Hello, and welcome to another episode of the Odd Lots podcast.
I'm Joe Wisenthald. Tracy Alloway is out this week unfortunately, but with me in the studio here for today's episode, I have Bloomberg macro strategist Cameron Christ and Bloomberg Cross Asset reporter Luke Kawa, and I'm very excited to talk to both of them because we are going to do our year in review of markets, or basically just talk about what the heck happened in markets this year, because I think it was one of the most interesting times
for markets across many asset classes that we've had in several years, maybe most interesting since or the financial crisis, or maybe at least uh And I think a lot of people have questions about what's going on, so hopefully we will try to answer them. So Cameron and Luke, thank you very much for joining us. So it's always tough to disentangle reasons for market moves, and Cameron, I think you're one of the most strident and sort of
pushing back against any attempt to do that at all. Nonetheless, this year was characterized by a very sharp turn starting in early October, where we saw some major winners just completely fall out of bed text docs. US equities which had been doing pretty well up until them, just started
getting relentlessly destroyed. What happened, well, I think you need to look actually back to February, because we had a very similar phenomenon in February, UH, and the genesis was broadly similar, I think in both instances where you had a performance of very good equity market performance that was punctuated with a sharp rise in market interest rates, say the tenure yield, and at the same time, inflammatory rhetoric from the US president vsa V trading relationships with China,
and that is kind of a potent and lethal cocktail for risky assets. And you had a market that was out over at skis and if you you might not be all neither one of you are probably old enough to remember the old wild WARLD wide world of sports intro where there was a ski jumper. Remember the thrill of victory in January and over the summer, and then the agony of defeat in sort of February and and then October thenceforth. And so what people try to say, Oh,
is it the Fed? Is it UH trade? Basically you can rely it's I think it's a combination of of a number of things. I mean, we need to take a step back and remember that the FED is in the midst of a tightening cycle. Montary policy has gone from unquestionably accommodative to arguably neutral. We had a similar phenomenon obviously two thousand five. In both of those years FED tightening years, the multiple of the SMP five hundred fell pretty sharply, and this was just, I think, to
some extent, the latest iteration of that phenomenon. Luke, come in here when we when we write the story of this year, the story of this year will be the huge blow up of the short fall trade, of the trade that essentially you could make your living easily from early through January. Early in the year, we had pretty much every equity and overbought territory, and you know, things
were great. We blew past everyone's uh, everyone's und target or at least like a quarter of analyst targets within the first five sessions, and then it all blew up. And then at two other points this year, two other large market moves that you can attribute to really the perils that can befall you when you sell options when you sell volatility. The drastic fall in crude and the drastic rise in natural gas that way douta options seller dot com that I think. I think this year is
a year we learned how dangerous options can be. Or if you know, people who needed a reminder of that lesson over the past couple of years, this is where you you really learned it, because there's no there's nothing
like you know, your February uh. And then recently what we've had included natural guests, And I think that speaks to a theme that old grumpy people like me like to talk about, which is, as financial markets have become younger and younger, you've sort of win out out people who have seen previous rate hike cycles and know what a rate hike cycle looks like, and typically it is associated with higher volatility. So it's the kids, it's get the get off my lawn and quit selling options kids.
The Canadian metalinnials have already traded through a bear market though, so that narrative, I'd like, how much is this sort of death of the short vall trade connected to changing
FED policy and a less accommodative a tightening cycle. Basically, I find it I find it less so just uh, given how you know, the trade did kind of blow up spectacularly and we went on to then eat price in even more, you know, FED tightening through through your dollars for calendar nineteen than we had at the time of and that the fact that you know, if we were thinking this is you know, a rates fall transmission,
we still haven't gotten rates fall. So I'm I'm wondering the extent to which this will be a twenty nineteen story in which rates wall really amplifies the equity vaul, because I'm not sure that's happened yet this year. I think we also have to look at we're so used to relying on Montrey policies are sort of signals. Let's not forget the importance of fiscal policy. Because we had the big tax cut past at the end of last year. We're having a blowout in the fiscal deficit of the
United States this year. What that's me That's meant uh much higher issuance both at the long end of the curve and short end, and that short end issues tabillar is showing to squeeze liquidity to a degree, and at the same time, the FED is engaging in what's popularly known as quantitative tightening um, which I don't think necessarily has a direct impact on say, equity prices, but it does make short term liquidity conditions less um ample less ample than they have been over the over the last
few years. So we've kind of had UH. We started the year with markets really excited about the earnings potential created by the tax cut, and the rest of the year to some extent, has been about, if you will, the negative externalities of the tax cut in terms of the deficit and what that's meant for fixed income markets.
