WARREN PIES: Welcome to the Real Vision Daily Briefing. It's Tuesday, March 29, 2022. I'm Warren Pies, founder at 3Fourteen Research. Today I'm joined by Tony Greer, founder of TG Macro. Tony, good to have you back. How are you doing?
TONY GREER: I'm great, Warren. How are you doing, man?
WARREN PIES: I'm good. It feels like every time we do one of these it's been a pretty eventful market day, no exception today. So let's get to it, let's talk about the action. What I saw out there, market rally, obviously some reports that Russia-Ukraine could be cooling off and that Russian forces are retreating. And that kind of lit the wick for all of these different trades that we've been monitoring starting to unwind.
But in the background, some interesting and I think really much talked about developments economically, we saw the 2/10 yield curve finally invert. I don't know exactly where it closed. But at some point today, it was officially inverted for the first time this cycle following on from the forward OIS curve inverting that we've talked about. So we see some ominous economic signs out there, some positive geopolitical signs, and the markets are-- really, this has been the most hated rally I can remember in my trading career.
And I have to admit, I haven't seen it correctly and didn't see it coming, so I wanted to pick your brain and see what your take on it all was and what was really grabbing your attention today.
TONY GREER: Yeah, Warren. This stuff is really, really tough to figure out right now. It feels like today is the first day in a while that we haven't seen two-year yields roofing to a new high, so there's a little bit of a sea change there. We've got breakevens pulling back off of the high prints in fairly large magnitude. So what it really is we had that inflation theme steamroll rolling for a while. We've had extremely strong commodities that maybe found their Icarus prints into the Ukraine-Russia story, backed off into a dip, and then we saw a rally, and now we're kind of consolidating somewhere in between.
But like you said, we've got now the Russia-Ukraine peace talk, rumors flying around. We've got a slowdown potentially being priced in out of China due to their virus controls for what's going on there. It feels like it's just a little bit of a pullback in-- behind the post-FOMC rally, everything took the air out of all of those commodity trades very briefly, and now I think the markets are just finding a range while equities retrace. But this retracement in equities is obviously getting very serious.
You've got the NASDAQ pushing up against major moving average resistance levels right now. And to me, that's kind of the key on how much further this retracement rally is going to go, but we're still being led by the names that-- and the sectors that are kind of weak on the year. For example, today a huge bounce in retail, which is still down on the year. Homebuilders up 3% today, that is another sector getting trounced on the year. Strength in biotech and ARK Innovation ETF. These aren't the leaders that I want to follow into battle if we're going to go back into a bull market rally in the S&P.
I'd much rather see natural resources taking off, and I would even prefer to see tech leadership, but we're not seeing that either. So I'm really, really cautious right now, Warren. It feels like there might be a pullback mode in the commodity trade and you've got to buy the dip, that's what the world is telling me.
WARREN PIES: That's a good point is buy the dip. I think on the commodity trade, I would agree with you. Our indicators for the oil market and the math that we've walked through over the last couple of times you and I have been together are basically along with that. I think this is an opportunity to continue to get long in that energy sector, especially if you're pairing that with any kind of broad market exposure. It continues to trade at negative correlation to the rest of the market.
And when you're constructing a portfolio, there's a lot of value in that. There was a chart I was going to show later, but might as well skip to it right now. One thing that we've talked about, and we've talked about on this show and repeatedly through the weeks, is how energy has outperformed the rest of the sectors this year, and it's been about-- I don't year-to-date. But at one point, it was 40% up for the energy sector. Every other sector at flat or down on the year.
And what that's going to do is force hedge fund, momentum funds to move into these energy stocks aggressively. So we model at 3Fourteen a generic momentum strategy off the S&P 1500. And the chart we're looking at here, blue line is energy stocks, purple line is consumer discretionary stocks. And the idea here, the yellow highlighted area, is what we're going to see as we roll forward into the summer. As these funds rebalance across different schedules and different time frequencies, they're going to have to buy energy stocks in size.
So this is another kind of technical flow-related tailwind to that energy trade. And so there's the old phrase that you buy on the cannons and you sell on the trumpets, and maybe that works in the reverse here for energy as well. So interesting to hear you say "buy the dip." What do you think?
TONY GREER: Yeah, I tend to agree you. The stocks in the sector have been scorching for quite a while. They've been riding well above their moving averages. It would shock nobody to see a market dynamic pullback across the board. It still seems that the right direction is to buy that dip in the commodity space, and especially in the energy space. I wrote up a chart-- just this morning, I was trying to find things to buy with the energy market was going to come off, and one of the stocks that have been on top of my leaderboard is Southwestern Energy.
