MAGGIE LAKE: Is the US economy headed for a soft landing, or are investors too complacent about inflation and the Fed's determination to rein it in? Hi, everyone. Welcome to the Daily Briefing. Harry Melandri, advisor at MI2, is here with us today to help us sort through the inflation data and the market's choppy reaction today. Hi, Harry.
HARRY MELANDRI: Hi, Maggie. Great to see you again.
MAGGIE LAKE: Yeah, it's good to see you. So, we had a PPI number that came in today, a little bit lower than expected, really mirroring what we saw with the CPI number. We also had the less talked about US jobless claims. They were rising again. What are you thinking about the US economy right now?
HARRY MELANDRI: It's a broad question, but on the economy, the economy is slowing. There's little doubt about that. Whether it's slowing at a pace that would reduce inflation and get the Fed off the market's back is a different matter. I don't believe in the happy ever after, happy ending here. I just can't see how the slowdown is going to be sufficiently deep without additional delivered hikes to satisfy the Fed.
MAGGIE LAKE: Yeah, because what seemed to happen, and I don't know, tell me if this is what it looked like to you. But it can be confusing, because we seem to have a situation when we saw the easing. And by the way, the year-over-year numbers are still really high, but it's decelerating. Everyone thought, oh, okay, inflation is going down. We're going to have a recession, but it's going to all happen, condensed in a fashion that the Fed's going to be able to pivot and that recession will look something like a soft landing, like the perfect track.
We know the Fed has a terrible track record on that. But that seemed to be what the sense was coming through yesterday. Today, it looks like people are rethinking that a little bit. But what is it that you think people are grappling over? Where is the disagreement? Why do we see this knee jerk reaction and everything?
HARRY MELANDRI: So, I think the first observation I'd make is that the best money managers in the world are probably mostly at the beach, right here right now. So, a large amount of the decision-making capacity of this market is choosing not to make a decision. And that's August markets are always thin, August markets are always choppy, I'm glad it hasn't been even thinner, even choppier, because they can get really nasty. So, that's one observation.
A second observation is that the pain trade for this market, and particularly the professionals is higher. The long, short equity guys, I think they did a great job navigating the fall, the decline in stocks, not so great getting any exposure to this kind of rally. And I'm just watching the WallStreetBets guys. I don't really follow that up as often as they should, those guys are really sharp.
Do not think of these people as retail. That ain't retail. That's sharp money with a big retail following. They found some shorts I had on in my personal account. And luckily, luckily, these are not a huge trade. So, they didn't tear my legs off or anything. But I had Bed Bath and Beyond, I was short that. I personally think it's a dead company. But maybe I haven't been in recently. It's just an opinion.
But that thing ran up 40% or something. August market, big short base. Great idea, guys. I'm with you. I see why you went for it. The pain trade, I think, for the hedge fund managers and for a good block of real money is higher. They don't have their full allocation.
MAGGIE LAKE: Wow, that's really interesting. It's funny that you brought up that because we have been-- and it's been puzzling. We've been getting questions from viewers on that. What do you make of the fact that people are in these meme stocks again? I think people are looking at it as some kind of sentiment indicator or is it something that are a risk on indicator? From what you're saying, it's just some really savvy people taking a look at where there is an imbalance or an opportunity.
Tommy Thornton tweeted out something to that effect today and said-- but I still think on the opposite side of this. If you missed the downside short trade with all the garbage stocks in the last year, the good news is you're going to get a second chance. Yeah, people are just looking at this like, I can't believe it, scratching their heads and what is a really difficult environment, as you just described, but we have this meme thing going. It was easier to understand when it was a raging bull market and everything was going up. What are you thinking about this? Is this going to lower, a lot of people in for some pain again, or?
HARRY MELANDRI: If you haven't buy a particular part of their body, their hearts and minds will eventually follow. So, yeah, it could force people out of trades. I think, me personally, I don't buy it. I was chatting just now, I do a podcast too. And I was just chatting to a technician, a guy called [?]. He's a fantastic technician. And I hadn't realized that we're near pivots in a whole bunch of interesting place. Look, I can always be wrong.
My mother, if she was still around, would tell you, oh, yeah, he can definitely be wrong. So, don't be a total surprise about this. Me personally, I'm bearish. I'm bearish risk. I'm bearish risk because I have a whole bunch of Fed watching friends from other jobs I've done in the past, my Fed watching contacts are telling me that means business, rates are going to 3%, 3.5%, probably 3.5% the market is just about right in where they think rates are going.
But if inflation doesn't come down in a timely fashion, the Fed will do more, because Fed officials don't want to be embarrassed. Nobody wants to be the new Arthur Burns, sorry, Mrs. Burns and other Burns relatives. So, with that in mind, if we have inflation above where the Fed wants it, we can get more hikes than are currently priced. And what I'm also being told is the notion that we should cut rates, they will cut rates soon afterwards.
