Episode #366: Darius Dale, 42 Macro, “Reflation Is Now The Dominant Market Regime”
Guest: Darius Dale is the Founder & CEO of 42 Macro, a startup investment research firm that aims to disrupt the financial services industry by democratizing institutional-grade macro risk management processes. Prior to founding 42 Macro, Darius was a Managing Director and Partner at Hedgeye Risk Management.
Date Recorded: 10/28/2021 | Run-Time: 1:26:11
Summary: In today’s episode, we’re talking all things macro! Darius walks us through his framework for analyzing macro regimes and then uses it to assess where we stand today. We touch on all the hot macro topics – whether inflation is transitory, the impact of supply chain issues, and how the rise of populism in the U.S. will impact markets.
Be sure to stick around until the end of the episode to hear what Darius says is the most important chart in macro today.
Darius was kind enough to put together a comprehensive deck for the episode, so be sure to either check out the episode on YouTube to see him walk through the slides, or click here to follow along yourself.
Sponsor: Public.com is an investing platform that helps people become better investors. On Public, ownership unlocks an experience of content and education, contextual to your portfolio, created by a million+ strong community of investors, creators and analysts. Start investing with as little as $1 and get a free slice of stock up to $50 when you sign up today at public.com/faber.
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Links from the Episode:
- 0:00 – Sponsor – Public.com
- 0:50 – Intro
- 1:34 – Welcome to our guest, Darius Dale – click here to follow his deck
- 2:49 – The difference between macro and macro risk management
- 4:23 – Overview of seeing the world through a regime segmentation lens
- 5:45 – Where we find ourselves today in relation to this slide
- 9:55 – Episode 363: Rick Bookstabber, Fabric
- 11:14 – Generalities about the different regimes
- 14:10 – Reasons why the bond market is forward-looking
- 22:28 – Reflation is likely to survive as the dominant regime into early 2022
- 27:58 – How Darius’ projections work based on his growth and inflation forecasts
- 28:48 – Sponsor – Public.com
- 30:03 – Major outlier countries in relation to the rest of the world’s trends
- 31:50 – Chinese equities and managing risk from a portfolio construction perspective
- 35:39 – How to apply this methodology
- 40:31 – Thoughts on market dislocations when the current narrative proves to be false
- 47:59 – The transitory versus persistent debate about inflation
- 1:00:07 – The most important chart in macroeconomics (slide #59)
- 1:11:11 – Thoughts on portfolio construction
- 1:15:55 – General thoughts about the end of the year 2021 winds down
- 1:21:41 – Learn more about Darius; 42macro.com; Twitter @42macroddale
Transcript of Episode 366:
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Meb: Hello, friends. Another great show. Our guest is the founder and CEO of 42 Macro, which specializes in macro risk management through the dual lenses of asset allocation, and portfolio construction.
In today’s show, we’re talking all things macro. Our guest walks us through his framework for analyzing macro regimes and then uses it to assess where we stand today. We touch on all the hot macro topics whether inflation is transitory, impact of supply chain issues, and how the rise of populism in the U.S. will impact markets. Be sure to stick around to the end of the episode to hear what our guest says is the most important chart in macro today.
Our guest was kind enough to put together a comprehensive deck, so be sure to either check out this episode on YouTube to see him walk through all the slides, or click the link in the show notes to follow the deck yourself. Please enjoy this episode with 42 Macro’s Darius Dale. Darius, welcome to the show.
Darius: Hey, what’s up, Meb? How are you doing?
Meb: I’m great. I’m sitting here…if you guys can hear me, you should listen to this one on YouTube. So listeners on the audio podcast, check us two handsome fellas out on the video link because we’re going to be doing a short book screen share today that is going to be awesome. Plus, you get to see our beautiful faces. I’m wearing a Hawaiian shirt.
Darius: As am I.
Meb: It’s hot here. What’s it like in the Northeast?
Darius: Well, it’s certainly misplaced in terms of my Tommy Bahama gear, but it works up here too.
Meb: All right. So we’re going to go deep on macro today, my favorite topic. I love it. A lot of macro shifts, rumblings going on. Jack just came out talking about hyperinflation, which means by the time this podcast airs, we’re at the end of October, hyperinflation means that prices should be up 50% by the time it comes out, if he’s correct.
Darius: If he’s correct, yes indeed.
Meb: We’ll dig into it. So you want to share your screen? And listeners, there will be a companion download on the show notes. mebfaber.com/podcast, you can find the link to the book to follow along as well. So take us away. Where do you want to get started?
Darius: Yeah, so appreciate your time, Meb, and appreciate being able to connect with your listeners and viewers. I put together a little outline and we can obviously deviate from that. It’s a pretty big deck in terms of the content we can cover. But I thought it important to start with a brief intro to our process. We do have a systematic regime segmentation process that I think is pretty instructive and really helps inform listeners on how we think about the world and more importantly, thinking about managing risk.
I do believe that macro is a little bit different than macro risk management. We tend to specialize in the latter. I think most people kind of spend most of their time and resources on the former, which, you know, is neither here nor there whether or not it’s better.
Meb: Explain what’s the difference between the two?
Darius: So I think macro is the putting together of narrative economic base narratives that allow you to sort of participate on the longer short side of investment. I think macro risk management is the systematic tracking of macroeconomic risks, whether they be growth, whether they be inflation, whether they be policy, and how they’re likely to inform asset market dispersion along the way to the destination that your investments are trying to get to.
Meb: Is it fair that the latter is a little more practical?
Darius: I would argue the latter is a little more practical and that’s really, quite frankly, what separates the buy-side from your average Joe investor is that on the buy-side, when people who are in institutional money management engage with macro, they’re not engaging with macro to tell a story, to tell a narrative about some future time, some future state. They’re engaging with macro to understand the balance of risks along the path to that future state. And that’s where firms like myself come in, in terms of helping those types of investors kind of get through the water, if you will.
Darius: So let’s hop right in. So again, you mentioned that we got a slide deck we’re following along with here. So I’ll start with the first slide here, slide four. When you think about the world in this regime segmentation lens, I think most investors kind of know what Goldilocks means from a market perspective, what reflation means, what stagflation means, what deflation means.
In terms of our nomenclature, what that means is that the market in Goldilocks is trying to price in growth accelerating versus inflation decelerating. That’s a risk on market environment with a disinflationary bias. When growth and inflation are accelerating simultaneously, that’s what we call a reflation.
That’s a risk on market regime where you have an inflationary bias to the impulse. When you kind of cross below the horizontal line on this axis here on slide four, that’s where you kind of hop into stagflation. We call it inflation because GRID sounds better than GRSD. But anyway, that’s when the market’s pricing in a risk-off regime with an inflationary bias. And then lastly, you got deflation. Obviously, we all kind of know what that means. That’s obviously risk-off with a disinflationary or deflationary bias.
So it’s our job as investors, as macro risk managers, to not only sort of measure or map where the economy, both the U.S. and globally, where the economies have been with respect to this process, but where they’re likely to be on a go-forward basis because that will influence this sort of sequence of events with respect to asset market dispersion, with respect to potential crash risk, melt up risk, things of that nature.
Meb: So where does it put us now, for the listeners who are waiting with bated breath? Where do we find ourselves?
Darius: Well, it’s interesting, I think we’re in a very important crossroads here from an economic perspective. So we’ve come out of this very elongated period of reflation whereby growth and inflation are accelerating simultaneously for not only the U.S. economy but for the global economies for quite some time. The reality is we kind of had the advent of delta strike us in the middle of the summertime and that’s created a little bit of consternation with respect to the early part of the fall.
But I do believe the economies have the ability to recover on the other side of delta. And what’s likely to happen in this kind of early Q4 period really could potentially be longer than that. To the extent we do see sustained economic recoveries out of delta, the economy is likely to now cast itself back into reflation.
However, as you look into 2022, particularly starting in around Q1 of 2022, that’s kind of it as it relates to the positivity that we’re going to get from the economy, or from the perspective of positive deltas on growth and positive deltas on inflation.
And we’re going to start to give way to a scenario whereby the balance of economies in the world are going to transition into a persistent state of deflation.
Again, that means when growth and inflation are decelerating simultaneously, that requires, quite frankly, the opposite asset allocation pivot, and the opposite sector and style factor tilts, then reflation. And so at some point between, I don’t know, let’s call it late Q4, early Q1, and mid to late Q1 and early Q2, we’re going to see asset markets have to kind of force themselves into a very defensive posture.
It doesn’t necessarily mean the market has to crash on that but it likely means you’re going to accumulate leveraged liquidity and concentration risk into that process that actually might have to get unwound in a way that may perpetuate a much bigger drawdown. But between now and then, we should see some clear blue skies.
Kind of keeping it moving on the process here. On slide six here, we kind of give you a little bit of background on why we think about the world through this regime segmentation framework. Certainly, I’m not the first person to do that. Obviously, Ray Dalio has probably done it the most successfully I think. Bridgewater’s average annual return is somewhere around 12% over the last 30 years versus 7% for the S&P. So they’re doing something right with respect to their macro risk management framework.
I tend to think about rate of change being a dominant force in markets. Obviously, Dalio and many others have proven that. I think Danny Kahneman and Amos Tversky have done the most work on that as it relates to Prospect Theory and the impact of rate of change. And then lastly, Benoit Mandelbot has brought his seminal work on volatility, and that being a leading indicator for asset market prices. The reason I kind of bring those guys up is because I think it’s…those three individuals in terms of their contributions to finance really sit at the intersection of our process.
So Ray, obviously on the bottom-up macro regime segmentation, that’s slide four and slide five. But then when you get into how we now cast the market regime, and more importantly, how the now cast for the market regime tends to help investors kind of reorient their sector and style factor pivots, their liens, their bets sooner than other sort of more fundamentally driven types of processes. So what we’re showing here on slide seven, it’s a big matrix, don’t try to squint.
