RAOUL PAL: Keith, what the fuck's going on?

KEITH MCCULLOUGH: Let me tell you. It's easy.

RAOUL PAL: There is so much going on.

KEITH MCCULLOUGH: My political lens is always explicitly affected by my quad outlook. We're right on the screws. I'm not a believer that any politician central planner or otherwise can part the heavens and give us a new path underneath the seas of economic gravity.

Our framework doesn't really solve for rainbows and puppy dogs, certainly doesn't solve for a man in a tower tweeting or men from anywhere for that matter, tweeting.

RAOUL PAL: Hi, I'm Raoul Pal. Today, I'm going to sit down with Keith McCullough of Hedgeye and really, I've got Keith here for one particular thing because I want to ask him one pointed question. Keith, What the fuck's going on?

KEITH MCCULLOUGH: Let me tell you, it's easy.

RAOUL PAL: There is so much going on. I know that the market narrative is shifting, I see you guys are shifting around with which quantum and things are moving. I think people are struggling to make sense of it because they look at asset prices and equity markets, they see all-time highs, they're saying, well, everything's perfect. It is becoming a complicated situation, which is precisely why you're in business to do what you do and why you've got a framework. Talk us through a bit of how you see things and maybe we'll just kick it around from there and see where we get to.

KEITH MCCULLOUGH: Yeah, for the last year, I think that it was a relatively easy environment to understand. You had basically both growth and inflation slowing at the same time. Everyone agreed to agree at the all-time lows and bond yields and I think it's pretty clear that growth was slowing in China, EM, Europe. Then of course, the US joined that. As we went through that path, you've had this Trump thing, like the tweets and the Trump and the deal and the non-deal and extended, it's so hard to keep track of it.

You have so many people that have now entered the game, so to speak, saying well, as long as we have a resolution to that, then it could all be rainbows and puppy dogs. Our framework doesn't really solve for rainbows and puppy dogs, certainly doesn't solve for a man in a tower tweeting or men from anywhere for that matter, tweeting. What it does is it solves for these four quadrants. What we have, the only change we've made is that we're going to see a return of inflation, or the rate of change of inflation accelerating, and really only for six months.

If you think it's confusing now, wait till we get six months from now and we start to make the turn again back into what we call Quad 4. Q2 of next year is where we have the US economy finally slowing towards the slowest point. You can go Quad 3, Quad 3, Quad 4 for the next nine months. Quad 3 is economic stagflation, which always is a precursor for the end of the economic cycle which is Quad 4 which is when you have both growth and inflation slowing in at the same time and we're going to be right on the screws ahead of the US election. It's going to be pretty intense.

RAOUL PAL: With markets looking forward, so they started sniffing some of this out whether it's from the tweets or other things, during the what you would refer to as Quad 4, are we likely to see the markets looking towards the end of the Quad 3 phase earlier, let's say in Q1 as opposed to Q2?

KEITH MCCULLOUGH: Well, the markets been very good at sniffing out every single move and front running the Fed, I might add, on every single move. Anytime the market saw a Quad 4 most intensely in the fourth quarter of 2018, and again in Q3 of 2019, the market was very quick to cut interest rates for the Fed. Don't forget that the yield curve steepened because the market basically said, if you don't cut rates at the next meeting, we're going to have another little meeting with you.

I think that that's the interesting part, is that all of that fully loaded cowbell from the Fed, fully priced in Fed cuts into the most recent meeting, and the idea that we could see demand change and rate of change terms. Like give me another 10 cents for the next person that tells me the ISM has bottled. With 100% of those 10 cents coming from people that never called it topping to begin with are 100% sure this is it. It's a very dynamic point but we're going to get inflation accelerating anyway because the base effect of what happened last year, which was highly deflationary is an easy comparison.

That's going to happen anyway. I think people are confusing that demand can accelerate at the same time that inflation could go up. It's quite the opposite actually, economic stagflation is when your cost of living goes up, and your real consumption slows.

RAOUL PAL: I think that's the key point. This year on year effect from this point last year is enormous now. It's going to skew everything and you're going to have, as you said, some very hot looking prints and a number of things. Then as soon as you start getting into January, because the markets all completely rebounded, you're going to see it completely unwound almost immediately. It's going to be a fascinating period.

Meanwhile, I look at the background of stuff, the rate of change of stuff, and I'm looking at the rate of change of the increase in price of copper is rolling over again. It looks like the increase of the rate of change in or even more so, emerging market currencies are now starting to fall in absolute terms again, quite sharply and we saw the Chilean peso today, stuff like that, just like okay, it feels that the weaker things in the background are starting to already transition.

