WARREN PIES: Welcome to the Real Vision Daily Briefing. It's Tuesday, March 22nd, 2022. I'm Warren Pies, founder and chief strategist at 3Fourteen Research. Today, I'm joined by my good friend, Vincent Deluard, global macro strategist at StoneX. Vincent, how're you doing?
VINCENT DELUARD: I'm great. I'm very happy to be here. It's got to be fun.
WARREN PIES: Yeah, I'm excited to talk to you. In case you weren't aware, this is the Daily Briefing. We start with what's going on in the markets today. Stocks were up again. Bonds down. Yields up. Commodities down more or less. And this is the continuation of a move we've seen over the last week is the way I would look at it. Let's expanded out to that last week's move, I've really struggled to understand what's behind this move.
I know like me, you're leaning to the bearish side on the markets, trying to find the evidence or reasons to get bullish, and there's an old saying in the markets nothing like price to change sentiment. And that's what it feels like to me. It feels price has changed sentiment. Just a week ago, everybody was giving you all these reasons to be out of the market, to raise cash. Today, it's all about how the economy strong. We can handle higher interest rates, yada, yada, yada.
There have been a number of technical signals that we've called Breadth Thrust that have fire over the last few days. The way we measure to 3Fourteen we haven't seen that, but we're watching as it close. Interesting chart today, we did break above the 200 day moving average on the S&P 500.
A chart that we're going to show here at 3Fourteen, we broke apart every combination of moving averages to look at which one is really matter in the Sharpe ratio for just following a simple strategy to get in the market when you're above the 200 day in or that the moving average of that duration we're looking at and out of the market below that moving average.
What you can see in this highlighted box is that this 200 day moving average area about 150 to 200 days, is a really historically key moving average. There are a lot of systems are going to be built on getting long again when you break above a moving average like this. I think there are ways to improve those systems is very simplistic, but you get the point. With that said, what do you make of this rally? How do you square it with the beginning of the year? And what's behind it?
VINCENT DELUARD: Wow, a lot of questions here. I'm not sure I would try to derive too much economy, meaning from this rally. [?] that we've seen in recent years is this very strong end of quarter end of month rallies. So, this is March 22. If you remember, the COVID market bare bottom was March 23. Before that, if you go back to 2018, the 23 [?] to the market bottom of 24, the Christmas massacre. Then even if you will before that, the Vol Magadan ended up also I think Mark 23 or March 24.
I've done some work with Mike Green simplify on that just looking at returns for the stock market when we have a big correction in the last week of the quarter. Then you see this anomaly, unexplainable anomaly, over the past seven, eight years. We have these extraordinary returns in the last week of the month as well in the quarter when stocks are down. Now, my theory for that is that we have the emergence of these whales, the target-date for the whale, which 3 trillion now in target data sets. Then this will be mechanic.
Every month, two weeks apart, your paychecks are 7% to 10% get wired automatically by default into GDI account, which typically is going to target-date fund. That target-date fund has to keep a certain balance between stocks and bonds. If was the case up until this morning, stocks are down and bonds are up, or down less than stocks which was the case up until this morning, currently in the quarter you have to rebalance. You sell bonds. You buy stocks. That seems to me like a pretty good description of what's happening today and in the past week.
WARREN PIES: Yeah, it's interesting. I know the word is always fascinated me on the target-date funds been just more or less rebalancing mechanics underlying the market. I guess the real logical question for me is that getting a chance to talk to you here in this format. Is this a sustainable rally? In your most recent report that you've shared with me, you came out and made some big bold predictions.
I want to read a quick quote from that. Set the table for you and let you answer if this is sustainable, given that this is what you report said. "This report will solve this contradiction by making three clear and verifiable forecasts. Number one, a bear market has started. Number two, inflation will not decelerate as much as the Fed hopes. And number three, the economy will not fall into a recession in 2022." Those are three big predictions. You say the market started, so is this really going to peter out? Or do you think it has legs?
VINCENT DELUARD: Well, let me answer on the macro part on the economic part, and then we'll go get to the market because I think that's just the logical order. Coming up the Fed meeting last week, I had a very strong feeling of cognitive dissonance of hearing two things that could not be to pull through at the same time. And I think that's how most people felt. Basically, the Fed was saying the economy is extremely strong. I think he used the word strong 4 or 3 times.
Also, inflation is going to fall gently to 2% by the end of 2023, and that's going to happen with seven rate hikes. The cognitive dissonance comes from the fact that even of these things can be true. Either the economy isn't that strong, we tend to be my camp, and we're going to need inflation is not going to come away and wanting more rate hikes or traffic is the camp of other people I follow and respect on Twitter is that the economies are actually already weakening.
