Higher Forever? With Andy Constan

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0:49Hire forever. Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Andy Constance, CEO of Dance Spring Advisor. Hi, Andy. Great to have you back with us. Hey, Maggie. How are you? I'm doing OK. I'm doing okay. So interesting action today. Earnings very much in focus. We saw Alphabet down 9.5%, big drop for that stock after disappointing after the closed Tuesday. And it seems like that really set the tone for US stocks. We had a sell-off across the board, then Asdaq down, taking the brunt of it really, down almost 2.5%, S &P down about 1.5%, Dow down a third, the VIX up 7 % or so.

1:30Treasury yield's kind of hovering around that 5%. So what's top of mind for you as you look across the macro landscape right now? Well, clearly earnings are very important for this particular period. You always have idiosyncratic risk that isn't macro. But it's also important to sort of understand how these earnings fit in and what the market reactions are to get an understanding of what's happening more on the macro side. So what do you make of it? I mean, we're in the thick of it now. We're starting to get the big names, especially these big tech names. And they, of course, have been leaders.

2:08And it seems like those who missed are really getting punished. And there is some upside for those who do better. but it seems like it's a little bit more skewed to the downside. I don't know. Is that what you're seeing? And do you see more downside risk from here? I mean, how - And I think the most interesting thing about earnings is, we're going to print, I don't know what will come out tomorrow, but we're going to print four, four and a half, maybe even 5 % real GDP for Q3. So earnings are going to be, have been, and are going to be fantastic. You know, Google's earnings were very strong. American Express last Friday, I think it was Friday, were very strong.

2:52And what I found interesting is the aftermarket reaction to strong earnings, which is consistent with what I think is happening, which is earnings expectations are extrapolating what has been a very strong real GDP with inflation still running well above target. And that flows through to great top line and excellent earnings. So I think people have extrapolated that. And if you look at earnings expectations for next year and the year forward, it's still 12 % annualized growth, which is extremely hot earnings. And so expectations are very, very high. And then you have the bond market sort of cutting into valuations by having higher yields, which impacts multiples.

3:46And so that combination of things means I think we're going to continue to get some good to great earnings with mediocre to poor market reaction. Yeah, well, this was the worry all along, isn't it? I mean, you just hear people say it's priced in. But I mean, that has been the concern that so much of that strength, even though the numbers are really good, is already kind of baked into the price. Does it feel that way or is there some other dynamic going on? Yeah. So, you know, I wrote the script for how we get to inflation finally being well and truly dead. And that ultimately leads to weaker demand and lower earnings.

4:29But we're not seeing lower earnings at all. So obviously, some of the earnings are priced in to continue to be strong, but there's no reason why they shouldn't be until the economy actually starts to roll over. And the economy won't roll over until what I think is happening, which is quantitative tightening does its work by creating a bear steepener and having long-term interest rates rise, hitting multiples. that multiple hit then results in a wealth effect. Everybody's losing money, no matter what asset you owned for the last three months, you're losing money. Even gold is only up a few ticks.

5:14Everyone's losing money, and that'll cut demand from the wealth effect standpoint. Then eventually, you would think it would flow through to earnings, but you have this other pressure, which is still strong fiscal. And so it's not certain that equities are overpriced, but if they are, bonds still need to have much higher yields. Wow. You just hit on everything on my wishlist to talk about. So let's break it down a little bit. Let's stick with stocks for the moment. So in what you just said, it really explains, I think why everyone keeps going back to bonds being a driver here. But when we're looking at equities, when we've seen these big tech names, let's keep it a little shorter term here.

5:58So we saw, as I mentioned, the big decline in Alphabet, Google, and we've got some of the big earnings coming in. When we've seen a decline like this in tech names before some of the magnificent seven, if you will, buyers have come in. We've seen people go, oh, wow, Google. Even I'm looking at it today, and I was like, wow, it's down 9.5%. We're just kind of all programmed to think like that. And the buyers have come in, even when people were worried about this before we saw them rebound. And it surprised some people. Some people weren't in the trade. Does it feel different this time? Or is there a possibility we once again see that?

