Transcripts
Erik: Joining me now is Things That Make You Go Hmmm... founder and editor Grant Williams. Grant, it's great to have you back! First interview of the new year. I want to send the way back machine all the way back 13 years ago this week, it was 2008 coming into 2009. We hadn't gotten to the final bottom in the stock market yet. You and I and a lot of other people really thought that that financial crisis was about too much debt. And we thought that the proposed remedy, which seemed to be creating more debt was not going to be sustainable. And we made a lot of arguments back then saying look, you can't just have the central bank propping up asset markets indefinitely. That's not sustainable. At least that's what I said, I don't want to put words in your mouth. I know I said it wasn't sustainable.
Gosh, it's been a dozen years Grant and they're sustaining it so far. At least, that's the way I see it. How should we think about the fact that although I still don't think it's sustainable long term and I think that they're driving us into what could be a really big inflation trap. Definitely, they could sustain things longer than I thought back 10 or 12 years ago. And it seems like in the eyes of a lot of people, but all of us skeptics got it wrong. And central bankers have proven that there really is a perpetual motion machine of finance here in the form of central bank largesse. How does this go from here? What do you think is on the horizon?
Grant: Well first of all, Happy New Year to everybody listening.
Erik: What a way to say Happy New Year! Did I just give you a great introduction or what?
Grant: It's a great question. I mean, look, you're right, I think I would bracket myself with you as saying that. If you put a gun to my head 12 years ago and said paint me a picture of life at the end of 2021 and asked me whether that was realistic, I would have said hell no. But, you know, I think the piece of the puzzle that perhaps a lot of people missed was that the market just wouldn't care about anything but liquidity. They wouldn't care about valuations, they would come to mean nothing to people, and that they would be happy to pay crazy multiples for things with either no profits or no chance of making profits for the foreseeable future. And I think that's the part that it was really hard to foresee ahead of times, because you know, that stuff has always mattered. And let's face it, regardless of any kind of suspension of that belief for the time being, we all know that it does matter.
If you're buying the shares in a company, you're buying those future cash flows, and if they're negative, at some point, that is not going to work out. Now, while the vast majority of market participants have the belief that either the Fed has their back, or there's going to be ample liquidity, low rates forever, and a bunch of people forced into putting money into the market as a place to get any kind of return that they can't get the bond market, then, you know, look, it can be sustained, and it has been sustained. The problem with that, as you've pointed out, and numerous guests on your show have pointed out is that you're just creating a bigger and bigger problem that will have to be faced on the day when all of this suddenly matters again. And, you know, it could be rising rates that make it matter, which is why the return of inflation is such a big problem. It could be some kind of collective awakening that makes people realize that they've paid the wrong price for all kinds of different things. Who knows? It could be something that none of us have thought of and generally that's the way these things tend to work out. But I agree it's amazing where we've gotten to and if you look at how we closed 2021. You know, there's this idea that markets are closing on or around the highs, it's going to make new highs.
If you look at some of the data, which is pretty extraordinary, you take away the top performing stocks from these markets, the NASDAQ for example, the average distance from the 52-week high of all stocks in the NASDAQ is 40%. 40% below the 52-week high while the index is just three and a half percent below the 52-week high. You go through all of these, you go through the S&P and the average stock is almost 12% below its 52 week high, the market closed at or within half a percent of its high. You know these are strange divergences that have been covered up by a small group of stocks which have priced in the sensitive buyers because they've been shoved into just about every ETF you can possibly think of and you know, at some point, you sound like a broken record saying this because we don't know when that point will be but financial sanity and financial gravity will return at some point. It just will be that way you cannot suspend your disbelief forever. So you know, does it happen this year? I would say we have as much chance as we do it any other January, the first trying to predict that, but this is why it's so important to understand what the return of inflation does and why it's such a dangerous phenomenon at the best of times, given the setup right now, the return of inflation creates a whole different set of problems because of this inability by central banks to raise rates by any meaningful degree to combat it. So I think this year, there's going to be a moment when the central banks are going to stare down the barrel of a gun, and have to decide what to do. And, you know, we can talk about what their options are, they're getting fewer by the week. And at some point, I suspect there's going to have to be some extraordinary monetary policy of the non-QE kind, rather, of the capital control, credit control kind which nobody wants.
