ASH BENNINGTON: Welcome to the Real Vision Daily Briefing. It's Thursday, March 3rd, 2022. I'm Ash Bennington, joined today by Frances Coppola, writer and speaker on Banking Finance and Economics and Michael Gayed, Portfolio Manager at Toroso Investments. But first, the day's top stories, multiple sources reporting that the Russian military has continued its advanced in Ukraine, particularly in the south of the country where Russian forces have reportedly encircled Mariupol between the Russian-controlled Crimea and the Russian border.

Let's take a look really quickly at markets, what's happening here. S&P off about half a point on the day closing at 4,363, NASDAQ off pretty considerably, off a point and a half on the day, 1.56%, settling down at 13,537. Russell 2000 also off 1.75%, settling down in 2022. Much to talk about here.

Let's pull in Frances Coppola. Frances, it's a pleasure to have you on the show. This is our first conversation here on the top of the show here on Real Vision Daily Briefing. Talk to us a little bit about what's happening broadly in these markets, frame out the macroeconomic landscape.

FRANCES COPPOLA: Okay, well, before this unfortunate [?] in Ukraine, we were facing an increasingly inflationary environment. Back in March 2020, I was a rather lonely voice saying that I thought that there would be inflation as the world emerged from the pandemic. And events rather proved me right that there was always going to be supply side damage.

And it's far more difficult really, for governments to protect against the kind of damage that we've seen, disruption of supply chains and things like that, than it is for them to support the demand side, which they've pretty much done. Not just through monetary policy, obviously, we've had enormous quantities of QE, but also through fiscal policy.

Support in the United States, extensive unemployment benefit and the stimulus checks. And in Europe, various forms of support through jobs. In UK, we had the [?] scheme. In Germany, they have things like what they call Kurzabeit, which is similar. It's basically to support people in their jobs so they're not working, but they get paid.

At the same time, as we had that during the pandemic, we had, obviously quite a lot of suppression of the demand side, close down of service industries particularly, and quite a considerable shutdown in purchases of discretionary goods. You could get them online, but you couldn't go to shops. That was during the pandemic itself.

And as we reopened, of course, we have people starting to buy things again, starting to buy not just goods, but also services. We're seeing manufacturing picking up, we're seeing production picking up, we're seeing demand picking up on the producer side, that the supply side, the international supply chains and so forth, have taken a while to recover, shipping rates have been very high. And that feeds through into inflation with a bit of a lag, because of the length of contracts involved.

We've had quite-- because of that, we've got quite an inflationary shock, which is going to take quite some time to unwind, and the debate around inflation is all about what central banks are going to do with that. There's little justification now for continuing with the loose monetary policy that we've seen for the last two years, and arguably not even for the loose monetary policy we've seen for the last decade or more.

I think we're going to be seeing interest rates rising really across the western world. And that's before we even get into this question of Ukraine, and what is going to be quite an inflationary shock, because of the effect on the oil price, on gas prices, that's obviously natural gas prices. And feeding through into consumer prices, so the cost of gasoline at the pumps and the cost of energy to heat houses and also into electricity prices through the production of energy with gas powered power stations and things like that.

It is a comprehensive shock that touches all areas of the economy and will feed into consumer prices. There will also, because of the sanctions that have been applied, there's going to be disruption to supply chains again. Remember we haven't yet recovered from the pandemic supply chain disruption and we're now going to disrupt them again. Again, we're going to see inflation picking up from that source as well.

In a way, I keep thinking we're almost back to where we were in the early 1970s, where we had a succession of wars that really pushed inflation up. We had Vietnam War followed by the Yom Kippur War, and then later in the 1970s, we also had the Iran-Iraq war, but it was really early wars. And I'm wondering whether we're going to end up in this kind of 1970s accelerating inflation situation again because of everything that's going on. We might avoid it, I don't know.

But I do think we are seeing fracturing of some things that we've taken for granted for a very long time, not just the low interest rates of the last decade but in fact, the stability, if you like, that we've rather taken for granted. I think now since the mid-1990s, I think that's beginning to change. And we're going to see a much more volatile macroeconomic environment dominated by inflation, by rising interest rates.

And I think also potentially, because this, again, tends to be the effect of sanctions, there's a currency war that we're fighting, we're going to also see stagnating growth, I think.

ASH BENNINGTON: Yeah, very sobering perspective, and top-level picture that you've laid out there. Effectively, you have this regime, in the 2007-2008 financial crisis, there was extraordinary period of loose monetary policy following it, you begin to see a period where we start to raise rates a little bit, still well below where [?] would suggest.

And then you have the COVID pandemic, and now you have an extraordinary regime of not just loose or ultra-accommodative monetary policy, but also fiscal policy adding an additional tailwind to the inflationary story. Frances, as you look here, across the story that you've laid out, what are some of the indicators that you're looking at? What are you watching? What are your datapoints? What are the gauges on your screen that you're able to read the situation from?

