Multiple models predict that the economy will enter recession by Q4 2023 or possibly as late as Q1 2024.
Credit is the lifeblood of the modern economy. Without it, nothing happens.
And right now, it appears to be contracting.
That’s likely to result in serious challenges to both economic growth and market prices.
Just how serious?
To find out, we’re fortunate to be joined today by macro and market analyst Darius Dale, founder & CEO of 42 Macro.
Darius Dale 0:00
You look at the Americas, specifically the US, it still continues to be on this sort of pre recession process. You know, we have a bunch of different indicators and tools that we use to track where we are specifically in the US business cycle. And that this sort of modal outcome from those tools suggests that a recession is likely to commence most likely sometime around q4 of 2023.
Adam Taggart 0:24
Welcome to Wealthion and Wealthion founder Adam Taggart. Credit is the lifeblood of the modern economy. Without it, nothing happens. And right now it appears to be contracting, that’s likely to result in serious challenges to both economic growth and market prices. Just how serious to find out we’re fortunate to be joined today by macro and market analysts, Darius Dale, founder and CEO of 42, macro. Darius, thanks so much for joining us today.
Darius Dale 0:55
Adam, it’s a real pleasure to be here. Thank you for having me.
Adam Taggart 0:57
Thank you. The pleasure is all mine. For your work for a long time, been wanting to have you on the program for a long time. So glad you were able to join us today. Look, there’s gonna get a lot of questions for you based upon a lot of your recent writings. Before I dive into the specifics of those, though, let’s just start off with a general question. I like to ask everybody at the beginning of these interviews, what’s your current assessment of the global economy and financial markets?
Darius Dale 1:21
Well, that’s a that’s a loaded question. So where I’m excited, we’re getting started getting started hot. So I think you really do have to separate the global economy into into regions into geographies? In order to answer that question, specifically, and accurately, we’ll start with Asia, namely China, very much coming out of COVID. Zero, we’re very much on track and you’re seeing the recovery, whether it be through a variety of high frequency indicators, some of the leading indicators continue to suggest that the Chinese economic Upswing is likely to continue for at least another quarter or two, when you transition to Europe, Europe seems to be recovering from the worst of it sort of, you know, kind of energy crisis doomsday prep, if you will, in the second half of last year, it’s sort of following along or tagging along with the kind of uptick that we’re seeing in global growth are in Chinese growth and really Asian growth. And then lastly, if you look at the Americas, particularly the US, it still continues to be on this sort of pre recession process. You know, we have a bunch of different indicators and tools that we use to track where we are specifically in the US business cycle. And this sort of modal outcome from those tools suggests that a recession is likely to commence most likely sometime around q4 of 2023. And so you know, ultimately, we do believe that the US economy is going to drag down global growth, you know, particularly as credit contracts as the lagged impacts of monetary tightening here in the US really catch up. But for now, we’re kind of in this, you know, I wouldn’t necessarily say Goldilocks, although we did make a transitory Goldilocks call back in January. So I think I think it’s continuing globally. But ultimately, it’ll all fizzle out in a quarter or two.
Adam Taggart 2:55
All right, great. And when you say it’ll all fizzle out, when the US goes into recession, if your your forecast is correct, do you think it will eventually bring the rest of the global economy down with it into recession? Because you mentioned that Asia is powering higher because they finally come out of lockdown. Europe’s was in the deepest hole imaginable. they navigated to dig out of that. But do you think that those recoveries in those area that worlds are short lived and will follow the US? Or will the US go into recession on its own? Yeah.
Darius Dale 3:26
So I mean, there’s two sort of ways to answer that question, which is, you know, is the US going to slow fastly and sharply enough to cause that problem? I think the answer is yes, at least according to our models. And then the second answer is, are those economies going to do something to offset that process? We saw in 2009, or, you know, the China come out with a big bazooka, they actually did it again, 2011 2016. And what I mean by bazooka is is large scale fiscal and monetary easing. It’s very unlikely we see that in this particular cycle, for a couple of reasons. One, the PBOC, or the net, BBC, the Chinese authorities, Beijing, they’ve identified their GDP target for 2023 is 5.5 5.5%. Actually, it was 5%, the street headed at 5.5, it actually came in as shy of that estimate. And so we’re already tracking it 4.5% On a year over year basis, in q1 of this year, we have the Chinese GDP numbers, I want to say a week or two ago. So we’re almost 90% of the way there. So it’s very unlikely, we’re going to see that, you know, the the Beijing really kind of pull out all stops as it relates to fiscal monetary stimulus to support the Chinese economy in 2023. And I do believe that as they start to, you know, really feel the impact of the US slowdown, you know, namely in q4, and really into the early part of next year, they will start to respond. But as it relates to the medium term outlook, you know, next week, I’ll call it two to three quarters, very much unlikely that the, you know, the rest of the world is going to be able to say unscathed relative to what we’re seeing what we have projected for the US economy.
Adam Taggart 4:51
Okay. I do want to talk to you at some point too, about what the Feds own response is going to be to this recession and what Yeah, Wanna get loose? Last question about Asia before we leave, which is, you mentioned, we’re not likely to see the same scale of response, potentially, as we saw coming out of the global financial crisis from China. You gave some reasons. But I, what I’ve heard, too, that I just want to get your feedback on is, China didn’t really have a lot of debt back in 2008. And a big reason why it was able to become such an engine of growth that kind of helped pull the world along with it. In the decade that followed, the global financial crisis was its embracing of debt, which it seemed to have done, you know, with a lot of gusto. And so now, it’s got a lot more, you know, a lot more of a debt burden this time around. So it may not be able to do the same kind of, you know, debt driven spending that that goosed the global economy last time around. Would you agree that that’s, you know, an important factor here? I think
Darius Dale 5:59
it’s 100%, an important factor, and I don’t think it’s that they can’t, is that they are they recognize the perils of doing so. I mean, if you look at, you know, so we run a variety of different models at 42 macro that sort of try to identify with the propensity of the policy responses, whether it be fiscal response, whether it be the monetary response, and not only do those models suggest that, hey, look, they probably should be doing more, but then you continue to get guidance out of Beijing that suggests, hey, President Xi, outgoing Premier Li Cushing, PBOC, Governor Yigong are going now. There’s so many people in China at the top brass that are all sort of coalescing around this idea that we don’t really want to go down that road again. Right. And I think going down that road, again, you know, kind of is History is littered with perils of, you know, economies that have gone over, you know, beyond the point of no return from the perspective of private sector leverage. And I think you can realize, in China, you know, the incremental dollar value, get out of any incremental dollar of debt from a GDP perspective, or a corporate profitability perspective, or any metric that really is very relevant to an investor, you know, those metrics continue to get lower and lower and lower. And I think that brass and China very clearly realizes that, and they very clearly, you know, shying away from that, if you look at their GDP target for 2023, at 3%. You know, that’s only a modest kind of downtick, from a budget deficit perspective, relative to where they were last year when they were mired in zero COVID People are getting pissed off. And so you know, both from a fiscal standpoint, and from a monetary standpoint, you have Beijing very much sitting on his hands, you know, kind of, you know, accepting the fact that Chinese growth is now structurally lower. And you know, GE would take that as a victory because when he wants quality growth, right, we’re sort of used to as American investors in quantity growth go by base metals, they’re about to build a bunch of stuff. They’re like, now we actually want people to hop on planes and go spend money at shops and restaurants and businesses. And so that’s kind of what’s happening right now. I think that transition is very much underway.
Adam Taggart 7:52
Okay, thank you. So just to recap here, you see us is sort of in pre recessionary state, we’ll call that kind of, you know, slowdown, we see Europe as is having maybe some more anemic growth, but it’s better than where they were last year, we see China coming out more strongly from its lockdown. But as the US falls into recession later this year, likely to see it, pull those other two economies down with it, and then 2024 will be okay, the year of alright, what are they all going to do in response?
