The Warped Physics of Markets: QE, Big Tech, and the Passive Flow Breaking Point – Live with Vincent Deluard

Published on
December 10th, 2020
64 minutes

Macro Maneuvers: John Floyd on Currencies, Interest Rates, and Debt Bottlenecks

The Warped Physics of Markets: QE, Big Tech, and the Passive Flow Breaking Point – Live with Vincent Deluard

Live ·
Featuring Vincent Deluard

Published on: December 10th, 2020 • Duration: 64 minutes

Vincent Deluard, CFA, of StoneX returns to update his views on passive flows and the macro picture and explains what he sees as the undoing of the market structure of the past decade. With Real Vision editor Max Wiethe, Deluard describes the three "perpetual motion engines" that have powered stocks' unceasing rally—passive investing continually reinforcing large cap performance and rapid market gains, ongoing QE engendering the "wealth effect" without creating inflation, and big tech outsourcing their payroll to the market via stock option compensation. These three components together, Deluard argues, have supported the 2020 bull market. However, he foresees the return of secular inflation as the real drivers of inflation — bank credit, minimum wages, and commodity prices — come to the fore and the vaccine shifting demand from digital goods to real goods. He also shares how gold and bitcoin are leaks in the perpetual motion stock market and why the rise of populism will put this era in markets and the 60/40 portfolio to rest for good. Key Learnings: Deluard describes how the underlying elements that prop up today’s markets—passive flows, big tech, and QE—are eroding in the face of secular inflation picking up speed. In light of that, he discusses why gold and bitcoin will continue to outperform and warns that the return of inflation will destroy bonds, hurt equities, and wipe out risk-parity strategies by essentially tearing up the playbook for 60/40 portfolios. To view Deluard's charts, click here:



  • HM
    Harold M.
    15 December 2020 @ 20:48
    Outstanding discussion Max and Vince!
  • SB
    Stewart B.
    15 December 2020 @ 16:57
    Great interview. Perhaps add to the list of three the radically increased household savings rate combined with many working from home (allowing day-trading without prying eyes).
  • HK
    Henrik K.
    12 December 2020 @ 15:48
    Great interview and a really important topic. I have been following Vincent’s work for a while and it is very thought provoking indeed and has helped me better understand how the flow (or supply vs demand) is currently seemingly more important in driving equity values than fundamentals (cashflow, earnings etc.) as also proposed by Michael Howell etc. I do have a few questions and comments: 1. Passive Flow. Mike Green has done a great job in explaining how the steady migration from active to passive leads to an investment of the higher cash allocation in active funds thereby creating additional flow into the market. However, I was wondering whether the relentless regular pension savings going into the US equity markets is also a significant contributor regardless of whether it is going into active or passive funds? And it’s not just US pensions going into the US stock market. For example, I am in the UK but c.30% of my pension contributions are regularly invested in the US market. Also, I assume that due to demographics we are currently seeing a net inflow into pensions but at some stage this could reverse and pension funds will have to liquidate more funds to pay their pensioners than is paid in by workers i.e. we could get to a net outflow due to pensions, at least in the Western World with a looming shrinking workforce? 2. QE. It’s clear that QE has, so far, not produced any meaningful consumer inflation (due to lack of fiscal spending with QE / asset purchase programs only directing the QE into financial markets etc.). However there has clearly been substantial asset inflation with proceeds from selling bonds to Central Banks flowing into corporate credit and then further into equities (and ultimately into real estate, art, luxury goods, fine wine etc.). As this QE money flows towards the highest return/growth areas I suspect a lot of the European QE ultimately also flowed into the US equity market which might explain the lack of impact in Europe of QE on European equities (vs clear impact on European fixed income)? Has anyone done the work to carefully trace the flow of European and US QE from their asset purchase programs and into other assets classes in order to figure out how much of the net inflow into US equities in the last say 5-10 years actually originates from Central Banks QE? 3. Stock Based Comp. I understand how stock based compensation basically overstates earnings and cashflows for those companies that are big users e.g. mainly US tech. This distortion may indeed explain some of the outperformance / allocation towards tech. But with stock based comp also comes increased share issuance and dilution for shareholders so it’s not clear to me why this should be a real driver of overall stock market increase (unlike the first two drivers)? Is there a more compelling way to explain / demonstrate this effect? Overall I am surprised that Vincent has not included share buy backs as a big driver of the perpetual stock market. I saw an analysis from GS at the start of the year which suggested that since 2017 US Corporations have been the biggest net buyers of US stocks; much bigger in fact than institutional investors. The relentless purchasing of own stock by companies such as Apple may also help explain their extraordinary performance despite very modest earnings growth? In a traditional fundamental valuation framework stock buy backs should not make any different (at least short term) to the share price because the reduction in shares is matched by a corresponding reduction in equity value (as the Enterprise Value remains unaffected but net debt has increased from using cash on the balance sheet to purchase the shares). However in this flow based world, it seems that the artificial stock demand created by share buy backs clearly does affect prices? Perhaps this is why share buy backs were illegal in the US between 1934 and 1982….? It would be great if Vincent would consider adding this factor to his framework as I suspect it’s a material contributor to the perpetual stock market machine…. In terms of things that could halt or reverse the machine, other than inflation and, longer term, demographics, could it also be that the QE machine needs to focus so heavily on funding government deficit spending (i.e. Central Banks will have to purchase vast % of their governments’ gross bond issuances rather than purchasing existing assets from the financial markets) that there will actually be a lot less of the QE flowing into the financial markets in 2021/2 (also pushing up consumer inflation in the process)?
    • VD
      Vincent D. | Contributor
      14 December 2020 @ 14:22
      Thanks for the kind words and long post. I thought I would answer two points: Dilution from stock based comp at big tech firms: the rotation to passive creates structural demand for big tech shares for three reasons: 1- money is leaving from small cap value active funds to cap-based or growth index funds, leading to net purchases of large tech / growth quality names 2 - Low float: many tech stocks have lower float then market cap: founder stake, restrictions on selling by early investors, base of "hardcore HODLERS" who will not sell regardless of price (cult-like following of Tesla and Apple). Some indices are float-adjusted but they cannot capture 100% of these distortions 3 - index inclusion effect: most indices do not include IPOs right away so index funds need to "catch up" as these companies grow and mature (tesla is the best example here) As you can see, there is a link between the first perpetual motion engine (passive rotation) and the third (stock-based comp). Buybacks: my first job was to build spreadsheets of buybacks and build and ETF around it so I am very aware of their importance from a supply / demand standpoint. Buybacks have been the main source of equity demand in the 2010s, but they collapsed with the pandemic. Here is a quote from one my recent reports which puts this in perspective "S&P 500 index companies repurchased just $85 billion this past quarter, down 56% from $196 billion in the first quarter. Dividends have also dropped by 11%. Apple, Microsoft, Google, Oracle and Facebook repurchased $35.5 billion this past quarter, versus $50 billion for all the other companies in the S&P 500 index. If the trend continues – and I see no reason why it should not – the two lines should cross this quarter." Best - Vincent Deluard
  • DS
    David S.
    13 December 2020 @ 17:16
    The far left of the Democratic Party -younger - and the far right of the Republican Party - older - are both populist - rule by a charismatic leaders. The base of both parties are the low and middle-class workers who were left behind financially for the last forty years. Representative democracies with two strong populist parties often vote in the opposition party in each new election. One populist leader will succeed in becoming a dictator eliminating the rule of law. When the rule of law fails, no one is safe even the dictator. It takes a long time to develop the rule of law again. DLS
  • DS
    David S.
    13 December 2020 @ 16:47
    Higher interest rates are the real dragon killer. We can have CPI inflation and low interest rates for awhile. The government guaranteed bank loans to keep businesses and citizens afloat during the pandemic recovery are not productive investments with real returns or productivity gains. Until money is invested in opportunities with real returns, the massive amounts of money will stay in the diminishing number of stocks and the bond markets. We are still pushing on a string. DLS
  • TS
    Theodoros S.
    12 December 2020 @ 19:18
    The end of passive is approaching. As everything in nature "after the rise there is a fall", it is the natural cycles of markets. When that will happen then active investing will rise again....Just get ready for the ride and choose good companies with good balance sheets that make impact to hummanity.
    • DS
      David S.
      13 December 2020 @ 04:51
      Mr. Green discussed a tipping point with passive investments in one presentation. I wonder with more information if Mr. Green still holds this position? DLS
  • PG
    Philippe G.
    12 December 2020 @ 17:43
    Fantastic, glad to see Vincent D. once more - really enjoy how he combines markets, society, and demographics!
  • DN
    D N.
    12 December 2020 @ 09:48
    Excellent interview and fresh insights. The point on money going into digital goods with no marginal cost...very on point.
  • JL
    J L.
    12 December 2020 @ 06:33
    Per comments on the folly of the die-hard dollar bull camp: With each passing day the price-ignoring dollar bulls bear more resemblance to John Hussman, a guy who used a stunningly elaborate set of complex intellectual theories and data sets to push the notion the stock market was going to crash or revalue ~40% lower "any day now" for a full decade (2009-2019). The dollar bulls are like Hussman in reverse, swearing over and over the dollar is going to crash upward based on a hodge podge of nuanced plumbing arguments, without recognizing it only takes the misweighting of a single variable (e.g. backdoor fiscal dominance, or a persistent net outflow from USD-denominated assets on the part of SWFS and central banks, or both) to make them wrong. And all they would have to do to gain some much-needed intellectual humility is 1) recognize, at minimum, the possibility that their case could be overturned by one or two key variables and 2) make Bayesian adjustments to their confidence level based on what the charts are saying. The obstinacy is embarrassing.
    • DD
      Dmitry D.
      12 December 2020 @ 09:47
      Great comment! Dollar bulls are so married to their thesis that they are simply not looking at the reality.
  • DS
    David S.
    12 December 2020 @ 03:49
    This was an excellent interview. Thanks. Hopefully more folks can watch over the weekend. DLS
  • DB
    David B.
    12 December 2020 @ 03:41
    Brilliant discussion
  • DS
    David S.
    11 December 2020 @ 23:18
    Great comment on health care promoting the common good on many levels. In the US we need to improve health care for rich, the middle class and the poor. Not reduce health care for the rich, but improve private and public health. In a representative democracy the reason to look at many different subgroups is to identify needs. Generational differences and similarities are only one of many categories like income distribution, education, economic mobility, tax policy etc. Our reprentatives are not suppose to be lobbyist looking to fund their own reelection. They are suppose to function as philosopher as in Plato's Republic. They are suppose to synthesize programs to promote the common good. Promulgating laws that just focuses on some generational difference is certainly myopic. DLS
    • VD
      Vincent D. | Contributor
      11 December 2020 @ 23:53
      Amen brother
  • DS
    David S.
    11 December 2020 @ 21:17
    It would be interesting to know the federal, state, and local tax implications between paying high income earners in payroll vs. 50% stock options. This should be done for corporations and individuals separately. This analysis could also look at the tax implications of a resident working and living in California vs. a Nevada resident working from home with a Silicon Valley firm. DLS