WESTON NAKAMURA: Hello, everyone. Welcome to the Real Vision Daily Briefing. It is April 20th, 2022. My name is Weston Nakamura. And I have the distinct pleasure of bringing back to Real Vision Mr. Darius Dale of 42Macro. How are you, Darius?

DARIUS DALE: I'm wonderful, West, and the pleasure is all mine, my friend. You've been killing it on the Asia analysis, man. Let's keep it going.

WESTON NAKAMURA: Yeah, I guess we joke around about every time Japan blows up, you and I end up on a Daily Briefing? Certainly not really like a joke anymore. This is really what is happening.

DARIUS DALE: I actually called Kuroda yesterday to make sure we had some awesome commentary to get things cooked up today for you.

WESTON NAKAMURA: Okay, so that's what's doing it. Okay. I gotcha now. Well, thanks for doing that. And let me just run through the markets. Usually, what I do as a trader, as a global trader, I just go through global markets process just very quickly.

Asian equities mixed today led by Japan, Taiwan, closing up just about 1% in the green, all the SPY Korea [?], Hang Seng down a half percent, Hang Seng tech got killed today. Europe, and we'll get to Japan in a moment, but Europe closed strong. German DAX, France CAC 40 was up about 1.5%, 1.4% respectively, Euro Stoxx 50 1.75% led by tech-- interesting giving the US intraday tech at the time of European close was down with a Netflix bloodbath, which we'll get into as well.

But also in Europe, we saw strength by some financial despite a slight bid for EU sovereign bonds. 10Y German bund yield was down as well as the BTPs, UK gilts. And then over to the US, we have markets that are-- the S&P is largely flat, big divergence, however, with the NASDAQ down over a percent. And again, this was from Netflix. Netflix, let's just get into that real quick.

Darius, you have been apparently sharing your password with too many people, so much so that Netflix had its worst, I believe its worst day on record on massive, massive volume. I think at one point, it reached almost 40% down on the day, so eight or nine analyst downgrades on the stock. Now, I'm not going to get into too specific details about the single stock fundamentals.

What I want to ask you is two things. One of them is there is this narrative that's being talked about out there that the Netflix subscriber growth that went negative, that was a byproduct of inflation. Do you have a view on that in terms of not specifically people canceling their Netflix subscriptions, but about people's consumption behaviors with services subscriptions like that?

DARIUS DALE: Of course, absolutely. A few things on Netflix, let me di the Wall Street disclaimer, we don't cover Netflix, we're not analysts. The data that I go get your-- go check your cooties and cross your eyes or whatever you need to say. With respect to Netflix, so for one, don't blame me.

I'd found out today that my fianc and I were paying for Netflix independently, I cancelled my subscription. Their stock crashing told me to log in and find out if I was paying for Netflix, which I was and didn't realize, so that they lost one more customer today and unfortunately, blowing up. But more importantly, I think this is more indicative of where we are in the broader capital market cycle.

You look at the history of bubbles. Go back to the housing bubble prior to the financial crisis, you go back to the dotcom bubble in the late 1990s, early 2000s, and there's usually one to two big misses, big guide downs, big stock blow ups that really kicked off the bear market. You go back to 2000, it was Qualcomm. You go back to 2007, there's a blow up in Bear Stearns.

And I believe the blow ups that we've seen in Facebook and Netflix, while at the moment, they're very idiosyncratic and have a lot to do with mismanagement of those particular companies, the broader reality is the capital market cycles, particularly this era of easy money that really allow these companies to create very uncompetitive moats around their businesses, that era is very clearly over.

We've seen a dramatic rise or over 100 basis point rise in the real 10Y TIPs yield, the 10Y TIPs yield in the last six weeks or so, and that's not an indication that that era is over, particularly for these large mega cap Fang type names, I don't know what else to tell you.

WESTON NAKAMURA: All right. What I also want to ask you too regarding Netflix was, look, at the end of day, I'm not a fundamentals person either because I care more about blinking green and red tickers rather than corporate stories.

DARIUS DALE: All squiggly lines on the page, man.

WESTON NAKAMURA: Exactly. But you send over a chart deck and one particular that's crowding dispersions deck, you have this dispersions month-over-month Sharpe ratios and you'd have various US equity sector and style factors. Can you just run through that? And the reason I'm bringing that up specifically is because you have all of these style factors and all that.

And then throw in there, you have two single stock names almost out of place, which is Tesla and Netflix. Can you comment on what Netflix is doing in there relative to those other ones?

DARIUS DALE: Yeah, so with that analysis, let me take a step back and explain the analysis. The chart shows the month-over-month Sharpe ratio for about 55 or so US equity sector style factors industries and mega cap Fang names. What I'm looking at is trying to study the composition changes in the composition of the upper quintile relative to the lower quintile.

Those changes tend to be a leading indicator for big reversals, and not only in terms of the market direction, but also in terms of the internals and in terms of asset markets, whether they're getting more procyclical and more defensive at the margins. One thing to call out with respect to the current setup is we continue to see, generally speaking, a pretty significant dominance of defensive type exposures featured in the upper quintile.