What I’m really doing on this matrix is knocking on the door of the 42 most liquid asset markets in the world, the 42 most widely trafficked and followed in market indicators through the lens of our volatility adjustment momentum signal process. That’s obviously a mouthful, but what we’re really trying to do is knock on the door of each of those markets and say, hey, which market are you pricing in? Where are we starting? Which regime are you pricing in? Is it Goldilocks, is it reflation, is it inflation or is it deflation? And we add up that score at every interval.
This is starting on slide eight now. We add up that score at every interval to identify what the modal outcome is from that process. And right now, reflation at 20 of those 42 markets are confirming reflation is now the dominant market regime. And how we determine that so it’s a share of the total markets, so reflation right now is back at 47%. That 47% is as high as it’s been since early May.
So you go back into the early part of June, the reflation trade really kind of ended pretty abruptly and it kind of…for certain segments of the reflation trade, if you think about something like lumber, copper, things of that nature, it really ended quite painfully and quite abruptly. And the reason for that…and this goes back to a conversation you had with a guest, the guy from Fabric…
Darius: Bookstaber, yeah, he’s an outstanding individual. He brought up something that was really important as well with respect to risk management, which is concentration is a big deal. And so one of the things that this process is designed to signal is concentration in and around a particular macro regime.
And so going back to early part of June, reflation got concentrated to the point where it was in the 99th percentile of confirmation. And so that’s telling you that hey, like everywhere you look, asset markets are pricing in reflation, which likely means if you take it one step further, that everywhere you look, investors are betting on reflation.
And that’s an issue from a concentration perspective because if anything changes…i.e. we did get a pretty material catalyst at that point in time, which is the June FOMC event, whereby the Fed effectively kind of put the kibosh on this MMT speculation with their dot plot revision, that catalyzed a pretty material shift.
And obviously, since let’s call it mid-June, or sorry, early July, through the latter part of September, we’ve been in this kind of messy let’s call it market regime ping pong. And that’s exactly why you’re seeing such violent rotations back and forth with respect to sector and style factor leadership because the market has had a really difficult time pricing in one regime. Well, that difficult time has just ended recently and now reflation is kind of back at the top of the leaderboard, and we expect it to remain there over the next few months.
Meb: As you think about these regimes, for listeners, is there any sort of generalities that people can tease out as to historically like how much time countries spend in the various blocks? And also, like, how often do they switch? Is it something where you can have a country or a regime that, like, lasts for years and decades? Is it something where it like can flip and flop, like, every couple of months? Is there one dominant? Give us kind of a view of, like, how do they spend all their time traditionally?
Darius: That’s a fantastic question. So going back to slide five. Economically…so attacking that question from two different ways leads to the same answer. Economically, there’s usually on average two bottom-up macro regime shifts per year, two material shifts. And what I mean by material is going across the horizontal axis on this chart on slide four. When you’re going across the vertical axis, i.e. going from Goldilocks to reflation, or going from inflation or deflation, that’s not necessarily the material, because you’re only making kind of marginal changes with respect to your asset allocation to take advantage of that.
However, when you go across the horizontal line, that’s when you typically have to go from risk-on or risk-off. And a better visualization of that kind of process is on slide 13 here is the summary of our GRID asset market backtest, where we’re looking at everything that takes in global macro, particularly every single investable exposure through the lens of that regime segmentation process. And we’ve backtested it through the prism of volatility returns, covariance, percent positive ratios, etc., etc.
And we understand in every single regime, there’s a pretty consistent set of outperformers and underperformers with respect to the regime. And so you draw a line down the middle of this page. If you look at Goldilocks and inflation, there’s not a ton of dispersion, or there’s not a ton of difference with respect to the sector and style factor bets that you’d be making in either of those. Same thing with inflation and deflation. The issue is when you go from one of these two to one of those two, and that typically happens twice a year.
And so that takes me back to the second answer of the question which is, economically, you crossed that line a couple of times a year on average. Again, we have had times like from 2016 to 2018, where you were pretty much in reflation the whole entire time. That was a record round of accelerating economic growth in the U.S., for example. But sticking with the averages, it’s usually about two a year, which takes you back to this dominant market regime process.
The dominant market regime again is a great regime that has the highest share of confirming markets at any given time. And that process coincidentally is also around two to two and a half times a year in terms of seeing an actual change, a material change, i.e. going from Goldilocks or reflation to inflation and deflation.
So what this process is really trying to do is help medium-term investors, medium-term asset allocators make sure they’re not on the wrong side of what the market wants to price in from a sector and style factor or leadership perspective.
Meb: What’s a treasury belly? Is that like a mid-duration treasury?
Darius: Yeah, exactly. Between sort of 3 to 10 years.
Meb: So as you look through this, like I think a lot of it people would be, like, that makes sense, okay, that makes sense in inflation and deflation. I see one surprise to me for the common narrative, which is in the inflationary world, top three fixed income sectors. Do you consider that a surprise to people when you talk to them, or is that some reasoning behind that? You want to give us any color?
Darius: Yeah. No, I think the bond market is extremely forward-looking, and part of the reason the bond market is forward-looking, because it understands what the implications for being in here are. And I think you look no further than today’s exercise. You go to slide 64 of this deck where we show Eurodollar calendar spreads, the blue line is the December 22 spread which is just skyrocketing, the investors are pulling forward rate expectations into 2022. And they’re borrowing those expectations from 2024, the black line, in 2023, the red line.
And so to answer your question, the pink line is the 5-year, 30-year spread. The long end of the curve is looking into what this actually means for the medium-term outlook for growth, which is obviously negative for both growth and inflation. And so that’s why you get positivity in the long bond or, you know, positive returns in the long bond and things of that nature.
And quite frankly, I think that’s what’s happening right now. You look at…this show at the top half of this chart on slide 68 is showing the 10-year treasury yield nominal, the bottom panel showing the 30-year treasury yield nominal.
And as you can see in this kind of return of reflation, the 30-year treasury refuses to budge or bounce to the same degree that the 10-year or the 5-year have. And I think the reason for that, again, is the 30-year is looking forward into the future and saying, hey, this stagflation is going to give way to demand destruction and more importantly, it’s going to give way to tighter monetary policy, which may, in fact, catalyze slower growth and slower inflation on the future.
Getting into where we see the world headed over the next few months, right now, as I mentioned, reflation has become the dominant market regime. Again, I mentioned, we expect it to maintain its status as the dominant market regime into the early part of next year. And the reason for that is we do believe the conditional probabilities associated with stagflation, or inflation, as we call it here in 42 Macro, I believe those conditional probabilities are going to go down in favor of reflation because again, we model the economy stochastically. We don’t necessarily believe in kind of making up GDP estimates or things like that. You know, the traditional sell-side does.
But what we do believe, that our now cast models for most economies are going to show positive economic activity at the margins relative to where we kind of were at the end of Q3. I think a good example of that are slide 34, if you look at the U.S. economy in particular, we have auto sales contracting at a…down 57% annualized pace in September. Broad industrial production gross contracted at -14% annualized pace in September. So that creates a very easy handoff for growth to bounce in Q4.
And ultimately, we do believe that bounce in economic activity is likely to create kind of the now cast outcomes of reflation for the economy, and that’s what the market, in our opinion, is pricing in. The key question as an investor is, okay, what are the risks of that view? And then how sustainable do you believe the reflation trade is? I think I’ll start with the second half of that question because it’s easier to answer.
The second half of the question sort of starts with okay, who’s not in the kiddie pool that needs to get sucked into the kiddie pool, in terms of pricing and reflation. And then secondarily, sort of how long will the water be running in the kiddie pool because if anyone’s ever played in a kiddie pool…hopefully, no one listening to this, plays in kiddie pools currently.
Meb: Kiddie pee pool.
Darius: Yeah, going back to our respective childhoods, you need to keep the hose on because the water always splashes out outside, right? You got to keep the hose on. And so we’ll talk about the probability of the hose remaining on and when it’s likely to turn off.
But if you’re starting with the kiddie pool exercise, one thing we look at is sort of rolling 260-day realized volatility. What you typically find is that, you know, when it makes new cyclical lows, it typically is a leading indicator for excess returns to the upside in the equity and credit markets. And the reason for that is that you have a lot of vol targeting funds, vol targeting players that will actually increase their leverage and exposure to the equity markets as a function of that signal.
That, in our opinion, was one of…we use the same analysis to sort of catalyze, hey, look, we think by April, the market is going to start ripping and roaring. And that’s something that exactly would happen because we were going to lose the observation window of last March and April. And once you got into May, obviously, we saw volatility plummet. And that in our opinion is what catalyzed a big move higher.
We’re actually going to start to see that incrementally as well because we’re going to lose the observation window of September and October of last year, and this will become the new reality. And so that new reality will catalyze, in our opinion, incremental flows into the equity and credit markets that could perpetuate something like a Santa Claus Rally. I hate that term because it’s so lazy. But I have no problem borrowing it for the purposes of this exercise.
In terms of incremental macro catalysts that can perpetuate reflation in Q4 into early part of next year, we obviously have this debt ceiling debate with respect to the budget resolution and the physical infrastructure bill. In our opinion, that’s a two-thirds probability being a positive outcome. So it’s very likely that we get…just in terms of reading the most recent tea leaves coming out of D.C. this week, the number is settling around $2 trillion.
Senator Sinema who has been basically playing hardball this entire time has finally given the Biden administration a list of demands on the tax side as it relates to getting her support for the package. And so it’s likely that no matter what it is… We knew it was not going to be $3.5 trillion. We always knew there was going to be a haircut, but they would likely get it done because again, the bear case here, kind of the one-third probability that this does not get done is extremely bearish for the party at large.
