While the Fed has succeeded in bringing inflation as measured by headline CPI down from 9% to under 4%, it hasn’t won the battle yet.
In fact, CPI has been rising over the past several months.
Today’s expert cautions that we’re likely to see an unwelcome transition from what he calls “immaculate disinflation” to “sticky inflation”, which could serve as the death nail for the current bull run in the markets.
Well, let’s ask him. We’re fortunate to have market analyst Darius Dale return to the program.
Follow Darius at his website at https://42macro.com/ Or on Twitter at @DariusDale42
Darius Dale 0:00
Ultimately, just if you think about this from a strategic asset allocation perspective, you know, especially for some of you slower moving institutional ra type investors, you need to make sure that you’re aware of these risks. They’re not all bad risks, you know, I think their stock market’s gonna go up a lot, and bitcoins gonna go up a lot, you know, bonds gonna go down a lot, they’re not all bad risks. You just need to be aware of the risks and making sure that you’re constantly orienting your investment posture from a strategic standpoint, in association and an appreciation of these risks.
Adam Taggart 0:31
Welcome to Wealthion. I’m Wealthion founder, Adam Taggart. Well, the Fed has succeeded in bringing inflation as measured by headline CPI down from 9% to under 4%. It hasn’t won the battle yet. In fact, CPI has been rising over the past several months. Today’s experts cautions that we’re likely to see an unwelcome transition from what he calls immaculate disinflation to sticky inflation, which could serve as the death nail for the current bull run in the markets. Why? Well, let’s ask him. We’re fortunate to have market analyst Darius Dale returned to the program. Darius, thanks so much for joining us today.
Darius Dale 1:13
Thank you, Adam. It’s great to be back with you and your viewers. Man, you guys do great work here. Wealthion.
Adam Taggart 1:17
Thank you, thank you, and you do great work yourself and 42 macro. And I think maybe you’ve just had your greatest accomplishment of all, which is getting married. Congratulations, my friend.
Darius Dale 1:28
It is definitely the greatest achievement of my life to date. Man, I really appreciate it. Very happy, very blessed.
Adam Taggart 1:33
All right. Well, I couldn’t be prouder for you folks. Please give Darius his well deserved props in the comment section below. Darius when you were on last time, we had an amazing interview went very long. But it was all just awesome stuff. Lots of charts, lots of great insights on your end, I’m assuming we’re probably only going to set the bar even higher this time. Very excited to dive into that with you got a lot of specific questions here for you. But if we can just start with a regular high level question I like to kick these discussions off with what’s your current assessment of the global economy and financial markets?
Darius Dale 2:09
Yeah, that’s a great question. So I think it’s a one of divergence, in divergence between, you know, places where we’re continuing to see above trend growth and inflation like US and Japan, to close economies where we’re starting to see below trend growth, namely China and Europe. And that divergence has had a pretty material impact as it relates to the global currency market. As you know, Adam, the global currency market has a pretty big input to the global liquidity matrix. And so ultimately, we believe those divergences are likely to persist, and they’re obviously going to continue to have impacts for asset markets over the medium term.
Adam Taggart 2:40
All right. Well, let’s talk about those divergences and about what the implications are going to be. Very quickly though, let’s, let’s just start with the quote of yours that I pulled in the introduction there. Here’s the full quote you said. We’re going to transition from immaculate disinflation as a market narrative to sticky inflation in the coming months. And that could be the death knell for this bull market. But we’re not there yet. So can you define for us? Immaculate disinflation? Why you think inflation is going to be sticky going forward? And why may this be the thing that actually causes the economy to stumble here? Yeah, absolutely.
Darius Dale 3:17
So uh, let’s take a step back and kind of talk about where we were, how we how we’ve gotten to this point, and asset markets, you know, this year, you know, one of the things we talked about, at the beginning of the year with our friend, Bob Elliott, we pivoted to this kind of transitory Goldilocks theme, underpinning data risk assets throughout 2023 was a confluence of Immaculate disinflation plus resilient US economy. I think the last time we were on, we were talking about the likelihood that the US economy was likely to remain resilient, at least until q4 of this year, perhaps q1 of next year. And that’s a view we’ve had really since going back to last summer, have not been sorry to interrupt but
Adam Taggart 3:52
but that’s what’s happened so far. Yeah. Yeah. As a
Darius Dale 3:57
matter of fact, if I can, if I can share my screen, because you know, I like to do that. Let me just hop right into our most recent macro scouting report. So we put out this presentation every month to help investors kind of understand the full distribution of a problem economic outcomes. And with respect to that Brazilian US economy theme, this is a theme that we discussed and authored last summer. And there’s 10 reasons why the US economy has been resilient since then, and why we I think we’ve been on the right side of pushing back against recession fears, you know, draft 2023 We still think recessions coming, perhaps 2020 q4, q1 is kind of the modal outcome expectation there are but it’s kept us on the right side of risks really throughout the year. And so there’s 10 factors contributing to that resilient US economy theme, Adam. We don’t have to go through all three of them in in great detail, but I’ll just quickly list them. We’re going to household balance sheets that are flush with cash. We have corporate balance sheets that are flush with cash, that ample liquidity has made the private sector impervious to rate hikes. We have longer long and variable lags in this business cycle. We’ve limited credit cycle vulnerabilities. We’ve limited exposure from the volatile manufacturing sector, which tends to account for as we talked about last time 98% of the net job loss, we tend to experience a recession here in the US economy. We have a perfect storm for new housing development. We got Biden Onyx juicing the economy from from a fiscal stimulus standpoint, immigration spiked in the last couple of years. And then lastly, we have labor hoarding, which is actually charting the path, potential credible path to a soft landing, although we still don’t believe that’s the total outcome. So Adam, you sort of answered the question about ask question about sticky inflation. Its art has been our view that one as a function of the resiliency of the US economy, that the immaculate disinflation, which has been one half of the sort of, you know, kind of transitory Goldilocks vibe, we got this resilient US economy, we got the somatically disinflation put those together, we get transitory Goldilocks, we knew in January, and we made the call that it was eventually going to run out, because ultimately, the US economy is not an economy that has historically seen inflation go from significantly above trend to back to neutral trend or below trend without a recession. And so there’s a couple of series analysis that we performed to get us to that view, I’ll start with our hopeless AI framework, which, you know, you and I talked about micro cancer, which is a hope framework. Last time on the program, I did some research on our own, we did some research on on 42 macro, and we arrived at some of the conclusions. But one thing I think, is missing from Michael’s framework that we added to this discussion, which is what happens to inflation in and around recession. And so in terms of how they interpret this chart, what I’m showing here is the median, tenure, trailing 10 year Delta adjusted Z score for a basket of indicators that represents each of these cycles. And when we say delta adjusted, it sounds fancy, but it’s all we really mean is oriented, the time series, so that up is good and down as bad. So you think about inverting jobless claims and things of that nature. And so how
Adam Taggart 6:36
they’re starting to wrap it just particular respect, don’t know, what is the z score?
Darius Dale 6:40
Yeah, oh, sorry, Z score, it’s the normalized change from the mean, from from the mean of a time series. So it’s, you know, for example, a minus two sigma reading is an extreme normalized change from the whatever the mean is, or whatever the duration of that mean is. And so what we’re effectively trying to do is normalize everything. So we put everything on one chart in one in one simple analysis. And so
Adam Taggart 7:01
we can compare apples to apples and, then Exactly,
Darius Dale 7:05
exactly. And so, just really quickly, in terms of getting to the inflation punch line here, housing tends to break down around 18 months ahead of a recession. So this chart is oriented around recession in terms of months before and months after recession, orders, the basket of indicators that represents the order cycles, and it breaks down around eight to 10 months, every recession, production and profits tend to break down four to six months ahead of a recession, employment tends to break down right on time when the recession begins, which makes sense, er uses recession or unemployment statistics largely to date the business cycle. But what we find is that inflation tends to break down six to eight months after a recession relative to its relative to his Darlington year, mean of time and milk relative to a showing 10 year time series. And so what we know is that okay, we’ve experienced a ton of disinflation thus far, you know, in this business cycle, and part of it is because part of the elements of inflation were in fact transitory you get things like used car prices, airfares, etc. But there’s an underlying level of inflation that is likely to, you know, kind of stop dis inflating, you know, well, before we get back to 2%, inflation, and we sort of, you know, having performance analysis kind of continue to see that as most likely outcome. And one final thing I’ll say, on inflation, I think we briefly touched on this in the previous discussion, is that when you kind of look at the evolution of core PCE inflation in and around recession, what this chart is, is a collection of indicators to help investors understand how things like the labor market cycle, the growth cycle, earnings cycle, etc, you know, kind of it performing around recession. And specifically with respect to inflation. If you look at the basis point change and core PCE inflation in the year ahead of recessions, we typically are flat to up in the year leading into recession with only one negative value in this particular sample. So what we know is that it’s very unusual experience and actually disinflation, which is why we’re calling it immaculate anyway. And ultimately, we understand that that that immaculate disinflation is likely to run up.
