New Market Lows + Recession Likely By Q4 — Darius Dale

[00:00:00] Darius Dale: you look at the America, specifically the U.S., it still continues to be on this sort of pre-recession process. You know, we have a bunch of different indicators and tools that we use to track where we are specifically in the U.S. business cycle. And the sort of modal outcome from those tools suggests that a recession is likely to commence most likely sometime around Q4 of 2023. [00:00:24] Adam Taggart: Welcome to Wealthion. I'm Wealthion founder Adam Taggart. Credit is the lifeblood of the modern economy. Without it, nothing happens. And right now, it appears to be contracting. That's likely to result in serious challenges to both economic growth and market prices. Just how serious? To find out, we're fortunate to be joined today by macro and market analyst Darius Dale, founder and CEO of 42 Macro. Darius, thanks so much for joining us today. Adam, it's a real pleasure to be here. Thank you for having me. Oh, thank you. The pleasure is all mine. I've followed your work for a long time, been wanting to have you on the program for a long time. So glad you were able to join us today. Look, Darius, I've got a lot of questions for you based upon a lot of your recent writings. Before I dive into the specifics of those, though, let's just start off with a general question I like to ask everybody at the beginning of these interviews. What's your current assessment of the global economy and financial markets? [00:01:21] Darius Dale: Ooh, that's a loaded question. So I'm excited. We're getting started hot. So I think you really do have to separate the global economy into regions, into geographies in order to answer that question specifically and accurately. We'll start with Asia, namely China. It's very much coming out of COVID-0. We're very much on track. You're seeing the recovery, whether it be through a variety of high frequency indicators. Some of the leading indicators continue to suggest that the Chinese economic upswing is likely to continue for at least another quarter or two. When you transition to Europe, Europe seems to be recovering from the worst of its sort of, you know, kind of energy crisis doomsday prep, if you will, in the second half of last year. It's sort of following along or tagging along with the kind of uptick that we're seeing in global growth or in Chinese growth and really Asian growth. And then lastly, if you look at the Americas, particularly the U.S., it still continues to be on this sort of pre-recession process. You know, we have a bunch of different indicators and tools that we use to track where we are specifically in the U.S. business cycle. And the sort of modal outcome from those tools suggest that a recession is likely to commence most likely sometime around Q4 of 2023. And so, you know, ultimately, we do believe that the U.S. economy is going to drag down global growth, you know, particularly as credit contracts, as the lag impacts of monetary tightening here in the U.S. really catch up. But for now, we're kind of in this, you know, I wouldn't necessarily say Goldilocks, although we did make a transitory Goldilocks call back in January. So, I think it's continuing globally, but ultimately, it'll all fizzle out in a quarter or two. [00:02:56] Adam Taggart: All right, great. And when you say it'll all fizzle out, when the U.S. goes into recession, if your forecast is correct, do you think it will eventually bring the rest of the global economy down with it into recession? Because you mentioned that Asia is, you know, powering higher because they finally come out of lockdown. Europe was in the deepest hole imaginable. They're now beginning to dig out of that. But do you think that those recoveries in those areas of the world are short lived and will follow the U.S.? Or will the U.S. go into recession on its own? [00:03:25] Darius Dale: Yeah. So, I mean, there's two sort of ways to answer that question, which is, you know, is the U.S. going to slow fastly and sharply enough to cause that problem? I think the answer is yes, at least according to our models. And then the second answer is, are those economies going to do something to offset that process? We saw in 2009, you know, the China come out with the big bazooka. They actually did it again, 2011, 2016. And what I mean by bazooka is large-scale fiscal and monetary easing. It's very unlikely we see that in this particular cycle for a couple of reasons. One, the PBOC, or not PBOC, the Chinese authorities, Beijing, they have identified their GDP target for 2023 as 5.5%. Actually, no, it's 5%. The street had it at 5.5. It actually came in shy of that estimate. And so we're already tracking at 4.5% on a year-over-year basis in Q1 of this year. We got the Chinese GDP numbers, I want to say, a week or two ago. So we're almost, you know, 90% of the way there. So it's very unlikely we're going to see that, you know, the Beijing really kind of pull out all stops as it relates to fiscal monetary stimulus to support the Chinese economy in 2023. Now, I do believe that as they start to, you know, really feel the impact of the U.S. slowdown, you know, namely in Q4 and really into the early part of next year, they will start to respond. But as it relates to the medium-term outlook, you know, next, you know, call it two to three quarters, very much unlikely that, you know, the rest of the world is going to be able to stay unscathed relative to what we're seeing, to what we have projected for the U.S. economy. [00:04:52] Adam Taggart: Okay. I do want to talk to you at some point, too, about what the Fed zone response is going to be to this recession. And we'll get there. Yeah, we'll get there. This last question about Asia before we leave it, which is, you mentioned we're not likely to see the same scale of response, potentially, as we saw coming out of the global financial crisis from China. You gave some reasons. But one I've heard, too, that I just want to get your feedback on is China didn't really have a lot of debt back in 2008. And a big reason why it was able to become such an engine of growth that kind of helped pull the world along with it in the decade that followed the global financial crisis was its embracing of debt, which it seemed to have done, you know, with a lot of gusto. And so now it's got a lot more, you know, a lot more of a debt burden this time around. So it may not be able to do the same kind of, you know, debt driven spending that that goosed the global economy last time around. Would you agree that that's, you know, an important factor here? I think it's 100% an important factor. And I don't think it's that [00:06:01] Darius Dale: they can't, is that they recognize the perils of doing so. I mean, if you look at, you know, so we run a variety of different models at 42 Macro that sort of try to identify what the propensity of the policy response is, whether it be fiscal response, whether it be the monetary response. And not only do those models suggest that, hey, look, they probably should be doing more. But then you continue to get guidance out of Beijing that suggests, hey, President Xi, outgoing Premier Li Keqing, the PPC Governor Yi Gong, or I'm going now. There's so many people in China at the top brass that are all sort of coalescing around this idea that we don't really want to go down that road again. Right. And I think going down that road again, you know, kind of is the history is littered with perils of, you know, economies that have gone over, you know, beyond the point of no return from the perspective of private sector leverage. And I think if you can realize in China, you know, the incremental dollar value you get out of an incremental dollar of debt from a GDP perspective or a corporate profitability perspective or any metric that is very relevant to an investor, you know, those metrics continue to get lower and lower and lower. And I think the brass in China very clearly realizes that. And they're very clearly, you know, shying away from that. If you look at their GDP target for 2023 at 3%, you know, that's only a modest kind of downtick from a budget deficit perspective relative to where they were last year when they were higher than zero COVID people were getting pissed off. And so you're, you know, both from a fiscal standpoint and from a monetary standpoint, you have Beijing very much sitting on its hands, you know, kind of, you know, accepting the fact that Chinese growth is now structurally lower. And, you know, she would take that as a, as a victory because he wants quality growth, right? We're so used to as American investors in quantity growth, go buy base metals. They're about to build a bunch of stuff. They're like, no, we actually want people to hop on planes and go spend money at shops and restaurants and businesses. And so that's kind of what's happening right now. I think that transition [00:07:51] Adam Taggart: is very much underway. Okay. Thank you. So just to recap here, you see U.S. is sort of in a pre-recessionary state. We'll call that kind of, you know, slow down. We see Europe as having maybe some more anemic growth, but it's better than where they were last year. We see China coming out more strongly from its lockdown. But as the U.S. falls into recession later this year, likely to, to see it pull those other two economies down with it. And then 2024 will be okay. The year of, all right, [00:08:20] Darius Dale: what are they all going to do in response? Yep. I agree with that. And before we move on kind of from this part of the discussion, I think it's important to sort of unpack the U.S. in a pre-recessionary state because I've listened to your, your previous guests. Yeah. You had Michael Cantor. It's on with this brilliant hope model. Thought that was an excellent episode. Obviously my buddy, Alfonso Picatielo is the long recession views. I'd like to share ours as well, because they do attack this problem from a little bit of a different timing, problem set. So if I can share my screen here, one of the, so I've updated our monthly macro scouting report presentation in preparation for this meeting. So every month we put out this presentation for our client base. It's usually about a hundred slides. It kind of covers our modal outcome views. It kind of expounds upon what we think of the left tail risk and the right tail risk to those modal outcome views. And with respect to some of the left tail risk views, you know, we'll walk through and I won't spend too much time on this, but we have a variety of different indicators that