Is a Recession Priced In? with Bob Elliot

28:17then I wouldn't, the commodity, for instance, oil wouldn't necessarily look great in the context of a globally slowing economy. But that's not how it works. You have to think about who are the producers and what are they doing. And the Saudis and OPEC plus cutting back on supply has created a purposeful squeeze on the oil price and created greater balance to somewhat, from a price perspective, a bit of a deficit, combined with the fact that essentially paper money, the futures folks, the hedge funds are getting squeezed, having held big short positions in these commodities. You put those dynamics together, and oil can certainly, and to some extent other industrial commodities, can trade in a way that feels cyclical, but it's really idiosyncratic in terms of the supply and demand in those particular markets.

29:16Makes a ton of sense, Bob. If we look for great risk-reward opportunities in a market environment with rising inflation, or at least inflation way above target still, and a slowing economy, Bob. Where would you look and how would you construct ideas in such an environment? Because we've kind of made the conclusion that equities are not super sexy here, bonds not super sexy here. So do we have anything to buy here? What are the risk rewards? Is there anything? Can we find anything in the market to buy. The pain and struggle of a long-only investor shrieking that right now. Well, I think there's a couple of things.

30:04I think when you're looking across the market, I do think that there's a real opportunity. I mentioned things like bank loans, preferreds. I know these are very annoyingly boring corners of the market. There are no high-flying NVIDIA tech stocks, but like value in yield, right? Where are there opportunities where there's value in yield that exists, right? And particularly, you know, taking credit against, you know, floaters and things like that, credit and floaters, that's the sort of stuff that, you know, has really, you know, everyone's sort of drawn to the high flying stocks, but there's a lot of these things where you can pick and choose what you're doing, pretty good credit quality, pretty high yields, you know, 10%, 12%.

30:54That sort of stuff is the most interesting stuff, I think, that from a long-only perspective, honestly, that's in the market. But you got to do your homework on it, right? You can't just buy any old, you know, private equity LBO financing that's going to go broke anytime soon. So that's part of the story is where are those opportunities, where is there a good risk reward in terms of the yield and the credit quality that you're seeing? I think the other part of this, which many people, we really haven't lived through this since the 08 period, is that these are the sorts of environment where trend and tactical alpha really would typically perform well.

31:43And if you think about it, we basically have this circumstance where the economy, equity pricing, et cetera, we're sort of like standing on a bit of the edge of the cliff. And these sort of gentle nudges moving us closer and closer to the cliff, whether it's rising interest rates or government shutdown or just the flow through the tightening that we've seen so far. We're sort of like someone's kind of gently pushing the economy and markets towards that cliff. And the way these things typically work is that once you start going, once you fall off the cliff, you keep falling. And so these are environments that can actually be quite attractive to use trend strategies in order to help make yourself a little more balanced, a little less long only, a little more balanced in the market.

32:37And you'll be able to sort of tactically respond as you get these sort of self-reinforcing dynamics, either on the long end of the bond curve or in the equity market. Bob, if you look at positioning right now, both among what I typically label as real money players, so pension funds, asset managers, et cetera, and then hedge funds, do you see any strong signs that markets have started to fear the recession again in positioning here? Well, I think, no, I mean, I think the, how do I say this? The, the, I think when you look at the long only managers, what you see is that there's still a lot of duration that those folks are holding.

33:18Um, and is that like a value? I think it's probably more a value play than a recession play for those, you know, uh, imagine being a bond manager, uh, for the last 15 years and like your baseline expectation is, you know, the long end yields one and a half percent. And you're like, oh my God, four and a half percent. It's like Christmas, buy bonds, buy bonds, right? I mean, the trouble was they were saying that when yields were 375 and 350, et cetera, early in the year. But anyway, I think that's more of what's driving the dynamic. And I think if you listen to the talking heads when they get on television on a regular basis, they'll all say, this is the greatest opportunity for bonds that we've seen in our lifetime.