Erik: Joining me now is Gavekal co-founder Louis-Vincent Gave. Louis, it's great to have you back on the show. I want to start with the big picture of where we stand in markets. Seems like the recovery was on and then we got the Omicron scare. I don't know what your take is but I've been looking at the data and as far as I can see, it's gonna be a while before the death toll climbs above zero. I don't think this is really the problem that the White House would like to make it out to be for some reason. What do you think's going on here and what does it mean for markets?
Louis: Hey, you know, roll out the usual suspects, right? We've had really a few ugly weeks, right? You got energy down 20%. I think last I checked that the Russell 2000 growth was basically given up all of its gains for the year and was roughly flat for the year. Think you got Bitcoin that more or less lost a quarter of its value? And I think behind all this, you've had a lot of things get slaughtered. Right? A lot of former, you know, beloved names of the general public, whether your Zoom videos, your Beyond Meats, your PayPals, your Spotifys, your Mercado Libres, or your Alibaba as pinned wood roads. So yeah, it's been a bit a bit of a bloodbath. You know, is it? It's, you feel a little bit like, you know, we allowed the usual suspects, right. So you've got, you know, COVID or Omicron as a potential suspect. You obviously have, you know, Fed sounding more hawkish as another potential suspect. And then you have, you know, continued China's slowdown and Evergrande finally, you know, slowest moving bankruptcy in the history of slow moving bankruptcies, sort of hitting the wall again. So, you know, you, I think you can find quite a few, quite a few usual suspects.
The reality, though, perhaps the simplest explanation is, you had a lot of things that were priced for perfection. And perfection is a hard, hard status to achieve. So if you look at a lot of the things that got absolutely smoked, it's a lot of things that were, you know, frankly, really, really over valued. And again, that only works, you know, if you buy things that are massively overvalued, that can only work for so long. Meanwhile, you know, if you look at the Russell 2000 value, it's still up double digits for the year, and the correction has been nowhere near as bad as the Russell 2000 growth. So I think for me, the interesting question is, alright, is the sort of massive growth bubble that we've experienced, really, since the start of COVID. Is it now running out of steam? And I think the answer is, you know, and I don't think that's linked to COVID. I don't think that's linked to China. I think the answer to that is linked to, to your view of Fed policies, as you look ahead.
You know, if you think the Fed continues to inject tons of money into the system, then there's no reason to think the growth bubble rolls over. If you think okay, you know, 2022 will be most likely a year where markets, you know, Fed starts raining stuff in, but also possibly, where market starts pricing in a post 2022 environment of just less of marginally more fiscal restraint. You know, if you assume that the Democrats are going to get a walloping in November, which seems to be on the cards, then do we have an environment like we did from 2010 to 2016, where a Republican Congress just refused to expand spending. So then you move from an environment of super easy fiscal super easy money to marginally harder money, and definitely tighter fiscal. And yeah, that's all of a sudden, maybe all the very expensive stuff starts to struggle. I think that's where we are.
Erik: Joining me now is Jesse Felder, founder of The Felder Report and Jesse has prepared a terrific slide deck to accompany today's interview. Registered users will find the download link in your research roundup email. If you don't have a research roundup email, that means you're not yet registered at macrovoices.com. Just go to the homepage macrovoices.com, click the red button that says looking for the downloads. Jesse, it's great to have you back on the show. I know you've been listening in recent weeks to our other guests and the raging inflation-deflation debate that we've been having. What do you make of all this and where do you stand on the battle?
Jesse: Well Erik, thanks for having me back on the show. I have to first applaud you for putting together just this fantastic resource. Your last few episodes that I've listened to just provide a terrific balance of you know, regarding the inflation debate. It's been a terrific panel and I've gotten a lot out of it. But I do come down on the side of inflation in terms of that debate. And I think it's more interesting to discuss the secular inflationary forces rather than cyclical. I don't think they're, you know, after the latest readings we've seen, you know, for CPI and PPI today that anybody's debating about, you know, cyclical inflation at this point. But to me, you know, when Rosie brought up the three Ds of disinflation. That was something that was very fascinating to me, because I see those same dynamics as having shifted in the last 10 years from disinflationary forces to inflationary forces.