So, we've got like 60 basis points nearly of cuts priced into 2023 after we peak in March. People, when I talk to people about it, they resist that notion. The idea isn't that the Fed's going to keep jacking up rates forever, but the Fed will do something akin to putting them where they think roughly they should be, like 3.5%, maybe a little higher than that.
And then leave them that. Squeeze out some of the spec and to soften up this economy. And labor markets are tight. I see it around me. I don't know if you see it as well.
MAGGIE LAKE: Oh, absolutely, absolutely. But this is where, so just pause for one second, the podcasts Harry does is The Next Big Trade because I know people are going to try to find it. Because the idea that we're at a pivot point on many things is super interesting, so I myself want to hear what [?] had to say. So, it's The Next Big Trade. You can find it wherever you find your podcasts.
And Harry started out working at the Bank of England. And that's just the beginning of his long career. So, when he says he has a lot of people who follow central banks, he's not kidding. Do you think, on the labor market point, though, I know that you moderate with Macro Insiders with Raoul and Julian and they're always saying, and Raoul was always saying the labor market's a lagging indicator.
HARRY MELANDRI: It is a lagging indicator. But I would argue that despite the fact that it's a lagging indicator, it's embarrassing for central bankers here and now to have 8% inflation, 8.5% inflation, and to have a labor market super tight. So, they need to raise rates, they need to tighten financial conditions.
And equity markets rallying doesn't do anything to tighten financial conditions. Financial conditions are way too loose relative to the real economy's performance and inflation. This doesn't compute, if you will, not consistent.
MAGGIE LAKE: And every time the stock market rallies, that happens. You're working against what the Fed is trying to do. Harry, it's really interesting. Everyone's been so fixated on rates, will they hike 75, 50? How long were they continue hiking? What's happening with quantitative tightening? No one's been talking about that. Is that contributing to tighter financial conditions? Is that a lever they have to operate in this environment?
HARRY MELANDRI: So, incrementally it will be. It's only just starting. It's only just starting, and I forgotten the run rate for QT. For some reasons, 90 billion a month rings a bell. And after a while, 90 billion here, 90 billion there eventually adds up to real money. I think I'm very concerned about risk markets, despite the rally.
And as I said, technically, we could pivot. I could reach stops and decide, you know what, you don't know what's going on. Get out. But because that's QT is happening simultaneously with much higher rates and simultaneously with issues surrounding bank ratios, bank risk ratios like SLRs. So, my understanding is banks will have to lighten up by about 90 billion risk weighted assets by yearend, it may be by March of 2023. None of this is particularly bullish.
Now, my one caveat is when I'm looking at signs of stress, I see stress in the real estate market. And I don't think that's difficult to spot, I think a lot of guys have probably better briefed me on what's going on in real estate. I see stresses in the private equity market, some of that pressure will have come off. But most of all, I see stresses in the emerging markets. I see stresses outside of the US.
MAGGIE LAKE: Yeah, this is something that we've talked about a lot. And for our regular viewers and members, you'll hear people all the time talking about the dollar wrecking ball, the US dollar has been so strong, you're starting to see strains in emerging markets. I spoke with Mark Mobius, a longtime emerging market investor, and he, I think, painted the dilemma that people find themselves in when they're trying to figure out directionally what's happening with equity markets, with markets and including those in emerging markets. Let's have a listen to what he said and then we'll talk on the other side.
HARRY MELANDRI: Sure.
MARK MOBIUS: Well, you must remember that we're now really in a bear market, the market is hit 30% down depending on what index you're looking at. So, usually, in such cases, there are opportunities, no question, it's a good opportunity to be looking at stocks that may be selling at very low prices. So, yeah, I would say, it would be a good idea to start nibbling, let's put it that way.
But I also feel that there's a chance for the other shoe to drop, so to speak, because the Fed will definitely have to raise rates more and more. The playbook is that interest rates have to go higher than inflation. So, with inflation now at about 9%, that's where interest rates have to go. So, in that case, a lot of companies will be hurting, the housing market will be hit. So, all these factors are still in play but the market in some ways has anticipated that kind of movement. So, I would say it's good idea to be nibbling, but not put everything in.
MAGGIE LAKE: Now, it's probably important to point out because we just got a little snippet there, the full interview is available on the platform. And I think you need to really watch the whole thing to get context, because Mobius is a long-term investor, his time horizon is long. So, when he's talking about starting to nibble, he's looking years out. And he has a bottoms up approach, which is interesting. I didn't really know that about him.
And so, those factors matter when he's talking about, yeah, you can start nibbling, and then he goes on to describe what is pretty horrible in the short term. So, I think that's important to keep in mind. He's very concerned about Taiwan, he has some fascinating comments about Taiwan and China. And also about crypto. There's a wild debate raging on The Exchange right now, feel free to chime in or on Twitter, because he loves digital assets but does not have positive things say about Bitcoin and Ethereum.
So, go check that out. But Harry, he presented both sides of the coin there. What are you watching in emerging markets that has you concerned?
