ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Wednesday, March 16th, 2022. I'm Ash Benington. It's Fed Day. The FOMC has pulled the trigger hiking the Fed funds rate 25 basis points. We're joined by someone who follows all of this very closely. Darrius Dale, founder and CEO of 42macro. But first, let's take a quick look at what's happening in US equity markets on this Fed Day.
Dow Jones Industrial Average up 1.55% up to 34,063 here at the end of the day. S&P 500 settling at the close of the session at around 4,358. That's up approximately two and one quarter percent. NASDAQ big winner on the day, up 3.77%, closing out today's trading at 13,436. Russell 2000 also up on the day, about 2.5% points closing out the day in 2,019. And we could not have a better guest here on Fed Day than Darius Dale. We know you're watching it closely. Darius, welcome.
DARIUS DALE: Ash, what's up, man? It's great to be back. How are you doing?
ASH BENNINGTON: It's great to have you back. By the way, Darius, you don't know this yet, but you are on the two year anniversary show for Real Vision Daily Briefing. So, not just Fed Day and exciting data have you here.
DARIUS DALE: I'm blessed to be here, man. Thanks for having me. It's awesome. Let's get right into it.
ASH BENNINGTON: Let's do it, man. What's happening? What's going on? What's your take on this Fed Day?
DARIUS DALE: Yeah, so Powell did a really remarkable job in my opinion of walking the tightrope that is appeasing the faction of the political spectrum of the factor of the investor spectrum that wants them to do get really serious on inflation and doing what it takes to restore price stability, to borrow their phrase. They also said enough about in terms of talking up the economy, and really just swaging some of the concerns around growth in a near term recession, in order to remove what I would consider to be the least temporarily hawkish right tail from policy.
And so, as you can see, obviously, asset markets are generally behaving positively as a response. If you look at where, for instance, the S&P was a prior to the [?] at 2pm statement, we're up about 30, 40 base or 30, 40 points S&P points higher than that. Bitcoin is up about $300 or $400 higher than that. There was a positive response in asset markets. Partially, it has a lot less to do with what Powell said, but what Powell didn't say.
What Powell didn't say was that, hey, look, we're going to have to slow this economy and drive up the unemployment rate in order to get price stability. What he said was, obviously, they did this through their summary of economic projections as well, but what he said is, now we're going to actually stick the landing here, which is very rare for the Federal Reserve in any policy tightening cycle.
ASH BENNINGTON: Alright, Darius, let me play devil's advocate on this. Here's the point, what did you expect him to say? We're going to get inflation down, but we're going to crash the economy? Doesn't he have to sound positive and say, look, we're going to work on the price stability side of the ledger to try and control this inflation at 40 year highs, and by the way, we're going to aim for a soft landing. We don't want to impair labor markets. What were his other options?
DARIUS DALE: There's no other option. The Fed is not allowed to forecast recession. But the O Curve can, as we saw with the yield curve continued to flatten on the meeting. We had two stances. It's about 30 basis points prior to the statement and came in at 25 basis points at the close of his press conference. He had 530s at 33 basis points at 28 basis points by the time Powell stop speaking. The market is looking forward ahead, and you also have 30 year bond yields.
We had to start to see a little bit of a divergence between the 2s, 5s, 10s. The 2s, 5s, 7s and 10s relative to 30s. 30 is actually down two basis points relative to where they were prior to the statement. The market is looking ahead and taking Powell's word for it and pockets of the market. Right now, as it relates to risk assets, and this is something we were definitely going to have to unpack, we're heading in OPEX on Friday. Typically, what happens in OPEX is that--
ASH BENNINGTON: Darius, explain what OPEX for those who don't know.
DARIUS DALE: Sorry. Let me take a step back. We're heading into options expiration on Friday, particularly for stocks and indices the S&P 500. As a function of the all the in the money puts that are about to expire, dealers are starting to pull back on those hedges. When you buy a put on the S&P 500 as an investor, what happens is the dealer who sold you that put has to turn around in delta hedge that exposure by shorting the underlying.
Well, as we get closer and closer in OPEX, they can reverse those hedges because obviously, theta and things of that nature, and also about the decline in volatility itself, are all dynamics in factors that are creating this positive lift into the market. What's likely to happen to happen from here is that in the absence of anything really negative happening out of Russia and Ukraine, the markets are probably likely to trade positively into and through OPEX.
The issue is what happens next week when we'll be in a situation whereby 30% or there about it was somewhere around a third according to SpotGamma of all the put exposure out there is likely to expire, all the gammas put exposures likely to expire on Friday. And so, investors will be left with this really awkward choice, which is the pile say enough to not spook me into not rushing to put those hedges back on. Or is there enough of a negative macro market environment out there that investor will have to reach for more protection, and we would tend to believe that the ladder is more probable.
ASH BENNINGTON: By the way, for those who didn't follow all of that, Darius is talking here about the options positioning, how dealers basically have to gamma and delta hedge their books to come out flat so that they're not picking up additional risk exposure to these markets, and that can impact and cause some mechanical changes in terms of price action. Is that roughly right, Darius?
