MAGGIE LAKE: Hello, and welcome to the Real Vision Daily Briefing. It's Wednesday, February 9th, 2022. I'm Maggie Lake here with Darius Dale, founder and CEO of 42Macro Hi, Darius.
DARIUS DALE: What to do, Maggie? How are you doing?
MAGGIE LAKE: I'm doing okay. So is the market today, right? US equities in the green across the board, the NASDAQ extending that rebound for another day. And looks like we're closing with buying right into the close, maybe at the highs of the day, the NASDAQ up 2%. And we see the 10 Year Treasury continued to edge back, hovering around 1.93%, or edging back from that 2% level. There's so much going on underneath those headlines, so what's jumping out from your dashboard?
DARIUS DALE: Yeah, what's jumping out from our dashboard is that the market is very clearly starting to shift towards pricing in this post-Omicron bounce dynamic we've been talking about in our research, very similar to the post-Delta bounce in economic activity, both in terms of duration and-- we're not going to get the same positivity we got out of the stock market and risk assets in the month of October. But certainly, we're well on our way to looking like we might begin some of it.
MAGGIE LAKE: Yeah, the big question is, is it sustainable, though? Is this a bounce, and then we're headed for a leg lower? Does it feel like this can carry through for a bit?
DARIUS DALE: Look, in terms of how we think about the world, one through the regime segmentation lens, but also through the lens of changes, impulses in policy, impulses in growth and inflation, we really don't really get into a bearish concoction as relates to those factors and those variables until you get into the springtime. And I would argue this post-Omicron bounce dynamic may delay that by a month or two.
So, if you're a bear out there, and you're looking to short stocks, and you're looking to put on some volatility trades, or CDX and all that sexy stuff to play for a big market decline, you probably going to have to wait a couple of months just to get this through the system.
MAGGIE LAKE: We have a big CPI number coming out tomorrow, the inflation narrative has really been dominating. Looking at your note today, you say inflation is tied with deflation. Walk us through what you're looking at there, because they're on two different ends of the spectrum.
DARIUS DALE: Yeah, those are the nomenclatures for our market regime nowcasting process or our GRID regime process in general. And what inflation means is that the market is pricing in growth slowing with an inflationary bias. And what deflation means, the market is pricing in growth slowing with a disinflationary bias. And in terms of the markets that are signaling that, we run our volatility-adjusted momentum signal process across 42 markets in that model to determine what the dominant regime is. Those two markets are tight now in terms of the signals that they're garnering.
And so, what that really tells you is that the market is confused on rather the direction of inflation right now, where the market's not too convinced that inflation is going to slow, but it's also not too convinced that it's going to continue to accelerate materially from here. But what it is convinced of obviously, is that growth is likely to remain on its trend lower irrespective of this bounce that we're likely to see a post-Omicron.
MAGGIE LAKE: I want to pick up on that growth aspect in a moment, but the market's not the only one confused, the Fed is confused it appears as well. We had the Atlanta Fed, we've been hearing from several of them this week, Atlanta Fed President Bostic today saying he's forecasting three hikes, could be four, but he cautioned that either the central bank's just going to have to wait until they see how the economy responds.
I sat down with Vincent Deluard of StoneX yesterday, who said part of the calculation that they're going to need to do that we're all going to need to do is gauging consumer sentiment. Let's have a listen to a clip of that.
VINCENT DELUARD: I think they're still going to try to maintain the myth that it will slow down by the end of the year, but you can already see them hedging their bets, at least for January, maybe February. And then I think they just want to try, okay, let's hike rates, see what happens. And we'll be in this feedback loop between the two. But again, it takes time.
If you don't get prior hiking cycles, it takes at least 12 months for monetary policy to start having an effect on the real economy. And our timing for when inflation is going to slow is, I think, if it doesn't slow within four or five months, then we have a problem. And one last thing I would mention, which is more on the psychological side, is that I would say that after a certain time, inflation is inflationary. The longer this last, the more people start to adjust their behavior.
And it's not happening very quickly in the US because again, we haven't seen inflation for years, so most people are like, oh, I'll just wait to buy. [?] I'd like to buy a car. I'm not going to buy a used car now, it's crazy. So, you're just waiting. It's been a year.
At some point, [?] is going to die. So, you're going to have to buy, and then you could flip in your head, wow, this thing keeps increasing. Like, if I keep waiting, I'm going to pay 20% more, and then you start pushing forward your purchases, which is the inflation expectation channel, which I don't think we've hit yet. But the longer we have this, you go to a grocery store in New York or San Francisco, their entire shelves are empty.
It looks like some in places like a developing country. And the mentality, if it were like in America, people would already have stopped buying stuff. It's only because we're in the US where we have this patience to inflation, but the more time passes, the more we're eroding this capital.
