Is Bond Volatility Here to Stay?

0:00Hi, I'm Raoul Pal, CEO and co-founder of Real Vision. Alongside brilliant minds like Edward Snowden, Benedict Evans and Balaji, I'll be on stage exploring the extraordinary potential of AI and the profound change it represents, not just for financial markets, but also for the world as we know it. With over 5 ,000 attendees and over 150 side events, Singapore will become a vibrant hub for a full week from the 3rd to the 9th of June. Visit superai.com to register and join me with 20 % off tickets with the code REALVISION. Link in the description. Thanks.

0:46Is Bond Volatility here to stay? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today, Sam Rines, Managing Director at Corbu. Hi, Sam. How are you? Hey, great, Maggie. Thank you so much for having me. Oh, I'm so glad that you were here with us. So I know everyone, we're going to resist the urge to lock into holiday mode because it feels like it's like one big day this week. That's the longest Friday ever as everyone's trying to wrap everything up. But there's some interesting market action going on. We have definitely feels quieter, but we have stocks rallying again across the board in the US.

1:22Russell up 2%, by the way, the best gainer, yields down. And that's despite the fact that we have Fed officials attempting to temper the mood. It seems like now, whenever they can get in front of a microphone, including Atlanta Fed Bostic today saying, he sees no urgency to cut rates. He's thinking way less than the market is. And investors seem to be ignoring anything they have to say. I don't know. What's your sense of this. Does the market have it wrong? Does the market have it wrong? The market and the Fed always have it wrong to a certain degree. If you look at the track record, it's the Fed always thinks that they're going to do something.

1:59They never really do it. The market always thinks the Fed is not going to do what the Fed says, and then the market is absolutely wrong. So I think what you really have to do is take a step back and realize that from the beginning of 2021 to the middle of 2023, it was really a question of how fast and how far was the Fed going to go? That was it. That was the question on rate traders' minds was, is the terminal rate 4.5? Is it 5? Is it 5.5? Is it 6? And now the question is really, how much is the Fed going to cut, how far are they going to go, and when are they going to do it. And when you combine those two scenarios into a singular mindset, it gets really confusing.

2:52But the way to parse it out over the next year is really to think about it as it's going to be volatile. Every single new data point is going to push out or pull in when the Fed's going to cut, how much the Fed is going to cut and when they're going to begin. So I think it's really how you frame a mindset around the data that's going to come in and be prepared for a significant amount of volatility in yields and bond prices. Yeah, it does seem like that. And do you think we're going to see a similar situation? Because this year was really marked by, we've kind of been saying people are running, like dashing from one side of the boat to the other, right?

3:38We get a weak piece of data and then you see people start to accelerate the idea that the Fed's going to pivot and then we get strong data and they race back. So yields have ricocheted back and forth. Does it feel like that's still going to happen? Oh, yes. A hundred percent. If you look at the expectation right now is for, call it five and a half cuts this year. Imagine you get a decent jobs report for December and a slightly hot CPI report. All of a sudden, that goes to four cuts. And instead of cutting in March or May, all of a sudden, it begins in June. So you're going to have this type of volatility based on the data as we move forward.

4:23And unless you're really prepared for that type of oddity within the markets, it's going to be a really tough way to navigate going forward. whether it's I think you want to be long the two-year as you move into the year, or I think you want to be long the five-year, or maybe the 10-year looks a little rich here and you want to begin to sell that off a little bit. This is going to be one of those times that's a lot different from past cycles. It's going to be one where the Fed isn't going to cut unless inflation is actually moving down. It's moving down sufficiently for them to be comfortable.

5:14And that is going to be problematic, more than likely, for people looking for March or May cut from what appears to be a rather hawkish Fed on the margin. Yeah, except it didn't seem like that when Powell was speaking, which is why I think we got that reaction, right? But they've always said they're data dependent. And so I think we had this sort of series of inflation data that really seemed to be moving in the right direction. So one-off, people reluctant, but we started to get what looked like a trend. And now it looks like people are revisiting that, especially given what we see happening in the Red Sea.

5:55And I know this is something on your radar. We swapped emails about it. And I feel like that drum beat's just getting a little bit louder. I mean, you look at the VIX, you wouldn't know it, right? But now we're getting announcements that shipping companies are rerouting to avoid that area. And you have the US and others trying to scramble together some sort of coalition. How much is that going to complicate this effort to figure out what's going on with inflation? And this is where I think in the near term, it's not as big of a deal as it could have been. If you look back, call it two years ago, this would have been a much more significant issue with regard to how inflation was unfolding, how supply chains were unfolding.

