JACK FARLEY: Hi, I am Jack Farley with Real Vision and I am here with Teddy Vallee of Pervalle Global, a global macro fund. Teddy, as my understanding, invest in commodities, currencies, equities, even Bitcoin, so everything. You are very pin asset.
TEDDY VALLEE: Exactly. A hundred percent. We are expanding more attention in the crypto space with the usual coins.
JACK FARLEY: Well, I am so glad that you can join us, Teddy. It is great when we can get someone who can invest in so many assets because that way, I have a ton of questions that you can answer. I know, Bitcoin, you were very early in that space. Obviously, that is on a tear. I want to get your views on that, but I know that you also have a strong thesis on the dollar, as well as growth versus value in equities. Let us start with the dollar. What is your view on that?
TEDDY VALLEE: The dollar overall is interesting. Long term, I am very dollar bearish, I think the structural things that we have going on the US, forward returns for the US versus the rest of the world favor the rest of the world, therefore, a lot of capital is going to leave US and find higher returns elsewhere. Right now, though, we are in the situation where everybody is negative on the dollar. Not only negative on the dollar, but they are also max long equities to an extent. From a prime broker standpoint, the Goldman Sachs hedge fund net percentage long is 97 percentile, 98 percentile. Right now with the dollar, everyone is positioned for it to effectively be weaker, whether that is in the dollar within commodities, max long cyclical commodities, max long cyclical currencies.
When you have positioning setup like this, it typically leads to an unwind before you can actually have a stronger move lower, because if everyone has the view that the dollar is going to go lower, then everyone is already positioned and has that trade on, so it makes it less likely. The key thing that I think with the dollar that we are a little bit worried about is liquidity. One of the things we track and build out is these liquidity models that lead certain asset classes and the one specifically that leads the dollar is this Treasury issuance less quantitative easing, or QE, the bond purchases that the Fed is doing.
Right now, we are looking at over the next 120 days, this model leads the dollar by 120 days, and right now, we are coming to this period where it should show dollar strength because there has been a significant amount of basically liquidity extracted from the market through the stimulus programs of the US government. The Fed is not covering or buying enough of those bonds to effectively fill the gap. If there is only call it $100 in the system, and the US government says, look, guys, we need $20, that $20 needs to come from somewhere in that $100 if the Fed is not buying. We have found that that is very liquidity negative and affects the dollar, the dollar primarily more of the developed market currency pairs, like the Euro, for example.
With this liquidity backdrop, everyone very negative on the dollar, everyone positioned for the dollar to continue to go lower, it seems the probabilities favor a bounce in the dollar, which I think will lead to probably precious metals on line, which is what we are seeing right now. We have been very bullish on gold and gold miners up to three or four months ago, where we saw real rates effectively moving higher, one because of breakevens coming in, and two, because nominals could potentially rise, but the probabilities right now are in favor of a higher dollar. That being said, if we see a breakdown through the lows, that view is likely wrong, and then you just need to reevaluate. As long as we hold the most recent lows in the dollar, the bias is to the upside.
JACK FARLEY: Interesting. What is your timeframe on that? Like one to two years?
TEDDY VALLEE: Two to three months. I would say through first quarter of next year. More tactical, exactly.
JACK FARLEY: Interesting. I want to dive into this chart that you have of the cumulative QE minus the Treasury issuance relative to the dollar. Van you just explain the dynamics and what is on the right side of the chart and what is on the left side of the chart in terms of the denominations?
TEDDY VALLEE: Year on year, though, I can tell you I think is on the right hand side, so the dollar year on year, so the percentage that it is rising or falling over the prior year, and then the left side is effectively the amount of Treasury issuance that the Treasury is doing versus the amount of bonds the Fed is buying. We accumulate that over time so, for example, in one month, if it is $100 of net Treasury issuance greater than QE, that would be $100, the next month is $50 net positive so that effectively over time and then take the year on year of that. You are looking at the relative changes, and rate of change of these liquidity profiles, not necessarily absolute level, which we found is a pretty good lead of the dollar and liquidity overall.
JACK FARLEY: Interesting. I find that to be such an interesting chart, and just so the blue line is that QE minus the Treasury issuance, and it is not negative. The higher it goes, that means the more Treasury issuance there is relative to QE, because the Treasury, when they issue a bond or a bill, primary dealers have to buy that so that sucks cash out of the system. Whereas when the Fed buys bonds from the Treasury, or from primary dealers, they inject cash into the system.
I was really fascinated by this chart, Teddy, because I like so many, including probably some of the viewers have heard this narrative that the Fed has injected unprecedented liquidity into the market, but you are saying sure they have, but relative to the amount of Treasury instruments there have been, it is actually liquidity net negative. Is that what you are saying?