You can’t have the party running both houses of Congress and the White House, and not be able to come to agreement on actually just passing a fiscal ’22 budget, let alone physical infrastructure that everybody wants to get done and things of that nature. So if they fail on this, it’s not just a failure for President Biden, but it’s a failure for the broad party. And they’re going to absolutely hand the Republican Party the midterm elections in 2022.
So we think that’s a low probability event with respect to failure, which means we have a reasonably high probability event with respect to a positive market catalyst.
Going back into the kiddie pool example, on slide 40 here, we already know investors have a record amount of cash on hand in terms of money market fund assets. And part of the reason of the record amount of cash that is on hand is because people just refuse to buy bonds. Well, as we get into the early part of next year, that money is going to start to buy bonds because it’ll become increasingly clear that inflation is transitory in rate of change terms, i.e it’s likely to be lower a year from now than higher.
But more importantly, we do believe this cash on hand is likely if it starts to see something that looks like a Santa Claus Rally may be prime to chase, particularly for those investors who have underperformed what has obviously been a very difficult market to keep up with this year, if only because the sector and style factor rotations have been extremely violent.
And so if you mistime those rotations, i.e. your leveraged loan reflation at June when our system was saying, okay, reflation is overcrowded, that kind of stuff can really weigh on you, at the same time, the broader market is not really having much of a correction, so that cash on hand still exists.
And then the next few slides are probably the most important as it relates to the kiddie pool. And this slide here on slide 41, we’re showing net liquidity, and there’s a million ways to calculate it. But our simple calculation is the Fed balance sheet minus the Treasury general account. As you know, the Treasury account, when that’s going up, that typically is draining funds from the financial markets, and when it’s going down, it’s typically adding funds to the financial markets. And so that’s why we do balance sheet minus TGA.
And the reality is, we know tapering is going to take the sort of exponential pace of this blue line and turn it into more of a logarithmic ascent over the next kind of nine months or so. The only thing that’s likely to catalyze an actual negative inflection in the blue line is the return of the kind of the bully to capital markets, which is the treasury market. But we have at least on slide 42 show there’s $1.4 trillion in overnight repo that can act as a real typical buffer with respect to the return of the treasury to public debt markets in a material way.
And that might offset kind of the decline in net liquidity that we eventually expect to see. Now it might offset that at least or delay it at least until the second quarter of next year so you don’t have to worry about the blue line, which is the blue line that’s gotten stocks from where they were in the lows of 2009, to where they are at the highs of today. That blue line is likely to continue higher, at least over the next kind of three to four to five months.
And so that’s kind of the summary on why I believe reflation is likely to survive as the dominant market regime or generally survive as the dominant market regime into and through the early part of next year. I can talk about the risks of that view, and why we believe that betting fully on reflation is probably not the appropriate exercise, given our forward outlook, if that makes sense.
Going back to slide 30, so supply chain disruptions are obviously a big topic, macro topic du jour, and so we’re not adding anything as it relates to bringing it up as a risk. Just trying to quantify it is what we’re trying to do here is use data to quantify changing probabilities.
Going back to that Danny Kahneman quote on slide six, where subjective confidence doesn’t really mean much. There are a lot of investors that have a lot of conviction and a lot of conviction in either their views or their process, but the reality is, confidence can be extremely subjective. What’s not subjective is our probability. So that’s why we tend to anchor on so much data in these presentations in our work in general.
But going back to the risks, you look at something like the ISM prices indices, they’re off their highs. But if you draw a line across the page, you’re obviously still extremely elevated in nominal terms. And when you talk about supply chain disruptions, you look no further than something like the two-year breakeven, which is making a new high here, new cyclical high. In fact, it’s a new post-crisis high. We haven’t been this high since kind of the summer of 2008. Baltic Dry Index continues to make new highs as well as a proxy for kind of the global supply chain disruptions that we’re continuing to observe.
And then last on this bottom panel here on slide 31, we’re looking at the supplier deliveries…the percent of the respondents in the ISM manufacturing and services surveys that are reporting supplier deliveries are actually slower. And we ticked up in manufacturing, still a no man’s land. And obviously, services are still a no man’s land as it relates to the longer-term time series. So we still have some very key issues that need to be resolved as it relates to asset markets.
And the reality is, going back to slide 12 here, when you look at these conditional probabilities, just kind of looking at the U.S. in general, you look at the conditional probabilities from a bottom-up macro regime perspective, it’s still pretty elevated with respect to stagflation. Now, again, I think those are headed lower as we get more data, but the reality is, the risk is that they don’t go lower. The risk is that they continue higher and these turn into … and kind of bleed into the early part of next year.
And if that’s the case, going back to this slide here on slide 13, that’s not the same. It’s not like oh, I can position for reflation and get inflation and just nail it. No, that’s exactly not how to do it. That’s how you get your head handed to you in sector and style factor leadership terms because it is a very different regime to risk manage.
If you look at something like the high beta, low beta ratio as a proxy for…the next couple slides show our intermarket analysis, high beta, low beta ratio is going up in Goldilocks and inflation…or in Goldilocks and reflation, it tends to go down in inflation and deflation. Same thing with small-cap, mega-cap ratio. Same thing with value to growth.
And so where I’m really going with this is if you get the reflation call wrong, not you but me, or us or anyone kind of betting on reflation here in Q4, if you get the reflation call wrong, it’s likely to mean you’re going to be dead wrong in your sector and style factor pivots. And we’re actually starting to see a little bit of that creep.
One thing we look at on a daily basis here on slide 19 is our dispersion analysis, which looks at month-over-month Sharpe ratios across 50 different U.S. equity sectors and style factors. The reason we look at Sharpe ratios, because it’s a better proxy for kind of the flows of your more fast-acting, more hot money-type investors. I think of the pod shop community, the Citadels, the Millenniums, the Balyasnies of the world, this is a very accurate representation of what those kinds of investors are rotating into and rotating out of at the margins.
And what you’ve seen is the return of kind of defensiveness to the top of the leaderboard. Again, this is the upper quintile, you got six sectors and style factors that I would characterize, at least our backtest would characterize, as defensive in nature, even though we’re in a reflation trade.
And so that kind of brings me to my final point on this whole thing with respect to the need to maintain some balanced portfolio construction. When you’re further away…so this is on slide 24. This is showing our U.S. GRID model, so we maintain this model for every economy in the world. The U.S. has significantly…it’s by far the most dominant because the U.S. GRID model would determine the direction of S&P, determine the direction of the VIX, determine the direction of the dollar, determine the direction of the 10-year treasury yield.
All those things are obviously pretty important signals as it relates to other asset markets around the world. But if you look at this model, the first thing I think most people notice in the model is that the blue dots are a lot closer to the origin than all the black dots. And the black dots are the historical. The blue dots are the projections.
And so what our stochastic processes are suggesting is that it’s increasingly statistically improbable that the economy moves at the same pace that it had been doing, i.e. when we were in deflation in winter last spring, we were moving really fast down in both growth and inflation, to reflation in the spring of this year, we’re moving really fast, higher with respect to growth and inflation.
And now that speed, that pace of change, the magnitude of the change is actually just narrowing and clustering around the origin of this chart. And this cluster around the origin of the chart means that the probability of each of those regimes is actually reasonably on. Like when you’re close to the origin, it doesn’t take much to go to 1, 2, 3, or 4, right?
Meb: Right. Said differently, there’s times when the picture is like very clear in one camp, but this is pretty close to the middle. Is that accurate?
Darius: You’re not only accurate, but you’re actually leading me to my next point which is, the further you get away from the origin, the more it is that the asset market behavior looks like what it looks like on slide 13. Like if you’re deep in reflation, the asset market performance will look exactly as it is on slide 13, which is the result of trailing 25 years of monthly observations from a market backtesting perspective. Going back to slide 24, the closer you get towards the origin, the more likely it is that you’re going to look like a jumbled mess. And that’s exactly what we’ve gotten since the early part of July.
Meb: And how does the projections work?
Darius: So the projections work…they’re a function of our growth and inflation forecasts. So we’re projecting growth and inflation through the lens of our stationary mean reversion model and our agent-based now cast model into the future on a rolling next 12-month forward basis. This is our U.S. growth model as well on slide 25. On slide 26, we’re showing the features of our now cast model for U.S. growth.
On slide 43, we show our inflation models, where on the features on 44 for a now cast model. We’re doing that same process for every economy. Obviously, we tend to focus on the U.S. because again, it’s the dominant force with respect to controlling the broader global macro risk matrix. But the reality is, every economy is contributing to some degree in the median conditional probabilities that we’re observing, that bottom of that table on slide five, to answer your question on how do we get to the future.
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Meb: Are there any, like, major outliers on this as I look through some of these countries?
Darius: China has been an outlier, whereas most of the world’s been in this bottom-up macro regime, reflation regime, which is growth and inflation accelerating simultaneously on a churning basis. They’ve been in sort of stagflation for an extended period of time, which likely means that they’re going to bottom at least in growth terms a little bit sooner than us. Talking about the early part of next year, our model has China inflecting into bottom-up regime reflation in May of next year. I do believe asset markets are forward-looking.
So it’s very likely that Chinese asset markets start to price that in much sooner than that. I would be looking to be buying Chinese equities sometime in Q1 of next year as a function of that process. But if you look at our China model, specifically on slide 70 and 71, we’re talking about China actually going into the steepest part of its deceleration over the next couple of quarters. You can really see that, you know, on slide 71, which are Chinese growth projections.
Some time in this kind of part here where I’m drawing on the screen, you’re going to want to start to buy Chinese equities because again, this process will be extremely disruptive and perpetuating outperformance next year. They’ll be on their own policy easing cycle, they’ll be on their own sort of potentially a regulatory easing cycle as well, to the extent that they overdo it now, with respect to the common prosperity initiatives. And oh, by the way, they got a big catalyst in terms of coronating President Xi at the end of next year that I think they’re going to want to show some strength into.
