MAGGIE LAKE: As the economic dashboard is blinking red, is the global economy headed into recession? Hi, everyone. Welcome to the Daily Briefing. Michael Gayed, CEO and portfolio manager at Toroso Investments is here with us today. Hi, Michael. Welcome back.
MICHAEL GAYED: I'm good. I'm good. Thank you.
MAGGIE LAKE: Good, good. Well, so interesting day we had a batch, a whole batch of really negative headlines almost right out of the gate for the US trading day. Anyway, Chinese authorities surprising everyone cutting rates after signs of widespread slowing there, New York manufacturing activity falling off a cliff, US homebuilder confidence collapsing, and yet we had US equities rallying. What do you make of the market action that we're seeing?
MICHAEL GAYED: Fear of missing it is more powerful than fear of a decline when you're in an environment like this. Look, this is you could argue a classic momentum type of environment. You had a lot of movement coming out of the lows of June 16th in small caps. And by the way, in Treasuries, which we'll talk about, that momentum looks like it wants to stick and yes, markets are forward looking. But I don't think anybody should be surprised that you have some continued drift here just because everyone now is forced to chase.
I don't think anybody really anticipated that a move that started really mid-June to where we are today when the bearishness was so negative and the positioning was so negative. So this is one of those catch-up moments for risk seeking behavior. Now, having said that, there is going to be I think, at some point, some realization that this is probably an overshoot. And as I've said many times on Twitter, the problem with these formations and markets that look like a V is you don't know if it's a V, or if it's a W, meaning you could clearly retest the lows as bearish sentiment maybe comes back in.
MAGGIE LAKE: I think that's what everyone is worried about. That is what everyone is grappling with. And to be honest with you, there's a lot of divide in the market. We could just see it playing out in the conversations that we're having amongst our viewers. And I think it's amplified everywhere else as well. So you tweeted something interesting that we talked about briefly over email, and it caught our eye. And that is that we were talking about how tough this market is.
We have divided opinion, but we also have markets behaving in a way that is a little confounding. And you tweeted out that we've never seen a time in history where we saw a significant drawdown in Treasuries and stocks. So clearly, it's making things tough, but what's the significance of that? What's going on with these market dynamics? Shouldn't these things be moving in the opposite direction?
MICHAEL GAYED: Yeah. So if you pull up that chart, what that's really showing is that historically, in these high volatility pulses for equities, these big drawdowns in equities, it's in my opinion going back to 1961. Usually, Treasuries act as the "safe haven" play where they are either down less, or in many cases, actually up while stocks are going down. We've never seen in a very, very big decline a match to big decline in Treasuries' spike in yield, which is what we saw in the first six months of the year.
Interestingly enough about that chart, it's so happened that it ended June 16th, which is when I ran that chart, which is pretty much the low coincidentally. Now, that candidly has been my hell as somebody who's running these three different funds that US Treasuries as a risk-off safe haven because when you're in an environment where your risk off safe haven Treasuries are acting like equities, your risk-on play, there's not much you can do except take the pain and the first six months were wildly painful.
It's more than just seeing bonds and stocks failed together. It's really about Treasuries in particular as the risk-off type of safe haven. Now, if you go with me that that's an anomaly, if you go with me that what we saw the first six months of the year was unequivocally an outlier, which again, the data would suggest, there's a lot of really important implications there. Because it would suggest that you may have cut off finally this hyperinflation fear that was, I think, gripping the markets, which might explain why both fell off the way that they did.
But also, it would suggest that diversification will have a comeback. Because Treasuries historically are a far better diversifier than having 500 stocks in a portfolio when you blend it against equities. That I think is going to be the most important thing for asset allocators. And certainly, from a tactical perspective, if Treasuries get back to their play as a way of benefiting from stock market volatility from risk-off conditions, well then, yeah, you're probably going to see yields lower if stocks tick another leg lower, which again, would be that W formation.
MAGGIE LAKE: So it's interesting, you see, the outlier is the Treasury performance. What leads you to believe that Treasury yields will fall from here?
MICHAEL GAYED: So the NHB, I think they basically said that housing is in a recession. Yes, you always have false signals in any signal, in anything that one looks at. But I find it hard to believe to think that we're not going to have a recession if you have a housing recession, because housing is such a big driver of the economy. Alright, if housing tends to lead in terms of declines and in terms of expansions, contractions and expansions.
So if housing is just starting its own recession, then probably that means rates have to fall, because everything is based on Treasuries, the 30Y is based on Treasuries. So if demand for housing slows, demand for bonds slows, which causes yields to drop in terms of lending growth, and then if that's the case, stocks probably go lower. Because, again, we move from fear over inflation which oil was the primary driver up to now, what could be a disinflation/deflation fear of housing really does correct in a big way. And that should bring I think, back these risk-on risk-off dynamics.
