Is This the Top of the Economic Cycle? w/ Eric Johnston

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2:07Is this the top of the economic cycle? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Eric Johnson, head of equity derivatives and cross asset for Cantor Fitzgerald. Hi, Eric. Maggie, how are you? I'm doing well, thanks. Yeah, great to see you. So it's so interesting to watch these markets because, Because once again, we're seeing stocks rally, technology rally, but they're doing it sort of heading into a really big, important economic release Friday, right? We have the U.S. jobs report. I mean, there's been so much going on with the debt ceiling. It's sort of been a little bit on the back burner.

2:41But NASDAQ up over 1%. What's driving the gains here? So I think, you know, I mean, as far as, you know, tomorrow's number, I think it's really going to matter only if it's a extreme number in either direction. So you had the Timurose article come out yesterday talking about how the Fed is going to pause unless there is a big payroll number. So I think you'd need to see a print probably north of 300 ,000 to 350 ,000 for it to be a problem on the high side where people think, okay, now the Fed is going to go in June. And then I think on the downside, you know, it would have to be probably below 100 ,000 to get those, you know, real economic concerns going anywhere in the middle.

3:27And equities probably take it, you know, take it OK. I think, you know, in terms of the strength that you referred to, equities continue to be extremely resilient. And I think we've seen that for a number of different reasons that we can go into. But certainly the liquidity picture over the last seven months has been favorable. The expanding budget deficit has been favorable. It's been a stimulus. And then, of course, AI, which is a big theme out there that is clearly having material impact on the overall broad indices. Yeah, absolutely. So we'll hit on all these topics, but when it comes to the economy, so that's interesting in terms of market reaction.

4:19It has to be extreme one way or the other. So otherwise, it's sort of like Goldilocks in the middle. Where are we with the economy, though? Because in some respects, it seems like we're seeing real signs of deterioration, weakness. And then in other areas, things look strong and resilient. Where are we here? I mean, are we kind of rolling over? Is there a lag? How are you thinking about this? So I think we're at the top of the cycle. And I think we are currently, if you want to think of the cycle, we're sort of plateauing as we speak. And I do think it's going to turn lower. And I'll go into why.

4:58So the unemployment rate is currently 3.4 percent. I think by most people's definition, we are currently at full employment. And so, as we all know, the economy goes in cycles. And typically, bull markets start after we've seen a significant contraction in employment. And the whole idea is that you've seen this contraction, and then you now have a path forward where you can say, I think employment can now be added to for quarters and years to come. And that's going to be the backbone of stimulating growth. And hence, I'm willing to pay more for equities because I see this clearer path. When you're at full employment, people say, of course, that there's always a recession in front of you.

5:50That recession is much more likely when you're already at full employment that it's more likely around the corner. And if you look at the consumer right now, as you said, there's a very mixed picture going on right now. From a goods perspective, you can see this. There's clearly weakening going on, and it's fairly material, and it's also at the moment focused towards the lower end. So today you saw Macy's report earnings, and they had a pretty big guide down, and they referenced the consumer. We had Dollar General also referencing the low end. But at the same time, we're also an ISM manufacturing, very goods-oriented indicator.

6:34While at the same time, service remains strong. We saw that with American Airlines two days ago, raising guidance for the quarter. So it is a mixed picture. However, if you look at the broader trends, the consumer is taking on much more debt. You can see that in the credit card usage, not at problematic levels yet, but the direction I think is concerning. If you look at delinquencies, delinquencies are rising at a fairly material pace, not at problematic levels yet, but the direction I think is. And then you look at savings. Those are in decline, though still high. And so it's one of these things where the consumer and the economy entered this rate hike cycle in very, very good shape because of all the fiscal stimulus and monetary stimulus we had seen.

7:31So as a result, it's taking a lot longer for the economy to slow down and eventually roll over. So I think it is going to happen. And I think our best case scenario is because we are at that full employment level is that I think our best case is that we would muddle along at a very low growth environment with sticky inflation. Yeah, which we know in and of itself is problematic. Dr. Block, you were asking about one ISM under 50. And I think, Eric, you make a great point about it being this sort of, you know, two tier or two track economy, one on the good side and one on the services side. And they are behaving very differently.