So that’ll be a pretty big theme I think for us next year on the long side. But for now, from a macro risk management perspective, heading into the steepest part of the slowdown is typically not something that’s going to be welcomed or rewarded by market participants with positive excess returns. And so you definitely want to be staying away from China as it relates to, okay, we see this coming, but now is not the appropriate time to do it. That’s what macro risk management is, is, is now a good time to do this? And if now is not a good time to do this, when might be a good time to do this be?
Meb: I’m a quant. So discretion doesn’t play a role. But it’s been interesting to watch sort of the attractiveness of China’s stocks sort of wax and wane over the years. And our strategies was a pretty low allocation but it seems like it’s starting to get some nibbles here this past quarter, partially because it’s a value strategy and things have just gotten pummeled in the last six months.
Darius: What does Petee Jay say? The last third of the move is always the hardest to risk manage because bulls sell too early and bears start churning through. Reverse is true, obviously to the downside with something like China, the value buyers are going to step in too early and bulls are probably going to start to emerge.
And so right now, in our process, from a shorter-term risk management perspective, it’s not a great time to be chasing Chinese equities. One thing we look at in terms of helping investors risk manage kind of the next few weeks is looking at changes in volatility risk premia across different market exposures.
And right now, Chinese equities have not only they’ve developed an implied volatility discount, which is typically instructive for lower rejected forward returns, but more importantly, they’re developing implied volatility discount on a low level of realized volatility. And so, like, it’s certainly relative to the recent trend, which is what we’re showing here, the mean trailing 3-month Z score for 10-day, 20-day, and 30-day realized volatility.
So if you’re on the left side of this chart, your realized volatility is lower than it has been on a trending basis. And if you’re below the horizontal axis on this chart, you have implied volatility discount which means the market’s expectation of implied volatility, and we’re looking at 30-day at-the-money put implied vol is actually lower than the market’s recently realized volatility.
So it’s telling you that there is a contingency of value investors that are crowding into Chinese equity exposures, and eventually, they’ll be rewarded. But it’s unlikely in our opinion, that they’re going to be handsomely rewarded, particularly with excess returns over the next few months. There are just simply better places to put your money in and better stories to allocate to from a macro risk management perspective.
Going back to how the risk managers saw from a portfolio construction perspective, because that’s probably the primary thing that investors engage with us in, which is you can follow along with what we’re doing here broadly, but I think obviously, institutional investors have their own set of tools that they’re using to gauge the portfolio construction, but what we’re really trying to do is help investors to understand how to allocate to the various themes.
Obviously, you have the GRID process G-R-I-D, each one of those is its own theme. And then you have cash, at any given time cash could be a theme to the extent you know how to use that as kind of a cyclical buffer for your portfolio.
And so if you talk about the reflation trade…I’ll come back to this slide in a second. But going back to slide nine, because slide nine is a really instructive slide. You talk about this sort of massive, obvious reflation trade that we witnessed from November through the early part of June, which we did a good job of calling out in real-time back in November.
This massive reflation trade on portfolio construction terms, you definitely would have had…the whole thing would have been lime green. This 20% here now would have been the entire portfolio. Well, that’s an inappropriate position to take if you’re talking about an economy that is not this far out in terms of clearly and obviously delivering investors bottom-up macro regime reflation.
And so given the downside risks that obviously are emanating from cost-push inflation from supply chain disruptions, from energy price appreciation, I do believe it warrants a little bit more balance.
And more importantly, the fact that we’re close to this sequence of Ds, you know, we’re a few months away to the sequence of Ds that’s going to be extremely favorable for fixed income, for bonds, you definitely want to have some exposure to deflation and Goldilocks as well, Goldilocks with respect to equities and credit, deflation with respect to long-term fixed income, and then obviously cash because what that’s really saying is, hey, look, I think reflation, likely to dominate, but I don’t think it’s going to dominate to the same degree that it did from November to June. It’s going to be a lot less obvious with respect to sector and style factor leadership. And again, that’s a function of being in this GRID zero process, as opposed to being heavily tilted in one of those four GRID regimes.
Meb: As people think about this, the shifting positions and regimes, what are sort of your ideas or best practices to the end investor? Is it a scenario where you say, look, here’s our model sort of ideas and actually make shifts in the portfolio? Is it to come up with some sort of systematic process for the end investor to manage that? Like, I’m just wondering if most of the institutions and advisors, individuals who follow you, are they actually doing the trading shifts or do they tend to manage it with, say, like, options exposure? Like what’s the takeaways from sort of how to actually put this into practice for most people?
Darius: Yeah. No, so I’ll start with kind of the longer-term investors and work my way backwards. The longer-term investors, what they care about is slide 5 intersecting with slide 22. So when I talk about slide five, just, okay, where’s the economy been? Where’s it likely to be generally speaking on a trending basis on a go-forward trending basis? And then how do I start to use the calendar, use time to get myself into the appropriate portfolio construction with respect to those anticipated changes.
And so we have this process whereby you’re three months out, you’re two months out, you’re one month out from an expected market regime transition. And by expected, I mean, we expect the economy to do this, or it’s the highest probability event. And as we get closer and closer to time, we want to start to allocate incremental assets to that view. So what that basically means is, once we’re some time in Q1, or Q2 of next year, you would expect to see this whole entire circle be dark blue because it’d be very clear that the entire economy is very much in bottom-up macro regime deflation, not just in the U.S., but globally, as well.
So it’s really…in terms of those types of investors, it’s walking this from let’s say, it’s June of 2021, you’re walking it from bright green to blue. That process of changing the bets across each GRID regime, and more importantly what the bets across each GRID regime signify is the expected sector and style factor leadership within the equity and credit markets. And ultimately, you know, expected direction of commodities, the dollar, things of that nature.
And so that’s kind of how those types of investors use the process. You’re sort of more shorter-term…I wouldn’t say shorter-term because I think the kind of the pod shops are, one, where most of the industry’s assets are increasingly being amalgamated so you don’t want to disrespect them with the phrase like shorter-term, but the reality is, they’re higher turnover investors and do so elegantly for a reason. Those investors really want to know, when does this sector and style factor leadership change.
And as we’ve seen throughout 2021, it’s changed several times. I mean, we’ve seen a market that was clearly dominated by cyclicals in the early part of the year, then it got dominated by sort of tech and commodity exposures. And then obviously, we’re back to being dominated by cyclicals. And then as recently as a couple of days ago, we’re back to being dominated by defensives.
And so what they’re trying to do is effectively use this process to confirm or disconfirm those changes. If you’re someone invested in let’s say, you’re invested in a small-cap value name, and we have a correction in something like small-cap relative to mega-cap or value relative to growth, do you buy more? Or do you start to say, hey, I actually need to sell into this weakness because it’s probably going to go down here?
What’s the process for determining the direction of the sort of…direction of dispersion, the composition and direction dispersion within the equity and credit and fixed income markets? And that’s how they use the process. They engage with the process to say, hey, okay, we corrected small-cap value, we corrected small caps relative to mega-caps, we corrected value relative to growth, should I be buying into that correction, or should I be actually kind of pressing that correction because do you anticipate a market regime transition to a different regime that’ll actually confirm that?
And I’ll say, hey, yes or no. And the answer is no obviously, at the current juncture. Sometimes the answer might be yes. If this is late January of early ’22, I’d say yes, you definitely want to be chasing that correction because again, we ultimately think it’s something that will persist. So that’s how those types of investors use us.
And then lastly, your kind of trading type-oriented investors use us through the lens of our problem range process. We have some pretty accurate risk management signals on all the big macro stuff that moves and obviously on all the exposures that we feature in our portfolio construction. And then lastly, our crowding analysis is pretty well known across the street with respect to being able to predict shorter-term price movements.
Typically what you’ve seen, you know, is something we were talking about all summer, which is the broad U.S. equity indices were consistently in this upper left quadrant with respect to this crowding analysis. And what that effectively meant was that every single one of those kinds of options expiry catalyst was an obvious buy.
And so that was a pretty instructive signal and so much that I think the signal on Chinese equities is pretty instructive to the downside there. We called out nat gas last week or week ago, saying, hey, it was getting close to this green box here is the best place you want to be if you’re establishing a new long position. And obviously, we’ve seen nat gas ran pretty materially from that point.
So shorter-term investors, people who are day trading options or day trading single stocks and things of that nature will look for opportunities at the sector and style factor level through the lens of this process as well.
Meb: This is kind of a happy hour subjective question. Does it seem like some of the biggest surprises in markets come when the dominant narrative either proves to be false or is the opposite? And what I’m getting at here is you have people on Twitter like Jack saying hyperinflation, there’s this macro environment, which you can comment on, but it seems to be like the overriding consensus to me is that inflation is here and it’s ramping. Do the biggest dislocations, in your opinion, in markets happen when that proves to be false? How do you think about that?
Darius: That’s something we sequence very religiously here at 42 Macro. And I’ll start by saying the biggest dislocations have been in markets when you go from…the answer to your question is, yes, simplistically, yes. Basis locations and markets are when you go from a highly convicted state in terms of pricing in one regime, to the opposite regime. And so you go from…for example, 2020 last spring was a pretty instructive catalyst. We went from several months from basically October, all the way through the end of January of 2020 in very obvious reflation, and oh, by the way, it’s deflation.
So the problem with that transition is that it was a very high conviction reflation regime that we had to exit out of. That’s kind of the crowded nature…your guest last week was saying, the movie theater is crowded…sorry, it was the nightclub, it was the fireman example with the crowded nightclub. And this was a crowded nightclub. And the issue is nothing wrong with a crowded nightclub unless there’s a fire. And the fire was the emergence of the deflation regime here, this transition out of reflation and into deflation.
