The Realities of a Recession

0:00People are going to lose their minds. This is a moment in history unlike anything humanity has gone through. It's a very different world for humans to come. Take a step back and see the broad picture, which is the way all these technologies are interlinked. Because this is all about exponentiality, and humans can't think in exponential terms. How consequential do you want to say machine intelligence is? It's almost certainly as consequential as writing. How long did writing take to disseminate through the human population? You know, hundreds, thousands of years. And we're dealing with it now on a scale of months.

0:33But in this kind of world, you're compounding 100 % growth every year, and the numbers become astronomical. AI is going to spot patterns in the world that were just completely invisible to us. Even if you think that the AI and the robots are your demise, you might as well bloody invest in them and make some money out of it. If not, you're just going to be angry man shaking your fists at the clouds.

1:09What are the realities of a recession? Welcome to the Real Vision Daily Briefing. It's Monday, November 6th, 2023. I'm Ash Bennington. I'm joined today by Daniel Lacalle, Chief Economist at Tresses. Daniel, welcome. Thank you so much for having me, Ash. It's a great pleasure. It's a pleasure to have you here with us. A quick note for our Real Vision members. We've rolled on our new Real Vision 2.0 platform. You can join it at realvision.com forward slash new. That's realvision.com forward slash new. So check your email to get on the new platform. There's some amazing new features that I'm sure we're going to want to check out.

1:46Daniel, we were talking just before the show. Obviously, a very eventful time in markets right now. A lot of conversations happening. A lot of price action. 50 ,000 foot big picture, Daniel. Where do you see us right now? Well, I think that the big picture would tell us that where we are right now is in what I call the hangover of the stimulus packages. We are not seeing a headline recession. GDP is not reflecting a recession fundamentally because it's bloated by debt. We have an enormous level of accumulation of debt in government spending, which obviously supports GDP, but also in consumer spending.

2:30We have an unprecedented level of credit card debt that is making the headline figure of consumer spending relatively stable. All of those indicate that things may get significantly worse as the reality of rate hikes and also the tailwind of the stimulus plans stop working. I think that those things, when we see rate hikes start to creep in the real economy, we start to see, we're already seeing delinquencies rising, no? But I think that we have not yet seen the true extent of the normalization of policy, because rate hikes are one side of the coin. But the other important side of the coin is monetary contraction, is the amount of money in the system being reduced.

3:26So I think that those elements need to be taken into account. And those should be playing out in the beginning of 2024, which also coincides with an important wall of maturities in investment-grade debt, also in high-yield debt. Yeah, Daniel, such an important point. I read your research note. You point this out. Obviously, Q3 2023 GDP coming in at a beat 4.9 % seasonal annualized rate of growth. This in stark contrast to some of the gloom and doom we're hearing. You point this connection out to debt. What's the precise mechanism for both the hangover from ultra low rates plus the fiscal stimulus that we saw during the pandemic period?

4:14What's the transmission mechanism? How does that work? How long does it take to unwind? I think that obviously the first element that we need to take into account is that the lag effect that we're all talking about, for example, of rate hikes, exists also in stimulus packages. So you cannot expect the stimulus plans of 2021 and 2022 to not continue to generate some level of tailwind in 2023. But we also must remember that this is the first time, at least in recent history, in which the monetary policy and fiscal policy are going the opposite ways. Monetary policy is contractive. The Federal Reserve is hiking rates and reducing the amount of money.

5:02It's unwinding the balance sheet slower than I anticipated, but it's doing it, while the government is not paying any attention. The government is continuing to deficit spend like there's no tomorrow. And obviously, that also creates some level of what I call unproductive GDP that disguises the weakness, for example, that is pretty evident in investment and is pretty evident in the export of the economy. Yeah. Let's talk a little bit about asset prices specifically here because it's been a quite unusual year. As we sit here in November, I just want to read these statistics out. S &P 500, which closed the day, weekly positive, about flat, I think up about two-tenths of 1 % on a daily basis.

5:53S &P 500 year-to-date right now, just over 14%. Equal weighted S &P 500 is negative on a year-to-date basis, off about, call it about half a percent. And if we want the extreme opposite end of the spectrum, NASDAQ 100 up on a yearly basis, nearly 40 % year to date, I should say, year to date up nearly 40%. This speaks to a great deal of concentration in what's happening in US equity markets. How does the thesis that you have in terms of the stimulus debt thesis translate into what we see happening in US equity markets? I think it's pretty evident that what we're seeing is actually the transmission mechanism of monetary policy working beautifully.