34:03And then I think until those folks capitulate and start to really recognize that the value on bonds may not be what they think it is, I think that's the time that eventually you'll start to see that positioning flip. You'll start to see those asset manager bond positions start to come off and equity positions to some extent. And that's really the sign of the final capitulation that will drive the final rise of bond yields that will then set us up for the other side. And that's why you've got to be so tactical in this sort of moment, right? We've all sort of like learned over the last 15 years, like, oh, just keep buying stocks.

34:48Just keep buying stocks. We're in choppy waters. We're going to be in this like really tough turn that's going to be very hard to time. And so you've got to remain very agile in these sorts of environments because the ordering matters, like yields go up, stocks go down, yields go down. That's a hard set of things to navigate as an investor. It sounds like, Bob, that a curve steep in a trade could be the optimal first trade in this kind of environment before we get to the next leg. at least if we need to see that the long end of the yield curve being sort of the release valve of all of this. So what do you see as the main drivers of this steepening of the yield curve in coming quarters?

35:36Yeah, I mean, I do like the curve steepener and I mean, partially because it speaks to this dynamic of the central banks in general, you know, taking the easy, sitting on the sidelines and then, you know, getting most of the work being done on the long end. So I do like that part of it. I think the curve steepener also has the benefit that we all must recognize in this business. And folks like you and I have been around long enough to have made a few errors in our day, recognizes that we've also been wrong about what's going on, which is a real risk, and that the economy might engage in a downturn faster than we might expect, which could easily create that steepener.

36:19But instead of the bear steepener or the bull steepener, if central banks respond relatively quickly to any sharp weakness in the economy or a credit event or things like that. And so I think that's kind of the interesting thing is like, I see a couple of different ways in which the steepener protects you on sort of both two plausible outcomes that I think both of which are a bit underpriced given the inversion of the yield curve right now. Keep the questions coming in, by the way. Ash will host a Q &A session with Bob during the last 15 to 20 minutes of the hour-long show here. Bob, a steeper, maybe just for the sake of the broader audience, is it tradable?

37:06And how does one construct such a steepener view? Is it relevant to look at various points at the curve? How would you go about such a process? Yeah, I mean, there's a lot of different ways that you can trade the steepener.

37:25I'm a simple guy. I like twos and tens, good enough for me. You can trade those in the futures. There's plenty of liquidity in that, you know, clear pricing and stuff like that. So that's typically how I'd look at this is kind of twos and tens. You know, if you wanted to trade, you know, say those, I don't know, I mean, part of what could be most interesting given the way that the, now we're getting weedy here, which is good. This is the nuts and bolts of how you construct trades and you have to think through these things. If you look at the SOFR curve, we basically have flat pricing through June or July next year in terms of no expected easings.

38:14And so that might be a way to go. You kind of go long at that point in the curve, which could be beneficial in the event that there's like something breaks in particular in the short term. I think the risk that that curve shifts higher, meaning that the Fed tightens really at all between now and then is pretty low. And so I think that's probably a pretty good point of the curve to be long right in there. And then you can sell the long end, you can sell a 10-year future or whatever, which is close enough. And that doesn't get you. The problem is with the twos, you also have what's priced into that easing that happens in the second half of 2024.

38:58It's priced into the second half of 2024. That may come out, which could actually be bad for twos. And so maybe you target something on the long side in the summer of next year. Makes a ton of sense, Bob. If we look at price action, but also market pricing of recession risks outside of U.S. borders, I'm talking in particular about European and Chinese assets here. In case of such a, say, global recession scenario, is value to be found outside of the U.S. here, Bob? Well, I think when you look across the global economy, and you look particularly about how assets are priced, let's be frank, US assets are priced, I don't know, 50 % to 75 % higher than they are in the rest of the world.

