Unraveling the Liquidity Cycle with Raoul Pal & Darius Dale

0:00If you've been considering futures trading, now might be the time to take a closer look. The futures market has seen increased activity recently, and Plus 500 Futures offers a straightforward entry point. The platform provides access to major instruments, including the S &P 500, NASDAQ, Bitcoin, natural gas, and other key markets across equity indices, energy, metals, forex, and crypto. Their interface is designed for accessibility. You can monitor and execute trades from your phone with a$100 minimum deposit. Once your account is open, potential trades can be executed in two clicks. For those who prefer to practice first, Plus500 offers an unlimited demo account with full charting and analytical tools.

0:45No risk involves while you familiarize yourself with the platform. The company has been operating in the trading space for over 20 years. Download the Plus500 app. Trading in futures involves the risk of loss. It is not suitable for everyone. Not all applicants will qualify. Hey, everyone. If you like this podcast, go behind the paywall to get privileged access to the smartest minds in finance. Visit realvision.com slash RVpod and use the promo code podcast10. That's podcast10 to get 10 % off our essential membership for the first year. Join the Real Vision community and learn how to become a better investor.

1:24And now to the top analysis of today's markets.

1:34Want to know why the markets are ripping? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today, RV co-founder Raoul Pal and Darius Dale, founder of 42 Macro. Hi, gents. Hey, Maggie. How are you? Hey, Maggie. Friday. Cheers. Yeah, we're having it's a pink Friday for both of us today. It has been across the board on Real Vision today. It's very weird. Darius and I were just talking about it. Wardrobe, drinks, everything. But I like it. It's optimistic, and I like that. Okay, everyone's really looking forward to this. We've got a ton of people in the chat. Before we dive in, though, a quick programming note for the regulators.

2:09You know, today is extended daily briefing. So we're going to go for an hour. We're going to take a ton of questions, but you have to be a member to stay past the half hour. And that's probably where we're going to tackle a lot of the questions because you want to hear what Raoul and Darius are thinking first. So if you're not already a member, scan that QR code, get on a trial so you can participate. we have the best community in the world. Just today, we did a live academy sessions where our members came on and asked Roger Hurst questions and figured out how to apply some of the lessons we cover in the academy and the masterclasses in the real world.

2:45It was a great conversation. I mean, the level of experience in this group is ridiculous. And a big shout out to Sean, Stephen, and Christopher, who were amazing today. I know a lot of them are listening or in the chat. Really appreciate you. If you missed it, you can catch it on the platform on Plus. So be sure to look out for that as well. And Raul, you and I just came from Elaine's Degen Happy Hour. Some of those folks are in this chat too. I did the Elaine's Happy Hour, which is always fun. The Degen Happy Hour, talking about NFTs and crazy stuff of which nobody understands what's going on.

3:19Straight into watching the Academy sessions, which was really fabulous. I mean, one guy did the opening trade on the S &P 500 futures. He's a Real Vision member who was at Bear Stearns for years, a trader. The other guy's a bond fund manager. The other guy's a technologist, got his own company, but loves options. I mean, I just love this Real Vision community. All sorts of crazy people there. Just such talent. I know. It's amazing. Christopher is amazing. And those of you who are on our platform chat, you know him, so you can put a face to the name. It was so fun today. So, yeah, it's amazing.

3:52So we want to do that same thing here, right? We want to make it interactive. We want to dive into some of these questions that you've been asking every day as we're watching the daily briefing. So we're going to put it to Darius and Raoul. But I want to start first. So we had a stronger than expected jobs number. Stocks are ripping. Everyone's wondering what's going on. Debt ceiling crisis over. But now questions about what happens next with interest rates and some concerns around that. So can we have each of you start by sort of laying out your overview, just a quick overview of how you're thinking about the economy and the markets right now?

4:27Raoul, why don't you start? So my general view is from the work that we do at GMI, I think the market's priced in, and I've talked about this many times, a recession last year. So the year-on-year rate of change, I'll show the chart later, of the NASDAQ got down to expecting the ISM to get to 37, deep recession. So we're on the backside of that as future liquidity is increasing. But also, you know, a simple thing is if you go back to 2018, the moment the Fed paused, the markets ripped. I've always said, you know, after you've gone through a whole miserable year like last year, and you've got things like technology that's advancing, the narrative kind of builds and builds and builds.

5:08And the Fed take their foot off the beach ball and it's underwater, it explodes higher. And so you've got this kind of crazy disconnect where people can't get their heads around why the markets are rising. And it's both a matter of, oh, finally, we can own equities and take some risk again. But also, there is an underlying forward-looking element of the liquidity cycle and the business cycle that's priced. We're still in the downside of the business cycle that Darius and I will both go through in a bit. But markets often like to look forward somewhat. And that confuses people. People always look at today as the snapshot.