6:45You have an earnings recession in 493 stocks. You have a completely evident situation of markets reacting the way that they should to profits that are below estimates, particularly when companies are missing both on sales and on EPS. So the market is reacting as there is a real earnings recession in 493 of the stocks. And there are seven that basically make this sort of disguised picture of what the index is showing. And why do these technology giants perform significantly better than the rest? Because they're the most immune to rate hikes, certainly the ones that benefit the most of a policy that, although the Fed would consider, is hawkish.

7:44is continuing to be accommodative. And we saw it, for example, in the banking crisis, how immediately the Fed increased its balance sheet. And we see it today by looking at how much the balance sheet has been reduced, which is, we are already in November, and it's half of what we all estimated at the beginning of the year. So it's normal that the highest risk, longest duration assets in equity, which are technology giants, perform better. And it's also normal that high yield bonds are actually doing significantly better than sovereign bonds. So I think that what the market is actually screaming is, OK, we have tightening and we have an earnings recession.

8:34We might get a macroeconomic recession in 2024. And the way to protect yourself is not through sovereign bonds, because it's not going to be supported by monetary policy anymore. It's going to be in those equities that remain, let's say, almost immune to the economic cycle because of their advantages in the technology sector. Yeah, Dan, when you say everything is working exactly as it should be based on the thesis, it reminds me of one of my grandfather's favorite expressions. The operation was a success. Unfortunately, the patient still died. Exactly, exactly, exactly. We hear a lot the concept of soft landing from the Fed.

9:25The Fed is engineering a soft landing, and this is very good. People don't understand what a soft landing is because they focus on the word soft. Obviously, they're not going to call it a hard landing. They don't understand the word landing. And the word landing means recession. They need a recession to bring down the quantity of money that has been bloated in 2020 to 2021 because rate hikes reduce the growth of the quantity of money. But the global money supply, you look at the proxies, has barely been reduced from 108 trillion to 104 trillion, which is almost nothing, if you think about the global money supply, isn't it?

10:16So I think that what we are seeing is simply that the concept of soft landing is based on the idea that you can unwind the excesses of monetary policy of 2020, 2021 without breaking anything in the economy. And that is impossible. The myth of the soft lending, we also saw it in 2007. If you Google the most looked up word in 2007, it was also a soft lending. Central banks and governments were also talking about a soft lending. Of course, things are different today than in 2007. But they're not massively different in the essence of a soft lending, which is that you need a correction in the quantity of money, and that can only come from a lower pricing of the assets in the balance sheets of banks, as well as a lower pricing in overall assets globally.

11:28So that is, unfortunately for people that think it's a different thing, is a recession. And if we don't get a recession, then we get persistent inflation. And then obviously, and this is basically what I think the market is starting to tell us, is that it's either a recession or a much worse period of prolonged inflation that's closer to stagflation. So if it's between recession and stagflation, what we need to bet, the place where you don't want to be in is in sovereign bonds. And certainly not in those industrials, materials, or consumer discretionary stocks that are the ones that are provided, in the case of Europe, for example, almost 70 % of the profit warnings, and there's been 37 so far since the 1st of September, come from those three sectors.

12:26We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing.

12:36Have 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. S &P 500, NASDAQ, gas, and much more. Explore equity indices, energy, metals, forex, and beyond.

13:09With 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, Plus500 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. Plus500. It's trading with a plus.

13:36Tanya, let me ask sobering words there, I should say. Let me ask you two questions at once here because they're interrelated. First, what does that portend for the future outlook for U.S. equities, indeed European equities as well, in terms of the concentration that we've seen in terms of those seven stocks that we've just mentioned? What does that portend going forward? And second, one of the narratives that we've heard or themes that we've heard is this notion that when you have the yield on longer-dated treasuries rising, price deteriorating, that there's some element of a Fed not needing to act because the bond market is tightening financial conditions for them.

14:18Talk a little bit about what that means and what the risks are there. They're absolutely right. When the tightening is happening in the credit market and banks are limiting the supply of credit to the economy, what basically ends up happening is what we are seeing right now, which is that the entire burden, in fact, of the normalization of monetary policy is falling on the shoulders of families and businesses, on the private sector. on the productive sector. The sovereign bond market continues to function adequately. Therefore, the Fed is not concerned because deficits are refinanced at a higher price, yes, but they're refinanced, no problem.

15:11And governments continue to deficit spend without a problem. So on the one hand, what you get is crowding out. The government continues to finance its deficit without any significant problem, and that reduces the amount of credit available to the real economy, to the productive economy, to families and businesses. And on the other hand, the tightening of the rate cycle is also entirely on the shoulders of families and businesses. So in essence, what we are likely to see is that if the Fed is able to achieve what they deem as a soft landing, and people start to think that things are going to get worse, the Fed is going to look at aggregate demand, which is what they do, by the way.

