TEDDY VALLEE: If you look at Challenger and Gray job cuts, big upticks year over year, especially in the industrial sectors. In the US, the economic data is going to continue to deteriorate until roughly June of next year. There's never been a higher probability in this cycle for the US to go in recession.
RAOUL PAL: Next up in the recession watch, I really want to speak to Teddy Vallee. Teddy's somebody I've known for a while. And he's only appeared on Real Vision once. I think he's got an incredibly interesting perspective on global economics and macro. He's a business cycle guy like me. He looks at things in very similar ways. We approach things independently very similarly. And I want to see how he is constructing his forward looking stuff, and what he thinks is going on, because I think it's going to be super interesting to see whether his correlates with mine, and also with Lakshman's view about where we think the cycle's going.
Teddy, good to see you.
TEDDY VALLEE: Raoul, good to see you.
RAOUL PAL: I thought of you when I was thinking about this whole thing about I'm struggling with trying to decide, are we going to go into recession or not? My personal view is we probably are even in one right now. But I know that you look in the world in similar ways me, you look at the business cycle, you look at correlations of different parts of the business cycle. And I've been following you on Twitter and some of your stuff. And I know you've been on Real Vision as well. I just want to get your view, where do you think we are? Talk me through a bit of your top-down framework, and we'll dig in a bit and kick around some ideas.
TEDDY VALLEE: Yeah, exactly. So, a lot of what we do is focus on leading indicators. So, our leads typically range from 6 to 18 months, and a lot of the stuff was deteriorating in October of last year, which is why we were pretty optimistic on the bond trade as were you. And that is continuing to deteriorate. We don't see really a bottom until December of this year, potentially.
We have some upticks in some of our leading indicators. But we're not necessarily sure, as we talked about off- camera, if that's an uptick and going to trend lower or if that's going to be sustainable. So, one of the things we're really watching is what happens in China with the China credit data. So, that comes out this week. Our intuition is that the Chinese are in a lot of pain with the tariffs and also the domestic economy. Some of the most recent data points have been pretty poor, PMIs, et cetera.
So, we think that the Chinese are now going to really kick in some of these off balance sheet local government financing vehicles that they've deleveraged that will lead to growth in one which could potentially lead to a bottom in economic growth December of this year.
But that said, the market that's on the assumption that that happens, we haven't seen that yet. We'll find out this week if we do get a positive trend. But that said, the markets right now our pricing in, I've put this together this morning, it's absolutely amazing. The markets are pricing in a global PMI. So, if you take the global PMI flat or year on year, but primarily flat, and then you take the year on year rate of change of ACWIs or ACWI or US equities, global equities right now, prices held constant or pricing in a global PMI at the end of this year of 53. So, that's marginally off the high of the global synchronized recovery at the end of this year. And we're seeing nothing that will create this environment-
RAOUL PAL: So, there is a disconnect between the global PMI and the MSCI world index or something like that.
TEDDY VALLEE: Exactly. So, year on year, equities will be up in December, roughly call it 16%. And the global PMI, given the relationship, and I can put together a chart- should happen down 10% year on year. So, down 10% year on year was significant. In December, you remember what happened in December.
RAOUL PAL: That's right. And I'm looking at this year on year, as well. Because the S&P for the same reason is not a lot of people are thinking year on year terms, but once you do, you'll realize it has to be quite a lot lower.
TEDDY VALLEE: Exactly, exactly. So, that's just from a top down macro perspective, looking at year on year rate of change of equities, and also the global PMI. And we have a lead on where the global PMI is going. And we think it's lower. So, equities are thinking this monster cyclical rebound by the end of the year, we still see it lower.
RAOUL PAL: And do you get a sense of where that's coming from?
TEDDY VALLEE: I think there's a lot of optimism around China. So, beginning of the year, the China trade deal, the Fed pivot is also a very big one. And then likely just fiscal stimulus in Europe, and that's what-
RAOUL PAL: Because I've been looking at the Shanghai HS, it looks like they're breaking down again. And if that's the case, then people going to have to readjust the Chinese talk.
TEDDY VALLEE: So, it's really interesting, an analog that we've been tracking is the 2015, August to- I guess a little past August, call it September to actually be more December, Q4 2015, leading into the self that we had in 2016. That's the final leg lower. The global economic data is almost like identical and the markets are also trading identically to it. So, China PMI just started ticking up, call it September, Q4 of 2015. And as it was going higher, that's when equity sold off, which is basically similar to what we're seeing today.
So, an analog or an overlay of emerging markets with today's prices, I'd say I don't like to put correlations on stuff, but it'd probably be 80% to 90%. And the next move is a good amount lower.
RAOUL PAL: In emerging markets?
TEDDY VALLEE: Emerging markets, but it would also be applicable to equities in general.