6:41The Red Sea predominantly is oil and LNG and gas related. So what you are really doing is beginning to put some volatility into the oil market and the cost of energy. How long does it take for the crude to make it from Saudi Arabia, Qatar, UAE, the LNG that they put out to Asia? How long does it take to get to market? That's really the problematic part here. It's not so much a good story, right? There's relatively little goods that are going to be restricted going through the Red Sea. It's going to be a problem on the margin. Don't get me wrong, but it's not going to be the story of 2020 and 2021 where ports were backed up, You had significant supply chain issues, et cetera.

7:45It's an interesting story from a longer-term perspective in that if you do begin to see these supply chains break again, it's going to further the process of re-regionalization into the US, the renaissance of manufacturing in the United States that began really before COVID, was accelerated by COVID, and is now really becoming something to pay attention to, is simply because if you're a large business, you can't have supply chains breaking down every other year because of some major catastrophe. So you will begin to see this become a much better story for the United States economy over time if you have more and more supply chain breakdown.

8:39So it's painful today in a number of ways, and it could become much more painful as we move forward. But it's a long-term positive for the ability of supply chains to be resilient and the movement of manufacturing from Asia, from Africa, Europe, back to the US, and call it Western allies generally as we move forward. So I think it's a two-pronged problem. And it's a problem that is also a really big positive for the U.S. economy moving forward. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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10:33That's so interesting, Sam. So there's so much in there. Is re-regionalization or regionalization or, you know, reshoring, however you want to phrase it, is that inflationary? Not necessarily. It seems as though it should be under the surface, but it's cheaper to manufacture in Mexico than it is in China. But when you put it all together, wages are kind of in line, and it's a lot shorter transport time, whether it's by train or whether it's by truck. It's a much better place to manufacture, and you're seeing a significant number of Chinese companies move their manufacturing to Mexico to have access to U.S.

11:18markets, not necessarily because of the import-export issues between the US and China, but because it's just a better place to do it. So overall, what I would say is it's not necessarily inflationary long term. It might be inflationary in the very, very short term. But in the long run, it's probably slightly deflationary because you're not going to have the hiccups in supply chains. You're not going to have to worry about war insurance premiums on shipping through the Red Sea or through the narrow Asian straits. You're going to have a much more resilient supply chain that's able to react to supply and demand faster.

12:06So overall, I would say it's really a benefit to the companies that are willing to put in the effort now and take the quote unquote hit. But overall, it's probably long term disinflationary, not inflationary. And do you feel like that building out that newer, more resilient supply chain, is that done on the private sector and on private companies' balance sheets? Is that a private investment or does that need government? And is there fiscal that has to be attached to that? So there's already been a fiscal package attached to that, right? So that's the Inflation Reduction Act. Right, the most hated name.

12:51The most hated name in the history of bills. But Inflation Reduction Act, it was a significant kind of stake in the ground when it came to reshoring or re-regionalization of manufacturing. That was a significant move. It's not necessary that you have a significant amount of fiscal from here. It's simply necessary that you have businesses buy in, that it's the cost of doing business moving forward. So like Apple with the watches today, right? Probably don't want to have that type of issue moving forward. So be better and build it in some place that makes sense. So it's interesting is if that is just another sign of that happening, That whole narrative seemed to have fallen.

13:46I mean, I guess it just got tsunami by AI, like everything else from an investment standpoint. Is that something we should be paying more attention to? Is that for equity investors out there? Is that something that they would want to think about in terms of who wins from that kind of money being spent? Oh, 100%. 100%. I like to point out that the construction employment in Tennessee is at an all-time high. That's middle America. Kentucky is almost at an all-time high. That's after the housing bubble. That's after everything. It's mostly because factories are being built. It's because there's actual money going in the ground to build factories, to build things.

14:33I think that gets overlooked a lot with the AI boom, with the headlines of what's the mag seven versus everything else. That's really being overlooked in terms of not only an investment opportunity, but something to really dig into and make money from over the longer term. AI probably is a great thing, but it is going to have winners and losers that are completely off the radar from your typical, call it big names. One of the great examples that I think everybody kind of overlooks is Kroger has one of the best data sets when it comes to training in AI and what consumers want and what consumers are going to buy and when they're going to buy it and why.

15:31And so when it comes to the AI winners, it's not just the people who build the AI model. It's the people who have the data. And those are really, really important. So a lot of these middle American companies that have been wildly overlooked and haven't been the best place to put a dollar over the past decade or so are probably going to end up being the accidental winners, not only of the AI revolution, but also of the bringing back manufacturing to America. That's so interesting. So what do you watch? I think that one of the things that this is where it's a very interesting macro environment now because everything's interconnected.