MAGGIE LAKE: Such a great point. And we also talked about where to find protection from short term inflation pressures and the case for what Vincent calls active intangible investing. Really, really interesting conversation. The full interview is available on Essential Plus and Pro tiers. But yeah, gauging consumer psychology, that's not easy, especially when we haven't been in an inflationary period in a really long time, Darius.
DARIUS DALE: Yeah, so there's a myriad of ways to gauge consumer psychology. There's a ton of surveys. It's hard to pin down which survey to look at when, just as a general rule of thumb, the Conference Board surveys here in the US will give you a little bit more color on the labor market, or they were a little bit more sensitive to labor market dynamics, whereas the University of Michigan surveys tend to be a little bit more sensitive to inflation dynamics.
But taking it into the Conference Board surveys, I would tend to agree with Vincent's general take that there are second round impacts of inflation, second order effects and inflation that are really just a function of the time you spend in an inflationary environment. And what I mean by that is, I think we're starting to see evidence of that. If you put up this chart I sent where we show the Conference Board's buying intention surveys, we normalized it to the month of October, because the month of November is really where the inflation narrative really changed.
If you go back to that October CPI print that we got, I want to say on November 10th or something like that, that one jumped up to 6.9%, it really cause the Fed to do an about face and drop the transitory language out of its forward guidance. That print, really since that print, we've seen an increase in consumer buying intentions in automobiles, consumer buying intentions in homes, major appliances, and consumer intentions on going on vacation.
And I'll say two things, one, that's incongruent with the consumer spending data we've received since then. It's actually gone down and contracted pretty considerably in the month of December. But that's neither here nor there for this point. The real point is that, hey, look, consumers are now responding to this persistency of inflation in terms of chasing goods and services at a faster pace, because they ultimately realized that their incomes, which are declining on a real basis and have been for several months, may not be able to buy them as much purchasing power as they thought they would months ago.
MAGGIE LAKE: Yeah. So, let's go back to the growth part of your equation. And that's concerning. So, in either scenario, you see a slowdown in growth. When will we see that? How bad will it be? Because you don't get the sense that that's fully priced in yet, or priced in at all?
DARIUS DALE: No, not at all. Look, the various pockets of the markets are very clearly far from their all-time highs, and very much likely not to recover their all-time highs. And I think, if you think about how markets typically peak, it's a series of rolling capitulations, if you will, in terms of different sectors and style factors, giving up the ghost and in our opinion, that's exactly what we're experiencing now and we're likely to continue to experience until this whole thing blows.
So, we're very negative on the growth outlook, certainly relative to consensus. Bloomberg consensus still has US GDP for 2022 coming in at 3.8%, which is 160 basis points north of the five-year trend line through 2019, so the trend we were on prior to COVID. To me, I think there's a lot of explaining-- they have a lot of economists, at least, Wall Street banks have a lot of explaining to do with respect to those forecasts. And the reason I say that is one we're going to see a near record fiscal contraction this year, we've been talking about that since going back to the fall.
We're obviously going to see a considerable amount of monetary tightening this year. But then when you actually start to look at the data, the consumer intention, some of the data that would lead a big consumer spending boom that obviously is priced into some of those growth expectations. Whether you look at consumer income expectations, we get that data through the Conference Board survey. You look at their expectations for improvement in the labor market, the diffusion indices therein, we get that from the Conference Board survey as well.
And then we look at some of these ancillary measures of consumer wellness and financial health and pretty much everything you look at, it says consumers are concerned about are their number one goals or their most important goals of this year are saving money for retirement saving money improving their financial health, at the same time where their outlook on the labor market is starting to deteriorate, and more importantly, their outlook on their own incomes is already deteriorating on a trailing basis.
So, when you put those three things together in the context of the fiscal monetary headwinds that we're likely to observe, I find it preposterous that investors can sit there with a straight face and say we're going to have an above trend growth year this year.
MAGGIE LAKE: Yeah, it's so interesting. Should we believe those surveys are what consumer say? Because I say, my most important thing is to save and pay down debt and do all the fiscally responsible things. But American consumers have a reputation of the one thing that you can count on is they're going to spend, maybe they spend less, maybe they spend more, but they're spenders. Do you think that's changed?
DARIUS DALE: Yeah. Well, no, what's changed is that they don't have any money.
MAGGIE LAKE: Yeah, you can't spend money you don't have.
DARIUS DALE: You can't spend money you don't have, and look, this showed up in a major way in the December personal consumption expenditure data. That's the broadest measure of consumer spending we get in the US economy. On a headline basis, that contracted at a 12% annualized pace in December. That's crazy.
And what's really happening underneath the hood is that we created a boom in the goods economy, goods demand and goods consumption was considerably north of its trendline prior to COVID, considerably north of that trend growth rate, that trend level. Now, we're starting to give a lot of give back to that, and it's having impact in the economy. The goods consumption on a real basis declined or contracted, crashed at a minus 32% pace in the month of December.
