Renewed Fears Of A No-Landing Scenario

Darius joined our friend Nicole Petallides on Schwab Network last week to discuss 42 Macro’s risk management signals, the resiliency of the US economy, the outlook for asset markets, and more.

If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio: 

The Divergence Between Fed And Treasury Policy Creates A Complex Environment For Investors And Requires An Increased Reliance On Risk Management Signals Over Fundamental Predictions

• When policymakers are not in sync, investing becomes more challenging. In an environment where all central banks row the boat in the same direction, investors experience a more favorable landscape. However, when signals across global growth, inflation, and policy are inconsistent, managing risk becomes significantly more complex.
• The US consumer remains resilient, continuing to spend robustly. Our “Resilient US Economy” theme, which we authored in September 2022, is supported by the strong consumer balance sheets and income dynamics we have seen recently. This resilience has been a key driver of the risk-on Market Regime investors have experienced since November.
• While the market impact of the policy divergence between the Treasury and the Fed remains uncertain, successful investing does not require you to predict the future; what it does require is an effective risk management system, which can help you navigate these uncertain times and stay on the right side of market risks. If you would like to add our proven risk management overlay to your investment process, we are here to help.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

How Do Retail and Institutional Investors Differ?

Darius recently hosted our May 2024 Pro to Pro Live to discuss the current Market Regime, the US consumer, key differences between retail and institutional investors, and more. 

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Investors Should Position According To The Current Market Regime

Our 42 Macro Risk Management Process transforms complex market dynamics into a clear and straightforward three-step approach:

1. Position for the Market Regime
2. Prepare for regime change using quantitative signals with our Macro Weather Model
3. Prepare for regime change using qualitative signals via our fundamental research

We have remained in a REFLATION Market Regime since March. However, our quantitative and qualitative risk management processes indicate a growing probability of transitioning to a risk-off INFLATION Market Regime.

Investors should understand the key portfolio construction considerations for each Market Regime. If you need help understanding these high-impact portfolio pivots, we are here to help.

2. The Difference Between Retail And Institutional Investors 

The key difference between the average retail investor and institutional investor lies in their approach to market signals. Institutional investors have robust observational processes that allow them to adjust their positions when signals change. 

In contrast, retail investors usually build their portfolios based on their [oft-erroneous] predictions about the future, and when data disconfirms their narratives, they lack a robust-enough observational process to help them reposition their portfolio in time to make or save money.

We offer our clients these robust observational tools, helping them recognize when market and/or economic conditions shift so they can adjust their portfolio positions accordingly.

3. The West Village-Montauk Effect Is Contributing To The Resiliency Of The US Consumer

The “West Village-Montauk Effect” can be summarized as follows: With a substantial stock of savings, there is less pressure to save a significant portion of your disposable income. 

We are witnessing this effect in relation to the US consumer. Since the close of 2019, households have experienced a boost in wealth:

• Household cash reserves have surged by 135%.
• Household net worth has increased by 34%.
• Nominal disposable personal income has increased by 27%.
• Inflation has surged by 21%.

To date, this business cycle features household cash, net worth, and nominal disposable personal income each having grown at rates that have exceeded inflation.

That’s a wrap! 

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What Comes Next for the Economy?

Darius joined our friend SpotGamma last week for their ‘PNL for a Purpose’ interview series to discuss our Macro Weather Model, Liquidity, the US economy, and more. 

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Our Macro Weather Model Currently Indicates A Poor Three-Month Outlook For Asset Markets

At 42 Macro, we monitor several crucial economic cycles simultaneously. We track five Real Economy Cycles: growth, inflation, the labor market, corporate profits, and fiscal policy. Additionally, we track five Financial Economy Cycles: liquidity, credit, interest rates, and investor positioning from both a fear and greed perspective.

We have developed our Macro Weather Model to systematically assess our position within these cycles and their potential impact on asset markets over the medium term.

Currently, our Macro Weather Model forecasts a bearish outlook for both the stock and bond markets, a bullish outlook for the US Dollar, and a neutral outlook for commodities and Bitcoin.

2. Up Until Recently, The Treasury Department Had Been Contributing To Positive US Liquidity Dynamics In This General Election Year

We track US Liquidity via our 42 Macro Net Liquidity model, which is calculated by taking the Federal Reserve Balance Sheet and subtracting the Treasury General Account (TGA) Balance and the Reverse Repo Program (RRP) Balance.