TEDDY VALLEE: Correct. The mechanism of the timing there is when the Fed does come in with those programs, the positive amount of-- so for example, early this year, the positive liquidity effect of that was unbelievable, because the QE relative to how much they were issuing was incredible, like 500 billion in excess QE in excess of the issuance. We are now financing a lot of one, the deficits, and two, the stimulus programs, which then-- so while it was liquidity positive, now we are paying it back effectively, and having to pull that money from the market to finance these stimulus projects.
We can touch on this a little bit later, but I think this concept and the dynamics of this are extremely important for the next 10 years, because you are effectively taking money out of the market via Treasury issuance to then give to either infrastructure, either stimulus payments, and I think we might have one more round of positive monetary policy in terms of rates coming down being positive for growth, but after that, you are on the lower end, and you do not have much room to go on the monetary side, therefore, fiscal becomes the new monetary policy. If you have to finance everything, the Treasury market liquidity negative, to then give out and push out to consumers, to businesses, et cetera.
That is growth, positive, liquidity negative, therefore, that is commodity positive, financial asset negative. We are creating this feedback loop, or we are at the beginning of this feedback loop that over a longer term period, significantly favors commodities, hard assets over financial assets, particularly US tech, which I am not very keen on.
JACK FARLEY: Let us talk about tech. What is your base case? Over this year, we have seen tech explode higher as lockdowns have happened. People have been working from home, they have not been going to stores. They have been ordering online. They have been using Zoom. You and I are using Zoom right now. That obviously has been a very good environment for tech. What is your view on tech going forward? I portrayed it the way that you would see it on CNBC in terms of it is a very clear narrative, but you have a more nuanced view about where tech is relative to the dollar. Just tell me your view.
TEDDY VALLEE: I think overall, just let us start at the beginning. The liquidity that came into the market was unprecedented, and that led to the dollar going lower. As the dollar went lower, that really ripped breakevens. Real rates, given that nominals did not move because the overall growth backdrop was still very poor, real rates went through the floor, because breakevens inflation expectations rose off of a lower dollar. That led to over 100% increase in the market because the multiple of the market, primarily technology, rose, it was the whole factor of the game from the March lows, not necessarily-- well, not at all from earnings growth. It is all multiple driven, which was due to lower real rates.
We have a chart, which I will send to you, which you may even have that shows real rates versus the S&P multiples. The appreciation that we have had has primarily been from one liquidity and to lower real rates. Both of those factors that drove tech now are fading. As a percentage of the total, and I can get into that a second, the percentage of the total market cap takes about $11 trillion, and about 31% of total market. If you look at some of these other sectors, energy, for example, it is up a decent amount over the past few weeks, but at the time of the report that you are referencing that we sent out last month, it was about 600 billion. If you get any flow from tech, which is 11 trillion to a 600 billion market cap, the moves are huge. This is what we are outlining in that piece.
Then we got the vaccine news, and then energy has had some serious moves, because everyone is overweight tech. As it relates to tech, the probabilities are that real rates are going to go higher. If real rates go higher, you do not want to own these growthy names. I can get into why real rates are going to go higher but tech, everyone is overexposed to it. It reminds me a lot of 2000 in the sense that everyone is long, it is the exact same percentage of the market cap, everyone is raving about it, how we are all going to work from home forever. To me, the things that were positive for the space overall are very negative going forward and will continue to be negative going forward. It becomes a funding, not currency, but funding source to pair against other cyclical sectors, but also parts of the world.
There has been so much capital that has come into it over the past 10 years because the growth profiles have been horrible and there has been really nowhere else to put your money, for example. Tina, there is no alternative. That situation is changing, and we are coming into an environment that looks much different.
JACK FARLEY: Teddy, that is so interesting. Can we dive into it a little bit on why low real rates are good for tech?
TEDDY VALLEE: Yes, absolutely. Effectively, when you have a low real rate, that, in a sense, is liquidity positive, but it also means that lower real rates mean that the growth profiles of the economy are very poor. Higher real rates mean that nominals are growing in excess of the inflation expectations, which is which is positive for cyclicality. As real rates go lower, that means that investors effectively do not have the same rate of return or a lower rate of return on the cost of money, therefore, they are more willing to pay up for something that actually has growth when the growth backdrop is very negative. Hence why you have seen this monster influx into tech and why tech is doing so well. The growth backdrops have been poor, real rates have gone down, breakevens have gone up primarily because of liquidity. That is changing in terms of the driver of the breakeven itself.
JACK FARLEY: Teddy, sorry to interrupt. Can you tell if you tell people what a breakeven is?
TEDDY VALLEE: It is effectively the market's view of what inflation is going to be over a certain time period. 10-year breakevens is what the market is expecting the future inflation gauge to be 10 years from now. It is the market's way of deriving where call it the CPI is, which I do not love. It is always important to focus on the breakeven market, because the end of the day, which is derived from the TIPS market, which is Treasury Inflation Protected Securities. You buy one of those, you do not have to worry about inflation, you are just effectively owning, you are getting the real interest rate.