5:40Today's actually never the day. Today's news is not the important news. The important news is what's going on in the forward-looking stuff. Darius, what about you? Absolutely. So I agree with probably 90 % of what you said, Raoul, and then we can obviously unpack the other 10%. But in terms of focusing on that 10%, we would say, yes, we very much agree. Market's going to continue to squeeze bears to the high heavens. We don't believe that we've seen the ultimate lows of this market cycle. We may retest the lows at some point. We're very much of the view that we did not price in a recession last year.

6:11where we actually priced in, in our opinion, was the change in the liquidity cycle. Obviously, the liquidity cycle has evolved a little bit since then. So it's created some obviously positive trading conditions. But we don't see that as a durable inflection in the liquidity cycle. We still think that durable inflection is ahead of us. Therefore, we still see, you know, maybe in two quarters time, a significant amount of market risk associated with pricing in the lows of the business cycle. So you think, just to clarify, so you think there's another leg lower, either a retest or a new low to come out of the markets overall before?

6:45And that will be Q3, Q4 this year? No, no, not as soon as that. No, we do believe there's probably going to be weakness this summer, which is also something we can unpack because of the changing liquidity landscape over the next few months. But that's not what I'm really worried about here. Because I do think we'll recover and rally from whatever low we reach in the summertime. From whatever peak we reach on the other side of that this fall, I do believe the markets are going to have to start to price in the actual credit cycle associated with the liquidity drain that we've experienced in 2021 through 2022.

7:15And that, in my opinion, again, to put a banana to my head, I don't have a crystal ball, but a best guess scenario based on our business cycle timing models suggests that that process should start sometime in Q4 or sometime in Q1 based on the modal outcome and the second highest probability outcome of when a recession is likely to commence. So one of the things I'm going to jump in for a second. One of the things I love is that you're putting timeframes to this because that is really important and that is often what trips people up and they think everyone has these contradictory ideas and it's really just they're operating off a timeframe.

7:47And Raul, you and I talk about this all the time. So we have questions and people are enthusiastic. Some of these questions are a paragraph long. So I'm going to tell you what. I'm going to dive in the chat. I'm going to step out for a second. Liquidity is key to this. This has come up almost every day. Raul, you've been posting stuff on the platform about this being so important. And Darius, I know it's central to what you're looking at as well. You just mentioned it. Can you both go back and forth a little bit and dig into that? And people are already asking you to do that. And start out, please, also explaining by what you mean.

8:20We've got people on different parts of the journey here. So what do you mean when you're throwing that term around? And then can you talk about where you may agree? And I don't know, maybe some places you disagree. Darius, kick us off and I'll step out and jump in in a minute. I'm going to jump in the chat. Yeah, absolutely. So I'll just be real quick and then we can unpack any of the summaries later in the presentation. I'll just be real quick. So in terms of how we think about liquidity, we think about sort of just the unencumbered money sloshing around a financial system that can be used to speculate in asset markets.

8:48Obviously, the central banks are a major player that commercial banks are a major player that primarily through the repo market. And obviously, central banks can also be a secondary player in that primarily through their FX reserves. So we've created a proxy both for the global economy but also for all the major economies in the world that includes the central bank balance sheets, the FNR money supply, and FX reserves minus gold as a sort of catch-all proxy for liquidity. And that catch-all proxy on a global basis has a 0.94 R-square with the S &P since 2009, has a 0.86 R-square with Bitcoin since 2009, which obviously is pretty remarkable given how aggressively Bitcoin tends to trade.

9:25And so these things are very big drivers of asset markets. I think you obviously very much agree with that. One thing that we think that's sort of a buggy man with respect to the media term liquidity cycle is the return of Uncle Sam to international capital markets. We have not issued debt on a net basis since January in terms of the U.S., and that's going to be an issue regardless of how Janet Yellen decides to refill the TGA. And secondarily, we don't believe that we are at a durable positive inflection of liquidity cycle. But we did bottom in October, very much agree with that point. However, the process to getting to more and more liquidity, like an unimpeded rise in liquidity, we have not met those landmarkers yet.

10:04So we can unpack any of that later in the presentation. 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.

10:19Have 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.

10:52With 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.

11:20Perfect. What I will do, because this, firstly, just talk about the definition of liquidity, and then I'll come on to a bit of my work and how I frame some of this. And you've not seen, in fact, I've not shared with anybody apart from GMI members. So virtually nobody's seen the everything code. They've heard me talk about it. But what I've kind of unpacked within this is, yes, liquidity, the regular styles of liquidity, but there's the different style of liquidity, which seems to be the Fed balance sheets that I think is a debasement of currency. So But all assets rise versus the denominator, which a lot of people can't get their heads around.

