ASH BENNINGTON: Welcome to the Real Vision "Daily Briefing." It's Monday, July 19, 2021. I'm Ash Bennington, joined today by Jack Farley and our guest, Darius Dale. Obviously, today is a difficult day in global equity markets, in US equity markets especially. Dow Jones Industrial Average the big loser on the day, off over 2%, 2.09%, settling down at 33,963. The Dow-- excuse me, the S&P 500 off more than 1.5%, down 1.58% off, settling at 4,258. Jack, what are you looking at?
JACK FARLEY: Well, Ash, as investors fled risk assets worldwide, they piled into the safe haven asset, that being the US Treasury market, with the US 10-year treasury yield dropping 11 basis points, from 1.29 now down to 1.18, which is the lowest level we've seen since February. Ash, what else is on your radar?
ASH BENNINGTON: Yeah, I'm also looking at energy, particularly the oil markets here. It's pretty ugly. WTI crude NYMEX off 8% on the day-- more than 8%-- settling down at $65.97, Brent off almost 7.5%, settling at $68.11. Not a pleasant day on the energy markets. Kind of a miserable day in equities. Fortunately we have Darius Dale here with us today to give us the big picture to bring some context to what we just saw in the capital markets, in commodities. Darius, how do you contextualize this in the big picture?
DARIUS DALE: Yeah, Ash, I would say the probability of the market regime transitioning to deflation just went up a lot today. Obviously, it's pretty clear to see that on the tape. But in terms of how we scored at 42 Macro through the lens of our global macro risk matrix, we're about as tight towards tilting to deflation as we possibly can be. In fact, all it's going to take is one more signal across those 42 indicators to actually break in a way that actually would amplify deflation probability to put that on.
ASH BENNINGTON: And Darius, you're transitioning right now from a Goldilocks view into a deflationary view. What are the key indicators that you're looking at? What is the place where you see the strongest intent of this transition? In other words, where do you see the strongest indicators that this is happening right now?
DARIUS DALE: Yeah, no, that's a great thing. So in terms of what happened today-- so we run this thing called our volatility adjusted momentum signal, which we're scoring price momentum relative to the regime of volatility to identify probable drawdown risk, probable breakout risk, things of that nature. So in terms of what happened today, we saw the DAX, the Euro STOXX 600, and WTI break down to neutral from the perspective of our volatility adjusted momentum signals from bullish. We also had bearish VAMS breakdowns today. VAMS is short for that-- or that's short for volatility adjusted momentum signal-- the Bloomberg Commodity Index, the euro, the British pound.
So those are the-- that's sort of the epicenter of what's happening today. And in terms of what I'm looking at for incremental signals, I would start by just focusing on WTI. We say if we go below $66-- we're at $66.30 right now. If we hold-- if we break down below $66 and hold below $66, that would actually catalyze a bearish VAMS breakdown. So keep that $66 number in your head. It's no surprise that we're closing right around there, because that's the signal line I think market participants are really worried about.
I would also highlight the Deutsche Bank Currency Volatility Index, CVIX on your Bloomberg terminals. If that number-- if we get we see a breakout above 640 on that, it's likely to catalyze a bullish breakout of the US dollar that would actually catalyze further bearish breakdowns across other commodity markets. And then lastly, high-yield OAS, this is something I haven't seen a lot of people talk about. But OAS is short for Option Adjusted Spreads. So it's the ratio-- or the spread of what you get when you own a junk bond relative to a US Treasury on an option adjusted basis, a call option adjusted basis. And that level of 335 has already been reached. We're tracking around 340, 345 this morning. If we stay above that, we're likely to see a bearish breakout in high-yield credit spreads, bearish breakdowns in high-yield credit prices.
ASH BENNINGTON: Darius, let me ask you one more big-picture question. I know you've explained it before on Real Vision and other places, but tell us a little bit more about the way VAMS works. How do you volatility adjust these market signals? And why is it significant in the way that you view indicators?
