And the reality of the situation is this is just a hyper bubble, but there are some obviously good companies still left. You're paying an awful lot for them. And the reality of the situation is when I look at the U S equity market, I think this is a massively, massively, massively overvalued market versus the rest of the world, right? Like four standard deviations overvalued versus the rest of the world.
But those dynamics are unlikely to change until either the dollar declines And that hurts foreign investors who've got their money in the U. S. And or the bubble bursts because it just runs out of puff, let's say. Doesn't look like that's the case. Or we go into recession and that doesn't look like the case either.
And so for me, you've got this sort of ongoing, self reinforcing, truly reflective type cycle going on in the US equity market where the purchase of the asset, In this case, stocks underpins wealth, underpins employment, underpins Fed rate hike, underpins the dollar, underpins the valuation of U. S. stocks for foreigners. You know, it's a very self reinforcing, literally reflective in the true Soros esque sense of the world.
Julian Brigden, welcome to Resolve RIFS. How you doing today, man?
Doing well. Doing well. I'm in I'm in Colorado again. So, we actually had some snow. So I'm, you know, happy camper.
Excellent. Let's just you and me today with the other DGENs who sometimes join us are often various productive activities. So, we get to have all the fun.
There you go. Perfect.
yeah. So what what has been on your mind? What are you focused on at the moment? Um,
So, know, the thing that's really been occupying our thoughts is this sort of dominant, let's put it like that, narrative of this Goldilocks soft landing. And I think the thing that I struggle with is that, first off, statistically, that's a very odd unusual event. It's not the norm. The norm is we've had 12 tightening cycles since the 60s. We've had eight recessions. We've had four arguable soft landings.
The problem that I have, and obviously the one that everyone quotes is this 95 sort of one. Onwards. Now, it's fair, I think, to assume that the Fed is pursuing the same sort of policy framework that it did in the late 1990s. But and we refer to it, this is opportunistic disinflationary policy framework. And I think, this is one of the ones that we discussed with you guys when we were last on the show.
And this idea of you, that when you have inflation of this sort of magnitude, there are truly two approaches you can take. The first one is you do what Volcker did. And you create deliberate disinflation. So you kind of kill the economy. And the second one is you choke the economy, but not to the point of death. Just enough that over time you can grind inflation lower. Now the issue with that is it did work in 1995. That's true.
And that's certainly what, They are trying to pursue, but there's a couple of problems with what's priced into markets based upon that. The first one is if you never killed the economy, if you didn't strangle, if you didn't deliberately annihilate it and Waller actually referred to this in his recent speech, if you don't break anything. There's no need for you to immediately start to hack rates, right? Which is what we're pricing in markets, right?
You can fine tune them so that real rates don't get too constrictive, but you don't need to slash them. And that's why, interestingly, the set forecast, so the Fed's central forecasts are Pricing in 75 basis points of cuts. And that's exactly what Greenspan did between the beginning of 1995 and the end of and the beginning of 1996. And these were kind of then fine tuning. And then, what's remarkable is then he left rates unchanged for the best part of 30 months. I mean really, 30 months.
Nowhere. Now, he also got extraordinarily lucky, and I'm not saying this couldn't happen. And he got the building productivity that we saw as we ran up into the dot com revolution. And maybe, over time, we can get that from AI. But the question is, is it this year? Right? Is it next year, is it year after?
Because if it isn't this coming year, then this idea that the Fed is going to be able to, slash rates aggressively because inflation is falling and give you kind of the Goldilocks and the Goldilocks is accelerated or high, let's say high levels of real growth, lower inflation and high levels of employment.
And And the other problem that we have is that In every other one of those quote unquote soft landings, or at least let's say in three of those quote unquote four soft landings, right, out of the 12 tightening cycles every single one started with higher unemployment. And this is the problem that we see.
If you try and accelerate growth from here, right, if you go from, you know, earnings growth being down 3 percent to up 11 or 12 next year, which has to be driven by higher real growth in the economy. The problem is, is where are you going to find the bloody workers to do that with 3. 7 percent unemployment, unless you're willing to take the risk of higher wage growth, which typically feeds straight into core service inflation. Now, there is one exception.
One of those four soft landings, which I think is where we're running and looks most likely. And it looked like a soft landing. I don't classify it as a soft landing. It looked like a soft landing because for at least nine months, things went according to plan. And that was the only other time in history where we tried to accelerate growth or in post war history, we tried to accelerate growth from this level of unemployment. And that was the late 1960s. And what happened is, Inflation came down.
The Fed had a little, they'd been tightening quite aggressively in 66 because inflation had broken out of a well established range. They then had a little mini credit crisis which was somewhat idiosyncratic in nature related to RedQ, but it caused a big slowdown in housing and then they prematurely eased and they eased into ongoing fiscal spending and unemployment never rose. It kind of flatlined for nine months and then it started to go back down again as growth picked up.
And what you ran into straight away was average early earnings took off, core inflation went, and the bond market went again. And When I look at the world, that I think is the real danger. I think the growth is just too robust. And I look at where rates are and they don't appear to be sufficiently tied to restrain GDP growth and to bring about that broad slowdown that the Fed is talking about.
Because while the market is just singularly focused on headline inflation or core inflation or inflation in general, the Fed keeps talking about Wanting to see growth slow down, wanting to see the labour market slow down, right? And these are much broader issues. So even if you get goldilocks, the question is goldilocks in what? Do you just get goldilocks in inflation for nine months and then it re accelerates as real growth accepts, right? It picks up. Or do you need to see slower growth?