16:19It always is. Don't get me wrong. But with the bond volatility, this creates It's interesting questions because if that is the opportunity out there, does the volatility in rates make it difficult in terms of the CapEx, in terms of getting money, spending money, borrowing money to build out or chase that opportunity for companies? So if it would have been an issue, it would have been an issue this year. And you've seen business investment in terms of actual building, in terms of investment in putting stuff in the ground, just absolutely go wild. So I would say maybe it could have been, but it certainly isn't right now.

17:05It's very much a trend that if you can overpower 6 % or 7 % interest rates on the margin, you're going to overpower 3 % to 4 % interest rates on the margin going forward. So I really don't see that as being something that's going to stop it. If anything, it's going to be somewhat enhancing from the background, because if the hurdle rate has already been overcome, then what's the hurdle rate that's going to break it? It's a pretty interesting scenario that unless interest rates go a lot higher, it's not something that's an issue whatsoever. Yeah, and it's all relative, right? We just had them so high that when they're coming down, I mean, you have that sort of like, oh, well, better than they were before.

17:52So when we look at that, first of all, do you stay away from, are you bearish on technology? Do you think the valuations are just too high? Or you just don't like that everyone's so overweighted? Oh, so I would actually push back and say a lot of the tech names are wildly undervalued over the past couple of years. If we think back to what was happening right now and in January last year and this year, everyone was cutting jobs. So Facebook cut, what, 25 % of its workforce? Google did something somewhat similar or meta, I guess. I know. We always think of it as. Whatever the name is today. But if you look at what they did to their workforce, they cut it dramatically.

18:4625 ,000 people from Meta, similar numbers at Alphabet. Those are very significant cuts. And then you get into this year, and all of a sudden, Meta has a 40 % operating margin. And you haven't really seen the advertisements come back. When you look at what's going on within the consumer products group, when you look at what's going on within some of the staples names that are really boring but have really pushed price and really held margins up over the past couple of years, when you look at what they're talking about on their earnings calls, they're not talking about, you know, we're going to, you know, raise price.

19:30They're talking about we're going to invest some of these gross margin dollars that we've gained over the past couple of years into ads. And where do they go for ads? CPG is 45 % of internet marketing. And they haven't really increased those budgets over the past couple of years. So you think about the meta operating margin going to 40 % plus ad budgets moving higher, needing to get some of those volumes back for whether it's Thai detergent or Heinz ketchup or mayonnaise. Those budgets are moving much higher, and they're going to try to compete for volumes without reducing their pricing. That is all meta.

20:20That is all alphabet. So in my mind, the pricing that we've seen in the grocery store over the past couple of years is all of a sudden going to materialize onto the bottom lines of some of the largest tech companies in the United States and on the bottom lines of some of these CPG companies because they're not spending every gross margin dollar down there. They're just spending more of them. So I think there's a really interesting dynamic where people are really underestimating just how profitable these tech companies can be and how persistent they can be into an election year where you're going to spend more money trying to get votes on these platforms to begin with.

21:04So it's a really interesting flywheel going into 2024 where Meta and Google are really in a very good position relative to, I would say, a lot of the businesses out there that aren't necessarily exposed to the dynamic of CPG spending, election spending, et cetera. I wouldn't necessarily want to bet on Amazon or bet on some of the other companies that are more exposed to the consumer spend side of things. But when it comes to advertising spend, when it comes to election spend, those two are pretty dangerous companies. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

21:52Hi, I'm Raoul Pal. CEO and co-founder of Real Vision. Alongside brilliant minds like Edward Snowden, Bendikt Evans and Balaji, I'll be on stage exploring the extraordinary potential of AI and the profound change it represents, not just for financial markets, but also for the world as we know it. With over 5 ,000 attendees and over 150 side events, Singapore will become a vibrant hub for a full week from the 3rd to the 9th of June. Visit superai.com to register and join me with 20 % off tickets with the code REALVISION. Link in the description. Thanks. So if you're in tech, it sounds like you're differentiating and saying there's an underappreciation of the potential ad spending.

22:38What about the AI spend? Oh, in terms of capex? Yeah. Yeah. Do you think that's been overdone? Like, would you would you concentrate more on those with exposure to because it's kind of flipped last year, right? People were kind of thinking we were heading into recession, worry about what that ad spend was going to do. But thinking A.I. is the next, you know, the next coming and all of the money that anybody wanted to spend would be spent on A.I. Well, if there's two companies that have incredible data sets for A.I., right, because A.I. really depends on what you have for data. It's alphabet and meta, right?

23:13There's nobody that can even begin to compete with those two. Amazon's kind of a weird third place type deal in terms of what people can consume. But other than that, I mean, those two are massive beneficiaries from AI. They have the teams in place. They already told us what they were going to do for CapEx. It's going to be significant dollars, but it's not going to really hit their bottom line in a meaningful way, right? They pivoted from spending on things that weren't making money to spending on things that could potentially make them money in AI. Google was pretty exposed, at least we thought, to are people going to search AI instead of search Google?