Adam Taggart 8:55
All right, hit back if you can, to your hopeless i. Okay, so where to start here, first on inflation. So your chart here basically shows inflation tends to be sticky through the recession, and it’s only once recession hits, that you finally get the inflation actually breaking under control. And so that’s what we should expect here is more or less what you’re saying. The stickiness that we seem to be seeing right now seems to be much more skewed to the services side of the picture versus goods. Is that correct?
Darius Dale 9:35
Yes. Yes and no. So we the we have been experiencing a significant amount of Immaculate disinflation for both. We are now starting to see immaculate disinflation come into the sort of seeking inflation starts to come into the picture, primarily through the lens of headline inflation, which had you know, which had broken down, you know, much faster and sooner than then the services components of inflation. And so what I’m showing In this chart is headline CPI, we popped up to 3.9%, on a three month annualized basis in the most recent month, that was gain was driven by risk, modest acceleration and food inflation at 2.4%. But primarily driven by this big pop to 25.4% through my annualized energy inflation. And this is the first time we’ve seen through methane wise energy inflation in the US economy on a positive at all, since going back to the half second half of last year, kind of the middle of last year. So that’s concerning. But when you juxtapose that from, from from, you know, core inflation and things like services, inflation, you know, it’s sort of suggesting that we are now kind of at the vanguard of what could be a sticky inflation thing that we think will kind of be consensus amongst market participants, let’s say, and at least three months or so. And so you look at Core CPI, you know, we decelerated to 2.4%, from annualized, we’re very much close to the pre COVID mean, that’s what the light blue line numbers represent. In these charts, we have negative core goods and inflation at minus 1.9%. Through my thing, we’ve been kind of stuck at 4%, for three months now, in terms of core services, inflation, but that’s been primarily driven by we continue to see deceleration in shelter inflation, we’re now at 4.4%. But we’ve also seen a little bit of a lift in Super core CPI inflation to 2.2%. We’re still below the pre COVID Train of 2.3%. So that’s very positive, but we’re now no longer improving. And it could be the case that if we continue to see wage pressure in the weeks and months ahead, that this number could really start to move in a very adverse manner as it relates to asset markets in the Fed reaction function.
Adam Taggart 11:29
All right, and let’s, let’s actually just talk for a quick second about your expectations for wage inflation going forward. You know, we’re all of a sudden seeing, you know, big unions out there demanding pretty substantial wage and benefit increases. Do you think it’s more likely that this is a trend? We’re gonna see more going forward? Or is this something that would dissipate once the recession arrives? And you know, companies are in a layoff mode?
Darius Dale 11:54
Yeah, so there’s two answers that question. So yes. So in this basket of inflation indicators, there’s about I want to say about eight indicators, wages are a part of that basket as well. So we do know that wages are tend to be lagging the business cycle with respect to inflation. But there’s a couple of other reasons why we continue to think that wages are likely to be, you know, sticky through this process, they’re likely to continue decelerating, but decelerating at an above trend pace, that ultimately means inflation is going to remain sticky through until we get to the other side of the recession. So I’ll give you a couple charts to kind of support that thesis. So if you look at corporate profitability, what I’m showing in the spread Area Chart in this in this plot in this chart, is our what we call our corporate profit Cycle model. And so that’s nominal GDP dominance, gross domestic income, the your of your rate of change, gross domestic income, and we minus that we subtract the spread between unit labor costs and productivity from that from that phenomenal, gross domestic income growth. And what we see is that it’s only on a structural basis is actually quite low that that spread is 177 basis points wide, versus a mean, a long term average of 574 basis points wide. So we know there’s a tremendous amount of margin pressure on corporates on corporates right now. So there’s going to have some some issues in terms of generating earnings and cash flows. And as long as that margin pressure remains elevated, they’re gonna have no choice but to pass on the price increases to their customers. So on the blue line in this chart, I’m showing private sector average hourly earnings growth on a year over year basis minus nonfarm productivity on a year over year basis. And that spread has historically been correlated to big spikes in inflation, it’s not always correlated inflation, there’s times when inflation is going to do a whole heck of a lot of nothing. But whenever you see these big spikes in inflation, dating back to the 70s, and obviously now, in the 2020s, you know, we’ve typically seen Hey, whenever, you know, the private sector is wage growth is significantly outpacing their growth of eight of their productivity, the goods and services that they’re producing in the economy. That’s when corporations feel like they have to pass on, you know, producer price inflation to, to their to their customers. And we are in fact, seeing an acceleration in producer price inflation. If you look at the last PPI report, we popped at 4.2%, on a three month annualized basis, and in headline ppi, this is number we’ve seen since the middle of last year as well. So we are now moving in the wrong direction for some of these leading processes of inflation in terms of, you know, kind of causing inflation to kind of get sticky at a level that’s inconsistent with the feds 2% mandate.
Adam Taggart 14:16
Okay, all right. Yeah. And you’re making a great job here for why inflation is likely to remain sticky, through, you know, the point at least where the recession hits. So, you know, further inflation relief is not necessarily that likely in the immediate term. Here is what I hear you’re saying, and the data certainly seems to be proving that out.
Darius Dale 14:33
I will say, I will make one caveat, we do think we’re going to continue to see some relief in the very immediate term. I just think as you get three, four or five months away, the probability that that relief goes to zero and the probability that the pain starts to rise is actually quite high in terms of these leading edges of the inflation process.
Adam Taggart 14:51
Okay. Let me let me ask you a really high level question before we get back down into the details here. I was having a conversation yesterday. With an analyst, and they had said that they were talking about potential further wage increases, especially through what’s going on with a lot of the unions right now. And their their point was, if you look at corporate profits as a percentage of GDP, now versus past decades, they’re much higher now. And so his general conclusion was, there’s a lot of padding inside corporate profits right now, where they could absorb a lot of the increase in in wages, right, without having to pass it on to the customer. And we were talking not necessarily what’s going to happen next month or next quarter, but kind of over the next decade or so. And his sort of general perspective was, yeah, you know, corporate America has really gotten a really good deal. And they’ve really had kind of all the bargaining power, or the market power here. And labor has really been squeezed. And the pendulum might be swinging back here now where labor is, you know, going to need, they’re going to demand need and demand a fair share. And the consumer is not necessarily going to be able to take that on with higher prices, that the corporations are going to have to tighten their belts here a little bit and say, you know, what, we had a really good run, but we’re gonna have to run leaner going forward than we did before. What’s your reaction to that thesis?
Darius Dale 16:24
I generally agree with the thesis with the exception of I don’t think corporates are going to willingly take the pain, I think the corporate,
Adam Taggart 16:30
they’re willing to probably kick and scream, but yeah,
Darius Dale 16:32
you and I run businesses are you willingly gonna take take some things I’m not. So let’s, let’s kind of unpack this from, from an empirical standpoint. So we are very much in the camp that the labor has bargaining power in this in this business cycle. And that, and that’s very clearly evident by sort of the spread between labor demand and labor supply. So going back to that list of resilient US economy features, and you know, in terms of number 10, was lead recording, in terms of why the US economy has remained so resilient. So I’ll kind of walk you through this chart to kind of get to the punchline here. So at the top panel, here, we show the total size of labor force at 160 8 million. That number is still below it’s, it’s 20 22,009 and 2019. Trend, we long ago recovered that 2009 2019 training gross domestic income. So that ultimately means is there’s a lot more cash circulating around the economy to demand goods and services, but we don’t have as many people to sort of create those goods and services. And you can sort of see that reflected in terms of labor demand versus labor supply, labor demand, we take that as household survey employment, plus Joe’s total job openings. So that number is at 170 million, versus that labor supply picture at roughly 168 million, we now have a 2.42 point 5 million spread positive spread in terms of labor demand relative to labor supply. And the reason that’s important as it relates to, you know, kind of weight workers having bargaining powers unions, you know, which are represented right around 5% of the private sector workforce, you know, have continued to having bargaining power with respect to their employers, is because this spread between labor supply and labor demand has historically been correlated to the private sector employment cost index on a year over year basis. And so we are now at 4.6%, which is, you know, about 200 basis points north of its of its longer term mean. And the reason that’s, you know, that that’s less likely to stick there is because you’re probably not going to get back to a safe, comfortable level, have that, you know, for an extended period of time, it could take us several more quarters before you get back to zero, and perhaps below zero, which is kind of where we’ve long trained it from, from the perspective of labor demand relative to labor supply. So by the way, this is the credible path to a soft landing that Jay Powell outlined in May, in March of last year, when they first started hiking, which is we’re going to take some pressure out of labor market through the lens of Job says the red line down here, we’re going to hopefully keep employment growth continuing to grow. And that’s been exactly what’s happened thus far, we ultimately don’t think that’s going to be the conclusion of the story. Because ultimately, we still believe that there’s probably going to come a period of time where corporates feel a lot of pressure to you know, she had some labor or she had some system fat from their from the business operating expenses. And the reason we say that is because when you look at projected sales and earnings growth, particularly on the earnings growth side, for this is the Russell 3000 index. So it’s the broadest measure of corporate of public companies that we have in terms of indices here in the US economy. And you know, we’re just perfect the faculty are projected to go from down 5%, which is the most recent quarter ignore kind of q3 Because only seven companies reported this far, but respectively going from down 5% to up like 15 to 20% in the span of the next four months. So there’s a hockey stick recovery expected in terms of corporate profitability, but there’s not necessarily a real credible path to getting there in terms of growth, likely slowing inflation, maybe stabilizing in a bad way in terms of cost push inflation, back and producer price or balance sheets, as opposed to you know, being able to kind of push price to consumer. So to me, I think that’s the probability that we see kind of a one off, maybe, you know, multi month maybe not even multi quarter reduction in aggregate labor demand primarily through total employment is quite high, particularly get in the first half of next year. And you start thinking about some of these lofty estimates and how they’re going to meet those those targets.