Because as I look at things, and I know that we've been, more and more people are jumping on this bandwagon, but we were pushing it at the end of last year, it looks to us that cyclical growth is actually re accelerating and I sit here and I go, I'm struggling with the justification for the Fed to do 75, right? Let alone the double that, that the market's got priced it. So I think that's what's really grabbing my attention. And how does that pan out in market?
Yeah, so really the templates are the McChesney Martin 1966 pivot into the 1970s stagflation. the Greenspan pivot in. In 95, remind me, I don't like, so the nine, the 89 to 94 scenario was major run up and over leveraging of the commercial real estate market. They set up a bad bank. They put hundreds of banks in receivership, right? Walk me through what happened there from sort of 89.
To 94 and let's see if we can tease out the dimensions of that that are similar today and what might be different. Like I remember there was a bond massacre in 94, right?
Correct. Correct. And that was, you know, that was another classic example where the bond market got ahead of itself and on these assumptions and then got proved utterly wrong by a Fed that flipped on them. And, you know, this is the sort of risk I think that we run because we'd had a, we'd had a big slowdown in 1990, right? We had a recession in 1990 and growth kind of picked up. And then CPI had been. Reasonably well behaved and was actually, but was still by Fed standards a little high.
And this is the point, right? I mean, they were dealing with inflation that was stuck, basically. It had come off the highs of around 6%, but it kind of got stuck. In 94 into 95 at around this sort of 3%, and so Greenspan came along and he decided that what he was going to try and do was grind this out and he did have the foresight to believe that productivity could allow this to happen and, productivity is the get out of jail free card.
Economic
so productivity starts to pick up very rapidly as we're moving into the dot com period. And what that enables you to do is kind of get the best of all worlds. You get falling inflation, right? inflation, falls, from those three levels that down to below two in 99. And it's great for the bond market. It also enables you to have great nominal GDP growth, kind of around the levels that we are now, around six, which is fantastic for corporate earnings because that's what they do.
And unemployment as well, also continued to fall because we come from this, relatively high level in the early 90s when we were, you know, we got to 7. 6 percent. So that was the big, and unemployment starting when he moved into this opportunistic disinflation, he started at five and three quarters and you got all the way down to the current level 3. 7.
So that's, you were coming out of this recessionary kind of backdrop and inflation just proved a little too stubborn and so the Fed kind of sat there and allowed them, you know, played this game where they ground the thing out. And I said, the big difference is In three of those four soft landings that you look at since the 1960s is that we always started with higher unemployment.
Well, was there a material fiscal impulse then coming out of that? So they absorbed all these banks, they went into receivership. What caused that impulse coming out of the 1990 recession, this sort of real estate based recession that drove inflation higher? Was there anything structural about it?
no, it was, it was sticky. Inflation wasn't significantly higher. I mean, if you look at where, CPI did come down, I'm just looking at it now and still get the right numbers, right? So if you look, inflation had hit in 1990, six, 6. 2%, just over six,
and then
and then it dropped.
did Greenspan insist on raising rates in big surprise raise in 94?
mean, in a way, it was proving sticky, right? Because it was stuck between 92 and 90, and the 96, at kind of 3%. And so he came up with this idea that what you need to do is you just nudge rates up a little bit, to just kind of grind it out. And that's what they did. They cut them in, in, as we move into recession in the early 90s, they cut rates from eight and a quarter, basically down to three.
Yeah.
And then in late 94, when the inflation proves resilient. In late 93 and into early 94, they then raise them back up again
Right.
to, basically six. So they double them
Right. And we'll
and it's just to grind it out,
okay. So the economy was humming at that point. It was back on its own two feet because they've absorbed all those bad debts that written it down. so the government
the balance sheet up, essentially allowed everything to sort of function properly again. And I think you could, you know, you can see it. I find it quite intriguing this morning to see the story that we got on Bloomberg about, I don't know if you saw it about the banks. Starting to duke it out with private credit to fund all this leveraged buyout debt that's coming due. So the banks had all been squeezed out of this space last year and the year before.
And private equity basically funded all these deals. And now the banks are trying to get back into that space. Now that, rates are lower and so on and so forth. And to me, this is indicative of. This easing of financial conditions that we've seen, the question is, is that justified?
And I question that, I, unless I, you know, I'm very much of the opinion that the labor market in broad aggregate terms, so how much people earn, how many people are working, that sort of thing, in, in totality, if you look at the labor market, basically dictates, nominal GDP because it's, consumption 60 percent of GDP. And if you look at it, It suggests nominal GDP is still around six.
And so, this is where I have this problem of, you know, how do we sustain 6 percent nominal GDP with 3. 7 percent unemployment? And the risks are, as I think, see things at the moment, if you go back to that Goldilocks analogy, the porridge is too hot still. It isn't just right. And the risk is, for whatever reason, the Fed seems to be happy with that, which I think is a long term threat to the long end of the bull market. But let's assume that They get it wrong.
The data that they think is softening, which they do, doesn't soften, as my model suggests is not going to be the case. And then they turn around to us in March and they go, no rate cut. And then they turn around to us in June and go, no rate cut. And they turn around to us in September and go, no rate cut.