One of the things you said in your first answer is that what characterized recent volatility starting in October, and what characterized the volatility spike we saw in February was the fact that, unlike in previous UH sell offs in the post crisis era, we saw people selling treasuries at the same time, so that if you have diversified portfolio, some stocks, some treasuries, you were losing on both sides.
You weren't getting that natural cushion. What changed there? Why hasn't this year up until I guess maybe sort of December, Why hasn't it been the case that when equity volatility spiked, people went to treasuries as a safe haven. Well, I think to some extent this issuance dynamic and the and the and the deficit um played a part. You know, you also have a new FED chair chairman in place this year who essentially gotten the seat and came across
as more hawkish as his last couple of predecessors. Yes, the yelling FED did hike rates three times last year and initiate the balance sheet rolled down process. But I think people had this underlying belief that listen, yeah, we know that if the stock market rolls over, you know, Janet's got your back. And there hasn't been the sense I think that that the Powell Fed has got your back until very recently. But Luke, even with the market volatility,
the US ECO data looks good. And of course ultimately the FEDS, the FED has a dual mandate. It's uh employment and inflation, it's not the stock market. And on its dual mandate, the thing it's sufficially charged to do. Things are still looking okay, yeah, right, like we've got well, we've been at full employment since you know, you can rewind the clocks on. People think we've been there for
for three years. We still keep managing to print well over a hundred k inflation, you know, around two percent by by most preferred measures. And I think this is something that you know, you and I have talked a lot about. This year is also characterized that macro economic vall. You know, throw out your kind of your Turkey shocks and you're outside U S stocks. Uh. The macro economic
volatility the U. S economy has not been large that whatsoever. However, you know, it seems to speak to more changes in market structure for why we're able to get these uh, these moves that do make us think that something is going I mostly the I would bow to cam here and the withdrawal of liquidity UH post crisis regulation that are making it essentially market making is is less of a thing. Bank balance sheets are not really extended to to the same extent, and and the rise of passive money.
All of this allows you to, I think, have sharper market moves. And the thing I wonder is, if you're an active manager in this environment, is generating alpha more a matter of when you get in than what you buy? Just because of how the liquid markets have been and how sharp some of the moves we've gotten our camera and your thoughts on that. Yeah, I think an underappreciated UM factor, and I think it's underappreciated because it's difficult
to quantify. Is the increased prominence of quantitative stres rategies as well, whether it's vault targeting strategies, which isn't quite the same as as the vaal selling stuff, um, but it's it's kind of the sort of the red headed cousin uh if you will, where there's this requirement when the stock market declines for for these types of strategies to to sell futures essentially to reduce its portfolio risk and then the risk parity stuff, which is a a
common sort of bogeyman in the in the closet. And going back to your your previous question about stocks and bonds and and sort of following in tandem, they are a popular um cause for that because there they tend to be their own stocks and they own generally own a lot of bonds, and when bonds start to fall,
then they have to de risk everything and they sell everything. Um. Who knows how much of it is down to these guys, but they're they're they're certainly they weren't there twenty years ago and they are there now, So it is at least one change in the market structure. I'm picturing you tweeting that and Cliff Asness say your tweet and him freaking out about efforts to blame the computers. Well, funny enough, you mentioned Cliff as nous I noticed that the a
q are risk parody is Mutual Fund. They're changing their name. They're just branding, you know, They're they're removing the risk parody name. So I mean that maybe that's ringing the bell for the bottom of this phenomenon. Like, I don't know, can we talk about the the year in trading and the year in markets without talking about the effect that just the trade issue has had, both state side and on the broader outlook Like I you can take it. You can take your pick whether it really started in
March with steal or really escalated later in May. But it seems as though everyone was calling for to be a year of convergence and the rise of the trade issue completely blew that up. Yeah, I mean, it's been one of the the stories of the year. And what markets hate above everything else is uncertainty, right, And that's what we've had with this this trade story. What you know, will it be resolved? When will it be resolved? Will there be will the tariffs that Trump has announced be enacted?