Adam Taggart 20:10
All right, and we’re going to talk more about this as we go through this presentation. But this is a great chart, showing those lofty estimates, right, this really rosy rebound in corporate profitability, I think for the reasons you just mentioned, but I’m gonna guess several other reasons, Darius, you may think those forecasts there may not materialize right now, the way that the earnings analysts, the analysts are expecting them to.
Darius Dale 20:33
Now they’re probably not. So again, I mean, you know, let’s, you know, we you and I talked about this in the last last episode, but, you know, it’s kind of give investors kind of a quick summary of why we continue to think of recession as the mode of outcome. You know, we do believe that the 10 year, three month Treasury yield curve is the sort of the best leading indicator for yield curve, it’s predicted eight of the last eight recessions and as far back as the only update, it’s only got one miss in terms of in terms of missing in the in the mid 1960s. So with the yield curve as deeply as inverted as it is, even when you subtract, you know, 4050 basis points of term premia from the from the from the number is still deeply inverted. So that gives us an indication that, you know, the this is the recession is likely around the corner. And so when we talked about this last time, you know, we sort of said, hey, look, when you go back and you sequence, the date of yield curve inversions, relative to the evolution of, you know, economic processes in the economy, what we find is that the 1318 month forward interval has the highest probability of seeing a recession. And how we determine that is looking at the problem looking for the interval, forward in time from the data to the inversion that has the highest probability of seeing a real GDP contraction. So the present negative ratio, the highest percent negative ratio in that particular statistic. And we also want to see the interval that has the highest probability of seeing the unemployment rate rise. And so that’s also the 13th, a theme of for an interval, as indicated by the percent positive ratio for the unemployment rate. And so we know that based on this data for the inversion from October of 2022, we know that a recession has the highest probability of commencing of starting sometime between November 2023, through April 2024. So you know, we’re not backing off that view, until we until further though, we need to see the economy now cast itself out of this through the duration of that forecast window, before we have, you know, we can start to say, hey, look, the economy looks like it might be self landing. And so we ultimately still believe that we’re on this pre recession path, but that path was always going to be through and sort of carry an element of resiliency through it to it as a function of all those features that we identified in that list.
Adam Taggart 22:32
All right, there’s, you’re such a joy to interview for so many reasons. But one is your data facility and your ability to put together all this information, and immediately jump over to the right chart in this whole sea of charts that you have to make your point. It’s wonderful, but also the fact that you keep anticipating the question that I’m planning on asking. So thank you for getting to the what I thought was going to be an unfair question, which is okay, there is timeline wise, where do you think we are then given this 1318 month lead indicator? And of course, you just just shared just your thoughts there. So November 23, through April 24. That’s pretty close. That’s not too far away. It’s not too far away. In real quick, can you? Can you pull up one last time? That hope plus eye chart?
Darius Dale 23:17
Yep, for sure. Absolutely.
Adam Taggart 23:19
Alright, so let’s look at the exes and hope. Right? Okay, so housing is down. Not not still not that much. And maybe at some point, we can talk about why housing has been so resilient and your expectations or the housing market is going to go through, but we can say, Okay, check housing market, no longer growing orders, the order data is also weak, I guess we’ll say, you know, not strong. corporate earnings. They certainly got beaten up a bit last year, you can tell us to where we are there. Now, we’re kind of waiting for that E in hope, right? That’s what Kantrowitz says, right is, hey, that’s sort of the last bulwark, when that really starts rolling over, we’re gonna really know, you just showed us a bunch of data that basically said, hey, you know, jobs market still pretty robust. Right? And so how do we square the current robustness? With a recession that potentially could start in two months? Were you expecting some sort of really big waterfall drop off in the jobs data? Or are we going to sort of slide ourselves into the recession from a jobs perspective?
Darius Dale 24:27
I’d be lying if I said I had a reasonable basis to forecasts at particular dynamic. So I’m going to withhold, you know, kind of judgment on that. But, you know, we’ve been, in terms of what we communicated to our clients, according to macro is, you know, we’ve been pretty consistent in the camp really, since about early Meigs, I think, last time we were interviewing, it was pretty clear that, you know, we were still in the aftermath of the regional banking crisis. And if you could have, you know, banana in my head at that particular moment in time, I would have said the early part of that, that forecast, right, that forecast winds up, you know, sooner closer to November as opposed to now that we’ve gone through all that we’ve now you know, sort of Nowcast to the data, we have a bunch on Nowcast systems that we use to, to analyze the evolution of the US economy, it’s pretty clear that that was a blip on the radar. And so you put a banana to my head today, I’d say it’s probably going to be the latter end of that six month interval in terms of that forecast interval. So it’s our view that it was kind of me probably still has resiliency in some legs, at least through urine, probably to the early part of next year. And if I had to guess, I mean, all we’re really doing is guessing because I don’t believe we have a real foundational basis to to forecast this as economist, which is, I don’t know if we can know if it’s going to be, you know, kind of a sharp slide into negative, you know, type payroll prints, or if it’s going to be a gradual decay into just a slower and slower, you know, business cycle process. I don’t know the answer to that. All I know is that the interval that has the highest probability of seeing a recession commence is sometime between November 1 of 2023, and April 30, of 2024. And I happen to believe it’s going to be closer to the latter end of that particular cycle, but we don’t have to guess right. You know, that’s one thing I think Kantrowitz and I share in common is that, you know, we have plenty of statistics that we can analyze on a on a consistent basis, day after day, week, after week, month after month, to give us an indication, okay, is it starting to look like this? Or is it starting to look like that. So this snap this picture, I’ll show you two pictures are actually three quick pictures to kind of summarize our general thoughts in the labor market right now. One, the labor market remains quite resilient, when you look at the growth rate of private sector employment. And what we take is the mean of household establishment surveys, and then took three months annualized rate of change there so that we’re not overly influencing our essence, our assessment of the labor market, on the birth, death adjustment, etc, etc. So we’re currently growing it through 2.3% on a three month annualized basis, in terms of August payrolls, in terms of August total employment for the private sector, private sector, wages are growing at 3.9%. Through my annualized, we’re currently flat there month, annualized in terms of agri weekly hours. So private sector, labor income, when you productize, those features is still growing at 6.2%, that number is still north of its pre COVID trend. And it’s consistent with the growth rate of nominal employee compensation that we get out of the PC statistics, that’s currently tracking a 5.8% from an annualized, so the labor market is resilient from that perspective. And then it’s also resilient for what we call our 42, macro Fab Five recession. Secondly, indicators. So you and I are old enough to remember the Fab Five from from Michigan, you know, the basketball team, the infamous basketball team from Michigan. So from my perspective, these are the five most important leading indicators that you can sort of watch to confirm whether or not you’re very you’re on the precipice of a recession, particularly as it relates to that, ie in the hope post AI framework that we haven’t been discussing. And so the first indicator is the University of Michigan employment survey, that number came out, I’m gonna say on Friday, it’s slow pretty sharply to 74. And we’re now just narrowly above the median level, the median value that the indicator has exhibited at the start of recessions. So now that’s kind of on the has got a yellow light, if you if you want to say if you, if you will, from the upside of this indicator,
Adam Taggart 27:54
that when we call it knocking on recessions door, yeah,
Darius Dale 27:57
absolutely. I wouldn’t necessarily say knocking on recessions door, but if it’s an Uber, it’s like a DoorDash driver, it’s like pulling up, you know, in front of your house, it hasn’t really your door yet with the food, but it’s close to maybe as close
Adam Taggart 28:08
you’re getting your change out to pay.