we use to sort of identify where we are in the business cycle. I think, I think, um, Kentridge's hope framework is extremely instructive. It sort of gives you a, a kind of efficient now cast of where we are. What we're trying to do is actually forecast where we are so we can actually make these pivots in our portfolios on a proactive basis rather than a reactive basis. I'm not saying that Kentridge is being reactive, but certainly I think it, um, you know, [00:09:35] Adam Taggart: adding a little bit more foresight might be, uh, somewhat helpful. So I think Michael would agree with that comparison too. I love that. His is more of a now cast years as a forecast. Yeah, totally, [00:09:45] Darius Dale: totally. And again, it's phenomenal framework as someone who built quantitative models for a living. I'm a big fan of his, uh, his hope framework. I just wanted to expound upon it with some of the tools that, that we use with our, with our clients. So I'll start with our, our, you know, uh, the inversion of three month, 10 year treasury yield curve, you know, we're at minus 162 basis points inverted when we sequence the, you know, this particular indicator relative to, you know, real GDP cycles, industrial production, payrolls, unemployment, core PCE. And what we're trying to do is identify what the interval is that has the highest probability observing a GDP contraction or significant uptick in unemployment. And what we can find here is that the probability, the probability of seeing, you know, both of those outcomes is actually in the kind of 12 to 18 month forward interval, i.e. the probability of seeing real GDP contract from the date of the three month, 10 year inversion, or, you know, the probability of seeing a significant rise in unemployment rate, um, from the date of the three month, 10 year yield curve inversion. And so that would suggest based on the timing of this inversion in October of last year, it would suggest a recession is most likely to commence in the October, 2023 to April, 2024 period. Again, that's the 12 to 18 month forward interval from that inversion. Uh, the next model we use is the, the, uh, model that, uh, anchors on, you know, kind of where we are in the labor cycle specifically with respect to continuing claims as a percent of the total labor force. So that's the red line in this chart here. We're at my, we're 1.12 or percent in historical, we've gone, you know, we've gone all the way up to, I mean, ex COVID at the cut off the chart, but you know, we've gone pretty high in this, in this indicator, you know, in upwards of five to 6% in previous recession cycles. And so what we looked at in terms of the same sequencing of events, you know, what we looked at is the monthly trough in this particular metric continuing claims as a percent of the total labor force. And right now with that, the monthly trough was in August of last year, where we're also, again, looking for the interval that has the highest probability of seeing a contract, a significant rise in the unemployment rate or a significant rise in the, um, in real GDP contraction. And that would seem to suggest that on the six to 12 month forward basis, that that's sort of it that, or sorry, 12 to 18 month forward basis. That's, that's kind of it when you factor in the unemployment rate as well. And so that put, kind of puts you in the September, 2023 to February, 2024 time period. So that's, that's October, 23 to April, 2024, September, 23 to February, 2024. And so that's kind of, that's two, you know, so we're two for two there. I've got a few more models here and I'll be quick, quicker. This model shows the spread between the conference board consumer confidence expectations index minus the present situation index. And we're at minus 83 in terms of that, in terms of that deep negative spread. Well, as you can see on the chart, you know, these deep inversions, inversions at all on this particular indicator tend to coincide, or at least be leading indicators of a red bar or recession showing up in the chart. And so what we're trying to do is identify what's the highest probability interval for a recession to occur. Cause again, it's not just enough to say, okay, we know a recession is coming. If a recession is coming two years from now, you could lose out on 35, 40% upside returns in something like an S&P budget. What we're trying to do is make sure that we're putting on the recession playbook with the appropriate amount of time ahead of a recession, so that we are not missing out on upside. We're, you know, we're, we're allowing ourselves to take advantage of beta in the market. And so going back to this analysis, the data, the trough spread actually is, is currently the trough spread is the most recent indicator, most recent month. And what we look at again, looking at, okay, what's the interval that has the highest probability of seeing real GDP contract unemployment rise. And that's the six to 12 month forward interval. So again, that puts you in the October 23 to March, 2024 period. We also look at this through the lens of coincident and leading economic indicators, specifically the spread between, um, uh, consistent and leading economic indicators. And this is, as you can see in the chart, chart data goes all the way back to the 1960s. It's one of the deepest inversions we've ever seen. Now that we can get into a whole tangent on, okay, why is this thing so low? So some people seem to believe that, you know, Hey, there's so much going on from, uh, with respect to the leading indicator basket, i.e. the U S economy is not as tethered to the manufacturing sector as it once was, you know, certainly had, you know, as it was, uh, going back to, um, you know, to, to these, uh, earlier time [00:13:55] Adam Taggart: periods, holding that aside. Yeah. Sorry. Go ahead. No, just saying, yeah, it's a different world today than it was in the fifties and sixties from us manufacturing standpoint. Absolutely. A totally [00:14:07] Darius Dale: different world. And actually just, I will finish up on this tangent because I don't like to leave the listeners hanging here. It is a totally different world. This chart here shows the percentage of manufacturing, the manufacturing share of total non-farm payrolls. And this line here, we only have data going back to 2005. It's manufacturing share of nominal GDP. And as you can see, I would assume the red line probably tracks the blue line over time if we had any data for it, but we're only at 14% of total non-farm payrolls and 18% of GDP. So very clearly manufacturing is not this, you know, giant, you know, you know, noose around the neck of the U S economy that it probably once was in these previous cycles. And that's part of the reason why we see less red bars in our opinion. Manufacturing is significantly more volatile than the services sector. And we know this as we sequence, you know, recessions through the variety of different indicators. Now focus your eyes on these two columns. It says manufacturing as a share of non-farm payrolls. So that's the blue line in this, in that previous chart. But this, this, uh, this column here is actually more important. It shows manufacturing sector share of the non-farm payroll drawdown during recession. These are each of the recessions that we had going back to act one of the great depression on a median basis, it's 98% of the drawdown in non-farm payrolls. And so there are plenty of instances where manufacturing was, you know, greater than a hundred percent, i.e. the services sector continued to grow despite the contraction in manufacturing. So a lot of times in recession, what you're effectively calling for, if you're making a recession call is a deep depression in manufacturing that may or may not spill over into the services sector. I happen to think both are likely to occur, uh, in this particular, um, in this particular cycle for, for a few reasons, but, you know, getting back to, um, you know, the timing, I think the timing is more important, uh, before we, uh, explain why. So going back to the leading indicators and coincident economic indicators is this inversion. When we look at the inversion, the date of that inversion was, uh, June of 2022, we're looking for the interval that has the highest probability of seeing a real GDP contraction from the date of that inversion, going back to each of those previous cycles. And that's the 12 to 18 month forward interval that puts you some time in the second half of 2023. And then lastly, um, in terms of these models, uh, we have the sharp rise in cyclical unemployment. So what I'm showing in this chart is a number of the total, the number of unemployed workers who have just either lost their job from being fired or who've also completed temporary jobs. And what I'm showing in the, uh, the, the black dotted lines in this chart from the perspective of respecting the X axis, that's what we're trying to do here, Adam. I think the number one thing that I preach to our customer, our client base and ranges from, you know, trillion dollar institutions all the way down to mom and pop retail investors, they all receive the same information from 42 macro. But the number one thing I think I coach investors on is this concept of respecting the X axis, you know, not just saying this is going to happen. Therefore, I need to put it on. If there's a lot of time and space between, you know, the X, Y, Z happening and you putting it on, you're subjecting yourself to a high degree of market risk in both directions, right? Risk works in both directions as always relative to your existing, your legacy positions. But going back to these, um, these, these black dotted lines here, what they show is the prize in the, in this, in this particular indicator, cyclical unemployment, uh, a 10% rise on a trailing three month basis off the cycle low. And what you see is that, Hey, look, it's usually in or just ahead of a recession. Well, guess what? We got one of these in, in March of 2023. And so you look at the, the, um, the, the, the, you look at the, the, the interval that has the highest probability of seeing real GDP contract or the highest probability of seeing the unemployment rate rise. It is the zero to six month forward interval. And so that puts a recession kind of in April, 2023, September, 23. So when you add up all this stuff, the modal outcome suggests a recession is, you know, probably somewhere in the Q4 range with a little bit of spillover to Q3 and a little bit of spillover, uh, from a tail perspective, uh, back into, um, into Q, into Q1 of next