And so that’s…when markets have issues, it’s the transition from one regime where you basically need to do the opposite if you go into the opposite regime and the associated crowding with that. And we have tools that help investors measure and monitor that. One of those tools is our cross-asset correction risk indicator, this is CACRI, so it’s the combined shares of inflation and deflation in that market regime now casting process. The reason I look at those combined shares is because those are the two risk-off regimes, risk-off with an inflationary bias or risk-off with a deflationary bias.
And so whenever you’ve seen those combined shares kind of get into this, you know, 20 to high teens, low 20s, it’s a signal of complacency. Now, it’s not always a signal that the market is about to crash because again, sometimes complacency is extremely warranted. When the economy is doing really well, when the economy is consistently in a Goldilocks state or consistently in a reflation state, complacency is extremely warranted.
And quite frankly, you’re going to underperform asset markets if you’re not, you know, at least having a sanguine take with respect to your portfolio construction. The issue with complacency comes when you leave complacency into a economic state that it no longer warrants complacency. And that’s what we’re trying to do is use those forecasts to say, hey, this is a high probability intersection in terms of time, growth, inflation, policy, etc., this is a high probability intersection where the complacency is no longer warranted and that’s what we’re trying to do.
And so using a forward-looking example, to help your listeners kind of practically prepare for this, I do believe that the early part of next year is likely to be a real important set of signals for investors who aren’t yet participating on the long side of the fixed income markets.
Obviously, with inflation and hyperinflation being the dominant kind of talking head narrative out there on the Twittersphere, in FinTwit, that’s something that has really catalyzed investors to kind of stay away from bonds from an asset allocation perspective.
But what’s likely to happen is when the delta on inflation really starts to move lower, pretty materially in the mid to late part of early Q1, we do believe there’s a litany of investors…again, going back to the cash on the sidelines, there are a litany of investors who are going to have to chase positive excess returns in fixed income.
And so again, I say this all the time, but risk works in both directions. Risk is about what you’re positioned for now, and how that legacy portfolio construction is going to be disconfirmed by the market. And right now, that legacy portfolio construction again, it’s not something to do with today, but I do believe at some point in the early part of next year, these people, this cash on hand that doesn’t want to buy a treasury bond are likely to have to chase in a pretty material way. And more importantly, they may have to sell some things that they’re currently long to do so to keep up.
And oh, by the way, it’s very likely we see material rebound into the long end of the curve anyway. I think that’s part of the reason why the 30-year has refused to budge because you have pension funds, insurance funds. Anyone whose asset-liability matching with respect to their capital allocation is already looking at one of the worst years, if not the worst year in bond market history from a return perspective and saying, hey, well, that’s a systematic rebalancing, we have to do it. And they’re going to have to do it at some point.
And I do believe that’s going to cap yields as well, particularly looking out into 2022, where again, most of the world is going to be in bottom-up macro regime deflation. And that’s historically been an extremely, extremely supportive environment for the long bond and things of that nature, obviously, defensive sectors and style factors.
Meb: Yeah, I feel like that is definitely a market outcome that would surprise a lot of people.
Darius: Yeah, and again the surprise is a keyword there, right? Surprise is a function of the starting point. The starting point is we have asset markets that are aggressively pricing in inflation, or more importantly, aggressively pricing in the Fed’s reaction to inflation. But I think the bond market has already kind of again, sniffed it out. If you look at the compression in the yield curve, as a function of investors…or the Eurodollar market pulling forward rate hikes out of 2024, and increasingly out of 2023 and into 2022, the bond market gets the joke on that.
I mean, the TIPS market already has gotten the joke on that. So this is supposed to be the TIPS market and the MBS market. If you look at the Fed’s share of those markets, in theory, those markets are likely to be most impacted by tapering. But you’re now seeing TIPS shields actually trade-off to get back towards the lows that we saw in early August.
And the reason we think those TIPS yields are going down that direction is because the growth expectations are really starting to weigh in on a medium to longer-term basis. The more the Fed is deemed to not be this MMT style Federal Reserve, the less likely it is we’re going to see elevated rates of nominal GDP on a sustained basis in this economic expansion.
And the Fed certainly has enough air cover to be that MMT style Fed. The issue with it is obviously the composition change of the FOMC to which we have no real color on. But more importantly, I think the energy price appreciation, the speed of energy price appreciation is really kind of catalyzing the expectation that they may have to do something more material.
But I do believe that the Fed can stick to its guns with respect to its soon to be announced, in our opinion, tapering scheduled program. And more importantly, the labor market, it’s very unlikely that we see the hawkishness from a policy perspective that is currently being pulled into 2022 come to fruition.
And that’s likely another catalyst that could surprise investors to the extent that they’re not long bonds, or more importantly, they’re not overweight fixed income, and overweight duration risk in the equity and credit markets sometime towards the end of this reflation trade because eventually, we’re going to have to book reflation and rotate into that because if you rotate it into…because there’s two ways to do rotation, right?
There’s proactive, which is what our process is designed to help investors do. And then there’s reactive. If you do it, reactively, you’re going to underperform. That’s the issue with reactive rotation is if you wait for the market to start rotating, you never get the opportunity to catch up.
And so that’s why we put out this information on a daily basis to help investors understand…changing probabilities with real math to understand, hey, the likelihood that this occurs in January or February is actually moving at the margin. It might actually happen in December, or it might actually happen in February or March. That’s what we’re trying to do in terms of updating those now cast and updating our market regime now casting process.
Meb: Well, all right, what else have you got in the quiver?
Darius: So I mean, I’d be remiss to be a macro guy and not kind of engage in the transitory versus persistent debate with respect to inflation. I’m sure your listeners would enjoy kind of our thoughts on that.
Meb: I had an $18 turkey sandwich yesterday, which if you’re in Los Angeles is probably just par for the course. It was delicious, meanwhile.
Darius: I hope it was.
Meb: But let’s hear your opinion.
Darius: So I’ll start with…so the spoiler alert is inflation is likely to be transitory and persistent. And I know that’s not the answer people want to hear but it’s the answer they’re probably going to get from a data perspective.
And so what I mean by that is, inflation is likely to be transitory and ready to change terms, which means it’s not going to stay here, it’s more than likely to decelerate pretty markedly as we go throughout the balance of 2022. And so that’s what our models are projecting both from a top-down perspective, our stationary mean reversion model, but also from a bottom-up perspective through the lens of projecting each of the individual components in the inflation now cast.
What I mean by persistent is that the stationary mean of this time series, which is somewhere around, I don’t know, 1%, 1.5%, 2% over the last kind of 10 years or so, is likely to transpose itself 150 basis points higher, which means the oscillations that we have, the cycles that we have in inflation are likely to shift higher.
So it doesn’t mean inflation is going to just come up to the high level and stay there, but it likely means that we bottomed somewhere much higher than where we’ve historically bottomed in previous cycles. And so I’ll walk you through why I believe that both from a transitory rate of change perspective but also from a persistent transposition of the stationary mean. And so going to transitory, so when you talk about inflation, we have to talk about the start point. How did we get here? Why has inflation been persistently lower decade after decade for the past 30 to 40 years? And part of the reason is obviously demographics.
You know, we have very slow working-age population growth. We’re obviously pretty old relative to a kind of developed world. We’re certainly not Europe or Japan, but we’re certainly getting there in the U.S. economy. But the secular drivers of disinflation, particularly since kind of the ’80s and ’90s, certainly over the last 20 years, demographics through the lens of the labor force participation rate, persistently declining, and obviously, dragging down money velocity, those two things have actually gotten worse in COVID.
Technology has actually gotten worse in COVID as it relates to perpetuating disinflation. I’m looking at here in this pink line is the NASDAQ 100 market cap relative to the Russell 3000 market cap that’s effectively at an all-time high, so it’s telling you that the advance of technology and the economy has actually gotten deeper and more pronounced.
The one thing that is changing, however, is globalization. And I use the imports of goods and services as a percentage of GDP as a proxy for that. And we know that’s been headed lower and peaked in the early part of this most recent decade and it’s actually heading lower. Obviously, during the pandemic as well, I would argue the pandemic is probably accelerating that decline.
And so that’s one thing that’s moving at the margins away from disinflation, but there’s still plenty of other things that are telling you that disinflation is still here for us. And this is what I think Cathie Wood is kind of the thought leader in a lot of these respects, which is understanding that corporate America continues to be dominated by monopolies. This kind of concept of worker bargaining power is really a temporary pandemic-induced phenomenon less than a structural regulatory-induced phenomenon.
And what I’m showing in this chart here on the blue line, is the S&P 100 market cap, the market cap of the 100 largest companies as the ratio of the S&P 500. And obviously, we’re up to the right there. So you’re seeing a ton of monopsony power still in the economy, at the same time, where most corporations have tended to favor CAPEX over labor. And this is something that’s been persistent since the early 1960s, which is the ratio of employee compensation to CAPEX, it’s gone straight down and straight down and has been a stair-step down on every cycle.
So those are the secular drivers of disinflation and they’re still very much intact. And quite frankly, I just named six things, five of the six things are actually more intact than they were prior to the pandemic. So in our opinion, that’s why you’re seeing this, kind of, this impulse in inflation. And when I go through these next series of slides, look at the bottom panel, so this is the headline CPI, the bottom panel shows the annualized percent change because we know the year of year statistic is really high. Well, part of the reason of that is obviously we got some pretty easy base effects as well.
But the bottom panel shows the impulse, the momentum, the annualized percent change. And the reason we couldn’t sustain that elevated annualized percent change in the spring is, in our opinion, a lot of the reasons that I just discussed, demographics, globalization, monopsony power, corporations favoring CAPEX over individuals, things of that nature.