Will there be new tariffs announced and then enacted? Will we have a deal. If so, what will it look like? Oh? Who are we going to arrest next? Uh, It's it's
become very very difficult. I think you look at the UK and the Brexit fiasco, which we haven't talked about yet as another example of uncertainty, and look at how that's impacted British markets, both stock market where the multiple of the foot Sea has gone down by this year, which is a heck of a lot more than most other markets, and then obviously the pound which has been
well pounded. And an interesting story with trade is that as the issue has been raised mainly, you saw whenever it was having an effect on markets, it would have an effect on a sector basis. Within the US, you know, you sell your industrial as you try and high out in small caps. But then on the global level it was happening more on the index level, AK sell everything,
but US China especially underperforms. Yet from the beginning, we've had, you know, this inkling or this idea that we were going to move into tech sometime, that this was going to be about tech, that this was eventually going to become about i P supply change in SEMIS. And one thing we've noticed since the recent trade truths, if you want to call it, is that you're starting to see more effects of trade play out on the index level
in the US. So that's one story that has been story that is changing as we head into the tail end of the year. I'm glad you brought up Brexit and the international situation, because even while US stocks we're doing fairly well up until early October, the international scene was pretty ugly, particularly emerging markets this year. And I think it's pretty remarkable because I think even as recently as January, we were still talking about global synchronized growth.
I don't remember when we stopped, but I think it was earlier this year, which just seems like I can't believe that it was that global synchronized growth was a phrase that people It was odd people's tongues because it just seems like such ancient history. Yeah, I remember going on your because on your television show in late January and the the eight shares that the HINT Enterprise Index hadn't gone down in almost a month, like it literally
had gone up every single day. Now, obviously that sort of thing can't persist forever, and like all great parties, you know, the hangover is usually pretty pretty vicious, which it's been this time around. Yeah, it's interesting because I think most people would focus on the trade stuff as being a reason for this um this under performance of emerging markets, and that to some extent that's true, But
there's a couple of other issues as well. Why is the lagged effects of China's own de leveraging process, which began last year, which is in the absence of any trade tension with the US, was always going to slow China's economy this year, and that obviously ripples through the rest of the world, particularly emerging world who sell to China. Uh. And to the hangover of dollar borrowing, which Luke alluded
to a little bit. UH, the dollar dollar borrowing over the last sort of six seven years by emerging market countries with large external vulnerabilities, the Turkeys, the Argentina's, you know, the Indonesia's of the world, and as liquidity is withdrawn from them. I think that ripples through the system as well. Yeah, it was. It was kind of interesting in the early stages of trade heating up. Uh. You know, everyone expects the textbook tells you that, you know, this should have
been dollar positive. It wasn't quite in the early stages. The figuring out the dollar this year has just been you know, kind of a headache. At the beginning of the year, we were you know, it was all about twin deficits going to drive the dollar in a weaken the dollar. And then you know, at a certain point we said, you know, real rate differential, growth differential, it's all going to be about strength of the the US dollar.
And and that's something that's that's weight on e m s. Also the big under performance of batstocks, your by Do, your Ali Baba, and your ten cent like in the US, these are for those these are huge Chinese. These are huge Chinese internet companies that also have a big weight in emerging market equity indexes. And when you think about how like early in the year, we were worried about the potential for Facebook to really get regulated, to come
under the crush there that hasn't happened. Congress has been kind of a joke on that. If anything happens, it's been in Europe. Yet in China they're actually like cracking down on ten sensibility to to offer new games. So they've been swimming against, you know, a regulatory headwind as well as a slowing growth head wind, as well as a equity market that's coming under trade pressure headwind. Uh. Going back to something you mentioned Cameron about again, I
think it was when you mentioned bregsit. But something I've been thinking about is, Okay, markets hate uncertainty, and there's a certainty really everywhere you look, and I think there's a real dearth of institutions or individuals that you can look to that you could say Okay, I feel like really confident that they've got to handle on this. We all know, we don't need to talk about our president. Did is uh? You know is twitter habit? We have a new FED chair who uh strikes me as very
competent but also inconsistent at times. And I think it's hard to um like figure out the Powell doctrine or what the Powell Powell world view looks like. There was a point earlier this year where I thought, oh, he might actually be more devilish than Janet Yellen. Then there was a point was like, well, it seems more hawkish than Janet Yellen. It's hard to put a finger on him.
