MAGGIE LAKE: Hi, everyone. Welcome to the Real Vision Daily Briefing. It's Friday, July 8th, 2022. I'm Maggie Lake. And here with me today is Real Vision co-founder and CEO Raoul Pal. Hey, Raoul, great to have you back on the Daily Briefing.

RAOUL PAL: We're both back from holiday.

MAGGIE LAKE: Yes, we are. Much needed. But in the environment, we're in it feels like you get like shot out of the cannon right back into the volatility, even though it's summer. And it's actually, I'm so glad that you're here with us today. It's a perfect day because we had a jobs report today, bond yields rising once again, everybody fretting about the Fed, an aggressive Fed. So, maybe the best thing to do since it's been a minute since you've been on the Daily Briefing is to start big picture. And why don't you just walk us through how you're thinking about the economy and the markets right now?

RAOUL PAL: Sure. there's there is a lot going on and it's very noisy for a lot of people. So, I'll see if I can distill my thoughts down. It's really as a follow on for the last piece I did on Real Vision on the platform that explains to people my macro view, which was that we were very likely to be going to recession, it was likely to upset markets for a period of time. And there were certain markers I was looking for that would usher into the next phase.

So, I'm going to walk you through in a bit more detail now where we are now. So, the first chart that I want to show is the financial conditions index, which is basically a combination of commodity prices, the rate of change of rates, and the rate of change of the dollar. That's against the ISM, which is the purchasing managers survey, which is a good guide to the business cycle, is a nine-month lead. It's one of the best indicators we've got.

And what it shows is financial conditions tightened by the fastest rate in history. And that is leading us to expect that the economy is going to have a wily coyote moment where the ISM goes from 53 down to let's say, 35. 35 is a severe sharp recession. Now, that indicates it's already bouncing as bond yields are starting to come off. And I'll come on to this a bit in a minute, and oil's come off a little bit. And it's suggesting we're going to see a sharp recession.

Now, last time I spoke, I spoke about previous recessions and times that have looked similar. The one I've been following the most is 1973-1974, where we had the Arab oil embargo. That was a supply shock. And what happened was the price of oil screened higher, the economy collapsed. And the markets collapsed. And in that last phase, roughly where we are now, actually went from 56 in the ISM to 30 in four months, it was the fastest collapse in history of the ISM. And that was caused by the supply shock in oil. And I think we've got a similar setup.

We also had something very similar after World War II, 1947. We had like COVID, the whole world have been shut down. You reopened it, not enough supply of stuff. Everybody's back into the civilian labor force and the price of goods explodes. Inflation goes up to 20% two years later, and economic growth collapses, the ISM goes down to 30, similar setup, and the equity market collapses with it.

The other one was 2018. We also saw a rise in commodity prices. We also saw financial conditions tightening massively because the Fed had been tightening and quantitative tightening have been going on. And the ISM again collapsed, and the equity market went down with it, the Fed pivoted. In all circumstances, the Fed actually changed very fast.

They didn't change when inflation rolled over, which is the narrative, they have to see inflation rollover. It actually changes when the ISM crosses 50. I went back and looked at every single time since 1967 that the ISM crosses and the Fed cut every single one except 2016, where they paused. So, it tells you that the economy takes over all precedent when it comes to things they monitor because then unemployment becomes more important because unemployment means voters and other stuff, even recession.

Okay, so where are the markets-- where are we pricing in other stuff? So, that's nine-month lead. So, the next chart to bring up is the ISM new orders, less inventories. That's a three-month lead. And that suggests the ISM in the next three months is going to 45 which is a full recession. So, it's saying we'll be in a full recession within three months. Okay, that's starting to get interesting for us.

Now, the issue here is inventories. So, the next chart is the chart of wholesale inventories of durable goods. That chart is shocking. And there's different types of inventories. And most of them show something similar is that inventories have gone up, because everybody stocked because of the supply issue, they overstocked and now demand is gone. Demand was gone because the financial conditions have tightened and inflation has taken away discretionary spending. So, now everybody's got too much stock.

Now, building of inventories is positive for GDP in the equation for GDP and releasing inventories is negative. Normally, to get rid of inventories, you lower prices, too. So, that starts to get interesting to say, if they're going to have to clear all this inventory, they're probably going to have to lower prices. So, that's the next big debate, inflation.

The next part of this equation, I've laid out what I think is demand destruction, writ large, and it's already in the data. So, then what does that mean for CPI? So, if we use the same inventories to new orders ratio, which is the next chart, this leads CPI. Now, CPI, if you can see on this, is crazily elevated. Now, that's because of the Russia situation and some of the supply situation. But it's also not unprecedented.