Darius Dale 8:22
Yep, I agree with that. And before we move on to kind of from this part of the discussion, I think it’s important to sort of unpacked the US in a pre recessionary stakes. I’ve listened to your previous guests. Yeah, yet, Michael Kantrowitz on with this brilliant hope model. But that was an excellent episode. Obviously, my buddy Alfonso pika TLO is longer session views. I’d like to share ours as well, because they do attack this problem from a timing problem set so that I can share my screen here, one of the so I updated our monthly macro scouting report presentation in preparation for this meeting. So every month we put out this presentation for our client base. So usually about 100 slides, it kind of covers our modal outcome views, it kind of expands upon what we think of the left tail risk, and the right tail risk to those modal outcome views. And with respect to some of the left tail risk views, you know, we’ll walk through and I won’t spend too much time on this, but we have a variety of different indicators that we use to sort of identify where we are in the business cycle. I think I think Kantrowitz is hope framework is extremely instructive. It sort of gives you a kind of efficient now cast of where we are, what we’re trying to do is actually forecast where we are. So we can actually make these pivots in our portfolios on a proactive basis, rather than a reactive base. It’s not saying that Kantrowitz is being reactive, but certainly I think you having a little bit more foresight might be somewhat helpful. So
Adam Taggart 9:39
I think Michael would agree with that comparison to I love that his is more of a Nowcast yours is a forecast. Yeah,
Darius Dale 9:44
totally, totally. And again, it’s phenomenal framework as someone who builds quantitative models for a living. I’m a big fan of his his hope framework. I just wanted to expand upon it with some of the tools that that we use with our with our clients. So I’ll start with our inversion of the three month 10 year Treasury yield curve You know, we’re at minus 160 basis points inverted. When we sequence the, you know, this particular indicator relative to, you know, real GDP cycles, industrial production, payrolls unemployment, core PCE, what we’re trying to do is identify what the interval is that has the highest probability observing a GDP contraction or significant uptick in unemployment. And what we can find here is that the probability, the probability of seeing you know, both of those outcomes is actually in the 10 to 12 to 18 month forward interval, ie the probability of seeing real GDP contract from the date of the through a three month 10 year inversion, or you know, the probability of seeing a significant rise in unemployment rate from the date of the three month 10 year yield curve inversion. And so that would suggest based on the timing of this inversion, and October of last year, it would suggest a recession is most likely to commence, and the October 2023, to April 2024. Period, again, that’s the 12 to 18 month Ford interval from that inversion. The next model we use is the model that anchors on kind of where we are in the labor cycle, specifically, with respect to continuing claims as a percent of the total labor force. So that’s the red line in this chart here, where it might were 1.12, or present. And historically, we’ve gotten you know, we’ve gone all the way up to I mean, x COVID, at the cut off the chart, but you know, we’ve gone pretty high in this in this indicator, you know, in upwards of five to 6%, in previous recessions, cycles. And so what we looked at in terms of the same sequencing of events, you know, we we looked at as the monthly trough, in this particular metric, continuing claims as a percent of the total labor force. And right now with that monthly trough was in August of last year, where we’re also again, looking for the interval that has the highest probability of seeing a contract a significant rise in the unemployment rate or a significant rise in the in real GDP contraction. And that will seem to suggest that on the six to 12 month for bases, that that sort of it that are sorry, 12 to 18 month for bases, that’s kind of it, we factor in unemployment rate as well. And so that could kind of put you in the September 2023, to February 2024 time periods. So that’s October 23, to April 2024, September 23, February 2024. And so that’s kind of that’s to, you know, server two for two there, got a few more models here. And I’ll be quick, quicker. This model shows and the spread between the Conference Board consumer confidence expectations index minus the present situation index, and we’re minus 83. In terms of that, in terms of that deep negative spread. Well, as you can see, on the chart, you know, these deep inversions, the versions at all and this particular indicator, tend to coincide, or at least be leading indicators of a red bar recession showing up in the chart. And so what we’re trying to do is identify what’s the highest probability interval for a recession to occur, because again, it’s not just enough to say, Okay, we know a recession is coming. If a recession is coming two years from now, you could lose out on 35 40% Upside returns in something, right. So what we’re trying to do is make sure that we’re putting on the recession playbook with the appropriate amount of time ahead of a recession, so that we are not missing out on upside, when we’re allowing ourselves to take advantage of beta in the market. And so going back to this analysis, the data the trust rate, actually, is currently the trust rate is the most recent indicator most recent month. And what we look at, again, looking at, okay, what’s the interval that has the highest probability of seeing real GDP contract, unemployment rise, and that’s the six to 12 month forward interval. So again, that puts you in the October 23, to march 2024. Period. We also look at this through the lens of coincident and leading economic indicators, specifically the spread between consents and in leading economic indicators. So this is, as you can see, in the chart, chart data goes all the way back to the 1960s is one of the deepest inversions we’ve ever seen now that we can get into a whole tangent on okay, why is this thing so low? Some people seem to believe that, you know, hey, there’s so much going on from with respect to the leading indicator basket, ie the US economy is not as tethered to the manufacturing sector, as it once was, you know, certainly, as it was going back to, you know, to the earlier time period. Yeah, sorry, good.
Adam Taggart 13:58
No, I’m just saying, Yeah, it’s a different world today than it was in the 50s and 60s from US manufacturing standpoint,
Darius Dale 14:04
but absolutely a totally different world. And actually, just that I will finish up on this tangent, because I don’t like to leave the listeners hanging here, it is a totally different world. This chart here shows the percentage of manufacturing the manufacturing share of total nonfarm payrolls. And this line here, we only have data going back to 2005. Its manufacturing share of nominal GDP. And as you can see, I would assume the red line probably tracks the blue line over time if we had enough data for it, but we’re only at 14% of total non farm payrolls and 18% of GDP. So very clearly, manufacturing is not this, you know, giant, you know, noose around the neck of the US economy that it probably once was in these previous cycles. And that’s part of the reason why we see less red bars in our opinion, manufacturing is significantly more volatile than the services sector. And we know this was resequenced, you know, recessions through a variety of different indicators. Now focus your eyes on these two columns. It says manufacturing as a share of non farm payrolls. So that’s the blue line in this in that previous chart, but this this, this column, Here’s actually more important, it says manufacturing sector share of the Non Farm Payroll drawdown during recession. These are each of the recessions that we had going back to act one of the Great Depression. On a median basis, it’s 90% of the drawdown in non short payrolls. And so there are plenty of instances where manufacturing was greater than 100%, ie the services sector continued to grow, despite the contraction in manufacturing. So a lot of times in recession, what you’re effectively calling for, if you’re making a recession call is a deep depression and manufacturing, that may or may not spill over into the services sector, I happen to think both are likely to occur in this particular, in this particular cycle for a few reasons. But, you know, getting back to, you know, the timing, I think the timing is more important. Before we explain why. So going back to the leading indicators in Queensland economic indicators is inversion. When we look at the inversion, the date of that inversion was June of 22, we’re looking for the integral that has the highest probability of seeing a real GDP contraction from the date of that inversion going back to each of those previous cycles. And that’s a 12 to 18 month forward interval, that puts you some time in the second half of 2023. And then lastly, in terms of these models, we have the sharp rise and cyclical unemployment. So what I’m showing in this chart is a number of the total number of unemployed workers who have just either lost their job from being fired, or who’ve also completed temporary jobs. And what I’m showing in the black dotted lines in this chart, from the perspective of respecting the x axis, that’s what we’re trying to do here, Adam, I think the number one thing that I preach to our customer, our client base and ranges from, you know, trillion dollar institutions all the way down to Mom and Pop retail investors, they all receive the same information from 42 macro, but the number one thing I think I coach investors on is this concept of respecting the x axis, you know, not just saying this is going to happen, therefore, I need to put it up. If there’s a lot of time and space between, you know, the XYZ happening, and you putting it on, you’re subjecting yourself to a high degree of market risk in both directions, right, risk works in both directions, as always, relative to your existing your legacy positions. But going back to these, these, these blades, these black dotted lines here, what they show is the rise in the in this in this particular indicator, so we could go on employment, a 10% rise on a trailing three month basis off the cycle low. And what you see is that, hey, look, it’s usually in or just ahead of a recession. Well, guess what, we got one of these in March 2023. And so you look at the the, you look at the the integral that has the highest probability of seeing real GDP contract, or the highest probability of seeing the unemployment rate rise, it is the zero to six month forward interval. And so that puts a recession kind of in April 2023, September 23. So when you add up all this stuff, the modal outcomes suggest a recession is, you know, probably somewhere in the q4 range with a little bit of spill over to q3 and a little bit of spillover from a tail perspective, back into into q into q1 of next year. So I think that’s kind of like, you know, trying to time this whole situation, where you’re comfortable making the transitory Goldilocks call back in January, because we understood that a recession was going to be a second half event, if not a q4 q1 of into 2024. And understanding that, you know, we kind of understand that we still have a couple of quarters to kind of price in not a recession, basically, then eventually, we’ll get to that process.