Then the risk is then that at some point by holding rates here, you'll actually will do more damage because as the refires come up and we know the commercial real estate problems, et cetera, et cetera. And then the risk is that you'll actually tip over the employment market and the thing will become too cold. Cause it's the bottom line, I think, I mean, bottom line I've been pushing to my clients is look, Goldilocks is not the base case. Statistically, it's at best.
one in three and given the three of those four occasions when we did end up with it started with much higher unemployment and the one where the unemployment started at the current levels and it wasn't really a sustainable Goldilocks scenario as I said it lasted for nine months and then went horribly wrong again as inflation soared. I think the true odds of Goldilocks are far lower than one in three.
Yeah, Julian. What's not really talked about so much is the fact that we've got unemployment. That's so low. We've got inflation that seems to be have almost troughed and. You know, it looks like maybe moving higher again, and we've got a, we've got fiscal deficits in the 6, 7, 8 percent range, as far as the eye can see.
Correct, correct, correct.
I don't understand is why everyone thinks that the economy is going to be so weak as to prompt any cuts at all. To me, the risk is on the right tail, not the left.
Now, I mean, that's, look, that, that's my view. I think from an economic perspective, I don't see how the Fed can justify really any cuts even what I would call the sort of fine tuning cuts that they are foreseeing, right? Remember, they have unemployment rising to 4. 1 percent in the SEPs. And they have growth falling to 1. 4 percent this year. And that's the reason to justify, and inflation falling. And that's the reason to justify 75 basis points. But as I think, see things setting up.
None of those are happening, right? I see unemployment that the labor metrics, which are anything you're at risk of reaccelerating. And a lot has that has to do with this effect that we call hyper financialization. So this relationship between basically equity markets and the real economy, whereby the equity market in this bizarre. Tucked up US world that we live in actually leads because the only thing that CEOs care about is their stock price.
So the ditty that we have is one is very simple, you know, equities rise, they fire equities. So equities fall, they fire. Equities rise, they hire. And equities have been rising again. So You know, all that weakness that you saw in 2022 when stocks in the labor market metrics, so things like the challenger layoff numbers, the claims numbers that were all going, looking like recession, recession, recession. Last year, as stocks recovered those things, all that weakness is just reversed.
In this economy, companies do not lay off staff when the stock price is, at these kind of multiples, right? They lay off when the market is telling them that the economy is weak. They're taking their cues from the market. If the market's telling them the economy is strong and earnings are going to be strong, they're not going to lay off workers. If they're not laying off workers, how are we slowing demand again with fiscal deficits in the six, seven percent
Correct. Correct. I, it's I love listening to the calls from the PMI guys, right? And there's a couple of the, there's a couple of places you can follow them online. And Tim Fiore, who's the current chairman of the ISM manufacturing survey, they did their sort of semi annual outlook and it was, reasonably upbeat. But what was interesting, it was done before the pivot. Yeah. Yeah. And Tim is very good at calling the economy. I really do put a lot of weight on what the guy said.
In fairness to him, you know, back in last summer, when everyone was really bearish, he was going, I don't think it's gonna, I think this thing is okay, actually, right? Looks actually okay. He just came out and he went right I mean this wasn't a bad survey even before they pivoted now They've just given us the green light to just go for it And I think we're gonna have ISM back at you know 5253 by March and what's actually interesting about that?
You've got to go back 30 years to find an occasion where the Fed cut when ISM came back up above 50.
Yeah.
they stop cutting or they hike.
Right.
So it's going to get, I think, really, really interesting. And the question is having arguably screwed it up again. In terms of their economic forecasting, do they have the, are they willing to pursue the cuts anyway? Because I think there are, there is some rationale to say that there's something else going on here. There is another driving force behind some of the cuts. I don't know the answer if they do it, but if they do. Then there's, look, they can do what the hell they like.
But as I always say, this, I don't judge people. I just like to figure out what the consequences are of their action. So, I could see them still in an environment where growth is still relatively robust, still trying to justify, you know, 50, but if they do, and my models are right and the equity market holds up, which is another thing we need to discuss.
Then I think it doesn't bode well for the long end of the bond market in an environment where I fundamentally believe we're in a structural bear market in fixed income. And if it hadn't been for COVID, that started in 2016.
Yeah, so if the trajectory of rates. Ends up being less dovish so let's first of all, let's explore. We've explored some of the reasons why that might be the case already. I think there's a very strong case for why growth and inflation are both going to be run considerably hotter than. Consensus
And you look fiscal is a huge part of this, right? It's just huge. You go, you want to go back to that late 60s analogy when we were fighting the Vietnam War, which was a big driver of that. We're arguably fighting three wars now, right? If not four,
yeah,
right? We've got two kinetic wars, Russia and Ukraine and the Middle East. We've got a climate change war, and we're in a cold war with China. It's hugely bloody expensive, all of those things, hugely expensive. So I struggle to see how fiscal
well, the other,
continue to expand, let alone gets addressed,
well, that, that actually might be a bit of a clue. Right? I mean, it could be that the Fed is sort of seeing the writing on the wall that deficits are going to continue at this pace, even in the event of a Trump presidency, that he may ratchet back on direct investment, but preserve the tax cuts. Whether you got supply side or demand side, the fiscal situation is unlikely to change dramatically.
The other thing that I think it's been a really interesting surprise this cycle is how the interest sensitives haven't responded at all. We've gone from basically zero rates to 5 percent and homebuilders are, are on fire, right? Like, um, auto manufacturing on fire, like which area of the economy is going to respond to higher rates. That would prompt the kind of cuts that the Fed is suggesting.