11:54And so optically, everything goes up. So I started using a different denominator to look at asset prices. Like the S &P has pretty much gone nowhere since 2012 if you use the balance sheet. In fact, real estate, gold, S &P 500, nowhere. While NASDAQ, crypto, up a lot. With NASDAQ one, crypto the other. OK, because they're both secular adoption curves of technology. So you can understand why it does it. So that's the difference I've got with liquidity to most, this debasement idea. And that has a very different, profound impact in the everything code. And I'll send it to you, Darius, because it's like 18 years of work.

12:34And I got to, I think, I think it's a thesis. It's a hypothesis. But I think I've got to figure out why it happens. which is, I think it's to do with the monetization of the interest payments of every of the major governments every three and a half years, which is between the three year and five year average duration of their debt, which has made the ISM completely cyclical because everybody reset interest rates to zero. We had a global, I only realized this recently when I wrote the article. In fact, after I wrote the article, the global reset everyone's worried about or wanted or thought about happened in 2008 when all rates went to zero was basically a debt jubilee yeah it was there's no jet there's no payments at that point so what's happened since then the refi of the debt has created cyclicality and i figured out and i'll show you the chart which i've never shown outside of gmi so far i'll show it in a minute is that the interest payments exactly mirror Fed balance sheet growth.

13:35And I was like, holy shit, I discovered this by mistake. And I'm like, holy shit. And then it went down the rabbit hole that I then did the same for the UK, Europe, Japan, and they're all the same. So they're all monetizing their interest payments. So that's what ends up in the balance sheet plus any banking crisis, right? So that's the extra delta that adds on top. So then I started looking at it and realizing, I think I've got a forward, I can look forward on the monetary cycle in this way because we've got forward-looking indicators. Now, are they going to hold all that stuff? Who knows, right?

14:11But I think I can look forward, and I think I can look forward to that until end of 2025. And because our weekly liquidity index gives us a 97.5 % correlation with the S &P 500, NASDAQ as well, we can put prices on assets going out to 2025. Now, I won't show them here because I don't want everybody to go, Raoul's predicting this, because you know what it's like. We got a thesis. We don't know. But anyway, that's what I got to with all this. I'm going to show you some of the charts because I think you'll find them interesting anyway. And I'll go through some of your stuff to see the difference.

14:44So let's see if I can share this now. And quick question before you even share your charts. When you say they were monetizing the interest payments, are you talking about economy-wide interest payments or just on the public sector balance sheet? um it is just it's the government balance sheet only and the reason being actually this is a really important point thank you for the question why is this happening all the major governments got to 100 of gdp and debt except japan which is 260 whatever it is so when they get 100 of gdp in debt, most of their private sectors are about 100 % of GDP in debt, more or less.

15:26So if interest rates are at 2 % and GDP is growing at 2%, I think of GDP growth as your income to service your debts. It is. So therefore, the government crowds out all of the private sector just by its interest payments. And in which case, the economy will keep shrinking by the amount that the private sector has to pay. So what they've done is removed the government interest payments. So then you've just got the corporate sector. And that is why, it's one of the reasons why it ends up on the balance sheet, but GDP is slow because we've got these gigantic interest payments. Because as you know, nobody pays off their debts.

16:05They just keep adding to it and refining it and it keeps going. So that's what I kind of figured out. I'll show you some charts of this. But yes, it's the reason that that's where the government can do it. It sticks it all on to not crowd out the private sector, because if not, everything blows up. So here's some of the charts. So here's we found and you're familiar with this is we found that the rate of change is actually probably more important. Agreed. Overall. But, you know, the overall trend of liquidity works very well as well. We both get high R-squared from doing this against multiple assets.

16:40So here's our weekly global liquidity. This is the G5 central bank balance sheets, this version. We've got some monthly ones. We've got various different liquidity indicators, but this one works extremely well. So we have a financial conditions index, which is based around the rate of change of the dollar rates commodities. And that started picking up. This is where we picked up the low. It actually came in June when we picked up the low in Ethereum. and then we confirmed by about October as actual liquidity started changing. So that's when we started getting more aggressive on our technology bets and crypto bets.

17:15It has a five-month lead over global liquidity. So this, and again, this is time horizon. I'm less focused on where we're going in the short term. It could be TGA stuff, whatever. We're not looking for exact matches here. We're like, directionally, what happens? So directionally, this is suggesting, and this indicates it's been pretty good for asset price and everything else. I'll come on to that in a sec. The ISM leads it by 15 months. And the reason being, which is weird, is because it's so perfectly cyclical. So each previous cycle looks like the next cycle. So we found that. Now, will this be persistent?