And that's just one name that I dialed into, and I'm like if you dial back and look at this name on a longer-term horizon-- it's as cheap as it's been a long time and then you dial in into the last couple of years, and you've got this massive inverted head and shoulders bottom that is so irresistible as a trader with a $1 low in the rearview mirror and a false breakdown and everything. So when you start to see these long-term bottoming formations, Warren, it totally lines up with the rebalancing that you're talking about that I'm definitely expecting in the coming months.
So this is sort of the trade of the year for me, the great rotation, and there's obviously going to be ebbs and flows, but I'm going to put my stake in the ground and say that when the year shakes out, that it's going to be natural resources on top and it's going to be tech struggling wildly behind that because of the move in rates.
WARREN PIES: Yeah. Fundamentally, I think that makes sense. The Southwest is going to be exposed to domestic natural gas prices. And when you Zoom out from the conflict, the war in Russia and Ukraine again, the big theme that I take away-- no matter what happens with the negotiations and everything else-- it's really going to be a difficult time, I think, for the world to go back to its pre-February 24 state, and part of that new world is a real emphasis on energy security.
We've heard already there's going to be fast-tracking of LNG's shipments from the US into Europe. I think that we've proven that our domestic energy policy makers are sometimes prone to mistakes. And if we funnel too much LNG over to Europe, or we force that, you could end up closing that arbitrage that has been so profitable for exporting LNG over the coming years if the right policy levers-- or the wrong policy levers, depending on your viewpoint-- are undertaken.
But either way, I think you get a bid into natural gas and energy in general, which includes Southwestern there.
TONY GREER: Yeah. It's key, I think, to stay pretty focused on the natural gas side of this equation and the reverberating effects of US energy policy and European energy policy. I've been speaking with Doomberg quite a bit, and we recorded an interview yesterday, where we went over exactly what's going on, where natural gas is now spiking, ammonia prices, which is now spiking fertilizer prices. And now you're seeing a lot of those fertilizers just become pure-play arbitrages between cheaper US natural gas prices and being able to make fertilizer under these conditions and export it to the places where fertilizer is way more expensive.
So as long as that trade is alive, and it seems like it's going to be with us for a while, as long as there's going to be pressure on natural gas production, Europe's going to be under tremendous pressure to build up their storage over the summer months. And we'll see if they take that opportunity, but I think that we're definitely looking in the right direction for the serious trigger points in this market. Because I think that's the cutting edge, Warren, of this inflation problem that seems like we're going to be dealing with at some point where the costs of food are going to cause problems. Just like we've seen before in the Arab Spring, but more potential to cause them all over the world, because we're at this point where all commodities are rising in unison. And even though it is a little bit of a pullback on the screen today, I think the fact that they've been higher for longer is something that we really have to concern ourselves with.
WARREN PIES: Yeah. I totally agree with you. I think that, really, this leads to the big question. I think what's been moving markets, if you really get to the crux of it, which is how strong is the underlying economy. And I think the market is constantly trying to discount how close that next contraction is.
And a big factor on the timing of the next contraction will be the commodity trade, because commodities do tighten the economic conditions, if not financial conditions, that we're dealing with. And so we had Raoul Pal and Lyn Alden had a conversation earlier in the week, and they touched on this. Let's take a listen to what they had to say and then get back and talk about it for a minute.
- It feels that this commodity price increase in inflation has actually have been a massive monetary tightening, and the market hasn't yet quite grappled with that, because everyone's screaming inflation. But because wages haven't gone up as mush corporate profits haven't gone up as much, what you've actually done is massively tightened. So I think I estimated it's around 2% interest rates already, which is why the yield curve is inverting.
It's like, no, no, please, don't raise rates now, because we're going straight to negative yield curve, if that's the case. You're thinking through that way, and also, therefore, if we do see that shift, the risk end of the market, these ARK stocks, tend to do pretty well. It's very good for crypto. It's very good for a number of things.
- Yeah. So one thing I've been looking at is, even before this war, we had the declining PMI environment, so economic deceleration. And historically, it's been very challenging for any central bank to tighten into a decelerating economy, especially the developed world. Unfortunately the emerging market often has to do it. Whereas, a developed world, they've generally tightened into accelerating economies. And so even before this, I was taking the under on how many rate hikes they would ultimately do in this cycle, because it didn't seem like to me a lot of, whether or not read Bloomberg, Wall Street Journal, all these different analysts out there, they don't seem to be referring to the fact that they're tightening into a decelerating economy.
WARREN PIES: Well, there you go, Tony, Lyn and Raoul talking about how the commodity price pressures are flowed through, obviously, to the real macro environment. What do you think?
TONY GREER: Yeah. You what's amazing to me, Warren, is that we've been talking about this trade for a while, obviously. We've been tracking it since the collapse of the lockdown, which is now two full calendar years ago. So it's amazing that, even though we've been on the beaten path of the move into hard asset trade for a long time, it's been encouraging to me to read fresh research reports from places as astute as 13D.