That typically is a market that's indicative, and take a step back again, one more, the reason we track the month-over-month Sharpe ratios is because we're trying to use this as a behavioral tool to understand the behavior of what we call pawnshop type flows. These are the multimanager platform hedge fund shops, there's world assets under management have gathered in the past decade or so. And these folks on any given day really control anywhere between 60% to 90% of market turnover.

This is where the action is taking place in terms of these pod shops. I use that as a very real tool to track flows into and out of different sectors and style factors from an aggregate macro perspective. Going back to Netflix, and really the composition the upper quintile and the lower quintile, one thing that we're seeing now is a big defensive dominance, utilities, consumer staples, REITs, dividends, all that stuff is exactly what you would expect in a market that's increasingly concerned about the growth, medium term growth outlook.

But when you look at the bottom quintile, it's not just your traditional procyclical high beta, your financials, industrials, all the stuff you would expect to go down, retail consumer if the economy was slowing. The composition of the lower quintile also features companies like Netflix growth names, etc, etc.

And that, to me, is telling us that there's a real liquidity trade being put on right now in terms of like, hey, get me out of anything that's high beta, high valuation, overvalued, anything that's really lived high on the hog over the past few years, or even real decade in terms of the lower for longer, slower for longer policy regime that we've been in.

WESTON NAKAMURA: That's fantastic. I actually want to pull up a chart that I grabbed off of my buddy, Craig Peterson over at Tier1 Alpha. Brian, if you bring up this chart of the S&P 500 constituents daily impact, what he has is, and he tweeted this out earlier, but basically it's the S&P 500 constituents, and you could see how far away Netflix is from the rest of the cluster, it's almost a ridiculous chart to visually look at.

But at the time of this, at least, we did this mid-day, I'm guessing, but Netflix has taken out about 0.6% of impact on the S&P 500. Therefore, that explains this 1% divergence between the two indices of the NASDAQ. Obviously, the other tech stocks, they were down, but you're looking at Netflix not only with like 120 million shares traded today, but options volume as well, most active options traded underwater name.

The reason I also want to bring this up is because Netflix, this is not the first time that this happened. Last quarter, Netflix also fell by 20%, 25% or whatever in a single day. And this is a massive market stock. And then also last quarter, you had Facebook, you had Meta that was down by 25%, you had Amazon that was up by 20% the following day.

These are the very top echelon of the S&P 500 that are moving hundreds of billions of dollars of market cap, they're shifting around on an intraday basis and sometimes on record volumes, and on record intraday swings. And that says to me a lot more about market structure and liquidity or lack thereof issues rather than any underlying fundamentals and the dumping of the shares and things like that, as well as Just like options activity that does that.

And you saw a lot of those blow ups happen throughout earnings last quarter, so I just want people to be aware of that. I don't see that not happening this this quarter as well as quarters going forward. There's a very big, within the plumbing or the market infrastructure, there's a liquidity mismatch happening due to largely things like passive vehicles that hold these names and the absence of activity from active until they all jump in together, and they trip each other.

DARIUS DALE: 100%, and it's going to get worse. There's two reasons it's going to get worse. You're going to remove the marginal buyer just purely as a function of the growth slowdown that we have prognosticating, particularly in the back half of the year, once you get into the summertime, you're going to start to see a much faster deceleration in growth that have implications for an asset market perspective.

But also, you're going to start to see a reduction in the Fed's balance sheet, and also a reduction in the net liquidity function in the market if you look at Fed's projected changes in the Fed's balance sheet, the Treasury General Account. The key takeaway is that as bad as liquidity might seem today, it's going to be worse three months from now and it's going to be even worse six months from now, and it will be even worse than that nine months from now.

You better be right if you're a stock picker, particularly as you navigate the next two to three quarters as it relates to just getting these earnings cycles right. We're in a very precarious point in time whereby operating margins for the S&P are coming off an all-time high at 16%. We could have an earnings recession depending on how bad quickly that retraces just to get back to the prior peaks.

If you look at every cycle we've seen since the 1980s, the peak in S&P operating margin is somewhere between 12%, 13% and 14%. And we're at 16% now on a way who knows what it will slow down to, but it's very clear that we're starting to see some margin pressure. I don't believe Netflix is purely indicative of that, it seems more idiosyncratic than that to me, but I think once we get into the real teeth of the growth slowdown particularly the back half of the year, you're going to start to see some wholesale negative revisions to earnings, expectations, cashflow expectations, etc.

WESTON NAKAMURA: Right, and fine, Netflix might be idiosyncratic, obviously. But there is a still broader tie in theme, which is going back to where we're talking about things like market structure, and like holders, call it shareholders, if you want to, I guess an ETF shareholder, whatever. But if basically, you have concentrations of holders in passive, and you have fundamentals that are changing, actual fundamentals for which active pod shops, for example, that you were talking about.

Pod drops are basically hedge funds that have different pods, different groupings that are segregated within one giant hedge fund umbrella. But basically, if you have these long/short fundamental funds, they're not necessarily going to act on those fundamentals until those fundamentals come out and reveal corporate earnings statement, and then they all jump in at once. And then you get these big blob moves.