16:04They look at aggregate demand. So far, if the government, which weighs between 39 % to 50 % of the GDP of the economy, is not reducing its demand, a reduction in aggregate demand is only going to come from the private sector, which means a significant slump in profits and a significant slump in consumption. Those are basically the transmission mechanism of this tightening cycle that we're living. And obviously, because I get excited about the answer, I forgot the first question. No, that was beautiful. The question was about the interrelationship between what's happening in longer-dated US treasuries in your view of the future pricing on a multiples basis and in terms of earnings of US equities?

16:56Yes. And coming back to equities, what I think is that this trend of concentration of very large multi-mega caps that absorb most of the performance is likely to continue. It's likely to continue because if we look at it from a more, let's say, extended period of time, what everybody knows is that the Fed is caught between a rock and a hard place. Therefore, policy will continue to be accommodative. And that helps disproportionately the ones that have access to markets and to credit beforehand. Printing money is never neutral. It always disproportionately benefits the first recipients of money and disproportionately negatively affects the last recipients of money, which are salaries and deposit savings.

17:53So no wonder the United States, with that allegedly phenomenal growth and with the level of unemployment at very low levels, is seeing negative real wage growth. And on the other hand, you're seeing deposit savings lose their purchase in power and obviously lose in value. So I think that multiple expansion is not likely to come to those sectors that are in the 493 side of the S &P 500. Actually, what we are seeing is coming back the multiples that were attached to many of those stocks, because another important thing is happening. Multiple expansion cannot happen when you have buybacks being reduced.

18:47The reduction in the amount of buybacks in the S &P 500 is a critical element of multiple compression. So as we see that dividend and buyback programs being reduced because companies are suffering, they're not generating as high cash flow as before, etc., It is very likely that the multiples of the per sector will likely contract, but that the multiple relative to the market of the leading companies that continue to absorb most of the returns is rising. There's the ETF effect there as well, because obviously, when the market is rising and people are starting to buy, the marginal buyer is buying mostly indices and ETFs.

19:41And inadvertently, it's buying more of the larger components of the indices. RAOUL PAL, MD, Just because of the way the weighting takes place. ED HARRISON Exactly. So if you see on the one hand that about 400 stocks in the S &P 500 are reducing drastically dividends and buybacks, and on the other hand, when people start to purchase stocks, they're buying mostly index-weighted or ETFs. What happens is that the 493 compress their multiples and the 7 expand their multiples. And I think that it's very unlikely, unless there would be a sort of vulgar moment, which we're very far away from, I think it's very unlikely that we see a drastic change there, i.e.

20:33we will continue to see more multiple expansion in the winners and multiple compression in the losers. And US versus EA versus Europe is very simple. United States, high technology exposure and continuing, even though it's reducing, but continued buybacks, Europe, no buybacks, and profit warnings. So multiple compression in Europe is likely to be more evident and more evident in the index than in the United States as well. Daniel, one of the things I always enjoy about having you on the show is your outlook is just crystal clear. No two-handed economists here. I really appreciate just the clarity of this.

21:18And when you're talking about this, it reminds me a little bit of the Cantillon effect, this idea that the closer you are to the monetary spigot, the more you benefit from these periods of monetary easing. And by the way, this is kind of just the price of passive indexation as you see flows into markets taking place in a more passive way. Absolutely, it is. And I don't think that there's anything that the Fed can do about it for a very simple reason. And monetary easing is like opening the floodgates. You cannot expect things not to get wet. And ultimately, it's not that they even care too much about this disproportionate concentration of returns in the S &P 500, et cetera.

22:09If you read what many people at the Federal Reserve talk about, the wealth effect, et cetera, They basically think that these are, let's say, acceptable side effects of what is, in essence, a policy that ultimately does help the economy. I would disagree with that, but that is the narrative. So you cannot change that. You cannot change something that has been driven by monetary policy. No one can argue that the rise of the multi-megacap giants in technology has been a direct consequence of easy money. And if they do, well, obviously, it's easily debunkable. But it's impossible to unwind now, no?

22:59Because the perverse incentive exists. We are already seeing it in the markets. you get a bad jobs report, or not even a bad jobs report, but a lackluster jobs report, people start buying like there's no tomorrow. Why? Because they're expecting easing. And obviously, as I said before, monetary policy disproportionately benefits the first recipient of money. And those are obviously those mega cap giants. Yeah, this is back to the 2008 era of bad news is good news, good news is bad news, weirdness that we saw. I can't resist asking you one more long-term question as you think about these markets and where we are right now.