Adam Taggart 18:19
That was super interesting and super helpful. Probably the fastest and most effective way for me and the listeners to find out kind of where your brain is, and how you got there. What I what I respect about that is not just the very data driven approach. And that’s why I love analysts like you. And like Michael Kantrowitz is, you know, you are not just a guy with a strongly felt projection, your projections are all steeped in a ton of data that you can walk us through, but is that you use multiple different modalities, if you will, or at least you’re looking at multiple different metrics by which you were seeing the data come to similar conclusions. And I presume that when you see different datasets, all basically still point to the same conclusion that gives you a lot more confidence that a conclusion is more probable in terms of happening, is that correct?
Darius Dale 19:15
100%. I mean, that’s, that’s the that’s the hallmark of being a good investor, or certainly a good research analyst. I think there’s a lot more on the behavioral side, you need to be a good investor. But certainly, as a good research analyst, it’s always about I mean, this is no different than, you know, writing a, you know, 20 page paper in college, right? It’s like, the more datasets you have the more you know, the proper hundreds of evidence, you know, liens in one direction, the more you know, authority you have in terms of communicating and expressing your views. I don’t think investing in you know, you know, I like to think that I create fancy book reports for living. It’s really no different than that in terms of just the contents of information that supports the conclusions.
Adam Taggart 19:48
All right. Well, I appreciate that. And I’m glad you mentioned the behavioral part because I do have some questions here at the end about that specifically, but let me ask you this. So you mentioned that you made the transitory Goldilocks call it the beginning of the year. And my presumption is you did that by saying, Look, we see some strong clouds out on the horizon. But our data tells us that they’re still far enough away, that there’s hay to be made. Now, in the markets, it’s not time to get out of the markets and give up potential upside. At some point, you begin to get into the zone where you can be in danger of we always like to say on this channel, picking up nickels in front of the steamroller. Right with a risk return just really isn’t worth it. Where are we right now, if you’re looking at, you know, something that could start sort of August, September ish of this year at the early side of things? Is, is the risk return still good enough to be fairly long these markets right now? Or when do you think we’re gonna cross the threshold to it not being worth it on a risk return basis?
Darius Dale 20:53
Yeah, no, that’s a phenomenal question. So we’ve been of the view that, you know, assets, like the s&p were likely to be range bound. And so you go back to the end of last year, right, December was disgusting. You know, it was a really nasty end of the year, you know, very clearly investors are, you know, de risking heading into that event. And, you know, we certainly were one of them, you know, we were definitely had been bearish since, you know, fall 2021. So, it’s been a long time, it’s actually quite taxing to be bearish. I’m sure most people get on here and understand, like, what
Adam Taggart 21:20
we hear that a lot in Sorry to interrupt, but but we have so many people, well, we have some people come on who say like, I’m so sick of being called a bear, because I’m not a bear. I’m just looking at the data. And the data is telling me to be bearish. I can’t wait until it’s telling me to be bullish.
Darius Dale 21:35
This is only 2018 Obviously, 2020 2018 2016 2011. Five times in my career, I’ve been bearish. I started my day, I started the business in 2009. Right after, or during, I guess, the global financial crisis. So, you know, kind of missed the making that call but you know, that’s neither here nor there. What I think, you know, in 14 years, I’ve been bearish five times, you know, and you know, and so it’s, uh, you know, I think it’s it, it does not pay to be bearish, generally speaking, you know, there are times when you need to use this and, you know, understand where you are, and things like the global liquidity cycle, the global growth cycle, etc. And these are all things that we track on a daily basis, I have 42 macro, understanding where you are, and when there is a certain setup that says, the risk reward for speculating in any, you know, risk asset is very poor. That’s, that’s where we were in late 2021. And that’s when you know, kind of how we made those calls back then, right now, I think the risk reward is a little bit more balanced, because you do have some positive dynamics that are supporting global risk appetite that was taking function of institutions at the current juncture, namely, the falling US dollar is a is a big driver. And what I think is driving the decline in the US dollar is this recovery in, in global growth. So I have a few charts on that as well. So we’ll start right here, we’re just showing a composite leading into indices for the US the Euro zone, UK, Japan, China, and the world. And what you can see here’s the Euro zone, composite PMI bottomed in late q4, we had the UK bottom and late q4 Chinese composite PMI is bottoming. If you look at on that sort of coincident basis, these are services PMI is is to the Americas, that Europe, Asia and kind of the rest of the world. And as you can see, Europe and Asia are very much on a cyclical upswing. Now, why is that bearish for the US dollar? The reason it’s bearish for the US dollar is because that rate of change in their economic output relative to our continued deceleration is allowing, you know, terminal policy rate expectations in money markets to compress. So what I’m showing in this chart here are terminal policy rates for the Fed ECB Bank of England and Bank of Japan, namely the Bank of Japan, starting with the ECB is the most important one. That’s this. That’s the red line in this chart here. What you’ve seen, really since the lows of last year, is a gradual upward slope in the spread between the Feds terminal policy rate and the ECB terminal policy rate. Now, again, why is that happening? It’s because markets are looking around and saying, Hey, look, the European economy is in a cyclical upswing. American economy is very much still in a cyclical downswing. And so the speed with which terminal policy and expectations are proving in Europe are actually is actually much faster than what we’ve observed in the US. There’s also another reason why we’re seeing such, you know, weak US dollar weakness in the context of this cyclical upswing in the Chinese and European economies. And that’s this sort of, you know, I don’t even know what to call this, but it’s to me, it’s one of the like, the biggest issues of our time, and will be an extremely positive development for risk taking on the other side of this recession. I think everything’s going to move on the other side of the recession, once the Fed acknowledges the recession, and does rate cuts and QE. Now, that’s a separate discussion that I do want to have before we go, but let’s talk about this for for now. Right now. It’s supportive. And what I’m showing in this chart is the net international investment position of the US that’s the green and red bars here. So the net international investment position for the viewers, that’s the total stock They have assets that foreigners foreigners claim on the US. So things that they own us real estate, US stocks, US bonds, etc, is the total stock of those assets. And what we’re seeing here is that this net international investment position doubled from right around $9 trillion to $18 trillion in the four years through 2024. Now this data is released on a severe lag. So we only have the data through 2021. But what it suggests to me is that, you know, this confluence of, you know, US growth being better than the rest of the world, interest rates going from, you know, basically three and a quarter in 2020 2018, to zero in 2020. And the US having the world’s dominant tech sector, you know, a lot of equity capital got flooded into the US as well. Don’t forget we overstimulated by orders of magnitude relative to what we saw in Europe and China throughout COVID. And so we grew faster, both from a GDP and profitability perspective as well. So there was every reason to just jam as much capital as you could into the US economy from the perspective of Asian and European investors. Now that capital start
Adam Taggart 26:03
sorry to interject here, but But are you familiar with? Brent Johnson’s dollar milkshake theory? Oh, yeah, absolutely. Big thing seems like a great example of that.
Darius Dale 26:11
Yeah, absolutely. He and I are very much on the same page for different reasons. I think, you know, with respect to Brent, I think we come at it from a more quantitative perspective. But I very much agree with his, you know, his conclusions that look, we’re not going anywhere, this system is not going anywhere, for a variety of reasons. I mean, if you look at the world’s outstanding stock of sovereign debt, of international borrowing, you know, it’s about $13 trillion, you know, 89% of that’s priced in dollars, whether it be debt bonds, or loans. It’s a It’s we’re going nowhere, the dollar is going nowhere without a big war,
Adam Taggart 26:43
without it. And his point is, when the world really gets into crisis, the the the dollar in the US markets become a real magnet for capital, because that’s where people, at least today continue to feel most confident about. And during the pandemic. That’s exactly what happened to these charts show.