FRANCES COPPOLA: Well, one of my favorite charts is actually Baltic Dry. And as an indicator of shipping cost, the Baltic Dry is particularly good one, which actually resembling a church spire, it shot up like a rocket, and then the screen coming down again really quite fast, which is good thing in a way but that inflationary shock from the enormous rise in shipping rates is going to take a while to feed through because shipping contracts do tend to have to be rather long-dated.

And there's a research out today by the Bank of England which says that the inflation is shock from that sharp increase in shipping costs in 2021 will take a year really to feed through. They're talking about inflation staying elevated really until towards the end of 2022. I personally think because we're now going to see shipping costs rocketing up again, that it's going to be more than that.

ASH BENNINGTON: It's never a good sign when you're talking about the Baltic Dry Index. I remember in the 2007-2008 period, we were talking about it because we saw this collapse of global trade, and it's a serious an inflection point to see what's happening in macroeconomic conditions. Frances, another thing that I thought was rather interesting was that we had Fed Chair Powell suggesting that he would support a 25-basis-point hike in contradistinction from a 50-basis-point hike which the more aggressive members had wanted, the more hawkish members of the Fed had suggested.

Today, we had Cleveland Fed President Mestre suggesting that the conflict in Ukraine could be inflationary. Do we run into this period, where the Fed winds up between a rock and a hard place, the two legs of the dual mandate are in conflict with each other, and they're damned if they do and damned if they don't on both sides of the mandate?

FRANCES COPPOLA: Yeah, I agree. This is the old stagflation dilemma, isn't it, really, where we got ourselves into the 1970s when we had high inflation, very poor growth and high unemployment all at the same time? And for increasing, we didn't have a central bank with the kind of inflation targeting mandates that they do now at that time. But if we had, then how would a central bank like the Fed with a dual mandate have handled that? Which does it focus on?

Does it give more credence to inflation, or does it give more credence to unemployment? It is actually quite a difficult trade off. The Phillips Curve, which balances this tradeoff between inflation and unemployment, has been, shall we say, in abeyance or certainly less important in many ways for really the whole of the last decade, to the point where people were starting to wonder whether it should be permanently broken. And that if we see the resurgence of both unemployment and inflation, I think we are going to see central banks having to make those tradeoff decisions again.

And it may be that we'll have to tolerate either higher inflation for quite some time or will have to tolerate higher unemployment for quite some time. And the drive of this, and the reason why I agree with you that central banks are stuck between a rock and a hard place, people will expect them to raise rates, but they're dealing with external shocks. And it's all a question saying, with these external shocks, we have the Ukraine war, we have massively rising oil price, we're going to face elevated gas prices.

We've got the effect of all these sanctions, we've got disruptions to supply chains again, we've got all of these external factors that are going to push up inflation, is this something that it is sensible for central banks to try and deal with by raising interest rates? Because that presupposes that you have domestic drivers for your inflation, that you have some expectations building up that those prices are going to rise, and therefore, wages should rise and so forth.

That's what central banks will be looking for, I think, and I think it's going to be quite hard to discern with these external shocks and with them being hit from lots of different quarters as it were.

ASH BENNINGTON: Frances, we're going to have to have you back for a full hour to do an explainer on the Phillips Curve, which shows the inverse relationship between inflation and unemployment. But I want to bring in Michael Gayed to talk about this from the perspective through the lens of capital markets. And I'm really interested, this is a great show today, because we have someone at the top of the show to set up the broader macroeconomic framework.

Let's have Michael Gayed come in and talk to us from a markets perspective. Michael, what do you see happening right now? What's your big picture thesis on what we're looking at?

MICHAEL GAYED: I'll add to Frances' point that she was not the only one making the argument for inflation back in April 2020, I had authored a piece where I said that the only way out is either hyperinflation or default into the Fed. And this was as we were coming out of COVID crash. And I'm saying that because it was very clear that they're going to either overreact or add a tremendous amount of debt, which will ultimately create the inflation we're seeing now, or everyone's going to basically be, again, defaulting to the Fed because the Fed is going to be the lender of only resorts.

A couple things on the current market dynamic. I know this sounds strange, I've made this argument continuously on Twitter, at the Lead Lag Report, we have not seen risk-off folks. What we've seen in this decline is not traditional risk-off. Risk-off is not about direction, it's about conditions that favor an accident.

In other words, it's where an environment results in a potential tail event which is a significant decline. It's been a very aggressive decline, but it's not been one where you have credit spreads widening in a meaningful way. It's been an aggressive decline, but it's not one where you see convexity with Treasurys massively outperforming equities. We've seen a couple of days here and there.

Today's one example where you see, for example, TLT, the long duration Treasury ETF, strongly positive while equities are down, meaning the long end falls. Yesterday was the exact opposite. The market had a huge rally, yields rose, and Treasury sold off. I think what we've seen here is a very unusual dislocation across the board in all asset classes.