year. So I think that's kind of like, you know, trying to time this whole situation. Uh, you know, we were comfortable making the transitory Goldilocks call back in January because we understood that a recession was going to be a second half event, if not a Q4 or Q1 event of 2024. And understanding that, you know, we kind of understand that we still have a couple of quarters to kind of price in, not a recession basically, and then eventually we'll get to that process. [00:18:17] Adam Taggart: Uh, that was super interesting and super helpful. Um, probably the fastest and most effective way for me and the listeners to find out kind of where your brain is and how you got there. Um, but I, what I respect about that is, is not just the very data driven approach. Um, and that's why I love analysts like you and like Michael Kantrowitz is, um, you know, you, you are not just a guy with a strongly felt projection. Your projections are all steeped in a ton of data that you can walk us through. Um, but is that you use multiple different, um, modalities, if you will, or at least you're looking at multiple different, uh, uh, uh, metrics by which you were seeing the data come to similar conclusions. And I presume that when you see different data sets, all basically still point to the same conclusion that gives you a lot more confidence that that conclusion is, is, is more probable in terms of happening. Is that correct? [00:19:15] Darius Dale: A hundred percent. I mean, that's, that's the, that's the hallmark of being a good investor or certainly a good research analyst. I think there's a lot more on the behavioral side. You need to be a good investor, but certainly as a good research analyst, it's always about, I mean, this is no different than, you know, writing a, uh, you know, 20 page paper in college, right? It's like the more data sets you have, the more, you know, the proponents of evidence, you know, leans in one direction, the more, you know, authority you have in terms of communicating and expressing your views. So I don't think investing in, you know, you know, I, I like to think that I create fancy book reports for a living, you know, it's really no different than that in terms of just ponderance of, uh, information that supports the, uh, conclusions. [00:19:48] Adam Taggart: All right. Well, I appreciate that. And I'm glad you mentioned the behavioral part because I do have some questions here at the end about that specifically. Um, but let, let me ask you this. So, um, you mentioned that you made the, um, transitory Goldilocks call at the beginning of the year. And my presumption is you did that by saying, look, we see some storm clouds out on the horizon, but our data tells us that they're still far enough away that there's hay to be made now in the markets. It's not time to, to, to get out of the markets and, and give up potential upside. Um, at some point you begin to get into the zone where you can be in danger of, of, we always like to say on this channel, picking up nickels in front of the steamroller, right? Where the risk return just really isn't worth it. Um, where are we right now? If you're looking at, you know, something that could start sort of August, September-ish of this year at the early side of things, is it, does it, is the risk return still good enough to be fairly long these markets right now? Or, or when do you think we're going to cross the threshold to it not being worth it on a risk return basis? Yeah, no, that's a phenomenal question. So we've [00:20:55] Darius Dale: been, uh, the view that, you know, assets like the asset plea were likely to be range bound. And, and so you go back to the end of last year, right? December was disgusting. You know, it was a really nasty end of the year, you know, very clearly investors were, you know, de-risking, uh, heading into that event. And, you know, we certainly were one of them, you know, we were definitely been bearish since, you know, fall 2021. So it's been a long time. It's, it's actually quite taxing to be bearish. I'm sure most people who get on here and understand like what it means. [00:21:21] Adam Taggart: We hear that a lot and start to interrupt, but, but we have so many people. Well, some people come on who say like, I'm so sick of being called a bear because I'm not a bear. I'm just looking at the data and the data is telling me to be bearish. I can't wait until [00:21:33] Speaker 3: it's telling me to be bullish. This is only 2018, obviously 2020, 2018, 2016, 2011, [00:21:45] Darius Dale: five times in my career. I've been bearish. I started in my, I started in the business in 2009, right after, or during, I guess the global financial crisis. And so, uh, you know, kind of missed the making that call, but you know, that's neither here nor there. What I think, you know, in, in 14 years, I've been bearish five times, you know, and, you know, and so it's, it's a, um, you know, I think it's a, it, it does not pay to be bearish, generally speaking. You know, there are times where you need to use this, you know, understand where you are and things like the global liquidity cycle, the global growth cycle, et cetera. And these are all things that we track on a daily basis, like 42 macro understanding where you are. And when there, there's a certain setup that says the risk reward for speculating in any, you know, risk asset is very poor. That's how, that's where we were in late 2021. And that's how, you know, kind of how we made those calls back then. Right now, I think the risk reward is a little bit more balanced because you do have some positive dynamics, um, that are supporting global risk appetite, the risk taking function of institutions, uh, at the current juncture, uh, namely the falling US dollar is a, is a big driver. And what I think is driving the decline in the US dollar is this recovery in, uh, in, in global growth. So I have a few charts on that as well. So we'll start right here. Uh, we're just showing, uh, composite leading indices, uh, for the US, the Eurozone, uh, UK, Japan, China, and the world. And what you can see here is that your zone, uh, composite PMI bottomed in late Q4. We had the UK bottom in late Q4, Chinese composite PMIs bottoming. If you look at it on a sort of coincident basis, these are services, PMIs, this is the Americas, the Europe, uh, Asia, and kind of the rest of the world. And as you can see, Europe and Asia are very much on a cyclical upswing. Now, why is that bearish for the US dollar? The reason it's bearish for the US dollar is because that rate of change in their economic output relative to our continued deceleration is allowing, you know, terminal policy rate expectations in money markets to compress. So what I'm showing in this chart here are terminal policy rates for the, uh, fed ECB bank of England and bank of Japan, uh, namely the, the bank of bank of, um, sorry, not the ECB is the most important one. That's this, uh, that's the red line in this chart here. What you've seen really since the lows of last year is this gradual upward slope in the spread between the feds terminal policy rate and the ECB terminal policy rate. Now, again, why is that happening? It's because markets are looking around and saying, Hey, look, the European economies in a cyclical upswing, American economy is very much still in a cyclical downswing. And so the speed with which terminal policy and expectations, um, um, are approving in Europe are actually, uh, is actually much faster than what we've observed in the US. There's also another reason why we're seeing, you know, such, um, you know, uh, we, the US dollar weakness in the context of this cyclical upswing in the Chinese and European economies. And that's this sort of, you know, I don't even know what to call this, but it's, to me, it's one of the, like the biggest issues of our time and will be an extremely positive development for risk taking on the other side of this recession. I think everything's going to moon on the other side of the recession. Once the fed acknowledges the recession and does rate cuts in QE. Now that's a separate discussion that I do want to have before we go, but let's talk about this for, uh, for now. Right now it's supportive. And what I'm showing in this chart is the net international investment position of the US that's the, um, the green and red bars here. Um, so the net international investment position for, for, for the viewers, uh, that's the total stock of, of assets that foreign foreigners claim on the US. So things that they own us real estate, us stocks, us bonds, et cetera, is the total stock of those assets. And what we're seeing here is that this net international investment position doubled from right around $9 trillion to $18 trillion in the four years through 2024. Now this data is released on a severe lag. So we only have the data through 2021, but what it suggests to me is that, you know, this confluence of, you know, US growth being better than the rest of the world, interest rates going from, you know, basically three and a quarter in, in 2020, 2018 to zero in 2020 and the US having the world's dominant tech sector, you know, a lot of equity capital got flooded into the US as well. Don't forget, we overstimulated by orders of magnitude relative to what we saw in Europe and China throughout COVID. And so we grew faster, both from a GDP and profitability perspective as well. So there was every reason to just jam as much capital as you could into the US economy from the perspective of Asian and European investors. Now that capital, sorry to interject [00:26:03] Adam Taggart: here, but, but are you familiar with, um, Brent Johnson's dollar milkshake theory? Oh yeah, absolutely. [00:26:09] Darius Dale: Big, big fan. It seems like a great example of that. Yeah, absolutely. He and I are very much on the same page, uh, for, for, for different reasons. I think, um, you know, with respect to Brent, I think we come at it from a more quantitative perspective, but I, I very much agree with his, you know, his conclusions that look, we're not going anywhere. This system is not going anywhere, uh, for a variety of reasons. I mean, if you look at the world's outstanding stock of, of sovereign debt or of, of, of, of international borrowing, you know, it's about 13 trillion dollars, you know, 89% of that's priced in dollars, whether it be dot bonds or loans, it's a, it's, it's, we're going nowhere. The dollar is going nowhere without a big war, uh, [00:26:43] Adam Taggart: without, uh, and his point is, is, is when the world really gets into crisis, the, the, the