Since Q2 2023, the Treasury has been drawing down the RRP balance to finance itself, reducing the balance from $2.5 trillion to $506 billion. This reduction has positively influenced asset markets.

However, since last month, the decline in the RRP balance has stalled out and is no longer supportive of liquidity, contributing to the recent correction observed in asset markets.

3. A “No Landing” Remains Our Highest-Probability Economic Scenario For The US Economy On A NTM Time Horizon

We forecast growth and inflation using our statistical models, which predict growth to be above consensus and inflation to remain above the Fed’s 2% mandate over the next year. 

While we are not concerned about a recession, we are wary of the potential for asset markets to reprice the forward rate curve, similar to what happened in 2022. Currently, significant rate cuts are being priced in: two cuts in 2024, two in 2025, one in 2026, and one or two more for the longer term.

However, the forward rate curve could flatten over the medium term if the Federal Reserve and Treasury ceased supporting asset markets with dovish net financing policies and dovish forward guidance.

That’s a wrap! 

If you found this blog post helpful, explore our research for exclusive, hedge-fund-caliber investment insights you can act on today.

Navigating Conflicting Economic Data

Darius joined Charles Payne on Fox Business last week to discuss the US economy, inflation, the Fed, and more.

If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio:

Recent Economic Data Gave Conflicting Signals To Investors. A Systematic, Rules-Based Investing Approach Is The Best Method To Generate Positive Returns In Today’s Confusing Macro Environment.

• Although growth is slowing from the well-above-trend pace we saw last year, the economy remains resilient. We currently see a low probability of a developing recession in the US economy, but that may change in the coming weeks/months per the latest data. 
• If inflation persists above trend, the Federal Reserve may postpone any dovish measures. Coupled with the Treasury’s policy of tighter net financing conditions, this scenario could cause a shift to a risk-off Market Regime.
• During most of the bull run that occurred since late October 2023, monetary and fiscal policies were aligned, supporting asset markets. Currently, however, monetary policy remains dovish, largely disregarding inflation data, while the Treasury’s net financing policy has become more hawkish at the margins. As we move into the third quarter, this policy shift could become burdensome for asset markets.

That’s a wrap! 

If you found this blog post helpful, go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

Who Cares What The Fed Thinks?

Darius joined our friend Maggie Lake last week on Real Vision’s Daily Briefing to discuss the resilient US economy, the Fed, inflation, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio:

1. The Resilient US Economy Does not Require Rate Cuts, But The Fed Wants To Cut Rates Anyway

Last week’s FOMC statement and press conference, led by Fed Chair Jerome Powell, were surprisingly dovish. Notably, the Fed announced a significant reduction in its balance sheet runoff policy, scaling down from $60 billion monthly to just $25 billion in its Treasury portfolio. Powell also downplayed recent increases in inflation and dismissed the likelihood of further rate hikes.

Additionally, we track the Fed’s dot plot alongside Fed funds futures pricing across different durations. Currently, futures indicate expectations for two rate cuts in 2024, followed by another two in 2025, less than a full cut in 2026, and subsequent cuts until the floor Fed funds rate is reached. Powell attempted to support that dovish market pricing in his press conference remarks.

It is clear to us that the Fed wants to ease monetary policy.

2. The Q2 QRA Sent A Hawkish Message To Investors

The Q2 Quarterly Refunding Announcement indicated Janet Yellen and the US Treasury Department are moving away from relying on bills for financing.

In the announcement, the Treasury stated that the proportion of bills in all Net Marketable Borrowing over the trailing 12 months until Q3 2024 would be 34%, marking the lowest share since Q1 2023.

This move suggests that the Treasury is extending its financing policy further along the yield curve. We believe this shift is intentional and aimed at sending a clear, hawkish message to market participants.

3. A “No Landing” In The Economy = A “No Landing” In The PCE Deflators

In the March PCE release, Supercore PCE Inflation increased to 5.4% on a three-month annualized basis, a level near the highs of the readings over the past three years. This uptick signals a textbook reacceleration pattern, where the three-month rate of change surpasses the six-month rate of change, which outpaces the YoY rate of change.

Turning to forward-looking indicators, the Employment Cost Index accelerated to 4.4% on a QoQ SAAR basis, 200 bps faster than its 2015-2019 trend.

If productivity growth decelerates and wage inflation persists, it could indicate the sticky inflation we have observed over the past couple of months may continue, and we may settle at a level of structural inflation higher than the Fed’s 2% target.