24:01And I like it when I don't get lied to. So I still use Google search. I don't really love when I get hallucinated by OpenAI. So there is this disconnect there. I would say Microsoft looks interesting from the perspective of you basically betting on it for Word, Excel, and OpenAI. And there's only one thing that anyone actually wants to use in that sentence, and that's OpenAI. I would say OpenAI as a product is incredibly interesting. It has a lot of potential. I'm just not sure I would want to buy Microsoft at its current valuation for exposure to OpenAI. Yeah. And there's always that question still around what the moat looks like for any of this, right, when you're talking about it because it's so early innings.

25:00It's all data. All data. Right. It's all data. And on that point, John asking, everyone's calling you Samuel. Do you prefer Samuel? Or are they just being really formal today? It's so funny. He's not the only one. What about Tesla when you're talking about AI? I mean, that's grok. I mean, Tesla has nothing to do with AI. Tesla is a software company that tried to be a car company. it's interesting from a couple of perspectives which is it collects a lot of real data but I would say Grok is really the GR okay Grok is really the interesting thing when it comes to AI within the Musk spectrum of things it otherwise it's not all that interesting I mean whatever we've already seen the recall on Tesla for self-driving.

25:55If you can't use the data for self-driving, AI is kind of useless in that space. The ability to train Grok on Twitter is really the only interesting thing within the must space on AI. Yeah. And a lot of griping about Twitter and who's still on it, as we know. Although some of those. I am. Yeah, I was going to say, I think some of those reports are greatly exaggerated because I still see people talking about tweets. But Andrew has an interesting question, and it loops back a little bit to when we're talking about some of the disruptions with oil. But what will happen to gold, oil and ag? Will the commodity slump of 2013 to 19 happen all over again?

26:39Oh, I think you have to differentiate here. There is a significant difference between ag and within ag. I mean, we could spend an entire 30 minutes talking about that. There's a significant difference between what goes on with ag, gold, and oil, right? They're not all the same things. Gold is a pretty steady state in terms of its output and its, call it supply. It's really just a demand equation in terms of whether that goes up or whether that goes down. Oil is a much different story. There is heavy sour oil, which is mostly what's being cut by OPEC. There's light sweet, which is mostly what the US pumps and the differential between those two.

27:27And what you've seen is the differentials, typically light sweet trades well above heavy sour. And you've seen that really come in with these fly cuts from OPEC. So I would say you need to be really careful about equating all three of those together and really pay attention to what's going on underneath the surface. Because even though WTI is down, the spread and therefore the amount of money that Saudi's making relative to WTI is pretty narrow. So Saudi is quietly winning under the surface. We have a couple of people asking about inflation. Someone asking, well, given what's been happening, do you think the Fed will need to hike to regain control of the narrative?

28:13I don't think anybody is thinking that they're going to hike again. No, I wouldn't say the Fed needs to hike to regain the narrative. They don't. It's just a lack of cutting or a dot plot that's slightly different in March. So if they don't cut in January, they don't cut in March. Guess what? They've got the narrative back. It's interesting If you look at what is actually keeping the Fed awake at night, it's core services, X inflation or X shelter. And that inflation has begun to stall mostly because of kind of a couple of underlying things, insurance and food away from home. And food away from home is dominated by restaurants, right?

29:02That's what we go out to eat. And it's great. When you look at what Darden is saying, that's Olive Garden, that's Capital Grill, it's really up and down the spectrum of the things that people go out for. They're talking about 2 % type inflation in 2024, from 8 % to 12 % type inflation in previous years. So I would say you probably are going to begin to see the underlying sticky inflation begin to break as these companies begin to moderate their pricing relative to what they've done in previous years. It's funny. You can always tell sentiment. We keep getting questions about AI, which tells me a lot of people are in tech and still into AI.

29:52Christine asking, with the AI discussion and your NVIDIA hat, what do you think 2024 has in store for NVIDIA? No surprises, none. It's going to be very difficult for NVIDIA to beat numbers from where it's at. It's going to be a good year. It's going to be a great year for NVIDIA, but everyone's kind of caught up to it. So if you all you have to do is look at the major spenders on AI and figure out how much they're going to spend and then just incorporate it into NVIDIA and you're pretty much there. That's Google or that's Alphabet. That's Meta. They're going to spend a fortune on trying to get those chips.

30:36And it's going to be a great year for NVIDIA. But in terms of business, it might not be a great year in terms of stock price. Yeah. And it might not. It's not. Yeah. And Oliver, similarly asking, what do you think of AMD's chances to expand into AI?