17:54I don't know, but I think it will be. So it's suggesting that forward-looking liquidity is going to go significant into 2024. Here's the chart that I've not shown anybody yet. This is the Fed balance sheet versus the interest payments leading by 36 months. And this goes back all the way back to the beginning of QE, and it's amazing. um now it's suggesting now should be in the obviously we had this little spike from the from the banking issue now it suggests that it should be slowing down in its rate of change and eventually starts going up in q3 and c right this is we've never used this before as a forecasting tool but the correlation between this and the longer term version of this was pretty staggering It's like, holy shit, it's just 36 months delayed payments is coming on the balance sheet.

18:50So that's the big hypothesis. So there's the weekly liquidity outright versus the Nasdaq, which is the one that you'll suggest, OK, this is probably rolling over. Maybe the TGA sucks from this. We don't know yet. But look, it's not going up. But the Nasdaq is. That's got a lot of people saying it's decoupling from liquidity. however back in 2018 19 when the fed stopped it completely decoupled from liquidity then this is this beach ball effect so i'm like okay that's not unreasonable i get it and the year-on-year rate of change of liquidity and the nasdaq is consistent so i'm like yeah that's fine i can see why the Nasdaq could outperform at this point.

19:36Crypto in 2019 at its peak was up to 300 % and then came back being up 100%, pulled back for most of the back end of the year. So it's like, OK, fine. We can see that as animal spirits come back in, the year-on-year rate of change in liquidity. So I've been looking at that, that the Nasdaq is outperforming liquidity. This financial conditions index was the thing that gave us a nine-month lead where we think we are in the business cycle. So whether this is the exact match dates or whatever, but it suggests we've got one more blast lower below, let's say, 45 before we start basing. Now, as you know, the economy actually, GDP comes out a quarter later.

20:21So you wouldn't see these numbers and you won't come out of a recession, even though it looks like it's very v-shaped from this it suggests that you know obviously i think there's a lot of slowness to growth to come out of commercial real estate the banking issues a whole bunch of stuff meanwhile all we're saying is forward looking our financial conditions suggest okay things are on the rise and this leads the goldman one by about six months or so as well or nine months and that's what gave us this view on the nasdaq is the nasdaq had priced for us 37 in the ISM. So that was like, huh, OK, interesting.

21:03And that was where we thought from the financial conditions index, the ISM could go. So I'm like, OK, it seems fully priced. And most of the other asset prices were doing that as well. So that's where we got to roughly with our thinking with this. And that helped us get long at the right time. The other liquidity cycle we've used just simply because it seems to be a better fit on the year on year basis is global M2 seems to work very well for Bitcoin. And that turned higher. Obviously, we know the Chinese have been increasing M2. I don't know where it is, 12.5 % or so right now. And that's dragging this cycle higher.

21:35And I think probably global M2 goes higher. So again, not looking for the wiggles here, looking for direction. We've probably got a M2 cycle at play globally. So whichever major countries that's a part of, and that should drive crypto. So the other one I found really interesting, and I think I'd be the first person to have found this one. Here's the ETH Bitcoin cross. Now, this will make sense to you. You're a financial markets guy. You know, stuff like junk bonds work out well from the bottom of the cycle upwards because they're riskier. So the smaller, less liquid asset tends to do better. The ETH Bitcoin cross seems to be a function of the ISM, which is the money supply and the business cycle, which is really interesting.

22:19So it suggests we should be going into the Ethereum zone versus the Bitcoin zone. You just gave me a phenomenal idea, Raul. So most people watching probably know that I'm certainly one of the thought leaders on relating factor investing back to the macroeconomic cycle. This right here, there's a big project here with respect to factor investing in crypto and relating that back to the liquidity cycle and the economic cycle. Excellent work. And we've done, Julian, who works for me, Julian Bittle, has done some work on that as well. So we've managed to put together the macro allocation models. And it does fit in pretty well.

22:52The crypto cycle works. So we've found that that's a stop sharing. So anyway, that's where my head's at. It's a little bit different to most people's frameworks. It has a different look. But as I said, I won't come on here to talk about them. But it gives forward projections of NASDAQ. I mean, very high and crypto and everything, but it goes all the way out to 2025. And our top of the liquidity cycle, because we use the China credit cycle and a few other things to go further into the future, that still doesn't suggest we get to the year-on-year rate of change of zero end of 2025. So it feels like we're set up for a big cycle.

23:36Kind of makes sense to me because we've got a broken banking system. we've probably overhyped rates. We're going to have a sluggish economic cycle and, you know, and so in comes the cowbell. So anyway, that's my overall view. Sorry, the dogs are barking at somebody. 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.