JACK FARLEY: Welcome to the Real Vision Daily Briefing. It is Monday, September 27th. I am Jack Farley and joined by Jared Dillian of The Daily Dirt Nap. Jared, how are you doing?
JARED DILLIAN: What's up?
JACK FARLEY: I'm good. I think, Jared, today, I'm lucky. I think viewers are very, very lucky because you come out with a little bit of a bombshell. You've changed a lot of your thinking over the past two weeks. You were a bull. You were leading the charge on the S&P 500 up. You were having your inflationary view. Since then, you've changed your mind a lot. And you're now actively looking for shorts. So much in fact that you actually started your piece today, which is called The Next Crisis.
You said play Bach's Toccata and Fugue in D minor here. So, that's what we're going to do. So, we're going to do exactly that. Jared, before we explain why you're feeling such ways, why people heard that ominous music right now, let's just quickly get into the news of the day. A bit of a strange day as bond yields spike with the 10 Year Treasury breaking above 1.5% for the first time since June. That put some pressure on technology stocks with the NASDAQ closing down 52 basis points.
Meanwhile, natural gas exploded higher, something like a 10% jump, as the energy crisis in Europe threatens to become global. And Brent crude oil surged to just below $80, the highest level since 2018. That's not even getting into Evergrande, which I'm sure we'll get into. But Jared, got to give it to you. Why are you now bearish? Why are you looking for shorts instead of longs?
JARED DILLIAN: A bunch of reasons. First of all, it's the evolution of sentiment over a very long period of time. I've actually first started getting bearish back in January when GameStop spiked, and I panicked that have a lot of longs when that happened. But then I reloaded on the inflation trade. But over the past eight or nine months, we've had Dogecoin, and we've had NFTs, there's all these examples of hyperspeculation. And it feels a bit tired. Some of the prices of NFTs are going down.
That's why I spend so much time looking at that stuff, collectibles, is because it's an indication of speculation, and it's starting to get tired. Another reason I'm starting to get bearish is because of inflation. And if you go back two years ago, I was bullish on inflation, because I thought that a little bit of inflation would be beneficial to asset prices. And we're past a little bit of inflation point. And now, we're getting a lot of inflation. PPI printed 8.3%, the next CPI reading is going to be higher. I think we're going to get CPI up around ultimately 6%, 7%, 8%, maybe higher.
Inflation starts becoming bad for asset prices. And what's happening is that we've compressed the decades of the 1960s and the 1970s all into two years. So, during the 1960s, you had a little bit of inflation that was good for asset prices. And in the 1970s, you had a lot of inflation that was bad for asset prices. And now, we're in the 1970s part, okay, so things are getting bad. I'm bearish because of China. We'll talk about that in some more detail.
I'm bearish because of rates. I've been keeping an eye on the bond market for a while. I thought it was anomalous that you had 10s at 1.2% while PPI was 8.3%. It didn't make any sense. That was going to resolve itself somehow. I did not think it was going to resolve by inflation going lower. So, that's a neat summary of all the reasons I've turned the ship around in the last couple of weeks.
JACK FARLEY: Thanks for letting that out, Jared. And yeah, I was right there with you when bond yields were at 1.2%. And we were getting these red-hot inflation numbers. And I was thinking, is it just because I'm so young and new to this that I don't understand this? Or is it that am I correct in thinking that this is very, very strange? Jared, I want to go back to you on inflation.
Normally, the channel of inflation eating away returns is that they raise bond yield because bonds sell off, and therefore the discount rate is higher, and that takes some energy away from stocks. But what if real rates are deeply negative? That is bond yields after inflation are deeply negative. What channel do you think will take the juice out of the equity market?
JARED DILLIAN: Well, the last time yields were this deeply negative was around 1979 to 1981. And that was a really bad time for stocks and valuations got compressed. The reason I brought up the example of the 1970s is because over the course of the entire decade, valuations compressed a lot until you got to about 1982 when the average stock had a single digit PE and a 6% dividend yield. So, I think over time, as inflation continues to rise, you're going to get that valuation compression.
JACK FARLEY: Yeah, and another point is In the 1970s, the Fed had the ability to jack interest rates up to 20. Whereas now, even jacking them up to 2% is spooking equity markets, right?
JARED DILLIAN: Well, they have the ability to do it, but just because of political constraints, they don't have the will to do it.
JACK FARLEY: All right. Well, let's move on from inflation to talk about China. You write, "the next crisis will come from China". Why do you think that?
JARED DILLIAN: So, we think of the best way to say this. So, China's history with capitalism is pretty short. It's only about 30 years, and over the course of that history, things have pretty much been up into the right they haven't really had a serious recession. There's been a lot of growth. Stock market's done well. So, they've had a lot of the benefits of capitalism without the bad parts. And now, they're starting to get the bad parts.
And the reason they're getting the bad parts is because Chinese capitalism is different from Western capitalism, which means that it's basically state directed investment, okay. It's not really free market, it's state directed investment. So, if you go back 10 years ago, around 2011, the big news at the time, was that China was building these ghost cities. They were building entire cities, and just directing people to move into them.
