Can You Trust the Recession Signals? w/ Tavi Costa

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

1:34Are we finally seeing signs of recession? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Tavi Costa, Portfolio Manager at Crestcat Capital. Hi, Tavi. It's great to see you. Hi, Maggie. Thanks for having me. Looking forward to this. Yeah. So it's interesting. We saw that Home Depot news come out today. Disappointing revenue, full-year guidance was lower, disappointing as well. And that really seemed to set the tone. U.S. equities down today, not heavy losses, but we did see the Dow and S &P just sort of hanging lower all day. The Nasdaq was holding up, but that slipped into the red right at the close.

2:11And everybody may be getting a little bit more nervous now. Are we starting to see now finally the signs of recession that everyone's been expecting and predicting? I think the data is starting to really show that in many ways. We've had earnings recently. I think the big news of the earnings releases that we've had recently have been the resilience in most of the revenue parts. However, when you look at earnings, they're beginning to contract already. Some of them, consumer discretionary is down over 40 % on a diluted basis, which is surprising for a lot of people. Financials are down as well over 30%, which is not as surprising given all the crisis that we've had recently.

2:53But a 40 % decline on consumer discretionary is something to be noted. And so we're starting to see also the data in other things, such as soft data from ISM manufacturing surveys in different parts of the U.S. are starting to show similar signs of weakness. And I think that we're also likely to see tightening of monetary conditions beginning to show its problems in terms of the economy being too levered. And it's been of our views that we're probably going to be into a recession here soon. I don't think the yield curve issues that we've had over in November when the threshold that we pay very close attention to, which is the percentage of yield curve inversions, went above 70 % in November.

3:44Since then, we've seen the data, macro data, starting to really show that we're probably going to be contracting economically speaking. I think we're getting pretty close to that. It's almost surprising to see VIX trading as suppressed as it has been and looking at credit spreads as low as they are. And we're seeing a total separation between mega cap companies and the rest of the market. If you look at the NASDAQ 100, for instance, right now, relative to Russell 2000, you can see that it's the largest spread since the tech bubble or the very peak of the tech bubble. So most of the performance we've seen so far, which also is not really news, but the degree and the magnitude of that outperformance of mega cap in larger companies is starting to get really stretched.

4:33And so I think there's certainly some issues that could come from there, especially if we have rates being higher for longer and other things that are priced in markets right now, such as easing by the Federal Reserve or other lower rates in order to justify the really high multiples that we have in overall equity markets. So it's a lot to unpack. But I think, as you said, most of the signs of a hard lending are starting to become more apparent. You know, it's interesting, though, because so, you know, we do have people expecting this Fed pivot. You start to see that weak data come in and people will sort of, you know, run to the conclusion that, OK, now we're seeing the signs that will give the Fed room to back off, certainly to pause.

5:22But if you look at retail sales today, it was way below expectation, but it was still kind of holding up. So we seem to be in this transition period that's going to be really hard to time how this all plays out. Where do you think the weakness is coming from? Is it the lending side? Is it due to some of the issues we saw in banking? Or is the consumer, which they've been so resilient, are they starting to roll over? Well, I think that you mentioned both of them. I would think that the consumer is going to start to weigh in a lot more in the following months because, you know, they're starting to see credit card loans increase significantly, which means that they are starting to run out of cash and use credit cards.

6:07And that's usually not a very good sign. But the consumer is still relatively OK compared to other decades. I do think that we're going to see a significant decline. It's also related to labor markets. labor markets have been very strong, but it's just in a few parts of the labor market specifically that are looking more resilient. So I don't know. I think what we're seeing right now, as far as performance across the markets that I'm really concerned about remains, yes, the debt ceiling is something that is in everyone's minds and because of the default risk and so forth. I think there's basically zero default risk.

6:48I mean, yeah, we can see a technical default and other things, but I'm not sure that's really the problem. What I'm mostly concerned is, as we see those two parties agree on extending the debt limit, is can we absorb a large amount of Treasury issuances as we move forward after the fact, after agreeing on extending the debt limit? And I'm not sure we can, because prior resolvements of that ceiling issue, we've had, I think in 2015 or so was an increase of about$1.1 trillion in the next nine months of the debt problem. And since then, that number has been increasing every time we've resolved the debt ceiling.

7:30And now last time was about$2 trillion. You're saying they're going to increase or issue about$1.2 trillion in the next months after the debt ceiling problem, because they have to catch up with the fact that they have not issued any treasuries. I think that it's easy to make the case that we're going to see over$2 trillion of treasury issuances. And can the market really absorb that today? I'm not sure there's really enough buyers of those instruments. And everything is tied to the treasury market today, right? I mean, look, I mean, even long duration assets or most of this bear market rally we've had since the beginning of the year is being caused by the fact that 10-year yields have not been rising like they were back in 2022.

