ALFONSO PECCATIELLO: Hey, everybody. Good evening and welcome to the Real Vision Daily Briefing. Today is Wednesday, December 15th. I'm here with Darius Dale CEO and founder of 42Macro. Hi, Darius. How are you doing?
DARIUS DALE: Alfonso, what's up, man? They got you up late over there.
ALFONSO PECCATIELLO: It's 10pm over here in the Netherlands. But hey, the Fed meeting is just over. We have a lot of energy and things to discuss here, so let's get started. I'm Afonso. I write The Macro Compass and I contribute to Real Vision regularly. Darius, let's get this started.
The Fed meeting is just over. The bond market is moving left and right. The curve flattened first, then steepened at the end of the conference. The stock market dipped a little bit and now we are hitting highs. The NASDAQ is leading but also Dow Jones, S&P, Russell, everything is in the green. Can you just tell us your broad take on the Fed? And then from there, we'll move into what does it mean for our listeners' portfolio and investment decisions going forward?
DARIUS DALE: Yeah. I think if you're playing the game at a lower level, CFA Level 1 game, this is a very hawkish meeting in terms of putting out more dots in the dotplot. In fact, the composition of which was actually even more hawkish than the actual updated projections in terms of three rate hikes next year, three hikes in the following year. But if you play the game from a CFA Level 3, or I don't know, what's higher than that these days, you have to go back to school.
But what really got the markets moving, particularly equity and risk markets to the upside, was that someone asked him a question about financial stability risk and are you concerned at all that you guys are moving towards accelerated tapering? What happens with respect to monetary policy in terms of its long and variable lags in the economy? And he effectively said, we know what markets actually really wanted to hear, which is, hey, we're not on this preset course to tighten policy.
If we see an adverse response from financial markets, we're well aware in terms of the impact that it ultimately could have on the economy on a short lag, but a lag that's much shorter than traditional monetary policy works. He effectively said we're not on this preset path, you don't have to worry about it. If we see things slowing down the economy, we'll react and pivot back dovishly, and that was obviously very, very favorable for markets.
ALFONSO PECCATIELLO: Yeah, a great summary. He also said, by the way, that he sees rapid progress towards maximum employment, he gave some projections out where he talked about real GDP being 4% next year on a year-on-year basis in America 2022, topped that by CPI projections to 2.6%, 2.7%, which makes for a nominal growth next year of 6%, 7%, which still is pretty robust. What do you think of his stake on maximum employment and how does that interact with the inflation mandate? Because he also sounded relatively concerned about inflationary pressure. How is he going to maneuver around the two?
DARIUS DALE: I don't think there's much wiggle room at al quite frankly. I don't think markets really believe there's a lot of wiggle room, otherwise, we would not have seen a lot of the pain we've seen in a lot of risk assets leading up into this event. Going back to this maximum employment discussion, the November jobs report was unequivocally hawkish. Obviously, the headline came in soft, but when you take one step past the [?] bill, and get in there and say, hey, look at all these maximum inclusive mandate, things that they give us to look at over the last 12, 18 months, and they all made substantial progress.
You look at it from an ethnic perspective, Hispanic unemployment rate dropped 70 basis points month-over-month. The black unemployment rate dropped 120 basis points month-over-month. High school dropout employment, if you look at it from an educational attainment perspective, high school dropout unemployment rate dropped 170 basis points month-over-month.
You're talking about the communities of people in this country that have historically been marginalized from the perspective of the labor market, and more importantly, the perspective of monetary policy moving too quickly to allow these folks to come back to work or find different jobs. And we saw very unequivocally very positive a jobs report in that regard, so I think that's got them I wouldn't say concerned, but it gave them the real big thumbs up in terms of being able to outline this really hawkish policy pivot.
ALFONSO PECCATIELLO: Yeah. And what about this discussion about the labor force participation rate? They mentioned it multiple times and the way I look at it is basically, legally speaking, the labor market is extremely hot and however you look at it, U-6 broader definition, unemployment rate, quit rates, however measure and also the ones you mentioned, it seemed to be secretly very hot and getting hotter as we speak.
Now what about the structural pressures that also Powell discussed, the ones that are pushing everything to the downside long term and are keeping participation rate low? Do you think they're going to be cognizant about that and consider also that as part of their labor market assessment, or they're simply going to focus on the cyclicality of these massive improvements in cyclical labor market and inflationary pressures they face, and therefore, they're just going to have to hit the gas and taper faster as they announced even faster or hike even in a more aggressive way? Which of the two stances are they going to take ultimately?
DARIUS DALE: Yes, I think they bought themselves enough time to allow for another upside inflation surprise over the next couple of months. It's unlikely that they have to accelerate taper. They're all going to be finished in March. It's not very far away. It seems as if they're, on one hand, we realized, when you go back to your point on cyclical, the weakness in the labor market cyclically, it's because the employment to population ratio is down, it's 180 basis points from where it ended in 2019, prime labor force working age labor force participation rate down 110 basis points from where it was in 2019. And then you have the female labor force participation rate down another 150 basis points.