23:40One of the most interesting features and probably the most durable in terms of my career watching markets, if you go back to 1981, probably before most of our viewers were born, you saw 10-year treasury yields peak out at around 16%. That has gone down, obviously, along a 40-year curve down to whatever it was, I guess, call it March or April, whenever the low was, maybe July of 2020, down to about 50 basis points. Now, obviously, a significant snapback effect, 4.653 right now on 10-year yields. What is the implication for this rise off the bottom? I mean, it's literally been a generational or multi-generational period where we've seen this massive bull market in US treasuries, the subsequent decline in yields.

24:28And now, as you point out, Daniel, there's this significant debt bubble, and you have rates rising. I mean, this is an intergenerational shift. It is. And we've had, as you very well pointed out, two generations of traders that have seen nothing but rate cuts and monetary easing. and monetary easing exponentially increasing to improve the need. What are the implications of this? It's that the 60-40 portfolio is gone in a nutshell. The 60-40 portfolio will not work, because the correlation between bonds and equities is so aggressive, because of monetary policy, obviously, that when rates are rising and the economy is slowing down, bonds don't protect you, sovereign bonds in particular.

25:26And in the periods of super-runs, that's when obviously, because you have negative real rates, when bonds and equities move by expanding multiples, Bonds become more expensive, and equities see multiple expansion. So I think that basically that's the problem. The problem right now is that there is a multi-generation view of what would be the ideal portfolio that is being destroyed by years of aggressive monetary policy. And that, to me, is the biggest problem. 2023 was supposed to be the year of bonds. Obviously, it isn't. High yield bonds are doing adequately, but that's it, basically. And that obviously creates very significant shifts in the way, will probably create very significant shifts in the way that people perceive risk.

26:24I think that many people are starting to think, and not incorrectly probably, that there's less risk in an alphabet stock or something like that than in the 10-year bond of Italy, for example. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

26:54Listen, let me pivot here just a little bit, because this is part and parcel of everything we've been talking about, which is where we are right now with inflation. I want to point specifically to a conversation with Alex Girovich and Harriet Melandri on the Real Vision Essential platform out today. Maybe we could take a look at that clip. Many people say, well, inflation came down sharply from like whatever 9 % to 3 % or 4 % because of just unwind of those supply chain disruptions. It means nothing in terms of actually taming core inflation. That's what the inflation camp says. But to that, I will answer just as we saw that it does not matter for what reason inflation came up in 2021.

27:35It's not going to matter for what reason it came down in 2022. It will create a secondary disinflationary effect. When the real rate is going to go from, and it already went, from negative 9 % to positive 2.5%, that will have effects. which not only we don't see yet, we could not possibly see yet. That's why I'm kind of totally flabbergasted. Even Powell talks about this. And honestly, when I hear people talk about economy resilience to interest rates, I think I'm in the house of lunatics. Because when people say things like economy withstood the rising of interest rates, I'm like, what planet I'm on?

28:15Because we don't know. It's not that they did or they didn't. How can we possibly know? That has not happened yet. Like Powell, even in his last speech, he talked about raising interest rates by 75 basis points in first half of 2022. So, yes, they raised interest rates to 3 % when inflation was 9%. So they contracted real interest rates from negative 9 % to negative 6 % in a huge hurry. How is it supposed to be crushed the economy if you still have negative real interest rates? It only became positive a few months ago. Daniel, Alex Kovic right there on the causes and effects of inflation. Any thoughts?

28:56I think Alex is absolutely right. The idea that we know how the rate hike process is going to play out is ludicrous. It makes absolutely no sense. We have no idea of what the rate hike process will damage because we don't know the lag effect. We have no idea whatsoever of what is going to be the ability of the real economy to accept those higher rates. And being way too optimistic, way too early about having the ability to sort out a process of interest rate hikes without breaking anything makes no sense. I think that monetary aggregates tell us a lot about that, in fact, and they're plummeting.

29:47All right, we've got lots of questions coming in from our viewers here today. Since we're running short on time, we're going to do a quick speed round. Apologies for the shortness of the answer. I know Daniel could answer each one of these questions at length, but I just want to get through as many of them as we possibly can. First one comes to us from TrillionX Macro. Daniel, won't you think we are heading into a stagflation rather than a recession, and therefore gold rather than bonds is the anti-fragile asset to hold? Thoughts on gold? I completely agree that gold is the anti-fragile asset.

30:20If you're looking for decorrelated assets to have in your portfolio, you need to have gold, not bonds. I agree with that. Okay, speed round question number two. Marty F., what signs do you see that money is coming out of the system, Daniel? Well, follow monetary aggregates. They're very, very clear. Unfortunately, Unfortunately, the United States doesn't publish M3 anymore, but follow M2, follow M1. And there are a number of very good analysts out there that make a proxy of M3 as well. So follow monetary aggregates. They tell you very, very clearly. And loans and leases that you can see published by the Fed as well.