserve can actually orchestrate a soft landing. He was asked at the presser yesterday whether it is still the base case of the Federal Reserve that they need to create a recession to bring inflation back to target.

5:22And the answer is no to that question now. I think they said in January 22 that a recession was needed to bring inflation down to target. They've kept on forecasting a recession over the past couple of meetings, but it is no longer the base case of the Federal Reserve that a recession is needed to bring inflation back to target. And I think that is a consequence of growing confidence within the Federal Reserve of this soft landing scenario. And it also means that should we get positive vibes from the economy, which I find quite likely over the next month or two, then the Federal Reserve will not necessarily act with interest rate hikes to try and kill that momentum in the economy because they're much more confident today that they can bring inflation back to target without actually having to kill the labor market completely to get there.

6:14And I think this is an interesting backdrop from a macro perspective relative to cyclical assets out there. Because what happens if both the Federal Reserve and the European Central Bank pauses interest rate hikes at the same time from here? I think that is a likely scenario, even though there is a risk that the Federal Reserve will hike once more from here. And that full installment of Steno Signals, Rebound or Recession, is on our website. And also, for PLUS members, Raul and Ash just wrapped an Ask Me Anything session related to the business cycle. Phenomenal. Questions were so good, too, for those of you who are able to also make it.

6:54If you weren't able to because you're working or tied up, I encourage you to go check it out. really, really good stuff. To access both of those programs, if you are not already a member, just scan the QR code and join our community. So Michael, interesting that the Fed, Andreas' description of the Fed, and if you go through the comments and even the statement of some of the things they said in the press conference, it does seem that way. And yet the Fed has a terrible track record of actually hitting a soft landing. Yeah, very bad. It actually worries me when they say that they're more confident.

7:31Because I think, well, in the piece that I wrote, I basically said that, you know, by the way, so to put it into context, I was the 10th panelist in a panel of mainly commercial real estate operators. And the big takeaway that I got from all of my real estate panelists was how well the market has been holding up from a rent perspective. It all comes down to the strength of the US consumer. And I think the US consumer is completely dependent, obviously, on the employment picture. So my own view is that risk assets seem to be drawing their ebullience from two factors. And I think the two factors might be mutually exclusive.

8:21One is the hopes for an imminent Fed pivot. The second is a hope for this immaculate disinflation, this Goldilocks scenario that we're seeing. But I have a hypothesis on why things look Goldilocks. And as my friend Shrub likes to call it, he calls it gothylocks. But my interpretation of this is that the Fed is trying to engineer short-term monetary headwinds to counteract a structural tailwind to inflation. The structural tailwind comes from the fact that at the same time, if you think about core PC and the stickiest components of the core, It's labor and shelter. Well, if you look at a demographic pyramid, I find it interesting that the cohort of age 30 to 39 is at a bulge right now.

9:16And that's like primary household formation home buying cohort, which has kept shelter inflation high, kept demand for housing high. You're seeing it manifest itself. And you see what's happening with the home builder stocks. You see it happening, and you're even seeing prices start to rise again in certain parts of the country despite a doubling of mortgage rates. And then the other part, the labor component, I also find it interesting that while we've got that bulge in the 30 to 39-year-old bracket, there's a corresponding trough in the, call it 45 to 59-year-old bracket, which I call the highest tenured part of the working population.

10:02So I think, I suspect that there are some structural tailwinds to this inflation, and the Fed is really trying to counteract that. And I guess, and what I said is, look, the good news for Goldilocks is that the US consumer is the strongest in the world. But that's also the bad news, because I think that the problem is that the rest of the world, consumers in other parts of the world, just can't keep up. And so when you talk about the Fed getting more confident in its inflation fight, last week was a very, very busy week, because not only did we have the Fed, we had the ECB, We had the BOJ. And I pointed out that Lagarde's commentary, when asked, do we have more ground to cover, she said pretty emphatically, at this point, I wouldn't say so.