dollar in the U S markets become a real magnet for capital because that's where people, at least today continue to feel most confident about. And during, during the pandemic, that's exactly what [00:27:01] Darius Dale: happened in these charts show. Well, I think, I think what also happens, uh, and, and I think Brent will very much agree with this as well, which is when the world gets in a crisis, a lot of times it's actually because of the dollar system. Brent would agree with that. Yeah. Yeah. Yeah. Yeah. The crisis is the light. We can't find enough dollars. The fed has taken them away. You know, the Euro dollar system's not creating them because there's some stress on European bank balance sheet. So there's some stress on Asian bank balance sheets. That's, you know, kind of preventing the, the flow of capital. Um, you know, not to go too much on a tangent, but you can make the case that there's a little bit of stress going on right now. If you look at the, um, this, this negative spread. So what I'm showing in this chart, the blue line here shows the reverse repo facility yield that the fed, um, supplies, uh, to kind of, you know, put a floor on, on policy rates in terms of this fed funds floor. And then these various T bill maturities, the red line is the, uh, one month T bill. We're minus 89 basis points in a one month T bill below what you can get for free by parking your money in the reverse repo facility. That's a problem. And the reason that's a problem is because it suggests that, you know, there's a real scramble for what is generally speaking, the most pristine collateral in the repo, global repo market, which are these shorter term T bills. It allows financial intermediaries, people with the liquidity to lend it out on a more consistent, you know, shorter duration basis and ultimately ensure that they get paid back as opposed to, you know, uh, you know, at term funding on a three month or six month or 12 month basis. And so, you know, to me, there is some stress going on in the global, um, dollar system. It doesn't mean you need to run out and sell everything today. I mean, this probably looked the same in like August of 07, but by the way, you know, you didn't have, you don't have to worry about Lehman until September 08. And so this kind of conditions can persist for a long time. But what ultimately means is that improvement in global growth that we talked about, you know, this dollar decline that we're talking about, that's a function of that improvement in global growth. Those things are probably longer in the tooth. Now I'm not saying we need to run out and change the trends tomorrow, but I do believe we're having this conversation, you know, six months from now, which, you know, maybe we should do. I think a lot of this stuff might be very much in the rear view mirror in terms of dollar going down as a function of the upsick in global growth and as a function of the compressing terminal policy rate expectations, you know, particularly in the ECB. [00:29:10] Adam Taggart: All right. And let's make an agreement to have that conversation in six months. I would love to have you back. Great. Yeah, that'd be great. Okay. So, phenomenal charts again. Thank you for walking us through that. So, right now, the markets are, have been hanging in there. They've had a, you know, relatively strong start to the year, certainly relative to the 2022, right? Yeah. You need to get back to that sort of nickels in front of the steamroller issue. So, obviously, a dollar continuing weekend will buoy markets here for a little bit. There are some other things going on. And I do want to talk to you about sort of what's happening with liquidity, because I think that will come to bite markets. But real quick, just to try to put a bow on this topic. As you are looking with an eye to the arrival of a recession in what we'll call a quarter and a half-ish, maybe? Yeah. Possibly? I'd say two, two. Okay. Two, two. Did that give you enough time as an investor and a capital manager to still make enough of a return for it to be worth the risk? Or is this the time to start basically, you know, [00:30:25] Darius Dale: lightening your load and moving towards safety? Oh, we've been... So, once we got to 4200 S&P, once we got to 30,000 on Bitcoin, we're like, this is definitely the spot to be selling to taking down. Now, it doesn't mean you need to run out and short things, because again, you know, when you're short something, you're exposing yourself, you know, to unlimited drawdowns if something were to squeeze and run. You know, I don't have a crystal ball that says the market is going to 4305 and Bitcoin's going to 32,000. I don't, you know, I don't understand that. But what I do understand is that at these particular price levels, you know, from a technical standpoint, looking at the chart of the S&P or just from, you know, looking at a chart of Bitcoin, all these, you know, we have a variety of different technical tools as well. This is just a good spot to start lightening up on risk in the context of our medium term views. Now, let's say we go back to the lower bound of this trading range we've been in for a year, by the way, you know, the S&P has been in 3,800 for more or less, you know, we had a brief touch above it in August in terms of going above 4,200. We had a brief touch below 3,800 in October. But really, since May of last year, we've been bouncing around between 3,800 and 4,200. At 3,800, let's say we get to 3,800 by the end of May, which is actually what I expect. Just get, we have some differentiated views on what's likely to happen in liquidity terms, only here specifically in the US as a function of tax receipts. And so we do have a view that the S&P is kind of in this corrective phase for now. But that doesn't necessarily mean it's the beginning of what we call phase two. Phase two, let me, so let me take a step back and kind of explain what phase two is. Phase one, when the Fed is tightening and sucking liquidity out of the system, it's what we call the liquidity cycle downturn. That's where, you know, balance sheets, central bank balance sheets are shrinking, you know, private sector money is deflating, you know, you have interest rates rising, it's just getting harder to sustain asset valuations. That's what happened last year. You know, even bonds go down in phase one. Phase two is when the credit cycle hits. We call it phase two, the credit cycle downturns. Phase one is the liquidity cycle downturn. Phase two is what happens when you take all that liquidity away. We start to have credit risk in the real economy. And phase two is the credit cycle downturn. So going back to this kind of 3,800 to 4,200 theme that we've been kind of oscillating around for a while now, I don't think we're going to break down below 3,800 in the correction I think we're currently in. I think if anything, you'd be, you know, covering shorts if you're an institutional investor, you're covering shorts and getting net longer at 3,800 assuming it's here by late May or early June, because I don't really see a path, a probable path to pricing in phase two, you know, that soon, that quickly. You know, there's still a lot of stuff that needs to happen from a reported data perspective, you know, particularly in some of the lagging, coincident to lagging indicators in the economy that might, you know, that will ultimately cause the, you know, the mood of the market, you know, because mood, you know, behavioral aspects of this, the risk taking, the risk appetite is a big deal here. You're talking about a phase two credit cycle downturn. I don't know that we're going to see enough degradation in the economy to have the mood materially change to break us out of that range. You know, I think what's likely to happen is that we probably, you know, have another rotation back to 4,200 by the summertime. And then that might be the one that you might want to sell. Don't forget, markets aren't as forward-looking as we think they are. You know, in fact, we, you know, not to get too geeked out on this, but, you know, I guess I get paid to be a geek. We'll go to our grid asset market back test. So we back test every factor and macro that ticks. There's, you know, hundreds of factors in our global back test. This is the summary of all the different indicators, all the different factors that we feature in our systematic KISP portfolio construction process. And we back test it through the lens of annualized expected returns, percent positive ratio, volatility covariance. And we use this information to construct expected sharp ratios for all these investable factors that we, you know, again, feature in our, in our systematic portfolio construction process. But the key takeaway I'm trying to make is I've experimented with various leads and lags on these back tests to explain asset market performance relative to the economy is what I mean by economy grid is what we call our grid framework. That's, you know, that's how we score the economy through the lens of the rate of change of inflation. That's on the x-axis here and the rate of change of growth. That's the y-axis here, you know, very similar to kind of the Dalio framework, if you will. And so going back to this, this, this back test process, the markets aren't for looking there about as the most one to two months for looking. If you relate the rate of change of growth, i.e. the delta in growth and the delta of inflation back to the delta and asset markets, you know, the asset markets on a levels perspective can be forward looking. But, you know, generally speaking, not. But certainly when you look at it on a delta basis, on a, on a, on a differential basis, no, the asset markets are generally only pricing in the rate of change of growth, the rate of change inflation at most with the kind of one to two, at most three month lead. And so going back to this discussion on picking up nickels in front of a steamroller, what I'm not trying to do is get investors to pick up nickels in front of a steamroller. What I'm trying to get them to do is understand if you're, certainly if you're a retail investor, is understand that, Hey, you're probably, this is not the beginning of the new bull market. So we're getting to these, you know, very exorbitant price levels and things like the S and P or Bitcoin, then you need to be taking down risk and accepting the fact that this is not the new, the start of the new bull market. If you're an institutional investor, it's to understand that you don't necessarily need to run out and put the full