Darius Dale 28:10
Exactly, exactly, exactly. You know, so labor differential survey, nowhere near there, you know, steel still at the restaurant waiting on your order. In terms of continuing claims total labor force ratio, we analyze that statistic on a trailing on a three month annualized growth rate of change basis. And what we find is that, you know, we’re currently tracking it down 9.7%, from annualized, and we’re well shy of the level, the rate that we typically exhibit at the start of recession, so still getting a green checkmark there. We look at cyclical unemployment as the fourth feature, and we’re down 6.2%, three month, annualized, that’s, you know, north or south of the level that we’ve historically exhibited prior to recession. And really the only indicator of this particular five recession single indicator kit, that’s actually confirming, hey, that the DoorDash guy is banging on your door waiting for you to gather shower, so you can hang your food, you know, it’s temporary implement, we’re actually contracting it minus 10.5% on a three month annualized rate of change basis. So right now, one out of the five are signaling, you know, recession, you know, very, the probability of a new term recession is extremely high. I’d say one other one out of the five is saying, you know, kind of getting parking in front of your house says, we’re going back to the DoorDash analogy in front of your house, and then the other three, or, you know, maybe they’re somewhere between waiting at the restaurant or picking up your order and starting to get into your neighborhood. So it’s given it’s telling us that the resilient US economy thing likely has legs, at least through the lens of these data. And then finally, that the third trend I take, as it relates to the labor market is just continued jobless continued jobless initial jobless claims and continuing jobless claims. We analyze those those those statistics on a three month annualized rate of change basis and initial jobless claims during the four week moving average is minus 18%. On a three month annualized rate of change basis, we are well shy the level that we’ve historically exhibited a heading into recession, we’re at minus 9%. Continuing jobless claims will shy the level that we’ve historically exhibited heading into recession on a median basis. You know, going back backed with data going back to the mid 1960s. So, you know, we have a lot of confidence that the US economy is not close to a recession currently based on what we find to be the best leading indicators for that. So that’s why we continue to say, hey, look, we know that there’s this six month interval that says this has the highest probability of a recession starting now, we say starting, you know, it’s the beginning of the recession is not like, right, sessions, headline news, by the way, for everyone listening and watching at home, these red bars show up like six to nine to 12 months after the recession starts. So like, you know, you know, we’re not going to NBR is not going to tell you on let’s say, the recession starts on April 1, it’s not going to say on April, second, hey, there’s a red bar here. You know,
Adam Taggart 30:38
it’s gonna tell you on February 1 of the following year, following
Darius Dale 30:41
year, you’ll learn that you’ll see the red bar and like 2025. So if we’re right on that forecast, so this is why it’s so important to be Bayesian throughout this entire process. And really just everyday as an investor to constantly be refreshing the same models, analyzing the same statistics so that you can notice big changes in the conditions of these, you know, these indicators, so that you can actually make informed decisions as an investor, as opposed to what I think a lot of folks are doing, we’re just sort of getting swayed to and fro by whoever has the sexiest narrative at the time.
Adam Taggart 31:10
Exactly. And I’m so glad that you talked about that, and keep the charts up here for a second, if you will, too. Because I think that that Understandably, people have heard listen to lots of people like you, and many of the other people have had this channel that hey, the likelihood, the probability of a recession is quite high. Right? And so they immediately go, okay, recession coming, gotta hunker down, gotta, you know, go short, the market, right. And you’ve got to be really cautious about taking too extreme of position, based upon a general thesis to your point, you’ve got to watch the data to tell you where you are in the story. And right and so somebody who heard the recession is probable narrative in January, if they got really aggressively say short the market, you know, if they sat out the market, they missed the gains if they got aggressively short, the market, they had a horrible year, right. And so it’s really important to look at the indicators like Darius is showing here. And I’m really glad you brought these up areas because you know, what I what I take from Kantrowitz, this framework is you know, those those four dominoes, H O P E, they all have to fall before the recession hits. We’ve seen weakness in the in the first three dominoes, we’ve been watching the final e domino closely and you listen to headlines sometimes about layoffs, or you know, other things that are going on, and you can really convince yourself, okay, now Now, now, this is really where things are rolling over, you’ve just walked us through a lot of data that suggests actually really not quite, I mean, it’s not wobbling that much yet. And so to your point, you are, even though you’ve got this window of probability where you think the recession could could happen, you are changing your your expectations and saying, I’m going to expect it to happen on the end of that window now, because I’m not seeing the weakness, that I’m not seeing enough weakness in this data to indicate that this is going to happen in the next month or two, right. So really, it’s really super useful. And if I can just go back, I want to I want to, I want to really murder this DoorDash analogy. So we’re not there yet. We’re we’re not looking like the the jobs, the Domino is going to fall over immediately or anytime super soon, and then let the recession commence. But for your Fab Five here, all of these show that Uber DoorDash driver is in his car, right? He’s in varying degrees of proximity to your household. But in pretty much every one of these, these data sets here he is driving or at least preparing to drive in your direction, right? We don’t we don’t see any one of these that’s going off in the other direction. That leads us to say, oh, my gosh, you know, forget the recession thesis. These are all somewhat to some degree supportive of a continued weakening of the jobs market.
Darius Dale 33:59
Andrew percent, my friend, and you’re spot on and kind of use that analogy. And one final thing I’ll say about this particular set of analysis is that we don’t need all five to confirm what we’re doing as Bayesian investors, data driven, you know, investors and what we do to help our institutional clients, our retail clients, our ra clients across the world, and really across the world, you know, very geographically well represented in terms of our client base. What we’re trying to do is give them bludgeoned them over the head with the preponderance of data, you’re never going to have every component of your process signaling the same thing. And every time in fact, I would argue 2023, much like 2018 has been one of those years where different components of your process were screaming loudly, very different things are different things. Yeah, yeah, exactly. And you sort of needed to have, you know what I could say when those things when those it was confusing moments didn’t happen. We tend to lean on our quantitative risk management signals. And our quantitative risk management signals primarily our weather model and our global macro was matrix have kept us on the right side of markets primarily for most of the year. You mentioned at the Beginning of beginning of January, if someone kind of, you know got really wedded to the recession playbook or the recession narrative, probably, you know may have shorted stocks in that moment in time. That’s exactly what we covered all of our shorts, right? Like, I wish I covered all my shorts back in October, I had a terrible q4, you know, kind of, you know, thinking some of these, I think it’s some of the stuff would happen sooner rather than later. But we ultimately allowed our we just went back to the basics and said, Hey, look, let’s just rely on our on our signaling tools to actually help us guide us through this kind of very confusing time and financial markets. And ultimately, it’s worked. It’s done us a great, great job. And it’s even relative to, you know, I went back and I listened to previous interview. And one thing that, you know, if you sort of just listened to the interview and said, didn’t hear anything else, I said, since then until, you know, to September, then we’ll use thought I got very wrong on bonds. You recall that we at the end of the interview, we were talking about how our systematic portfolio construction process had us allocated to fixed income? Well, you know, that process pivoted, literally a week or two after that discussion, to taking us out of fixed income. You know, in fact, we got very bearish on bonds, very bullish on stocks, I want to say in the first or second week of May, and you talking about TLT is down almost not 10, nine 10%. Since then, you’re talking about the s&p is up 19%. Since then, so this is one another lesson I want to share with your viewers is to make sure that, you know, it’s you puck financial podcasts, particularly the good ones like Wealthion, do a phenomenal job of helping aggregate investor consensus, helping teach investors process helping expose investors to new datasets, and ultimately making us all better investors. But there’s one thing that I don’t think that podcasts do, which is, you know, kind of take you from point A to point B, right? Like, if you’ve heard me speak on Wealthion, four or five, six months ago, and I said, I like bonds. But guess what if two weeks after that, I say we don’t like bonds, short bonds, sell bonds and buy stocks, then you’ve you missed that message. And you’re kind of exposing yourself to a lot of financial market risk, if you’re not really, you know, kind of doing your due diligence as an investor. So please make sure you’re, if you’re going to be listening to folks like myself, talk on these podcasts and inform and educate you just make sure that you’re following along with what they’re saying along so you can ultimately kind of infuse their process into yours.