Darius Dale 27:02
Well, I think I think what also happens, and I think Brent would very much agree with this as well, which is, when the world gets in a crisis, a lot of times, it’s actually because of the dollar system does.
Adam Taggart 27:14
Britain would agree with that?
Darius Dale 27:15
Yeah, the crisis is that we can’t find enough dollars, the Fed has taken them away, you know, the Eurodollar systems that created it, because there’s some stress on European bank balance sheet. So there’s some stress on Asian bank balance sheets, that’s, you know, kind of preventing the flow of capital, you know, not to go too much on a tangent, but you can make the case that there’s a little bit of stress going on right now, if you look at the negative spread. So I’m showing you this chart, the blue line here shows the reverse repo facility yield the Fed supplies to kind of put a floor on policy rates in terms of the Fed Funds floor. And then these various TBL maturities, the red line is the woman T bill, we’re minus 89 basis points in a one month t Bill below, which you can get for free by parking your money in that virtual facility. That’s a problem. And the reason that’s a problem is because it suggests that, you know, there’s a real scramble for what is the generally speaking the most pristine collateral in the repo global repo market, which are the shorter term T bills, it allows financial intermediaries people with the liquidity to lend it out on a more consistent, shorter duration basis, and ultimately ensure that they get paid back as opposed to you know, term funding on a three month or six month or 12 month basis. And so, you know, to me, there is some stress going on in the global dollar system doesn’t mean you need to run out and sell everything today. I mean, this probably look the same in like August Oh, seven. But by the way, you know, you didn’t have to worry about leaving until September Oh, eight. And so this kind of conditions can persist for a long time. But what ultimately means is that improvement in global growth that we talked about, you know, this dollar decline that we’re talking about, that’s a function of that improvement, in global growth, those things are probably longer in the tooth. Now, I’m not saying we need to run out and change the trends tomorrow. But I do believe we’re having this conversation, you know, six months from now, which, you know, maybe we should do that. I think a lot of this stuff might be very much in the rearview mirror in terms of dollar going down as a function of the uptake and global growth and as a function of the compressing terminal policy rate expectations, you know, particularly in ECB.
Adam Taggart 29:11
Alright, and let’s, let’s make an agreement to have that conversation six, I would love to be great. Okay, so phenomenal charts again, thank you for walking us through that. So right now, the markets are had been hanging in there. They’ve had a they’ve had a, you know, relatively strong start to the year certainly relative to 2022. Right. Yep. I’m gonna get back to that sort of nickels in front of the steamroller issue. So obviously $1 continuing weekend, we’ll be markets here for a little bit. There are some other things going on. And I do want to talk to you about sort of what’s happening with liquidity because I think that will come to bite markets. But real quick just to try to put a bow on this topic, as you are looking with an eye to the arrival of a recession in what we’ll call a quarter and a half ish, maybe, possibly to two, okay to do that give you enough time as a investor and a capital manager to still make enough of a return for it to be worth the risk, or is this the time to start basically, you know, lightening your load and moving towards safety?
Darius Dale 30:27
Oh, we’ve been so once we got to 4200, the s&p once we got to 30,000 on Bitcoin, we’re like, this is definitely the spot to be selling to take doesn’t mean you need to run out in short things. Because again, you know, you’re when you’re short, something, you’re exposing yourself, you know, to unlimited dropdowns. If something were to squeeze and run, you know, I don’t have a crystal ball that says the market is going to 4300 4305. And bitcoin is going to 32,000. I don’t know, I don’t understand that. But what I do understand is that at least particular price levels, you know, from a technical standpoint, looking at the chart of the s&p, or just from, you know, looking at a chart of Bitcoin, all these, you know, we have around a variety of different technical tools as well, this is just a good spot to start lightening up on risk in the context of our medium term views. Now, let’s say we go back to the lower bound of this trading range we’ve been in for a year, by the way, you know, the s&p has been in 3800, for more or less, you know, we had a brief touch above it in August terms of going above 4200, we had a brief touch below 3200 In October, but really since May last year, we’ve been bouncing around between 30 140 200 1300, if let’s say we get to 1300 by the end of May, which is actually what I expect, just get we have some apps and some differentiated views on on what’s likely to happen and liquidity terms only here specifically in the US as a function of tax receipts. And so we do have a view that the s&p is kind of in this corrective phase for now. But that doesn’t necessarily mean it’s the beginning of what we call phase two. Phase two, let me let me take a step back and kind of explain what phase two is. Phase one, when the Fed is tightening and sucking liquidity out of the system is what we call the liquidity cycle downturn. That’s where, you know, balance sheet central bank balance sheets are shrinking. You know, private sector, money is deflating, you know, you have interest rates rising, it’s just getting harder to sustain asset valuations. That’s what happened last year, you know, even bonds go down and phase one. Phase two, is when the credit cycle hits, we call it phase two, the credit cycle downturns. Phase one is the liquidity cycle downturn. Phase two is what happens when you take all that liquidity away, we start to have credit risk in the real economy. And phase two is the credit cycle downturn. So going back to this kind of 3800, to 4200 theme that we’ve been kind of oscillating around for a while now. I don’t think we’re going to break down below 3800. In the correction, I think we’re currently I think, if anything, you’d be, you know, covering shorts, if you’re an institutional investor, you’re covering shorts and getting net longer at 3800, assuming it’s here by late May, early June, because I don’t really see a path a probable path to price again, phase two, you know, that’s that quickly, you know, there’s still a lot of stuff that needs to happen from a reported data perspective, you know, particularly in some of the lagging, coincident lagging indicators in the economy, that might, you know, that will ultimately cause the, you know, the mood of the market, you know, because mood, you know, behavioral aspects of this, the risk taking the risk appetite is a big deal. Here, you’re talking about a face to credit cycle downturn, I don’t know that we’re gonna see enough degradation in the economy, to have the mood materially change to break us out of that rage, you know, I think what’s likely to happen is that we probably have another rotation back to 4200 by the summertime, and then that might be the one that you might want to sell. Don’t forget, markets aren’t as for working as we think they are. In fact, we you know, not to get too deep data on this, but you know, I guess I get paid to be a geek. Welcome to our grid asset market back test. So we back test every FX factor and macro that takes there’s hundreds of factors in our in our global back test. These are the summary of all the different indicator, all the different factors that we feature in our systematic kiss portfolio construction process, and we back tested through the lens of annualized expected returns percent positive ratio, volatility covariance, and we use this information to construct the expected Sharpe ratios for all these investable factors that we again feature in our in our systematic portfolio construction process. But the key takeaway I’m trying to make is, I’ve experimented with various leads and lags on these back tests to explain asset market performance relative to the economy. Here’s what I mean by economy grid is what we call our grid framework. That’s, you know, that’s how we score the economy through the lens of the rate of change of inflation that’s on the x axis here, and the rate of change of growth. That’s the y axis here, you know, very similar to kind of the Dalio framework, if you will. And so going back to this, this this back tests process the markets aren’t for looking they’re about as most one to two months for looking if you relate the rate of change of growth, ie the Delta and growth and the delta of inflation back to the Delta and asset markets, you know, asset markets on a levels perspective can be forward looking, but you know, generally speaking not but certainly when you look at on a Delta basis on a differential basis, now, asset markets are generally on The price again, the rate of change of growth, the rate of change inflation, at most with a kind of one to two at most three month lead. And so going back to this discussion on picking up nickels in front of a steamroller, what I’m not trying to do is get investors to pick up nickels in front of a steamroller. What I’m trying to get them to do is understand if you’re certainly if you’re a retail investor, is understand that, hey, you’re probably this is not the beginning of the new bull market. So we’re getting to these, you know, very exorbitant price levels and things like the s&p or Bitcoin, then you need to be taking down risk and accepting the fact that this is not the new start of the new bull market. If you’re an institutional investor, it’s understand that you don’t necessarily need to run out and put the full deflation playbook on because again, you’re institutional investor, you have a cost of capital, you have a cost of transacting, you have it there’s a cost to everything right. eyesight and so it’s to get you to align your your decision making, particularly if you’re on a pawnshop, you know, these sort of multi manager platform funds, you know, you don’t want to have a drawdown of you know, three to 5%. Because your position for a recession that doesn’t occur for six months, right, that stuff matters, risk works in both directions. That’s another important key takeaway from this
Adam Taggart 36:04
discussion. All right, super useful. Okay. So it particularly that point about markets really only being one to two months forward looking. Because I would say, if there’s been a frustration with I think the the average General Wealthion Viewer, it’s the fact that they have been watching the macro data degrade for quarters and quarters now, they’ve been watching the growing disconnect between what the Fed is saying it’s going to do, and the markets anticipation of a Fed pivot, and who knows what’s going to be right there. But the fact that they are still quite different. And there’s because of so much of the current data, it does not look like the Fed has reason to pivot anytime soon. Right. And so they’re kind of pulling their hair out saying like, but the market is has been in party mode for, you know, a good chunk of this year. How can that be right? And what you’re basically saying is, is their Outlook doesn’t really stretch long enough to see the same storm clouds that you do, they’re really just looking at, you know, the short term data that’s given them a one to two month view here.