39:58You look at equity yields. What do you get? Like the MCHE ETF yield is something like 8%. And what's your yield on US stocks? Four and a half, something like that, four and a half to five. That means that you got to believe that US equities are going to have radically better earnings growth in the medium term in order to make the tradeoff to overweight US stocks to make sense. And so I look at how are equity markets priced in China. I mean, real weak conditions are priced in China. Maybe things could be worse. That's certainly possible. But like you have a situation where you have, you know, peas that are running in the in, you know, 11, something like that.

40:53And you have surveys that say that everyone, you know, every asset manager thinks that the Chinese economy is never going to open up and never going to grow again. You know, it's possible that that's the case. But the trade-offs, the skew is certainly a bit to the upside relative to that set of expectations in asset markets and sentiment. And then Europe, I think the challenge with Europe is the momentum is not great because the European economies are slowing down, particularly Arizona is slowing down more rapidly than in the US. But it's also priced to be terrible in terms – you're getting pretty good yield.

41:32or UK equities, which are really global in nature, but skewed to the commodity sector, you're getting, you know, PEs that are in, again, the low, you know, 11, 12, something like that. You know, it could, those UK listed companies could be a lot worse than the ones in the US. But, you know, all of those sort of speak to the fact that US exceptionalism is priced into the market. And the odds that US exceptionalism persists are not nearly as high as what's priced into the market. That's all there is to it. This has been a widow maker view over the past 10 years, Bob. And I have traveled with such a view quite a few times as a sell side strategist in banks.

42:20And it is a somehow easier view to take on the sell side than on the buy side, I think. I agree with that. But I perfectly agree with your assessment. I mean, it is evident that the European economy is priced for a much worse scenario than the US. It is evident that the Chinese economy is priced for a much worse scenario than the US. The question is just whether you want to bet against the US anyway. And right now, I'm probably not willing to, even though I admit to the pricing being as you described it. But before I leave you for the Q &A session with Ash, I'd like your take as sort of a concluding remark to this discussion on a boom or a recession and how you profit from it on how to, across assets, map whether a recession is priced in.

43:21What's your thinking on how to do it across asset classes? And is there a bulletproof methodology in terms of how to assess these recession risks and to which extent they're priced in? Yeah, I mean, the main thing you've got to do is you've got to look, Yeah, start with what's priced into each one of these markets and the way you do that in the bond market or really it's in the short rate market is to look at that path of expected interest rate changes, particularly in that sort of first two years to sort of understand what's priced in there. And the, you know, very valuable to look at, to really look at what is priced into expected earnings growth in terms of, you know, earnings growth in the next year, in the next two years to really understand how those, you know, what the expectations are there.

44:17I think typically if you look at the fact set earnings insight or something like that and look at the analyst expectations, those are typically a little bit elevated. So you have to take a little bit of a haircut around that. But you sort of put those pieces together and what you see is you try and create essentially a connected narrative, right? And that's really what you have to do because you can't really quite understand the motivations. The pricing is just the facts. And then the question is what economic scenario could plausibly create that pricing and what's the likelihood of that scenario?

44:56And so like right now, what you see is you see modest interest rate cuts over the course of the next couple years. And you see very, very elevated equity earnings growth expected. And you put those two things together and it kind of looks like everyone's pricing on a soft landing. That's basically what the scenario is that would achieve those outcomes. And so that's kind of what you have to do is to kind of look at the facts, but also then create the narrative. It was a tremendous pleasure discussing these recession risks with you, Bob. I will leave the floor to Ash Bennington for the Q &A session.

45:34Andreas, always fun. Great to catch up. Hi, Bob. That was fantastic. How's it going? It's going well. That was fantastic. I get to hang out in the bullpen for 45 minutes and watch that interview and think of questions to ask you. I mean, it's just a really compelling conversation. And it really does feel, based on your remarks, that you think we're at kind of something of an inflection point here, having this conversation, obviously, after the hawkish hold yesterday from the Fed. It's an interesting moment. We got a lot of great questions from our audience. I just wanted to jump in and start with this.

