Will Risk Assets Keep Rallying Into 2024?

0:00Join over 5 ,000 attendees for the largest AI event in Asia, Super AI in Singapore, February 28-29, 2024. Edward Snowden, Benedict Evans, Balaji Srinivasan, and over 150 others will hit the stage, joining the industry's most influential minds to explore and unveil the next wave of transformative AI technologies. Singapore will become a vibrant AI hub for a week from February 26 to March 3, with over 150 side events that will make for unparalleled networking opportunities. Visit www.realvision.com forward slash super AI for 20 % off tickets with the code realvision.

0:56Welcome to Real Vision Daily Briefing. It's Monday, November 27th. I'm Harry Melandry from MI2 Partners filling in for the much better looking Maggie Lake. Maggie Lake. I'm joined today by Vincent Deluart, Director of Global Macro Strategy at Stonex. Vincent, how are you doing? I'm excellent. Very happy to be here. And I miss Maggie, but I'm very happy to be speaking with you today. I miss Maggie too. I'm just no replacement, really. I really am not. But I'll do my best. For what little I can do, I'll do it. So Vincent, Vincent, you were saying that if people at Real Vision know you, They know you as the inflation guy.

1:37And the question is whether inflation has reset to a higher level. Talk to me about that. Are you still thinking the same? Over the long term, yes, very much so. I think we are, you know, great reset. I'm not saying that in a conspirational kind of way. I'm just saying that rates, inflation, nominal growth were subdued in the 2000s, 2010s, and they have reset to what is really their more normal level where we should expect inflation of 3%, 4%, nominal growth of 4%, 5%, and as a result, long-term interest rate, I would argue probably above 5 % with ebbs and flows. I suspect we are in one of these ebbs where I'm not denying the reality that the CPI is falling and may continue to fall.

2:43I just don't believe that we will reset sustainably to, I mean, maybe we'll see a 2 % handle if we get lucky if energy prices cooperate, rate, but I don't think that that will remain over the long term. And really, the key data point is wages. And as long as we have wage growth in the 4 % or 5 % range, that means inflation needs to be in that range as well. So it's only wage inflation, which I agree with you, what I see seems to be consistent with inflation in the medium term being at more a 4 % to 5 % level. All the wage settlements I see from the unions seem to be pointing in that direction.

3:31And companies don't seem to have anything to push back against it. But why has that happened?

3:40I mean, a lot of that has to do with just demography, really. I mean, you have almost two boomers who are retiring for every Gen Z that's coming into the labor market. And that creates a squeeze on many professions, especially things like manual labor. Gen Z is highly educated. The prior generation is more into kind of technical trades. And then workers have a lot of bargaining power. So at the same time, we had almost no immigration during the COVID years and much lower immigration during the Trump years. so we're not getting these workers uh and then we're still feeling the the headwind from um the great labor arbitrage which to me was the store the greatest story of the past 30 years was that i mean you could you know basically cut 70 of your labor cost by moving your corporation to china uh and and and we don't have that anymore uh so we're going back to the world were before china which is a world where unions have power where um margins are a bit smaller and then employers have to share a bit more with with employees um and um yeah it's the big if you look at um work stoppages there's lots of strikes this past year it's the highest since the early 80s and then i believe that the more uh the more these actions we see the more we will see i mean there is a contagion effect, right?

5:15I mean, if you work at American Airlines and you see the United Airlines pilot get a 20 % pay raise, you would want one as well. If you are a teacher and the guy next door is a UPS truck driver and makes twice as much as you do, you're pretty pissed. You know, why have I gone to college? So, and I would argue from an economic standpoint, that's a great thing. I think many of the troubles we've been into in terms of debt and low growth and high asset prices owe to the fact that the middle class has been gutted in the past 20 years and workers' compensation has not kept up with health care costs, the cost of college and certainly not the cost of assets.