KEITH MCCULLOUGH: Yeah, the weakest thing is China. When I look at copper, I see China. When I look at the Shanghai Composite Index or Shenzhen and for that matter, I see copper. They're all the same thing. They are not the US formal. They're very different things but under the same assumptions, people are expecting Chinese acceleration and demand. Meanwhile, the Chinese themselves, the locals won't buy it.

It's an amazing thing to watch now. At the same time, you can see I see big divergences in the softs, or on egg, on long cattle for God's sakes, Raoul, this is getting out there. I'm long cocoa, actually, to make it even worse, because we're actually seeing some of the supply shortages that we did see with commodities being so oversold with the dollar at a 20-year trade weighted high. That's actually just a simple pivot to reflate from anyway. It's not one that I think is going to be sustainable and I don't particularly care selfishly, I just want to make money trading the pivot, but in no way shape or form do I think that this is the signal broadly and macro to your point that we're going to see a Chinese acceleration in demand.

That's the easily the ugliest thing that we've seen in rate of change data this week, which is the October Chinese data. You're either staring at Macro Tourist and somebody's unfortunately getting shot in Hong Kong and thinking markets are trading on that or you actually paid attention to the rate of change data, which was a new high in inflation in China, a new low in the producer price index at the same time and a 15-year low in loans in year over year demand. It's quite alarming to see an economy of that size, and of that order of magnitude in terms of expectations, slowing against easing comparisons, that is as damning as it gets for an economy and that's what's happening in China right now.

RAOUL PAL: I think one of the hardest comparisons is actually what you're picking up as well is obviously the pork prices. It's coming through all the food chain. Hence why you're seeing beef prices pick up and a number of other things, along with tariffs is the Chinese have basically we don't know the size of the destruction of their herd, but its enormous. It looks like it's spread elsewhere around the world as well. That's a huge input price to the average Chinese person. Meanwhile, they can't borrow money to smooth out the effects of that, so that's a real consumption crimp.

KEITH MCCULLOUGH: Yeah. Big, big problem. People sit there and they said, well, how could that matter? Well, it mattered big time. It's affected the entire US protein complex. 70%, I'm saying this increasingly at the dairies when we're looking at these numbers, I'm like, they're making up the numbers, they should make up a better number than that number, because that's a-- first of all, that's a really bad made-up a number in the Chinese demand terms.

Now, the inflation numbers, it's easy to see pork prices are up 70% year over year. Again, that's happening. Chinese inflation is now running hot and that's just going to make Chinese growth slow even faster. Let's just imagine that we go through the most beautifully wonderful deal with all the adjectives fully loaded in tweets, and that happens. Let's just say it and by the way, it can happen next month, because it's always the month after that and demand continues to slow. Post your bounce, give me a bounce in ISM, actually, give me a bigger bounce. Give me PMIs, ISMs, the bounce is higher than where I think.

You're going to wake up in January with-- our nowcast for US GDP growth has a zero in front of it. 0.58%--

RAOUL PAL: For Q4 or Q1?

KEITH MCCULLOUGH: For Q4, which will be reported at the end of January. Post all of this happening, the Fed is now going to have to reduce their dot plod and probably go right to the wood for you on your Eurodollar position and finally get more incrementally dovish, because currently, they're nowhere near dovish enough relative to what that GDP headline number, I'm talking about the quarter over quarters [indiscernible].

RAOUL PAL: It's not unusual. I read tweets about this the other day, it's not unusual in the midtown cycle to see this part of reflation trade now, because whether it's the earlier comps that do it or whatever it may be, the start of the Fed cutting cycle and the psychology of oh, we're saved isn't that amazing, it's pretty common to see a pullback in fixed income, a slight increase in the inflation style data before the whole lot rolls over because everyone's backward looking. Always looking at the unemployment numbers and consumption numbers, which are the last things always to move.

KEITH MCCULLOUGH: Right, and don't forget October of 2007, November of 2007, this is exactly the same setup. Now, when you mentioned those dates, or when I mentioned those dates, I first of all, remind myself that that's when I got fired, but people naturally say, oh, my God, like I literally just came out of a couple institutional hedge fund meetings, where there's a-- you said that this is like the consumption setup relative to commodity costs inflation in the fourth quarter of '07. I said, absolutely. It's called Quad 3.

It's where your cost of living rises on a short term basis. Don't forget where oil went in the first part of 2008. That perpetuates your real consumption slowdown, and that really plays to the heart of the biggest consensus. You literally, even if you're watching it on mute, you're going to hear people at CNBC say that the consumer's in great shape. This is what we know. 100% of the time anyway, at the end of every economic cycle.

