ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Monday, January 24, 2022. I'm Ash Bennington, joined today by Real Vision's own Weston Nakamura. A lot going on to discuss today with Weston. Geopolitical instability driving volatility across asset classes, global equities selling off but then at the end of the day, it looks like we're in green territory, positive territory on all US equity indexes, a striking day. Crypto also continuing to get hammered. We're going to talk more about this. This all comes in the wake of rising tensions between Russia and Ukraine in Eastern Europe. Much to talk about today with Weston Nakamura. Weston, welcome back to the show.
WESTON NAKAMURA: Thank you, sir. How are you Ash? What are you doing in my place?
ASH BENNINGTON: I'm trying not to get whiplash from US equity markets.
WESTON NAKAMURA: OK. Good luck avoiding that. Pretty wild day.
ASH BENNINGTON: Obviously a lot going on today. Wild day, wild week. What do you see? What are you looking at? Most important, tell us your view.
WESTON NAKAMURA: OK, so the Fed obviously is right up on us. What is happening in the markets in terms of this risk, the risk off at least-- especially today? This is not the Fed. This is by and large driven by, as you just mentioned, what is happening geopolitically in Ukraine. The reason I say that is very simply, if you look at two charts-- I tweeted them out earlier-- but one is if you just look at a chart of the euro ruble and you just throw that on top of the S&P 500 or you have to invert that. Or you just leave it as is and you throw it on top of the VIX, you'll see that they-- intraday basis, they line up very, very closely. Another chart is that if you look at the--
ASH BENNINGTON: So what this is showing, Wes, and just so for people who aren't familiar with macro and global markets as you are, so what this is showing essentially is when the Russian ruble is selling off against the euro, we're seeing that tracking exactly with what's happening in US equity markets. And also in the VIX. In other words, geopolitical tension rising declines in US equity markets.
WESTON NAKAMURA: Correct. Because I mean, if Putin and company, if they invade Ukraine and then you start to get a lot of aggressive hawkish talk out of the Biden administration and out of the UK as well, but there's a lot of uncertainty around there. But they're going to hit Russia with sanctions, this and that and it's going to be a very ruble negative. So euro ruble that's going to trade down. You see it trading sharply-- well, euro ruble trading sharply higher. And that corresponds in line with the price action of the S&P 500.
Also if you just look at the equity markets from a global open to close, so starting from my side of the planet with the NKY from the DM markets. The NKY opened down something like 1.25%. But it basically just rallied all the way up and it closed on the green from being down 1.25%. Euro stocks, however, they opened down and they closed down like over 4%, not just SX 5E but like the DAX, the CEC, like they all just closed on a straight line down.
And then during that overlap period, you see the US open. You see equities get pulled down during US cash hours until Europe markets closed, at which point your US stocks rebound after being dragged down by Europe and they closed green. So what's happening is it's Europe and the European geopolitical risk that is pulling global risk assets down.
ASH BENNINGTON: Talk a little bit about that. Give us your framework for thinking about why we're seeing declines in European equities as a consequence of this geopolitical instability.
WESTON NAKAMURA: I mean, I guess it would be sort of a-- for once in a very, very long time, certainly I guess within my lifetime, sort of this like Western alliance but leaderless, Western alliance. And it's certainly the first kind of major geopolitical conflict within the Biden administration.
ASH BENNINGTON: Right.
WESTON NAKAMURA: You know, [INAUDIBLE] really was but absent an Angela Merkel and all of these sort of-- like a vacuum of leadership or at least conflicting leadership. I mean, you have nat gas, you have Putin with leverage over that, over Europe. You have the winter.
You have China involved basically. We have Xi Jinping saying, do not start invading countries heading into the Olympics. We are going to have a global orderly Olympics. Putin cannot wait until the end of the Olympics because it'll start to get warm out and will no longer have his nat gas leverage. There's so many like different parts that are-- any one of them could be a source of major uncertainty and volatility in and of itself. So versus like the Fed, which everyone knows what? They're going to cut rates?
ASH BENNINGTON: Let me just add three quick data points here around what's happening in Ukraine right now in Eastern Europe. So first of all, the Russo Ukrainian war has been an ongoing conflict. Over 10,000 people have already unfortunately died in that war that began in 2014. The fear now, the concern, is that there is going to be a large scale invasion of Ukraine by Russia. That's the worry. That's the concern. That's particularly troubling because Ukraine borders Romania and Poland, both of which are within the NATO alliance, part of the Article V mutual protection agreement, meaning that this has direct geopolitical impact vis-a-vis the United States and Western allies.
And finally, reporting today by The New York Times that President Biden is considering putting US troops into the region. And that is obviously something that is potentially a direct involvement for the United States. Again, this is being reported by The New York Times. It has not been confirmed by the White House. So that's just the general framework. Weston, you transitioned there a little bit to talk about what's happening more broadly in the macroeconomic sphere with inflation and the Fed. Give us a sense of what you're thinking is there.
WESTON NAKAMURA: Regarding the Fed for this upcoming FOMC policy or?