6:31Well, I don't know, really. I'm not an individual stock guy. But I do think that the S &P 500 as a group is doing awful. And there are a lot of stocks that are a lot cheaper than the Magnificent Seven. And so it comes down, by the way, Meta looks like it just missed. It seems like the

7:01overall market is so weak that you have to be comfortable going into this very narrow set. And that very narrow set has been driven principally by AI. And that story, I think there's a lot to that story, but it's not clear when that story will create the value for shareholders. And it's fairly well priced into markets. So I'm pretty pessimistic about the markets generally. I've been max short for about since July 31st. And I'm still fairly bearish, but it definitely has to come from some giveback of the significant gains we've seen in the Magnificent Seven. And that may not be in the cards. Yeah, and I think you just touched on something that's been so difficult and why you've been seeing some people come back or that just gravitational pull to those stocks is that you do have this really compelling AI story.

8:03And by the way, it's not the only, let's layer in AI, quantum, throw some other maybe sort of VR in there, which I'm going to talk about in just a moment. basically exponential age. And people have been trying to figure out what's real, what's hype. You have a lot of smart people saying, listen, we are on the cusp of something that is even bigger than the internet. And we feel that. So we've been trying to sort of do our best to stay on top of all these fast moving developments. We've been doing a series this week as part of an exponential age, exponential technology series, really looking at some of the forces and where are they?

8:44What's happening in these sort of on the forefront of these different areas, pockets of tech, if you will. And David Matten spoke with Evan Hella about the developments in virtual reality as just one example. Let's have a listen to that and then we'll talk on the other side. You look at most VR today, people have been trying to get the cost down, trying to get the cost down, trying to make it affordable. And it's led to an experience that's novel, but not something that people are coming back to. And so Apple was smart. They recognized that. And they recognized that it was not going to be smart to go into a red ocean space and be another Me Too device in that lower end of the spectrum.

9:22So they wanted to go high end and make this really desirable, make it delightful. And so what they do, they reach into the future five years old, the most insane technology forward invented new technology. And yes, the price is high as a result, but they made the right trade offs, right? Because they chose to be deficient on vectors that the progress of technology, I think will naturally take care of, right? Things like the price, things like the battery power, things like the tether to the battery pack, things like the overall size, right? the arrow of progress is going to dissolve those things.

10:03And then they're going to emerge as a result with having, I think, captured the market and have better technology in things that are harder to invent today. So that's why I think they nailed it from a strategy perspective. 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. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 Futures, you can trade crypto without the hassle of opening a wallet. With just a few clicks, you can register and start practicing with their free and unlimited demo.

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11:29That's just a tiny little snippet of that, but it's an amazing conversation with someone who's been at the forefront of this for a really long time. He's, by the way, a principal of spatial engineering at Amazon Web Services, and he's an RV member, which is just another reminder of how awesome our community is. To watch the full interview, and I highly recommend you do, So go to realvision.com. So Andy, this stuff we're all trying to sort through, right? And we all feel it's powerful. We kind of get the AI. We saw in Microsoft's earnings, net revenue of 13 % on the back of Azure and some of the stuff they're doing with that.

12:04So we're seeing it realized quickly, which is different. So that keeps pulling people in. What does it mean if we don't see a pullback for the Magnificent Seven? Does it continue to sort of push us up into dangerously thin air if the breadth is that narrow? What does that mean for the year end as we come here? Because a lot of people are trying to figure out, do we see a rally? Are we going to see seasonals kick in? Or is this going to be painful? And do we all need to try to preserve our capital before the end of the year? How are you thinking about that? Yeah, so I look at seasonals actually as a legitimate flow that's driven by tax shifts for people's portfolio and chasing for performance.

12:55And when I look at those factors, in almost every year in which the stock market's up 10 % or more, you have a positive, a strongly positive, like stronger than it has been positive last two months of the year. And that's very reliable, 30 out of 36 times in the last 100 years when you've been up 10%. only 36 times we've been up 10%, but in those, they've all had a Santa effect. And so we're up 10%. And so it's right for people to think there's going to be a Santa effect. But what I think is fascinating this year is the amount of stocks trading at a loss is by far higher than any other time in which we're up 10%.

13:50And every bond that anyone purchased in the last year is down, is going to have a capital loss. And so typically what happens is capital losses are very hard to find because in a 10 % year, most things are up. So finding a capital loss is very hard to find. And so what investors, taxable investors do is they delay selling their gains until January, so they don't have to crystallize a capital gain. This year is very different. There are seven stocks. Well, there are really many hundred stocks, but only those seven have actually outperformed the S &P. all the other ones, all 493 other ones have underperformed the S &P.