DARIUS DALE: It's a outstanding question, Ash. So I'm from the Mandlebrot school of risk management. I do believe, as he proved with his empirics, that volatility is often a leading indicator for price, particularly for big changes in price momentum. And so obviously, it's pretty easy to calculate price momentum. There's a million different ways to do it, exponential moving averages, simple moving averages, moving average convergence. That's the easy stuff.
How we actually overlay the volatility adjustment factor is we're actually looking at where volatility is relative to its distribution. If you break volatility into two medians, any time series of volatility, one side of the median for the asset, depending on if it's positively or negatively correlated with the asset, will likely produce higher levels of drawdown risk in the asset. And so what we're trying to do is identify, where in the local volatility regime do we cross over into that quantile that suggests there's higher drawdown risk for that particular asset? So when you see both volatility on the wrong side of the distribution and you see price starting to break down, that's what we call a bearish VAMS breakdown. And actually, we're starting to accumulate those.
JACK FARLEY: So Darius, with the VIX now at above 20, how does that impact your model?
DARIUS DALE: Yeah, no, the VIX would have to get above 27, or right around 27, to catalyze a bullish breakout in the equity volatility for that particular indicator. We've seen-- volatility and credit spreads, broadly, were bullish as recently as a few weeks ago. They actually, a couple weeks ago, really started to break to neutral. So moving from bearish to neutral is a positive delta. And then I think, as I highlighted with the credit spreads and obviously highlighted with the VIX level just now, we're obviously moving to levels that would start to catalyze broad risk-off signals.
So I spoke about this in my round over on "Wheaton" publication on Saturday. Hey, this is going to be very important week. We talked about this last time, and for at least a couple of weeks now. Deflation, when you think about the four different market regimes-- Goldilocks, reflation, some people call it stagflation, we call it inflation, and then lastly, deflation-- deflation-- among those four regimes, deflation has historically been the fastest to capture what we call the modal outcome title and actually become the dominant market regime that investors are risk managing on a trending basis. So knowing that, we understood that, hey, we're dangerously close in terms of neutrality that we're observing across the models that would suggest say, hey, this week could be very, very important in terms of investors finally pricing in deflation at the margin and actually having to make that full portfolio construction theta.
ASH BENNINGTON: Hey Jack, we said it at exactly the same time. I was about to throw to you to ask about the VIX. VIX right now at 22.49, off the day's highs but still up considerably, about 20-plus percent on the day. What are you thinking about what's happening in VIX tracking? How is it informing your view of the other things you're looking at in these markets?
JACK FARLEY: Well, let's see, so the VIX is the about 30-day implied volatility for options that you would get via what's called a variance swap. So the thought is when it increases, people are paying more for protection on the downside as well as for upside gains on the upside.
ASH BENNINGTON: This is on the-- this is on-- we should point out, this is on the S&P 500.
JACK FARLEY: Correct. So when we went into the crash in late February, early March, the VIX reached a high of somewhere in the 80s, I believe, with the high being on March 23, the day that Jerome Powell announced his decision to buy individual bonds. Actually, I think it was March 18. March 23 was the low for the S&P 500, excuse me. But Ash, to be honest, I haven't done a ton of work exploring the relationship between a spike in volatility and the S&P 500. I know, on an intraday basis, they are negatively correlated, as one would expect. Implied volatility goes up when the market goes down.
But Darius, my question for you is which do you think is the chicken, and which do you think is the egg? Which is the ultimate cause, and which is the effect, if that makes sense?
DARIUS DALE: I certainly believe that the volatility signal-- so I have a saying-- I'm not sure who the origin of the saying is, but it's certainly someone much smarter than I am-- volatility is the mathematical expression of fundamental uncertainty or certainty. i.e. if you're in a low-volatility state, that means the broader investor consensus has a lot of-- they're agreeing to agree on a lot of stuff. When you're in a higher-volatility state-- i.e. price changes are much higher, the liquidity isn't there for a price to change hand, for an asset to change hands-- that's usually when the fundamental outlook is becoming uncertain.