ASH BENNINGTON: Well, yeah. You essentially said that you think that the risk is baked in. I would say, look, the Fed is having problems right now on both sides of the mandate, the dual mandate. You have effectively CPI at higher rates than we've seen at any point in the last 40 years. This is considerable inflationary pressure while meanwhile, at the same time, while we've seen a kind of baseline recovery on the unemployment rate, we're still negative 3.6 million jobs dating back to February of 2020 at the beginning of the COVID crisis.
This is a challenging time for the Fed. Obviously they've begun the taper. There's talk now about interest rate normalization in the wake of rising inflation and potentially unwinding the balance sheet. How do you parse all of these variables?
WESTON NAKAMURA: So I would say that I guess from the beginning of this year, which is obviously not too long ago, certainly the sell side banks have kind of gotten into this competition of trying to outhawk each other with how hawkish the Fed is going to be. And right now you have markets pricing in I think four rate hikes. You have a 50 basis point rate hike for March and all that. I think that is a little bit excessive in terms of not what they should do anything like that but what's actually going to transpire.
And I think also that if the Fed doesn't deliver on a very, I guess, super hawkish, relative to how they've been the last several years, super hawkish sort of message this week, then that's going to seriously kind of throw a I guess sort of like a whipsaw into markets directionally. You're probably not going to see a flood risk on but you're going to see a lot of short covering and a lot of volatility, upside volatility, which is not any more pleasant than downside volatility.
The one thing I'll also say too regarding-- I mean, there's obviously a lot of cross asset sort of correlations but, Brian, if you actually pull up this chart of eurodollar futures versus Bitcoin, so the last time I was on the Daily Briefing, Maggie had asked me about do FOMC-- does the hawkish Fed have any impact on Bitcoin? And basically what I said was no because Bitcoin traders probably don't really care about FOMC expectations. And what I was referring to in my defense was dot plots and all that kind of thing.
But nonetheless, I looked into it later that day. It turns out that was very, very wrong. So December 22 year dollar futures. That's the orange. They actually do trade very much in line with Bitcoin spot and that's kind more of a recent phenomenon. And if you look at the bottom part of the chart, that's kind of zoomed in for like a year to date, last few days or so. And you'll see that of trades inverse for a little bit but. But then starting at the beginning of the year, when the volume drops, after the volume picks up again, they really just kind of lock into place.
So you might see a situation in which right now eurodollar futures are pricing in, like I said, are very kind of hawkish Fed. And if the Fed, for whatever reason, because risk assets have sold off a lot or whatever it is, but if they aren't as hawkish as the market is kind of positioned for and eurodollar futures start to trade upwards. And that might actually put at least a temporary floor under or stop the momentum under risk assets, including Bitcoin and S&P and other things too.
ASH BENNINGTON: So those declining eurodollar futures inversely correlate with the rate. In other words, those are showing a hawkish tightening stance being priced into eurodollar futures markets by the Fed.
WESTON NAKAMURA: Yeah. So when those trade down, that's basically rate hikes. The Fed funds rates, front end rates being pulled up.
ASH BENNINGTON: Yeah. Weston, by the way, much to talk about here with Bitcoin and crypto. But while we're talking about the Fed, while we're talking about inflation, I wanted to turn to an interview on Real Vision today. This is an interview between Rob Arnott interviewing the economist John Cochrane, a piece called "Why Chronic Misdiagnosis Will Lead to Persistent Inflation." This is on the essential pro and plus tier here at Real Vision. Let's take a look at the clip.
JOHN COCHRANE: The other feature you should keep in mind is inflation is-- it's like a bank run. It's like stocks. The central mechanism of inflation is if we knew exactly inflation would be higher next year, then everyone would go out raise prices now. We'd have inflation right now and everyone would demand higher wages right now. And everyone would be willing to pay those higher prices right now. Just like stocks. If you knew stocks would be higher next year, you'd go out and buy them and they'd go up today.
So inflation is inherently hard to predict and a lot of the mechanism is like a bank run. It's like a crisis. If you knew there was going to be a bank run tomorrow, you'd go get your money today and out we go. So the way I think of it is inflation is like a fault line. It's like an earthquake fault. I live in California on an earthquake fault, haven't had an earthquake fault in 10 years either but that doesn't mean you shouldn't worry about one breaking up.
To add to that, so this one was much larger. This is how Larry Summers got it right. He took out a back of an envelope, he said my best guess of the GDP cap is-- I forget his numbers but I'll make something up-- of my best guess the GDP gap is about $2 trillion. They showered us with $5 trillion of money. Bing, there's going to be inflation. And Larry's back of the envelope said it was less last time. Also last time there was credibly a lack of demand, if you want to use some simple term for why we had a recession.
This time, a COVID crisis and lockdown is not a lack of demand. You can give people all the money you want. When there's a pandemic out, they're not going out to dinner. It's like a big snowstorm as far as the economy is concerned. So treating it with extra demand was simply a mistake. You had a supply shift. The economy is locked down and it's not-- the restaurants are not empty because people don't have enough money to buy things. The restaurants are empty because they're legally locked down and no one wants to go to them. So there's a fundamental misdiagnosis of the need for further stimulus.