8:12And the fact that we didn't see financial conditions really tighten as much as they were back in 2022. They actually ease up in many of the measurements that we looked at considering credit spreads, although I do think that's an opportunity that credit spreads may blow out. They've been declining recently along with the VIX. And so I don't know. I think that we're setting the stage for something big to happen, in my opinion. I haven't seen many of those times in my career where you have fundamentals really deteriorating. You have the narrative really deteriorating. But at the same time, some of the instruments that should be showing some of that weakness are not doing that.

8:54And I think that the volatility is way too suppressed. And we're creating, setting the stage for a vol event in my opinion. Why do you think volatility is so suppressed? What's going on that we're not seeing this reflected in the markets? I think the way we measure volatility in the first place that people like to talk about is the VIX, which arguably is not a good way to really look at volatility itself. But thinking about how the weights of that, which is mostly looking at the S &P 500 put options and so forth, but looking at the underlying index, which is the S &P, and looking at the weight of most of those mega cap companies that have been performing well over the last months or so.

9:41I think that's the reason why we haven't seen some of those issues really unfold. Look, credit spreads also shouldn't be explained by the mega caps. They should be explained by the fact that we just haven't seen a credit event outside of the banking problems. So I don't know. I think this is, as there was a good chart that we put out, I probably didn't send to you guys, just came to my mind, But it was a good chart that we put out recently that really looked at the number of bankruptcies that we have had in a way versus today. And there is a lag. Initially, you see a very large amount of assets going bankrupt initially or businesses that have a lot of assets.

10:21And the following wave is the other number of businesses that follow along with that. And I think we've had some bankruptcies happen. Some of them are very important ones in the banking section, in the crypto space and some others. But I don't know. I would think that there's more to go. And if that is the case and there's a credit or a vo event in the horizon, you know, credit spreads and VIX are way too cheap. And, you know, maybe mega caps don't deserve to be where they are. Why would you pay 100 times earnings to a company that is not even growing anymore? Most of the things stocks are actually starting to deteriorate, even on the top line and the bottom line.

11:01So, no, I think there's a lot of risk that people are not really perceiving as risk right now. 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.

11:21That's so interesting. And we're going to talk about how you grapple with that risk in a second. I do want to get to that, but it's interesting that you're talking about tech stocks because there was all this concern about that, about future profitability not being it. We heard all about this rotation that was going to go into value and into sort of more traditional names. And then I feel like ChatGPT came out and it just blew the roof off. And a lot of the gains that you're seeing, pace and tech are really around this. AI revolution. We had OpenAI's CEO, Sam Altman, and other tech executives testifying in front of Congress today.

12:02I mean, everyone's trying to wrap their head around this. First of all, do you think that that's ushering it? Do you think that that's responsible for this enthusiasm and this money pouring into the tech sector and causing this outperformance? I sound like a perma bear, but I just really, really struggle getting behind a market that the CAPER ratio is just so excessive or the cyclically adjusted PE ratio is so excessively historically. I don't think we've ever seen a time in history when we reach that level that the next 10 years will look really attractive. I know other folks are starting to talk about that as well.

12:39Druckmiller mentioned that not too long ago. It's an important point because where will valuations really inflate from here, especially if rates stay higher than they were 10 years ago and growth will be lower than it was 10 years ago. Now, let's use the AI idea because I think it's something I've been thinking a lot about too. Look, AI is almost like a perfect assistant. It almost replaces at least 100 people working for you as an assistant sometimes. And it's amazing what it can do. It's been very helpful for our business as well. We've been using quite a lot. And what I find interesting is there is today a gap in valuations between small companies and larger companies.

13:25And if anything, what AI really does, in my opinion, so far of my experience using it and talking to people, is that perhaps, yes, there is improvements across the board of technological breakthroughs, but also in efficiencies and other things that may be created. But one of the things that is interesting is that I think it will close a little bit the gap between smaller companies and larger companies. because, you know, it's not the need for, you know, having to really have an army working for you. It won't be as necessary as used to be in the past. And so something to, you know, to really think about, because right now in the market, you see this major, you know, I would say divergence between small cap names and the mega cap names.

