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What is the Bond Market Signaling?

Darius recently sat down with Ash Bennington on Real Vision’s Daily Briefing to explore the bond market, inflation, FOMC, and more.

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

1. The Resilient US Economy Is Likely To Perpetuate The Bear Steepening in The Bond Market

The economy has been and will continue to be resilient for the following ten reasons:

We expect the resilient US economy theme will continue for the next three to six months and continue to perpetuate the bear steepening in the bond market.

2. We Challenge The Fed’s New Economic Projections 

This week’s FOMC meeting produced a “goldilocks” summary of economic projections:

With these projections, the Fed implicitly states that we will get more growth and better labor market conditions while still having a soft landing in inflation.

We disagree with the Fed’s view on this, as our research shows that inflation typically breaks down six to eight months into recession. 

3. Is 3% the new 2%?

Our secular inflation model indicates that we will have 50-100% more trend Core PCE inflation in this decade relative to the last decade. 

We track a basket of indicators correlated with the underlying trend of inflation that indicates the underlying trend is headed to 2.5% in this decade. 

Additionally, when you weigh the model on each indicator’s impact, the core PCE trend goes from 1.6% to 3.2%, equating to a 3.5% trend in headline CPI. 

Our models indicate that 3% may be the new 2% – both in terms of the trend in inflation and the Fed’s likely-to-be-revised inflation target. 

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!

Macro Pro to Pro Live: Kris Sidial Recap

Earlier this week, Darius sat down with Kris Sidial from the Ambrus Group on 42 Macro’s Pro to Pro Live show to discuss reducing the cost of tail risk hedging strategies, investor positioning, #recession, and more.

Here are three takeaways from the conversation that have significant implications for your portfolio: 

1) If The Economy Does Not Enter Recession In The Next Quarter, US Corporations Will Be Underinvested And Understocked For A Soft-Landing

Over the past five quarters, 

If consumers continue to spend in line with recent trends (Real PCE on Goods increased 5.4% on a 3-month annualized basis in the most recent report), corporations will need to invest, kicking off a second wave of resilience in the economy.

We believe this second wave of the “Resilient US Economy” narrative will force more underpositioned investors to rotate off the sidelines and into stocks this fall.

2. Although We May See A Short Term Correction, Investor Positioning Implies More Right-Tail Risk In The Equity Market

The following positioning metrics are at levels consistent with local market tops:

Actual positioning in the futures and options market remains historically depressed.

As such, we believe a short-term correction could be the bear trap that leads to the final blow-off top in Q4 2023 or Q1 2024.

3) The Stock Market Typically Increases Leading Up to Recessions

Equities usually rally in the year leading up to recessions, returning a median of +16%, with an interquartile range of +14% to +20%.

They generate more than half of that return in the final three months leading up to a recession; blow-off tops in these late-cycle environments are the norm.

We expect the stock market will peak between October 1, 2023, and March 31, 2024, and we believe a crash will follow once market participants begin pricing in the Phase 2 Credit Cycle Downturn.

Until then, investors should continue riding the momentum wave higher.

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 @42Macro and @42MacroWeather.
  3. Have a great day!

Is A Blow-Off Top In Equities Approaching?

Earlier this week, Darius joined  Anthony Crudele to discuss the Recession, Equities, Investor Positioning, and more.

Miss the discussion? No problem. Here are the three most important insights that can help your portfolio: 

1) Hard or Soft, the “Landing” in Inflation Will Mirror the Landing in Growth

If we have a recession, inflation will come down swiftly.

On the other hand, if we manage to avoid a recession and see a soft landing, then inflation will decline naturally over time. However, in a soft landing scenario we believe it will decrease to a terminal level higher than the Fed’s 2% target. 

Both roads lead to cuts, but the severity of cuts will depend on the outcome: a hard landing will likely lead to 200-300 basis points of rate cuts, while a soft landing only leading to 50-100 basis points of cuts. 

2) We Believe There Will Be A Blow-Off Top In Equities

We urge investors to expect a blow-off top in the US equity market, which is a phenomenon that happens ahead of every recession.

Our research surrounding market cycles, specifically around late business cycle turning points, reveals that in the year preceding the equity market’s peak, the S&P rises by approximately 16%, with zero non-double-digit values in a 12-cycle sample.

Typically, the S&P peaks just before the recession, approximately a month before the trough in the unemployment rate and breakout in jobless claims, squeezing bears right up until the last innings of the expansion.

3) Bearish Investor Positioning Is Fueling This Rally

Our 42 Macro Aggregated Cross-Asset Positioning Models indicate that investors are still very bearish from a positioning standpoint.

The most recent data shows investors are more resolute in their bearish positions than at the October 22 lows.