MAGGIE LAKE: We have a couple of questions, and I do want to bring them up, because I think they're interesting and we've been mulling over this as well. And I'm going to start with a comment from a viewer first on Twitter, and then the question from someone else. But we had a comment that this will end in tears in September when volume and volatility return. Will you be left holding the bag? Not you, Michael. But collectively, will we, anyone chasing this be left holding the bag?
Paul is asking something similar, I think. Government says it's hedge funds plowing back in trying to make it back before the end of the year. Do you agree with that? Is there something, I don't want to say technical, but is there something in the nature of the short-term markets right now that could be exacerbating this move?
MICHAEL GAYED: Maybe, although if you look at seasonality in terms of where we are in the presidential cycle, we're still tracking actually pretty closely to historical periods where you had a weak first half and then a rebound afterwards. Yes, I do think there's probably an element of chasing because there's career risk because everything got smoked in this first six months, except commodities. Obviously, now, commodities are getting smoked as we've seen.
But I don't think that's the full story. The sentiment was so dark mid-June, and I've used that line many times on Twitter. Opportunity always exists when the crowd thinks it knows an unknowable future. I put out a series of tweets saying the market is probably underestimating now upside surprises, which now we started seeing. And by the way, keep in mind that I really think the driver of this is ultimately oil. It's not really about a Fed pivot.
It's not a coincidence that a week after energy stocks peaked, small caps bottomed. It's not a coincidence that a week after energy stocks peaked, Treasury yields topped. Oil has been what's gripped this market's narrative since day one. It's not really about Fed policy, I would argue. Fed policies is reacting off of oil prices. Oil prices are what's driving inflation expectations. If oil keeps dropping, suddenly now, disinflation becomes the concern.
MAGGIE LAKE: Well, that's so interesting. We are not hearing that from the Fed, aren't we?
MICHAEL GAYED: Of course not because the Fed wants to act like the control.
MAGGIE LAKE: They seem like they're burnishing their inflation fighting credentials. But if we see oil, so you know what, I'm going to pop up, we had Raoul on with Andreas on Friday, and they were all over the place on this. Where are we in the business cycle recession? Raoul's been expecting things to weaken, so that spencer his base case. They had a very interesting conversation about their growth and inflation expectations. Let's have a clip of that one, then we'll talk on the other side.
RAOUL PAL: I think that the economic damage from rates, the dollar inflation is done. But what's confusing people is the market's job is to look a year or 18 months forward and think what are the conditions, or even if it's six months forward, what are the conditions in six months' time? This is the Stan Druckenmiller argument. The conditions in six months' time if we're all right that a recession is coming, then rates are much lower. And if we're wrong, and it's a soft landing, equities go higher. So in all outcomes, equities go higher. So it's a matter of where was the low?
So my view is, we go into recession, it's pretty nasty. It's pretty quick. And the bond market's right to start pricing in a change in Fed policy at the turn of the year, they'll probably go on pause beforehand, by which case and again, you've been tweeting about this, and I've been tweeting about it. All of our work both suggest that the ISM is going to go hurtling through 50 in the next two to three months, which people aren't really prepared for.
We try to tell people, they know but I don't think they are so I think they're going to try and sell equities on it when it comes out and that's probably going to be a very big mistake because the bond market's telling us what needs to happen. But there's still a few factors in place that aren't fully in place. I think both you and I would love to see the oil market break this $85 level, because I think it comes down to about $60, then the year-on-year rate of change would be negative 50%. I think we get negative inflation in 18 months' time.
MAGGIE LAKE: So two really interesting things there. Raoul's also watching oil, and we have seen, as you pointed out, oil coming down, and I just want to check, it looks like it's below $90 now. $89. So we're not that far from $85. I don't know if you think $60 is the number that you're looking at. But everyone seems to think it's the CPI number and maybe the employment report, but you're focused on oil, Michael?
MICHAEL GAYED: Well, that's what the market itself seems to be telling you. Again, it's just curious to me that it was a week after energy and oil pretty much peaked that you saw everything start to really rally hard. Now it makes sense, by the way, that stocks and bonds will both fall, it's really about hyperinflation fear, and then you'd have just like everything burst and everything relief rally, which is why you're seeing stocks and bonds both come back fairly decently.
My contention is that at some point, that risk-on risk-off dynamic comes back, meaning Treasuries diverge from equities. Stocks do go lower, yields go lower, that's your classic risk-on risk-off dynamic. And it's important to note that this is, whenever we talk about a recession 18 months from now, analysts worry about the endpoints, portfolio managers have to worry about the dance in between the endpoints, the sequence of returns.
It is very hard to know if we're going to be entering a recession. But if the market believes that we're entering a recession because oil has fallen so aggressively, which is what happens after spikes prior to a recession, if that's the playbook, then yeah, you probably are going to have risk assets still have another wave lower.