And then you look, of course it bregsit and you know you can't have any confidence in any institution there talk about that what that does to the markets when there's is no institution that someone could say, okay, the adult is get a step in the room and said a clear, clear policy path forward, we could feel confident it will be executed. Well, I'll take a small issue with your with your preamble there. I think Powell has
generally been fairly consistent. You can argue that he may be overstepped a little bit in early October with his comments about being a long way from neutral. But I think if you look at that contact that comment in the context of what he was saying at Jackson Hole uh the symposium in August, which is that the whole concept of neutral interest rates, particularly in real time, is
kind of specious. Um. You know, it's not sort of a line in the sand that you approach it and then as soon as you step over, different things happen. The best you can say it's kind of arrange, and you only know in retrospect what neutral really was, So I'm going to give him a little bit of a past there. Frankly, I find him quite refreshing because he speaks relatively plainly, and I think generally he's been fairly upbeat about the state of the economy right throughout throughout
the throughout the course of the year. So, uh, maybe I'm just uh inclined to give a plane to speak or a bit of a bit of a But in terms of the you know, the effect on the effect when you start to question or worry about institutions. I think there was a while there in early October where there was a popular narrative that you know, the fan's
gonna hike until something breaks. I think everything from October three to now has been trying to put that issue to bed and then trying to say, like, hey, if the data weekends, we're gonna respond. We're not dead set on moving very quickly. They've done a good job of retaining uh, that optionality. But to the larger point of what does it mean for markets when you start to you know, question institutions, Well, you talked about the fitz
he rerating. We've talked about the SMP five hundred three rating. Despite earnings throughout, it seems like you just pay less for each to all our earnings because you're not as confident in the in the backdrop, that seems to be one effect, I mean, ultimately, uncertainty and lack of confidence and institutions requires a higher risk Broomium across across assets, across currencies, I mean, obviously currencies. It's it's a bit difficult because you have to you have to buy something.
You know, if you buy euro dollar, you're you have to buy one and your trade euro doll You have to buy one to sell sell the other. I mean, maybe you could argue gold, but even gold has been pretty I mean, given the apparent manifest risks across markets, it's been pretty man this year. That has been one of the funny jokes of the year has been, well, not not as funny as bitcoin, we should that's been. That's been. That's been probably my favorite part of the year.
It was the demise of the Lambeau crowd. Hey, there's there's a popular long long bitcoin toward the bankers trade that's currently in early December on a six week losing streak, even as banks have gotten absolutely pummeled. That kind of speaks to how bad it's been for bitcoin. But I think one of the and we'll see how it plays out over the next year or two. But I think
what's been a change this year talking about institutions. It's the first time in a long time that you've had the President of the United States overtly criticizing the FED and FED policy. And I think if you had gone back five years ago and you you know, you know, change the names to protect the innocent or or whatever, you know, whatever the stock disclaimers on those reality TV shows.
H if you had said, if you had put the quotes that we've had from Donald Trump uh this year VSA V the Fed and shown them to people and said what will just do to markets? I think they would have said, Well, you're gonna you're gonna see a lot of alatility and you're going to see the stalt market lower. UM. And I mean there's a tendency this kind of wave Trump off and say wow, it's just Trump being Trump. But eventually this stuff kind of matters UM.
And maybe we were just accustomed last year to nothing mattering est unless let's let's yeah, let's not forget last year was the anomaly. This year is not the anomaly. Last year was the anomaly in terms of the absolute absence of volatility or draw down or anything. I mean, the sharp ratio of the SMP or a sixty forty portfolio was way too high relative to history. And then this year we got in October the worst month for the sixty forty portfolio since the financial crisis. So that's
the kind of that was their coming full. Every party has a hangover, and as I learned to my Street Grin over the weekend, on that note, I think that is a perfect time to end it. This has been another episode of the Odd Lots podcast. I'm Joe Wisenthal. You could follow me on Twitter at the Stalwart. My normal co host, Tracy Elloway is off this week, but you should still follow her. She's at Tracy Alloway on Twitter.
And you should follow our guests. Cameron is on Twitter, he's at Fifth Rule, and Lucas on Twitter he is at Jake Kawa and sometimes they banter and go back and forth and argue about all these things that we talk about. If you want more and you should follow our producer to fur Foreheads on Twitter. He's at foreheads t as well as the bloomberg head of podcast Francesca Leavy at Francesca Today. Thanks for listening.