5:59So as part of this reset, we are resetting the relative value of labor versus that of capital. So, you know, I'd love, it'd be a much more interesting show if I could push back. But I agree with everything you said. There's not anything there that I would really argue with. So that leads me asking you questions about the trade. We got about 80 basis points of rate cuts priced for the next 12 months in short-term interest rate contracts. What trade should I be looking for over the next six months? So I used to get, you know, very, very angry and mad at the SOFR curve. Because my, especially last year, I mean, my expectation was there would be no lending whatsoever and trampoline lending.

6:49I think the last interview that I did with Real Vision and the curve was, you know, obsessed with pricing a recession yesterday, right? I mean, every time, oh, the Fed's going to cut, the Fed's going to cut. And it's not going to cut. I mean, nominal GDP was growing at 10%. All my indicators were suggesting the economy was not slowing down. So I would argue that disconnect is still there, but it's so much smaller than it was just six months ago. So I'm a lot less sanguine about it. But I still think if I had to take a position, I think maybe not the magnitude of the cuts, but at least the timing of these cuts is perhaps excessive.

7:28I think we're starting to price the first cut as of probably something like March. And then we have about 75 basis points throughout the year. I mean, I could see a scenario where, yeah, the Fed cuts by more than 75 basis points. It's not necessarily the magnitude, but it's the timing. March is probably too early. I mean, what's going to be that different in March from today? I mean, the labor market will not, it's very slow moving boat. It's not gonna, you know, we're still creating 150 ,000 jobs a month, pretty much. These things are not gonna go away in three months. I mean, it looks like, you know, we had a fairly good Black Friday or Cyber Monday, whatever they call it.

8:14Then we're gonna hit the vacation, the holiday period. So it's hard to see that the Fed would cut. And why should they? I mean, that's the part that I think is delusional when it comes to the bond market is, you know, if you're Powell, things look pretty good right now. I mean, you know, you've pulled out that soft landing. Unemployment is still very low. The stock market is almost a record high. The economy's, you know, inflation has gone all the way from 9 % to 3.5%. Why would you mess things up? Why would you change? Just if you didn't broke it, don't fix it. Hey, everyone, we're going to take a quick break right now to hear a word from our partners.

9:01We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

9:21trading 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. With a simple and intuitive platform, you could trade anytime, anywhere. Experience the fast, accessible futures trading you've been waiting for with Plus 500. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit us.plus500.com to learn more.

9:58Trading and futures involves the risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus.

10:10I suppose the counter would be that financial conditions are just not particularly tight. So in the same way you don't see a recession, I don't even see much of a slowdown. I made the mistake, you know, my wife being the clever woman she is, she managed to persuade me that driving to New York the day after Thanksgiving would be a good idea and there'd be no one else on the road. Turns out that wasn't true. And in retrospect, I looked up what was going on because it was a ridiculous journey. And there was a lot of shopping going. People were going to every outlet model. So if casual empiricism is worth anything, hint to the audience, no, it isn't.

10:54There's no signs of a slowdown whatsoever. So how does this story actually pan out on a medium-term, one - to two-year view? When does the Fed move, and what would cause that to happen? um well on the on the slowdown i i'm with you i think it's um it's a slow slow down uh if i may say so um i i mean we i think we get some we'll but again it's going to be very marginal but um my my timing is basically uh kind of the a three punch combo uh so the first punch is going to be next year some, and I'm putting air quotes here, but like some level of fiscal contraction. And again, we're still talking about deficits of 7 % to 8 % of GDP at full employment.

11:53So we're not exactly in Tea Party mode. But some things are going, at least if you look at the delta, the secondary, the fiscal impulse, the change in deficit, that's going to go from positive to negative next year. a lot of that is actually due to inflation dynamics right last year when we set our cost of living adjustment when we reset the income tax bracket for um filing taxes this was off this nine percent print of june of 2022 so the cost of living adjustment was 8.5 the tax brackets was raised by 7.5 now when we did this again this fall that was off this three percent print so you're going to get a much smaller cost of the adjustment, probably less increase in federal salaries.