11:01Now, I think you compare and contrast that to Jay Powell's message that basically every meeting is live, essentially. It's going to be data dependent. And they're getting more confident that we're going to have a soft landing. And then the last thing I'll just point out is that the BOJ, its much touted tweak to yield curve control, lasted all of two days before they're in the market buying JGBs again. And so I think maybe the BOJ might have boxed itself into a corner because certainly the yen is saying that. All of this is just to say that if the US consumer is the strongest in the world and are fed, I think the question isn't anymore whether the Fed is going to out-hawk everybody.

11:50I think the question, the narrative is going to become who's going to start out-dubbing the Fed. And I think obviously China has a huge economic problem. I wrote, I've written extensively about why I think the yuan is at risk of devaluation. I think Japan is struggling for what I just said. And I think the ECB is about to fold next. So that happens, right? Despite the headline that you put in our spaces about the US dollar wrecking ball getting wrecked, I think, yes, it got wrecked last month on this much cooler than anticipated CPI, which obviously led this knee-jerk weakening in the dollar and spurred risk assets to ever higher heights.

12:38But I'm wondering whether or not we're getting closer to the turn. We'll see. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

12:58Yeah, so I think there's a few important things in there. So let's back up a minute. First of all, in terms of the US consumer, so what do you think is propping up the US consumer? Because a lot of people, I mean, it's always hard. I think it's always hard to gauge this and everyone tends to undershoot. Sometimes the US consumer, somehow we keep spending even if it's on debt. But But what do you think is underpinning us right now? What do you think is underpinning spending? Because it was kind of YOLO. Everybody's getting those trips that they, all that spending they held back from COVID. And then it was supposed to dissipate.

13:31And it really hasn't. What do you think is going on? Yeah, I mean, I do think, though, it's a tale of, it's a bit of a, what do you call it, a K-shaped recovery. so you're definitely seeing the revenge travel continue at the high end but at the same time I think that you're hearing anecdotes of you know you know Joe Smith on the street having a hard time making ends meet and I'm seeing various I've seen a lot of charts about of like I guess excess COVID savings drying up by the second part of the year. But the most important thing, I think, is the labor market, is the strong labor market, right?

14:18Because look, the unemployment rate is still 3.6%. And when you think about, and I also put this in my thread, I said, when you think about what the Fed has implicitly guided to in terms of a target, like 4.6%, to really take core inflation back down to 2%, the delta between there and here is about 1.5 million jobs. And the labor market is super, super strong. So we'll see whether or not that holds up. I suspect that we're going to start seeing the cracks show in the second half. That drives a lot of my macro views. It drives why I continue to remain wary and bearish about oil, notwithstanding the recent rip into the second half.

15:08Equities are harder to call just because people were buying equities all the way up through summer of 2008. So it's hard to see. The earnings that we've seen so far have been, I mean, it's mixed, but at least the mega cap earnings have generally been fairly strong still. So yeah, it's a very, very confusing macro environment, to say the least. Yeah, it is. And people have been following for a long time, like yourself. You can see that just navigating the cross currents. So the labor market's tight. Do you think that the Fed, when you say they're going to break something, do you think that they will keep hiking interest rates until they start to see the labor market weaken?

16:02They were very focused on that. They seem to have backed off thinking that they can get a handle on this without killing the economy. But you think they're going to have to do that? Are we mispriced in terms of Fed expectations? I don't have any super contrarian views on what the Fed is going to do at this point. I think a lot of people thought that the last hike was the last hike. And I still think that the dot plots are basically telling you where they intend to be. I still expect probably one more hike between now and the end of the year. But to me, that's not the big deal. The big deal is how long this H4L higher for longer period is going to remain.

16:49And what I think is interesting is when you consider the yield curve and the type of omniscience that many pundits ascribe to the yield curve, it's been completely, completely wrong for the last year, especially in terms of the rate of implied cuts. But yet, risk assets don't seem to care. I think they won't care until they do. And when they do, risk happens very, very fast. There was a chart that I put out last week where I basically looked at a chart of the S &P 500 versus essentially three-month LIBOR or three-month sort of Fed funds, essentially, starting from, I think, 1983. And I basically looked at, OK, the magnitude of rate hikes and then the magnitude of the correction that then happened.

