ASH BENNINGTON: Welcome to Real Vision Daily Briefing. It's Wednesday, January 19, 2022. I'm Ash Bennington, joined shortly by Darius Dale. But first, here's what's happening. It looks like NASDAQ is officially into correction territory. This is the NASDAQ Composite closing out the day at 14,340, off the high of 16,057 on 19 November 2021. Lots happening against a backdrop of inflation and rising rates. We've got the perfect guest with us today to discuss it, Darius Dale. Darius, it's been a minute. It's macro time. It's Darius Dale time. What's going on, man?

DARIUS DALE: It's been too long, mate. I've been told that if I present the show in an English accent, I'll sound smarter.

ASH BENNINGTON: [?] to mention that we should just roll with it. Darius, listen, I know that it's always hard for people who love watching markets. Clearly, this is experiencing, people who are US equity investors experiencing some pain here. But there's something going on here in markets, it's obviously an exciting time to be doing what you do on the macro side. Tell us how are you thinking about this, the broad context of what's happening right now?

DARIUS DALE: Yeah, great question. It's great to be back. Appreciate everyone for joining and tuning in. I'll open it up with a quick summary, and then we can unpack it from there. I think this will be the first of many corrections we're likely to see throughout the year 2022. Obviously, it's pretty clear now that the Fed is on a doable path towards policy tightening that we're not quite sure is fully priced in. We think there's a little bit more to go in terms of baking in, marking expectations on what they're likely to do over the next 12 to 18 months with respect to the policy rate and the balance sheet.

And then with respect to the near-term trajectory, I've talked about this on the program over the last couple of months, but 2022 is going to be a year of normalization. It's going to be a year of normalization in growth. And the real key question is how fastest growth slow and normalize back towards its trend? It happens all at once, it happens all in 2022, we're going to have a lot more and a lot deeper corrections.

We're also going to see a normalization in inflation. The speed with which inflation normalizes will have a direct impact on policy tightening, because again, the Fed is a levels-oriented institution, markets tend to focus on the rate of change, but the Fed will react to the level of inflation at various intervals throughout the year. And then thirdly, there's normalization of monetary and fiscal policy.

And I would argue as a function of those two processes, we're likely to see normalization in asset market valuations particularly in the sectors of the market, namely high beta risk assets that have enjoyed a really, really good run on the tailwinds of record growth accelerations, inflation accelerations, obviously record nominal growth, or near record nominal growth, and obviously, some very aggressive monetary and fiscal easing. We can unpack any of that, happy to go deeper.

ASH BENNINGTON: Well, there's a lot to unpack there. That's a very comprehensive view of what's happening, obviously, some normalization, or at least more trending toward mean reversion I guess you could say, on some of the rates that you've mentioned. Also, the Fed policy actions. Let's specifically talk to something you brought up because you have a great chart today in your research note.

US inflation, two charts actually, US inflation secular view and US inflation cyclical view, talking precisely to that point. Unpack what you're seeing here as you see this rate looking like it's mean reverting, at least on these charts.

DARIUS DALE: Yeah, absolutely. The CPI chart contains the time series of inflation on the US basis. And then we show our two different models that we project inflation, and there's a couple key takeaways. One, we're traversing the peak in inflation. And I don't think we're particularly alone in making that view, a lot of economists share that view.

One thing I think that's important to note in that chart is if you look at our forecasts, we're running two separate models. We have a stationary mean reversion model, and then there's our Nowcast model, and one's more of an auto regressive framework. And that auto regressive framework, which is based on mean reversion on previous cycles, takes you to a level of inflation. And it's same with growth, a level of inflation that's significantly below consensus, significantly below consensus for growth in particular.

But if you run the same process with the Nowcast features, you actually get a much more sticky level of inflation so that you could argue that if you train them out, what that really means is if you're training the model based on what's happening in the pandemic, you're going to have a higher level of inflation throughout 2022. And if you train the model based on what's happened in previous cycles, you're likely to decay and decelerate much, much quickly, much more substantially throughout this year.

That obviously has policy implications, but when you put up that chart for growth, GDP, it's the same dynamic but I would argue it's even more disparate. I think the key takeaway from all this is, if we get a sharper than expected normalization in inflation, we're likely to see the Fed back off on monetary tightening at some point this year. But I don't think that's the bullish panacea that investors want. Because that also likely coincide with a sharper than expected deceleration in growth, which is a very, very big headwind for asset markets and something that come into question in the middle of this year.

ASH BENNINGTON: Yeah. Talk to what you see happening right now in terms of growth here in the US. Obviously, a critical driver of what's happening in equity markets, and more broadly in asset markets. What do you see happening there?

DARIUS DALE: In terms of the growth value dynamic?

ASH BENNINGTON: Well, we can talk about that as well, which is an interesting point. Give us a sense of what you think about in terms of the relationship of growth to earnings, growth to valuations.