That's not the point. It's when they slow for the first time and moreover, when jobless claims rise for the first time, which we haven't seen happen in a decade, that is actually the high probability bet that we have right now, is that year over year earnings go negative. People start to file jobless claims because they're getting fired and the consumption patterns slows at a faster rate. That, I can't calibrate until I see more data points but we're along the rate of change, the sine curve, we're at precisely the same point at the end of the fourth quarter of 2007, which is not a good reference point.

RAOUL PAL: No, I was just writing an article today about car industry. The currency is screaming that this is a bigger deal going on here. We've got, obviously the slowdown in sales that's going on around the world, but we got pick up in inventories. There's a whole bunch of things. The collapse in price of used cars and you look at that thing, and this is exactly the thing that starts before jobs get lost.

We're starting to see layoffs in fact and coming in some of these places, jobs start getting lost and people start losing faith because if your car starts losing its value very quickly as well and you're living in the margin anyway, that's an expensive thing to think about because you need to replace your car. You start worrying, oh my God, I've lost all that money in my car. It's these things at the margin that change consumer behavior and they take time, because consumers are listening to the President saying, isn't it great? Stocks are at all-time highs, which is not a million miles away from 2000 and 2007, but the reality is underneath, everything's going to shit.

KEITH MCCULLOUGH: Well, if corporate earnings go to shit, your job prospects and how you think about buying these big ticket items is going to go to equally go to shit. There's actually a very good sentiment survey within-- there are plenty of consumer sentiment surveys you can look at but if you look at the University of Michigan Consumer Sentiment Survey on your propensity to buy a big ticket item, ex-auto at the 2008 lows.

As you know, and I know, if you get zero percent financing, people might actually go do that, but you can't get zero percent financing for a washing machine. You can't do that for-- it's within the durable goods complex that people are saying, hey you know what, I'm actually not that confident and there are certain things that I can't quite put my finger on, but I'm pretty sure it has to do with the company that I'm working at. Starting to cut a little bit on the margin and starting to talk about the world changing a little bit.

Don't forget that only a year ago, we hit the triple peak, GDP growth, inflation and corporate profit growth. Rainbows and puppy dogs as far as the eye could see. When you have corporate profits, you spend on capital mid-cap CapEx, you buy back stock, and you hire more people. That was the peak. A year later now, people understand that something's changed but they're probably a little lost here for words when you have somebody tweeting at you from the presidential office, like look at me, look at your all-time high spend away. It's like those tweets take me like, wow, those won't age well.

RAOUL PAL: No. It's irresponsible as well, potentially, if we're writing the underlying trend of the global economy, the US economy is slowing still over time, then to be telling people to spend money and take out more credit or do whatever they're doing is irresponsible.

KEITH MCCULLOUGH: I think that that'd be a kind way of putting it. It's negligent and you're misrepresenting simple and basic economic facts which Larry Kudlow, or anybody who's got anywhere with all on a sine curve could tell you that we're slowing. By the time-- that's the utility of the nowcast on GDP. We have not seen it zero, you can look as far back as you can go. To find a zero on headline GDP is hard to find. Moreover, we went from one to two to three, we had one headline that was north of four. This is a dramatically different version of the truth than what's been represented with some of these, like I said, they're negligent tweets if we got for better right on the number, then those are negligent tweets.

RAOUL PAL: Yeah. I think, you and I talked about this in the past, this is almost precisely the reason we even got into business is to stop people being fooled at times like this. Because it's important, it's people's money. It's people's life savings. It's their pensions, all of that stuff. It's not right that the President is making the noise that he does. You don't have to be negative, sure, but don't cheerlead. Don't try and push people into doing things they shouldn't do. Sure, we could be wrong, but the probability is not that high.

KEITH MCCULLOUGH: Now, this is not-- you don't do that with the man on the street. It's not cool. It's not right. It's not a political comment. It's just if you're against fake news, then don't perpetuate the ultimate of fake news, which is not acknowledging what's happened to the US economic data, which even the Fed itself, they're the last to figure it out, as obviously figured it out. It's not going to hit, like I said, these tweets will not age well. In fact, it might-- and in the institutional community, I think it's an also-- I don't think it's negligent. I think the word fiduciary comes to mind.

Because everyone who does math, again, rate of change math, everybody knows that growth, inflation and profits have slowed. Yeah, they might be better than expected because S&P profits are down 1% to 2% year over year instead of down 10%. That's everybody knows. For you to buy stocks with people's 401k, again with other people's money, because you believe that he believes that there's a chance, that I think that there's a lack of fiduciary responsibility.

RAOUL PAL: