ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Wednesday, May 18th, 2022. I'm Ash Benington joined by Michael Gayed, CIO and portfolio manager at Toroso Investments. Let's jump right in. Obviously, busy day, equities just getting smashed right now.

Final numbers coming across the tape. S&P 500 off more than 4% down below 4000, closing out the day here at 3924. NASDAQ off nearly 4.75%, closing out the day at 11,418. VIX over 30 here, just an ugly, brutal day. But I want to read something as we get started here. "For whatever it's worth, if stocks are going to crash, conditions are here for it to happen this week or next. This can't persist much longer." That's from May 15, written by Michael A. Gayed, CFA. Our guest, Michael, welcome back to Real Vision.

MICHAEL GAYED: I appreciate it, but you didn't mention Treasurys, by the way, which are perhaps the most important thing in terms of today's action. We'll get into that.

ASH BENNINGTON: Well, kick it off. Let's talk about fixed income. What's driving action today?

MICHAEL GAYED: Yeah. As you recall, I joined the fantastic Twitter Space that you guys were hosting at Real Vision last week, Jim Bianco was there. And I popped in for a few minutes, and I noted that last week was the first time all year that it looked like Treasurys were getting back to how they historically behaved during a classic risk-off period, meaning long duration yields fall, they act as the counter asset when stocks get volatile and go down.

This year, that continued-- rather this week, it's continued today as well. Treasuries rallying, long end yields dropping as the S&P is down hard. This is really, really important for people to understand as far as how this year has played out. I've been very public in saying this, I've been going through hell with my ATAC rotation mutual fund, my Ro-Ro ETF, my Jo-Jo ETF, because all my funds are built on the premise, which is validated throughout history, throughout backtesting, throughout deeper research, that when you're in a real risk-off periods where stocks get volatile, Treasuries are the best place to be.

And then if you can get that Treasury trade right based on certain leading indicators that tend to get ahead of that volatility, you can really do quite well over the long run by avoiding those big declines in equities. The problem this year is that Treasurys acted like equities. In other words, they correlated. Risk-off was risk-on.

Now, if that relationship is starting to come back where they act as the risk-off asset, and today's a good example of that, conceivably, we could be in the midst of a crash right here right now, because that would suggest entering risk off already with volatility elevated. We're entering risk-off already with most equities way off their highs.

ASH BENNINGTON: Yeah. Let's talk about the long end of the curve. Let's talk about TLT, the iShares 20 plus year Treasury bond ETF.

MICHAEL GAYED: Yeah, so historically, I know a lot of people are talking about correlations between bonds and stocks. The correlation that matters the most in my world is when you have that inverse correlation during high stress periods, that flight to safety trade, again, when stocks tend to act volatile. And I'm not saying this haphazardly, but when you have real risk-off periods when equities collapse, and Treasurys do well.

If you're in Treasurys in advance of those big declines, you can outperform the S&P by 2000, 3000, 4000 basis points in a matter of weeks. Consider just today, TLT is up I think, roughly 2%, the S&P is down 4%. That's 600 basis points. That's a huge spread against equities.

And it's not uncommon to see that type of convex move when you have equities go down if you're in Treasurys and if you have that flight to safety trade. That really does relate to this other point I keep mentioning that I believe the deflation pulse is returning. I know everyone's talking about inflation, but I keep making this point, inflationary shocks are inherently deflationary because of the speed with which it takes place. Bonds are now I think, going to start to react off of that.

ASH BENNINGTON: Yeah, lots to talk about here. TLT moves in the same direction as the price of Treasurys. You'll see the TLT moving the inverse direction of 20 plus year Treasury yields. Talking about inflation, lots of stories around inflation today. UK inflation hit a 40-year high. This is off data coming out this morning UK time.

And also, some of the steep declines that we're seeing in US equities being driven by some really ugly numbers in terms of the trading for stocks like Target, which was off I think 27% on the day, and then also Walmart down I think 6% or 7%. Significant, significant declines in the stocks based on inflation.

First, talk us through the inflation component of it. It almost sounds like your thesis is high prices lead to lower prices. As you see rapid increases in prices, you see deceleration in economic activity. We've seen that in the data, and therefore a potential, potential flip into deflation. Is that a rough frame on the thesis? And how does it correlate with what we're seeing today in US retailers?

MICHAEL GAYED: I put out a Twitter poll yesterday, and the poll was, are high food prices making you rethink going to the movies? Maybe 48% said yes. And some of the comments were, I don't quite see the connection. The connection is very, very simple. At some point, as these food prices keep getting higher and higher, at some point, as people started getting the sticker shock and start realizing that gas prices are not going down, behavior has to change.

Now, spending is no different than any habit, discretionary spending is no different than any habit. And there's this old saying that it takes 21 days to make a new habit. It takes some time for consumers to start changing their behavior, but not that much time. Given how fast this move has had been in inflationary pressure, it's clear that people are going to have to start making choices on where they spend their dollars, because even though they're making more money, they're making less after inflation.

And all that ultimately is going to not only result in demand destruction, but it's going to bring everything lower in price, because at the end of the day, if you don't have a gradual rate of inflation to allow for companies to respond to it until after consumers react on it, and if it's a shock, how can it possibly be inflationary long term?

ASH BENNINGTON: Yeah, it's an interesting open question. Just some color around Target and Walmart right now, Target looks like closing up the day here minus 24.87%, so down about 25%. This is on an earnings miss. Walmart closing off the day off almost 7%. This, I believe, is off the decline yesterday of 11%.

MICHAEL GAYED: Yeah, and I think it's a good reminder that nothing is safe in this environment, including the stalwarts, including the blue chips. And look, we all know about this gradual deterioration that's been happening beneath the surface in terms of a lot of these innovation names and small caps in terms of emerging markets that made it very public that I believe the bear market really started February of last year, because that's when Brent started weakening, even though it looked like everything was fine as the headline average just kept on pushing higher.

But you're seeing a lot of these very big mega cap companies getting taken out to the woodshed. These are billions of dollars of market cap erased in a single day. When you see action like that, that tells you something's very, very wrong, not just with the thesis around the idea that we maybe retouch new highs at some point, but also, I think it makes people question just how healthy the underlying dynamics of the market were to begin with.

Oftentimes, these types of big declines happen largely because there's an overlevered player that's on the back end that push these prices to those levels. But what happens when everybody is the over leveredplayer? I keep making that point on Twitter, it's all one big leveraged trade. If you have everything being so overly levered, yes, you're going to have these gap downs in mega companies on any disappointment, which then by the way, will probably cascade into other types of declines and margin calls writ large.

I'm not trying to be overly bearish by any means. Because again, I have not done well up until maybe hopefully now in this environment, because nothing's really worked. Treasurys have not been the counter asset. But things are normalizing, and then suddenly, people start waking up to the reality that, wow, there's a lot more fragility underneath the surface than we think. Yeah, you could have a very, very nasty air pocket. And believe me when I say this, the stock market will break inflation faster than the Fed, full stop.

ASH BENNINGTON: Yeah. By the way, we should say to precisely that point, TLT off about 19% year to date, looks like on a one-year basis, off about 14%. Obviously, some movement there. Michael, a knack for talking about the obvious, let's talk a little bit about your view of what's happening at the Fed and with policy rate normalization.

MICHAEL GAYED: Normalization is always a funny word I find. Because it sounds like, well, what's normal? Is $30 trillion of spending normal for US government expenditures? Is 167 of unfunded trillion liabilities normal? Normality is always in the eye of the beholder.

This narrative, I think, is unequivocally true that the Fed has been very late to the game to hiking rates. I've put out a tweet in June of last year saying the most responsible thing for the Fed to do now, back into In 2021, was to hike rates, do a surprise rate hike. Look, you can't fault the Fed for not seeing the future, in fairness, because nobody can. I don't care how smart you are, I keep making this point, no amount of intelligence increases the clarity of one's crystal ball.

But I do believe that when you have subjective human based decision making, that is not rules based, it is very prone to being late, to making errors. And I think from that perspective, the Fed probably like a lot of other people, got very sucked into the fear that Omicron would be worse than expected, that COVID will last longer than it actually did in terms of the bulk of the seriousness of it.

And they obviously kept the pedal to the metal too long, not realizing that they should probably look at home prices around where they live, and the pace at which they're accelerating, not realizing that when you go on Twitter, and you see the level of uneducated speculation that was occurring last year, and the way people were thinking about investing like it was a game, that that's classic in terms of a sign that you have to take liquidity out of the system yesterday.

ASH BENNINGTON: Yeah. Michael, to precisely that point, I want to take a look at a clip that really drives that home. This is called the big bond investors view. It's an interview with Jeff Moore that was done by Raoul Pal on Essential Plus and Pro tier. Let's take a look at that clip right now.

JEFF MOORE: The macro story we have today is we have a Federal Reserve that feels like it's late, whether or not you believe they're late or not, they believe they're late. They've been moving fairly aggressively late. And the bond market, when the Fed is raising rates, is no longer a diversifier to stocks. It's s diversifier of stocks when the crisis is happening at stocks. But when the crisis is bond driven, it's not a counter to anything, it's now just selling off because the Fed says we're late.

And not just the Fed, even the ECB seems to be changing. President Lagarde, she's starting to talk about changing a little bit. Governor Kuroda in Japan, he's on the hot seat, he's the one trying to hold 25 basis points for 10Y JGBs. We'll see how that goes. Our macro piece here is that we have more rate vol, the kind of rate vol back to the 1990s. That's where our head is.

We got used to interest rate repression, spread repression, we had a big Fed, there are always Fed put in our back pockets since Chair Greenspan. This is the group, because they're behind and the Fed, it's going to have to suck it up and allow the market to be a little less efficient, a little bit more volatile, and have a little less price transparency.

ASH BENNINGTON: Exactly what we're just talking about. The Fed is late, and this expectation of a Fed put dating back to Alan Greenspan. How does that shake out? What's your view of the trajectory going forward, Michael?