You will get the bond market. You will get yield curve. You will get corporate bond spreads and demand disruption promote a higher prices, and the Fed is over tightening into recession, and they will have to [?] back in 2023. These are two intellectually consistent positions. The Fed is not. With that juncture, in my view, okay, I'm going to go with the two hot gap. We're going to have too much inflation. We will not have a recession in 2022.
Now, of course, this is a key theories variables, all else equal assumption. Assuming we keep oil around 100 to 130, and we don't need to have 10 rate hike [?] as of now. I don't think we have recession 2022 and I think we have inflation. Now turning this into a market forecast, what I did is I looked at the historical bear markets, and I classified them. I was at a recessionary bear, inflationary and recessionary, inflationary and non-recessionary.
What I found is that what really matters is the inflation question. Actually, if you have a recessionary bear, which is what everybody seems to be afraid of, it's actually more shallow because at some point the Fed will kicks in. If you're at recession and you can't raise, you get some liquidity. People start buying stocks, again. If you do have what I expect to be an inflationary bear without necessarily recession, you don't have your Fed put.
I like to say that we don't have a Fed put, we have a Fed short call. Everybody's expecting when is the Fed will be going to kick in. I would say that question is that, what do you think happens if we make a new high in the S&P 500? Of course, the Fed is going to tighten. So, it's like the Fed has sold a call against future market gains. And I'm not really sure if the Fed put exists. And if it does, at what level it is?
WARREN PIES: That's an interesting analogy. It's similar to how we thought of the market to-- what we would say is that every one of these rallies is self-defeating. Because at the end of it, you have the Fed waiting there, just to drop the hammer on risk assets. Into that point, today, we had Bullard come out and basically make the case for 50 basis point hikes. Market starting to lean that way for May. The consensus is floating to 50, and then another 50 in June. You're saying seven. Is that your base case for the Fed hikes this year? How do you see that path evolving if you can do that kind of work?
VINCENT DELUARD: I think the uncertainty here is really enormous. I mentioned seven, because this is what Powell said last week, and this is more or less what the Fed Funds Futures market is pricing. If I had to take a position here, I would probably over that. I think we'll get nasty impatient numbers. We haven't seen the impact of Russia on inflation, and we're already accelerating at 8%. Remember, we're supposed to slow down in the summer of 2021, then the fall, then the winter, then that 7.5 was the peak. We're already at eight without this.
It's hard for me to imagine a world where inflation does not reach double digit in a couple of months. When that happens, I think there will be pressure on the Fed to maybe just for-- I think that was the idea we'd brought, just front load that thing. We're already behind the curve. It's always going to be easier to take hikes after, so it could be that it goes that way. And of course, the Fed is the political entity. The US economy is very asset price dependent. There will be other concerns that will go at the Fed. If I were to make a guess here, I think more than seven.
WARREN PIES: Okay. So, we take the over on seven. Given that outlook, you see inflation but strong growth. And you're basically outright saying the bond market is wrong, is that correct? It's a pretty big statement to say the bond market is wrong. I would imagine you like commodities and real assets in this environment. How would you recommend your clients position themselves given the outlook?
VINCENT DELUARD: On the bond market, and I know overtime, you look at this chart of a yield versus nominal GDP role for inflation, and the bond market has been more right than wrong for a period of time so it is indeed, I would say, at a consensus. A lot of the other people I like and follow on this platform, and if you think about someone like Alex [?], like you, like [?], they generally respect the bond market.
There's really two parts to my distress to the bond market. One is I think this is wrong on inflation, and I think it's been wrong for a long time. The daily hours of me on YouTube talking about inflation as early as late 2019. On this, I don't think I need to make my case anymore. It's more the people who think we're going to see this inflation, who needs to justify how that would happen. So, there's inflation component.
Then on the very mechanic of the bond market, again, I think it's a case of the tail wagging the dog. Obviously, the Fed I think given the form-- all central banks have intervening in every bond market, so that price message has been degraded. And we also have this target-date on mechanism. I think one thing that happened last year is because equities were rallying so fast, target-date funds will systematically underweight bonds. What they recall is they had to buy bonds in order to catch up with equities.
Now if you think about the way the market saw that, well, although yields are low, the bond market is well big, so that means inflation is transitory, so that means equity can rise some more. We have this weird circular reasoning going on. It could be a defense is judging what the bond market is telling.
WARREN PIES: Yeah. Just a quick chart that we've been showing to get into how to position portfolios in this environment. The chart here, Brian, with the scatterplot, that I gave you. We're looking at high yield credit spreads versus breakeven tenure, breakeven inflation. Historically, this chart showing that there's a linear relationship between these two series. Historically, in the modern American economy, especially since 1998, we've seen inflation fall along with growth, which means that spreads blow out when inflation falls.
What we're seeing here recently in the month of February, something I think is really interesting. It's what we would call a stagflationary smile emerging in this data. We're now starting to see these red dots that are highlighted on the chart pull out and move up. And so, what we're seeing now is inflation is rising at the same time that high yield credit spreads are widening. This is really unprecedented in modern American market history.
What I would say is, this is the first emerging evidence of stagflation. Our view has been, we didn't see a big risk to stagflation, but obviously, Russia and Ukraine has changed that calculus. We'll get into that in a minute. To me, now everyone's in a scramble to understand, number one, what to stagflation mean? How you define it? And number two, what assets work in this environment? Do you have any thoughts on what assets work in this stagflationary environment that we are potentially looking at?
VINCENT DELUARD: The first thing about stagflation is that it is the worst economy configuration for the 60/40 portfolio. Most of the stuff that we are most invested in by default amount, that's what a target-date for me is. If stocks and bonds and it's based on the notion that growth is going to be positive. Inflation is going to be limiting. The correlation between the two is going to be negative. Everything we do, whether it's disparity, most professionally managed money and manage based on this format.
Stagflation is for the wrench into this. It's difficult because obviously bonds on the big loser, especially long duration. In the case of US stocks, because it's such a long duration stock market, I think this is highly valued long duration assets perform very poorly during periods of stagnation. You could see bonds and stuff going on at the same camp. I expect to see these in the coming decade. Things that do well, and I think we're trying to figure it out.
I think people are trying to understand, that's going to realize that your Treasurys are no longer going to hedge your stocks. You've seen that every correction in the stock market, Treasury is actually healed went up, prices went down. And we're looking for some safe haven asset. Why people thought it was going to be crypto? I think this has not worked very well this year. Gold finally is doing better. Commodities, gold, they have a role to play.
I would add emerging markets to this list. They have very nice carry across Latin American bonds. You have [?] rates in China and Indonesia. I like the Swiss franc as a risk of assets, but I think you need to look outside of the 60/40 portfolio. And this need is only going to increase as this stagflationary environment becomes the new normal.
WARREN PIES: That makes sense. Just to distinguish our views at 3Fourteen, and some of this you're familiar with. Coming into the year, we were more or less bearish, but at the same time, we've made the case that cycles are compressing. The US economy is more asset price dependent now than it's ever been. And so, as interest rates, monetary policy, the transmission mechanism between monetary policy and the blue economy, I think actually has short contrary to the arguments that it seems like you're making, which is that the real economy and markets have divorced from each other.
The big change to that has been the conflict of war between Russia and Ukraine, and what we calculate back at the [?] to be a result, 4 million barrels a day, which is about 4% of global demand deficit in the global crude oil market. We've been arguing, really even leading up to the war that energy stocks, they have been overweighting your portfolio. That these stocks hedge a bunch of tail risks to this market. And so, that's been our portfolio construction and how we've been positioning clients.
Here recently, Maggie Lake got to speak to Michael Kao, who's a friend of mine, and somebody had been on Real Vision twice with about his outlook for oil prices, while we take a listen to what Mike said.
MAGGIE LAKE: What are you looking at for oil prices?
MICHAEL KAO: Well, I'll tell you. Before the Russia-Ukraine wildcard, my scenario was that we wouldn't officially enter the structural phase of the oil bull market until late 2023. There is still a spare capacity in the world I'll be dwindling. Even the most conservative assumptions of how much global spare capacity there is get challenged by the end of 2023.
Now, the Russia-Ukraine conflict just puts a huge wildcard in everything because now even though the energy sector of Russia isn't officially sanctioned. We have all seen that as a result of self-sanctions and lack of insurance and whatnot, we saw that massive spike to 130. Now it's eased back. But the question I keep contending with and I don't have a good answer for this, I wish I had a crystal ball on this is, will the long term supply destruction be greater than or less than the long term demand destruction?
It's really hard to figure out right now because if you have six months of 100 plus oil, you're definitely going to see demand destruction. But then the question is, how long is Russian production going to be disrupted and whether or not the Russians need to shut in or not?
WARREN PIES: Alright, so that was Michael Kao's take on the whole market? I think him and I, were have similar mind that the big bull market was probably more schedule for 2023 before the war. Now we've made the case that under certain scenarios of how this thing breaks, there's more or less no ceiling on the price of oil. I know from talking you previous to this conversation, Vincent, that oil is kind of a risk factor here you call, is that correct?
VINCENT DELUARD: On the recession, call for sure. On the inflation obviously, that the higher price is gold. You know the impact of call on the CPI. Not just through its direct impacts, it's very small like less than 7%, but all calls and everything we consume. Obviously, oil higher prices are opposed to inflationary. Now in terms of my no recession call, yes.
I think Michael is asking the right question here. We know the supply destruction. So, let's go to your estimate 4 million barrels a day. You look at the market, it's hard to see where that's going to come from. We have to beg Saudi Arabia. Are they going to help us? Do they want to help us? Can they help us? Then you go down the list? You and Michael are the only experts here,