Although those investors may be correct about the market’s destination in six to nine months, the challenge lies in the three to four months leading up to that period. 

We believe there is risk of a continued market rally in the back half of the year, not driven by fundamentals but simply because the recession every bear is waiting on has not started yet.

That’s a wrap! 

If you found this thread helpful, go to www.42macro.com/macro-bundle to unlock actionable, hedge-fund caliber investment insights and have a great day!

Where Do We Go From Here?

Where Do We Go From Here?

Last week, Darius joined Erik Townsend from Macro Voices to discuss the Stock Market, Credit, Inflation, and more.

Here are the three biggest takeaways from the interview that are critical for managing risk:

1) The Stock Market Always Rallies Sharply Leading Up to Recessions

When we evaluate the S&P 500 performance a year before its peak preceding a recession, we usually see it in the green, up on a median basis by +16%.

This year’s rally is not abnormal.

Our expectation is that the coming recession could kick off by the end of this year or early next year. 

Moreover, we evaluated the S&P 500’s behavior in and around recessions since 1948, and our research shows the index, on a median basis, typically experiences a drawdown of -24%. 

What triggers these rallies are not just macro fundamentals but also how investors are positioned in relation to potential outcomes. 

Right now, we believe the current positioning dynamics may push the market higher in the short term because investors remain underweight equities to an extreme degree.

Understanding these positioning cycles is essential for getting the investment game right.

2) We Believe That A Phase 2 Credit Cycle Downturn Is Still On The Horizon. 

The Silicon Valley Bank crisis, despite its impact, does not suffice as the Phase 2 Credit Cycle Downturn that we expect to see. 

We believe there was a substantial decline in credit and lending standards already evident in January’s senior loan officer survey report. 

The crisis did trigger further degradation, but only marginally. 

Additionally, we review five key cycles as part of our 42M research – housing, orders, production and profits, employment, and inflation. 

The current data indicates a very regular business cycle, with housing, orders, and production and profits already breaking down. 

Employment and inflation have yet to break down, and typically do not until the start of (employment) or well into (inflation) a recession, meaning we likely have not seen the start of the recession yet. 

As such, the Phase 2 credit cycle downturn is yet to come and recommend incremental patience in terms of respecting the x-axis.

3) Immaculate Disinflation In The US Economy Is Likely To Conclude In 2H23 

Over the past few months, we have seen substantial declines in measures of underlying inflation like median CPI, trimmed mean CPI, median PCE, trimmed mean PCE, super core CPI, and super core PCE. 

This immaculate disinflation has contributed to the “transitory Goldilocks” theme we’ve observed in asset markets. 

We refer to this inflation as ‘Immaculate’ because inflation normally breaks down 6 to 8 months after a recession; here it has meaningfully broken down beforehand. 

For a variety of cyclical and structural reasons, we anticipate immaculate disinflation is nearing its end and that we will likely see inflation firm up in 2H23 – relative to expectations and potentially on an absolute basis as well. 

We expect soft landing expectations to peak before the “immaculate disinflation” narrative is overtaken by our “resilient US economy = resilient US inflation” theme, contributing a blowoff top that leaves the stock market vulnerable to Phase 2.

That’s a wrap! 

If you found this thread helpful, go to www.42macro.com/macro-bundle to unlock actionable, hedge-fund caliber investment insights and have a great day!

Why is the stock market ripping?

 Last week, we joined Real Vision’s Raoul Pal and Maggie Lake to discuss Liquidity, Debt Monetization, Recession Risk, and MUCH more.

In case you missed it, here are seven highlights from what many are calling “the best Real Vision Daily Briefing yet”:

Liquidity Drives Asset Markets 

Although we believe the stock market will continue to squeeze bears well into the fall, poor liquidity conditions will likely drag asset markets down this summer. 

Additionally, we are not sure we’ve seen this market cycle’s ultimate lows because we did not price in a recession last year. What we priced in, in our opinion, was a change in the Liquidity Cycle. 

The markets will eventually need to price in the credit cycle downturn associated with the liquidity drain we’ve experienced in 2021 – 2022. We expect that to start in Q4 2023 – Q1 2024.

Understanding and Monitoring Liquidity

Changes in liquidity, driven by factors like central bank policy and the activities of commercial banks, can significantly impact asset markets.

We have tested this extensively: our proxy for liquidity has a 97% correlation with the S&P 500 since 2009 and an 89% correlation with #Bitcoin since inception. 

Over the short and medium term, we expect liquidity to fall with the return of Uncle Sam to the international capital markets.

We do not believe we have reached a durable positive inflection in the liquidity cycle yet. Liquidity bottomed in October, but we haven’t met those conditions yet in terms of getting an unimpeded rise in liquidity. 