The real question as it relates to wage pressures is, is that cyclical or structural? And quite frankly, no one knows. It's impossible to know. There's so many different factors driving it and it'd be impossible to create a model on this until after the fact. We don't have enough data to determine what's actually the driving forces behind why would those labor force rates are so low, given all of the demand in the economy. We've got an economy growing 10% on a nominal basis, we should be people-- all-time high JOLTS job openings, so we should be sucking people back into the labor market and over fist.
The reality is, there's a lot of things holding back those rates and the reason I bring that up is because the one thing the Fed said, that's not currently in our forecast. What can actually cause us to move the needle today was wages. He effectively said, hey, look we understand wages are a little hot, and you have the quit rates really high. But we don't really see wages really filtering into inflation at the current juncture. Well, they very much could, given the current hot state of the labor market in terms of demand for labor with a reduced supply.
ALFONSO PECCATIELLO: Let's try to move a little bit towards portfolio asset allocation and what does this mean effectively for our listeners. We have a Fed that is looking at a pretty hot labor market, the cyclical recovery, they decided to accelerate the tapering plan, which in their words, buys them optionality or what to do in terms of monetary policy and how to hike and when to hike and how to face this hiking cycle?
What does this mean for investors when it comes to different asset classes? What are they looking at here? Bonds, gold, equities, crypto, which sectors in the equity market should be preferred at this stage? What do you think?
DARIUS DALE: Yeah, absolutely. Great question. I have a couple charts for the viewers today. The first chart, slide five in our monthly Macro Scouting Report that shows our US grid model. For most of you viewers watching me know that both you and I think about the world from a regime segmentation, a quadrant-based regime segmentation approach. We use growth inflation as our primary variables there. And as you can see, the modal outcome as denoted by the first row in that chart is transitioning from a sea of ice to see of blues.
What we're saying here is we're effectively going from stagflation to a situation where inflation and growth will be decelerating simultaneously, albeit off very high levels. We're talking about 30-year highs in growth and inflation. These are some really important statistics to be aware of. The reason I bring that up and another chart we're showing is the full table. The full table shows the entire world's transitioning from a very similar state where we are in now to a situation where both growth and inflation are decelerating simultaneously.
And this will be persistent throughout most of next year. Again, the reason I bring this up is because that has a very different set of asset allocation recommendations than the ones we just exited for the past, I don't know, 18 to 20 months. Investors are very overweight high beta risk assets relative to a lot of their strategic objectives. We can see this in asset allocation data, we can see this in survey data, we can see this and where people are concerned in terms of market overvaluations.
We can see it in valuations themselves. The reason I bring that up is because I think the Fed did buy investors another, I don't know, couple of months of price appreciation in risk asset terms. Maybe we get the market up higher through February or March at the latest, but you're starting to get to the place in that cycle where a lot of investors have to rotate out of things that they probably shouldn't be long in the context of both the US and global economy that are persistently decelerating on growth and inflation terms. They're not long enough of high beta assets. They're not long enough for bonds in that environment.
ALFONSO PECCATIELLO: Basically, we agree on where do we stand in the cycle? What I would like to stress for our audience is that Darius said something very relevant when it comes to the impulse of growth and inflationary pressures. Despite the direction of travel might still be positive, we have the tailwind from a healing labor market. We have the tailwinds we discussed before when it comes to real economy next year, the impulse of growth is decelerating, the impluse of inflationary pressures is likely to decelerate. Sorry?
DARIUS DALE: There already is.
ALFONSO PECCATIELLO: Yes, of course. In this environment, once the monetary policy starts to become a little tighter, then also your asset allocation has to be changed accordingly. You talked about high beta exposure and low beta exposure in equity markets. Can you elaborate a little bit more on that? How would you try to steer your portfolio? What can you suggest from an equity sector allocation when it comes to investment decisions?
DARIUS DALE: I always say this, when you're trying to risk manage a growth slowdown, and an inflation slowdown at the same time, it becomes less about companies or industries or sectors and more about the style factors themselves. However, when you rip the style factors apart, you find that a lot of healthcare companies, a lot of real estate companies, particularly the towers and the storage providers, a lot of consumer staples companies, all those types of companies, and obviously, utilities, those types of companies tend to find themselves in the low beta aspects of those types of indices or ETFs.
You can make the case that we learned a lot in this pandemic, particularly in March of 2020, when a lot of the mega cap tech names really outperformed and performed as if they were low beta securities. That was a meaningful transition, in my opinion, in terms of the market response to those types of events. Historically, those types of sectors or those types of names have really traded down in line or worse than the market.
I think you run out, from an equity allocation standpoint, you very quickly run out of things to buy, you're talking about low beta, and it's definitely not the stuff a lot of investors have been pitched all year about secular inflation, secular inflation, persistent inflation, transitory, stupid. And guess what? All those things are right on a longer term time horizon, but throughout the year of 2022, it's very unlikely that you're going to make money and certainly not outperform being long those types of exposure.