14:12It really is a divergence. One is going up and the other one is going down. And, you know, I'm not sure that is really justified by what's going on either. So look, I think we've had other breakthroughs during parts and times of the market where valuations are really high. Yes, there is maybe this time is different and we're going to see two sequences of decades of robust growth in corporate earnings. We've never seen this before. We've had that one in the 1920s, one in the 1990s and one in the 2010s. Both of the other ones were really preceded very important contractions in corporate earnings in the following decade.

14:53Can we see something similar today? I think it's very possible. So, you know, I'm a little concerned about that. I think we extrapolated way too much in terms of what will look like ahead. And I think this whole idea that markets are discount mechanism, which obviously is the case. in 2022, all we've had has been a discounting of duration, not a discounting of cash flows. I mean, even InfoTech, which, you know, as you're talking about with AI and other developments, their earnings are down over 11 % year over year. You know, Microsoft, which is one of the darlings of AI and so forth, just freeze salaries of their own employees.

15:36They're not raising any sellers. So, you know, it's just a lot of conflicting data and information about all this as well. So I think it's a little bit hyped. Yeah, it's a great observation, a lot of great observations in there. So if you're nervous about this, these risks that, you know, vol's too low, that risks are not being appreciated, credit spreads, tech, megatechs running too fast, too far. How are you positioning? How do you protect yourself if we're setting up for a vol event? Well, we have hedges. And I think the long side of our portfolio won't change much in the next, you know, call it five to 10 years, which is very heavily invested in natural resource companies.

16:22I still think there's a lot of reasons to believe that resource companies will do very well in the And there's still a fraction of the global equity market. And yeah, they can get caught up in a recession as well. So it is absolutely critical to have some sort of a hedge in those businesses too. And so the way we've been doing it is we've been, you know, we think credit spreads are going to blow out. So we've been short a lot of junk bonds. We have shorts in the mega cap space. I think it's shorts in the mega cap space are becoming cheaper and cheaper, given the fact that everyone disagrees with the thesis.

16:58Everyone thinks that they are supposedly haven assets today, which is insane in my mind. I think there's still opportunities to be sure things like private equity companies or private equity funds that I think are massively mismarking their balance sheets. You know, some of them carry a lot of, you know, startup tech startups in their balance sheets. Some of them carry commercial real estate in their balance sheets. And, you know, those things still need to be marked accordingly. And there is a significant narrative shift happening across the general and the public in general regarding the, you know, the issues of private equity in different businesses like hospitals and other things.

17:45And I think those are going to be big shifts in terms of the narrative that could eventually hurt those companies. We've always been skeptical about those industries just because, you know, I'm not sure this, if people really knew what was really happening, you know, in terms of how those valuations really occurred and how those fees get paid through those managers, I think people would be surprised. And so anyways, I do think there's a lot of pain in that part of the market still ahead. You know, some of them are already suffering outflows and other things that we know of. And so, you know, I'm not saying that this will happen tomorrow, but that's one side of the market that I think could be potentially at risk.

18:31And so mega caps, corporate bonds, private equities, I think insurance businesses that carry a lot of corporate bonds today, those businesses have a lot of corporate bonds in their balance sheets. It's basically a big chunk of what they own. And so I think there's, you know, there's reasons to be worried about some of those parts of the markets. And yeah, and technology have the separation, right? The smaller companies and the larger ones. The larger ones are really cheap to be finding ways of being exposed to the short side. And I'm really attracted to those. Are you, is there a concern that trouble in that part of the, or if the pain starts to become real in that part of the market, that it could become systemic?

19:16Do you worry about something like that? Oh, I think there's the potential. You're asking really the question of if there is a risk of a full hard lending sort of scenario. And I think it's, you know, I would say that there is a very high probability of that. I think very soon here, given how things are developing, the situation with the banks really adds to that case. I think there was a chart I used recently, which was showing the commercial and industrial loans in terms of growth. And we're starting because people are looking at those things on an annual basis. So the delta on a year-over-year basis.

19:55I'm not sure that's really as critical as looking at this in a shorter time frame, given the fact of most of those developments happened in the last month or so. But you're starting to see some really significant declines in terms of contraction of those loans. And, you know, I think that that is just adding to the case of the yield curve that has been telling and warning us about a potential recession and the fact that we're starting to see the separation even on earnings beginning to contract, but revenues is still staying resilient. Revenues would be the last ones to fall. And I think that's in the next earnings, we're probably going to see that.