Now, some of these cities got filled up, some of them didn't. But what you have is a massive overhang of malinvestment over the last 10 years. So, Evergrande really is just a manifestation of that. And I know you're going to ask me if this is the Lehman moment for China, and having worked at Lehman Brothers, I resemble that remark. But it's not really analogous, like, the point is that there will be more Evergrande. Because of this malinvestment that has accumulated over such a long period of time, there will be more failures, It'll be a drag on growth.
And also, just from a political standpoint, I don't think Xi Jinping is really into capitalism. I don't think he is. I think that he views it as a threat to his authority. I think you've used very wealthy people as a threat to his authority. And I think ultimately, China is going to slowly go back to socialism. So, I think if you're an investor in China, either actively or passively, if you're investing in one of these emerging market mutual funds that have like 35% China, you have a huge exposure to China. There's going to be expropriations, there's going to be nationalizations, there's going to be failures. This is going to be a very bad place to invest over the next 5 to 10 years.
JACK FARLEY: Okay, so you have a very bearish view on China. To what degree do you think that this financial contagion could spread outside of China? So, for example, it's not just Chinese real estate that goes bust. There are other properties around the world that leak out value. Do you think that will happen, or no?
JARED DILLIAN: I think it'll happen. I really don't have the ability to predict how it will happen. Evergrande only had 19 billion of international debt. There's going to be more companies that have international exposure. I really don't know how it's going to play out, but it's going to have huge implications. And if you're a manufacturer in the US and your supply chain is in China, I think the rule of panicking applies. You want to panic before everyone else does and bring that home. And by the way, all of this is super inflationary. It's super inflationary.
JACK FARLEY: Really? Jared, what I'm hearing is that if China wants less steel, it wants more or less iron ore, it wants less copper, that it will decrease the demand and that it will export deflation. No or no?
JARED DILLIAN: No. I think what's going to happen is that international trade is going to go down. And countries like the United States are going to be forced to produce goods at home, which is going to be more expensive, which is going to be inflationary. That's my thesis. Maybe you're right, maybe I'm right, who knows?
JACK FARLEY: Okay, what you're saying makes sense. Jared, let's actually take a look. This reminds me about the role of denial, which you talk about in an interview with Peter Atwater. Let's take a clip of your interview with Peter which airs next Friday on the Essential Real Vision tier. I want to get your take. Let's take a look.
PETER ATWATER: It's been fascinating to watch the parallels, honestly, between our response to COVID in China and our response to Evergrande in China. In both cases, everyone has quickly concluded the problem is contained. And while that may or may not be the case, I guess we'll soon see. We've jumped to a conclusion that I think is potentially perilous when the subprime crisis hit, everybody had the same response. It's contained, it's insignificant. There won't be any fallout from it.
And I think what people forget is not the size of this specific issue, but the sentiment reflected within it. The reason that subprime mattered wasn't that it was enormous, but that it was ridiculous behavior. And the question to me with Evergrande is not its absolute size, which is admittedly enormous. But what it says about sentiment, particularly to your point that it's going on as long as it has.
JACK FARLEY: So, setting aside the comparisons between Evergrande and the 2008 Great Financial Crisis, Jared, one thing you and Peter talk about later in the interview is about the role of denial. How investors tend to deny the existence of a problem until the last possible moment. You refer to the Tom Hanks moment for COVID-19. Tell us what you mean by that.
JARED DILLIAN: Yeah. At the top of any bull market, all the concerns that I listed whether it's China or inflation or rates or sentiment, it accumulates over time. And it's not a problem, it's not a problem, it's not a problem. And then suddenly, it's a problem. Suddenly, it goes into everybody's consciousness. So, with COVID we knew in January, what was happening in China. We knew that it had the potential to transfer to the rest of the world. And US investors were ignoring it. And then on March 11th of 2020, Tom Hanks came down with COVID, and that was the moment that it just became real to everybody that this is a threat, we're all going to die.
JACK FARLEY: Even though that wasn't true, that was the feeling that they got.
JARED DILLIAN: Yeah. And if you remember, the markets were pretty bubbly at the time. And then a couple weeks later, we were down 35%. It happened very fast. And the sentiment at the time, people were very afraid of COVID. It's a deadly disease, for sure, but I remember being locked down in my house in South Carolina, and my wife and I would go for walks around the neighborhood. And if we saw another couple walking, we cross the street. We would cross the street. People were terrified.
We thought that there were going to be tens of millions of deaths, that the economy would be shut down for 10 years. And we went to the other extreme in sentiment, and it only took about three weeks for that to happen. Prior to that, it wasn't a problem, it wasn't a problem. And then one day, it was a problem.
JACK FARLEY: And what do you think that moment will be for Evergrande, or for inflation? And you know when you see it.
JARED DILLIAN: I had this discussion with Peter on the interview, and I don't want to spoil the interview. But one of the questions I asked Peter was let's say this is analogous to the financial crisis, and Evergrande is like New Century or First Federal or one of the subprime lenders, and this is 2005. And we still have two years to go. Which is possible. We could have two years to go. And Peter said, no, I don't think it's going to be two years. I think it's going to be a lot faster than that.