Darius Dale 37:13
Well, you also think about this. Yeah, completely agree with what you just said, I would expand upon that. I say you have to think about who are the players in the market that are really controlling the market, right? You got Captain mutual fund, of which it’s really naff capital mutual funds, Mom and Pop jamming 401k flows into into into legacy mutual fund type assets. So that’s kind of one school of investors, those people haven’t needed to sell because they’re still gainfully employed, we still have a 3.5% unemployment rate. And so you know, if you look at their their equity exposure, as a percent of their total assets, it’s still very high. And appropriately so. Right, it’s 31%. It’s come down, obviously, these stocks have come down and cash balances have gone up. But if you look at the black, the blue dotted line in this chart, and sorry, so let me explain the chart. This is a household cash as a percentage of total assets, household equities, the percentage total assets, fixed income real estate as the percent of the total assets for us, US households, at 31%. In terms of equity ownership, you know, we’re just shy of that the peak of the.com bubble. And why these people, you know, why haven’t they so the reason they haven’t sold is because they haven’t turned off the 401k thing yet. Because we have a 3.5% unemployment rate. Don’t forget, the Mike Green, I’m sure you’ve had on your show, friend of ours oversimplify. He’s done a tremendous amount of thought leadership, in terms of trying to get investors to understand that the market is not this, you know, kind of active manager, you know, thoughtful, forward looking vehicle that it wants was it certainly still has those elements. But it’s just it’s just as much, you know, if not a little bit more these days, kind of like, where’s the flows coming from? You know,
Adam Taggart 38:44
where there’s this is the giant mindless robot that he’s Yeah, yeah, exactly. Those passive capital flows. Yeah.
Darius Dale 38:51
And it by the way, have you looked at a chart of jobless claims relative to the s&p, there’s a reason those things are very correlated in terms of being inversely correlated. And so you know, that’s what my one of my key takeaways here, as relates to why the market isn’t for looking particularly in recent market cycles is because you kind of have to wait for people to get fired in terms of the 401k flows. And more importantly, you also have to wait for people to change your liquidity preferences, which ultimately happened in a recession. But this chart here shows is household money market fund exposure relative to their equity exposure, and I show it on a ratio basis here, we’re only at 5%. You know, you look at x COVID is the only last for a month. But you look at the last few recessions, we got up to 14%. We got up to you know, I want to say a little bit close to 11%. Got up to 8% 9%. You know, we’re 5% here and a 38th percentile this reading. So here’s a couple things that still need to happen in this phase two credit cycle downturn process, households need to change and liquidity preferences because they’re scared right now. They’re talking about recession, but they’re not scared and that’s a very different thing. Being bearish is not the same as being scared. Right? I just want to make sure everyone understands that particular dynamic
Adam Taggart 39:58
and assuming because once you get scared you actually change your behavior,
Darius Dale 40:02
you change your behavior. Exactly. Just talking about a recession, anytime a recession for six years, who cares? People thought when at the beginning of my career, most of Wall Street while while we were bullish thought we were in recession from like, oh, nine to 2011. If you really go back, he really meant that behavioral psyche in the market didn’t really change until early 2013. I remember that very vividly, how negative the sentiment was that entire time, despite the market, you know, having more than doubled off the, you know, the March nine lows, and so I just wanna make sure that it’s very if they hear nothing from me, in this interview, it’s being bearish is not the same thing as being scared from a liquidity preference perspective. And so,
Adam Taggart 40:41
right. In front of liquidity preference perspective, we’re seeing a lot of headlines and data, showing that there’s money flowing out of banks, bank deposits, and going into money market accounts, or US Treasuries. What you’re saying is, while that might be true, right now, that’s just kind of a cash asset swap, that’s not people selling their stocks to get into money market. Yeah,
Darius Dale 41:05
100 100%. And we track that as well. So what I’m showing here is money market fund assets, total assets, were at around $5.2 trillion, you know, we’re kind of growing at a 16 17% for him of annualized, right around 17%, on a year over year basis, as well. I mean, look at where that liquidity preference can go in a recession, you know, in terms of the red line on either your basis, you know, we haven’t seen anything yet, in terms of, you know, the actual, you know, liquidity preference shift, we’re seeing the asset swap shift, and the asset swap makes a ton of sense. If you look at the spread between, you know, money market fund rates and national bank rates, you know, we’re about four and 30 basis points in basically the 100 percentile of this reading. So, households are smart, they’re being rational, but they’re not being they’re being rational, but they’re not being fearful. So let me just quickly wrap up on that previous point here. The one thing I would call out going back to this household allocation of stocks at 31%. Again, just shy of the all time high in the.com. Bubble, you know, we haven’t seen the change in liquidity preference. And we haven’t seen the change in asset allocation that typically coincides with the recession. It ultimately is the reason why we have not why we believe that this kind of phase two credit cycle downturn process has not been priced in because this is something I get into some pretty good debates with our institutional clients. So you know, in recent months, you know about, hey, October was the low, you know, with markets looking through all the rest of the weakness in earnings is going to bottom in q2, if you look at bottom up consensus estimates, that’s actually what, you know, Wall Street consensus believes, yep, we don’t buy any of that stuff. I mean, this chart here is one of my favorite charts in the deck, and it’s been featured on our deck, you know, for the past, you know, kind of for, you know, six months or so, which is, you know, every recession has a phase two credit cycle downturn, so you can go back and study any economic history and understand that. And so what I what I mean, you know, the reason I say it hasn’t been priced in, is just look at the levels of these instruments. This is the Goldman Sachs financial conditions index, this is investment grade credit spreads, this is high yield credit spreads. And this is the sector. You know, this is the sort of dispersion within the equity market, the high beta stocks as a ratio, low beta stocks, you know, go back to Stan Druckenmiller, who I met, you know, back in 2010, when he’s at Duquesne, he said, the number one best economist in the world is the dispersion within the equity market. And so these are high beta stocks as a ratio, a little bit of stocks. What I’m showing in these, in these, the dotted lines is, is the sort of the level that each of these indicators peak or trough debt in the previous three recessions. And why do they matter? The reason I think they matter is because they’re all very different styles of recession. The 2001 recession is the shallowest recession in US history. 1991 recession is the third shallows in history was driven by energy. This was driven by, you know, kind of an overbuilding of CapEx, and then this was obviously a financial crisis, one of the deepest recessions in US history. And as you can see, the blue line is the mean of each of those peaks and troughs. And as you can see, we are nowhere near a peak or trough. In India, these indicators, you know, that would indicate, hey, the households have changed your liquidity preferences, households are due to change that asset allocation, and not just because they want to, don’t forget, when you get fired, you don’t take more equity risks, you take less equity risk, you know, you’re the guy sitting next to you gets fired, you don’t go, let me turn my four Oh, and take out up and buy more small cap stocks, you start selling small cap stocks, you know, it’s not like we do this stuff on purpose, but it’s behavioral, we, you know, we’re human beings, we were all, you know, succumb to greed and fear, which is one of the why those two things are featured in our weather model, which is our primary tool for managing risk. So know kind of summarizing all this this part of the discussion is, I don’t think we’ve seen the Big Bang yet. The Big Bang is probably you know, that the earliest, in my opinion, probably five to seven months away, could be, you know, seven to nine months away. You know, again, we’re not it’s impossible to be debt specific with timing, but I do want to make the case that just because it’s that far away, at these price levels, I wouldn’t be chasing on further upside. If we get to 3800 or 20,000 in debt. Coyne in the next six weeks, you probably could buy in there for final trade into the summer highs that you’re probably going to see.