Now, you could write it off and say that was pull forward in terms of holiday spending, and I would tend to agree, we certainly saw that in the October data, didn't necessarily see it in the November data. But the real key takeaway is that look, people are just going to run out of stuff to buy. You're not going to buy six houses, you're not going to buy six cars, you're not going to buy 10 washing machines and two dryers.
At some point, that debt cycle comes to a head and the issue for the economy this year, and this is why I continue to believe the big risk for 2022 in terms of market repricing is that we could potentially have a growth scare in terms of the speed of the deceleration back to the trend in the context of the services sector boom not materializing. And that the reason for that is because we're already showing a pretty considerable pace back towards the trend in goods consumption, potentially even through trend, if people pull forward a lot of these purchases from future years. And so, I think if we don't get this service sector boom, we could be looking at a low for growth expectations, and ultimately look at a low for risk assets.
MAGGIE LAKE: So, let's get to some questions. This is from Goncalo on The Exchange. Darius, I know you're calling for deflation in the next months, and you can tell us whether that's true based on the fact that the market's confused between inflation and deflation. I know you're calling for deflation in the next months, is that possibly going to occur with rising energy prices? And will that transfer to the economy? Could that feed into that growth scare that you're worried about?
DARIUS DALE: Well, it's already [?] into the growth scare with consumer incomes. If you look at real disposable personal income on a per capita basis, it has contracted at a 3% annualized pace in the month of December. Now, we've had some pretty squirrely numbers throughout the pandemic as a function of all the fiscal stimulus here and there and taking and giving. But the reality is x pandemic, that would be a recessionary number.
That's a pretty big deal to have consumer spending, real disposable personal income per capita contracting at that pace, and it really just goes to show how much inflation is really taking a bite out of consumer purchasing power. The one thing I would address in the question, I think I mentioned this at the beginning of the show, it's very likely that high frequency data bottomed in the month of January and accelerate at least over the next couple of months, like here in February, most likely.
And then certainly by the month of March, we'll see a market acceleration off those January lows, whether or not that bounce is to be sustained is up for debate. We would argue it's very unlikely to be sustained well into the spring. If anything, you might get at most two to three months of an acceleration off of these Omicron-driven January lows. And then from that point forward, it's very much likely we return to this trend of deceleration we've been on since the second quarter of last year.
MAGGIE LAKE: So, Basking Turtle on YouTube is asking, what are the possible catalysts signals for the end of a post-Omicron bounce, and the realization of that deflationary regime?
DARIUS DALE: Yeah, absolutely. So, this is stuff-- by the way, everything I say is obviously being published in our research on a regular basis, so come check that out at 42macro.com. So, one thing we publish on every day are the two signals. So, we call the-- there's the two sides of assessing market risk in terms of whether or not you need to make major portfolio changes, and your sudden stop risk like something happened, we need to get out of this burning movie theater quick. And then there's, oh, I think there's a guy in the back of the movie theater playing with matches. And so, we call that rolling stop risk.
From a sudden stop risk perspective, we anchor on our volatility-adjusted momentum signals, and what we call our four horsemen of market risk. These are intermarket indicators that tell you whether or not the market is pivoting towards risk-on and risk-off, that would be the VVIX/VIX ratio, the high beta/low beta ratio, small cap/mega cap ratio and the value/growth ratio. When three of those four ratios are signaling or are bearish from that perspective and making lower lows, that typically is a warning sign that the market is about to go no bid.
So, right now, we're not there yet in terms of meeting those signals. And I would suspect we're actually going to get less close to that, less close to hitting that signal in the ensuing weeks as a function of this post-Omicron bounce dynamic. And then there's too the rolling stop risk. Let's say post-Omicron bounce catalyzes some positivity in asset markets over the next couple of weeks, or maybe even a couple of months. I'm sympathetic to it potentially lasting a couple of months, although I don't feel the need to make the call on that.
The reality is you're going to start to see market internals really start to transition back towards defensive and so, one of the other analyses we look at is our dispersion analysis where we're trying to identify extremes in leadership and more importantly, extremes in flows into various sectors and style factors and right now, those extremes and flows don't necessarily say the market is ready for a big drawdown. So, investors have some time in terms of if they're shorter-term risk managers, they can take advantage of a post-Omicron bounce and being long things like pure reflation plays, cyclicals, and things of that nature.
That's certainly something that would seem to be supported by our near-term outlook. But if you're not that kind of investor, and you're someone who doesn't have the ability or doesn't want to pay to have the ability to actually time that exit, then you're probably better off doing what our research would suggest you do for the balance of this year, which is maintain a defensive exposure. Take down your overall beta in your portfolio, your overall volatility, your overall correlation of certain asset classes and high volatile, high beta risk assets.
Continue to buy bonds tactically, build up that position, build up some cash buffers, because again, I mince no words about this, the conditions are there for 20% to 30%, potentially 50% market decline.
MAGGIE LAKE: In equities?