14:45And 250 of them are at a loss and bond markets are at a loss. So there are capital losses galore. And so that allows people to, when you take a capital loss, you can carry it forward and use it for future capital gains to offset future capital gains. But it's also quite normal for you to say, wait, I have a capital loss, I'm going to take a capital gain, particularly in some of these high-flying stocks. So I think the tax purpose of these, you know, the tax deferral of these Magnificent Seven is not going to happen. There's going to be active selling, or at least normal selling, instead of this deferred selling.

15:32And so I think that'll keep the ramping of those into year end out, you know, muted. And then there's the performance chasing. And performance has been so spotty. Unless you own the passive index, the dispersion of performance is very wide, with lots of people down for the year. You see all these Princeton, Harvard, Yale, all reported down years for the years, not that those were taxable institutions, but the breadth of the losses versus the people that were overweight Magnificent Seven is interesting in that when you have no incentive, I mean, you always have incentive to make money for your investors, but at year end, the incentive changes between portfolio managers who are paid based on their performance annually, their incentive switches relative to their investor.

16:34And so they often ramp things that they can so that they can get better performance. And typically, that's into the best performers. The funny thing is that the reason why the best performers have performed and why many have not done well because they haven't owned those is because of the hesitancy for people to buy into AI. If you look at NVIDIA and you don't buy into AI, and I think there's a significant portion of people that believe it's hype. Just because it's up, I don't think you're going to likely chase that particular stock for performance because it's so antithetical to the reason why you haven't owned it for the whole year.

17:22And so I'm concerned about performance chasing in that narrow group. And so if you don't have performance chasing and there's plenty of taxable losses to offset taxable gains, all the things that are typically drivers for that seasonal effect just don't exist this year. And so I've been saying Santa's dead for about a month now. And I think that's going to disappoint a lot of investors. I wouldn't be surprised at all if the S &P is unchanged for the year. Wow. That is such a compelling case you just made because this is something that not everyone digs into, but that dynamic, and you're right, this is not only is everyone holding onto bond losses, it's like the third year in a row this is happening, right?

18:11So it's a really different place than we've been. So it makes sense that those factors might have a different outcome. And I think your AI hesitancy is right on too. And this is what's so interesting as we're doing all of these conversations. And by the way, weigh in if you're watching the content, because these are people who are really well-placed, but they are in some cases technologists. And we go back and forth between, okay, the technology is super exciting, but how quickly is it going to get there? And what does it mean to actually be actionable on that? And so those are two different things and are the best opportunities and values in the private market still.

18:52We talked to Ben Miller about this Friday. If you haven't seen that episode of the Daily Briefing, go back and watch that because he's focused on that and talking about that. So this is it's a really interesting dynamic and there are really, really divergent opinions. And we're putting them all on the skeptics as well as those who are who are really into it. But we've really all got to educate ourselves on that. It's so important. So let's let's hit the other two big, big issues that you talked about, rather, or referenced, bonds. So let's do bonds. And we mentioned that higher forever because it's a nod to some of the research and questions that you've been asking, which are really provocative.

19:27So bonds have been really dictating this idea that they're still knocking on 5 % for the 10-year. But there seems to still be an assumption that it's only a matter of time before we see the economy weaken and that the Fed cuts rates. Everyone's pushing that timeline out, but it's still coming. That's why so many people have been sucked into the bond trade and then got their head handed to them because they've been trying to time that change. What do you mean by asking higher forever? Do you think that's coming? Is it just pushed out so it feels like we're waiting forever? How are you thinking about that?

20:05Yeah, so for about a year now, I've been on higher for a longer island. And that's a place where the incredible fiscal stimulus and the

20:20forces of deglobalization, which is creating things like the Inflation Reduction Act, the CHIPS Act, and generating additional fiscal spending, along with an extremely tight labor market where wages are coming in strong and thus people have money to spend, is creating a relatively strong both real and nominal GDP environment. And so I haven't believed in this recession idea for a long, long time. And so here we are. Now, finally, we are starting to see long-term interest rates, which have really lagged short-term interest rates, catch up. We had significant inversion between the 10-year and the two-year or the 10-year in the bills market for a long time.

21:20And a lot of people thought that was the indicator of a recession, was a heavy inversion. And that's just not true unless there's a credit crisis, which there's no sign of. We had a small little tempest in a teacup with a few banks. But beyond that, there's been no credit crisis. So what you need to get to get a recession is to get jobs and assets down. And the first First phase of getting assets down is raising interest rates, which the Fed has done. The second phase, which I observed on July 31st, is that there needs to be a supply catalyst to transmit quantitative tightening to the bond market.