Adam Taggart 45:07
Okay, super fascinating. And but I take from these, this preponderance of debt. And first I congratulate you, I think Lance Roberts has met his match went Roberts, you may be familiar. Yeah, he’s on this channel every every week doing a market recap with me every weekend. But there’s hardly a comment I can make where Lance doesn’t say, Well, you know, I wrote an article about that I’m writing an article about that. You’re the guy with the chart for everything that we think of. And it’s amazing how fast you can just pull up the chart here. So this is this is all super useful, valuable and impressive. I appreciate that. But what I see your chart saying is is, hey, lots of reasons to believe that or to conclude that there’s a recession coming on the general timeframe that you mentioned. But a It’s not here yet. And what I hear you saying is we kind of have to wait for the E. And Michael Kantrowitz as hope framework, we have to wait for that final e employment domino to fall. And as Michael says, and as you said, That’s why his is like an outcast, right? He’s not willing necessarily to commit to a timing for the recession. He says, once the E domino falls, then I’ll tell you, we’re a couple of months away from the start of the recession. But I don’t know when that E dominant, I can just tell you, it hasn’t fallen yet. Right. So it sounds like you’re looking at that equally as closely Correct.
Darius Dale 46:23
100% Yeah. And it goes back to the jobless claims, continuing claims, the the the cyclical unemployment, you know, that’s our, that’s I was trying to forecast the, you know, we’re trying to, you know, eventually we’ll get the, you know, the amount of data that we run through our Nowcast and stuff, you know, for the grid model framework, but that’s us trying to say, okay, when is the E probably gonna show up. Because if I can, if I understand when these probably going to show up, I can manage risk effectively, more effectively along the way, doesn’t mean you’re going to be perfect, you’re never going to be perfect as an investor. But what we’re trying to do is help investors manage that risk more effectively along the way. And I know you mentioned, you know, kind of this path, this path dependency between getting to now and then I think one of the things that we haven’t talked about yet that I think is extremely important to kind of explain to the to the audience, is where we kind of in the liquidity cycle,
Adam Taggart 47:10
exactly where I was gonna go. So so let’s go there. And if I could just tee it up, and then let you knock it out of the park here. As I said, in the introduction, you know, without liquidity, nothing happens in the economy, right. And, and, and liquidity impacts credit, and really, without credit flowing through the economy, nothing happens. I’m just going to I’m just going to go through a quick list of, of contracting liquidity metrics or contracting credit metrics, it’s a little bit of a soup here. And I just want you to react to that list as you start to give the answer of the importance of all of this. So right now we have contracting m two, which is a common metric of the money supply. That hasn’t happened in the data set that I’ve looked at, which goes back for 60 years, we’ve actually never had a negative growth in m two like we do right now. We have an 89% probability as currently projected by the CME FedWatch tool of another 25 basis point rate hike in May, right. Just coming up in a couple of weeks, we have continuing quantitative tightening. We have bank lending has been contracting for the past year and a half. But post. Silicon Valley Bank Signature Bank Credit Suisse bank lending has tightened even further. Jerome Powell himself has said, Hey, that actually substitutes for additional rate hikes, right so that there’s additionally contract contractionary to the economy. We also have deposits that are fleeing banks to go into money markets. And treasuries, like I said, which just mean, it’s money that’s not available to be lent out going forward, we are apparently going to have to have a forced replenishing of the Treasury general account once the debt ceiling is raised. And I think everybody agrees at some point, the debt ceiling is going to be raised, right. So that is actually going to get a sub capital out that could otherwise be going into the economy. We also have lower than expected tax revenues for this year. So again, less money that the government has to spend. So you can probably add some more factors to that litany of factors but all of those basically say, there’s just less liquidity slash credit, moving around or will be expected less going forward, at least in the near term. So a lot of analysts several on this program have said Yeah, I think we’re going to be having a liquidity crunch this year, some are arguing are actually maybe already beginning to be you know, in the early innings of one right now. So please talk about how the outlook for liquidity and for credit is impacting your outlook for recession.
Darius Dale 49:39
Adam, that is music to my ears, man. That is you are you are you are firing all cylinders. And the you’re hitting the liquidity topic right where you need to hit it. So I’m actually very proud of you. That’s, that’s awesome. So I’ll start by saying, let’s define liquidity for for starters, right? Like there’s a variety of different metrics that you can anchor on and you anchored on the most The key ones that we look at, it was a few that we track on a daily basis that in the context of our weather model, and again, the weather model was our main kind of engine of our process. It’s the tool that we use to help investors manage macrocycle risk through the lens of you know, what I think are the most important macro cycles that matter, at least not I not buy my education from, you know, different bystanders reading books and things of that nature. I’ve been told to what matters. So we’ll start to kind of go down the list and we’ll land on liquidity, so growth, inflation, employment, profits, fiscal policy, we’ll skip those fear and positioning fear and greed in terms of positioning, those are, you know, these are things that we monitor on a day to day basis to give us a sense, okay, what’s the near term outlook for something like the stock market, the bond market, the dollar commodities are our digital assets. But we’ll focus our thoughts on you know, this kind of component of the, of the weather model, monetary policy. So we look at monetary policy through the lens of what we call 42, macro adjusted net liquidity now, I don’t mean to say this disparaging manner, because I’m all for sharing information. But I think I’ve had I’m actually up to 11 different analysts and or investors that I’ve heard on podcast, in the last 18 months, take our model and say it’s their own, I’m totally fine with them using I love, I’d love a little hat tip, you know, I’m a working man with a small business.
Adam Taggart 51:15
It’s the highest form of flattery, although I’m sure Yeah, exactly.