12:41And then there was a bunch of kind of unique factors that led to the blow up of deficit, more money sent to Ukraine, which is unlikely to be repeated. There was also some sale of, I think, 5G auctions that did not go through. There was also the fact that Californians did not have to file taxes all the way till late October this year. That really pulled money away, required more borrowing. So adding all these things, I think we see modest fiscal retrenchment. And we're in a fiscal cycle at the end of the day. You know, it's not, I think we've moved from a monetary world to a fiscal world. And as fiscal slows down a little bit, I think you see a little bit of a sort.

13:24You may see this a bit more at the state level. One thing that I found interesting was that we had a surge in state spending last year. And in large part, that was political. In Florida, I think teachers got a 15 % to 20 % pay raise. In California, I mean, I'm unfortunately a California resident. California had a surplus in 2022, which is as rare as snow in Los Angeles. And we did what smart politicians do when they have too much money. They basically sent money. I had to fight inflation. I got a debit card with money on it to fight because inflation is too high. This is almost Latin America level style of politics.

14:09But of course, this was all because of the expected primary, right? Both Newsom and DeSantis in South Carolina, Nikki Haley, basically goosed up spending in 2003 in order to juice up the economy to run on this beefed up economy. Now in 2024, the money that was spent last year was not going to be there. So we're going to have modest contraction at the federal level and maybe a greater contraction at the state level. So all in, you get a little bit fiscal juice into the economy. I would agree with you, that's probably not enough to throw the economy into recession again, because even after that slowdown, we'll still have a deficit of GDP of like 6%, right?

14:49So that's just a tremendous amount of money being thrown at the private sector. So, you know, again, but we're coming off nominal growth of almost 10%, right? So we can slow significantly still without hitting that recession mark. So fiscal tightening in 2024, then we move on to 2025. 2025 is really the year where you finally hit these long and viable lags of monetary policy. If you look at the maturity of corporate debt, this is when your maturity wall hits. for most companies. Again, a lot of the bonds were issued during the 2020-2021 period. Average maturity of a high yield bond is about four or five years.

15:31So that's going to mature in late 2024, early 2025. And this is when companies' interest expense is going to reset, and it's going to reset significantly higher. As that resets, margins are going to go down. Companies are going to look to cut costs. Maybe that's when the labor market starts to slow down. You could also see the same dynamic with construction slowing. We already saw that today with the new home sales. I mean, one of the big surprises of 2023 is how well the restate industry has weathered the interest rate shock. Over time, again, this will happen. Eventually, people will have to, you know, the people are just holding on right now.

16:11I'm holding on to my house because, you know, I don't want to get this higher mortgage rate. well, but people get divorced, people die, people switch jobs. Eventually, prices are going to drop. Eventually, these rate buy downs by home builders will no longer be efficient. So, eventually, we'll see this kind of construction market slow down that could lead to job losses. Typically, there's an eight to 12 months lead between when you see the first losses in construction sector to the overall sector. So, that brings me to, again, late 2024, early 2025 is, I think, where a lot of these headwinds are going to come together.

16:49And then finally, more of the second half 2025 story is going to be the liquidity issue. For now, we've been able to withstand this foresightening and very large deficits based basically on excess savings and excess liquidity from the COVID years. We still had at one point almost two trillion reverse report facility. So if we drain that, there's no impact. eventually you'll run out of reverse repo facility. So we'll have to pick into bank reserves. And the question is how much excess bank reserve do we have? Nobody really knows. My best guess is from here, we have about a year and a half of excess liquidity.

17:31So that points again to this mid 2025 as a perfect storm when the economy kind of slows, we may be breaking something with liquidity and maybe we don't have the fiscal room to do much about it. You know, I would have suggested about mid 2025 as well. A lot of it's like about putting pins in things because you really don't know until it happens. You just got to game it out in advance to know what your plan is. But I'd have said 2025 because I've never seen a politician choose to tighten fiscal policy in the run up to a presidential election. And, you know, the Treasury Secretary, bless her, she seems perfectly adept and perfectly capable with very good advisors of running the same scam that every Treasury Secretary runs in a presidential election year, running that TGA up as high as it needed to go and then letting it all go in Q2 or Q3.