deflation playbook on. Because again, when you're an institutional investor, you have a cost of capital, you have a cost of transacting, you, there's a cost to everything, right? Right. And so it's to get you to align your, your decision-making, you know, particularly if you're on a pot shop, you know, these sort of multi-manager platform funds, you know, you don't want to have a drawdown of, you know, three to 5% because your position for a recession, that doesn't occur for six months, right? That stuff matters. Risk works in both directions. That's another important key takeaway from this discussion. All right. [00:36:06] Adam Taggart: All right. Super useful. Okay. So particularly that point about markets really only being one to two months forward-looking, because I would say if there's been a frustration with, I think the, the average general wealthy on viewer, it's the fact that they have been watching the macro data degrade for quarters and quarters. Now they've been watching the growing disconnect between what the Fed is saying it's going to do and the market's anticipation of a Fed pivot and who knows what's going to be right there, but the fact that they are still quite different. And there's, because of so much of the current data, it does not look like the Fed has reason to, to, to pivot anytime soon. Right. And so they're kind of pulling their hair out saying like, but the market is, has been in party mode for, you know, a good chunk of this year. How can that be? Right. And what you're basically saying is, is their, their, their, their outlook doesn't really stretch long enough to see the same storm clouds that you do. They're really just looking at, you know, the short-term data that's given them the one to two month view here. [00:37:12] Darius Dale: Yeah. Well, you also have to think about this. Yeah. I completely agree with what you just said. I would expand upon that. And I say, you have to think about who are the players in the market that are really controlling the market, right? You got Captain Mutual Fund of which it's really not Captain Mutual Fund. It's mom and pop jamming 401k flows into, into, into legacy mutual fund type assets. You know, so that's kind of one school of investors. Those people haven't needed to sell because they're still gainfully employed. We still have a 3.5% unemployment rate. And so, you know, if you look at their, their equity exposure as a percent of their total assets, it's still very high and appropriately. So, right. It's at 31%. It's come down, obviously as stocks have come down and, and, and cash balances have gone up. But if you look at the black, the blue dotted line in this chart, and sorry, so let me explain the chart. This is a household cash as a percent of the total assets, household equities, a percent of the total assets, fixed income and real estate as the percent of the total assets for us, us households at 31% in terms of equity ownership. You know, we're just shy of the peak of the dot-com bubble and why haven't these people sold? You know, why, why haven't they sold? The reason they haven't sold is because they haven't turned off the 401k thing yet because we have a 3.5% unemployment rate. Don't forget, uh, Mike Green, I'm sure you've had on your show, a friend of ours over at Simplify. He's done a tremendous amount of thought leadership in terms of trying to get investors to understand that the market is not this, you know, kind of active manager, you know, thoughtful forward-looking vehicle that it once was. It certainly still has those elements, but it's just, it's just as much, you know, if not a little bit more these days, kind of like, where's the flows coming from? Yeah. This is the giant mindless robot [00:38:47] Adam Taggart: that he talks about. Yeah, exactly. Those passive capital flows. Yeah. And it, by the way, [00:38:52] Darius Dale: have you looked at a chart of jobless claims relative to the S&P? There's a reason those things are, you know, very correlated in terms of being inversely correlated. Uh, and so, you know, that, that's one, one of my key takeaways here as it relates to why the market isn't forward-looking, particularly in recent, uh, market cycles is because you kind of have to wait for people to get fired and turn off the 401k flows. And, and more importantly, you also have to wait for people to change their liquidity preferences, which ultimately happened in a recession. But this chart here shows is household, uh, money market fund exposure relative to their, uh, equity exposure. And I show it on a ratio basis here. We're only at 5%. You know, you look at, you know, ex-COVID because it only lasted for a month, but you look at the last few recessions, we got up to 14%. We got up to, you know, I want to say a little bit, uh, close to 11%, got up to 8%, 9%. You know, we're up 5% here in the 30th percentile of this reading. So there's a couple of things that still need to happen in this phase two credit cycle downturn, uh, uh, process. Households need to change their liquidity preferences because they're scared right now. They're talking about recession, but they're not scared. And that's a very different thing. Being bearish is not the same as being scared, right? I just want to make sure everyone understands that particular dynamic. That's a great distinction. And assuming because once you get scared, you actually change your behavior. You change your behavior. Exactly. But just talking about a recession, you can talk about a recession for six years, who cares? People thought when, at the beginning of my career, most of Wall Street while, while we were bullish, thought we were in recession from like 09 to 2011. If you really go back, you really meant that, that, that behavioral psyche in the market didn't really change until early 2013. I remember that very vividly, how negative the sentiment was that entire time, despite the market, you know, having, you know, more than double off the, you know, the March nine lows. And so I just want to make sure that it's very, if they hear nothing from me in this interview, it's being bearish is not the same thing as being scared from a liquidity [00:40:39] Adam Taggart: preference perspective. And so how... That's great. And from the liquidity preference perspective, we're seeing a lot of headlines and data showing that there's money flowing out of banks, bank deposits and going into money markets accounts or US treasuries. What you're saying is, while that might be true right now, that's just kind of a cash asset swap. That's not people selling their stocks to get into money markets. [00:41:04] Darius Dale: Yeah. A hundred percent. And we track that as well. So what I'm showing here is money market fund assets, total assets right around $5.2 trillion. You know, we're kind of growing at a 16, 17% three month annualized right around 17% on a year over year basis as well. I mean, look at where that liquidity preference can go in a recession, you know, in terms of the red line on a year over year basis. You know, we haven't seen anything yet in terms of, you know, the actual, you know, liquidity preference shift. We're seeing the asset swap shift and the asset swap makes a ton of sense. If you look at the spread between, you know, money market fund rates and national bank rates, you know, we're about 413 basis points in basically the a hundred percentile of this reading. So households are smart. They're being rational, but they're not being they're being rational, but they're not being fearful. So let me just quickly wrap up on that previous point here. The one thing I would call out, going back to this household allocation of stocks at 31%, again, just shy of the all time high in the dot com bubble. You know, if we haven't seen the change in liquidity preference and we haven't seen the change in asset allocation that typically coincides with the recession, it ultimately is the reason why we have not, why we believe that this kind of phase two credit cycle downturn process has not been priced in because this is something I get into some pretty good debates with our institutional clients, you know, in recent months, you know, about, hey, October was the low, you know, markets looking through all the rest of the weakness, you know, earnings are going to bottom in Q2. If you look at bottom up consensus estimates, that's actually what, you know, what Wall Street consensus believes, yeah, we don't buy any of that stuff. I mean, this chart here is one of my favorite charts and in the deck, and it's been featured in our deck, you know, for the past, you know, kind of four, you know, six months or so, which is, you know, every recession has a phase two credit cycle downturn. I mean, you can go back and study any economic history and understand that. And so what I mean, you know, the reason I say it hasn't been priced in is just look at the levels of these instruments. This is the Goldman Sachs Financial Conditions Index. This is investment grade credit spreads. This is high yield credit spreads. And this is the sector, you know, this is the sort of dispersion within the equity market, the high beta stocks as a ratio of low beta stocks. You know, go back to Stan Druckenmiller, whom I met, you know, back in, you know, 2010, when he was at Duquesne, he said the number one best economist in the world is the dispersion within the equity market. And so these are high beta stocks as a ratio of low beta stocks. What I'm showing in these, in these, the dotted lines is the sort of the level that each of these indicators peaked or troughed at in the previous three recessions. And why do they matter? The reason I think they matter is because they're all very different styles of recession. The 2001 recession is the shallowest recession in U.S. history. 