Now from the perspective of the investors who follow my work, there's nothing uncertain about the fundamental outlook. We the economy is going into what we call deflation from a bottom-up macro regime perspective. So again, the market regime is what the asset markets are doing. The macro regime is what the economy is doing. The market regime is usually trying to price in what the economy is doing 90% of-- 90-plus percent of the time. And so we know-- we have a lot of conviction in our view that the economy, starting in August or September, is likely to finally enter what we call deflation from a bottom-up macro regime perspective. So we always knew that the markets would have to price that in.
Now when the markets are going to catalyze that shift was anybody's guess. We could all use the Fed catalyst. We're all reading the Fed tea leaves. They're about as hard to drink as they've ever been, because obviously we have two certain-- two brand-new frameworks to analyze and really try to anticipate and front run Fed policy changes. But ultimately, there's a real big case to be made that the Fed is unlikely to change policy any time soon. But there's also a big case to be made that, yeah, everyone sort of gets that, but it's really just a matter of inevitability associated with that ultimate policy shift.
So the answer is I don't know. Well, I don't need to-- I don't actually need to know. All I know is the model needs to know. And if I wake up tomorrow morning and something else breaks, I think we'll be in deflation.
ASH BENNINGTON: Hey Darius, to that point, I'm curious what you thought about-- I guess it was on Friday-- consumer confidence number looking like it's rolling over, suggesting we hit a peak earlier, possibly as early as spring of this year. Does that play into, I would assume, your view of this deflationary scenario that we're entering?
DARIUS DALE: Yeah, absolutely. So let me take a step back and make sure I clarify for the viewers, when we say deflation from a bottom-up macro regime perspective, we're not talking about outright recession. We're not talking about the economy really kind of piking down. All we're saying is that the trending rate of change of both growth and inflation are likely to be dealt a negative for an extended period of time. And so yes, we've already seen this.
I mean, year over year rate of change data peaked in April. It's been rolling over since. The peak year survey indicator, they broadly peaked in May or June. They've been rolling over since. So it's really just a matter of time before the sequential momentum in the economy from reopening and vaccination dissipated to the point where you're going to start to see broad-based declines in PMIs and things that investor consensus really anchors on from a growth perspective.
ASH BENNINGTON: Yeah. So we're about halfway into this show, and nobody's said it yet, but coronavirus delta variant-- all over Bloomberg today, all over Twitter. What are you guys thinking about this? First, Jack, I'll go to you, and then we'll throw over to Darius.
JACK FARLEY: Sure Ash, well, what I noticed is that this is the first time in a while that the stock market, really, risk assets globally, have reacted to news of COVID. It hasn't been a very long time since 2020, since coordinated risk assets have sold off and bond yields have surged on news of a COVID variant. I might add, Ash, that during the heyday of-- the absolute peak in cases in the US for January and February, that was a very good time to be in risk assets, and SPACs, tech stocks, growth stocks. Obviously, that rolled over. But it's been totally possible for cases to be absolutely out of control and risk assets to be performing well.
But this is an interesting case where you saw that divergence. So Darius I want to ask you a question about this. Do you think this is different? And if I can bring it back to volatility, if you had shorted volatility every time it spiked in 2021, that would have been a phenomenal trade. There was some some meme stock madness going on in late January, early February. VIX spiked up to, what, high 30s or something?
If you had shorted that and faded that spike in volatility, you would have done enormously well. Is this spike in volatility to be faded as well, Darius? Or is this, if not a March 2020 moment, a moment where a spike in implied volatility is not be faded but to be bought, because it signals that risk assets will continue to deteriorate?
DARIUS DALE: Yeah, let me-- so I'll answer that question in two ways. One, I'm grateful that you brought up the spike in coronavirus case accounts, and hospitalizations, and deaths that we saw in the early part of-- late last year, early part of this year. And the difference between that and now is the economy is just fundamentally doing something very different. You go back to-- I don't know if I wore this shirt in my interview with Ed in December, but I certainly will when I interview with him in late May. And it kind of was the same-- it was certainly highlighting the same dynamics.