RAOUL PAL: And my view on that emerging market thing- because I'm waiting for that. And the emerging markets may have been pausing for a while. But I look at the chart of the ADXY, the Asian currency, a monthly chart, is this enormous head and shoulders tops like the biggest chart pattern I have ever seen in foreign exchange, which is also if I look at the Fed trade weighted broad dollar index, or the RMB, they all look like, oh, my God, something could happen here. It's the dollar, I think.
So, if I'm thinking about your forward looking indicators. And I put similar things in mind. Some of them have stabilized. But I'm having a feeling if something's going to upset the applecart going forwards, it could be the dollar. And if the dollar starts to rise, then I think it could really change the situation.
TEDDY VALLEE: I agree. I agree. So, we have a similar view on the dollar into the end of the year. So, you've done much more work on the funding issues globally. But the way I've always looked at the dollar's growth differentials, and right now, the US still has the higher differential or higher rate of growth versus the rest of the world. And the rest of world is going to continue to deteriorate into the end of the year along with the US but probably the larger rate there for either the dollar stays flat or goes higher, which really could also weigh on emerging markets into the end of the year. And moving on to the rate picture right now, rates, huge move, some technical stuffs and weekly DeMark, daily DeMark.
RAOUL PAL: I have been looking at those stuff. So, I closed a whole bunch of my positions.
TEDDY VALLEE: Same, same. So pretty much out of 2s couple weeks ago, on the sidelines waiting for some either digestion or a move higher. And then what will be really interesting if it breaks, this initial breaks in the nine, the weekly nine, then the trend is just super strong. Right now, we're bouncing a little bit. So, given the bounce, I could also see that supporting the dollar, call it over the next two, three months, which has really gone away on the EM stuff, and then also a lot of the economic data.
RAOUL PAL: And I'm looking at those DeMark counts, and I'm thinking the same thing. And I'm thinking I'm also looking at the- I put 2s against 2s in 2000, and 10s over the same period. They're a fantastic fit. It's all identical. And you saw where the curve started steepening, because 10s are at a quite sharp correction, 2s just went sideways for a little bit. And then they both absolutely plummeted. And so, I keep thinking that's going to be two, three months. And then really, when you look at, it's usually after the first cut, because the first cut, the market digest it for a week, and then it's like, okay, what's next? Are they going to cut again? And then everyone pulled back into the bond market.
TEDDY VALLEE: So, there's couple of interesting points on that. As soon as unemployment claims tick higher, that's typically when the Fed really starts- this would be what they've done once before, once or twice, but they haven't really cut in terms of- I'm going to call with that unemployment claims rising. So, if we see an uptick in unemployment claims, that could be the catalyst to multiple cuts, and we're actually starting to see like- if you look at Challenger and Gray job cuts, big upticks year over year, especially in the industrial sectors.
And then also paychecks has a small business employment indicator that's basically just falling off the cliff. So, there are indications that makes sense because wages are rising. So, business is getting more squeezed so they're having to lay off employees for this part in the cycle. So we haven't seen it in the NFP numbers and Friday, we had a pretty big print and everyone's focusing on that. We were talking off-camera about all the economy's doing fine but that's the most lagging-
RAOUL PAL: And it was going from- it's 50 basis points, they don't need to raise rate, they don't need to cut rates at all?
TEDDY VALLEE: What are they doing? So, the Fed are idiots. So, that's the most lagging economic data there is. So, you can't focus on that if you want to trade, you have to look out like 12 to 14 months.
RAOUL PAL: I think most people don't understand that. It's so lagging.
TEDDY VALLEE: No, and I don't understand why more people don't focus on it. I don't know if that's just the nature of the business and a lot of people are just asset razors and constantly bullish, which works if you can make money for 10 years like that, and then you don't. But one interesting point on the 2s and why I think 2s are going to come lower, we've created this-
RAOUL PAL: You say 2s lower, yields lower?
TEDDY VALLEE: Yields lower. So, we created this global policy index for global central banks. So, basically takes the GDP weighted year on year change of policy rates, and then we've overlaid the global PMI to track each other perfectly. And what we've seen recently is that global PMI is really curated. But policy rates year on year are still significantly high. And if you were able to break out why it's so high or where it's coming from, it's all of the US.
So, the US right now needs the rates year on year need to come down significantly. So, if they're flat, that still is not enough to match the global PMI, which is down which is indicating global rates should be down pretty significantly, or policy rates.
RAOUL PAL: Because I've looked at- so how I looked at the same thing is I took Libor 2-year on 2-year, looked at the rate of change, and then put that against the ECRI or whichever PMI you want to use. And what it showed, it gave me a perfect forward indicator about how tight monetary policy was. At that point I realized, oh, my, God, they completely overtightened, and people don't realize, and it's just been following that cliff on its way down and that bought the trough sometime late next year based on the same idea that global policy rates have got to move a long way.