1991 recession is the third shallowest in history. It was driven by energy. This was driven by, you know, kind of an overbuilding of CapEx. And then this one was obviously a financial crisis, one of the deepest recessions in U.S. history. And as you can, the blue line is the mean of each of those peaks and troughs. And as you can see, we are nowhere near a peak or trough in any of these indicators, you know, that would indicate, hey, the households have changed their liquidity preferences, households are changing that asset allocation, and not just because they want to. Don't forget, when you get fired, you don't take more equity risk. You take less equity risk. You know, when the guy sitting next to you gets fired, you don't go, let me turn my 401k dial up and buy more small cap stocks. You start selling small cap stocks. You know, it's not like we do this stuff on purpose, but it's behavioral. You know, we're human beings. We're all, you know, succumb to greed and fear, which is one of why those two things are featured in our weather model, which is our primary tool for managing risk. So, you know, kind of just summarizing all this, this part of the discussion is, I don't think we've seen the big bang yet. The big bang is probably, you know, that the earliest, in my opinion, probably five to seven months away could be, you know, seven to nine months away. You know, again, we're not, it's impossible to be that specific with timing, but I do want to make the case that just because it's that far away at these price levels, I wouldn't be chasing on further upside. If we get to 3,800 or, you know, 20,000 in Bitcoin and, you know, the next six weeks, you probably could buy in there for a final trade into the summer highs that you're probably going to see. [00:45:07] Adam Taggart: Steve McLaughlin: Okay. Super fascinating. But I take from this preponderance of data. And first, I congratulate you. I think Lance Roberts has met his match. Lance Roberts, you may be familiar with him. Lance Roberts: I know Lance. Steve McLaughlin: Yeah. He's on this channel every week doing a market recap with me every weekend. But there's hardly a comment I can make where Lance doesn't say, "Well, you know, I wrote an article about that, or I'm writing an article about that." You're the guy with the chart for everything that we think of. And it's amazing how fast you can just pull up the chart here. So this is all super useful, valuable, and impressive. Lance Roberts: I appreciate that. I'm thankful. Steve McLaughlin: But what I see your chart saying is, hey, lots of reasons to believe that, or to conclude that there's a recession coming on the general timeframe that you mentioned. But A, it's not here yet. And what I hear you saying is, we kind of have to wait for the E in Michael Kantrowitz's hope framework. We have to wait for that final E employment domino to fall. And as Michael says, and as you said, that's why his is like a now cast, right? He's not willing necessarily to commit to a timing for the recession. He says, once the E domino falls, then I'll tell you we're a couple of months away from the start of the recession. But I don't know when that E domino, I can just tell you it hasn't fallen yet, right? So it sounds like you're looking at that equally as [00:46:22] Darius Dale: closely. Correct? Steve McLaughlin: 100%. Yeah. And it goes back to the jobless claims, continuing claims, the cyclical unemployment. That's us trying to forecast the E. Eventually, we'll get the E and all the economic data that we run through our now cast and stuff for the grid model framework. But that's us trying to say, okay, when is the E probably going to show up? Because if I understand when the E is probably going to show up, I can manage risk more effectively along the way. It doesn't mean you're going to be perfect. You're never going to be perfect as an investor, but we're trying to do is help investors manage that risk more effectively along the way. And I know you mentioned this path dependency between getting to now and then. I think one of the things that we haven't talked about yet that I think is extremely important to explain to the audience is where are we in the liquidity cycle? [00:47:08] Adam Taggart: Steve McLaughlin: That's exactly where I was going to go. So let's go there. And if I could just tee it up and then let you knock it out of the park here. As I said in the introduction, without liquidity, nothing happens in the economy. And liquidity impacts credit. And really without credit flowing through the economy, nothing happens. I'm just going to go through a quick list of contracting liquidity metrics or contracting credit metrics. It's a little bit of a soup here. And I just want you to react to that list as you start to give the answer of the importance of all of this. So right now, we have contracting M2, which is a common metric of the money supply. That hasn't happened in the data set that I've looked at, which goes back for 60 years. We've actually never had a negative growth in M2 like we do right now. We have an 89% probability is currently projected by the CME FedWatch tool of another 25 basis point rate hike in May, right, just coming up in a couple of weeks. We have continuing quantitative tightening. We have bank lending has been contracting for the past year and a half. But post Silicon Valley Bank, Signature Bank, Credit Suisse, bank lending has tightened even further. Jerome Powell himself has said, hey, that actually substitutes for additional rate hikes, right? So that is additionally contract contractionary to the economy. We also have deposits that are fleeing banks to go into money markets and treasuries, like I said, which just mean it's money that's not available to be lent out going forward. We are apparently going to have to have a forced replenishing of the Treasury general account once the debt ceiling is raised. And I think everybody agrees at some point the debt ceiling is going to be raised, right? So that is actually going to get a suck capital out that could otherwise be going into the economy. We also have lower than expected tax revenues for this year. So again, less money that the government has to spend. So you can probably add some more factors to that litany of factors, but all of those basically say there's just less liquidity slash credit moving around or will be expected less going forward, at least in the near term. So a lot of analysts, several in this program have said, yeah, I think we're going to be having a liquidity crunch this year. Some are arguing or actually maybe already beginning to be, you know, in the early innings of one right now. So please talk about how the outlook for liquidity and for credit is impacting your outlook for recession. Adam, that is music to my ears, man. That is, [00:49:41] Darius Dale: you are firing on all cylinders and you're hitting the liquidity topic right where you need to hit it. So I'm actually very proud of you. That's awesome. So I'll start by saying, let's define liquidity for starters, right? Like there's a variety of different metrics that you can anchor on and you anchored on most of the key ones that we look at. You know, there's a few that we track on a daily basis in the context of our weather model. And again, the weather model is our main, you know, kind of engine of our process. It's the tool that we use to help investors manage macro cycle risk through the lens of, you know, what I think are the most important macro cycles not I, not my, my education from, you know, different by-siders, reading books and things of that nature have been told to what matters. So we'll start kind of go down the list and we'll land on liquidity. So growth, inflation, employment, profits, fiscal policy, we'll skip those, fear, positioning, fear and greed in terms of positioning. Those are, you know, these are things that we monitor on a day-to-day basis to give us a sense, okay, what's the near-term outlook for something like the stock market, the bond market, the dollar commodities, or digital assets. But we'll focus our thoughts on, you know, this kind of component of the, of the, of the weather model. Monetary policy. So we look at monetary policy through the lens of what we call 42 macro adjusted net liquidity. Now, by the way, I don't mean to say this in a disparaging manner, because I'm all for sharing information, but I think I've had, I'm actually up to 11 different analysts and or investors that I've heard on podcasts in the last 18 months, take our model and say it's their own. I'm totally fine with them using it, but I love, I love a little hat tip. You know, I'm a working man with a small business. I love it. That's the highest form of flattery, although I'm sure. Yeah, exactly. In fact, Morgan Stanley was the biggest of those institutions. Oh, geez. Yeah, they're, they're clients, so it's not a big deal. But anyway, so going back to, so adjusted net liquidity, we actually did make an amend, amendment to our initial, the net liquidity model, which again, fed balance sheet minus reverse payroll minus treasury general account. We've actually subtracted the emergency lending on the Fed's balance sheet from this calculus as well, because we think it gives a more true approximation of the kind of the total amount of liquidity being supplied by the Fed in any given juncture. That's still trending lower. I'm sorry, I'm getting sloppy in my pen here. Global central bank balance sheet. So this includes the total assets on the Fed's balance sheet, the ECB's balance sheet, the Bank of England's balance sheet, the Bank of Japan's balance sheet, the PBOC's balance sheet, and the Swiss national bank balance sheet, you aggregate those balance sheets. They're about 91% of total central bank balance sheets. So that's pretty much all, you know, anyone's going to have time to monitor on an individual basis. That's still trending lower. We look at liquidity also from the perspective of private sector money. So this is what we would consider to be public sector liquidity. How much liquidity are we getting from the manna from the heavens or, you know, the fire from, it's either the manna from the heavens or the fire from the heavens. This is the money that we create as private sector entities. This is narrow money supply. So looking at M1 here, it's actually down 8.3% on a year-over-year basis. Down 8.3% on a year-over-year basis in the U.S. economy. On a PPP-weighted basis, globally, it's down 1.3% on a year-over-year basis. You know, these two time series have almost never contracted. This is the only second year-over-year decline in M1 in the U.S. It's the first year-over-year decline in global PPP, narrow money supply. And more importantly, as it relates to a dispersion that these signals are sending to the asset markets, they're actually, they're still continuing to trend lower. We still have policy rates trending higher in the U.S. And one final thing that's actually positive for liquidity right now is that the markets are expecting the policy rate to inflect. So let's go and kind of look at this from a quantitative perspective before we kind of unpack some of these more esoteric dynamics. So right now, adjusted net liquidity is trending lower and it's contributing a negative excess return to most risk assets. Global central bank balance sheet is trending