And you read their report from over the weekend, and they're talking about a potential sustained shift into the new market leaders being commodities, commodity-related sectors, and markets that are likely to benefit from continued rising inflation. And it's just refreshing to hear a more bulge bracket research firm admitting that these are the new market leaders now and in such a way that it sounds like the world hasn't already positioned into them. And I still keep saying by virtue of how much length there still is in these big behemoth tech stocks that, until a lot of that length comes out, we haven't even seen the whites of their eyes yet, in terms of that rotation into natural resources. So I still think there's a point ahead of us where it sees its finest day, and we're not there yet.
WARREN PIES: Yeah. I would agree with you. I just don't think that there's going to be some just grand resolution to what's happened overseas and geopolitically in general. I don't think we can go back to the way things were, and I do think you're seeing mixed signals in the economic market, economic signals that we get from different markets, the rate market.
Today, big news, yield curve inverts, the 2/10's that everybody classically looks at. Let's take a look at a chart that we put together, because there is a unique thing going on in the yield curve land, so to speak. So we've heard a lot about the yield curve inversion.
Some people brought up, even a month ago, when the forward OIS 2/10 curve inverted, that there's already these less famous versions of the yield curve that have inverted. So today, we get the classic 2/10 inversion, but when you look at the 1/10's and then the 3 month versus 10 month, which is something the Fed has called out as what they're looking at, you're seeing those curves actually steepen a bit here recently. So there is a mixed signal that we're getting from these curves, and it's something that we haven't really seen recently.
One kind of analog that we looked at was the 1999 to 2001 period, where we had a recession in 2001. You pull that chart up, and you can see the four yield curves that we look at here from 3/14, and you can see this forward of inversion. We went forward OIS, then 2/10's like we saw today, and then 1/10's, and then the latest cycle is the 3 month 10 month. And so you're still a far distance between seeing this happen, but if the Fed is as aggressive as they have signaled in the next couple meetings, then this thing could flatten and invert really quick on these other measures.
So this is an analog to look at, and then we leave some stats on this table, on this chart, to show how much of a lead time you usually get between yield curve inversion and recession. It's about 20 to 24 months, depending on which one you're looking at. So it's not perfect, but this is the table that I'm seeing, and how it's set right now, what do you think, Tony?
TONY GREER: That is some really, really sharp analysis, is what I think, Warren. I appreciate that you share that. It's interesting to see the timing of how those dominoes fall in the curve. Right? And then try to apply it to what we're seeing now.
I'm not that smart. I can't track all of these curves and decide what they're telling me. I've been leaning on the break-even five-year really as my go-to inflation beacon, as to what the market can tolerate. And so I guess, it just shouldn't surprise me now that, as they've gotten so much farther away from their moving averages, and the move has gotten so steep, that there's finally a reprieve in break-evens.
There's finally a couple basis points of reprieve in rates. The market's reacting accordingly in a slight unwind of the great rotation. It all seems like it's falling right in between the ebb and flow. We're still working off the effects of the post-FOMC rally. Right? I mean the S&P now is up almost 500 S&P points since the day before the FOMC meeting, March 16.
So it still seems like we're in that runaway, short-covering freight train, and we're going to see where it tops out, and then we'll make our next decision on the S&P. But I still think that the natural resources sector is one that's going to come roaring back, regardless of which way the curves meld. Because I still think that, with this attack on supply, that those receptors are going to be the ones that perform this year.
WARREN PIES: Yeah. The way we tied it up, because we're confused too. So it's not that we have all the answers. We just like to look at it and try and orient ourselves through data. But the way we tied it all together is we created, all right, let's blend these various yield curve signals and then also look at high-yield spreads. So we have our own three-factor blend of financial conditions.
These are all things that the Fed has talked about, and what's interesting is at different times historically, the Fed picks different measures of the yield curve to pay attention to. So if you go back to 2016 papers, they were talking about what they call the excess bond premium, which is really just credit spreads versus the 2/10 yield curve. That was 2016. In 2018, the San Francisco Fed wrote a whole paper about the 1's versus 10, 1-year versus 10-year yield curve, and its predictive power. And now what we have is Powell picking the latest possible cycle version of that yield curve to help drive their messaging.
I think you can pick and mix and match whatever yield curve you want. But what we did is we blended a couple of the Fed's mentioned curves the, 1 versus 10, the 2's versus 10, in a high-yield credit spreads, and we created a recession probability model from those three factors. Can throw that on the screen. In the bottom line, however you want to slice it, is that we've seen, according to these three-factor probability model, recession probability in the next 12 months has gone from 10% heading into the year-- it's almost very little probability of a recession going forward-- to about 40% on these three factors, and so this blends the yield curves.
It takes away that divergent effect of the various measures that you could have with the yield curve, and it also throws in credit spreads which is another thing, another financial