Yes, the level is high. But if you peek on that chart back in 2008, what we had was inventory to sales got to zero and crossed it. But meanwhile, we have this peak in CPI still. Now, the Fed were cutting through that, by the way, and they did in other periods too, similar. But that period is telling us again, six months lead time, the CPI should fall dramatically. Now, if I go on to the next chart here, it's the chart of commodities. Remember when Peter Zeihan came on and shocked us all to say we're going through world food shortage? Well, most of the food prices for Western economies have actually collapsed.

So, the commodity complex overall is down between 20% and 60%. So, this is all commodities year-on-year rate of change. Now, considering oil hasn't gone down a lot. It's only pricing in an ISM of about 54. The actual inflation from commodities has evaporated. And the longer it goes on, even if prices stay the same, the more this will go to negative year-on-year. So, the inflationary effects of the commodity prices, the supply crisis of all of these commodities, agricultural energy, they're all going out the numbers superfast.

So, I think we're teeing ourselves up for a situation where the narrative shifts from inflation and growth is bad, to, okay, inflation is coming off, but growth is much worse than we expected. So, what does that mean for markets? So, if I look at the next chart, it's actually-- I love the ISM, the business cycle. I don't know why more people don't use this stuff. So, the ISM, the next chart, versus the NASDAQ. The year-on-year NASDAQ is pricing in the ISM at about 41, which is almost pricing in the full sharp 1970s recession. So, it's already priced it in or close to it, maybe there's another leg lower.

The S&P in this terms would be somewhere like about 45, 46, so pricing in a recession. Discretionary stocks, consumer discretionaries are the same as the NASDAQ pricing in a full recession. The growth end of tech, the real growthy stuff, that's at 39. So, that's really pricing in a full recession. So, a lot of this is in the price. Now, we hear a lot about people talking about-- Tim has talked about this, the next phase down of markets is when the earnings goes down.

Well, these charts suggest that's already started happening in the price. And yes, maybe there's a final leg lower as they have the price in the even lower ISM that I think is to come over the next nine months. What is also interesting to me is that the markets tend to bottom before the ISM does. So, if we go back all the way to 1947, it actually bottomed in line. When we go back to 1974, it bottomed three months beforehand. And if we go back to 2018, it bottomed nine months beforehand.

So, I can't be extremely bearish equities. I can imagine that there is some more downside to come. But I can't be very bearish equities. But there are other trades that really interests me. Firstly, the cycle I think will be short and sharp and therefore, we will be looking for the upside in equities in the next three months or so and I've been buying the growth end of tech because it's the most discounted. And I think that rates won't be rising.

So, let's go on to the next chart, which is the one that's really interesting because I always say bonds are the truth. But interesting enough, the 10Y bond yields year-on-year versus the ISM is actually quite mispriced versus everything else. It's pricing the ISM over 60 when everything else is pricing it much lower. The NASDAQ's pricing it at 41, 42. Now, again, when we go back in history, we saw this happen before. It happened in 2001. The market mispriced bond yields and bond yields collapsed.

So, I'm very interested in what bond yields will do in all of this. And I'll come on to another chart in a sec that ties this all together. The following chart is the one that is keeping bond yields from falling, it's oil. Oil's remain elevated and I'm looking for it to come lower. I understand the supply story and we'll see the clip from Warren Pies later. But the supply story, I understand it's not going away fast. But the demand story is probably worse than most people expect.

And what's interesting is if I look at the year-on-year change in the dollar, which is blue, which is the DXY inverted, and the white, which is the price of oil dollar, dollar and oil are usually very correlated. Now currently, they're not. Now, the DXY is pricing oil at $20. And oil is at $104. So, it's telling you roughly the premium that's in for supply issues. It's telling you there's like $80 in the price. So, I think that anything, any positive news on the supply side brings oil lower, or any shock on the demand side brings oil sharply lower.

So, I'm expecting oil to come back into the $80 to $60 range, which again, if you then look back, that will mean that inflation basically evaporates, the Fed with the headline of oil coming low, it's the last shoe standing in all of the commodity markets. If that comes lower, then the Fed will see a recession and lower prices ahead. And they will pivot, and they will pivot quite sharply.

Now first, you have to go through the narrative what a pivot is. First, they'll say, well, we're just going to watch the data. And then they'll say, maybe won't do as much QT and then eventually, they'll cut rates and the market is already pricing rate cuts in for January. I think they might even bring it forward. It might even happen this year. That's how it played out in 2001.

So, I'm watching all of this. And there are no certainties with any of this. These are all probabilities I'm trying to ascertain. Coming on to the next chart which ties it all together. That's that financial conditions index again with the ISM against it, and it's showing you where all of these asset prices are pricing right now. So, US Treasurys is the most expensive versus where the economic cycle is, and the NASDAQ is the cheaper. Then after is the S&P 500 cyclicals versus defensives, large cap small caps high yield spreads.

So, it tells you the NASDAQ is getting close to be fully priced. And the bond market's nowhere near fully priced and a lot of other stuffs in line, so high yield spreads will probably move lower as the economy slows. And on to my final point before we dig in some of this is this affects crypto, too. And if I look at the global money supply year-on-year against the year-on-year rate of change of Bitcoin, you can see it's a dominant driving factor of the overall direction. It is not the only factor but a dominant driving factor.