46:04This first one from William, how high do you expect the 10, 30-year rate to rise? So he's asking about the long end of the curve. What do you ultimately see being the direction of those rates over the longer term? Yeah, and I think, I don't know how much people heard, but I'll start again at the term premium, which is typically you'd expect long end rates to trade at a higher yield than the cash rate. And I think what we've seen, we basically have about as negative a term premium as we've had in a very, very long time. And so the idea that while we're late in the cycle, which might lead people to expect to have cuts in the medium term, we could easily have a circumstance where long-end rates start to move up, let's say, closer to on par with short-end rates, which would be something like 50 or 100 basis points of further elevation.

46:58And if you think about that from the perspective of how it might affect broader asset prices, particularly stock prices, something like a 550 bond yield would probably hit stocks in the range of 10 % or 15%, which is about what's necessary to start that sort of negative economic dynamic playing out. And so something in that range is where you start to see, I think, value in the long end. But you should also recognize there's a lot we don't know. And so it's a little bit feeling the markets as they're playing out. Talking about feeling the markets and doing a little bit of a broader, deeper dive into this question, one of the phrases that we've been hearing most recently is this notion of higher for longer.

47:44Obviously, with the dot plot moving up yesterday in terms of the expectation of rates remaining higher for longer periods of time, one of the questions that came up, and there's a terrific piece in the Wall Street Journal last night by Greg Ip, asking the question about whether or not the natural policy rate, the neutral rate of interest has in fact increased. These are a longer term dynamics, things like population supply and demand of capital. But the question on the table, and I've read it raised elsewhere, is have we seen a shift in the fundamental neutral policy rate? This is the rate at which it's neither expansionary nor contractionary, the rate at which inflation and unemployment remain stable over time.

48:23Have we seen a change in that variable, sometimes called R-star by economists? Well, I think it's a confusing question because if you look at the fundamental drivers of R-star, which is meant to be long-term, the long-term interest rate pressures, we're in an environment where you'd actually expect long-term neutral rates to be falling. And the reason why that is, is demographic deterioration combined with elevated debt levels should pretend lower interest rate, lower neutral interest rate in an economy. And at the same time, what's happening is the Fed just keeps hiking rates and the economy doesn't seem to be slowing down.

49:02And so they're sitting around going, like, I've talked to a few Fed economists in my day, and they're sort of sitting there going, like, I don't understand what's going on. Like, our models are saying it's going down, and the reality seems like it's going up. And the issue is, I mean, first of all, R-Star is kind of a stupid concept, because it's not that useful in setting monetary policy. What is useful is understanding what needs to happen in order for the economy to slow down. And I think what we're seeing is the fact that the lack of sensitivity, tactical sensitivity of the economy to interest rate hikes means that the effective interest rate that creates a meaningful slowing of economic growth is higher than most people expected.

49:46And so that's not our star. That's not the neutral 30-year interest rate. That's what's the interest rate the Fed needs to deliver today. And so I think that's the most relevant question when you're thinking about it. And the answer is like higher, right? Meaningfully higher than most people expected. Yeah. And you're right about this sort of this open question about the usefulness of the concept of R-star. It's something that could kind of only be extrapolated based on actual inputs and actual outputs. So really, what's the relevancy when you can actually look and say, hey, OK, the actual rate is at X.

50:18And these are what we're seeing in terms of the variables we care most about, specifically employment inflation. Right, right. And I think that, you know, I mean, this is my, you know, don't listen to the economists, the academic economists. It's like not that useful. Like the thing that people you should listen to are people who are economists who have money on the line, who have learned the practical realities of how to think about it. And so, yeah, sure, there's hundreds of economists sitting around trying to fight which academic paper is smarter than the other, sounds smarter than the other one about our star.

50:51But like, you know, the real thing that matters is, you know, very practically, how is this, you know, how is this economy working? And how are these interest rates flowing, these interest rate hikes flowing through? And that's really, as investors, like focus on that. Stay away from the academic discourse. That's very funny. All right. Next question comes from David Sims. Bob, what's your view on the US dollar? We should say, obviously, DXY right now up over 105. Yeah, I mean, it's been the dollar has, despite all the claims of the death of the dollar here, it continues to be relatively strong.