At a time, when you have things like earnings, uncertainty earnings, like estimates, divergences, and all that stuff, yeah, you could totally see single stock volatility high, even if index volatility might not necessarily be high.

DARIUS DALE: You're hitting on something that's market microstructure I think, is important to unpack. Because if you think about this, there's been a couple of things that have if you notice in the past, let's call it, post-GFC era, particularly in the last three to four years going back to 2018. It seems like markets grind up, grind up, grind up, and then take the elevator or take the window out, take the stairs up or the escalator up and they take the window out.

That feature has always been a feature of equity markets, credit markets, but it seems to be like that feature itself has become much more intense in recent years. And part of the reason for that is obviously the growth of the options market and all the Vanna and [?] flows that contribute to the grind higher, and eventually you get some event ball or event that causes the window down.

The second feature of that I think is going back to this pod shop discussion, the growth of those platforms has real big impact on asset markets. And one of the reasons I say that is that these are market neutral long/short money managers. They can't put on basis trades for any reason, style factors, sectors, industries, it's Netflix versus whoever sells Disney. I don't know, Home Depot versus Lowe's, those types of trades.

All these managers on these platforms, they have to have live updated models to transact in the stock and to keep it at the mothership. Those models are live, they're updated. That increases the likelihood that we have, hey, when you get some incremental earnings information, the people who need to explain to Ken Griffin or the Dmitry Balyasny or Steve Cohen why they're long Netflix or why they're short Netflix.

They all have to update their models at the same time, and they all come to the same conclusion at the same time and they all price the stock higher, price the stock lower. It's like handing a room for the kindergarteners a coloring book with Santa Claus is the first page, they're all going to color red for the coat and white for the beard and black for the boots. That's exactly what's happening here from a microstructure perspective.

WESTON NAKAMURA: And just to add to that, as well, you also have risk managers that also exhibit the same behavior. In that same kindergarten classroom example, when the fire bell rings, everyone gets tapped on the shoulder, they're all going to say, so, yeah, they might have different marketing material, but they behave the same by and large.

Just stuff to keep in mind, it's not just about fundamentals, you really have to watch more so of the investors who's holding the positions, and what they're doing. Bill Ackman, I think he went long at Netflix the last quarter when it dumped by 20% or whatever. If he's still long, he just got killed. If he's getting killed in this, what else was he holding? Maybe see if there's going to be an unwind in some of those holdings. That's just a random example. But I have no idea that you should do that.

DARIUS DALE: Just to put a Tiffany bowl in the Netflix discussion, it just reminds you that when you're in a bear market, you could always lose 100% of your money from any starting price. Not saying that Netflix is going to zero or its stock market is going to zero, but it just reminds you that a stock might be down 20%, 30% off its highs, that doesn't mean it can't go down 20%, 30% lower. Just log math, this is just percentage change. That's all it is.

WESTON NAKAMURA: Thank God, there's no leverage in markets, though.

DARIUS DALE: To the [?] situation.

WESTON NAKAMURA: Let's do this. Basically, what happened? Why are we here, Darius? Why are we here? Why did you blow up Japan? This is now what happened. Yesterday, towards the end of about 24 hours ago, I put out a tweet, basically saying that JGB futures are currently selling off in the middle of US trading hours, towards the end of US trading hours severely on volume.

Watch out for a potential fixed rate operation by the Bank of Japan at 10:10am in Japan time, fixed rate operations when Bank of Japan offers to buy an unlimited amount of JGBs in order to cap yields, because the way that JGB futures are selling off, the cash JGB market is going to see a massive spike in yields. At 10:10am, the Bank of Japan announced the fixed rate operation, and thereby capping yields.

But Brian, if you go to, let's see, if you go to Chart 3, what you'll see is, these are the JGB futures. And the JGB futures market, you'll see that selloff that I was talking about. And then you'll see this reversal. That reversal was when the fixed rate operation at 10:10am was announced.

And then after Japan close, Japan cash close at 3pm or 4pm or so, the Bank of Japan announced an entire new set of fixed rate operations going forward for the next four consecutive days. This is the second time they did this. They did this back in March, in which they pre-announced consecutive days of fixed rate operations in which they're going to keep the 10Y JGB yield at a cap of 25 basis points by unlimited bids.

And next chart, Brian, if you take a look at what it did to the rest of the markets, not only did JGBs basically V-bottomed at 10:10am, and then take another boost higher from there, so therefore yields lower, but this had an effect on the currency markets and the Treasury markets. You'll see the yen had basically bottomed as well as the Treasury market had bottomed right at that point, and then rallied from there.

And then the next chart, Brian, with dollar/yen and the US 10Y yield, it's basically the same thing as the futures chart that I just showed you. However, this one is obviously just showing the underliers of those respective listed derivatives. And you'll see that the V reversal point, the top in dollar/yen and the top in 10Y US Treasury yields was right at 10:10am on that Bank of Japan fixed rate