8:14And that's a layover from the pandemic. But maybe you argue it's something more structural now. So against that backdrop, so the economy weakening, heading to recession, a lot of people pointed out, listen, this is like the most well-telegraphed recession or most highly anticipated recession in sort of the history of the universe, right? We've all been talking about it, waiting for it. It's taken a lot longer, as you point out. But that's going to be happening at the same time that we're kind of coming through this debt ceiling. And we've had a lot of people coming on talking to us about the kind of mechanics around what has to happen now with the debt ceiling.

8:52And I know you're looking at that as well. We've got all of this bond issuance coming, don't we? How is that going to work coming against a weakening economy? Yes. So I think the backdrop is, you know, since October, when equities hit their lows, the global liquidity picture has improved by about$800 billion. And at one point, it was about a month ago, it was a total of about$1.4 trillion. And so I think it's no coincidence that since the October lows, that equity valuations have moved sharply higher from there. And this liquidity picture improvement has come from the Bank of Japan growing their balance sheet, which is now paused or stopped, and also has come from the draining of the TGA.

9:47And so what I think is important is that if you look at the global liquidity picture going forward over the next six to 12 months, it looks like it's going to be quite negative. And part of it is the refilling of the TGA, which could be$500 billion. Now, some of that, I think, will come from reverse repos, which will negate part of it. But I do think that there will be a pretty significant drain from there. But then it goes beyond that because, in addition, you're going to have the LTRO in Europe rolling off. You're going to have the ECB and the Fed continuing to be in QT mode,$95 billion a month from the Fed.

10:31And then do the loans that the Fed just made that just jumped – caused a significant rise in their balance sheet, do those start to roll off over the next six to nine months? So I think that there are, and then we, of course, have a new Fed governor at the Bank of Japan. And so that's unlikely to see the liquidity that we've seen over the past eight months. So I think the liquidity picture is very negative. And I think the correlation remains very high. And so although people are talking about the liquidity drain coming, and many people are talking about the recession possibly coming, I think when those things happen, which I do think both are going to happen, they're going to be negative for risk assets.

11:19And if equities were to go down, which we think that they will, that will then actually have an exacerbating negative impact on the economy. Yeah, I think that's the worry and sort of what a lot of you are putting together for us, that you have these things happening at the same time, which is problematic. like confusing it all when we look at the, well, first of all, so let's stick to bonds for one second. If that's the case, when you're looking at this issuance, what is that gonna mean for bond yields? Because if we were going into a recession, you would think maybe yields have to come down to reflect that if we're finally getting there.

11:57But then now you have all this issuance and some people talking about, which cart's gonna lead here? Because that has the potential to put upward pressure on yields, right? That's right. And on top of that, you have the 10-year yield, which is 180 basis points below the three-month yield. So it's pricing in already that you're going to see a significant decline in inflation, and that's most likely due to a weakening economy. That's going to allow the Fed to eventually cut. And it's pricing in a pretty high degree of likelihood and of that happening. and the magnitude pretty significant. You've never seen, at least in the last 40 years, this type of discount in the 10-year yield relative to the three-month.

12:46And to your point, there are cross currents because eventually the Fed is going to initially issue bills, but then they'll roll down the road some of that into notes and bonds. And so that will be something that will put upward pressure. I think the continued with the Fed likely holding, I think, for some bit, I think that'll also be a tether higher in yields. But then the counterbalance, of course, will be the weakening economy. What I would say is that right now, equities and the bond market, to me, are very much out of sync. and that right now, I believe that they're saying two very different things around what the outlook is for the economy.

13:33Because although people are talking about a recession, I do not believe at all it's reflected in equity prices. Yeah. And it's really interesting because so we just had Beth Kinding on, who's a guest who was on Three Ideas at the beginning of the year, made a really, really bullish call on technology, specifically NVIDIA, ended up being our top performer for that show because we tracked their performance. And we brought her back sort of mid years to see how she was feeling. This is what she had to say broadly about the tech sector right now, very much in line with what you were just talking about.

14:08Let's listen to a clip from that. Ultimately, we feel very strongly that tech does not operate in an insulated fashion. So if you look at economically sensitive areas such as small caps, transportation, industrials, these are all very weak. And as much as tech is very special, it absolutely gives us the world's most valuable companies. It doesn't operate in a vacuum. So we, and tech can get hammered harder than others during any kind of macro weakness or a macro or weak macro narrative. So we prefer broader leadership, even when we're buying. And we saw buy signals October through February, really.

14:47And And we've paused overall and just held those positions, let them grow, taking gains when we can. And right now we're not buyers, ultimately. 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. 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.