22:14And that came when the Treasury announced that it was going to issue a significant amount of coupon treasuries in the second half of the year. And so we had this disinversion, bear steepening. And that's taken a lot, you know, TLT, you know, one of the classics that everyone sort of retail plows into is down 17 % in the last two months. You know, there's a significant hit on long-term bonds. And equities are down, you know, call it 8 % since then now. Matt Russell is down close to 17%, maybe 18 % today. And that's going to hit the wealth effect. And it's going to get companies starting to get pressure from their shareholders to make cuts.

23:07And it's the cuts of employment that actually create a recession. And if you look at the jobs reports, we're nowhere near that. So I'm sure you've noticed in earnings statements, there's been virtually nothing about downsizing. You don't downsize after a 5 % GDP quarter. You don't downsize after record earnings. You downsize when your earnings are actually coming in because of weakening demand and your share price is falling. And I don't think that happens this quarter. And I think the first time we'll start to see corporations reigning in spending, reigning in employment, cutting employment, is not till February or February earnings cycle.

23:59And so my outlook is fairly strong economy, which is going to keep pressure on the bond market. But equities that already have priced fully in strong earnings. So that's not a good combination for the 60-40 portfolio, for sure. 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.

24:28Yeah, oh gosh, we've been really talking about the pain of that 60-40 portfolio. So do you ultimately think there's a recession? And if there is, do we finally see the Fed respond? You mentioned before, do you think that the Fed will cut or do you see something else happening? Because now we have this also issue of supply that's out there further complicating the bond market, right? Yep. So here's where I think we go. Stocks fall, bonds fall. We start seeing a little bit of weakening in the economy. Employment starts falling. At that stage, there are two places we can go. We can go into the new normal where the Fed and fiscal policy do stimulative actions, cutting rates, potentially doing more asset purchases, spending to offset the weakness in the economy.

25:29And that's not higher for longer. That's just the classic response that we've seen for the last 40 years. When things get tough, the politicians print money and spend money. And so that's a possible outcome, and that, I think, will take some more severe pain than we've experienced. But another outcome is the Fed and the fiscal side don't respond, that they accept the fact that, and that will be dictated by whether inflation comes in or not. If inflation doesn't come in, the central bank is not going to respond to a weakening economy quite as rapidly. It's not going to cut as much, if at all. And that's what I call the higher forever situation.

26:20It's when fiscal just is unwilling to get its house in order and slow the massive deficit increase, and thus inflation stays sticky. Employment may fall a little bit, but stays sticky. and the economy can run at higher rates for quite easily. And that's what we saw most of my career and pretty much all the time before 2000. Since then, it's been a very different world. And since 2008, it's been a QE world. So it's possible that we veer off to a world, not this classic cycle where bad things happen, rates get cut, but this cycle where bad things happen and rates don't get cut. Right. And things are awful painful for different patches, depending on where you're sitting.

27:22So that's a really, really interesting thought exercise to go through because there are things. And so it brings to mind, and Chris just said hello to me. I had the pleasure of being at a dinner with one of our members earlier in the week. Hi, Chris. And he said something that has stayed with me and I've been really thinking about all week. And that is that the center of power, financial power, has moved from New York to D.C. because of the fiscal situation now. Because not only may you have inflation sort of handcuffing the Fed, but maybe bond vigilantes, right? We have all this issuance. Foreign buyers aren't buying as many U.S.

28:01treasuries. So if you suddenly are cutting the rates and they're not that interesting to the people and you bought all the supply coming, it's difficult. Layer on that, the fact that we're going into an election year, which we already know is going to be crazy because it took us four weeks to get a Speaker of the House. And in fact, when it comes to the election, which is going to be contentious anyway, you try to slice it. But I, as our members know, and our audience knows, I had the opportunity to sit down with Peter Zahan more than a week ago. And we discussed the whole geopolitical landscape, but also the U.S.

28:37election. Let's listen to a quick clip of that. Sure. Well, I'm not worried about the next election. I'm pretty confident that Trump is going to face a landslide defeat. We can go into the logic of that later if you want to. Yes, we will. Okay, so a couple things. Number one, he has full control over the Republican Party apparatus, and I have no doubt that he'll get the nomination. I mean, he could campaign from prison where he's been convicted of 90 felonies, which is how many there are now. And he could live stream the abortion of his underage, illegal migrant, trans lover, and he would still get the nomination.