Adam Taggart 37:07
That’s a great point and Daris this interview will be no exception. At the end of every interview, I encourage people to go follow the speaker themselves and you know, ask you to tell people where they can go. And so folks, this Darius is saying, if you’re going to say I really like what Speaker extra saying, like, I really like what theory has said in this interview, and I want to I want to take some of that into action in my own portfolio. Well, then make sure you are following that expert. So in case they do change their mind based upon what happens in the market, you know, and aren’t operating on old information.
Darius Dale 37:44
One final thing? Yeah, not only do you know that they changed their mind. But I think it’s also helpful to know why they changed their mind. Exactly, it could be something that may jive with your process in terms of your investment horizon, and maybe something that they may be changing their mind tactically, they may be changing the mind, you know, fundamentally, from a longer term perspective, you need to also know why they’re changing their mind as well. So it does behoove you to, you know, kind of do a little bit more due diligence, you know, when you’re hearing talking to ants, like myself, you know, kind of preach on these pockets.
Adam Taggart 38:08
Absolutely. And Derek, you’re kind of giving, maybe an unintentional great plug for Wealthion Saturday show, which is our weekly market recap, I do it with Lance Roberts every every Saturday. You know, Lance’s does, I think, a very good job of giving people transparent clarity into the thought process and the decision making of a portfolio allocator as things are changing, you know, on the ground, and in a lot of times, you know, he has to remind people look, we don’t have the luxury of trading the markets that we want, right, we have to trade the markets that we have. And so we have to be looking at these indicators. And even if, you know, even if we have a very like, strong conviction that at some point, something’s going to happen, like the Fed is going to pivot or there’s going to be a recession or whatever, right? Great. But the market may not get that memo for a long time, and may had an entirely different direction. And so you know, if you’re in the business of being a good financial steward of your wealth, your clients wealth, you may have to adopt a, a nearer term strategy that is inconsistent, maybe even flies in the face of your longer term conviction. But you you can’t let that long term conviction guide all of your portfolio allocation decision making, decision making because you could get completely wiped out, while the market ignores your thesis until your thesis actually matters, right? You’re sort of nodding as I’m saying this. But of course, this is what you do on a daily basis. So this is the world you live in. Absolutely.
Darius Dale 39:39
This is institutional finance folks. You don’t have the luxury of trading the markets in one or having the clients we want we have the clients we have in the markets we have and so we ultimately have to do a better job of you know, learning from our mistakes and implementing the right tools and the right processes to kind of see us through some of these more challenging difficult times. You know, not every year is going to be as hard as 2023 or 2019. You know, I would say 2007 was pretty hard as well, you know, they’re gonna years like, what my opinion doesn’t I was pretty easy, you know, 2013 was pretty easy, you know, 21 was pretty easy there years, in my opinion to 22 was pretty easy, you know, at least until q4 of last year. But you know, I mentioned one thing early, I think it’s important to go back to because, you know, we go back to the fundamental stuff, there’s one final thing I do want to hit on in terms of process, in terms of, you know, kind of putting guardrails around, you know, what it is that we think as investors from a fundamental viewpoint standpoint, you know, whether it’s our global macro risk matrix, which is one of the most powerful tools we you know, we’ve designed here at 42 macro in terms of helping investors stay on the right side of risk, or it’s some other tool, it could be your own tool, your own technical indicators, your own market, you know, technician, it doesn’t matter, I think it’s just very important to do one thing, and one thing only every time you wake up in the morning, separate your research, from your risk management. Your research is what you think is going to happen in the world. Your risk management is what is happening in the world and how you should be sort of dispose as an investor, what’s your investment disposition. And so what we use this tool to do and what this global macro risk matrix is, is we’re scoring 42 of what we think you know, are the most important markets in the world to track through the lens of our volatility, just a momentum, sec, and that volatility just have a minimum signal based on the condition of that signal per each indicator. It’s we’ve historically back tested each indicator through the lens of our what we call our grid regime process. And we ultimately assign a score per each indicator to a particular grid regime. And what we ultimately try to do with this process is say, hey, which of the four grid regimes is getting the most love from this collection of 42 markets on a daily basis? And what we found? Yeah, since since the beginning of the year, really since q4 of last year, and I ignored the initial part of phase of it, but we were smart enough to pivot to it and Jay were this q4 of last year, we’ve been in a risk on regime. We started in Goldilocks going back to kind of, you know, December of last year, and then we transition to reflation, you know, going back to going back to kind of May I want to say like March or April of this year, and as long as we are in one of those two risk regimes, Goldilocks or reflation. As an investor, you need to be buying the dip and risk assets, you need to be leaning process, typically from a factor tilt selection standpoint, until proven otherwise, until one of the risk offers teams pops up and rears its ugly head and becomes what we call the top down or the dominant market regime. But that hasn’t happened yet. It had a cup of coffee, or the kind of we had threatened and threatened to transition to what we call inflation, which is a risk offers union going back to a eats ago, but it didn’t happen. And so guess what, I’m still bullish, because the markets are telling me to be bullish, irrespective of that expectation for a recession to commence sometime between November and April. The recession may not commence sometime between November 8 and April, remember, that’s a forecast. And if that forecast is wrong, we will still have put ourselves in a position to make money because we’re ultimately respecting the wisdom of the crowd, and respecting the wisdom of our quantitative risk management signals. Great.
Adam Taggart 42:50
I want to just I want to compare what you just said with what technical analysts spend. Henrik, who was on this channel a couple of weeks ago said which was very much same thing Darius and basically spent said, look, I can I can talk all day long, about the macro fundamental reasons why I think this market is overvalued, and the economy is, you know, going to slow down from here and a recession is due. And in fact, we should have a, you know, kind of a, a reckoning to, you know, remove some of the really unsustainable elements about the asset bubbles that we built, and, you know, parts of the economy that have been over subsidized and all that type of stuff. And he said, but I gotta be bullish, and I look at the TA, and it’s really, really bullish right now. And until, you know, these key levels get violated, I just can’t turn back as much as my, every fiber of my being from a macro standpoint, wants to be bearish. I just can’t be right now. And, you know, it’s not, he’s saying like, it’s not good or bad. It just is what it is. And so if you’re an investor, and your goal is to not get wiped out, or not experience losses, or disappointing years of returns, you’ve got to pay attention to what’s actually happening. Anyways, you’re nodding as I’m saying this, but it’s it’s one of those things that I think can really frustrate the average viewer of channels like this, because everybody just sort of prefers the black and white answer and just give me the one solution, and they’ll just go do that. Right. And And sadly, especially in markets like this one, it’s just not that simple. Yeah, no,
Darius Dale 44:29
it’s not that simple. And I think we can make it simpler. And you know, I certainly will put myself in the category of investors that probably does too much research, but that’s because we have clients all across the world in different capacities and facets, you know, we’ve global fixed income investors, global, long short hedge fund managers, you know, we have all these types of clients. So we kind of have to do a bunch of research but the reality is, you could sort of boil investing down to a couple of like basic principles. One separate your research from your risk management no matter what you think is going to happen mark in the markets, you can’t put the trade on until the markets are giving you some form have confirmation right now. And if you’re bearish as an investor, let’s take it back to this global macro risk matrix. The markets aren’t giving you confirmation there are 42 markets in here from the DAX to the Shanghai Composite to the move index to the CRB raw industrials to gold to German break the breakevens to high yield credit spreads to the yield curve, there’s 42 different markets in here across 12 Major, you know, asset classes and sub asset classes that are all being scored not technically, you know, I don’t necessarily believe in technical I think technical is is very useful for those who knew how to do it. But I think technical analysis is actually quite hard to do that well. So I don’t do technical analysis. Well, we just stick to the quad and the quad, from the perspective are volatile just momentum signals when you amalgamate them relative to how these markets have historically traded in the past and the relationships to one another are saying it’s still a risk on regime now. I’m gonna refresh this model every single day. As you can see in this far left column, been refreshing this model day after day after day, we start at 42 macro and we will refresh it day after day after day after day and time in the dirt. And we will keep refreshing because I’m sure my my analysts will continue refreshing it in my in my honor. But the reality is until this mark does so we go from a risk on regime go from risk aubergine we’re currently in reflation to a risk off regime, which is inflation or deflation, you need to be buying the dip, leaning pro cyclically until proven otherwise.
Adam Taggart 46:19
All right, great. Well, look. So Darius, I’m looking at my list of questions here for you. We just got we just got down with question bullet number one. So much more to turn through.
Unknown Speaker 46:31
You got all day, brother. Let’s do it.