Well, I think in fairness to the Fed, they're not, right? I'll read you a quote from Chris Waller, which I thought was quite interesting, from last week. so he said, in many previous cycles, there which began after shocks to the economy, either threatened or caused causing a recession. The FOMC cut rates reactively and did so quickly and often by large amounts.
This cycle, however, with economic activity and labor markets in good shape and inflation coming down gradually to 2 percent I see no reason to move quickly as quickly or cut as rapidly in the past. So I think this goes back to a large extent what they are trying to do this opportunistic policy. Disinflationary policy framework, which is what Greenspan did, but they've done an absolute appalling job at explaining this to the markets for whatever reason.
So we, they keep saying things, well, you know, the market can do what the market wants and we'll see which one's right. We're right or they're right, and. I just think it's so self defeating and so I don't understand why they don't have, and we discussed this on a policy call this morning internally, where they don't have the balls basically to come out and say the sort of things that you see from other central bankers, where the other central bankers just go, no, it's too early.
One thing I think has been quite interesting is something that's got me thinking a lot is, comments from the bank of England who have highlighted the fact that sure, goods inflation is zero or negative, right? But goods inflation is always zero or negative. And what's more important is service inflation. And the bank of England said, you can just forget it because service inflation is still Miles above where it should be.
And, you know, when we look at it, I know everyone gets their knickers in a twist about, Oh, owner's equivalent REN and it's going to come down. Sure. It's probably going to come down. But as a fact, when you look at the dynamics versus the overall service thing, it could still come down and overall service inflation could remain relatively high. I'm not saying it's, it's not going to come down a bit. Could it, but it could remain uncomfortably high.
yeah. And we haven't even really seen any kind of self reinforcing labor cost spiral, right? I mean, it's been miraculous how labor has been completely neutered in this cycle. They haven't had any negotiating power at all. They're, you know, a
mean, you still, but you have got Atlanta wages, which I like, still running above five and that's still pretty bloody brisk, right?
Sure. I mean, but they're still far behind.
yeah, no, no, no, no, but I think they, yes, exactly. They're still far behind, but I think they're going to, I see no reason why they don't catch up.
Which would be another inflation impulse, right?
I just can't see politically how wages don't, over time, and this is the big political problem that Biden faces he's, the economy's in great shape he's just getting the blame for that 20 percent haircut. you took in the real disposable income essentially as the US corporate sector ripped your bloody heart out in terms of price increases because we live in this highly uncompetitive economy. And so what has to happen now is over time, wages need to play catch up to rebuild that.
20 percent or you're going to a shit load of political turmoil in this country, which I think you're going to have anyway. I don't see wage. I don't, none of our models are suggesting wage pressure really drops all that much. It still looks to me like it's stuck at five and change well into 2024, which that's why I struggle to find.
Any rationale for the Fed to really cut at all, and certainly to go beyond, a couple of 25s, which have either justified because, they've cocked it up and they don't want to ride it back and say, oh no, we were wrong again. Or, and I do believe this is the case, and I hear this from policy friends, out of fear of Trump, right? There is a large institutional fear in the Fed, and you can see it. In all the global elite, I mean, just look at what Christine Lagarde said about Trump.
I mean, she broke every single protocol to come out and criticize Trump. A central bank governor should not under any circumstances, certainly a foreign one, say anything about a US president. And yet she did. And I think that to me is just indicative of the angst. In those policy circles and all that global elite.
So how do you think of Trump?
go 25 50 on the back of that to ensure there is no slowdown and that we'd run this economy Hot into the election because Janet Yellen sure as hell her behavior is she's doing everything to frustrate the Fed's Attempt to slow this economy down by the equity market, I don't know but as I said, you can do what you like, but it just has consequences in that environment I don't want to be long the bond market
Yeah. How does a Trump presidency change things, if at all?
So it's something that, I've been reaching out and starting to examine with policy friends. I mean, I'm very worried in this world. Not, doesn't impact markets immediately, but it will impact us on an ongoing basis. I'm very worried about it, what it does to the geopolitical side. Look, I think he, to your point, he rolls over his tax cuts, he won't increase taxes. So you don't address the fiscal problems. I mean, they could even get worse.
I do think there is a risk that he entrenches US isolationism. Which is exactly what we saw in the 1930s and you can already see with this acceleration in global conflict that we got that we're going back to a world that looks more like the 1970s, right? When I grew up as a kid. You know, there were wars all over the shop.
There was conflict and coups and every other week in Latin America, there was proxy wars being fought in, Latin America between Cuba, there was a proxy for Russia and, funding, various rebel groups in Latin America and the U S on the other side, right? You had the same going on in Africa. And I look at this thing and it looks like that.
And one of the reasons it ends up looking like that is because no one's afraid of the bloody global policeman anymore because he has proved to be either incompetent or unwilling to take the steps to actually enforce law. And, partly that's because we live in a much more, connected world and it's no longer possible to do what the English did and roll up the battleship into the port and blast, the capitals a bit, or to shoot rioters, in the streets. You know, that, that's a problem.
When it comes to imposing that, and we've just seen, the difficulties of the British and the Americans have found taking on these who to who to rebels, right? Your modern weaponry at two million bucks a missile against some bloody drone and a bunch of camels, right? And guys with AK 47s. These are some of the longer term inflation trends, which really, really do worry me.