That’s a wrap!

If you found this blog post helpful, go to www.42macro.com/research to unlock actionable, hedge-fund-caliber investment insights.

Could The Election Make Assets Explode?

Darius joined our friend Anthony Pompliano this week to discuss the Q2 Quarterly Refunding Announcement, US Liquidity, the outlook on asset markets, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio:

1. Janet Yellen Sent A Hawkish Message To Investors Via The Q2 Quarterly Refunding Announcement

This week’s release of the Q2 Quarterly Refunding Announcement sheds light on the Treasury’s net financing estimates for both the current and upcoming quarters, projections for the Treasury General Account (TGA) balance, and more.

Within the announcement, two key data points stand out: the Privately Held Net Marketable Borrowing totals for the current and next quarters, and the Treasury General Account Target Balance. For the current quarter, the Federal Reserve estimates a need to borrow $243 billion in net marketable borrowing from the private sector, marking a $41 billion increase compared to the previous Quarterly Refunding Announcement.

Looking ahead, projections for privately held net marketable borrowing for the next quarter have surged to $847 billion, representing a significant $604 billion uptick from the preceding quarter. This increase coincides with a notable $100 billion raise in the TGA account target balance. These figures paint a picture of a Treasury issuing a decidedly hawkish signal to market participants.

2. US Liquidity Dynamics Shifted Negatively In April

We track US Liquidity via our 42 Macro Net Liquidity model which is calculated by taking the Federal Reserve Balance Sheet and subtracting the Treasury General Account (TGA) Balance and the Reverse Repo Program (RRP) Balance.

Throughout much of 2023, the Treasury adopted a net financing strategy aimed at accessing the surplus funds held on the Federal Reserve’s balance sheet, primarily through the reduction of the RRP balance. Beginning last year at $2.5 trillion, the RRP balance has steadily decreased to its current level of $506 billion. This move notably bolstered asset markets.

However, since the start of April, both the RRP and TGA balances have shifted in a manner less supportive of liquidity, actually draining it. This trend has contributed to the recent correction observed across asset markets.

3. The Backdrop For Asset Markets Is Becoming Less Bullish At The Margins

Our “Resilient US Economy”, “Green Shoots Globally”, and “China Front Loading Stimulus” themes persist, all of which are supportive of asset markets.

However, our “Sticky Inflation” theme is now a dominant driver of asset markets. Moreover, the US Dollar has broken out to a bullish condition according to our Volatility Adjusted Momentum Signal. This is significant as the Dollar’s movement is inversely correlated with global liquidity on a coincident basis.

Presently, we are witnessing a transition from a simultaneous dovish stance in both Fed and Treasury policy towards one that is net neutral, given the Treasury’s hawkish pivot this week. This shift represents a less bullish environment for asset markets.

That’s a wrap!

If you found this blog post helpful, go to www.42macro.com/research to unlock actionable, hedge-fund-caliber investment insights.

Have a great day!

Risk On Or Risk Off?

Darius joined our friend Anthony Crudele last week to discuss the current market regime, the 42 Macro Positioning Model, inflation, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Our Positioning Model Nailed The Correction In Risk Assets 

Heading into this month, our 42 Macro Positioning Model, which tracks several short-term tactical indicators, including the AAII Bulls-Bears Spread, S&P 500 Implied Correlations, and AAII Cash Allocation, flagged an elevated risk of a tactical pullback.

These indicators suggested the market was overextended from a short-term perspective.

Whether a geopolitical catalyst occurred or not, we expected a pullback. 

2. The “Immaculate Disinflation” Theme Is Dead

The latest March PPI and CPI figures supported our “Sticky Inflation” theme. Super Core CPI surged to 7.9% on a three-month annualized basis, three times the pre-COVID trend and well above the Fed’s 2% inflation target.

Across most sub-categories of CPI and PPI, as well as leading indicators like NFIB or the UMich surveys, there is an array of disconfirming evidence in the “Immaculate Disinflation” narrative. At this juncture, we believe that the “Immaculate Disinflation” theme is over.

3. “Sticky Inflation” Is Not Bearish In Isolation 

Our “Jay And Janet Want A Soft Landing” theme hinges on two key factors. First, the Federal Reserve is more dovish than necessary. Second, Treasury net financing policy is contributing to favorable liquidity dynamics in this general election year. 