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15:57Yeah, that idea that it's hard to see how things stay aloft when you've got the situation deteriorating elsewhere. I think Peter Buchfar put it this way, like everybody breathes the same economic air, right? So like to have one sector, by the way, to hear the full interview, including Beth's view on NVIDIA specifically and three new trade ideas that she likes at this juncture, head over to our platform. If you are not a member, scan the QR code and join. We also have a really fantastic series about AI coming up. I'm going to tell you a little bit about that later in the show. But, Eric, I think this is the really difficult thing, right?

16:38So, you know, you have this problem that you see liquidity issues, recession issues, the markets, you know, telling you two different tales. All of this makes people nervous. And we've been having a lot of people ask, you know, are we in the beginning of a big retracement? But then you've had this really powerful AI narrative that's come along. And I think it's really confusing for people. How are you thinking about both these things? Just today, we had news that Microsoft made another acquisition, a core weave, I think, to help fuel its AI computing power. How are you thinking about that? So the first thing I would say is it's extremely tricky and challenging.

17:23It's a huge variable that's out there. So what we've seen so far is that investors all think, including myself, that AI is going to be revolutionary and it's something that's as big as the coming of the Internet or bigger than the iPhone launch, et cetera. And people, of course, want to profit from it. So the trade so far has been to go into a very select number of names that investors feel are going to be at this point part of or leading this AI revolution. And so it's caused positioning within the NASDAQ to actually go from pretty underinvested five or six months ago to now being very extended.

18:18And investors have kind of piled into a group of five or six different names to play this theme. What I would say is that I would agree with the comment that technology clearly has a secular aspect to it, but it also has a cyclical aspect to it. And I don't think it will look through a recession, in particular if it's on the more aggressive side. If you look at times where there have been these material launches of different things that are similar to AI, if you go back, the iPhone was launched in 2007, which was clearly revolutionary and has impacted all of our lives. And that was in about the middle of 2007.

19:08Obviously, that was taken over by the great financial crisis. The internet bubble started in the mid to late 90s and ultimately ended with a recession. We had a rate hike cycle, and the on look of the recession and the actual recession did damage and pop the bubble in the tech sector. If you bought the NASDAQ in, or excuse me, the S &P or NASDAQ around January of 97, which is before Amazon went public, you were unchanged on that trade in October of 2002. Now, obviously, it went up significantly over the next three years, and if you got out, you made money. But the point is, as revolutionary as this age was, it was also a time from 97 to 02 that the returns were very poor.

20:00So the idea that it's revolutionary and making money off of it are two very different things. I think in the short term, there are clearly money-making opportunities in a lot of these names. That's causing the breadth to be what it is, which I don't think in and of itself is a bad thing. But, you know, it's something that is going to transform things, but cannot, in my view, necessarily survive a recession if that ends up happening. Okay. Underscore, exclamation point. Bold that, everyone. David H. on the YouTube chat, I think that answers your question because he was asking if he thinks AI is so big, then why does he think it will fade?

20:43Makes no sense. Again, we played Beth's, and I encourage you all to go listen to her, both her interviews, go back and listen to her talking about the narrative back in the beginning of the year. But her views on some of the sort of fundamentals of what she's talking about are not different. The difference is the market has changed, right? That where everything is and the outlook for the rest of the economy, you always have to update that. So that was a great point, Eric. And I think there are a lot of lessons when you look back in the dot com. By the way, it also matters your time frame, because if you are going to hold for a really long time and this A.I.

21:21plays out and you have the ability to withstand a downdraft, you know, maybe that maybe that's different. Maybe you're not going to worry as much as somebody who has a who needs the money more in a shorter time frame. So all of those things are really important and plug in. So thank you for making that point, Eric, because I think it's really confusing for people. Yeah, if I could add one more point is you had someone like Bill Gates the other day. come out and saying, you know, we don't know who the winners are going to be, saying we are not going to search on the internet like we currently do, and we're likely not going to go to Amazon.

21:51And so I think the point is, is that Google is a great example who is on the absolute forefront of AI. The R &D that they've been doing for all these years is incredible. But one of the thing, one of the number one things that's going to change is search. And Google has 93 % share in search, and it's extraordinarily profitable. So if Google walks away from this and search changes in a material way, and if they walk away with 60 % share and different economics, well, sure, that 60 % share is great, but they gave up the 93 % share in a very profitable search. Transitions are hard. Ask anyone who works in a media company.