And it's one of the, one of the reasons, not the main reason, but one of the reasons why, I am a structural bond bearer and I just don't. I think it's very, very difficult to address these problems in the West.
Have we seen the trough in rates for this year, do you think?
I, I think at least for the next three to six months, I think, yes, we're short, we got shorted around 3. 92 in 10 year treasuries, a kind of target probably 4. 25 first off, and then 4. 40, 4. 50. And it's, it's part of this sort of reset.
And this tightening, this offsetting, moving, tightening financial conditions that if the equity market will not give up the ghost, And as I said, I don't think Janet Yellen has any, she understands this type of financialization, this relationship between stocks and employment, right? She's not willing to let this thing go. And she's got some pretty big tools that she can deploy, right? She's done a great job at basically pushing.
Refunding into the front end of the curve and then draining liquidity from the reverse repo.
What an unbelievable hit to taxpayers this is to continue to front load funding. Like, honestly,
Yeah, but come on, we've got to win the election, right? We've got to fight, the fear of the orange man is much greater than the fiscal, survivability of the U. S. long term. This is all just fiddling while Rome burns type shit, right? That's where it becomes scary when you look at this and go, really? Is that what our politicians have really got? Come down to, and I think the answer is, I hate to say it, I think yes.
so why isn't gold running in this environment?
But I think part of the problem I think gold has performed quite well, right? If you look at it against the S& P, it's actually held its own for quite, quite a long time.
But I think, the big disappointment is when you look further down the kind of Periodic cable, and sort of peer periodic cable, and you look at things like silver which doesn't look good and it really shouldn't, you break much lower than this, and it could start to get look quite ugly, and I think the big problem there is that we built in, you know, lots of rate cuts into the dollar. Right. And the dollar is now starting to look a little better as we price out some of these rate cuts, right?
Such an aggressive stance on rates. And I do think, when you look at the data, even though I don't think the ECB will cut anywhere close to what's also priced into their curve, I do think there's much more justification for, and in the UK, for some rate cut. Versus arguably, I don't think any rate cut in the US, as I said, depending on exactly how the Fed plays it, we will see, and that will determine exactly how strong this dollar gets. But it looks, I think that's the immediate.
The immediate thing that's weighing that and the higher rates is weighing on gold at the moment.
And internationally, so you're just talking about Europe and the UK how is the European economy looking? How's the UK economy looking? Is it gaining strength in the same way as
No, I mean, I think the UK looks quite vulnerable. It's really, you know, Brexit was an enormous own goal. It's been, it's a structural headwind for the UK and it's something. That we talked about for the next decade, basically the consumer is very vulnerable given the mortgage structure and the lack of fixed rate mortgages is going to become increasingly vulnerable to these high rates. She's got a structural problem to some degree.
Because we lost a lot of skilled craftsmen post Brexit, you know, they went back to Eastern Europe and they were keeping a lid on some of these costs. Some of it's being offset by short term visa issues, but, we have, there just aren't enough workers there. The same problem is the US, the same problem is Australia.
A very large Australian bank They're treasury team the other day and talking about, how do we grow again with 3. 7%, unemployment in the U S and they said, it's exactly the same in Australia, right? They just, there aren't enough workers, right? And so this idea that everything just picks up again, unless you get that productivity burst is going to be, it's going to be problematic. So I think for the UK that gives us sort of a stagflationary esque kind of overtone.
Continental Europe is a little more interesting actually. I think When I look at my models, they've done a much better job at dropping inflation. And I think the primary reason for that, and it's something that we talked about or hinted, touched on a few minutes ago, and that was continental Europe is a much more competitive economy So the ability of corporates in Europe to price gouge to the same degree that US corporates have done is just not there.
There are many practices which in the United States are deemed legal, which are really price collusion that in Europe would end you up in jail, I don't know when last time you did your kitchen up. But I'm sure when you did, your wife said, right, there's three appliance makers we're going to buy, darling. You know, one of them is going to be Wolf. One of them is going to, and SubZero, the other one is going to be Miele.
And you go to the dealer and you go, well, I want the dishwasher and the oven and the cooktop and the extraction fan and the blah, blah, blah. And the guy goes, yeah, 20, 000 bucks, probably 30 now. And you say, yeah, but I'm buying all of them from the same manufacturer. So what's the deal and which one's going to be better? Can I get a better deal in the wolf or the sub zero or whatever? And he goes, no, they're 50 bucks difference.
And I can't negotiate because if I do, I'd lose my license, right? I mean that price collusion. I mean, that's price fixing, right? In Europe, you go to jail for that shit, and you can go and buy your melee online, basically, and haggle between about five different providers. So, it's, when I look at inflation in Europe, it really looks to me like they've vanquished it. Now, don't get me wrong, they've also got some labour problems, wages have been sticky.
And high by European standards, four and a half percent, so not as high as the US, but pretty high. But it does look to me that those have started to show signs of peaking. When you look at growth levels relative to inflation, I'm sorry, relative to rate, relative to rates, growth levels relative to rates, you could argue the case that if you rank Those three economies that the ECB has the tightest policy to the tune of about, by our calculations, about a hundred basis points.
So they could ease to, a hundred basis points. The Bank of England is easy by about a hundred basis points and the Fed is easy by 200 basis points. So the economy that is growing the most has the easiest policy. So I think they can tweak a little bit. The encouraging signs that I see. in Europe. And I think this could become a surprise, not immediately. And there are still steps that I need to be completed.
Europe is a very heavily focused, particularly the Germany, which tends to drive a lot of our sentiment around Europe to obviously the manufacturing cycle and the manufacturing cycle is itself very sensitive to the inventory cycle and the CapEx cycle. And there is absolutely no doubt whatsoever that as we've seen in the U. S. with, the weakness that we've seen in U. S. manufacturing that could be coming to an end that they got themselves caught up with this bloody great big inventory overhang.
And so we've written, 18 months ago, we'd said, this manufacturing sector is going to go from inventory shortage to from famine to feast to hangover, right? So we're dealing with the hangover now. Right. In the U. S. I think that hangover looks like it's partly addressed. Europe, it's, Germany, it's certainly got more to do. But when we look at one of our favorite kind of canaries in the coal mine, Sweden, it looks like she has totally got on top of our inventory overhang.
And now her inventories are running under her orders. And so that suggests to me that as we move into Beginning of Q2, even in Europe, you could start to see the manufacturing cycle start to pick up again. And
dependent is that on Chinese growth? Europe has migrated most of Yeah.
But remember and yes, that will be important. And I think China does look is a wild card and does look kind of messy. But you're actually what China, I think is going to try and do and you can see already, she's going to try and export her way out. of, part of the problems that she's facing. And certainly when you look at the Chinese equity market, I've tweeted this, it's like a bloody train wreck.
There's a, you know, we just broke a trend, a multi month, a multi year trend line on a monthly basis that goes back to like 2005. In the Shanghai Composite, and it looks like that thing could drop another 30%, 25, 30%. So, yeah, it's a risk, but it's, as I said, I think growth certainly from just from an inventory restocking perspective could push us cyclically in some of these manufacturing PMIs back into expansion territory in Q2.
And that I think is going to come as a bit of a problem for some of these central banks.
Are you surprised at how resilient countries like Australia, Canada, and the UK have been in the face of these high rates, given the high level of mortgage debt on household balance sheets and the fact that those mortgages reset on average every two or three years?
Yes, I am. I am. And I think it's, and as I said, I think in the UK it's going to start to bite. And I think, in some of these other countries it's going to start to bite. The US is in that sense a little bit of a special case. But even when you look at some of these markets, I think we have to remember there's a lot of accumulated wealth, even in, they're less equity focused than some of these other markets, but people have got a lot of money, right?
There's a lot of money that you can use to cushion some of this blow. And
I think so much of it is in houses though, right? There's a lot of
a lot of, yes, for the vast majority of people, right, it's in housing, right? That's your biggest asset. But there's shortages of houses, right? They're everywhere. Everywhere there's shortages of houses. You can see every single government looking at, and they just did it in I think it was in Canada, where they just imposed this thing on on all the the guys doing short term rentals, right? They were like, Oh, we're going to tax you higher.
Every single country is trying to loosen up its housing market because they just aren't enough homes. So I think that the resilience of the house price thing, and it goes back to your homebuilders comments, right? No one's moving in the U. S. Existing home sales have dried up. So by default, the homebuilders have to do well in a very, very unusual move. I mean, one that, to be honest, we got wrong. Didn't cost as much because you run, that's what stops are for.
And they did move in our favor, at least initially. But there's a lot of things that are resilient. And if you look at some of the economic papers that people are writing, some of these effects start to kind of wane. It's quite possible a lot of two thirds of the rate increases that we've seen have essentially already worked their way through the economy. And I think the other thing that people need to bear in mind, and this is, it's going to sound un PC, but I don't mean it like this.
The vast majority of consumers don't count.
right.
The vast majority of consumers spend every red cent that they have from their income. And it doesn't matter whether they spend it on all on food or on all on medical costs, right? It does if you're trying to pick which ones are the winning sectors within the equity market, right? Is it the food companies or is it the insurance companies, the health insurance companies, right? But it doesn't matter from a GDP perspective.
Yeah. No, it's more from a marginal spending by the middle class who in Australia, UK and Canada have, been bolstered so substantially by paper housing wealth, right? And, if your house appreciates at a multiple of the rate of your labor income savings every year, then, you just, you feel like you have a lot more money to spend. If you believe that that trend is going to continue and any sign of that cracking, it also, this has to come out from a mathematical standpoint.
Sure, people need to buy homes and form families and there's a shortage of homes and so home prices stay higher. That means that a much larger portion of people's income is going to mortgage payments that's not going to other purchases of goods and services, right? So
So that, yeah, so
valve has to come from somewhere.
yes, so that, that has an impact as I said on, when you look at consumer discretionary stocks, right, you would expect they're not going to buy, oh Christ, what's that bloody brand they all buy up near me, I live in Boston, Aloe, right? They all walk around with Aloe, it's one of these millennial brands and they all, and you go in there and you're like, 150 bucks for a pair of, sweatpants. Are you bloody insane?
But these kids all seem to wear it and yes, as they get squeezed out because they have to pay their student loans back or their rent goes, up or they're trying to buy a house and all that sort of thing. But from abroad, cause they've got no, they don't have that many stocks, but from a broad consumption expenditure from a GDP perspective, it doesn't make any difference, what really makes the difference is how the wealthy spend, and the wealthy are locked in.