Darius Dale 51:19
In fact, Morgan Stanley was the biggest of those institutions, their clients, so it’s not a big deal. Anyway. So going back to so adjusting that liquidity, we actually did make an amended amendment to our initial debt liquidity model, which again, fed balance sheet minus diversity row minus Treasury general account, we’ve actually subtracted the emergency lending on the Fed’s balance sheet from this calculus as well, because we think it gives a more true approximation of the kind of the total amount of liquidity being supplied by the Fed, in any given juncture, that’s still trending lower. I’m sorry, I’m getting sloppy with my pin here, global central bank balance sheet. So this includes the total assets on the Fed’s balance sheet, the ECB is balance sheet, the the Bank of England’s balance sheet, the Bank of Japan’s balance sheet, the PBOC balance sheet, and the Swiss National Bank balance sheet, you aggregate those balance sheets, there about 91% of total central bank balance sheet. So that’s pretty much all you know, anyone’s gonna have time to, to monitor on an individual basis, that’s still trending lower. We look at liquidity also from the perspective of private sector money. So this is what we would consider to be public sector liquidity, how much liquidity are we getting from the manna from the heavens or, you know, the fire from it’s either the manna from the heavens or the fire from the heavens, this is the money that we create as private sector entities, this is narrow money supply. So looking at in one here, it’s actually down 8.3%, on a year over year basis, down at 3%. On a year over year basis in in the US economy on a PPP weighted basis, globally, it’s down 1.3%, on a year over year basis, you know, this, these two time series have almost never contracted, this is only second year over year decline and one in the US, it’s the first year over year decline in global PvP, in our money supply. And more importantly, as relates to the dispersion that the signals are sending to the asset markets, they’re actually they’re still continuing to trend lower, we still have policy rates trending higher in the US. And one final thing that’s actually positive for liquidity right now is that the markets are expecting the policy rate to inflect. So let’s let’s go and kind of look at this from a, from a quantitative perspective, before we kind of unpacked some of these more esoteric dynamics. So right now, just enough, liquidity is trending lower, and it’s contributing a negative excess return to most risk assets, global central bank balance sheet is trending lower, and he’ll be back tested everything, you know, we don’t say anything, nothing comes out of my mouth. If I didn’t back test it, you know, we’re very, very quantitatively oriented here. 42 macro, so that’s contributing negative excess return on a forward looking basis for asset markets, domestic narrow money supply is contributing negative excess returns to in terms of the forward outlook for asset markets, same thing with the global narrow money supply. So public sector liquidity, private sector liquidity, both all these factors, that all these features in the model are contributing to negative kind of extra excess excess returns and a forward looking basis, benchmark policy that’s been rising, that’s also contributing to negative excess returns. And the one thing that’s actually contributing to positive excess returns into the kind of liquidity framework is the fact that the markets are expecting the Fed to do about face pivot. We’ll finish on that because I think that’s kind of one of the more dangerous aspects of this whole the where we are in financial markets, in terms of timing of the Fed pivot, because I actually know let’s Let’s not mention that because I do I think that’s a very important thing to discuss before we move on. A lot of investors when you hear you know, because I listen to about 10 to 1215 hours a financial podcast every week, in addition to having all the institutional client meetings that we have every week. The number one thing that I hear that I just it’s, it puts a bee in my bonnet, a giant bumble bee in my bonnet, is this concept of the XYZ they’re going to print. And that is true, excellent. Who cares what XYZ is, it could be interest rate expense is too high for the US. I don’t know No, the US is about to go into recession. And who cares what the XYZ ABC is. It’s the dot, dot dot, they’re going to print that I take great offense with. And it’s not that I disagree that they’re eventually going to print. It’s that I disagree with the sequence of events. And so we were talking about this with our clients on our weekly podcast, we do a weekly presentation, as well as the 42. Macro, as is our monthly presentation, our weekly presentation last week, I was kind of making a new joke, which is, have you ever seen a firefighter get in a fire truck and turn the sirens on without a fire to put out? I’m actually asking you a question, have you? No, no, yeah, no, no one has Yeah. And we’re probably combined 100 years old. Like we we neither of us have seen that. And so the point I’m trying to make is that the Fed is a reactive government agency that responds to adverse developments in the economy, or adverse developments in markets, usually the markets lead to adverse developments in the economy. The reason why I’m so concerned about, though, that ABC XYZ turns into liquidity, so therefore, by everything now, that I’m so concerned about that kind of general consensus amongst investors, is because this is a Federal Reserve, that is almost guaranteed to have its reaction function be lagging when phase two when the phase two credit cycle downturn begins. And the reason we say that is because they’re already forecasting, a mild recession, if you look at their unemployment rate target, this is their 2023 year in unemployment rate target of 4.5%. And this is the current unemployment rate, or at least a time series, they’re calling for 100 basis point increase in the time series on a nine month interval. Well, if you go back, and you look at the trailing nine month momentum in the time series, that’s what this bottom study shows, there’s never been 100 basis point increase in the unemployment rate on a nine month interval on any interval for that matter, that did not coincide with the red bar or recession. And so the key takeaway here is that this is a Federal Reserve that is going to be eating popcorn, while at the beginning of the recession process, it’s going to be saying, Yeah, but yeah, so what when the markets are the s&p is at 3200, and bitcoins at 20,000, or 17,000. Again, at some point in the next kind of, let’s call it three quarters. That to me is very concerning. I mean, it could be as soon as one to two quarters from now, I’m being very conservative when I say three quarters, because that get that puts you into early part of next year. But irrespective of when phase two begins, we can conclude based on what they’re guiding, I eat higher for longer. And we can also conclude based on what their forecasts are, in terms of already anticipating a mild recession, that at the beginning of the recession process, at the beginning of phase two credit cycle downturn, that has not been priced in, by the way, they’re going to do nothing, they’re not going to do rate cut, they’re not going to QE, they’re going to do nothing. And we know that monetary policy works with long and variable lags. So that’s actually quite scary in terms of, hey, look, we actually need you to do some probably today, if you want to make sure that it’s going to be a recession and markets do you know, markets do, okay? If you wait too long, and they’re almost guaranteed to wait too long, we’re gonna have a real problem on our hands and asset markets and the economy.
Adam Taggart 58:07
There’s so many great points there. Your point about if they wait too long, I mean, that’s what the Feds track record has been, and certainly, you know, in past recent years, is they just, they are a follower, their reaction function, if you said has been very delayed, how they responded, inflation is a great case in point. And that just happened. You know, over the past two years, we’ve got really recent data to show these guys take a long time to realize there’s a big fire raging, right? They could have put it out when it was small, they don’t really react until the whole buildings on fire. Right on a personal. So when you talk about you went through the your liquidity factors, and you said there’s really only one that is supportive of, you know, markets going higher from here. And that is market expectations for fed pivot. So obviously, if the market wakes up at some point, as it might be in the process of doing so, because just a little over a month ago, it was projecting that the Fed was going to pivot, I think, June, June or July, right now it shifted that back a bit, I think September. But if the market wakes up and says, oh, golly, I don’t know, it looks like the Feds not gonna pivot at all this year, I’m assuming that that positive factor may flip to then be a negative one, like all the rest, is that true?
Darius Dale 59:16
It may not flip to be a negative factor, because the markets still may on a two year forward basis, because that’s what that’s the tracking, they may still be, they might just push it down into the future. But what I’m concerned about as it relates to the pricing of risk assets and asset markets, is the process of that happening. Right? Think about when unemployment rate is really starting to rise, jobless claims are really picking up, people are starting to sell assets and their liquidity preferences are changing. And you’re starting to see you know, kind of, you know, recession type conditions and asset markets. The issue that I’m concerned about is if the Fed is already anticipating a recession, they’re likely to not be quick with the liquidity hosed environment as they’re not going to be cutting rates and doing QE early on in that process, which means at some markets are going to have to be the conduit to tell the Fed to get in the fire truck, turn on the sirens and fill out the liquidity hose and put the giant burning house down by the time they get to the house, it’s going to be almost burned down. And that’s my number one concern. So
Adam Taggart 1:00:14
as I’ve said very often, which I think you’re saying is is those who are wishing for a pivot may actually get the pivot. It just might not be for any market bullish reasons. Right. To your point. Things might have to get so bad in the market to get the Fed to act that yeah, by the time you’ve got your pivot. Alright, great. You got it. But the markets down by 2030 whatever percent at this point.
Darius Dale 1:00:35
Yeah. 100%. And we haven’t even I mean, I can’t believe we’re it’s 2023 We haven’t had even a sniffle discussion about inflation, but inflation discussion.
Adam Taggart 1:00:45
That’s where I was gonna go next. I love how you think.