ALFONSO PECCATIELLO: Yes. And I would like also to point our audience to the fact that there has been a pretty good interview released on Real Vision, I think just today or maybe yesterday between Rick Rule, who's the CEO of Sprott US Holdings, and Dan Ferris, who worked for Stansberry Research where they talk about boring investing. Those stocks you just talked about, the low beta and high beta, and they compare the two, and they deep dive into value investing and what actually looks good today or doesn't look good today in a portfolio.
RICK RULE: If you look at the word boring and you think about the antithesis of boring, it's probably terror. And I think it's important for the people that are listening to this broadcast to understand the basis of value investing is I would describe as a relief from terror. And in that circumstance, I consider boring to be high praise indeed. Do you have any comment on that?
DAN FERRIS: Could not agree more, bring on the boredom. Bring on the boredom. All I want to do is make money over time and compound and buy assets with a margin of safety. I absolutely do not want excitement. I don't want to be losing sleep over my investment portfolio. In a way, I guess this is our orientation as value investors, but in a way, the idea of losing sleep over your investment portfolio, it's crazy to me, why would you ever do it? I don't know.
ALFONSO PECCATIELLO: Welcome back guys to the Daily Briefing with Darius and Alf. We were covering equity sectors and the perspective that that resides on equity allocation, your portfolio, there are also other asset classes out there. I would like to ask Darius what's his take and what's the Fed's stance now to other asset classes, like Bitcoin or gold. Do have a take about altcoins or crypto and gold? Do you have a take on that?
DARIUS DALE: Yeah. Certainly, crypto is one of the highest beta asset classes in the world, if not the highest beta asset class in the world, so I would definitely put it in that box. That doesn't mean you need to go run out and sell your crypto today. We recently sold our crypto exposure and took it down.
I think the Fed opened a window today for risk assets to trade well at least over the next couple of months into the end of QE because again, that process of tightening monetary policy is not going to be as preset as we initially thought it was. Coming from 7% thereabouts inflation, 4% or 5% core PCE inflation, it feels like it should be pretty straightforward, but it cracked the window for the bulls to remain pretty, pretty ardent there.
Beyond that, it's going to be very hard to make money in our opinion in crypto, because again, the reality is investors are overweight these exposures relative to where the cycles take them, and more importantly, where their strategic objectives are. Once they start losing money in these exposures. Obviously, we've seen a preview of that in recent weeks, the reality is that what we've seen in recent weeks could be five, six, seven, eight, nine months of next year.
That is a real risk. And once people start to see those trending price declines, see that technical damage, you're going to start to see people rush for the exits and there's just simply not enough liquidity in a lot of these markets for people to get out safely.
ALFONSO PECCATIELLO: People on The Exchange have come up with a couple of very interesting questions, Darius, and I want to ask you but also ask myself, because a couple actually were including both of us in the questions. Well, basically, the gist of it is, Darius, I know that Alf compares today to summer of 2018, where stocks are still relatively okay until October, but Darius, you say that we are now closer to Q4 2018 where stocks suffered. Do you think the Fed decision today changes any of that? Do you think we are in summary of 2018 or in Q4 2018? And how do you guys reconcile your quadrant's view basically? You go first, Darius.
DARIUS DALE: Yeah. I would correct the premise of the question, in terms of Q4 2018, very much been categorized as deflation in our framework, that's where both growth and inflation are slowing simultaneously. We are not there yet. We have inflation as the probable outcome through the month of January. That's where growth is decelerating, and inflation is accelerating. Again, we're looking at composite leading indicators for growth.
It's very likely that if we're going to see a Q4 2018 type event, it commences sometime in the March to May time period. And the reason I say that, I'm being expressly specific about that problem, more specific than I am going to regret later but that's when the growth slow down and at least according to our models, should start to really materially accelerate to the downside.
And historically speaking, whenever you're in inflation or deflation, one of those two regimes, you tend not to get negative absolute performance in risk assets until growth is accelerating materially to the downside or inflation and very rarely does inflation accelerate materially to the downside and growth's not also slowing.
ALFONSO PECCATIELLO: In my last piece at The Macro Compass, which is my newsletter, I pointed out that we are in summer 2018. That's the German that I used to express the fact that we are not yet in the Q4 218 period, because I saw two main differences. The first of it is that despite the impulse of growth and inflation slowing down, if you look at it from an absolute perspective, we're still looking at a relatively healthy quarter maybe, I cannot quantify support at three months or five, four months or five months, but we will have a relatively healthy nominal growth going forward for the next foreseeable future.
That's quite a difference compared to the fact that the impulse of growth and inflation in Q4 2018 was slowing down pretty aggressively pretty markedly. From that perspective, we are not there yet. My credit impulse shows we have decelerated and we are decelerating, but we are not yet into the critical phase. But most importantly, the main difference is that real interest rates and financial conditions are much, much easier and below equilibrium levels, while in 2018, the Federal Reserve was making a pretty strong effort to bring real rates higher, and also to communicate that they will be on autopilot and they were far from neutral rate with [?] to