DARIUS DALE: Yeah, that's a great point. We also are going to see-- normalization again is the theme next time I come here, and we have a [?] that says normalization, hashtag normalization, but we're going to see normalization in earnings. And I think the biggest normalization in earnings doesn't have anything to do with the growth rate, because everyone knows that earnings growth, they're likely to come down and we're likely to see more margin pressure than we've seen thus far in the pandemic.

Margins are at an all-time high for the S&P, so they have nowhere to go but down in that regard. And the speed of the growth normalization process will really dictate that. But when you talk about normalization on earnings, in my perspective, the one thing that I'm noting thus far throughout Q4 earnings season, 43 of the 500 S&P companies have reported and we're actually seeing that continued decay in the beat rate of both sales and earnings.

We're pretty low both in terms of the Q3 earnings season, and part of that was chalked up to delta and things of that nature. But what that's really telling me is that the market is really losing its ability to save the day with macroeconomic fundamentals. And we lose the ability to save the day with macroeconomic fundamentals that puts more onus on macroeconomic developments, change in growth, change in inflation, change in policy settings to be the real key driver of asset markets, and very clearly from our perspective, all those major drivers, growth, inflation, and policy being the principal components there are all moving in the wrong direction.

Markets are likely to continue to have a tough time this year. I don't think this is the real big correction we expect. We think that correction is very likely to commence sometime like late Q1, maybe early to mid Q2 in terms of our growth models, and what that's likely to project at that timeframe. We do believe you can buy this dip, but the reality is we're likely to be selling that rip at some point of the matter of the next couple of months.

ASH BENNINGTON: This is a crucial point thinking about it at the tactical versus strategic level, thinking and talking about multiple time horizons, how you can be short term bullish, but longer term or intermediate term bearish.

DARIUS DALE: Oh, yeah, absolutely. And this is something we talked about as well in just terms of helping coach retail, high net worth individuals, RIA type investors, institutional folks get this a lot. But when you're constructing a portfolio, it's not supposed to just represent your general view, I'm bullish, or I'm bearish or I have this long, very long-term secular view on growth or inflation and things of that nature. It's supposed to represent a combination of views that are both laid out across durations, short, medium, long term, but also laid out across themes, secular inflation, secular deflation.

At 42Macro, our themes are predicated on what we call our GRID process which marries the rate of change of growth and inflation and produce four distinct outcomes from the perspective of asset allocation. This Goldilocks, reflation, inflation, deflation, I'll let everyone go to our website to get more color on that. But the reality is at any given time in terms of how we're helping investors construct their portfolio and manage a lot of these building macro risks, it's all about understanding how those GRID regime probabilities are changing in real time and making the appropriate pivots to balance the portfolio in accordance with those changing probabilities.

ASH BENNINGTON: Yeah, by the way to call back to something we were just talking about a second ago, it appeared that for Q4 2021, we saw relatively weak earnings from banks, from financial institutions. By and large, the story there seemed to be relatively strong revenue, but rising costs eating into earnings. I guess that looks a little bit like an inflation scenario, doesn't it?

DARIUS DALE: Yeah, very much so. There's been three economic releases in the past few months that have really helped us change our tune on the Fed's policy setting. I wouldn't necessarily say we traded it all well perfectly, but certainly, it's helped us get up to speed on a lot of what that's happened in asset markets over the last few weeks, which is go back to the October CPI print. In our opinion, that October CPI print striking to the upside really took away the fiscal policy agenda, that incremental fiscal easing we were likely to see from a Build Back Better perspective.

And then when we got the November jobs report in early December, followed by the December jobs report in early January, to us, we saw some step function increases higher or jump conditions in the improvement in some of the more beleaguered parts of the labor market, whether you look at the female labor force participation rate, whether you look at the unemployment rate for the individuals that are maybe black, Hispanic, with a high school diploma, lacking high school diploma, all these pockets of the labor market, where our "woke" Fed is really focused on, we saw some positive jump conditions or junk conditions in the positive direction the last couple of months that told us, hey, look, the Fed has lost the ability to cite the labor market as a reason to remain easy.

In fact, I would argue going back to your question on inflation, if you look at the wage inflation dynamics, we're getting to a scary point. Looking at average weekly earnings in the December jobs report, that accelerated to a 12% seasonally adjusted annualized rate of change. It's the fastest rate we've seen since March of last year, so clearly seeing a buildup in wage pressures. And I think the more important dynamic with respect to wage pressures comes from twofold.

One, the lack of labor supply. Now we're seeing that with the prime working age labor force participation rate, in the most recent print. I think that was at 1.9. That number hasn't budged in six months. That's part of the reason we showed this wage chart, Brian, if you could put that wage chart up. The reason that we're up into the right with respect to wages, the red line is employment cost index, is because the blue line, the quits rate, is at an all-time high.

We got that data out of the JOLTS data, and so very clearly, folks who are still very much attached to the labor force are looking around and saying, hey, there's just less people doing what I do. And there's more demand for me as much demand as ever for my services from the JOLTS data, so let me go find higher wages. And that's exactly what I believe you said JP Morgan was citing that as well. I believe David Salomon is out today talking about that as well.