Now going forward, I think that we could get into a little bit about why I think this dynamic changes, which ultimately affects tech but the reason everyone has been in this is because it has been going straight lower, and that makes the multiples or the earnings of tech significantly higher, because there is some growth there, or there is more growth in some stocks, there is no growth, but there is more growth than in the more cyclical elements of the market.
JACK FARLEY: That is so interesting, you make the point that investors are willing to pay more for growth in a low growth environment because rates are so low. Another way of looking at it is that the discount dividend model when equity investors buy a stock, they are paying for the future cash flows, and then they discount that back to the future relative to a discount rate. If that rate is low, the terminal value of that company just could not increase, and if rates go zero or even negative, theoretically, the value would be infinite. Obviously, that is just the theoretical. I want to get your view on tech going forward. Tell me about why you think real rates are going to increase and how that will exert pressure on tech.
TEDDY VALLEE: There are two things that I think are going to drive real rates. One, if the dollar rises, and we are correct in that view. Because this liquidity backdrop and positioning, breakevens are likely going to come lower, because breakevens are very commodity sensitive. As the dollar goes higher, commodities go lower, and breakevens go lower. If the view is correct, or the assumption is correct, that the dollar goes higher, breakevens likely come lower. Here are nominal rates, I do not know if I can do this with my hands to make it easy, but as breakevens come lower, that means that real rates rise. If real rates rise, it unwinds this whole concept that we were talking about previously, with multiples in DCFs.
From a breakeven standpoint, there is a potential for real rates to rise. However, from an actual growth standpoint, we focus a lot on leading indicators of what the economy is going to do over the next 12 months. All of our leading indicators, a lot of our real time models are showing that the economy is absolutely improving and moving in the right direction. Now, COVID could throw a little wrench in that if we have a second wave, more shutdowns, but from a pure cycle basis, outside of that, things are improving, things look pretty good after we get through this liquidity period. Under that assumption, real rates really move, and nominal rates could go much higher, much higher. They could go to 1.5% probably in the next six to nine months after we get through this liquidity period.
JACK FARLEY: Nominal rates, is that being the 10-year or is it short term?
TEDDY VALLEE: I think the bias for the 10-year from now is higher, or the risk reward profile of bonds is likely lower after we get through this little liquidity period. This little liquidity period is the next three to four months or call it through the first quarter, is making things a little difficult. If you recall back, when I launched the firm in October of 2018, our first piece that we put out was called Bonds and Chill, and rates at the time were 3.18%, 3.12%, around there, and we said, look, we think rates are going to go 100 to 200 basis points lower, all leading indicators are straight lower. It is a pretty dismal backdrop. You want to be long bonds. I think that thesis has played its course, and now we are on the other side with the leads turning higher.
Some of the markets are starting to confirm this. We have this real time PMI model, which is like 35 different ratios of the internals of the market. It has got an unbelievable correlation with the global PMI. It is very much higher. The cyclical elements of the market are turning and looking much better. I think that likely continues through 2021, which means nominal rates go higher. On the assumption nominal rates go higher, real rates will go higher, and you could have a situation where multiples get cut by 20 to 30%.
Now, why do I think tech is going to have a difficult time? Well, even if you assume-- or equities in general. 70% of the US market cap is tied up in tech, equities, and defensive lower real rate bets. That is utilities, staples, telcos and healthcare. If you have $24 trillion, or 70% of the market tied up in these lower real rate bets-- and I am saying the probabilities favor higher real rates from two angles. One from economic growth slowdown or two, from an economic growth, pickup, those assets, the multiples of those assets, get rerated. Even if you have a growth pickup, the equity market as a headline basis, might not move anywhere and actually might go lower.
JACK FARLEY: I was just thinking the same.
TEDDY VALLEE: Because there is this unwind. Then another way to think about it is financial conditions right now, if you look at PEs versus financial conditions, price to EBITDA, price to sales, price to book, price to book is probably the highest correlation. Price to book relative to fin conditions is just phenomenal correlation over the past two, three years, you cannot really go much-- financial conditions are at all-time low. You cannot go much lower than they are currently at. In terms of a multiple perspective, you have pulled all the juice forward. Now, the counter to that would be okay, well, we are going to have earnings pick up. Fair.
However, if we assume ACWI, the global stock market earnings are at the highest level, at $34 per share. COVID never happened. They were at $34 and next year from the high, they grow 20%. If I am right on real rates, and earnings still grow 20%, the market trades flat. It shows you the potential difficulties we have here from a headline basis, from a passive basis, which plays into some of my longer term thinking, however, there is going to be huge rotations within the market, within the parts of the world. For example, we are starting to see it in energy which I am pretty keen on over the next-- I do not