18:30And if they do that, that's just going to be one big stim hitting the market in the middle of 2024. then you have to ask yourself, when will politicians choose to try and wind back fiscal? And to me, you're only going to do it after you've gotten yourself reelected. You're never going to stand up and say, no, it's enough money until after that. So sometime in 2025 seems to me the obvious bet. And if it's 2025, the Fed will have to pretend to be hawkish. I don't think it is particularly hawkish because as you point, if you've got to run 7 % fiscal deficit, 7 % GDP fiscal deficits, how hawkish can the central bank be?

19:19So it's only then that there'll be enough headroom for the Fed to actually cut rates in response to what's probably going to be a pretty deep financial crisis by then. if we actually ever do see that kind of fiscal retrenchment. 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.

19:45You mentioned LATAM. You mentioned it in passing. I'd love to talk about LATAM. Do you have any thoughts about things that are happening in LATAM today? I mean, obviously, the big story is Argentina. And it's a fun story. I mean, listen, at this point, and I think that was the thinking of the voters. You know, how bad can it get, right? Let's give crazy a chance. You know, we tried Macri, you know, for a while. That seemed good. And he had the endorsement of the IMF. And he sounded smart and all that. and then he couldn't get inflation under control, he couldn't really kickstart the economy, then back to the old Peronista establishment, which has predictably been incompetent.

20:37So there is this new guy, he has a lot of ideas on a wide variety of topics, including organ sales and ménage à trois. on the economy. Who knows? Like I said, it cannot be much worse. It seems to me that the economy is already effectively dollarized. I read somewhere that I think one in$5 bills or even more than that for the$100 is somewhere in Argentina. So the dollars are already there. It's just a matter of getting them outside of mattresses and locks. That's a big business in Argentina. Just rent locks so that people can keep their dollars without facing the risk that the bank will take them away from them.

21:28So the money is there. I mean, if you can get people to be confident enough, there's a chance that it works. I mean, certainly, I think the odds of it working are higher than by reelecting the same people who crashed the Argentine economy for 63 years. I know you're an investor in Argentine bonds. You know, I'm what you might term irresponsibly long of Argentinian bonds, and for that matter, Venezuelan real estate. Those are the two ridiculous positions I own. I hear Caracast is booming, right? I mean, that's an inflation hedge, right? Yeah, so - How do you do that with, I mean, if you don't mind me asking?

22:14I did it via a private equity fund. And I know the guy would like me to plug him, but I think it's just kind of wrong to plug people. So if you want to know who I invested with, send us an email and I'll tell you. And I'm sure he's looking to raise more money. My logic for the trade, apart from, you know, I can lose money in every single really dumb way possible. So I wanted to try this too. But the logic was that the Venezuelan economy is very oil-centric. We've cut off Russian export for the global economy. There are oil refineries in Texas which are designed to take Venezuelan crude. Russian crude was an adequate substitute, but we can't get that anymore.

23:00At least it's more complicated to get that via intermediaries. So they were always going to relax sanctions against the Venezuelans and look for a deal. You can't have a war against Russia and a war against Venezuela simultaneously. So and if they did that, well, I was buying a really, really cheap market with a lot of oil. So the cap rates we're talking about are about 10 percent. And the actual valuations, you can buy office buildings in downtown Caracas in the good neighborhoods where you're much less likely to be murdered. and you're paying about the same price as a 5 ,000 square foot house in Andover.

23:45So that was sort of the reasoning for it. We'll find out in about 10 years if it was really dumb. A lot of my trades are really dumb. The Argentinian trade, though, has been quite gratifying recently. It turns out that lunatics with lots of hair winning elections can be really good for bond markets. Who knew? so you know what can i say he has a lot of hair i don't i just want to be him really um but yeah i i i think it'll probably be something a bit like the trump election where uh he can take power but he won't be able to govern so a lot of this will be moderated because he doesn't have the civil service on his side he doesn't have this so they'll try and do big possibly done things but they may not succeed and he intends to pay debts that he should probably shouldn't be trying to pay um so this stuff could rally further and we'll see but um i wouldn't buy it at these levels it's true what about on um on the corporate side i mean because i mean it's been a lot of companies have actually done quite well despite the and and they will continue to do you You know, Argentina is scraping along the bottom.

25:04It can't get significantly worse. It can get a lot better. If they're going to have a libertarian government, then the corporate sector will benefit from that. So, yeah, I can see things improving for the corporate sector. The thing is, I bought corporate bonds early in the restructuring process, and I've sold them since. So I'm no longer one of those things. They bought them at 30, 40 cents in the dollar, and they sold them at near par. You could buy, people are buying IPFA, you know, kind of. But whether I'd recommend it for retail, I don't know if I would anymore. I mean, it was a trade into the election because sentiment was so negative.

25:46And you know what? This is a really good point for broader assets in the US. We're entering year end. As you go into year end, there's going to be tax loss selling in US markets. There's going to be minimum distribution trades going on. And hedge funds are going to be right now in the process of clearing out their books for year end. So we shouldn't really expect U.S. equities or debt markets to trade particularly rationally. I don't know. And what do you think? Yeah, I would add to that target date funds. I think that's really been a factor in pretty much every major market moves that we have.

26:27when you see this rebalancing flows uh typically you see them at the end of the month another quarter i mean another year is of course the biggest one um maybe that's i mean maybe that's me just rationalizing my uh i mean i'm a bear steeple type of guy when company so i obviously had a very good august september um and then november has been a total disaster um you know So maybe some of that is, again, when Treasuries underperforms so much, you typically see, well, not you typically, anyone who has a fixed allocation, target allocation has to buy whatever underperforms and sell whatever outperforms.

27:11so some of these uh meaner version trades that would like that the rally of small caps for example or the rally of tlt um yeah maybe we can we we can throw story onto it but by the way the stories would be completely incompatible by the way because you know if you see you know small cap rally that would be kind of all higher nominal growth blah blah blah but then why why bond deals dropping at the same time so instead of like making up a story for everything that moves But yeah, I would go with more buyers and sellers. And as you described, some of these kind of non-fundamental driven year-round effect, which means that, yeah, we probably won't have a clear picture of where we are until early January.

27:58I would not read too much economic meaning in market moves.

28:09And, yeah, I think people will, though, because there's an industry that's paid to do that. What I hope happens, unfortunately, the problem is, you know, we have this kind of reflexive loop between markets and the Fed at this point. Always. Yes, but I would say even more so today because the Fed has explicitly said, oh, I'm not a hiking race because the tenure yield has done the hiking for me. Now the question is, is this reciprocal, right? Is this symmetrical? I think it should be. I think we've had monetary easing in the past month. and that would going back to our earlier topic kind of makes me doubt that Powell is going to cut in early 2025 when the market is rising when effectively I would say financial conditions have eased quite significantly in the past it's hard to avoid that looking at it when we have our internal debates in MI2 I argue that it's obvious the Fed doesn't want to do anymore.

29:28And I can kind of put together a case for why that's so. I think you've got a position where the microeconomics of higher rates is a kind of mailed check, which will eventually cause absolute havoc in the US financial system. It hasn't yet because neither the borrower nor the lender want to acknowledge these losses. So you're a regional bank and you've got guys who own buildings which are now worth 50 cents what they paid for them. Why would you acknowledge that? You'll take a hit on your capital thing. You've got no one to sell it to anyway. You'll end up managing it. No, you just pretend. Let's pretend it's fine.