Darius Dale 1:00:48
Yeah, absolutely. So I did want to just one final point I want to make on global liquidity before we wrap up, but I did want to just quickly hit on inflation, which is why this is what I’m showing you this chart here is just corn, various metrics of core inflation, will focus your attention on the bottom panel, the super core inflation tracking at 4.3% on a three month annualized basis. I don’t care. I mean, it’s been since since the summer of 2020. I have not as a quantitative research analysts known or cared about what your view inflation was, I have no idea what your view inflation is at any given time. Because the reason I don’t care is because we know COVID has going to have a significant significant impact on base effects. We know we’re in a tightening cycle and base effects can’t be the only reason that gets inflation down. Because ultimately what it means that the time series is going to continue to trend higher. And so what you’re ultimately going to happen is you’re going to bottom off with a higher level. So we can’t rely on base effects on a time series that is graduating higher. This is very esoteric, esoteric, quantitative economics. However, let’s go back to why we’re looking at this on a three month thing you realize basis, the Fed cares about this on a three month annualized basis, because it’s going to give them this the quickest out of tightening monetary policy. They don’t want to overtake and they’re probably going to over tighten, but they don’t want to and so 4.3% Three month annualized tells us that they were nowhere near the 2% that they need in order to feel comfortable that the new year over year time series is going to actually get back to 2%. If the three month annualized isn’t a 2%. How the heck is the year of you’re gonna get the 2% bottoming at a very high at a very high level start compounding higher again, core PCE This is a various metrics of underlying inflation, which I think are more instructive in terms of understanding, at least Jay Powell his reaction function, Jay Powell, Jim Bullard Chris Wallace, kind of the Hawks on the committee, 6.8% thrum of annualized median CPI 5.1% trim mean CPI, you look at core PCE is compounding at 4.8%. You know, we are whether you take the easiest way out at 4.3. Or you just accept the fact that it’s somewhere between four, three and six, eight, underlying inflation in the US economy is still so tight, that this is a Federal Reserve that’s going to be spooked, even as the phase two process begins, because inflation is a lagging indicator. And the reason I say inflation is a lagging indicator. Going back to our recession analysis chart, again, these are all the recessions that we’ve had in the US economy since going back to act one of the Great Depression. We’re kind of looking at it through the various deltas, various metrics, but I’ll draw your eyes your attention to this set of columns here. Right here, where we’re showing here is the core PCE peak in heading into the recession. This is the trough during in our sorry, in and around the recession. This is the basis point change your view your core PCE in the year ahead of recession, this is the base point change in the year during and is the base point change in the year after or not the year during just during the recession, however long it may last. I’ll draw your eyes to this statistic here plus five. And more importantly, I’ll draw your eyes to this compendium of numbers. What this shows is that in the year leading up to the beginning of the recession, there is almost no historical evidence of core PCE decelerating, meaningfully or even at all in fact, the only recession in which core PCE decelerated heading into the recession is the July 81, to November 82, recession. All other instances, we saw core PCE either flat or up heading into the beginning of the recession, which tells us much like wages, much like employment, inflation is a very lagging indicator, which means when the recession starts when phase two starts, and we’re demanding the Fed to get in the fire truck and turn the sirens on and spray the burning house with liquidity. They’re going to be handcuffed by not only inflation, that’s probably still going to be too high and sticky. But they’re also going to be handcuffed by their unemployment forecasts, which are you know, to basically telling them that, hey, look, you’re expecting this all along. So why are you panicking, they’re not going to panic until unemployment goes above 4.5% or until the s&p is down 20 bitcoins down 40 to 50. Both all three of those things could happen by the way. All those things are probably likely to happen. In fact, that’s our modal outcome view once we get into the back half of the year. So that’s kind of it on this and then I did want to quickly wrap up on global liquidity because I think this is a topic But I think it’s very misunderstood. You know, we have said, Michael house of the world over cross border capital, you know, world famous world renowned, you know, kind of understanding all those dynamics. I think there’s probably a more, I wouldn’t say less sophisticated, but I think there’s a easier but the jest is, you know, not necessarily just as accurate, but reasonably accurate way to track this stuff. So we’ll start by kind of amalgamating what I think are the three most important metrics to look at from a global liquidity cycle perspective, which is the world central bank balance sheet, world narrow money supply those two, those two factors in our macro weather model, which again, we use to drive the basis for all our investment decision making on a systematic basis. By the way, we’ve been talking for a little over an hour. Now, as sharp as this presentation may come off, I make zero discretionary trades in our portfolio construction process, everything we do is based on a systematic process that combines top down and bottom up risk management overlays, how kind of if we if we want to have a different discussion about that, in a future discussion, I’m more than happy to explain how that works. But going back to this liquidity discussion, so central bank balance sheet, narrow money supply, world FX reserves, and the reason we track world FX reserves, is because FX reserves are rising, foreign central banks tend to buy dollars they tend is particularly when the dollar is falling in that process. They tend to sell their own, sell their own currencies and buy US dollars. Not only does that create liquidity in their geographies, it also creates demand for treasuries in our geographies, and kind of loosens, that lessens the burden of our private sector from having to take down Treasury debt. You know, one of the things that was kind of a big deal for the asset markets in 2020, and 2022, is the fact that private sector creditors had to basically suck down a bunch of incremental Treasury issuance, you know, what I’m showing you this chart here is the share of total treasuries on marketable treasuries owned by the Fed, owned by US commercial banks, owned by foreign central banks, as you can see is kind of that uptick there has been pretty positive. And then this is the share owned by us the private sector, we’ve gone from, like 38% to 45%, in the last kind of, you know, 18 months, not even 18 months, 16. And so that’s part of the reason we saw treasuries go down in price, everything go down in price a lot last year, because again, there was this this kind of like sucking sound of liquidity from the Treasury market, that really was a big deal for for asset markets. But going back to, you know, this kind of concept of global liquidity, because I do, I do want to wrap up because I do believe it’s a it’s an important topic to help investors kind of better contextualize, provide investors with a better framework to understand it. And so FX reserves do supply liquidity when they’re rising and the dollar is falling. Obviously, central bank liquidity, narrow money supply, that stuff is very positive. These things peaked in January and February, by the way, if you look at an a trailing three month basis, so this is the trailing per month momentum, and each of these time series in these bottom panels, we peaked at plus $1.4 trillion in January of 2023. In terms of the global central bank balance sheet on a trailing three month basis, we picked up plus $2.2 trillion in January of 2023, in terms of net world narrow money supply on the trailing three month basis. And we picked that plus 430 billion in February 2023. And the global for FX reserves. If you look at our trawling through my bases now, through the most recent data, we have minus 331 billion in global central bank liquidity, we got minus 982 billion in global narrow money supply, and only plus 30 billion down from 430 billion in world FX reserves. So going back to the question, you you go back to your list of indicators, you know, I think our indicators are very much aligned with yours, which is a lot of what’s been very much driving transitory Goldilocks year to date, and helped us you know, it wasn’t really the dominant driver of that call back in January. But it’s certainly been a very dominant driver of things like the digital asset, space, etc, year to date, I think people need to go back to the data and kind of revise some of those views. In my opinion, I think what’s really happening underneath the hood is the fact that China Bank of Japan doesn’t need to defend Yoker control to the same degree that they had, if you look at the Bank of Japan’s balance sheet, up 18 point or up 18% on a three month annualized basis, the PBOC doesn’t need to defend or help its economy as much as it did now that it’s actually confirmed a simple recovery, its balance sheets up 16% on a trailing three month basis. But if you actually look at on a month over month basis, it’s down 2.6% and down 4.2%. And so my key takeaway is that so much of what’s been very positive from a global liquidity perspective, year to date, is actually inflecting in a negative way. So the, you know, we kind of landing the plane in this discussion, that, you know, kind of picking up nickels in front of a steamroller is very much was very much supported by improving global growth, improving global liquidity. Now, I think global growth is likely to continue improving, namely driven by China for at least another quarter or two, but ultimately, it’s going to run into a it’s going to run into the steamroller when the US is really starts to reassess and its global liquidity cycle dynamic. If this is going to be something that has a tail on it, then I think that that path to you know, cut that amount of nickels in front of that steamroller or even there to pick up I think it got deteriorate pretty pretty versatile. financially.
Adam Taggart 1:10:01
All right. Got super fascinating. This has been wonderful Darius, like, I have a couple of so many questions I’m not going to get to and you’ve given us so much time already I do if you’ve got a little bit more time, just want to start briefly about your market outlook here, given this macro outlook of approaching recession in the next five to seven ish months, and I know that something might happen that might impact that forecast, if it does there. So we want you to come back on this program and tell us about it. But yeah, if we could, so you expect a recession this year, I haven’t asked you I want to dig more deeply than we have time to in terms of sort of like the severity and duration of the recession that you expect. But if it’s if it’s one that you think is going to be meaningful, and I’ll let you define what meaningful is, what impact you think it is going to have on markets, and maybe maybe a question for you to react to there is May we find a new market bottom versus what we saw in 2022. In the type of recession that you see ahead. Yeah, even if it’s a mild recession is our interview with Darius will continue over in part two, which will be released on this channel tomorrow, as soon as we’re finished editing it. To be notified when it comes out. Subscribe to this channel, if you haven’t already, by clicking on the subscribe button below, as well as that little bell icon right next to it. And be sure to hit the like button to while you’re down there. And if you’d like to download a copy of the full chart presentation that Darius was showing slides from in his interview, you can do so for free right now by going to wealthion.com/ 42 macro. And finally, if the challenges Darius has detailed in this interview, have you feeling a little vulnerable about the prospects for your wealth, then consider scheduling a free no strings attached portfolio review by a financial advisor who can help manage your wealth, keeping in mind the trends, risks and opportunities that Darius has mentioned here. Just go to wealthion.com and we’ll help set one up for you. Okay, I’ll see you next over in part two of our interview with Darius Dale
Transcribed by https://otter.ai