20:34And if you look at most estimates, we're still seeing growth is still being embedded in most of those estimates today. So, yeah, I'm concerned about overall in terms of the economy. I think there's going to be some real pain here in the near future. Yeah. So your bullish commodities, we talked about that last time you were on, but it's interesting now if we're seeing recession, we're seeing the potential for some vol events. These are all negatives that would presumably hurt demand and weaken the economy, and yet you're still bullish commodities. It sounds like it's a longer term. and let us know if it's a longer-term call and what fuels that?

21:13Well, first and foremost, I'm a big believer that we're going to see correlations playing in markets very differently than we saw back in 08. And so I think that, I don't think this is 1970s, but I do think correlations could be very similar in the sense of how you've had protective assets like treasuries in the last couple decades have been very good defensive assets to your portfolio. I'm not sure that would be the case today. So you think about gold playing that role. There's a reason why. Yes, I know gold has been underperforming the last week or two, but it's the only asset in the whole world that is actually about to make new highs in terms of a macro asset, not Bitcoin.

21:55Bitcoin's down 70 % from all-time highs. And so not NASDAQ, not the S &P 500, not oil, not copper. So it's really interesting to see that gold is holding up well up there. And I think there's a reason for that. It's a trifecta of macro imbalances that we have, the 1940s debt, the valuation problem of the 1990s, inflation problem of the 70s. All that is playing a role into allowing gold prices to be lifted. And I think that's probably going to be the case moving forward. And so the reason why I'm so bullish on commodities, I understand the risk and the cyclicality of some of them like silver or copper.

22:34But I do think gold will play more and more of a role into becoming that defensive asset. And it's important to see what's going on with central banks buying those instruments. Central banks were basically the big buyers of treasuries in the 80s. If you look at what caused the 60-40 portfolio's creation, in my opinion, it started with the larger institutions, even larger than the pension funds, which are the central banks. They started buying the treasury market before anybody. And then we saw this construction of a conventional portfolio called the 60-40s. And I'm not sure that will be the case in the near future, meaning five to 10 years from now.

23:14I think there's going to be not the end of fixed income and equities in a portfolio, but a more balanced portfolio where gold will start playing a bigger role into that. And I think, you know, look at the performance of treasuries versus gold in the 70s, which is very important. That was a major divergence between the two where gold was rising every time the market had some painful moments. I think we're going to start seeing that here as well. 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.

23:50Jim was asking what resources you like and why. It sounds like even though we're talking about commodities, it's really gold. Or do you like them all? You just like gold the best. Oh, no, I like a lot of it. I think the metals and mining is one of the most important ones. I had a chart that I sent to you all looking at the industrial production in the U.S., and it's such an important chart because it creates and sets the stage for the long-term demand for commodities in general. So if you look at that chart itself, you're going to see that there's been an 80-year process from the 1920s all the way to 2000, 80-year process of exponential growth of industrial production in the U.S.

24:30And then from 2000 to now, we've basically seen a stagnant period where there was no growth whatsoever in industrial production. In fact, this was really aligned with the fact that China entered the WTO and became a large exporter of, I think, China went from 2 % of total exports in the global economy to 15%. So big changes there in terms of reliance in that country. As we continue to see things play out in terms of more deglobilization trends and so forth, countries will be forced to go above and beyond and shift their economies back to onshore and reduce the geopolitical risk that they currently have.

25:09And as we see that happening, it's hard to believe that just like China entering the WTO created a bull market in commodities in the early 2000s, I'm really excited about seeing the G7 economies doing the same today. It's going to be much bigger. So I think there's a case to be made there in long-term commodities. And you look at the metals and mining industry itself, which will be serving most of those developments. Boy, again, it's a fraction of the S &P 500. It's a fraction of the global equity market. So, you know, I'm bullish, you know, not on just gold, but silver, copper. We have cobalt, nickel, all sorts of things.

25:50And I just think it's really interesting that today you have, you know, gold prices approaching new levels and properties that own gold that have, there are in the process of defining large discoveries of gold trading at very depressed valuations. And so either I'm really stupid or this is one of the best opportunities I've ever seen. So I'm really excited about this because I don't know per se 100 % the value of everything that we own in terms of their assets underground. But boy, it's definitely not what's being priced in the markets today. So I think it's really interesting the level of inefficiencies we're finding there.

26:32And that's why I'm so attracted to it. So, you know, as I'm thinking about this, and I don't know if this is exactly the right question, but if there is deglobalization and we do see this industrial boom as everyone reshores, if you've got AI on the loose and it's going to be robots that do much of the heavy lifting or a version of computer learning and things are way more efficient because of that, You don't need nearly the amount of people. Does that still mean we see a commodity boom? Do we just get rid of wage inflation, but you still have commodities going up? Or does that change the calculation for commodities as well?