Here comes Russia, here comes Ukraine, here comes war. And now, we might be reentering a more traditional risk-off environment. But it's still not clear just yet that from a market-based perspective, we are on the precipice of another leg lower. The reason I'm saying that is keep in mind, okay, that usually when you have big declines, there are certain indicators, let's call them the Four Horsemen of defense, okay?

Those would be utilities. When they outperform, it tends to precede major corrections crashes. Only now when it's starting to happen, utilities outperforming equities, healthcare outperforming the S&P. Same deal, only now starting to show some outperformance. Consumer staples, same deal. The three most defensive high dividend sectors of the market, they tend to outperform, up more and down less in advance of major clients.

The fourth one is lumber. Now, on my Twitter profile, lumber in gold eyes and I'm presenting actually the CFA Dallas presentation next week about this, lumber has been a very, very strong here. And I understand people are expecting that lumber prices will keep going higher because housing is strong, because war is going to result in some restocking of raw materials to build things back up. But the reality is as long as housing is strong, that's a hard backdrop for equities to really fall hard under.

Most major tail events are preceded by housing weakness. You have not seen that yet. Most housing weakness is preceded by lumber weakness. You haven't seen that yet, either. I caution people, and I keep making this point that this is a wildly uncertain period because as bearish as everyone is, there is an argument made that maybe equities do climb the wall of worry. But having said that, it does seem like we're now transitioning towards a more traditional risk-off period in the short term.

ASH BENNINGTON: Yeah, Michael, two questions for you. The first of which, we were actually talking about offline, which is, what happens if these historical correlations that we've seen start to break down? What happens if we're in a regime shift period, where the things that have been true since the 2008 or post-2008 period no longer hold?

And second, from a basic portfolio construction theory, give our viewers a framework on how professionals think about the split between equities and bonds. We've heard about 60/40 portfolios for many years. Tell us what you think, whether the 60/40 portfolio is in fact dead, and what you think about in terms of asset allocation between fixed income and equities?

MICHAEL GAYED: Okay, so first, let's hit on this correlation issue. Correlations always change. It's just a function of which timeframe you're looking at. I can't tell you many people think that gold is correlated to rising dollar, falling dollar is deflation, correlations change on average. And the key is to figure out what the average is over some persistent period of time, but there's always going to be these spurious noise aspects to correlation.

The correlation, let me take a step back. I'm known for having published five different research studies that won these different awards. That's how I built my name over the last several years, and these research papers all document how do you tell if conditions favorite accident? What are the leading indicators to risk-off events?

The joke about the five research studies, the two Dow Awards and the three NAAIM Award papers, is they all are related to interest rates. The correlation there being that interest rates sensitive groups, because they are telling you about the demand for money, will tend to move in advance of some slowdown in the market or some events in the market.

To that extent, utilities, staples, health care, even the VIX, even moving averages, lumber, all that relates in some way, shape, or form to the demand for money changing and those areas, we'll see at first. If that correlation breaks, if the relationship of interest rates as a tell to market sentiment, if that changes, and that's something that's been in place for much longer than 2008, that's core to capitalism, or the demand for money. If that breaks, I will argue to you and everybody here, we have much bigger things to worry about than our portfolios, because it would suggest capitalism is broken.

And maybe that's okay, but I'm trying to make an argument here that I don't think you can bet on correlations changing in terms of the relationship of interest rates to the market. Because if that's the case, then there is no market. That's number one. Now on these 60/40 point, I know there's a talk about it beaten to death conversationally. Look, the reality is nobody's prepared for 60/40 for both bonds and stocks to not work.

Nobody's prepared for an environment where nothing is working. You could argue, well, what about the 1970s? Okay, in the 1970s, you didn't have the same amount of debt to GDP that you have now. You're in a much nastier situation in terms of overall leverage. The golden rule of diversification is that if you want to figure out how to properly invest, you have to beat investments that you hate. Everyone has loved 60/40. Why? The stocks and bonds both made money?

Why now does everybody suddenly talk about gold? Because that's the only thing that's diversifying now. Gold is the only asset class and the dollar, which is diversified. Why should people hate those two asset classes? My suggestion here is that if you're going to try to figure out what to do with your portfolio, you've got to be in the things which nobody wants to touch, the things which aren't performing over long periods of time, because they're not sexy.

They're not interesting. Gold is not really interesting. The dollar is not really interesting. Bitcoin's interesting. The last I checked, Bitcoin's pretty correlated equities. And correlations change.

ASH BENNINGTON: We're going to have to see if that correlation breaks down, because the most passionate advocates of Bitcoin have long posited that, in fact, they will see an inverse correlation when there was risk in US equity markets, that it would become a risk-off trade. As you say, that hasn't been the point. Maybe we saw that a little bit a few days ago, or at least the correlation is starting to weaken.

That's going to be a really fascinating thing to watch, which gets back to your point, Michael, about how correlations change. It's in their nature. It's what they do. Boy, this has been the fastest 20 minutes in financial television. We have so much to talk about. But we've gotten so much good information in here, in this conversation, but