MAGGIE LAKE: So you don't buy the argument that maybe that's priced in already?
MICHAEL GAYED: The term priced in is always an interesting one, because it's always priced in until some new information occurs that nobody ever sees coming. So it's like, well, in June 16th, what was priced in, not much. Because market's obviously in reverse what they're pricing in. So my point is that it's going to look the same that price is truth. Price is always changing. So the truth is not changing every day.
So I just think that we're in a situation where the sentiment is very obvious to see how extreme it swings. Everyone was wildly bearish thinking the world was basically coming to an end mid-June. Now, I'm seeing the opposite. Everyone seems to be suddenly very bullish thinking that this momentum is going to continue. They could be right, and I'm not disputing that.
But if the stock market is misinterpreting the message of the bond market, which is that the real concern, maybe disinflation/deflation down the line, then equities have to respond on that new information and price that in. This is really, really tricky. Because you can make a really bullish case and a pretty bearish case, and probably you're right, it just depends on where you are on the calendar.
MAGGIE LAKE: Timing. And that's what's been so hard about this, is the timing. And also, so we're talking about the timing of events, but also we need to say you have to be aware of your time horizon as an investor, short term trader is going to have a different perspective perhaps than somebody who has a medium to longer term view. Maybe they're not too worried about whether there's another leg down, because they're looking out 18 months.
We've been trying to make sure everyone's aware of that. What is the time horizon that you're operating on? Are you looking at this from a quarterly basis? I know you've got to track performance. What is your time horizon?
MICHAEL GAYED: Yeah, so it's much more short to intermediate. I'm very much a believer that the longer you try to look out in time, the less accurate your predictions will be, because variables come in and suddenly throw off that forecast. Again, I go back to this point, this has been somewhat easy to see in terms of the sentiment being so extreme. What has been really difficult is the relationship of Treasuries to equities, the risk-off to risk-on play.
That dynamic comes back, I want to see that with my own funds, it gives me a chance to come back from the drawdown that I myself, am suffering through all three strategies. But that I think is going to be the most important thing. And the final thing I'll say about that is you got to be really careful with narratives. Because if everyone starts believing one thing, it's time to feed it.
So now, the narrative changed so aggressively coming off in the low. I tweeted out in early July, saying watch how quickly the narrative changes. What happened with the narrative in traditional financial media? Well, we're not going to have a recession now. Well, they're saying that because equities rallied so hard, that doesn't mean the recession is off the table just because equities rallied.
In bear markets, you have these rip your face off rallies. For all we know, this may be exactly the way a bear market should play out. Suck everybody in then hit them again.
MAGGIE LAKE: So we have a question from Gino on YouTube, and it's a good one. I want to pop this one up and ask it. Michael, are you seeing demand destruction feels like earnings so far aren't showing this yet oil is down. The reserve release contributing to this. I would also say like throw in all the data we saw today. The New York manufacturing, by the way, is, as Ben pointed out, and folks on our air pointed out. is a volatile reading.
But still, it's worth pointing out that it fell 31.3. This was a massive turnaround. This wasn't a declining trend line where it's got-- this was a completely fell off a cliff. It's a pretty sizable drop. So what about the fact that we haven't really seen that in earnings yet?
MICHAEL GAYED: So this is, again, why this is so tricky, because there's all kinds of timing mismatches that are taking place here. Consider that supply chain pressures seem to be abating just as the Fed still wants to be hawkish, just as the economic data is starting to really break down, you're going to have oddly enough a situation where everyone with hindsight says the Fed was too aggressive, which sounds like a really strange thing to say.
But given how long the supply chain disruptions have been ongoing, given the lagged effects of monetary policy, and given now an economy that's clearly responded to the oil shock, not the interest rate shock just yet, to the oil shock, it's really interesting, because you could have a very, to your point, a very dramatic turnaround in inflation expectation. You could have inflation crash.
If you believe in mean reversion, if you believe that at some point, you've got to get back to some normalized inflation of whatever 2%, 3%, well, you have to really overshoot the mean on the downside. And that's, I think, what's being missed in this. If you have a situation where a recession really starts to take hold, it could be very ugly just to undo all these excesses of inflation, and then the Fed is going to be, with the tail behind his legs, trying to debate what to do next.
MAGGIE LAKE: And that is the fear of some, and you just brought up a really great point is that policy works with a lag. We feel like in the world we live in where everything is immediate, that it shouldn't be like that. And maybe there's an argument that it is changing. But most people still believe that these things filter through the economy with a lag.
MICHAEL GAYED: Right, and that's why actually the real leg, I go back to housing, is going to be what happens with home prices. Because the big driver of credit creation is the value of your home. And that is a lag, home prices are only just now starting to break down and the affordability is only maybe just now starting to pick up so that's a very early bearish trend that I think with a lag, will spill over to equities.