17:51Well, what was very interesting was that in 1987, the correction happened pretty quickly after the rate hike cycle happened. And it was a very fast and sharp correction, as we all know. But then when you compare and contrast that to, say, 1995, in the mid-'90s, the Fed also embarked on a rate hike. And then it literally took almost three years before things metastasized into the Asian contagion of 1998 that caused the Russian default and, you know, LTCM collapse, et cetera, right? So, you know, what I tweeted out with that chart was I said, look, you remember the famous quote that Chuck Prince is known for in 2007, I think.

18:45He said that, look, as long as the music keeps playing, we're going to keep dancing or something to that effect. There's a lot of Chuck Princey vibes I hear out in the market today, whether it's in AI stocks or crypto or just stocks in general. But I think that it would be, and I don't know when the music stops. But when it does, I think it's a little bit fallacious for people to think that they're going to be let off this train in a graceful manner. It never ends that way. So you brought up a really interesting point when you said it took three years and then you had the Asian financial crisis.

19:32Do you think the catalyst for something for this turn, right, when the music stops? By the way, it's not like we didn't get a hint in that cycle. We got the first hint in the summer of 97 when all of the Asian currencies devalued. devalued. And then we thought, okay, everything is fine. And then it took another 18 months before the butterfly flapping its wings eventually metastasized into something really, really bad. And so, sorry, I cut you off. No, no, but this is exactly my point. And who knows? We saw with Silicon Valley Bank how quickly things move now. Maybe it doesn't take 18 months. But I think people were looking at regional banking here and commercial real estate, looking for the catalyst internally in the US on that rate default initially, with the amount of hiking the Fed's done.

20:36Should we be looking abroad? Should we be looking at something international as the catalyst that maybe people don't see coming in time? Precisely, precisely. So in March, I wrote a piece called Ball in a China Shop, referring to, of course, the US dollar wrecking ball. And I wrote that at the height of the financial crisis. And I said that this regional banking crisis is going to wind up being a sort of a provincial worry, because I think the real deflationary catalyst for the world is China imploding. So let me explain. So in this last piece that I wrote last week, I said, I think there's two things that the Fed, the Ivan Drago Fed could break.

21:25One is our own labor market. We'll see whether or not they're successful. But the second thing is the rest of the world's economies, particularly China's economy. Because when you think about compare and contrast the US COVID response to China's COVID response, we flooded the system with liquidity, with monetary liquidity and fiscal liquidity. We took extraordinary measures to cushion the consumer. Right. China, if you think about it, they locked down for an additional, what, 12 to 18 months. And they did not support their consumer. And not only that, they actually, by trying to peel back the property speculation with policies like three red lines, it was a little bit too successful.

22:25So I hearken back to an interesting interview that Richard Kuh did on Odd Lots, where he said that the Japanese property bubble peaked and popped in 1990, but it took 19 years before their demographics peaked. Now, if you look at China, China's property bubble and its demographics peaked at the same time, about two years ago. So when I talk about how we are in this almost fake Goldilocks environment because we are seeing the effects of this longer-term inflationary tailwind being counteracted by the Fed's short -term headwinds, in China's case— And by the way, that phenomenon in the world of physics and engineering is called destructive interference, right?

23:22Just like the way your noise-canceling headphones work, right? When you have like one sinusoidal cycle counteracted by an exactly opposite or mirror image cycle, the effects tend to cancel out. And in our case, that looks like Goldilocks. In China's case, though, you have constructive interference where you've got a short-term cyclical down cycle created by the property bubble bursting. But it looks like it's coinciding with its long-term demographic down cycle. So when you have two waves then kind of superimposed upon one another, I think you have the makings of potentially a major, major collapse, which is that is the big, I guess, elephant in the room that I'm watching.

24:18We'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.