Central Banks and the Concept of Debt Monetization

Debt monetization is when a government issues bonds and the central bank purchases them, thus increasing the money supply. This mechanism can prevent the public sector from crowding out the private sector. 

“Crowding out” happens when the government borrows so much that it drives up interest rates, making borrowing more expensive for businesses and individuals.

We believe the central banks are currently playing a Debt Monetization game. However, we do not believe central banks are purposely causing economic deterioration to monetize public sector interest payments. Instead, we believe they are responding as crises occur. 

The Liquidity Cycle 

Our research shows there’s a three and 1/2-year cycle in global liquidity, with approximately 2 ½ years from trough to peak. 

Assuming the most recent trough occurred last fall, we expect the cycle’s peak to occur sometime in the first half of 2025. 

Similar to Raoul, we’re bullish in terms of the destination. We just differ on the path to get there and believe there will be pain in asset markets along the way. 

The Drivers of the Global Liquidity Cycle

To forecast global liquidity, we analyze the YoY change of a group of proven leading indicators, including equity market performance, real 10-year yield, real effective US dollar exchange rate, OECD composite leading indicator, core CPI, and the unemployment rate.

All of those factors combined imply that:

Although we expect the liquidity environment to be positive in 2024, we expect there will be a period of 2022-style liquidity conditions along the way.

Recession Expectations

We believe the recession will commence in Q4 2023 or Q1 2024 and will overwhelm whatever favorable liquidity conditions are present at the time. 

When the economy goes into recession, and people start losing jobs, risk assets decline (the median S&P decline in a recession is -24%). 

Even if liquidity is increasing, there can still be corrections. And we expect that will happen at some point over the next year. The maximum drawdowns of the S&P 500 and Bitcoin during the Liquidity Cycle upturns experienced since 2009 are -34% and -74%, respectively. 

When will this rally end?

We still believe most investors have the recession playbook on too early.

The economy will likely stay resilient until sometime around Q4 2023 – Q1 2024. History shows that the stock market is NOT forward-looking heading into recession – largely because it is busy squeezing bears. Rather, it tends to peak on a coincident basis with the peak of the Employment Cycle.  

That’s a wrap! 

If you found this thread helpful, go to https://42macro.com/appearances to unlock actionable, hedge-fund caliber investment insights and have a great day!

Macro Market Outlook: Pivot Soon?

We joined Paul Barron last week to discuss inflation, the jobs market, crypto outlook, and much more.

In case you missed it, here are 7 takeaways that will SIGNIFICANTLY help your portfolio over the next 6 months:

1) Although inflation is moving in the right direction, we still have some work to do.

Given the stock market’s (relatively) high current valuation and the bond market pricing in a quick Fed pivot, the inflation numbers we are currently at are scary.

2) “The Fed has been explicit about waiting to see slack emerge in the labor market.”

Two significant labor metrics, Job Openings / Unemployed Workers & the Employment Cost index are 2x their pre-covid levels.

The Fed won’t pivot to rate cuts & QE until they see change.

3) The Fed doesn’t have enough data yet to determine the damage we will see in regional bank lending.

Pausing is how they can buy themselves time & assess those effects.

Given its change in guidance at the May FOMC, we believe the Fed has already implemented the pause pivot.

4) “Inflation tends to peak at or in recessions. It’s a very late cycle indicator, like the labor market itself.”

We’re currently experiencing an unusual inflation cycle – a lot of inflation was pandemic and fiscal stimulus-related.

Pandemic and fiscal stimulus-related inflation aside, we still have structural ~4% core inflation. 

We’re going to need a recession to get that structural inflation back to where the Fed wants it to be.

5) What’s the outlook on Crypto?

Pre-halving years are extremely volatile for Bitcoin; there are usually several large drawdowns throughout the year

On top of that, global liquidity isn’t ubiquitously improving anymore (and it will likely worsen throughout Q3).

The liquidity narrative that propelled BTC from $16k to $30k made sense; liquidity was improving back then.

But, it’s not anymore.

Bitcoin needs more liquidity to go higher.

Realistically, that likely won’t happen until next year.

6)Will there be opportunities to find outperforming single stocks?

Absolutely. 

When the yield curve is inverted, we’re typically in the late stages of the economic cycle.

When you’re in the late stages, you usually see good companies continue to grow, while other firms increasingly fall by the wayside. 

It becomes a stock pickers market.

7) How long will the recession last?

The recession will most likely happen in Q4 or Q1 of next year.

But, there’s a lot of time before then; we can easily see a short squeeze at some point.

So, be patient.

Remember, these are the times when great wealth is made.

That’s a wrap!

If you found this article helpful, go to https://42macro.com/macro-bundleto unlock actionable, hedge-fund caliber investment insights.

Have a great day!