They've locked in their mortgage and their stock portfolio keeps going up, right? The amount of wealth,
Canada and Australia, right? I mean, they're
less so, less so.
you know, the wealthy have already paid off, such a substantial portion of their mortgage, right?
Right. And the same here in the US, right? I mean, a third of homes being bought with cash,
Well, the U S is a totally different case because. Only abandoningly small fraction of the mortgages reset, right? Cause everything's at 20, 30 year fixed terms. So
Yeah, correct. So look, I think it all comes down to this, whether we see, it all comes down to me, to this labor market, right? That's what will dictate Goldilocks. And I, and it's also why I think Goldilocks is so insanely difficult to achieve,
yeah, I'm just wondering, I'm more talking about Canada, UK. And because
And as I
I wonder if they're with their good currency shorts, I wonder if, like, I think
I do. Yeah, I
they, might be forced to cut.
they are. I do think they will be forced to cut. Will they cut? And as I said, look, if you rank them, and I, you know, Australia, I haven't done this but if I rank the big three currency pairs yen doesn't really come into play because the BOJ's on a, still on its different planet kind of thing. But if I would look at, Relative growth relative to rates, right? And say, who's running the tightest, where, and given that growth is picking up, who's, where the biggest surprise is going to be.
The biggest surprise would be in the US, where rates should not get cut, and if anything, do need to go up arguably more. So that's dollar supportive. Then the next one is sterling. And then the worst one should be Europe. And I think there's a case to be saying that you could end up with quite a weak.Euro I don't think it's as weak as, necessarily some people think because I do think growth is, will pick up a little bit, but the ECB can easily justify cutting rates.
And then you put a Canada and Australia in there, they're in somewhat similar circumstances, I think, to the UK.
Yeah. Okay. Equities leave the best to last. What are you seeing on the equity front here?
I mean, look, if you, Broadly look at the S& P. It's gone nowhere for two years, right? Last year it was down until the fourth quarter. Then Janet Yellen rather deftly slewed all the issuance to the front end of the curve, drew liquidity back into the system as a result out of the reverse repo into The liquidity metrics, which set the level of the equity market. And we got this everything rally, right? We've got an everything rally.
And I think this is an important thing that people need to bear in mind if we are in a structurally inflationary, higher inflationary environment, which I believe is the case. You are back into an environment that basically existed prior to 1998. 1998 was a year in which Alan Greenspan for the first time shifted from focusing on inflation to focusing on deflation.
Cause even in 1998, he was beginning to talk about the risk of the zero bounce at this point in which, the central banks would lose out of ammo. And so they became much more focused on preventing deflation. And that did something really. very dramatic and unprecedented. It slewed the correlation between bond and equity prices. So prior to 1998, and there's a Bank of England study that goes back and looks at 250 years of bond pricing, bond and equity pricing.
So prior to that period, you'd never ever, ever seen negative correlation between bond and equity prices. So both assets either went up or down. together. So bonds rallied, yields fell and stocks rallied or vice versa. And from 1998 onwards, that relationship changes. You move to focus on deflation. I think we're moving back into that positive correlation environment. It's certainly been the case since 2020.
We're about where we've gone back into negative correlation, but Q4 was all about a positive correlation. Rally, right? And everything rally now that got people quite excited by this idea of the reflationary cycle. So we had people thinking about, do I buy the Russell? Do I buy the blah, blah, blah? Do I buy the blah, blah, blah? Do I buy cheap things? Are we going to rotate into stuff? But the reality of the situation is I struggle with that thesis.
I think it could pick up a little bit in Q2 is if we start to see these PMIs come back, but if, but then, from. you look at the growth value metric which is we've gone back to right to growth picked up in Q4 and into the beginning of of this year for the first week at least. Uh, sorry value did, value outperformed and then growth kind of underperformed. Now growth is coming back and providing all of that you know the big mega caps are providing all of that, that thing.
Now we were talking before this about some of those names like Tesla, I think is a classic bubble. I, just tweeted out and I know, well, I will tweet out. I know I'm going to get shit From the apostles of Tesla, which is I think the fundamental problem. There are investors, they are believers. But to me, Tesla is a narrative that's been fit to a price action and a price action that was created by QE.
And you can see the domes when Tesla started to perform, and it was exactly when the Fed did in 2019, not QE if we remember that, and then we had the COVID QE, and it peaked exactly at peak Fed liquidity. And since then it has not managed to recoup its thing and people are like, Oh, but you know, it'll come back, it'll come back and he'll build a bloody robot and he'll decide the truck and all this bullshit.
And the reality of the situation is this is just a hyper bubble, but there are some obviously good companies still left. You're paying an awful lot for them. And the reality of the situation is, is when I look at the U S equity market, I think this is a massively, massively, massively overvalued market versus the rest of the world, right? Like four standard deviations overvalued versus the rest of the world.
But those dynamics are unlikely to change until either the dollar declines And that hurts foreign investors who've got their money in the U. S. And or the bubble bursts because it just runs out of puff, let's say. Doesn't look like that's the case. Or we go into recession and that doesn't look like the case either.
And so for me, you've got this sort of ongoing, self reinforcing, truly reflective type cycle going on in the US equity market where the purchase of the asset, In this case, stocks underpins wealth, underpins employment, underpins Fed rate hike, underpins the dollar, underpins the valuation of U. S. stocks for foreigners. It's a very self reinforcing, literally reflective in the true Soros esque sense of the world.