51:37And, you know, those of us who've been trading currency markets for like 20 years have been hearing that for a long time. So every time you hear the death of the dollar, just remember people have been saying the same thing for like 40 years. And the reasons are always good. The logic is always – The reasons always feel good. But it's in the land of the blind, the one-eyed man is king. And that is really what the dollar sort of structurally is all about, right? It may be ugly, but it is the least ugly, certainly long-term investable asset in capital markets across the world. And so I think putting aside those things, when you start to think tactically about the dollar and relative monetary policy conditions, I think what we're seeing is we're seeing that the US and its lack of sensitivity to interest rate hikes and its stronger economic conditions are putting the US in a position where it can run stronger growth and tighter monetary policy than many other places in the world.

52:46That probably will persist in the sense of Europe is weakening a little bit more than the US and the UK as well. And so some pressure on those European currencies on a forward-looking basis makes sense. And similarly, Japan, the next time Japan will have 5 % interest rates, 5.5 % interest rates, I think we'll probably all be dead. So probably not something to worry about there in terms of Japan really getting on their high horse and tightening monetary policy meaningfully on par with the US. And so the US, the dollar is, the pricing is relatively elevated. The US still looks like it's an advantageous position.

53:27And so, honestly, of all the assets that are out there, the dollar is kind of like, yeah, maybe it trickles up a little bit. It's not that interesting a trade right now. A lot more interesting stuff going on in the bond markets, I think. Yeah, this is kind of the least dirty shirt in the pile of laundry. That's right. That's right. Yeah. So talk a little bit about bond markets and what your view is there, where you see the most opportunity. I know that Andrea has covered some of this already, but you talked about this concept of value and yield. Where do you see the most value in yield? Well, I think the most value in yield, I mean, the picture of short end yield is pretty attractive, particularly when you compare it with credit style, with some credit, maybe moderate term, one, two year investment grade corporate.

54:27or higher up in the capital stack type assets where you can start to get a trade-off, like in the event that you get a spread expansion, you're probably going to get some cuts get priced in. And those two have some nice negative correlation benefits in there. And you're not as sensitive to sort of the pressure on the long end of the duration supply. I think that's kind of, you know, there's a bunch of different ways to look at that. You know, there's preferreds, floater preferreds, there's bank loans. All of that stuff is the sort of stuff that has modest credit risk relative to a relatively elevated yield.

55:06And in this environment where there's not, when essentially risk premia seem compressed in a lot of different places, you kind of want to find those corners of the market that just haven't gotten the type of cross-asset flow that have really bid them up meaningfully. And so, you know, I think those are the sort of areas that are the most interesting in the yield space. Yeah, it's interesting. You said that to a certain extent, the value may not be there in terms of what people perceive as the value in the bond market. You also make the point of how pricey stocks are right now, S &P trading at a PE of around, I think, about 22.

55:45I'm wondering, what else do you allocate toward? Is there a sense, You mentioned gold and energy. Do you have a particular play in the energy space, for example, where you see an especially high degree of opportunity relative to the risk and volatility? Well, I don't really trade individual names. I'm sure there's got to be some good, you know, I don't know. There's probably somebody drilling in Canada that makes a lot of sense and has nice convexity to oil price rises. It's been a long time since I've been through that, down in the details of that. So mostly, I'm trading macro assets and asset classes.

56:25And oil still has some positive convexity, although that is fast eroding as we get almost to the triple digits in prices in terms of upside growth potential relative to what's priced in.

56:46And this is the problem is we sort of go through all these asset classes like bonds, long end bonds, term premium seems too low. Stocks, earnings are priced in, earnings growth is priced in to be too high. Commodities, well, oil at 100, it looks a lot less interesting than oil at 70, in the 70s. gold has outperformed bonds by 60 % or 70 % over the last few years. So starting to raise questions about it, whether it's still going to continue that outperformance. Yeah. So it's a tough, tough to be a long only guy in this environment. Here's a question from Lena. I don't know if I can answer this one, but the question is, what is the best way for retail investors to position gold?