Given these ongoing dynamics, we maintain that investors need not worry about inflation pressures in isolation. Unless the Fed or Treasury takes action to address sticky inflation, we believe asset markets can continue to perform well over a medium-term investment horizon.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Fed’s Policy On Inflation Is A ‘Step In The Wrong Direction’

Darius joined our friend Maria Bartiromo on Fox Business last week to discuss the Fed’s policy on inflation and what it means for asset markets.

If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio: 

The Fed Is Kowtowing To Fiscal Dominance, And We Believe It Will Accept Higher Than 2% Inflation Over The Long Term

• The FOMC has stated that it would need greater confidence that inflation is moving sustainably towards 2% before easing policy. However, recent data hasn’t provided that needed confidence; instead, it suggests a prolonged timeline for achieving 2% inflation. If higher inflation persists, the Fed has stated they will maintain the current level of interest rates for as long as needed, rather than tightening further. 
• When we refer to the monetary authority “kowtowing” to fiscal dominance, we are describing a situation where the Federal Reserve is being influenced by the government and fiscal policymakers. In 2023, the Federal Budget Deficit grew by $364 billion. The Fed is accepting the increased government spending will continue and inflation will remain elevated. 
• Our analysis of prior economic cycles found that periods when the monetary authority kowtows to fiscal dominance are structurally bullish for risk assets like stocks and crypto and structurally bearish for assets like the bond market. 

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Is There Further Upside Risk In Asset Markets?

Darius joined David Hunter last week on our Pro to Pro Live to discuss the 42 Macro Positioning Model, the outlook for asset markets, our “Green Shoots Globally” theme, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Our Positioning Model Suggests There Is Likely Additional Risk To The Upside Over The Medium Term

Bears have found themselves reluctant to join the recent rally in equities. 

Our 42 Macro Positioning Model monitors the aggregated non-commercial net length as a percentage of total open interest in the combined futures and options markets for US Equities. Currently, this indicator sits in the 33rd percentile of readings, notably lower than the median reading of the 62nd percentile seen at major bull market peaks.

Despite the significant market rally, we have yet to witness the structural upside capitulation characteristic of bull market peaks. This absence suggests there is likely potential for further upside over the medium term, although there may be a correction in the near term.

2. Cash On The Sidelines Stays On The Sidelines Until There Are Reasons For It To Exit

Currently, over $6 trillion is parked in money market funds. 

Our analysis, spanning the last four cycles—2020, 2008, 2001, and 1991 —reveals a consistent pattern: cash on the sidelines tends to stay put in these funds until after a crash, recession, and rate cuts have each taken place.

We anticipate this cycle will follow suit, with the bulk of cash on the sidelines staying put until these pivotal events unfold.

3. “Green Shoots Globally” Continues To Support Risk Assets

In January, we authored our “Green Shoots Globally” theme that was supportive of asset markets.

The theme persists, as our models show that every major economy in the world has a Composite PMI trending higher—a bullish leading indicator suggesting what is likely to occur over the next three to six months from an economic standpoint. 

Moreover, we track the number of industries reporting growth in the ISM Manufacturing survey. In December, that number bottomed. Our backtests have found that in the year following the bottom, the S&P generates a median return of 28%. While this is just one data cyclical framework to respect, it strongly suggests that the broadening of market breadth stemming from improving global fundamentals is likely to continue.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Managing Risk in a Risk-On Environment

Darius joined Caroline Woods on Schwab Network last week to discuss the current risk-on Market Regime and its implications for asset markets.

If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio: 

The Market Remains In A Risk-On Regime, And We Believe It Has Room to Run

• At the beginning of the month, our Positioning Model flagged an elevated risk of a short-term correction. While some investors point to geopolitical factors as the cause of the correction, we believe the market was stretched thin in terms of positioning and needed a cooling-off period.
• We believe the market rally will continue because several fundamental themes, including our “Resilient US Economy,” “China Front Loading Stimulus,” “Green Shoots Globally,” and “Jay and Janet Want A Soft Landing,” may contribute to upside risk in asset markets. Until the drivers causing these themes dissipate, we expect asset markets to perform well.
• Although the Fed is discussing rate cuts this year, we maintain that the resilience of the US economy negates the need for cuts, as the economy continues to grow at an at-or-above-trend pace on a real basis and at a well-above-trend pace on a nominal basis. The hawkish repricing of policy rate expectations is bearish, but only to a point in this context. Said simply, the resilient US economy is unlikely to require rate cuts anytime soon.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!