We’re seeing it impact…core CPI momentum has gone down from 12% to just under 3% in the most recent month. We’re seeing things like used cars contract at an 8% annualized pace in September, that’s down from like 200% in the spring. You’re seeing hotel price has contracted at a 7% annualized pace in September, that’s down from over 150% in the spring. And then you’re seeing airfare prices contract at a 55% annualized pace, it’s down from over 10% this spring.
The reason I bring all this up, not to be too overly granular, but the point I’m making is that we couldn’t sustain this. And the reason we could not sustain that goes back to demographics, disinflation, advanced in technology, all those things are preventing the sustained momentum in price change. You’re going to have…your statistics will be elevated, but its preventing sustained momentum and we’re obviously seeing that in the dissipation of momentum in something like core PCE.
So that’s the case I’m making on transitory because, again, if you can’t sustain the momentum, once you start to lap up against the easy bait, the very difficult base of next year, inflation, by definition, just has to mathematically go lower. And that’s the process that’s really driving a lot of our projections is understanding the relationship between momentum and the actual base effects. And so I’ll leave that part of the discussion.
So that part of the discussion, just wrapping up, is saying, hey, look, we couldn’t sustain momentum for all these secular reasons that actually have gotten…in many cases, in many respects, have gotten actually more pronounced in the pandemic, and that’s the reason we can’t sustain the momentum. However, the stationary mean of many inflation time series is likely to transpose itself higher for a combination of cyclical and secular forces as well.
And so I’ll start with the cyclical aspect of that. You know, this is on slide 54, we’re looking at the spread between home price appreciation, that’s the blue line, that’s an all-time high at the current juncture at 19.8% year over year looking at the Case-Shiller National Home Price Index. The red line shows owners’ equivalent rent, that’s the OER, it’s within the shelter CPI. Shelter CPI is about a third of headline CPI, about 40%, 50% of core CPI. And so when you’re talking about the spread, historically, cyclical peaks in the spread have tended to presage 18 to 24 months accelerations, persistent accelerations, and owners’ equivalent rent.
And part of the reason for that is fundamental, and part of the reason for that is technical. Fundamentally speaking, obviously, people, they get priced out of the housing market and they’re forced to rent. Or more importantly, what typically actually I think is happening is people sell their homes into a very buoyant housing market and then join the rental market because it doesn’t make a ton of sense to go buy a really expensive home after you just sold your own. So I think that typically is what’s catalyzing that kind of rental market inflation after the peak in housing market inflation.
But what’s really happening from a reported CPI perspective is the manner in which owners’ equivalent rent is calculated. It’s calculated on these sort of biannual panels, which means it takes a lot more time for the price changes in the housing market, and really, more importantly, observed price changes in the rental market to actually impact the time series, to impact the index.
And so it’s this kind of very slow, granular process. And whoever designed it clearly designed it with the expectation that they don’t want very obvious housing market inflation to overly impact CPI inflation in any given year, they prefer it to be a much more smooth process. That’s clearly what this process … because it’s a very different process than most other things in the CPI basket.
So they’re going to get their wish but unfortunately, they’re going to get their nightmare too, which is, the red line is likely to continue higher for an extended period of time and act as a countercyclical buffer to the otherwise disinflation we’re likely to see from a headline perspective, if that makes any sense.
So I think that’s one cyclical aspect of why the destination that we’re heading to in terms of the disinflation our models project, kind of starting in the early part of next year, all the way through the balance of ’22 that disinflation is likely to end up at a higher spot. It’s going to bottom at a higher spot than we’ve traditionally bottomed in recent cycles, in recent inflation cycles. And part of the reason I believe that, obviously, shelter CPI but more importantly … is more important, but it’s certainly very important which is median CPI.
So whereas everything…you look at core CPI, headline CPI, core PCE, all those things I mentioned, like auto sales, used cars, airfare, all those things are now losing momentum, and quite frankly, have lost a considerable amount of momentum since the spring.
Median CPI which, you know, sort of your … and rises the inflation…sample of inflation components gets rid of all of the most volatile things in any given month. And what it’s saying is, look, there’s a lot of breadth with respect to inflation. And what I mean by that is median CPI on an impulse basis has actually accelerated to 5.6% on an annualized basis. That’s the highest annualized rate of median CPI since going back to August of 1990.
And so what that’s telling the investors is that hey, look, we’re going to get some very obvious disinflation, just as a function of rolling forward in time, and more importantly a function of rolling forward in time having already lost a lot of momentum into some pretty material base effects, but inflation is actually not this thing that’s going to go away. Like we’re going to have this sort of transitory…it’s almost sort of too elusive, or, you know, kind of two dynamics that are neither correct in their own right.
This run-up that we saw in inflation, in our opinion, was driven by transitory factors in and of itself was just record fiscal stimulus, the easy base effects of last spring. And oh, by the way, you had reopening, and vaccinations act as a positive shock to economic activity in the spring. So all those things are transitory in their own right, which means the resulting inflation should likely be transitory in their own right. Well, the same thing could be said about the disinflation we’re going to see in 2022. A lot of the disinflation we’re going to see, it’s just really a function of having lost the momentum into more difficult base effects.
But the reality is the medium CPI metric is telling you that something is different now about inflation since going back nearly 30 years. And that’s also what the Dallas Fed trimmed mean statistics are telling you, particularly on a 6-month annualized, you got to go back to 2008 to see a number that high. And I think what those metrics are telling you is that we have jumped the shark from a fiscal policy perspective, this kind of buzzword has been thrown around in recent months, which is fiscal dominance, fiscal dominance, fiscal dominance.
Well, let me tell you why the fiscal dominance buzzword is actually being thrown around. Taking a step back from even that, there are four key things that you need to understand as an investor. If you’re a long-term investor, these are four things that are absolutely crucial that you understand, demographics, where you are in the leverage cycle, politics, and balance of payments.
If you don’t have a great handle on that, it’s very unlikely that the balance of your portfolio is really going to do well, unless you’re concentrated in some company or credit that does really well. From an execution perspective, you know, trying to run diversified money across asset classes, you need to understand those four factors.
And one of those factors again is politics. And how we quantify political risk is through the lens of income inequality, as measured by the Gini coefficient that’s on the x-axis here. Higher is more unequal and then obviously, the headline unemployment rate. And kind of the issue with where we are with respect to the U.S. cycle right now is that we’ve effectively become an emerging market from a political risk perspective. If you look at like our amigos that are surrounding us here…
Meb: We’ve got it worse than Russia and China.
Darius: We have it worse than Russia and China on these very basic metrics. We’re more unequal, we’re more unemployed. Now, granted, I don’t know if I can trust the employment statistics coming out of Moscow or Beijing, but just keeping it consistent with the data, apples to apples data, right? Like if you look at this chart 10 years ago, we’re down here somewhere, and now 10 years later, we’re up here somewhere.
And part of the reason I think you saw the zeitgeist in America right now is one that’s uneasy and unsettled. And in my opinion, I think that’s why we kept handing out these big checks to people because it’s a lot easier to pacify people when you’re giving them stuff. You give them gifts, you give them money.
And I think that pacification process is one that is likely to be persistent. You’re going to have to keep giving people stuff to prevent them from taking to the streets and protesting last like they did last summer, or taking to the Capitol Building, taking to the actual nation’s capital and protesting like they did in January of this year. That pacification process, in my opinion, is really just a function of this chart. This chart here on slide 59…
Meb: The most important chart in macro you saved this to the end. I was going to bring it up in the beginning but here we are.
Darius: This is the most important chart of macro, man. This chart shows the blue line is employee compensation as a percent of GVA, that’s the broadest measure of income for a corporate sector in the U.S., and the red line shows corporate profits as a percent of GDP. Well, if you kind of look at the chart, the first thing you should notice is that it was kind of a stable relationship. Like the blue line was cyclical, the red line was cyclical but they kind of stayed where they were around their own respective stationary means for a really extended period of time, particularly throughout the ’60s, all the way through the early part of 2000.
Well, something must have happened in the, you know, turn of the century of the new millennium to say, okay, we really transposed. They’ve traded places, if you look at the stationary means of these two time series. Okay, what caused that? In my opinion, there are three big factors. Obviously, China joining the WTO in 2001 was a real critical factor in terms of hollowing out our productive capacity and kind of reducing the amount of wages and salaries we pay to domestic employees.
The advance of technology and the proliferation of the digital economy, which I would argue is perpetuated by a decade-plus of easy monetary policy with respect to QE. You’re making it easier and easier and easier for large tech companies to build and sustain moats, and take market share from people in the physical economy.
I think Amazon is the most obvious example of that. You’re effectively saying to Walmart, it’s harder for you to capitalize yourself and easier for Amazon to capitalize itself, which is why Amazon can eat away Walmart’s margins, and ultimately reduce the total amount of employment in the economy. Now, it’s maybe a little bit different now because Amazon’s gone so big. That’s a classic example of why the blue line has gone down. And you can multiply that across sectors and companies.
The third example is kind of less stealth but I do believe it was pretty instructive as well, which is the advance of the private equity industry as well. The industry consolidation that we’ve seen, we’ve been in a decade-plus of easy monetary policy, which made it obviously much easier for levered companies to invest funds to raise money on longer terms. And that whole process has really perpetuated this kind of decline in employee compensation and its real kind of sustained, advanced and really kind of a secular high plateau in corporate profitability.
And so to me, going back to this pacification process that I highlighted, I alluded to on slide 58, until we see this kind of social contract in America go back to what it used to be, go back to where a lot of Gen X and baby boomer workers remember it as, and certainly, millennial investors, they don’t even remember it being…that being the social contract, but they’re demanding it anyway because they understand now that you go to work and you risk your life with a pandemic to make, I don’t you know, what’s the minimum wage, the federal minimum wage, from around $9 an hour. That’s not going to cut it.