57:31And then she also asks, Does Bob have any opinion about Bitcoin? So in gold, I mean, I trade gold. I mean, you trade futures if you're a big enough size. You can also trade IAU. The ETFs are good enough, highly liquid, tight bid-esque spreads, reasonably cheap in terms of operating. They're a little less tax efficient than you might like. But that's how it goes when you're trading gold, given the tax structure of it. But Bitcoin, my 30-second background on Bitcoin is that I, back in my Bridgewater days, led Bridgewater's research on Bitcoin, went through, got a good understanding of the asset and basically said, this looks nothing like my macro considerations and the macro drivers that I understand.

58:25And so I'm just not going to trade an asset that I don't understand the fundamental macroeconomic properties of. And I still basically hold that view today, which is I'm sure there's lots of very smart thinking about Bitcoin and what's driving it. I just don't. It's just not mainly driven by macroeconomic drivers in a time frame that at least I'm trading at. And so you don't have to trade everything. That's the most important thing to recognize as a trader. You don't have to trade every market. You don't have to be in the market every day. You should trade the things where you have an edge and where you see good risk return opportunities.

59:04So it's okay. You don't have to trade everything. Yeah. I mean, I think one of the smartest answers can just be, I just don't have a call on that. It's just outside. I just don't understand it well enough to be able to feel like I've edged. That's all there is to it. Yeah. Very well said. Bob, great conversation. Great conversation with Andreas. We really appreciate you joining us. Obviously, you guys covered a tremendous number of topics. Final thoughts, key takeaways that you'd like to leave our audience with? Well, I think the most important thing, everyone likes to talk about stocks, but in the next three or six months, it's going to be all about the bond market.

59:36And how that plays out is going to drive basically how asset prices evolve in the medium term. And in that sense, the ordering really matters. While we probably will get to a recession across the developed world economies, The ordering really matters that first yields are going to have to rise and asset prices and stocks are going to have to fall before we get to the opportunity that it makes sense to start to buy bonds. And so keep that in mind. Don't get ahead of it. You'll get burned and stay nimble. This is going to be an exciting three or six months coming up. Exciting in the sense of the old Asian curse.

1:00:19May you live in exciting times? That's right. There certainly will be interesting times. No question about it. Bob, thanks so much for joining us. We really appreciate it. Yeah, thanks so much for having me. It was great fun. Great conversation. Listen, before we wrap here, I also want to mention a conversation that Raoul Pal is having with Beth Kindig tomorrow on Real Vision. I got a chance to get a little bit of a sneak peek of an early cut of this. And it's really just fantastic and interesting stuff. It's a conversation mostly about AI, its effects on the tech industry, tech investing, and how, according to Beth, it's the biggest investment opportunity of our lifetimes.

1:00:53I found this an interesting perspective. Most folks who are analysts come to this from the financial side, and then they learn the tech piece. Beth did it the other way around. She was a tech analyst out in Silicon Valley, assessing various technologies from M &A activity and other corporate actions. She developed a really deep understanding of the way the technology worked. She was also long NVIDIA, far before this massive run-up that we've seen in the price of the equity. I think it's going to be a great conversation. Check it out tomorrow on Real Vision. Thanks for watching, everybody. Thanks for joining us, everyone.

1:01:22Today's Real Vision Daily Briefing is sponsored by CraneShares. Learn about their KCCA ETF at craneshares.com forward slash KCCA forward slash Real Vision. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus 500 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. See a trading opportunity? you'll be able to trade it in just two clicks. Feel ready? You can move to real money with as little as$100 once your account is approved. And the great thing is that in addition to crypto, Plus500 gives you access to a wide range of instruments.

1:02:03S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, Forex, and beyond. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus500. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit us.plus500.com to learn more. Trading in futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500. It's trading with a plus.