22:35We see this playing out. I I know you probably all watched the end of succession stuff, but there's disruption going on. And sometimes the economics, as you make a leap to new technologies, aren't always there. We also know that there are memos leaked about does anybody really have a moat anymore? That's going to be a really big issue. By the way, I'm going to take this opportunity right now because we have a question. I'm laughing. I don't know if this is exactly which I think you asked the question twice. But Matthew was really like raising his hand, waving his arms. First time question asker.

23:09Welcome, Matthew. Asking, will quantum computers and all the possibilities it brings do the same thing? I'm just going to we are thinking about all these questions really hard. We're actually, I mentioned before, launching a series. I'm just going to let you all know about it right now so that you could sort of set your calendar. Because of all these questions and issues that Eric and I are talking about, we're going to do a sort of two week festival of learning. but it's not going to be a day event. It's going to be spread out over the course of a couple of weeks. You've got to sign up for it.

23:39We'll tell you how to do that. I think, Nick, if you want to put that screen up, if you can, I'm totally front running when we were going to talk about this, but you need to register to do it. But we are going to really sort of tease this out. We're going to talk about what happens, what the hell happens with this AI wave. And that includes, you know, from a 30 ,000 level foot businesses, a relationship between machine learning, AI, tokenization. Matthew, to your point, what happens when quantum computing and AI collide? We're going to have an expert in quantum computing. I did an event with him, Nardo.

24:17He's amazing. He and Mike Green are going to break that down for us. And then after that, sprinkled in, we're going to have what you can do. So how you need to be thinking about this. How do you future-proof your job? How do you think about this from a business perspective, whether you're an executive at one or running one? How to think about investing using AI? And some of them are going to be tutorials. So super pumped about this. I think we're all going to learn a lot. So we'll keep telling you where you can register for that. But this is why we're doing it, because it's affecting every conversation.

24:53Eric, I think, I don't know about you, are your clients asking you about this all the time? Because I think every person that we have on, no matter what asset class they're looking at, because of the role this is playing in macro, AI comes up. Are you experiencing the same thing? Absolutely. I mean, now it's part of every conversation. It's part of what, you know, it's part of my job. I'm using AI as we speak and other people are. And everyone knows it's going to be transformational. And there's more questions than answers around how to profit from it and what the impact is. But absolutely, it's part of every conversation I have.

25:40Yeah, and who the winners are, right? And we're so early in this that there's a lot to unwind. So, Matthew, make sure you roll up for that conversation with Mike Green and Nardo. There'll be a schedule out on when to find that. So let's look at some of the questions. So Lewis was asking, what about Bitcoin and are we at a tipping point for the U.S. dollar, euro dollar specifically? So I think as far as the dollar goes, part of the reason that you've seen the most recent rally has been partly it's been a squeeze to some degree. And I think people are shorted for very good fundamental reasons that I certainly believe in.

26:30And so my more medium-term view is negative on the dollar. But I think from a short-term perspective, I don't necessarily have a strong view, and I think it's very difficult, tricky with the current positioning. Bitcoin, I'm going to assume you do have a view on because you're worried about risk assets. Andrew also asking, is it a good point to take profits on Bitcoin since we're all waiting for the recession to come for a visit? Yes. And so I think Bitcoin has certainly, you know, certainly of late benefited from, you know, from the liquidity being added to the system. And I think it is a prime candidate to suffer as the liquidity gets, you know, dries up over the course of the next six to 12 months.

27:22Also, if you look at the money supply, the money supply continues to be negative. Right now, it's about negative 4.5 % year over year, which I think will also be a headwind for Bitcoin. Ralph asking, what do you think is going to happen to the yield curve over the short to medium term? Yeah, so I think that's a great question. I think part of a hedge for being short equities is to play the yield curve because, like I said earlier, I think it's saying two very different things. embedded within the two-year are one cut from the Fed funds rate this year, and then more cuts next year. And then clearly, the 10-year is pricing in a fair degree of cuts.

28:17If you look at the five-year break-evens, they're pricing in 2 % inflation. I think it's 2.07 % inflation. So from a the bond markets essentially saying the inflation problem is really done and behind us. Now, I think they're saying that because of their their economic outlook. So I think in a situation where we to the point earlier, you know, what happens to the curve? I think in a situation where the economy finally starts to roll over, I think that the long end is going to be much stickier, meaning yields will go down a lot less on the long end than has historically happened before in economic downturns because the Fed essentially has kept rates at 5%.