Now, global money supply has been shrinking because everybody has been tightening. So, that has reduced the price of Bitcoin. So, the crypto winter was essentially in that chart. The following chart shows that the money supply is cyclical, too. And the ISM leads it by nine months. The ISM inverted suggests that the M2 rate of change is going to start rising again. So, that basically tells us things like Bitcoin and risk assets which ties into the NASDAQ being cheap and the exponential age stocks being relatively cheap, that there is a potential big turning point in markets to come.

What I'm waiting for is that turn in bond yields. I think yields are forming a head and shoulders top with 275 in the 10Y as the neckline. If it breaks that, then we're going back below 2%. Inflation breakevens are already falling. So, we've seen that I'm fall sharply. And I'm expecting the oil market to show more liquidation. We saw a glimpse of that this week when we had some really rough days in oil. And I know there's a lot of oil bulls out there. And I understand the longer-term picture.

And Dwight Anderson made this clear in his interview is the thing that will pause the longer-term picture is a demand destruction. And Warren talks about it as well, I think we are going to see more demand destruction in a shorter sharper period of time, then maybe oil steadies again back at $80 to $100 range, but the rate of change won't be as high. You won't keep going up at 100% increments, which means inflation is not as high.

So, the inflation we get out of this, after this recession is going to be much less than people expect. People are overextrapolating past prices and rate of change than current prices. So, that's basically my macro view is maybe a bit more pain to take, really unclear, one gush lower, but the thing that will happen is that we need to brace ourselves for the economic impact as it's going to start to become clear to people, clearer than it is, people don't yet believe that story, but I think it's going to, I'm very clear.

MAGGIE LAKE: It's so interesting. First of all, I just want to say we will link all the charts because I know that people are going to be asking, so we'll put them all somewhere where you can access them and really pull them up and dig into some of what Raoul was just saying. I think that's super important. So, let's unpack some of that, Raoul. We've got some questions that are directly related to this.

But one of things that's interesting of what you just said is, first of all, I know you've been looking for this as do have some others and there was so much skepticism, I think we started to see that shift prior to the payroll number today, everyone was talking about and this was the change, really in the last month, everyone was starting to talk about recession. But now, that confusion has entered again, because of some of what I think you would probably say backward looking data.

RAOUL PAL: That's right. That's the key thing. Unemployment data is lagging, the ISM employment data has started looking at contraction. There's a lot of data that looks at forward looking contraction of employment. You're seeing the tech layoffs day in day out. So, that's coming, it's not in the data yet, because the data is lagging. CPI is a huge lag, the biggest lag of CPI is owner equivalent rents. So, these things are all phased, which is why you tend to see after these inflationary bursts, I'm going to say something that might shock people, inflation goes negative.

It went negative in 2009. It went negative in 1947. It can go negative just from the year-on-year effects, and after such big moves that comps versus the previous year are really hard. So, to end up with ongoing endless inflation is almost mathematically impossible. The question in people's minds are, can we get the 1970s again, where inflation came down, and then it came back up again? Well, for that to happen, that was a demographic demand shock. We don't have that this time.

Can we have another supply shock? Could China be a big problem? Yes. But we're going to have to move the oil price to 200, 300 to have the same magnitude of price increases with the year-on-year comps. That's a really tough call to say that that's the most likely outcome. But again, there's lots of possibilities out there, not as many probabilities.

MAGGIE LAKE: Yeah. And the thing is there are some forecasts. Now, maybe they've been revising it. I think JP Morgan was on the high end of that oil forecast, which I think is so confusing to people. So, let's start with some of the questions and then I'm going to play a clip in a moment. But just speaking to the mispricing of the bond market, which is so interesting, and a lot of people have been caught out and hurt by this, who are possibly more short term, who'd been looking for that market to move.

Bill from The Exchange asking, since the flash update, 10Y yields have risen while the yield curve inverted even more. Is it a signal? Is it noise? What do you make of the fact that bonds are mispricing it as you say?

RAOUL PAL: Look, when the yield curve is inverted, and the bond market is doing this, which is still bouncing around, hasn't peaked fully, that should put bonds completely on the radar screen. Because what it's telling you is the yield curve is inverted. Therefore, the probability of recession which backs up a lot of what I've been talking about, is there. And what you're usually missing is something that changes that equation.

And may it be the CPI prints next week. May it be an ISM print later. It could be anything. We don't know. So, you just have to keep watching this. And I have suggested for a while this 275 level is the key level. We just have to wait. These things take a while to play out. Markets have a lot of noise in the interim, I still think bond yields are taut.

MAGGIE LAKE: And you have a longer-term perspective, but you were talking about a series of bond in Eurodollar bets that you were interested. You're