Adam Taggart 46:32
This is great. Thanks. All right. Well, I’m trying to think of which one to go next. Let me I want to ask you about interest rates. So we’re going to talk about that just a second. But real quick, I want you to respond if you can, to a quote of yours. So we’ve talked about your thoughts of recession, in timing, which thank you for offering that. This is going to be a little bit wider view. But here’s a quote that you put out recently, navigating the deepening fourth turning crisis over the next decade, approximate decade will be the greatest challenge we face in our lifetime, as investors. So if you and I just spent a lot of time talking about we got to trade the markets the way they’re trading today. Right. But you seem to have, you know, a long term macro outlook that is concerned, maybe it’s a good way to describe it. So and I know that you you, you’re a fan of Neil Howe, and I absolutely am too. And for those watching, Neil Howe is the demographer that that has the framework of the fourth turning which magic most people have watched my interview with him, but if you haven’t, the fourth turning is basically a period in society usually measured in 20 ish years or so where the status quo falls apart and is replaced by a new cycle. Right. So as you look to that period, and obviously seem to be a bit concerned about it, what is it about what you see ahead, that makes you say that this may indeed be the greatest challenge that we face in our lifetimes as investors? Yeah, so
Darius Dale 48:09
a shout out to my former colleague, Neil Howe obviously learned a lot from him in terms of, you know, trying to implement some of his some of his similar findings and research into what we do here. And 42 macro and, and what I meant by greatest challenge we face as investors, I think it’s going to be challenging for not the obvious reasons, like bad stuff is happening, because bad stuff will happen. For sure, we know that total wars, potential risk, you know, we obviously have all sorts of negative outcomes in the in the economy and and what we did in our in our most recent macro scatter presentation, which we put up a monthly for our clients, what we tried to do is actually add some empirical analysis to Neil’s framework, which is, okay, let’s look at a compendium and a series of indicators across the economy that we all know to be very relevant for predicting dispersion and within and across asset markets, and try to understand how do these, you know, you know, sort of statistics evolve through this context of before turning throughout a fourth turning? And also, how are they you know, what’s the baseline for those statistics during a fourth turning relative to the baseline outside of before turning into first, second, and third turnings? And so, you know, you know, we’re not going to give away that, you know, that’s a brand new research we put up for our clients. So we’re not going to give away the kind of the open the full kimono on that particular presentation. But there’s two key conclusions that I think investors need to understand as it relates to this big challenge that we all face as investors, which is, there’s a lot of bad stuffs gonna happen. But I think you have to be extremely bullish because of it. And the reason you have to be extremely bullish because of it, because, you know, one of the key takeaways from this kind of deep dive analysis is about 3040 slides of empirical evidence, you know, kind of taking data back to the 1800s. And trying to understand again, how the cycles have evolved throughout fourth turnings, and relative to the baseline of non fourth turnings. And one of the key conclusions of that deep dive study is that government’s going to get a lot bigger, like a lot bigger way bigger than the CBO thinks, way bigger than Stan Druckenmiller thinks way way bigger. And as a function of how much bigger the government is going to get, we are going to struggle to capitalize the fiscal coffers of the United States of America. If we don’t see some change in Fed policy, or see some change and regulatory policy, which we haven’t, I think we’re going to see both. And now we can unpack why after I make this point. So what I’m showing here in this particular chart, are the shares of the marketable Treasury market, you know, that are kind of owned by various cohorts of investors. So the blue line here shows the Federal Reserve at 20%, obviously, in decline, the red line shows us commercial banks at 16% in decline as well, the black line shows foreign central banks, which are been in decline sexually since going back to 2008 2009, if 15%. And so that leaves us with the residual, the private sector, which now account for half of total marketable Treasury securities, we were at the end of 2021, right around 35 36%, of total marketable treasuries outstanding in terms of you know, our share of the total, we are now 50% of the total, because each of these other main cohorts are selling them to us. So that’s a problem, because we are private sector investors, we need a return to take on the units of risk. And you know, these folks are all for various reasons, price insensitive buyers, Fed buys for economic reasons, the financial banks buys for either economic reasons or regulatory reasons, then the commercial the foreign central banks buy for economic reasons, as well in terms of, you know, trying to protect their currencies, from devaluation. And so that’s, you know, in our view, this, this is a one of the most important charts that you can burn into your brain in terms of trying to identify and understand where treasury yields are headed in the absence of, you know, financial repression, and, you know, particular move towards large scale asset purchases, permanent large scale asset purchases, permanent yield curve control, here in the US Treasury market by the Fed. And we do believe those are very high probabilities, investors should expect financial repression because banks have ample capacity to lend to the Treasury market. And so what I’m showing here in this top panel is the total amount of Treasury and agency securities on bank balance sheets and commercial bank balance sheets, relative to their available bank credit, and it’s around 24% of the total. Now, you go back to the last four, turning in the late 1940s, we were at 64%, of total bank credit. Now bank credit is this wonky statistic that they don’t even really keep anymore, it’s as only as far back as we can get the data. But when you sort of relate the relationship between bank credit and total assets, we can understand that at currently at 18% of total assets, right now, in terms of Treasury and agency securities, that ratio, when we apply the same kind of mean structural mean, in terms of bank credit, the bank assets, we understand that 50%, of commercial bank balance sheets back in 1947, were in Treasury agency securities. And so this is where we’re headed, we’re headed for something that looks like financial repression through the lens of commercial bank balance sheets, and we’re probably looking for something that looks like a permanent move towards yield curve control. And, and, and, you know, just permanent large scale asset purchase programs by the Federal Reserve, in my opinion, you’re talking about Venezuela, you’re talking about Argentina, you’re talking about Turkey, Zimbabwe, there’s so many historical corollaries of what happens to stock markets, to currency markets to fixed income markets, when you cost the point of no return from the perspective of burgeoning public debts and public deficits. And we are very much headed towards that in terms of the key conclusions of that analysis.
Adam Taggart 53:25
Wow. Okay. So that is laying down a pretty big prediction. They’re pretty big gauntlet. So I just want to I just want to ask this question to make sure I heard you, right. So you see, potential for in the next of a generous 10 to 15 years, the US to head down the path of an Argentina or Venezuela, meaning do a aggressive yield curve control on its debt, and basically sacrificing the purchasing power of its currency in the process. They have no
Darius Dale 54:00
choice at and we have no choice. This is all part and parcel of the fourth turning. So I’ll share what I was are the last elements of the analysis that I feel comfortable sharing here, because I don’t wander
Adam Taggart 54:11
in, by the way. So if somebody goes and subscribes to 42 macro, they can obviously get the full enchilada, correct?