24:29I always come back to this question when we're talking about China. They're centrally controlled. They control every lever of their economy. And they've seen the West go through the financial crisis and pull tools out of and make up tools that central banks can use. Wouldn't they have the ability to buffer that kind of implosion by doing whatever extraordinary means they needed to? Well, yeah. Yeah, I mean, Brad Setzer put out an interesting piece a couple of weeks ago where he claimed that he thinks that China has an additional$3 trillion in, quote, shadow reserves over and above what they publicly disclosed.

25:10But to me, it's a little bit of a moot point, because what does China want to do? In the last several weeks, you have seen the PBOC intervene to stymie the weakening in the yuan, right? The yuan got out to 727 in this recent about a weakening, and then now it's around like 715 or so. But that's with heavy repeated PBOC intervention. And so to your point, yes, they are intervening, but I think it's coming from a position of weakness. They want to do that only to prevent a disorderly devaluation. But if you think about what China really needs, they need a weaker yuan. They have no, their consumer is eviscerated, not that they even had a consumer-driven economy in the first place.

26:09Their centrally driven investment-led growth targets just aren't going to happen. There are only so many bridges to know where you can continue to build. Youth unemployment is over 21%. And so what are they going to do? The only thing that they can do, in my opinion, is to continue to try to export their way out. But when I say that the U.S. dollar wrecking ball isn't dead, I mean it. Because if you look at, forget about DXY for just a second, because DXY is, as you know, 60 % weighted towards the euro and about 20 % the British pound. So it's heavily anchored by those two currencies specifically.

26:50I happen to think the euro is about to weaken. But if you forget about that for a second and you look at the dollar relative to a lot of Asian currencies, especially the yuan and the yen, it has very much been a wrecking ball. It's just hiding in plain sight, primarily because the euro has been so strong. That's a really, really good point, Michael. And we should have said, what's the US dollar wrecking ball going to rack, not is it racked? Because I think that that's it. So let's go through a little bit, though. So do you see, so it sounds like you do think risk assets are at risk. I mean, yes, this can go on irrationally maybe, but you feel like there is risk lurking in the global economy that would send risk assets down sharply at some point.

27:41The risk, I mean, to me, the risk reward of owning public equities right now, especially when you're talking about the mega caps is horrible. I think it's just absolutely horrible. So my own personal balance sheet is, I mean, if you think about it, even though I have zero exposure to passive equity, I have a couple of special situations. But I also have a lot of, I have puts, I have currency hedges. But I'm also way overexposed on long risk through real estate holdings and other different types of hedge funds that I'm invested in. So I'm very concerned. Oil, one of the reasons why I worry about oil is that I have a large oil private equity exposure.

28:43long-term. I'm a long-term bull on oil. But in the short term, again, notwithstanding this recent rally, which I think has primarily been off of seasonals and dollar weakness, I don't think that there is a global resurgence of fundamental commodity demand at this stage in the cycle. If anything, I think that that fundamental picture gets uglier as the year goes on. Because there is going to be some sort of weakness or recession. What about inflation? Do you think inflation continues to head lower, or do you see a resurgence of inflation that makes it difficult for the Fed? At some point, people are still pricing in Fed rate cuts.

29:33Does that sound like a mistake? I mean, I still think when I don't know what the exact, I think what the market is pricing in, like four or five cuts in, I think, is it over the course of 24? I think so. They pushed it out a little bit, but they're still in there. But again, my point is that when you look at the yield curve starting in July of last year to July of this year, that plateau out to the one-year point, it just keeps getting extended and extended and extended. And at some point, you would think that risk assets will care. And by the time risk assets care is when you're much closer to the real Fed pivot, I think.

30:22But there really is no reason for the Fed to embark on an aggressive easing campaign. I mean, look at the equity markets, look at the housing markets, look at even commercial real estate. I mean, the data points that I heard from these big managers of big operators and developers of assets, in many cases, public REITs, I was very, very surprised at how generally sanguine people were at this stage of the game. But sorry, I didn't answer your question, though. With respect to inflation, here's what I think. I do think that ultimately, the Fed is going to win this game. I do. I think that the Fed is going to break the back of inflation, come hell or high water.