These days, record profitability are likely over, and if they’re not over from a fundamental perspective, they’re going to be over from a regulatory perspective, increasingly, so as you go further in time. And that’s part of what they’re trying to do with the budget resolution, right, they’re trying to take money from corporations and give it to individuals. And that’s really just a direct function, in my opinion, again, of the most important chart of macro, which is explaining why we’re an emerging market.
And so to wrap all this up and, you know, kind of land the plane on our persistent inflation view, the reason we panicked with respect to our budget deficit and our willingness to add incremental public debt to the balance sheet, in the same pandemic, that oh, by the way, everybody else enjoyed as well, is because of that zeitgeist. It’s because of the zeitgeist born out of these previous two charts, which is we’re an emerging market from a political perspective in terms of our unemployment and in terms of our income inequality and wealth inequality. The reason we are such an emerging market is because of the social contract being broken by three big factors, which are globalization, technology, and private equity, for lack of a better word.
So that’s the zeitgeist that perpetuated our hyperactive response to the pandemic relative to everyone else, is something that I think is persistent, that zeitgeist is persistent, which means politicians are going to have to increasingly promise goodies relative to what they promised in previous cycles. This is why the Biden agenda is $3.5 trillion as opposed to, I don’t know, $500 billion. This is why physical infrastructure is $550 billion as opposed to, I don’t know, a couple hundred billion. These numbers are getting bigger and bigger, not just in nominal terms, but in terms of percentage of GDP, and that’s something that we expect as it relates to what’s driving the fiscal dominance that everyone’s talking about. These are the drivers of fiscal dominance.
It doesn’t just come out of nowhere. It comes from the voting booth. The voting booth says, hey, Mr. Trump, we want tax cuts. Go blow a hole in the deficit through the guise of supply-side economics. Good. Mr. Biden, can you also blow holes in the deficit under the guise of Keynesian economics? Great. What’s the result? You have two gigantic holes blown in the budget deficit and that’s something we think is likely to be persistent as we go deeper and deeper into this fourth turning.
And so to wrap it up, foreign central banks aren’t going to pay for it. They’ve proven that since 2014, 2015, which means the Fed, our buddies at the Federal Reserve are the ones that are likely to be forced to capitalize the U.S. government’s foray into this kind of zeitgeist foray into fixing the zeitgeist.
If you think about the phrase fiscal dominance, you have to also think about, okay, how does the Fed, how does the Treasury, how does the U.S. government fix that zeitgeist? How do they address the zeitgeist? And I do believe that zeitgeist is likely to be addressed over the next several political cycles through the lens of just wider budget deficits.
Meb: U.S. hanging out there with Greece.
Darius: Yeah, I mean, look, there’s a reason we panicked.
Meb: Of some of the countries, if you had to put some in the warm and fuzzy, we talked about China, we talked about the U.S., are there any countries that kind of stand out as being in a nice, happy place, warm and fuzzy place right now?
Darius: So the broad balance of EM should do particularly well on a near-term basis. I do believe they continue to be challenged by COVID, continue to be challenged by sort of residual strength in the U.S. dollar. But I do believe as the world, I wouldn’t say comes out of the pandemic because I don’t believe that…I do believe, I said this the entire time, the pandemic is going to eventually morph into an endemic because there’s no way you’re going to be able to eradicate COVID from the globe. It’s going to just become part of the process. We’re going to have to get our vaccines and booster shots every year, and eventually, we’ll get there.
So my expectation is that towards the end of next year, once we’re tightening ourselves into an economic slowdown in the U.S., the emerging market economies will really be emerging from their pandemic-induced slowdowns, their depressions, if you will. And so that’s right around the time we would expect to see dollar weakness. It’s very likely you see trending dollar strength, kind of throughout the balance of 2022, as a function of the market’s pricing in this on a deflation regime, the dollar tends to do best in that regime.
But as we get into late 2022, early 2023, eventually, the dollar is going to be looking just like the bond market looks today, which is looking forward into the advance of easy policy on the other side of it. And that advance of easy policy on the other side of that to me sets emerging markets up for a potentially, I won’t say decade-long, it’s a pretty ridiculous statement, but a multi-year trade whereby it was very similar to what we saw in kind of ’03, ’04, ’05, ’06, ’07, where you look at something like…this blue line shows the defensives as a ratio to cyclicals.
I think that you can be EEM relative to SPY, it’s the same line or you know…or sorry, this would be SPY relative to EEM, it is the same chart. SPY is going down relative to EEM if the dollar goes down. Defensives are going down relative to cyclicals if the dollar goes down. And I think the kind of big trade of this next kind of three to five years, in my opinion, is a dollar that’s much, much structurally lower as a function of this sort of…the fiscal policymakers in the U.S. addressing the zeitgeist, if you will.
Meb: Yeah, hard to see that not be the case.
Darius: Yeah, we got to get through next year though. I think it’s premature to bet on a weak dollar between now and then because again you have a policy tightening cycle ahead of us. And you have bottom-up macro regime deflation for the U.S. and most of the global economy. And those two impulses are actually quite positive for the U.S. dollar, but when you get beyond that, that’s where it starts to get interesting.
Meb: As you update your Excel models and wherever all this exists, my goodness, this is like the most thorough macro deck I think I’ve ever seen, Darius. This is amazing.
Darius: Oh, wow. Thank you, man. Appreciate that.
Meb: Are there ever any, like, particular data points that are just, like, haymakers that, like, change everything? Is it…tend to be the case where it’s like, they’re all related and cousins, and they all kind of shift things, you know, in a little way? Or is it a certain scenario where there’s just, like, one or two indicators they’ve moved, it’s like the big muscle movement that shifts everything?
Darius: Yeah, that is true. The policy tends to be the thing that offers the most surprise to investors. I think it’s easier to project a probable path of inflation and growth than it is to project the policymakers’ reaction to those paths. And so that’s why I go back to policy to answer your question. But starting with 41, this thing could inflect at any given moment. If let’s say that all this money in overnight repo does not want a home in the treasury market at all, for whatever reason, it is just a function of a broken monetary system, and the bully comes back and you’re talking about more near-term inflation, the blue line, which is net liquidity, that is going to be an issue for asset markets. You look at when the line goes down, that’s where the volatility starts. And when the line goes down, you can barely see the 2020 event but they stopped. They started fixing repo and then they stopped in the early part of 2020. By the way, they did that precisely at the wrong moment. So when this line goes down, or the bare minimum starts to flatten, that’s where you get that volatility.
I think China is another one we didn’t really spend too much time on today but I do believe China is really important as it relates to kind of being one of those shocks that could come out of nowhere. We’re all reading the tea leaves out of Beijing and out of the PBOC and understanding what the policy plan is going forward in the mainland, but the reality is China has done this many times where they come out and do a pretty meaningful shift with respect to monetary easing, or tightening, or fiscal easing or tightening.
And so what I’m showing on this chart here on slide 75, is 3-month CHIBOR, which is 3-month interbank lending rates in China. The reason I tracked 3-month CHIBOR is, in my opinion, this is the most relevant proxy for Chinese monetary policy, or the impact of Chinese monetary policies because right around 82%, 83% of all private non-financial sector credit in China on the mainland is on bank balance sheet. That’s a pretty astronomically high number for an economy of that size.
So what it effectively means is that China doesn’t have this sort of well-developed capital market infrastructure that we enjoy here in the U.S. and other parts of developed world. For example, that same ratio is right around 47% for the U.S., We’re nearly…talking about nearly double the amount of credit that’s on bank balance sheet in China relative to the U.S.
And so when you look at something like CHIBOR, and you see it plummet like it does ahead of these big bottoms in the credit cycle in China, that’s when you typically see a massive recovery in the credit impulse in China. Well, we haven’t seen that. In fact, if you look at the most recent kind of rate of change of the three-month CHIBOR, it’s actually moving in the wrong direction, to perpetuate a near-term balance in the credit impulse. And if you go back to our growth expectations in China, that is supportive of our expectation that Chinese growth is unlikely to bottom for another couple of quarters.
But again, I do believe the asset markets are ready to get out in front of that, if only because by the time it does bottom, maybe the PBOC will have had a change of heart with respect to their neutral monetary policy setting at the current juncture, and we actually start to see something that looks more like this, that could actually perpetuate that bottom. So if I think about two things that created a lot of surprise risks in the economy and in markets, it’s the Federal Reserve…the confluence of the Fedsury, I call it the Fedsury, the Fed and the Treasury, and then obviously, what’s coming out of Beijing.
Meb: As you look at these portfolios and putting them together…like if you look at a traditional 60/40 portfolio, U.S. market-cap-weighted, 10-year U.S. government bonds, maybe the ag, and maybe it’s global, and so you look at sort of the different regimes, the shifts, and the sectors, but there are certain areas that I think people don’t traditionally have as much exposure to everything real asset-related, that’s often like an afterthought in portfolios, maybe it’s a 5% position, but never necessarily that material.
What, for your experience, and this can be pro-institution, individual, whatever, does that sort of portfolio composition, when you start to apply your lens, what are the areas that tend to be the least represented, that once they added has the most impact? So I’m thinking, hey, if you switch from consumer discretionary to energy, or tech, whatever it may be, for a traditional portfolio, it may not have as much impact when you’re saying, hey, let’s use Darius’s methodology, and all of a sudden, we have real estate and commodities. Does that question even make any sense?
Darius: No, it makes a ton of sense. So I’ll start by saying our process is designed to help investors manage liquid market exposures. When you’re thinking about something like real estate or private equity, that’s a separate discussion. I think you can use our process in terms of identifying…most important with respect to kind of longer-term holdings, you need to understand where you are with respect to the growth sine curve. If you’re at the bottom of the growth sine curve, it’s a great time to put capital on a liquid basis. If you’re at the top of the sine curve in growth, it’s a very poor time to put capital work on a liquid basis.