DARIUS DALE: 100%. 100%, yeah. We're in this window of time where the decline in volatility, in fact, Brian, if you don't mind, put this chart up. We have a chart called crowding versus dispersion. On the left chart is the one I'm speaking to specifically. Or we're tracking deviations and skew relative to the volatility risk premia across certain assets.
One thing we call out is that upon refreshing that analysis during Powell's press conference, it's pretty clear that equities and risk assets in particular are running out of some of this juice of that supplied by some of these supportive flows. If you look at US equities, we have about 30 or 40 US equity ETFs in the sample. In a median basis, the volatility risk premia there is minus 11%, in terms of how we calculate it. And same thing with risk assets, we have about 30 to 40, or 40 to 50 risk assets in the sample on a median basis. It's also minus 11%.
What that means is that you don't have this healthy degree of overvaluation and puts in the volatility markets that could perpetuate some very positive Vanna flows beyond this OPEX cycle. And so, that means we need to start seeing fundamental improvement in order to put in a durable bottom in the market. And according to our analysis, we're not there yet.
ASH BENNINGTON: So, Vanna is de vega/d spot. This is the delta with regard to volatility, is that right? Did I get that right?
DARIUS DALE: Yeah, exactly. The change in delta relative to changes in volatility.
ASH BENNINGTON: Yeah. Darius, obviously a lot they're talking about the options side of this market, and also the macro component which you touched on earlier, you said something that was really important, and I wanted to double click on it. Brian, if we take a look at the chart of the 2s10s spread for a one year time horizon, I think this is a really interesting sharp chart, because it shows the flattening that already been in the curve. That's a chart going back to March of 2021. And as you can see, by looking at the screen, it's one that you could ski down.
DARIUS DALE: Ski. If you tried to ski down there, you're going to break something.
ASH BENNINGTON: It's a double diamond.
DARIUS DALE: Yeah, absolutely. Whatever the hardest ski, I think that the double diamond sounds about right to me, I'm not much of a skier.
ASH BENNINGTON: I wanted you to jump back actually, and take a look at the one day chart of the one year chart, because this shows a little bit of just how quickly we saw the 2s10s curve flattening. Take a look at that. They're pretty significant. Darius, what are your thoughts on that?
DARIUS DALE: Yeah. Look, economies headed towards a below trend growth. That was our call to begin in the year. Or sorry, that was our call in the fall of last year. We could have just had the view that. Consensus was still out the lunch. And Brian, if you don't mind putting up the chart, this is one of the important charts US growth trends, would be the chart Brian, where we show the trend in US growth, but also to consensus forecast for 20 to 23. And we continue to be, now we--
ASH BENNINGTON: While Brian is putting that chart up. Let me just connect the dots for our listeners and our viewers. This is basically the 2s10s curve forecasting a decline in trend growth on GDP, and that's what we're seeing here on this chart.
DARIUS DALE: Yeah, it's forecasting a negative economic outcome, either your session or something, a slowdown that takes you to below trend from a growth perspective. The issue with that as it relates to risk assets and financial conditions on a prospective basis going back to the chart, is that we could Bloomberg consensus, if you look at for US growth, in particular it's calling for 3.6% real GDP growth in this year, that's 160 basis points north of our trend rate.
And mind you, this is in a year we're having a near record fiscal contraction and projected seven interest rate hikes and some quantitative tightening. That in our opinion remains a big risk to the downside for investor expectations, and obviously, financial markets, particularly risk assets. Last thing I'll say on all this is if you put up the chart, economic versus market cycles, Brian, where we show in the blue line, the OECD composite leading index time series, relative to the black line which the S&P 500 high beta low beta ratio, and the red line is the Bitcoin to Treasury bond ratio.
The world has been in a cyclical slowdown since going back to the second quarter of last year. [?]the pick your economy, but Europe started slowing on a trending basis in terms of leading indicators in November. But most economies, this halt the middle of last year, have been decelerating. That deceleration is only going to accelerate. Our models have that except pace of deceleration picking up to the downside mid to late Q2.
As long as we're decelerating, we're going to have a natural growth headwind to risk asset valuations, investor sentiment, positioning, and all those dynamics that can actually perpetuate a durable bottom. Last thing I'll say on all this is that when we do the analysis with you look at the business cycle, investor positioning, we can unpack any of this if something tickles your fancy, or valuations. We get to a terminal downside or something along the lines of a Fed put in a range of 3171 on the S&P to about 3429. That's a long way down from here.
ASH BENNINGTON: Darius, it all tickles my fancy. I wish we had four hours to unpack everything you just said there. I'm curious about your calculation of the Fed put relative to the price action on the S&P 500. I heard Jay Powell today at the press conference declined very graciously to give a forecast on the S&P, therefore, maybe claim the cards close to the vest in terms of signaling where we might see concern from the Fed, and then theoretically, of course, potential intervention.