JACK FARLEY: Yeah. I'm glad you said that. I had a take on Twitter that Evergrande is not a Lehman moment. It's countrywide. And I think that I'm also in the camp with you that it has the potential to be slower rather than fast, because in 2008, once the party was over, it unraveled in a spectacular fashion very quickly, because I was insuring your bond, you're insuring the other person's bonds. And it is this daisy chain that unwound.
I think with Evergrande, you have a very similar situation in that there are lots of hidden debts, and a lot of assets that really shouldn't be quantified as debts, but are assets, but they're not packaged into a collateralized entity. They're not on the Bloomberg screen. So, for example, someone who's a rice farmer in a rural Chinese province, they will be bought out by Evergrande to turn their rice paddy into an empty office building, by the way, talk about malinvestment, and then they will be hired--
In order to keep the peace, they will be hired by maybe a joint venture with Evergrande as a security guard or some sort, then we'll use those proceeds to maybe buy Evergrande land maybe on margin, maybe on debt before the property is even built. And they'll maybe buy a wealth management product that has a trust loan to Evergrande. So, all these things are similar to 2008 but there's not a lot of Bloomberg terminals that are flashing sell signals that can spiral out of control. So, I do see a lot of truth in what you're saying about the fact that it could be a slower thing.
JARED DILLIAN: Yeah. And the other thing is that China being a command economy has the ability to paper over losses and postpone the eventual pain, where you can't do that in the United States. We have a free market economy, flat prices fluctuate. So, when there are failures, they're transmitted to the rest of the economy. It's not necessarily the case in China. If you think about the Soviet Union, the Soviet Union lasted like 45 years. It can go on for a really long time.
JACK FARLEY: Yeah, definitely. Just to give a little news update to people who maybe aren't following this as much. On Wednesday, Evergrande has to pay interest payments on a second round of dollar-denominated bonds. Evergrande has already failed to pay on the first round on Friday. And this happened as its electric car subunit, Evergrande New Energy Vehicle, plunged 10% as it announced a shortage of funds. And I believe it was going to be traded on some exchange. It was supposed to be the saving grace of this New Energy Vehicle thing but doesn't appear like it's a lot of saving grace now.
Jared, we've got a question from Ellen, wants to know, does Evergrande have the potential to take down the entire real estate sector in China? And if so, what are the implications for the larger Chinese economy and worldwide?
JARED DILLIAN: I'll just go back to what I said before. The losses can be papered over. This can take a really long time, so I don't think there's-- Look, I'm just starting to find shorts in the newsletter. I'm starting to position myself bearishly. But I'm not under the illusion that we're going to have some kind of global crisis or crash anytime in the next three to six months or even a year, it could take longer than that.
JACK FARLEY: Jared, we got another question from Bill T., who asks on the Real Vision Exchange, why is Jared out of the oil trade? Is it because everyone seems to be all in the oil trade? And does the COT, Commitment of Traders, report show that there's an all-in participation in oil?
JARED DILLIAN: Well, a bunch of reasons. So, getting back to my 1970s analogy, okay. You didn't want to be long commodity producers, you wanted to be long the actual commodities, okay. Being long the commodity producers didn't really help. So, that's one reason and yes, sentiment was another reason. I tweeted out about a week ago. I said that when I bought energy in 2020, everybody said I was nuts.
And then when I sold it a week or two ago, all the people who said I was nuts in 2020 were telling me that the energy bull market was just getting started. So, I was getting a lot of those incoming emails. When I was selling energy, people are saying you're nuts. It's just getting started. And there was too much consensus, and I went the other way.
JACK FARLEY: So, you got out of the Exxon Mobils, the XLEs, take your pick, the producers, but you remain constructive on the actual oil itself, let's say the physical contracts?
JARED DILLIAN: Oh, yeah, absolutely.
JACK FARLEY: Oh, okay. That's very interesting. Why is it that the commodities outperformed the commodity producers?
JARED DILLIAN: Well, ultimately, if you're a commodity producer, it's a company, it's a stock and you're affected by these inflationary pressures. Like I said, I think we are pretty much at peak valuations right now. And I do think those valuations are going to compress over the next 10 years, and I think forward returns are going to be lower. I'm just not excited about equities. I don't care what equities they are. I don't care if they're energy equities or financials. I'm just not excited about stocks here.
JACK FARLEY: What other shorts do you have your eye on? If you're really fairly bearish, you can short the general index, you can short semiconductors. Tell us about semiconductors.
JARED DILLIAN: Well, I don't want to go into too much detail, but I will say that the shorts are going to be based in tech, mostly because-- we can talk about bonds for a little bit. I think we're finally starting to get some technical confirmation in rates, the rates are going higher. I think that's going to continue. I have some exposure to that. But I really think that tech is going to underperform. I've been saying this for-- I'm a value bull, I'm a value bull. And the shorts are goin