lower. And again, we back-tested everything. You know, we, I don't say anything, nothing comes out of my mouth if I didn't back-test it. You know, we're very, very quantitatively oriented here at 42 Macro. So that's contributing negative excess return on a forward-looking basis for asset markets. Domestic narrow money supply is contributing negative excess returns to, in terms of the forward outlook for asset markets. Same thing with the global narrow money supply. So public sector liquidity, private sector liquidity, both all these factors, all these features in the model are contributing to negative kind of excess returns on a forward-looking basis. Benchmark policy that's been rising, that's also contributing to negative excess returns. And then the one thing that's actually contributing to positive excess returns into the kind of liquidity framework is the fact that the markets are expecting the Fed to do an about-face pivot. We'll finish on that because I think that's kind of one of the more dangerous aspects of this whole, where we are in financial markets in terms of timing of the Fed pivot. Because actually, let's not finish that because I do, I think that's a very important thing to discuss before we move on. A lot of investors, when you hear, you know, because I listen to about 10 to 12, 15 hours of financial podcasts every week, in addition to having all the institutional client meetings that we have every week, the number one thing that I hear that I just, it puts a bee in my bonnet, a giant bumblebee in my bonnet, is this concept of XYZ, they're going to print. And that is true. Who cares what XYZ is? It could be interest rate expense is too high for the US. I don't know, the US is about to go into recession. Who cares what the XYZ, ABC is? It's the dot, dot, dot, they're going to print that I take great offense. And it's not that I disagree that they're eventually going to print. It's that I disagree with the sequence of events. And so we were talking about this with our clients on our weekly podcast, we do a weekly presentation as well at 42 Macro. This is our monthly presentation. Our weekly presentation last week, I was kind of making a new joke, which is, have you ever seen a firefighter get in a firetruck and turn the sirens on without a fire to put out? I'm serious. I'm actually asking you a question. Have you? No. No, yeah, no, no one has. Yeah, we're probably combined 100 years old. You know, like, we, neither of us have seen that. And so the point I'm trying to make is that the Fed is a reactive government agency that responds to adverse developments in the economy or adverse developments in markets. Usually the markets lead to adverse developments in the economy. The reason why I'm so concerned about, you know, that ABC XYZ turns into liquidity, so therefore buy everything now, that I'm so concerned about that kind of general consensus amongst investors is because this is a Federal Reserve that is almost guaranteed to have its reaction function be lagging when phase two, when the phase two credit cycle downturn begins. And the reason we say that is because they're already forecasting a mild recession. If you look at their unemployment rate target, this is their 2023 year end unemployment rate target of 4.5%. And this is the current unemployment rate or at least the time series. They're calling for a hundred basis point increase in the time series on a nine month interval. Well, if you go back and you look at the trailing nine month momentum in the time series, that's what this bottom study shows. There's never been a hundred basis point increase in the unemployment rate on a nine month interval or on any interval for that matter, that did not coincide with the red bar or recession. And so the key takeaway here is that this is a Federal Reserve that is going to be eating popcorn while at the beginning of the recession process. It's going to be saying, yeah, but yeah, so what when the markets are S&Ps at 3,200 and Bitcoin's at 20,000 or 17,000 again, at some point, you know, in the next kind of let's call it three quarters. That to me is very concerning. I mean, it could be as soon as one to two quarters from now. I'm being very conservative when I say three quarters, because that puts you into the only part of next year. But irrespective of when phase two begins, we can conclude based on what they're guiding, i.e. higher for longer. And we can also conclude based on what their forecasts are in terms of already anticipating about recession, that at the beginning of the recession process, at the beginning of phase two credit cycle downturn, that has not been priced in by the way, they're going to do nothing. They're not going to rate cut. They're not going to QE. They're going to do nothing. And we know that monetary policy works with long and variable lags. So that's actually quite scary in terms of, hey, look, we actually need you to do some probably today if you want to make sure that it's in a mild recession and markets do, you know, markets do okay. If you wait too long and they're almost guaranteed to wait too long, we're going to have a real problem on our hands in asset markets and [00:58:07] Adam Taggart: the economy. So many great points there. Your point about if they wait too long, I mean, that's what the Fed's track record has been. And certainly, you know, in past recent years, they are a follower. Their reaction function, if you said, has been very delayed. How they responded to inflation is a great case in point. And that just happened, you know, over the past two years. We've got really recent data to show these guys take a long time to realize there's a big fire raging, right? They could have put it out when it was small. They don't really react until the whole building's on fire, right? 100%. So when you talked about, you went through your liquidity factors and you said, there's really only one that is supportive of, you know, markets going higher from here. And that is market expectations for a Fed pivot. So obviously, if the market wakes up at some point, as it might be in the process of doing so, because just a little over a month ago, it was projecting that the Fed was going to pivot, I think in June, June or July, right? Now, it's shifted that back a bit to, I think, September. But if the market wakes up and says, oh, golly, I don't know. It looks like the Fed's not going to pivot at all this year. I'm assuming that that positive factor may flip to then be a negative [00:59:15] Darius Dale: one like all the rest. Is that true? It may not flip to be a negative factor, because the market still may on a two-year forward basis, because that's what that's tracking. They may still be priced. They might just push it down into the future. What I'm concerned about as it relates to the pricing of risk assets in asset markets is the process of that happening, right? Think about when unemployment rate is really starting to rise. Jobless claims are really picking up. People are starting to sell assets, and their liquidity preferences are changing. And you're starting to see, you know, kind of, you know, recession-type conditions in asset markets. The issue that I'm concerned about is if the Fed is already anticipating a recession, they're likely to not be quick with the liquidity hose that the fireman has. They're not going to be cutting rates and doing QE early on in that process, which means, Adam, markets are going to have to be the conduit to tell the Fed to get in the fire truck, turn on the sirens, and pull out the liquidity hose and put the giant burning house down. By the time they get to the house, it's going to be [01:00:11] Adam Taggart: almost burned down. And that's my number one concern. So as I've said very often, which I think you're saying is, is those who are wishing for a pivot may actually get the pivot. It just might not be for any market bullish reasons, right? To your point, things might have to get so bad in the market to get the Fed to act that, yeah, by the time you've got your pivot, all right, great, you got it. But the market's down by 20, 30, whatever percent at this point. Yeah, 100%. And don't forget, we haven't even, [01:00:37] Darius Dale: I mean, I can't believe we're it's 2023. We haven't had even a sniffle of discussion about inflation, but going back to this inflation discussion. That's what I was going to go next. I love how you think. Yeah, absolutely. So I did want to just one final point I want to make on global liquidity before we wrap up, but I did want to just quickly hit on inflation, which is this is what I'm showing you in this chart here is just corn from various metrics of core inflation. We'll focus your attention on the bottom panel, the super core inflation tracking at 4.3% on a three month annualized basis. I don't care. I mean, it's been since the summer of 2020, I have not as a quantitative research analyst known or cared about what year of year inflation was. I have no idea what year of year inflation is at any given time. Because the reason I don't care is because we know COVID is going to have a significant impact on base effects. We know we're in a tightening cycle and base effects can't be the only reason that gets inflation down, because ultimately what it means is that the time series is going to continue to trend higher. And so what ultimately is going to happen is you're going to bottom off of a higher level. So we can't rely on base effects on a time series that is graduating higher. This is this very esoteric quantity of economics. However, let's go back to why we're looking at this on a three month annualized basis. The Fed cares about this on a three month annualized basis, because it's going to give them this the quickest out of tightening monetary policy. They don't want to over tighten. They're probably going to over tighten, but they don't want to. And so 4.3% three month annualized tells us that they were nowhere near the 2% that they need in order to feel comfortable that the year over year time series is going to actually get back to 2%. If the three month annualized isn't at 2%, how in the heck is the year over year going to get to 2%? Great point. We're just going to wind about them at a very high level and start compounding higher again. Core PCE. These are various metrics of underlying inflation, which I think are more instructive in terms of understanding at least Jay Powell's reaction function. Jay Powell, Jim Bullard, Chris Wall are kind of the hawks on the committee. 