TEDDY VALLEE: Exactly. Then you get this cohort of people saying, how's that possible? Rates are so low. But there's that much more debt in the system. So, net-
RAOUL PAL: The corporate debt, so corporate debt was up a hundred percent since 2009. So, a couple years up, is the IMF think it's roughly like 76% of US GDP, we're just to talk GDP. If you're talking global GDP, 96% of global GDP is corporate debt now. And it basically doubled in the last- over doubled in the last 10 years. And it's all been done at ultra-low rates. So, any incremental rate of change was enormous for everybody.
TEDDY VALLEE: And this is an interesting point that I'm trying to get my head around, it's still a little ways away. If our leading indicators do tick up, say China really starts cranking on the credit, leading indicators turn higher, there's going to be the drag on the economic data in, especially in the US, so the US won't bottom until, we think, middle of next year. Just call it Q2 next year, we think the rest of the world potentially could bottom in December this year. So, if the data deteriorates significantly, and we do see that the LEIs tick higher, is there going to be some- I don't want to say Boogeyman, we'll call it Boogeyman for now- but when the tide goes out, and we've had 10 years of these rates, is there going to be something that no one's really paying attention to that manifests, that then basically nullifies the leading indicators for the time being?
And then luckily, the way I'm thinking about this, as we'll see in the markets, like huge respect for the markets and look at basically everything globally. So, hopefully, we'll be able to pick something up there. But that's one of the worries I have that if it does turn higher, and we get to towards December, when also liquidity conditions, we have a liquidity indicator that measures dollars available to flow into risk assets, that's also turning higher then when we get to that point, it would probably auger for being long emerging markets, and lagging into them. But if we have some issue into this year, then-
RAOUL PAL: So, talk about those issues, what are the ones that you fear? What are the ones that are on your radar?
TEDDY VALLEE: Some of this, Europe just keeps- you've spoken about Europe, but Europe keeps coming back to me to have interest rates where they're at and constantly going lower, the lifeblood of the system, the banks- they need higher rates to breathe. And that's the reason. This is huge point on why people right now are saying Europe's cheap, Japan's cheap. If you look at the banking sectors, and you adjust for the rates, they're roughly- So, for example, I think US banks right now trade at like 13.1 times, European banks trade at nine, eight, nine times, and the Japanese banks trade at around seven times.
The reason there's the difference between the three regions is because of the interest rates, because the interest rates have constantly gone lower, which kills the banks. So, it brings down the valuation. So, banks look cheap. Well, it's because interest rates are killing the whole system. I don't know what it would be. But for some reason, Europe keeps popping up or China's not able to crank their M1.
In China, this cycle has been so important. We did some work. Before the piece, we just put out figuring out who's been the driver of global GDP growth. And China, since the beginning of the cycle, has churned 47% of total GDP growth. So, it's basically the cycle. And that's why we've spent a ton amount of time on China in figuring out what's going on there. So, they're not able to crank their M1.
RAOUL PAL: Do they want to? Because what I'm observing is okay, you've got hostile with the US, you've got a weak world. China's obviously, I think we take a decision, why do we need to bail out the rest of the world? So, what they should do- that doesn't mean they will do, and what they have been doing is just supporting their own system in a way that doesn't inject massive amounts of capital to perpetuate the mess that they've already got. And that means there's no marginal increase in consumption of iron ore or cars, or all the usual stuff that you should drive.
TEDDY VALLEE: Exactly. And so, I think people miss that, up to this. So, everyone thought the global economy green shoots was bottoming in the first quarter. And what they missed this that point that a lot of the stimulus measures that they were taking were domestic based.
RAOUL PAL: Exactly, because January was all about this China stimulus. And it was down.
TEDDY VALLEE: In year on year, it was like total stimulus was down. The reason it was down year on year is because they were de-levering local government financing vehicles or local governments and then off balance sheet debt. And these two things were the primary lifeblood for the rest of the emerging markets, that trade with China, that correlation between these two and how like South Korean exports do for example, is very positive. So, it's been domestic in China, and I'm thinking it might start to be more global in the sense that recently, they relaxed some of the curbs on the local government financing stuff. And I'm getting some indication or hearing some stuff from some third parties in China that the off balance sheet stuff is really starting to crank up again.
We'll see if it comes to the numbers. But if those two buckets of the four Chinese buckets don't rise, then you're probably going to have a tough time for the rest of the world to grow, which would be very supportive of the dollar.
RAOUL PAL: And okay, talk to me about the US. What are you seeing in the US, because a lot of people are seeing Europe, are seeing China, they're nervous about places like Australia, and they understand the risks of the UK. When you talk about the US, people goes, it's fine. Now, we talked about unemployment, but what are you seeing more specifically in the US?
TEDDY VALLEE: So, one of the best leads and taking a step back, Fed cut, or Fed pause interest rates or from hiking rates in December, huge rally. 27% from the low. So, if you look back historically, since the 1980s- 1980, 1985, 1989, 1995, 2000, 2006, every time, regardless of the economic data, really [inaudible] in equities, which is what we just saw, because