So that’s where those types of investors might engage in that process. But we do less work with them only because we’re not at the top or the bottom of the sine curve that often, right? So talking about liquid asset exposures, I think to answer your question on that, I do believe cryptocurrency plays a role in investor portfolios and will increasingly play a role, if only because it’s taking share from things like gold and silver as an inflation engine.
Quite frankly, I don’t know if inflation has the appropriate monitor because the reality is if you’re talking about something like crypto, crypto is an appropriate investment in three of the four GRID regimes. Deflation is the only one where you have negative absolute and excess returns in something like crypto.
And so I think that’s something that’s going to be a secular story with respect to institutional investors having to consistently increase their allocation in that, if only because of the fiscal dominance that, again, is a function of policymakers reacting to the zeitgeist. The reaction to the zeitgeist…I think everyone in crypto kind of gets the zeitgeist and everyone’s got their buzzwords…they’re really not buzzwords.
They’ve got their catchphrases on why you need to be levered long on Bitcoin or Ethereum, or Solana or something like that. But I don’t know that anyone is really doing the deep dive on, okay, what’s actually causing that, and how likely is that to persist? Or more importantly, when is that likely to end? And the reality is, it’s unlikely to end anytime soon.
So to the extent that you are long cryptocurrency, this is obviously a great forward-looking multi-year environment to maintain that exposure. So that’s something I do believe that is underrepresented. Commodities, in general, tend to be underrepresented. The problem with commodities is they get overrepresented at the peak of the cycle. Like 2011…I remember 2008, 2011, I mean even 2014 in energy, these are like, oh my God, you can’t buy enough of this stuff.
You can buy enough commodities in ’08, you can buy enough commodities in 2011, you can buy enough oil, and gas, or U.S. E&Ps in 2014. And I was on a team that made each of those calls. That’s the reality, this asset class is extremely volatile. And the reason it’s extremely volatile, the commodities are self-correcting vehicles. The reason this price goes all the way up here, it’s because it’s telling investors to capitalize the natural resource sector so we can get more things out of the ground. When the price goes down here, it’s telling investors to stop capitalizing on the natural resources sector because we have so many things above ground.
That’s a difficult asset class to risk manage on a longer-term basis. But I think on a shorter cycle basis, using the process like the GRIDs to manage your exposure on a 6, 9, rolling 12-month basis, that’s where you can actually say, hey, we’re here and should be going there, or we’re here and should be going there. That’s where our process does extremely well.
And ultimately, to answer your question, I do believe that the commodities asset class from an asset allocation perspective is probably very underrepresented in longer-term institutional portfolios. I’m talking, like, pension funds and…
Meb: Yeah, I mean, it feels like there was like the big cycle, the early 2000s, and everyone got all hot and bothered. Like, just as oil was like peaking, every institution on the planet, the various commodity white paper allocations came out. And then you had a decade of just garbage returns. And like, one after another, every institution has just puked up those allocations over the past five years. You see the news where like, ah, you know, so and so’s divesting, and so and so is…just on and on, and then here we are. It’s just like, it’s markets, rinse, repeat over and over again. It happens all the time.
But it’s every asset class, like it just happens over and over again. Darius, as we start to wind down, this has been a masterclass, I’m loving it, we’re definitely going to have to do this again every so often, any general thoughts on anything that we didn’t cover today that you think is either timely, got you worried, got you excited, got you confused, as we start to wind down 2021?
Darius: Yeah, absolutely. So I’ll be brief, with respect to kind of the process. So there are two things, trying to help investors rethink about the way that they think about managing macro risk relative to kind of just incorporating macro into the process.
When you’re talking about macro risk management, it’s about understanding what regime you’re in. It’s about understanding the pace and the direction of travel for things like growth and inflation. It’s about understanding the pace and direction of travel of things like the Fed’s balance sheet, monetary policy, time. These are all things that we’re programming into our systems to understand, okay, what’s the likely expected path? Or more importantly, what’s the likely expected dispersion in asset markets? What’s likely to outperform from a risk-return perspective, looking at things like expected returns, percent positive ratios, volatility covariance?
So that’s how we’re kind of getting to this at every interval when we say, hey, reflation is not just reflation, but what do we expect about all those other factors? And those things are quantifiable. It’s not just enough to look backwards in time and understand how things have historically reacted to. But I do believe history, in terms of market history, is really instructive in terms of being the most appropriate kind of risk management of them all. I think it’s impossible to quantify things like leveraged liquidity and concentration at every interval to specificity. So you do need to actually look at historical corollaries.
But that’s what our process is designed to do. It’s designed to be fractal in nature whereby this sequence of those characteristics, if we see a similar set going back 40, 50, 60,70 years, that’s instructive in terms of how we should expect asset market dispersion to behave. So that’s kind of the first thing I’ll say.
And then I’ll leave with the more exciting thing, which is this chart has been making rounds on Twitter, on slide 36, in recent weeks. And this chart shows the S&P 500 earnings yield deflated by headline CPI, by realized headline CPI. As you can see, we’re obviously in deeply negative territory. And the reason that I bring that up is because when you go back and look at…every single time we went to negative territory in this chart, and this is going back to the early 1970s, it was ahead of a big drawdown in risk assets, looking at the S&P 500, in particular.
And so I do believe we’re going to see a pretty material shift in the behavior of asset markets in the early part of next year, as a function of the economy starting to slow at a more material pace, and also as a functioning of net liquidity starting to inflect lower. This, to me, says that could actually be a more painful process than I would even currently anticipate. So this is certainly a big risk out there in terms of the next kind of 3, 4, 5, 6 months from now.
Meb: What’s the blue line showing?
Darius: Blue line is the S&P 500 earnings yield deflated by headline CPI, so the real earnings yield.
Meb: Interesting, yeah. That’s a haymaker of a chart. We keep it all the way to the end.
Darius: I came of age in this business. I started in 2009 so obviously I’m a baby of the raging bull market and I do believe what you experience early in a career do have material impact on how you view markets going forward. And so I tend to be in the more of the Tom Lee camp than I am in the kind of…who’s the famous…there are no more famous bears anymore.
Meb: Yeah, they’re extinct.
Darius: Been forced to open family offices. I hope the chart isn’t a haymaker but who knows. But the reality is we’ll be well-positioned for it regardless because our process is forward-looking and anticipating that.
Meb: Darius, what’s been your most memorable investment looking back over your career? Good, bad in between any come to mind?
Darius: The most profitable is buying Bitcoin last October and really kind of coming up the educational curve on that because that’s a difficult asset to maintain exposure to. One, obviously, because of the volatility. But two, because there’s no real proven framework to help you risk manage it. Now we have a framework based on Bitcoins, limited history of market information. We understand that it does well in GRI and does poorly in D. So as long as we’re not in D, we tend to get positive returns of Bitcoin. When it’s being extremely volatile, it’s very difficult to say, hey, I know why it’s down, and therefore it should be up pretty soon. That’s hard to do that.
Meb: There should be a Hodo app. When we talk about this with equities, this is a billion-dollar idea, listeners, Hodo app, you buy the crypto, you’re not allowed to sell it for 5, 10, 20 years, whatever you want to set up, or you get some big penalty. There you go. That pre-money valuation, that’s like a $100 million idea.
Darius: You got to start that, Meb. I’ll start it with you.
Meb: Give me some advisor shares.
Darius: I’ll give you one that’s more for your traditional financial markets, which is buying bonds in October 2018. Most people don’t know this and most people don’t bother to understand or looking stuff up. But from October 2018, through March of 2020 bonds outperformed…like looking at the 25-year treasury bond total return index relative to the S&P 500 total return index, bonds outperformed stocks by like 60%.
So like just maintaining that exposure from the peak of the growth and inflation sine curves in October 2018 all the way through March of 2020, that’s something that I think investors need to understand, which is you don’t need to run out here and short everything if you’re bearish. There are plenty of ways to extract risk premia from the market, as opposed to paying risk premia into the market to actually take advantage of being negative. So those are two important trades I think are good learning experiences for me as an investor, and it should be for everyone else.
Meb: I mean, it’s hard for people to become asset class agnostic. Everyone gets attached to whatever it may be, which is I think a big mistake over time. The bond one is interesting. I was saying this last year where people always just assume stocks outperform bonds, you’re a stock guy, great. But I was like, again, go into the long bond versus U.S. stocks, it had been 40 years, 4 decades where they’d had similar returns last year, which I think would surprise a lot of people but it happens to be true.
Darius, if you’ve got offerings for all sorts of people, what is the best place if people want to find out more to check out what you got going on and follow along and subscribe to the best chart book in all of macro? Where do they go?
Darius: You said it, not me. If I can give like a quick kind of spiel on why we price our products so competitively, it’s I really do believe in the concept of democratization. So a lot of what we talked about today is stuff that I traditionally have historically only talked to the world’s largest asset managers. And CIOs and PMs are running money at these major institutions and the reality is, everyone needs this information. I think everyone can benefit from this information. So that’s why we price our products appropriately to allow retail investors and RIA investors to access the content.
And so 42macro.com is our website. I’m very active on Twitter, @42macroDDale, D-D-A-LE. I’m pretty heavily featured on shows like this. I do a spot on Real Vision every week, the “Daily Briefing” on Wednesdays as well. So come check us out, man. This is a dream of mine, it’s a passion of mine. The biggest passion is democratizing information and helping people make and save money.
Meb: Well said. Let’s end it there. Darius, thanks so much for joining us today.
Darius: Appreciate you, Meb. Thank you so much for having me. Catch you next time.
Meb: Podcast listeners, we’ll post show notes to today’s conversation at mebfaber.com/podcast. If you love the show, if you hate it, shoot us feedback at email@example.com. We love to read the reviews, please review us on iTunes and subscribe to the show anywhere good podcasts are found. Thanks for listening, friends, and good investing.