DARIUS DALE: He didn't play and close to the vest at all. He let one slip actually. He said financial conditions will become less supportive of various functions than the economy. I'd wrote that down. He's telling you the Fed is on the track to tighten financial conditions. And so, this has been our core thesis the whole time, and going back to--
ASH BENNINGTON: Well, we knew that from the dot plot. We knew that from the forecast. We knew that from the SEP. But he's declining to give you a particular dollar figure in terms of valuation of S&P where it might become a particular concern.
DARIUS DALE: Our analysis puts it about minus six to minus 13%, lower than where the BofA fund manager survey had it on Monday, they had it at 3636, and we're a little bit below that. I don't think there's any fair value in the stock market until you get to at least 3636, but as I mentioned 3200 to about 3400 is probably our target zone.
ASH BENNINGTON: Darius, and that's why we're so glad to have you here today, because you are not afraid to make a call and you're not going to put the cards close to the vest. Explain what that gap means between where we're trading right now. It looks 4,357 on the S&P 500. In terms of valuations and how you think about it, and how you come to that number for the delta between where you see that as a point of concern?
DARIUS DALE: There's a myriad of analysis, and I'll be quick. The three main pillars of our analysis, when you think about it from either the business cycle or positioning or valuations, so we look at the Conference Board labor differential index as a proxy for the business cycle, that's the spread between the jobs plentiful six months forward, versus jobs not so plentiful. That's usually a good proxy of peaks and troughs in the labor market.
They've been eight cycle peaks since early 1960s, as in this indicator with a median S&P 500 drawdown of 35%. That's one. Positioning, if you look at household equity on a ship relative to full of fun, so the proxy, how much of your net worth is being contributed by your ownership of stocks? That numbers at about 30%, and the most recent quarter, Q4, and there's been 19 of those peaks since mid-1940s, with a median drawdown of 22% for the stock market.
Then lastly, probably the most bearish one is just valuations. I don't tell anybody that stock market is still overvalued here. If you look at on a real basis, earnings yield minus headline CPI were about 3.4% negative. There had been six negative reading since the early 1960s, with a median drawdown of minus 41%. You marry those things up in terms of averages, and you're at right around down 30% peak-to- trough from the highs in the S&P. Now, that's just one candidate analysis.
The other candidate analysis was looking at this from an analog perspective. 2011, if you think about the secondary inflation impulse that we're seeing to the 2018, Q4 2018, if you think about the Fed being on its path to tighten while the economy is starting to slow and having that divergence really start to perpetuate tighter financial conditions. Then lastly, if you think about the unwinding of the dotcom bubble, and the overvaluation that the corollaries between equity ownership and overvaluation.
Those are the three most closely knit analogues to our current situation, although that's a perfect analog. And when you marry those things together, you get somewhere around 30% on the downside for S&P. We look at this from a variety of different angles, growth, inflation, policy, valuation positioning, and we still keep coming up to this minus 30% number in terms of peak-to- trough drawdown.
ASH BENNINGTON: I know that when you talk about minus 30%, that's a sobering phrase for people to hear. What are your catalysts? What are your time horizons? How do you see that unfolding?
DARIUS DALE: Great question. Great question. That's question [?]. In terms of catalyst, because you need a catalyst, markets just don't go down a lot or go up a lot by themselves. Usually what's happening underneath the surface is the broader economic and market cycles are taking you there. When you think about the catalyst for a growth slowdown, typically what you need to have happen in order to see negative the outsized negative deviations in risk assets is a sharp deceleration and growth.
In fact, we back tested everything six ways to Sunday here at 42 macros. And the reality is, you do need to see what we call a minus two sigma a deceleration in growth. So, [?] the speed of the change in growth to the downside is right around two sigma on absolute basis relative to the trailing [?] trend. We expect that those types of decelerations, that magnitude of change will start to show up in the economy around mid to late Q2. And that's one catalyst.
There's another catalyst that we haven't spoken about, which I think is equally important as it relates to investor sentiment, which is earnings. If you think about S&P earnings, we continue to make new highs in terms of the next 12 month earnings estimates. We haven't really seen much of a pullback, despite what we are all seeing in the yield curve, bond market, new lows for 530s. Almost new lows for 2s10s from a growth perspective. If you look at earnings estimates, they haven't really moved that much.
Earnings, if you look at on a trailing 12 month basis, S&P 500 operating margins at 16%. You pull that chart back as far as the data goes in the previous cycle peaks are all at 14%. You could very easily have an earnings recession just to get back to the prior cycle peak, which probably is not the terminal destination. There's a lot of headwinds from a medium to long term perspective with respect to the equity market, but obviously from a short term perspective, with the Fed just not spooking markets with cause commentary or the dot plot, there's a window for a relief rally here.
ASH BENNINGTON: Yeah. By the way, that's discounting any potential risks or a negative exogenous shock.
DARIUS DALE: Oh, yeah. I said this a couple weeks ago. The negative exogenous shock of 2022, it is obviously there's no way anybody has any crystal ball on it. Its China get starting to get aggressive with Taiwan. Think about it. This is as good as an opportunity for China to commit to some very aggressive policy on the geopolitical front as ever. The US and NATO's hands are tied with Russia and Ukraine.
Obviously, all the central banks hands are tied with respect to