Back in December, I said, hey, all of the positivity that we're likely to see in risk assets this year, and all the negativity that-- the negative convexity we're likely to see in the fixed income market is likely to come in the first half of year, or maybe even spill over into the early part of the third quarter. And the reason for that is because the economy is fundamentally accelerating both inflation and growth. You had fiscal easing at the margins. You had monetary easing, obviously. And you have corporate profit growth accelerating.
There have been five-- or sorry, there have been 10 quarters since 1960 where all five of those things have happened. So that's pretty meaningful. In terms of why we're seeing charts that look like they do on a one-year, trailing one-year, trailing 18-month basis, that's why. So now we're losing a lot of those positive fundamental drivers.
So in terms of answering your question, the second part of my answer is, look, if we have a coronavirus slowdown, a new slowdown now, we just don't have the fundamental momentum in the economy from a growth perspective to really overcome that. And more importantly, it's very unlikely that we get bailed out by fiscal policy like we did in Q1. That's a very big difference. It's very unlikely we get incremental fiscal stimulus.
Obviously, they're trying to get the budget-- the budget reconciliation process is ongoing alongside the incremental infrastructure. But who knows what that's going to do? I mean obviously, if you have a strong view on DC, you're definitely not working here.
ASH BENNINGTON: So Darius, it does sort of rhyme though in terms of what we're seeing. We see the-- obviously, the surge in bond prices, yields falling dramatically. I'm looking at the sector analysis right now. It's been financials and energy competing on the day for who would be the worst performer, 1.92 off on financials, 1.86 off on energy. I think it was reversed a little bit earlier. This looks a lot like what we saw during the worst days of the closing down trade.
DARIUS DALE: Yeah, no, you're absolutely right. I mean, look, this is-- look, deflation-- the reason we look at the world from a regime segmentation perspective is because you tend to see low degrees of variance across time-- across the time series for various regimes with respect to sector and style factor leadership and laggership. There's a reason high data tends to not work in deflation. There's a reason defensives, and low-volatility, and high-quality names tend to outperform in deflation. People are seeking safety. They're seeking perceived safety within the asset classes that they must remain invested in and in asset classes they have a choice to be invested in. And I think that's what's driving this move, the spike in bond yields lower.
I mean, you go back to, I believe, on June 10, the day-- it was June 10 where the 10-year Treasury yield broke down a bearish VAMS the day after the 30-year Treasury yield in our model. And so this is not news to us in terms of what's happening. I think the acceleration to the downside, the convexity that we're experiencing to the downside is really starting to freak people out in terms of, OK, I have this very reflationary asset allocation, and at the bare minimum, I didn't sell enough reflation. And now I'm at this really critical juncture in the economy whereby something like a delta variant can actually have a lot-- much bigger impact than the second-wave surge that we saw in the spring and winter.
ASH BENNINGTON: So talking of delta and data, let's just review for our viewers what's happening right now, what the science is telling us. So the delta variant-- this is B16172-- has spread very rapidly in India and in Britain in particular. We know that it's more transmissible. It spreads more easily between people. Delta was 50% more transmissible than alpha, and alpha was 50% more transmissible than the original.
We were talking about, early in the crisis, the R0 number. This is the number of people who are infected by any one given person on average. Obviously, anyone who's familiar with exponential functions knows how quickly raising an exponential function can change the output several steps down the line. R0 was 2.5 on the original. For delta, it's somewhere between 3.5% to 4%. And data out of the UK shows that kids and adults under 50 are 2.5 times more likely to be infected with delta than other variants. This is obviously something that is a bit troublesome when we look at those numbers, obviously relatively early studies, geographically isolated.
But there's also a Scottish study that suggests that delta is more severe, specifically that the delta variant causes 2x-- two times-- the amount of hospitalization in unvaccinated individuals. And a Chinese study shows that viral load from delta variant is