6.8% three month annualized median CPI, 5.1% term median CPI. You look at core PCE is compounding at 4.8%. You know, we are, whether you take the easiest way out at 4.3%, or you just accept the fact that it's somewhere between 4.3% and 6.8%. Underlying inflation in the US economy is still so tight that this is a Federal Reserve that's going to be spooked even as the phase two process begins because inflation is a lagging indicator. And the reason I say inflation is a lagging indicator, going back to our recession analysis chart, again, these are all the recessions that we've had in the US economy since going back to Act One of the Great Depression. We're kind of looking at it through, you know, various deltas, various metrics. But I'll draw your eyes and your attention to this set of columns here. Right here, where we're showing here is the core PCE peak heading into the recession. This is the trough in and around the recession. This is the basis point change in your core PCE in the year ahead of recession. This is the basis point change in the year during and is the basis point change in the year after, or not the year during, just during the recession, however long it may last. I'll draw your eyes to this statistic here, plus five. And more importantly, I'll draw your eyes to this compendium of numbers. What this shows is that in the year leading up to the beginning of the recession, there is almost no historical evidence of core PCE decelerating meaningfully or even at all. In fact, the only recession in which core PC decelerated heading into the recession is the July 81 to November 82 recession. All other instances, we saw core PC out of flat or up heading into the beginning of the recession, which tells us, much like wages, much like employment, inflation is a very lagging indicator, which means when the recession starts, when phase two starts and we're demanding the Fed to get in the fire truck and turn the sirens on and spray the burning house with liquidity, they're going to be handcuffed by not only inflation that's probably still going to be too high and sticky, but they're also going to be handcuffed by their unemployment forecast, which are basically telling them that, hey, look, you're expecting this all along, so why are you panicking? They're not going to panic until unemployment goes above 4.5% or until the S&P is down 20, Bitcoin's down 40 to 50. All those things could happen, by the way. All those things are probably likely to happen. In fact, that's our model outcome view once we get into the back half of the year. So that's kind of it on this. And then I did want to quickly wrap up on global liquidity, because I think this is a topic that I think is very misunderstood. We have Michael Howells of the world over at Crosswater Capital, famous, world-benowned, kind of understanding all those dynamics. I think there's probably a more, I wouldn't say less sophisticated, but I think there's an easier, not necessarily just as accurate, but reasonably accurate way to track this stuff. So we'll start by kind of amalgamating what I think are the three most important metrics to look at from a global liquidity cycle perspective, which is the world central bank balance sheet, world narrow money supply. Those are the two factors in our macro weather model, which again, we use to drive the basis for all our investment decision-making on a systematic basis. By the way, we've been talking for a little over an hour now. As sharp as this presentation may come off, I make zero discretionary trades in our portfolio construction process. Everything we do is based on a systematic process that combines top-down and bottom-up risk management overlays. I'll kind of, if we want to have a different discussion about that in this future discussion, I'm more than happy to explain how that works. But going back to this liquidity discussion, so central bank balance sheet, narrow money supply, world FX reserves. And the reason we track world FX reserves is because when FX reserves are rising, foreign central banks tend to buy dollars. They tend, particularly when the dollar is falling in that process, they tend to sell their own currencies and buy US dollars. Not only does that create liquidity in their geographies, it also creates demand for treasuries in our geographies and kind of lessens the burden of our private sector from having to take down treasury debt. You know, one of the things that was kind of a big deal for asset markets in 2020 and 2022 is the fact that private sector creditors had to basically suck down a bunch of incremental treasury issuance. You know, what I'm showing in this chart here is the share of total treasuries, marketable treasuries owned by the Fed, owned by US commercial banks, owned by foreign central banks, as you can see, is kind of that uptick there has been pretty positive. And then this is the share owned by us, the private sector. We've gone from like 38% to 45% in the last kind of, you know, 18 months, not even 18 months, 16 months. And so that's part of the reason we saw treasuries go down in price. Everything go down in price a lot last year because again, there was just this kind of like sucking sound of liquidity from the treasury market that really was a big deal for asset markets. But going back to, you know, this kind of concept of global liquidity, because I did want to wrap up because I do believe it's an important topic to help investors kind of better contextualize, provide investors with a better framework to understand it. And so FX reserves do supply liquidity when they're rising and the dollar is falling. Obviously, central bank liquidity, narrow money supply, that stuff is very positive. These things peaked in January and February, by the way, if you look at it on a trailing three month basis. So this is the trailing three month momentum in each of these time series in these bottom panels. We peaked at plus $1.4 trillion in January of 2023 in terms of the global central bank balance sheet on a trailing three month basis. We peaked at plus $2.2 trillion in January of 2023 in terms of world narrow money supply on a trailing three month basis. And we peaked at plus $430 billion in February 2023 in the global for FX reserves. If you look at our trailing three month basis now through the most recent data, we have minus $331 billion in global central bank liquidity. We got minus $982 billion in global narrow money supply and only plus $30 billion down from $430 billion in world FX reserves. So going back to the question, going back to your list of indicators, I think our indicators are very much aligned with yours, which is a lot of what's been very much driving transitory Goldilocks here to date and helped us. It wasn't really the driver of that call back in January, but it's certainly been a very dominant driver of things like the digital asset space, et cetera, here to date. I think people need to go back to the data and kind of revise some of those views, in my opinion. I think what's really happening underneath the hood is the fact that China, the Bank of Japan doesn't need to defend yield curve control to the same degree that they had. If you look at the Bank of Japan's balance sheet up 18% on a three month annualized basis, the PBOC doesn't need to defend or help its economy as much as it did now that it's actually confirmed a monthly recovery. Its balance sheets up 16% on a trialing three month basis. But if you actually look at it on a month over month basis, it's down 2.6% and down 4.2%. And so my key takeaway is that so much of what's been very positive from a global liquidity perspective year to date is actually inflecting in a negative way. So the, you know, kind of landing the plane in this discussion that, you know, kind of picking up nickels in front of a steamroller is very much, was very much supported by improving global growth, improving global liquidity. Now, I think global growth is likely to continue improving, namely driven by China for at least another quarter or two, but ultimately it's going to run into a, it's going to run into the steamroller when the US is really starts to recess. And this global liquidity cycle dynamic, if this is going to be something that has a tail on it, then I think that that path to, you know, the amount of nickels in front of that steamroller that are even there to pick up, I think it got to deteriorate pretty, pretty substantially. [01:10:01] Adam Taggart: All right. God, super fascinating. This has been wonderful, Darius. Look, I have a couple of so many questions I'm not going to get to, and you've given us so much time already. I do, if you've got a little bit more time, just want to talk briefly about your market outlook here, given this macro outlook of approaching recession in the next five to seven-ish months. And I know that something might happen that might impact that forecast. If it does, Darius, we want you to come back on this program and tell us about it. But yeah, if we could, so you expect a recession this year. I haven't asked you, I wanted to dig more deeply than we have time to in terms of sort of like the severity and duration of the recession that you expect. But if it's one that you think is going to be meaningful, and I'll let you define what meaningful is, what impact do you think that is going to have on markets? And maybe a question for you to react to there is, may we find a new market bottom versus what we saw in 2022 in the type of recession that you see ahead? Yeah, even if it's a mild recession. Our interview with Darius will continue over in part two, which will be released on this channel tomorrow as soon as we're finished editing it. To be notified when it comes out, subscribe to this channel if you haven't already by clicking on the subscribe button below, as well as that little bell icon right next to it. And be sure to hit the like button too while you're down there. And if you'd like to download a copy of the full chart presentation that Darius was showing slides from in this interview, you can do so for free right now by going to wealtheon.com/42macro. And finally, if the challenges Darius has detailed in this interview have you feeling a little vulnerable about the prospects for your wealth, then consider scheduling a free no strings attached portfolio review by a financial advisor who can help manage your wealth, keeping in mind the trends, risks, and opportunities that Darius has mentioned here. Just go to wealtheon.com and we'll help set one up for you. Okay. I'll see you next over in part two of our interview with Darius Dale. [01:12:23] Speaker ?: Bye.