Mm hmm.
And I struggle to see that ending and I particularly struggle to see the ending because I said, I think Janet Yellen since the, really since Q3 of last year. has understood that she can't, she's only got any one job, right? And it's radically different from the job that she used to do. Her job these days is to just get our boss reelected. And if as I think she understands this stocks determine what goes on in terms of employment, then you have to keep this equity market.
Boyd up and she has between her ability to slew issuance and control the reverse repo and this other big pot of cash that she hasn't tapped the treasury general account. If she sees stocks wobble at all, she could just pump liquidity into the system. And that's just another reason. So I struggle with seeing a big bearish bearish move. I mean, could you get a 10%? Sure. You can get one of those any day of the week.
But a big bear market between now and the election, it doesn't look, it doesn't feel that way. It doesn't feel that way.
Um,
That's why another reason to be bearish bonds, right? Cause if stocks aren't going to do any of the heavy lifting to try and tighten financial conditions has to be bonds. Maybe the dollar plays a bit of a role going forward, in the next couple of months, that would help a bit, but it's going to have to be it's going to have to be bonds a lot.
So is there a sleeper trade besides being, net short fixed income? Are you interested in, are you looking at Japan here, Japanese
look, I like, I do love Japan. I do love Japan. But there's a couple of concerns I have about Japan. So the first one is, is the politics is a bloody mess, right? And so I think, a real mess, a real, real mess. We write about this a lot with clients. We're one of the few shops, I think, that have anyone who really has experience in Japan and follows Japan. And Jeff is being very good on this one. And the politics are real mess.
It could end up over the next couple of years, really destroying the LDPs. Iron grip over Japanese politics. So that could get really quite interesting. But the impact of that for markets is it probably delays the the BOJ's normalance normalization of, or the end of negative interest rates. We don't think they can really probably move until July. So some of the euphoria that you see around some of the banks, which have been great trades, brilliant, brilliant trades.
And really one of the driving forces behind the Nikkei, that kind of, may retest that, but I would buy on any day. The other thing that I'm a little concerned about in Japan is if you go back and you look at history and you go and look at back like 2007 and the dot com bubble, you get this interesting factor before the whole global equity market goes. And that is, it seems that equity investors go, Oh yeah, the US is a bit expensive. Bloody hell, have you seen how cheap Japan is?
I'll have me some of this. And you get this major final like, woohoo! Japan is the final like, hurrah! Where you pile into this thing. Now, that said, I have a line, I have a little chart that I'm watching. We're not there yet. I'm looking at the Japanese banks in dollar terms. I think it's the best piece of chart porn that I've got. And you can draw a multi-year line that comes in at $2 for the Japanese banking index.
And if we can crack above that and we haven't, then I think it can double or triple from there. But until it does, I'm not playing.
you be would you be a buyer of Japanese equities hedged or unhedged?
I would be inclined to do them unhedged when I buy it, I want to buy it unhedged. And that's another reason why, look, we're still in this game where, you know, Oh, you buy Japanese equities because the yen is weaker and they really just a yen play at the moment. And that is in itself is just a treasury trade. And, it's all, when you start running the correlations across the book, you find out that by being short treasuries, you've got a lot of the same trades on.
And as I said, I think Japan is an interesting story. is it there yet to have autonomous growth? Eh, I don't know. And as I said, the problem is, is that as long as the U. S. is growing so rapidly and that means running a very large current account deficit. We need all the world's cash to fund it. And so until those dynamics change, it's kind of tough to buy other things. I'd love to, I'd love to, but you need either the dollar to break down. And that's makes, Mr. And Mrs. Watanabe go.What?
Why am I not making money on my U. S. stocks? Oh, because the yen is going up. Okay. Or you need to go into recession in the U. S. That current account deficit shrink and the money go home. Or we just need to burst the bubble in U. S. stocks in one day. You know, we just find out NVIDIA can't grow at 25 percent per annum or 100 percent per annum, or whatever the hell, the equity analysts have penciled in for this week, right?
Yeah. Is there any trade, no matter how niche that we didn't touch on that is worth mentioning?
you know, we don't really get involved in very niche y stuff. We're pretty plain vanilla macro. And we, we're looking at some stuff, the oil markets this morning we were discussing, you know, crude kind of looks quite interesting.
Potentially for a move to the top side, which would get a little interesting, but not, there's nothing much really compelling outside, all our CTO models, are long now, pretty much every stock market with the exception of FTSE and we're short, most bond markets and the dollar looks quite interesting for further strength. One of the ones that's had a big run, is dollar max.
We've come down to multi, multi year trend lines on the dollar against Mexican peso and down here, if anything, you're probably supposed to be a bit, a little bit long, but It's not like, you know, it was easy in 21, you just shorted bonds because inflation was going way up. Last year was a toppy macro year. I think this will show us its hand but it doesn't look like this is a market where you're supposed to be betting big yet on macro. Outside, probably fixed income.
Right. Awesome. Julian, before we go, where can people find you?
So, you can find us if you're interested in the institutional product, reach out to support at MI2partners. com. And if you want to and it also, if you want to follow what Raoul and I both do on Real Vision, because we obviously produce a joint product there, you can use the same email address. And if you just want to follow me on Twitter at JulianMI2. Thanks
All right. Well, thank you so much again. Always a powerhouse of a guest and an awesome conversation. So, until next time.
Thanks very much indeed.