MICHAEL GAYED: On the idea that the Fed is late, they're so late that in their desire to play catch up, they'll even be more late. And here's what I mean by that is you mentioned Greenspan, the Fed, I believe was hiking rates up into the 1987 crash. And then Greenspan came in and started lowering rates. I think they are so late to the game that there's a real risk here. And again, I go back to the stock market brings inflation.

ASH BENNINGTON: Explain what you mean by that, Michael, that it's this idea that the Fed effectively is hiking into a recessionary cycle rather than into a bull market rally that starts to look like a bubble. It's typically the reverse. We're in this place, when we say they're behind the curve, it means that they're the Scylla and Charybdis that they're always trying to steer between inflation and maximizing employment, there really is no way to thread that needle when things get this tight.

MICHAEL GAYED: And when leverage is this high because of their own actions. I keep going back to this point. Why do we keep on seeing these crashes seemingly happen closer in time than what you'd normally expect with the normal distribution? Well, because every single response to prior crashes is through leverage, you never fix the problem. You keep making the problem bigger, and then the crash happens again.

And every single small butterfly flapping its wings creates the cascading marginal. My point about the idea that the Fed is so late to the game here is that they are, to your point, hiking rates probably in a recession that we're already in. Stock markets are responding off of that, and there's been a lot of devastation beneath the surface. All that ultimately is probably going to mean that they have to lower rates again.

And by the way, if I'm right that risk-on risk-off dynamics have returned, that Treasury yields on the long end drop. Well, that would actually confirm the idea that the bigger fear is going to be the disinflation that all leverage creates from a longer-term perspective. I really think people have this wrong. When you have so much leverage, the risk is not that the Fed is late to hiking rates. The risk is that the market crashes, and they have to then re-lever it up again.

ASH BENNINGTON: Yeah, leverage really is in many ways is the [?] out of bubbles, isn't it? It's always the factor that seems to be present in some form or another.

MICHAEL GAYED: Yeah. And I'm fond of always using this line on Twitter. Overconfidence leads to leverage, leverage leads to crashes. It's always about conditions, you may not know the exact mile marker you might crash your car, but you know that if it's raining, you better slow down, and leverage is the pedal to the metal. That's not to say that leverage is necessarily a bad thing if it's done properly, if you're not magnifying to the point of risk of ruin. But when the whole system is levered, that means nothing can really go through any major decline without a systemic event. Now that by the way, is an interesting conversation to crypto we can talk about too.

ASH BENNINGTON: Yeah, much to talk about. I want to jump in and grab some questions, because they're starting to come in fast and thick and they're questions from people who clearly are following you and your work because they're very dialed in. First question is a question about liquidity events. This is an interesting one. This comes to us from Marty from the Real Vision site. Michael says everything is going down together, to your point about there being only one trade, is this a liquidity event? Are large funds being forced liquidated?

MICHAEL GAYED: Yeah, it's hard to really know what's happening in terms of the plumbing. But it will not surprise me if you have some major institutions that are going through these VAR shocks, Value at Risk shocks, these multistandard deviation types of moves that they can't model off from the risk teams. And because a lot of these institutions also tend to be levered and don't realize how much leverage they have, because the underlying investments they have are levered, you can see how it becomes very easy to spark a broader margin call the moment there's any real volatility.

Now, again, deleveraging Treasurys tend to behave the best. That's why I'm saying I think what's happening now is really interesting in terms of that thesis that we may only now just be starting the margin call. And by the way, in a margin call, nothing gets spared. Everything tends to correlate to one except Treasurys. That means commodities, I suspect, are also going to take a pretty big hit.

There's a lot of people, I think that are under the false notion that energy stocks would be able to keep going up as the broader S&P collapses, or that oil itself would stay elevated as the S&P collapses. Time and time again, we've seen when commodity spike, equities collapse, and then commodities collapse. Nothing gets safe in an environment where everything's getting delevered.

ASH BENNINGTON: Yeah, and indeed, to your point, WTI June 22 crude contracts are at one, off almost 3% here in today's trading.

MICHAEL GAYED: Everything, again, except Treasurys, more often than not, everything tends to correlate to one, it holds its back, it's all one big trade. And this is really the big point. I really want people to think about this more, and to be a little bit more thoughtful in the way they approach their investments. It's one trade. It's just-- I don't know.

ASH BENNINGTON: Yeah. Here's another question. Obviously, someone who's following you probably quite closely on Twitter. This one comes to us from Is This It. This is from YouTube. And the question is what's going on with lumber prices and the lumber/gold ratio? By the way, for people who aren't following lumber give us a little bit of a sense of the significance of it in these markets and in the broader macro picture.

MICHAEL GAYED: Yes, I left my lumber and gold eyes. This relates to 2015 Founders Award paper, the idea is a very simple. Lumber's a tale on housing because the average house has about 16,000 board feet of lumber so as lumber performs, it tells you a lot about housing starts. It tells you a lot about expectations for housing construction activity.

When you compare it against gold, which