ASH BENNINGTON: Yeah. One of the things I always appreciate about these conversations, Darius, is that you dig in into the internal dynamics beneath the headline numbers on these reports, which is so important to do to really understand the full context of what's happening in these markets. I also wanted to talk a little bit about the Fed, since you've mentioned it, and it's come up a number of times. We were talking about this and reading some of the tweets that you've put out. The Fed obviously, figuring out what is happening with the trajectory of the rate path, understanding the way back to policy normalization.

These are all absolutely crucial things to understanding where these markets are headed. And I wanted to call out to a video. This is done by our own Roger Hirst, an insider's talk, how should we think about interest rates and inflation running today on Real Vision, on our Pro tier, speaking precisely this point. Let's take a look.

ROGER HIRST: Now, the second one is going to be bonds, the bonds framework. I'm going to kick off with really just thinking about what's going to happen this year, and then comparing it with what we've already seen over the last 10. This chart that I've got here is the Fed's balance sheet versus Fed funds.

And the reason why I'm showing this is sequencing. The sequencing of the end of QE to tightening to QT. It really started back in 2013, this first cycle, because we had the taper announcement, the taper tantrum, yields screamed higher. Well already, we can see a difference between then and now. And this time we've had a taper announcement and yields have edged a little bit higher, not particularly, we're still below 170.

But what is the key differential here is the timeframe. We had the taper announced in 2013. We had the actual taper of QE in 2014. And it was pretty much done by the end of 2014. Then we had a year before rates started to rise. And then towards the end of 2017 is when we started to see quantitative tightening where we saw the proper selloff or rundown of the Fed's balance sheet.

Before then, things had run off, gently been flatlining, slightly going lower. But this was anywhere between five and a half years, four years at best between the taper announcement and QT before eventually, QT and rate hikes cause the equity market to implode at the end of 2018. Today, we're talking about doing all of that, so the end of QE to nothing, no purchases, to rate hikes. That's going to be March, to potentially QT tightening, selling the balance sheet, all in a matter of six months versus three and half, four years before, it's happening at a much faster pace.

ASH BENNINGTON: There you have it, the great Roger Hirst doing what he does so well on Real Vision, breaking it all down, talking about the sequencing and the acceleration of the rate at which monetary policy is being normalized. Darius, what are your thoughts on this in a broader sense?

DARIUS DALE: Yeah. The Fed, and then by the way, that was an excellent clip. The Fed is trying to engineer significant reduction in inflation pressures in the economy without tightening financial conditions. That's preposterous, they're not going to be able to do that. I suspect the more market-oriented folks at the Fed are going, we're certainly losing them if you think about Clarida leaving, but the reality is, I think they know, at the end of the day that the joke is on them with respect to that expectation.

They're going to have to tighten financial conditions, in order to relieve some of the pressure, the demand pressure out of the US economy in order to get inflation, supply/demand dynamics back under control, because the risk if they don't do this, is that the wage pressure that we're starting to see, really starts to build up. And by the time the base effects kick out, because right now, they're kicking in to take inflation down from a cyclical perspective.

But once those base effects kick out, let's say early 2023, we might be at a significantly higher level of inflation than the Fed may be comfortable with in terms of perpetuating both longer term inflation expectations higher and also just inflate for consumers, but also perpetuating higher inflation expectations in the market. And I think the Fed is going to have to take some poison, if you will, in order to prevent that longer term doomsday scenario.

If they don't take the poison to prevent that longer term doomsday scenario, you're not going to have as rocky 2022 as we currently expect you will. We put up that chart, that market cycle chart, that's my favorite chart, I think that's the most important chart out there for 2022, which is understanding where you are in the market cycle. When global growth, the blue line in that chart is accelerating, you get paid to be long, high beta risk assets, relative to their low beta counterparts. You get paid to be long things like crypto and Bitcoin relative to cash and Treasury bonds.

However, when you're on the wrong side of the global growth cycle, you tend to lose money on both on absolute unreal basis in those kinds of exposures. And the speed with which those assets reprice both from a valuation and price perspective is really dictated by the speed of the normalization in growth and the speed of the normalization in policy. The Fed's got a lot of cards in their hands, we suspect just based on some of these wage dynamics that they have yet to really articulate.

They've talked about the unemployment rate, but they haven't really talked about the reduction, potentially a more permanent reduction in labor supply, perpetuating longer term wage inflation, and how that may ultimately, at the end of this early phase tightening process, may actually perpetuate higher inflation expectations. We haven't really seen them discuss that, so ultimately, they're going to have to acknowledge that.

We suspect they might start to acknowledge it next Wednesday at the FOMC meeting. They'll certainly have to acknowledge it by the march FOMC meeting. And that might be it as it relates to the market pricing in more and more tightening. But from there, we're still going to have to deal with the slowdown in growth and inflation.

ASH BENNINGTON: Well, you said that the rotation between these style factors just seems to be happening in such an incredible pace this time.

DARIUS DALE: Yeah.