ASH BENNINGTON: Well, there you have it. A fundamental misdiagnosis, this idea of 2 and 1/2 times the demand cap being put on fiscal policy stimulus. This sets up the case for structural inflation. Weston, you and I were talking a little bit as the clip was running about your thoughts on how to position for this scenario.
WESTON NAKAMURA: Yeah, it's not really a position for this particular scenario but I actually had a trade on in which to play this current market that I kind of want to share with the audience.
ASH BENNINGTON: Yeah, walk us through it.
WESTON NAKAMURA: This is not trading advice. OK, here's a disclaimer. If you listen to me, you will lose money because this is a very bad idea. That's as clear as I can get, OK?
ASH BENNINGTON: I've never heard that disclaimer before.
WESTON NAKAMURA: Yeah, that's as clear as-- and if you want to use me as a reverse indicator, you'll still somehow lose money. So just don't. Just don't. So now, it's very dangerous for me to at least be outright short anything. The unlimited upside and the limited-- or the limited upside and unlimited downside is not appealing risk for it. I like to do pair trades, market neutral pair trades, where you short something, you take the proceeds and you go long something and therefore, you actually don't have any sort of out of pocket capital outlay. And if you do it sort directionally market neutral, then you actually reduce your volatility.
So a way that I've been playing the downside for like NASDAQ, for US tech for example, is that I've been taking advantage of this Sony sell off. So Sony sold off because Microsoft put a bid for ATVI, at $95 per share and that basically just crushed Sony shares. Sony had its worst single day drop since October of 2008. October of 2008, when Lehman you know, destroyed the world. Because Microsoft went long Call of Duty and the metaverse.
So seems basically every sort of bad news is kind of currently priced into Sony. And that sets up for a really interesting pair trade in which you can go long Sony and short-- I actually used-- you use the Qs, but I actually used the tech sector ETF. So if you look at, Brian, if you go to the first chart, is that up already? Yeah.
So basically what you have here is Sony is a Japanese company, trades on the Tokyo Stock Exchange. So basically, I have both the ADR and 6758 Sony up. And what you see here is this huge drop led by the US. But then you see this enormous drop further during Japan hours. And basically, Sony gets crushed because of Japanese panic selling. That was sort of this kind of opportunity for me to do this pair trade. So second chart is basically-- go to the second chart, Brian.
This is yeah, same thing versus the NKY. And you could see the NKY has not been doing well. It's down 4% over that time. But you can see how badly Sony got crushed. That makes it a great opportunity for you to go long this because basically every sort of bad news is priced in from a single stock perspective as well as a broader sell off perspective.
Third chart is-- OK, so these are basically the sectors. This XLK is the ETF that I'm using to go short but you can use the stocks, Philadelphia Semiconductor ETF as well. And you'll see that Sony is just kind of just underperforming all of those. The next chart, this is the actual long short. So this is-- since I put it on, this is just about two days ago Sony has kind of recovered a little bit. XLK is down 5%. This was before today's open. And this pair trade-- this market neutral pair trade is up about 6% right now as we speak.
And then next chart is-- this is since the March 2020 sell off. And you'll see that Sony actually does track XLK quite well. This is why I chose. It but it is not a member of XLK. However, many of its competitors are in it. So it makes it sort of a perfect sort of long short setup. Then final chart is-- what's the date? What is the [INAUDIBLE]? Oh yeah, again, this is just the pair trade. So this is the way that you could actually-- this is not a long Sony trade or anything like that.
This is more so a short SPX tech. But you could do it hedged because Sony has just been crushed and sold off and not in the way that Peloton did and not the way that Netflix did. Those are fundamental to those specific companies. This is because of a takeover that might not even go through. I think Microsoft offered $95 per share. Activision never even got up. I think it got up to like $86 so even Activision shareholders aren't really believing, aren't buying it or selling it in this case.
So this is just sort of a way that you can hedge a short position, play the downside and really, you're kind of market neutral directionally and you're neutralizing all of the volatility as well. And then you're neutralizing cost. So this is just something I have on. It's probably short term. If Sony reports earnings in the beginning of February, if the stock pops like it has times over the last several earnings, I'm going to have to take off the trade, which is kind of unfortunate because I want to play more of the downside if that should continue.
But that's basically a way that you can think about playing the downside for situations like this. Because this is not like-- this is an actual sell off. This is not like some gamma flip or some mechanical like March 2020 sort of situation. This is an actual orderly sell off that's taking place right now.
ASH BENNINGTON: Yeah. Really interesting, Weston. Always a pleasure to take a look at those charts, look at your correlations. Fascinating stuff. By the way, talking about sell offs, we mentioned earlier in the show a couple of times, actually, what's happening right now in cryptocurrency. I want to jump in here a little bit. Actually, while we've been talking it looks like Bitcoin up over 37,000. I'm looking right now on CoinGecko. It's really interesting to see the volatility in this asset class. Let me give a little bit of context here of what we're looking at and a little bit of the historical framework and there it