Darius Dale 54:18
Well, everything we’ve ever published, including this presentation. And one thing I will say, you know, just as a tiny plug for our business here, we publish what I think is some of the world’s top institutional macros management resources. We have you name a major hedge fund or major investor, they’re probably a client, because I’ve been it’s been my entire career and global Wall Street. We sell that same information that we sell to them, folks who can afford to pay hundreds of 1000s of dollars for the resource at the same price that we sell it everyone else, which is only $100. You know, we want to democratize this information. I could easily say hey, no, we just charge $10,000 A quarter for it. But we’re not going to do that because we ultimately believe in our mission of democratizing finance but in the in The spirit of respecting our paying clients, I’m going to show you one or two more charts in this particular section of our most recent scouting report. And so the first one is this is this chart on inflation in terms of how we actually get to the yield curve control and, and that, you know, in the in the in the Zimbabwe ification of America and its financial markets, particularly the equity market, which partially, I think you got to be extremely bullish on stocks, you got to be extremely bullish on on Bitcoin heading into this fourth turning, and a lot of folks will see this presentation and think the opposite is true, until they realize Uncle Sam has to get his money somehow. And the only way relief out the only escape valve for us as investors is to ultimately lever up and buy financial assets. So here in this chart, where we show our analysis on headline CPI. So as I mentioned, we performed a deep dive empirical study, with data going back all the way back to 1800, for opinion of you know, economic statistics, in terms of trying to understand how they evolve throughout a fourth turning. And as you can see, inflation tends to spike. In the fourth turning, you stand to see, you know, we’re actually, you know, kind of par for the course here early in this fourth turning here. But we also see inflation tends to be about double on a median basis relative to its baseline. And so if let’s say the baseline of inflation is somewhere around 2%, inflation, two and a half percent inflation on a headline basis, here, we’re talking about four to 5% inflation on a dub in terms of doubling, you know, in terms of, you know, the baseline relative to four turnings. And that’s consistent Adam with what we talked about in our previous discussion, which is our secular inflation model, our second inflation model, you know, we talked, we built this model back in, in, in the beginning of 2020 22, trying to get investors to understand that, hey, look, this isn’t just a transitory spike in inflation, it’s going to feel transitory. But there’s elements of this, this transitory moving inflation that are going to be persistent. And the model is still saying the same thing here almost two years later. So this, this model stuck, at least arguing that core PCE inflation is likely to trend 50 to 100%, higher throughout this decade. And now that sounds like a lot, it’s kind of a headline. But the reality is we’re talking about going from a trend rate of 1.6, to a trend rate of 2.5 to 3.2%, in this decade, based on the current evolution of these features in the model that have all been proven to be correlated or CO integrated with inflation with underlying trend and inflation in academic research. And so if this model is correct, and this analysis is correct, we know we’re headed for an error of higher inflation. Well, the only way we can get to using modification and yield curve control and stocks, you know what to do with the money printing go Burr and stocks go up number go up, what does I know what these Gen Z kids say these days, but God bless them. Until we get the only way, the only credible path to getting to that outcome is through capitulation by the fit. So one of our big calls for this, you know, from a longer term standpoint as a strategic asset. allocator is to understand that the Fed will capitulate on what Jay Powell talked about Jackson, oh, this year, which is quadrupling down on this concept, 2%, inflation, fine, sure, whatever, as long as the unemployment rate to 3.7%, you can quadruple down on whatever you want. But if the unemployment rate is at 6.7%, there will be no quadrupling down on 2%, inflation, you’re going to have to pivot to something that looks like three and a half, you know, something that looks like three and a half to four, in our opinion, you know, as we progress throughout this decade, and that has significant implications for portfolio construction, Adam, stocks and bonds are inversely correlated when inflation is 2% or below. But when you get into the three to 5%, ranges, whatever models effectively arguing we’re going to be trading at, you know, throughout this decade, you know, and again, it’s not all gonna happen at once we’re talking about a decade plus long empirical study, if we if this study is correct, you know, from this starting point, you should expect positive correlation between stocks and bonds, and limited diversification from the perspective of stocks and bonds in your portfolio. And if you don’t have a process to figure that out, and ultimately do something about that, from a longer term perspective, you will struggle in an environment where the s&p looks like Venezuela when when things are fine, but as to be looks like I don’t know, the collapse of the Weimar Republic when things aren’t fine.
Adam Taggart 58:57
Yep. Yep. So super fascinating. First, I got to just remind folks, what we’re talking about here is your outlook now for the next decade plus, so this isn’t necessarily a call for what’s going to happen for the remainder of 2023. And certainly, if we go into a recession in 2024, you may have very different positioning than you’re going to have on average for the next decade plus a hit from here. Super, super fascinating. I get if we expect higher inflation to go inflation to be higher on a secular basis going forward from here, that equities probably are a good place to be. Equity markets tend to you know, well, they generally tend to move higher and nominally at least in periods of inflation. Bonds, let’s talk about bonds for a second. So if you expect massive central bank intervention, then you know, one might say okay, well, that means lower rates, right. The central banks are intervening there. You mentioned that the bank balance sheets have a lot of them. Room to invest more in treasuries and things like that. So that will obviously, you know, lower rates would raise bond prices. Now, somebody might say, well, in a secular higher inflationary era, bond investors are going to demand higher rates to compensate for that inflation. So what do you think is more likely to happen? With bonds? I noticed you kind of went immediately to be being bullish stocks and Bitcoin you didn’t say bonds? I’m just curious, where do bonds do you think? How do you think they perform in this environment that you’re projecting up?
Darius Dale 1:00:34
Well, a great question, Adam. So really, it’s about getting the Fed to go from quadrupling down 2% inflation as a target to accepting three and perhaps higher than three on a sustained basis. Because ultimately, that’s what the public debt and deficit situation is going to demand. And ultimately, you go back, think about the UK LDI crisis last September, in my opinion, that’s a precursor to what we’re likely to experience as probably the one of the fat will final catalyst to getting the Fed, you know, to kind of get off its high horse and ultimately jump back into the kiddie pool in terms of capitalizing Uncle Sam for us. And the reason I say that is because as an investor, you have to be extremely based on everything I just said about inflation, the fourth turning financial repression, you have to be very concerned if you’ve got a lot of bonds in your portfolio, and you’re expected to hold those bonds over an extended period of time in terms of, you know, locking in duration and all this stuff, because to me, that sort of misses the key conclusion of what we’re the starting point is with respect to the bond market, we are priced to an incredible amount of perfection, not relative to all the risks that I just highlighted for the bond market, just relative to a standard business cycle process. And so what I’m showing in this particular chart here is in the in the shaded area curve, we show the, the 10 year Treasury term premia, which is the excess return you get as an investor for locking in your money for an extended period of time as opposed to rolling over TBLs for that same duration. You know, this school, very wonky kind of statistical concept, but ultimately, it’s effectively saying based on the Feds model, that we’re kind of at minus 21 basis points in terms of term premium. Well, we the mean for term premium as far back as we have the data since the early 1960s is 152 basis points. So right there, if we just go back to the mean of term premia, which is very likely to very likely to be the case because term premia, generally speaking are correlated with inflation. Because there’s a couple things that inflation does to the economy, high levels of inflation do, which is a cause more volatility and inflation, and it causes more volatility in nominal and real economic growth. And if you have more volatility in the nominal and real economic growth, you by definition, have to have higher term premia to account for that, because it makes it difficult to project the policy rate on a go forward basis. So we think term premium are headed higher, let’s just say they go back to their to their longer term mean, they’ve gone as high as you know, five 600 basis points wide, going back to the late 70s and 80s. But will you know, I don’t think that’s the most likely scenario, let’s just take it back to the long term meet. So you’re talking about, I don’t know 175 basis points on top of the 10. Year today. So that gets you to about 6%, let’s get you to look at look at inflation expectations. They’re very neatly priced around two, two and a quarter percent. And this is both looking at market implied inflation expectations when you look at breakevens, but also in terms of a model implied inflation expectations, looking at the Cleveland Feds models, which again, were neatly tucked around two and a quarter percent. Well over talking about, you know, going back to our second inflation model, let’s just use the high end of that estimate range, we’re talking about three, three ish percent core PCE inflation on return basis, you have to slap another 50 basis points on top of that, to get to the headline inflation, you’re talking about another 75 to 100 125 basis points of a bond market back of yields backing up on a nominal basis to appropriately account for the level of inflation that we might experience over the next decade. So you’re talking about right there. When you put on term premia to a regular level to a normal level, and you have to use up you slap our inflation model in our Felician analysis into the bond market, you’re talking about six to 7% nominal treasury yields.
Adam Taggart 1:04:04
My goodness, can we can we
Darius Dale 1:04:07
afford six or 7%? Nominal Treasury yield data as an economy?
Adam Taggart 1:04:11
I love how you’re intimating again, the question that I was about to ask you, I would say no,
Darius Dale 1:04:16
no, no, the answer is hell no and part of it. So this is why I say enter Federal Reserve enter financial repression, we are going to have to implement yield curve control at some point in this decade, we’re going to have to financially repress our commercial banks and to buy more and more of this stuff in this Treasury paper. And some will call it toilet paper by the end of the decade, until their balance sheets, then that’s very positive for you know, things that aren’t tethered down and hunker down in terms of financial assets speculation. Now, you might not be getting a great return on a real basis, but it’s your going to be a lot better than the return you’re going to get sitting here as a frog being boiled alive in a pot of water in the bond market that and that sounded the key takeaway from that analysis. So again, Um, you know, I sound like a very colorful, bright, educated guy, and I’m certainly am. But I highly recommend folks, even if they don’t want to stay customers a 42 macro for an extended period of time, just sign up for a month, download the presentation, watch the webcast, download the charts, and keep them by your desk for the next decade and reference them when we’re talking about this stuff going forward.
Adam Taggart 1:05:20
That is amazing. And yes, I highly recommend anybody that has any marginal interest in this go do that. It’s this Darius said. Not much money, especially relative to
Darius Dale 1:05:31
a lot of money you might save as an investor.
Adam Taggart 1:05:33
Exactly. That’s the whole point. Exactly. Alright, and Daris as a reminder, when we get to the very end of this conversation, which we’re not going to get to yet, because there’s still more questions for you, I’ll let you tell people exactly how they can go sign up for 42 macro. All right. Okay, so in this world, now, I’ll hop on to just a second. In this world where yes, you know, hell no, they we can’t live in a world where treasury yields are six to 7%. Do you have a gut guesstimate at this point where you think they’ll have to be like, what? What’s the level at which you think that the Fed says okay, I think the economy can sustain this level.
