ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Friday, June 17th, 2022. I'm Ash Bennington, joined today by Michael Gayed, Portfolio Manager at Toroso Investments. We're going to get to Michael in just one second. But first, a quick look at what's happening in US equity markets.

NASDAQ Composite is the big mover on the day, 1.6%, up 1.6%. Everything else I would call like relatively flattish, S&P 500 up about two tenths of 1% on the day, but I want to take a look here at the weekly numbers. This is where the action is. Obviously, an eventful week, which we're going to talk about shortly. Nikkei on the week minus over 5%, Euro Stoxx 50 down about 4% on the week, NASDAQ on the week, minus roughly one- and three-quarter percent, S&P 500 off over 4% on the week. Dow Jones Industrial Average off 4%, Russell 2000 off a shade under 6% on the week, nearly 6% decline in the Russell 2k.

Michael Gayed, obviously, an incredibly eventful week, the Fed hiking 75 basis points to a target range of one 1.5% to 1.75% on the Federal Funds Rate, lots of price action, lots of volatility across asset classes, fixed income equities and crypto especially, what's your overall frame for what's happening here? What's your big picture narrative, Michael?

MICHAEL GAYED: Yeah, so a few things. First of all, I was early in saying that Monday, but I do maintain this belief that I think we're probably at some a near term capitulation type of moment, for both equities and bonds. As much as this has been a wildly difficult painful week, I just saw a tweet from an old friend Ryan Dietrich, who noted that the last time you had performance like this was pretty much on major lows, March 2020, 2011, following the summer crash. And I think it was a juncture in 2003, I think he mentioned March of 2009 rather.

So, as painful as it's been, my framework here is very simple. Everyone's convinced that things are only going to get worse. Everyone may be right about that. It doesn't mean they have to be right tomorrow. And you've already had so much destruction, devastation beneath the surface, and there's enough indicator to you that would suggest you're probably at a bottoming of risk assets and risk-free assets, meaning Treasurys, that that surprise may end up being that you end up having some positive catalysts nobody's thinking about, which could cause markets to rip higher, and which would give the Fed some time to try to counter these concerns about hiking rates.

ASH BENNINGTON: Yeah. So, we started with talking about stock markets, and jumping right to the effect over the cause. Let's talk about fixed income, bond markets, bills, notes, what are you seeing there? How do you frame it, particularly for equity investors, who may not pay as much attention to the bond market, except when things are moving?

MICHAEL GAYED: Yeah, so credit spreads are now widening, they're not blowing out in a big way, but credit spreads basically is the differential between poor quality issuances versus high-quality risk-free type of Treasurys, AAA versus CCC or B. The spread is widening right now. Usually, that is consistent with risk-off periods because when you have high volatility in stocks, spreads widen because there's suddenly fear of default risk premiums increasing.

And the higher that interest rates go, the more those default risk premiums will probably do increase because we know there's a lot of zombie companies, which should no longer be around that have been only kept alive only because of cheap credit. Now, the problem that the Fed is going to be faced with, which is why I think you're going to probably have some kind of positive catalyst coming soon is that the wider credit spreads get, the more default risk premiums increase, the faster that brings down inflation, probably at a speed that the Fed does not want to see.

Because if you were to have, at some point real refinancing risk by some of these companies on higher rates, to the point where these companies may not exist anymore, well, that's a deflationary shock. That's how you have a real deep recession, unemployment suddenly picking up. So, my point here is that I think we are nearing a juncture where the Fed is going to start to try to cool off risk assets again to buy them time. Because if it were to persist at this rate, the reality is, you risk a much deeper decline than what the Fed is hoping for with a soft landing-ish type of future.

ASH BENNINGTON: Yeah. Let's focus a little bit on credit spreads, particularly for people who don't have a lot of experience in the fixed income space. We're talking about spreads between, for example, BBBs and AA credits. Give us a sense of first of all, what this means, why we see these spreads rise, and what metrics you look at specifically to determine where you see the benchmark being for credit spreads.

MICHAEL GAYED: Yeah, so it's ultimately about the market's perception of whether a company is going to survive or not, which is the default risk premium, the risk of a bankruptcy. Typically, companies that issue a lot of debt and don't have necessarily the right balance sheet will be rated lower because the risk is higher in terms of their ability to pay off that liability. In the initial phase of this decline in risk assets this year, bonds sold off very aggressively.

But what was odd is that you saw a bond selling off without credit spreads really widening, meaning you end up having a strange scenario where it was more about duration and conservative bonds are doing far worse than-- on a relative basis-- than high yield junk debt issuances. This second phase here seems to be more classic in that sense that now, spreads are widening as bond markets across the globe are still selling off and yields are rising.

The Fed does not really care so much about the stock market, only to the extent that the stock market impacts the bond market. And that's something that I think a lot of people really don't understand when they say the Fed cares about markets, what they really care about is the spread movement because if spreads widen, that means there's liquidity that's harder and harder to get, because there's a degree of fear that's been getting priced into bond yields. And that's often where you end up having the about face by policymakers.

ASH BENNINGTON: Yeah. So, let's talk a little bit when we talk about duration, we talk about what's happening in government Treasury markets right now. I'm looking at a chart in front of me, this is the US 2Y Treasury yield chart, I'm looking at year to date. Boy, this is not unexpected given what we've seen from the FOMC. But you're looking at about 240 basis points or so starting the year at about 75 bits thereabout, trading right now at a yield of 3.16.

So, obviously, you see these rates rising very dramatically, the yields rising very dramatically in 2Y Treasurys. Talk to us a little bit about the transmission mechanism and the impact that you see that happening.

MICHAEL GAYED: Yeah, well, it seems to be right, because the real transmission mechanism isn't really from the short end, it's from the long end. Because the 30-year, which is what mortgage rates are ultimately based off of, it's what a lot of longer finance type of projects, assets or finance so when you see a real spike in the long end of the curve, it's where it really gets to be dangerous.

Now, I've used this line many times on Twitter before that this has been my hell, right in the sense that I've got these three funds, you see that in my background, ATAC, RORO, JOJO. All three funds are designed to benefit from this historically proven relationship where when stocks go down and there's high volatility, Treasury yields drop on the long end. Treasurys actually do well as the so-called "risk-off safe haven asset", instead of risk-off, it acted like risk-on. The correlation has been pretty much one for one.

The drawdown in equities in some ways been less than the drawdown in Treasurys, which is really abnormal, even from the 1970s. That transmission mechanism, well, that translates ultimately into the economy is in the price of homes, which I think now it's very clear, we're about to see a pretty significant about face. I do know the spaces like you guys do. And I just had a homebuilder analysts on earlier today.

And he was saying, yeah, there's a very sudden and aggressive slowdown, the demand just suddenly dried up. And it makes sense, because now mortgage rates are so much higher than they were at the start of the year. Now, just like the saying is that the cure to high prices is high price when people talk about it for commodities. Well, the cure for high price of cost of capital is high price for cost of capital, meaning at some point, the market is going to see this spike in yields as being an opportunity to actually bet that they go down again, because of the sudden realization that you just killed off housing.

ASH BENNINGTON: Yeah. By the way, we should talk about US 30Y Treasury yield, jumped right now trading on a yield basis at about 3.28%. That's up about 120 basis points from the beginning of the year. So, you see that, obviously, more sensitivity to the front end of the curve, which is of course, to be expected. The Fed has a great deal more challenge with the back end of the curve. But let's talk about the flow--

MICHAEL GAYED: Real quick, because I think it's an important thing you just alluded to, the challenge of the back of the curve with this quantitative tightening, and this, I would argue, could be a positive catalyst, which nobody's really anticipating. The Fed wants to lessen the balance sheet. They want unload some of these bonds. That's what quantitative tightening is.

Well, good luck doing that with this type of a disruptive environment happening in bonds, they'll make it even worse. So, they say they're going to do a fixed amount per month, it seems very plausible to me. And I think this is actually going to be a very positive catalyst if that's the case. It seems plausible to me that the Fed is going to change the way they plan on doing quantitative tightening, whereby a set of a fixed amount per month, it's a range.

I think the ECB recently alluded to this idea that they're going to have a range of the selloff of their balance sheet per month. If you make it variable based on "market conditions", if the Fed were to allude to that, that would probably stabilize bonds, do a lot to stabilize bonds, because then the fear suddenly comes out that the Fed will add pressure to issuances when bond yields are spiking. Well, if they're going to be dynamic in the pace in which they do QT, that will take a lot of fear out, I think.

ASH BENNINGTON: Yeah. What we're talking about debt, I wanted to take a listen to a conversation on Real Vision that touches on something that you and I talked about, Michael, on our Twitter Spaces. This is from a conversation called Great Trades During Tough Times, Lessons From a Master. It's Mark Ritchie II hosted by Mark Ritchie. So, father and son conversation here. This is available on the Plus and Pro tiers. Let's take a listen right now.

MARK RITCHIE: Everybody in this country has some debt. We've all got some debt, whether it's car debt, or house debt or credit card debt or something like that. It's debt we can manage. Do you think anybody in Washington knows how much debt the US government can deal with?

MARK RITCHIEII: I'm not going to answer that, because I think--

MARK RITCHIE: No, of course. It's a rhetorical question. It's a rhetorical question. So, you asked the question, how bad can things get? I was in the pit when somebody came along and told me that the Federal Reserve had just raised the interest rate from 22% to 24%.

MARK RITCHIEII: One shot.

MARK RITCHIE: This is the advantage that's specific of being old. Nobody in this room can remember that. I promise you that.

MARK RITCHIEII: That's for sure.

MARK RITCHIE: Can things get worse? Oh my gosh.

MARK RITCHIEII: Certainly.

ASH BENNINGTON: So, Mark Ritchie Sr. talking with his son on Real Vision, talking about debt. Michael, you and I just talked about this on our Twitter Spaces. In essence, they're discussing the challenges of a rising debt stock. Give us a little bit of context on what some of the risks are there.

MICHAEL GAYED: Well, okay, so this is important. And this is why I put out a tweet not too long ago, saying be careful what you wish for on this narrative that 60/40 is dead. Because when you have rising debt, and spending which is not ever stopping, and you have higher interest rates, and you have collapsing risk assets, you have a double whammy that only makes the debt load increase even further, even in the absence of new spending, which is to say that you'd have to keep on rolling over the debt, which means the cost of capital, the interest ends up being a lot higher. So now, you're going to you got to pay for a higher cost of capital.

And then again, if risk assets don't rebound, capital gains receipts are going to be a lot lower, you're going to have higher unemployment, so you're going to have a double whammy on the deficit. This is the challenge that the Fed ultimately has to face. Because they've got to stop the inflation monster that you can argue they created. They also have to try to buy time for supply chains to resolve themselves, but they have to also do so in a very gingerly type of way which would you ever leave a CFA lever four term?

A gingerly to have a way to make sure that it doesn't cause a real, real systemic event for government debt. Now, you can argue that because of the reserve currency, none of that matters. Well, we know that's not true, because look where we are now.

ASH BENNINGTON: Yeah, but already CFA level six.

MICHAEL GAYED: That's the easiest one.

ASH BENNINGTON: Yes, because you never have to sit for it. Michael, what else is on your dashboard as you look at these markets? We talked about the top of the show, obviously, a lot of moving parts, a lot of moving pieces. Tell us what else you're looking at right now.

MICHAEL GAYED: Okay, let's talk about sentiment for a moment because, again, this has been a very difficult and frustrating environment I've gone through severe drawdowns in my funds. And anecdotally, I'll tell you that I had a few emails from shareholders in my funds saying that your approach has not worked for a year and a half. This market's going a lot lower. I'm going to bomb out of your strategy.

Now, I've seen this before. I've seen when the sentiment is so vitriolic, and it's to the point where it was literally insulting me as a portfolio manager when it's a rules-based approach, where I am like everybody else, just watching what the rules are saying as far to where to allocate for ATAC, RORO and JOJO, which again, I've had nasty drawdowns, but the last year and a half has been very unusual. And this year, it's very clear it's an anomaly in the way stocks and Treasurys are behaving.

So, I've seen that when you have sentiment that's so vitriolic and points that the person not considering the context, that tends to be a major inflection point. Now, I can't prove that other than to say, subjectively, I've gone through that before. But let's think about--

ASH BENNINGTON: It's the flame index.

MICHAEL GAYED: Yeah, right. But let's look at the numbers. So, sentiment is wildly negative. And people will say that when you see sentiment being negative on equities, that's the time to buy. It's funny. They never seem to apply that to fixed income. Because the sentiment is even worse when it comes to bonds, which have gone through an utter crash with this yield spiking.

I think the market and individuals are underestimating the potential for some positive catalysts, that there could be surprises on-- as far as they don't always have to be negative. You can't have these positive surprises. So, I mentioned one of them earlier, which is there's a positive surprise that the Fed could cool off concerns about a fixed amount of selling of bonds through QT to something that's more variable, all right.

That alone would probably be a positive catalyst for stocks and bonds, because I suspect that if you're going to have a reversal, it has to happen in both asset classes, because they both went down in the same way. So, the initial recovery would probably be on both Treasurys and stocks. So, that's one positive potential catalyst. Another one is, which may explain some of the oil move is oil could suddenly break down because let's face it, Biden needs a win. He's going to Saudi Arabia next week.

Now, I hear everybody's arguments around capacity. I'm fairly confident that if OPEC wanted to find more capacity, they probably can. And it wouldn't surprise me at all if something like a backroom deal or something is done where Biden basically claims victory, oil prices break down very suddenly very sharply, that would cause a breakdown of inflation expectations, cause stocks rally, yields to drop.

The final catalysts, which there are some rumblings about this, which you can't say it's positive or negative, but at least for equities, it's probably positive, is apparently, the Biden administration is basically internally saying to themselves, let's try to push Zelensky to give up some land to Russia. Now, you can say that that's bearish, you can say that that's not what we want to see. But the reality is, if the expectation is that that does happen, if it does happen, that's going to cause us a ceasefire, at least for a moment in time, and there will be a relief rally just based on that.

So, my point is that, I keep going back to this line, opportunity always exists when the crowd thinks it knows an unknowable future. Everybody that I see now, everything that I've seen, says that everybody is convinced that this is only going to go straight down. But again, bear markets, as I've said before, make fools of bulls and bears. The final thing I'll say is, it really is true, like we're bombed out here as far as the movement beneath the surface, breadth peaked in February of last year, this has already been ongoing for a while.

You look at the percentage of stocks in the NASDAQ Composite, they're trading above their 200-day moving average, as of yesterday, only nine-point-something percent of stocks are above their 200-day moving average. The only time it was lower was post-Lehman and the absolute depths of 2020. And not by that much. So, you have had severe devastation underneath the surface.

And I look at that and I say to myself, interesting. What if you get a positive surprise catalyst and given that the sentiment is so bearish and you've had so much devastation, it seems possible