HARRY MELANDRI: On my positions? So, I've got a load of RG, restructured sovereign debt, enough for my wife to ask me about it occasionally. And that stuff has been crushed, absolutely crushed. I think it's cheap personally, but I make mistakes. And this may be one of them.
But if you look around all over the Nigerian sovereign debt, I know that we're talking off peace when we talk about Nigerian government bonds, but Nigerian dollar debt, that was trading at 14% too. Nigeria's got a 20% debt to GDP ratio, that's stupid. So, why? Apparently, they have oil. Rumor has it. So, you can see that there's a lot of stress on the balance sheet of EM investors. They are not carrying the paper happily.
And I think that's because a lot of people who naturally carry this paper up are struggling to get hold of dollars. I have friends who talk to Asian investors, bigger Asian investors, and they have been reporting significant stresses in obtaining dollar financing for non-US entities, people paying way above what you might think of as the right price for dollar financing to carry them through and some this might reflect--
If you decide to guess what's causing that, I'd say that maybe Asian entities who have clients on the West Coast of the US are struggling a bit to fulfill orders, or receive payments, maybe their clients have stopped buying as much because of the private equity slowdown in some of those clients. But at the margin, some of our tech giants are hiring a little less, spending a little less. So, maybe it's to do with that. But generally speaking, the dollar rallying and dollar rates going up makes it hard to get hold of dollar financing if you're short.
MAGGIE LAKE: Yeah, I think you've talked to Jeff Snider, didn't you, for your podcast as well. And he's always focused on collateral scarcity and the concerns in the system. It can be hard to get your head around, but worth taking a dive in and super interested in that conversation. I want to get a couple questions in because we have them coming in.
And in Jimmy D, I think that you're asking a question that is how we started, which is, hi, Maggie, could you ask Harry what are the chances of a range bound market here with S&P 500 at a 3800 to 4200 range and oil 90 to 110 for some months, and inflation is still high, but getting less bad slowly? It's that soft landing, I don't think we want to call it Goldilocks, but it's that scenario everyone's hoping for, but it seems like there's a pretty narrow path for that, Harry.
HARRY MELANDRI: I don't know why they'd be hoping for it, doesn't make any sense to me. If you have stocks, and you don't like the idea, they might go down, sell them. If you don't have them, then you want them to go down. But is it possible? Yeah, it really is possible. It's not my core scenario, because I don't believe in soft landings. I'm an old man, you can tell by looking at me. I haven't seen many soft landings, I really haven't.
And, first, to get a soft landing, one of the things you have to assume is that inflation is going to cooperate and go straight back in its books. Well, observation number one about stocks is that with 10% inflation, stocks got 10% cheaper in real terms. So, you got to 10% at one point, we were down to maybe 25%, 30%. So, all in, you were down 30%, 35%, 40%, that's not a bad discount, and I can see why the market might repudiate that level and come back up.
Even here, they will trade with a 10% discount because of inflation. And they are real assets. So, most of these companies have something, either a factory or something which should retain value. They even have debt against them, which means they'll benefit from the inflation in some way, with fixed rate. So, that's one observation about why we might just chop wood at these levels.
It's definitely not my core scenario, because I'd say there's probably more spec in this market than meets the eye. And generally, that has to get squeezed out.
MAGGIE LAKE: More speculation. Is it retail? Because people had been thinking that professionals are out of the equity market, but retail has hung in there, h igh net worth individuals have hung in there.
HARRY MELANDRI: Right. So, that's definitely true, particularly high net worth. And I think high net worth may have been funding some of those-- may have a levered book. I have this sneaking suspicion from some of the anecdotes I've heard that if you're an average American high net worth individual, like me, actually, I'm not that high net worth, but never mind. I could be higher, I could be higher.
MAGGIE LAKE: You talked about that in the podcast we talked about. We talked about some Harry's best and worst trades in his life, which trades he's best in.
HARRY MELANDRI: But I've certainly both seen and heard and talked to other people who have suggested these trades to me where you take your equity book and use it to finance real estate purchases. People have done that. People have encouraged me and I have done some of these trades that go into private equity in the last three to four years. Not all of those trades look so smart right now. I've done it. I don't see why other people wouldn't.
And I was resistant to it because it felt late cycle already. You don't want to do private equity late cycle. So, I would guess that if I've done it, other people have done it and it's an easy thing to do. It made sense. People could give you a great story as to why you should do it. If you do private equity, you're getting in at levels and rate multiples, which are better than the public market.
Not as better as they should have been done, not as cheap as it should have been. But a battle of-- there was a great story for it. It's not difficult to think that maybe there's a bunch of high-net-worth individuals who are a little bit over their skis, and I definitely have seen anecdotes about Rolexes coming out. Secondhand Rolex prices have been dropping, secondhand watches have been coming down, light airplanes, small boats. These are coming out. There are all sorts of good reasons why. I wonder.