Darius Dale 1:06:15
If treasury yields are above the level of nominal GDP, we got problems, okay? I now they’re not. So we don’t have problems. But when we start getting treasury yields to backup persistently above the level nominal GDP, that’s when you start to have real problems as a as a sovereign. So we also understand that going back to the seminal work that Ryan and Rogoff performed, you know, kind of early in my career, this time is different. We know that, you know, 100% debt to GDP, which we crossed a while ago, and 10% deficit to GDP tend to be a Rubicon. Now, I don’t think it’s going to be the same Rubicon for the world’s reserve currency as it is for No, no Zimbabwe, Argentina, but we do know that we’re playing with fire, as it relates to the evolution of the global currency system, you got the bricks system out there. Now, although it’s not this direct hit to dollar demand globally, but at the margins, what it ultimately means going back to that chart, where we show the relative shares of marketable Treasury debt outstanding, it just means that one cohort of buyers, which used to be around 30%, of demand for treasuries is going to go basically to zero over the term. And so only we got to replace that quarter buyers, we actually have to find more demand for treasuries, because the rate of change of treasury growth, the Treasury supply is going to accelerate asymptotically, not just based on CBO projections, we’re saying it’s going to accelerate asymptotically relative to those projections, CBO has gotten going this way, we are falling off the page backwards, based on our analysis in the fourth turning
Adam Taggart 1:07:36
guy that CPI chart, I’ll see if I can find it and put it up on the screen here in a few seconds. But it is asymptotic already. And you’re basically saying your expectations are to be asymptotic off of that async note, which is crazy. And I should note on the day that you and I are talking the national debt, the US federal debt just surpassed 33 trillion, we added the last trillion in I think we added 2.2 trillion in the past year, the past 12 months. So you know, we are already the in that exponential phase of the debt mounting at a very visibly shocking rate that the eye can see now. And that tends to be what happens in the exponential systems like this is, you know, basically, the rule of thumb with an exponential system is once you can actually see the problem, there’s no way you’re going to avoid it, like you’re already on that crazy ride at that point.
Darius Dale 1:08:34
And and we got another 10 plus years to go in this fourth turning at least according to this entire framework. So again, what we’re trying to do is help investors prepare their portfolios for the long term, you know, we’re going to be Bayesian, you know, we’re going to refresh our models refresh our systems, we’re going to lean our weather model, we’re gonna lean on our global macro risk matrix in terms of helping investors manage risk and financial markets throughout this entire process. But ultimately, just if you think about this, from a strategic asset allocation perspective, you know, especially for you some of the slower moving institutional ra type investors, you need to make sure that you’re aware of these risks, they’re not all bad risks, you know, I think their stock market’s gonna go up a lot, and bitcoins gonna go up a lot, you know, bonds gonna go down a lot, they’re not all bad risks, you just need to be aware of the risks and making sure that you’re constantly orienting your investment posture from a strategic standpoint, in association and in appreciation of these risks.
Adam Taggart 1:09:23
Got to know how the rules of the game are evolving so that you can position yourself to actually benefit from them wherever possible. All right. I do want to get to your market outlook. In the near term. Right now we’re looking way out. And any asset any thoughts you have on assets in the near term, good and bad. Real quickly, though, just because it’s so seminal to what we’ve just been talking about. In in that fourth turning view that you just outlined. Talk about what you think’s going to happen to the US dollar. Now, obviously, I think we gave away the punchline, it’s going to be worth a lot less. On a real The two bases, how is that gonna fare versus other major world currencies? I mean, it’s not like there are many other players out there that we can point to and saying, Oh, these guys are doing it way better. And if we’re having these issues, a lot of other countries are going to be having the same ones as well. So, obviously, you’re saying probably, you know, at some point, you want to be light on dollars in heavy on assets that are going to appreciate in purchasing power, at least in preserving it. But as a world currency versus other world currencies, what do you expect? Yeah, fantastic
Darius Dale 1:10:28
question is something I’ve laid, I’ve lost a lot of sleep trying to think through because this isn’t complicated stuff to think through, you know, someone who spends a lot of you know, all day thinking about these things, and all night really, rarely sleep. This is our, in terms of I think about the dollar, you can sort of think about the dollar price in two types of assets, financial assets, by and large stocks, you know, stocks, bonds, you know, that kind of stuff, your real estate, etc, etc, dollar is very likely to depreciate against those assets with the exception of sovereign debt. You think about it through the lens of the currency market, that’s where it gets very interesting, because, again, most of the major sovereign economies, particularly the Western European economies, which very much comprise the DX y basket, those economies are very much aligned with our fourth turnings, including Japan, you know, World War two kind of was a seminal moment in time, that kind of put all of our turning cycles together for a lot of the rest of the world, and even parts of the emerging market world, if you look at places like Turkey, and Philippines, and Brazil. So we’re all sort of tethered in this fourth turning together. So it’s not just like, we’re all going to have the same problem, or you know, us is going to be out here with this bad problem, and everyone else is going to be benefiting from the dollar depreciation. I think if you think about where we might go from an inflation standpoint, and ultimately, how just you know, the elements of dollar devaluation might spill over into the commodity market, this actually could lead to dollar appreciation. And the reason I say that is because the two, you know, to the biggest kind of net international investment creditor economies in the world, Japan and the eurozone primarily are, you know, energy importers and food and energy importers, right, and they don’t have domestic supplies of these assets. And so you think about how are they going to acquire these assets persistently, in the context relative to an economy like the US, which is sort of coming from a starting point of a negative net international investment position, a negative current account balance, obviously, a deeply negative sovereign debt balance, which by the way, the budget deficit is at a record non war, non recession budget deficit right now we have in the US economy, and this is something we’ve been calling out all year, as part of our, you know, kind of, you know, sanguine bias on the economy, you know, so this weather model was just really quickly, you know, I’m gonna spend too much time on this, because, you know, we got to wrap up. But, you know, the, what we try to do with this system is look at everything that matters as it relates to financial markets, in terms of predicting dispersion across financial markets, growth, inflation, employment, profits, fiscal policy, liquidity, credit, interest rates, positioning, etc. And one thing we’ve been persistently harping on all years saying, hey, look, this budget deficit is at at minus, you know, it’s been somewhere around, you know, minus seven and a half to minus eight and a half percent all year. And that’s a record non-war non recession budget deficit, the US economy, you mentioned,
Adam Taggart 1:13:00
sorry, never had one that high percentage of GDP with unemployment this low, yeah, totally.
Darius Dale 1:13:05
We’re going to 10 We’re never gonna go persistently stay there for a little structural basis, you know, if we don’t get our act together in terms of productivity, but that’s impossible forecasts I’m not going to try. So in terms of like, you know, you think about this, again, through the lens of the global currency market, and the relationship between, you know, kind of commodity importers and commodity exporters, you look at a place like, like the eurozone economy, for instance, its current account surplus has narrowed all the way down to 0.4% of GDP, that’s a minus 1.7 Sigma relative to the trailing 10. Year mean, that’s a problem in America, Japan, which is historically had a much wider current account balance, current account surplus, it’s a down now it’s a 2.2%, the of the end goes to 200. You know, that 2.2% could be minus 2.2%. So this is why I say it’s really difficult to kind of project the currency market with respect to kind of, you know, across on a cross currency basis, I think it’s much easier to say that the dollar is going to depreciate relative to things like, you know, stocks and relative things like big one.
Adam Taggart 1:14:06
Okay. And I’m presuming you think it’s going to depreciate to relative to things like food at the grocery store and gasoline and things like that, just for us our lived experience in this fourth turning world that you’re projecting?
Darius Dale 1:14:19
On a percent? Absolutely, absolutely.
Adam Taggart 1:14:21
Okay. All right. Well, like I said, Let’s try to bring it down to kind of the next, let’s say six months, 12 months, whatever, maybe six months, more so people who are saying, okay, look, you know, Darius is saying that, you know, looks like things are going to hold together for the near term here. But there’s a recession lurking out there on the horizon. Maybe now it’s going to hit more in the sort of April 2024 type range. As I’m looking at different types of strategies or assets to consider, you know, Daris what are some of the things that 43 macro that you guys have your eyes most close? put on here. Yeah, absolutely. So I’ll start by saying our interview with Darius will continue over in part two, which will be released on this channel 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. Also, don’t forget that tickets for the wealthy and fall conference are still on sale at the early bird price discount of nearly 30% off the standard price. And alumni of our previous conferences get an additional 15% discount on top of that, to lock in these low prices while they last go to wealthion.com/conference. And if the challenges Darius has detailed in this interview, 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 Darius has mentioned here. Just go to wealthion.com and we’ll help set one up for you. Okay, I’ll see you next in part two of our interview with Darius Dale