If you just start with demographics, I think the IMF put out a thing, a report, you know, three, four years ago pointing out that demographics in the United States actually globally, everywhere but Japan, you know, we're seeing these increasing age dependency ratios of you know, more retirees than working population, and that is an inflationary dynamic. I think something, one of the things that people don't really appreciate, is that in the wake of the financial crisis, I think we had a lot of baby boomers who were forced to stay in the workforce. They weren't able to retire because their retirement accounts took a hit and so they had to stay in the workforce longer than they otherwise would have kind of artificially increasing the supply of labor for a period of time acting as a disinflationary force. But what we saw with the pandemic was a total reversal of that, where all those folks said, hey, look, my retirement accounts now 300%, whatever front, you know, in the last decade, and I can now afford to retire, and I don't want to stay at work and get sick. So all those folks retired, and then you had, you know, even further to that degree, a bunch of people who maybe were going to retire 5-10 years from now, who thought you know, what, I've just done so well, with my retirement accounts. Why don't I retire early. And so we're seeing this dramatic decline, I think in the working population relative to the non-working and that is an inflationary force, putting pressure on wages. And I think that's one of the factors we're seeing right now that's a secular push. That's, you know, in place, but it's been exacerbated by the pandemic.
You know, when you talk about debt as another disinflationary force. I think that's true for folks like me, and you Erik, who, you know, if we get too indebted, we have to cut back on our spending and hurts demand. But that's true for everybody but the federal government who can, you know, print money to monetize the debt. I think that's another thing we've seen as part of the pandemic is this, you know, when debt-to-GDP, you know, gets to where it is, it's typically problematic for countries that can't, you know, get away with money printing. The United States government has been getting away with it for the past, you know, a couple years now. And obviously, that's not disinflationary at all to be issuing $4 or $5 trillion dollars of new debt and having the Fed you know, buy it all up is has not been disinflationary, it's been absolutely inflationary.
And I think the final thing that Rosie brought up, and I'm a big fan of his work. He talks about disruptive technology. And I think that's been true for a long time, too. But if you look at what's happened in the economy, in the last 10 years, we've seen a concentration of economic power in fewer and fewer companies. You know, who's disrupting apple today, who's disrupting Facebook today. Facebook and Google are maybe a good example of companies who have their finger on the pulse of who in social media is going to potentially disrupt Facebook? Well it's Instagram then we will just by them. And you know, same thing with Google. And so they've been able to make 1000s and 1000s of acquisitions to essentially shore up their position, their monopoly or duopoly positions that have really prevented from disruptive tech from exerting a disinflationary impact in recent years. And I would say, Amazon is probably another example of this. Who's disrupting Amazon? Nobody. In the pandemic, we saw that you know, sales already off of a huge base, go up 40% or something insane, you know, we've never really seen a company of that size, see that type of growth. And they just have such a strong position in the market that they can't be disrupted. I think we're seeing this in wages, too, with Amazon, there was a good article in the Wall Street Journal recently, that pointed out that, you know, with Amazon paying $18 starting wage in its warehouses. It's putting pressure on every other employer across the country to raise wages. And they're telling, you know, all these small towns, they were telling, you know, the Wall Street Journal, and whoever else cares to ask it, we're paying 12, 13, 14, 15 bucks an hour and we have to go to 18 just to compete with Amazon and try and get workers. And so this is actually feeding through into prices for the first time, since the creation of the internet. We're seeing internet prices increase. They've been in decline for a long period of time as as technology was a disruptive force. But it hasn't been so we're seeing, you know, inflation even in internet prices.
So to me, that also just points to the fact that disruptive technology is no longer that factor that it once was. I think there's one final D and that's deglobalization. That's also exerting an inflationary impact now. I think we saw global trade peak in 2007. It took a hit during the financial crisis and has been in decline ever since. And obviously, Trump's trade war was an important, you know, chapter in that saga of deglobalization. And the pandemic has been another one where I think a lot of countries, especially the US have noticed that this just in time manufacturing is potentially a national security issue. And that we need to go from just in time to just in case so that we don't have the shortages of really crucially important items to the economy and to our healthcare system and whatnot that we've had in recent years. So I look at these three days, and I call them the four Ds of inflation. And I think they're all pointing towards higher inflationary impulses in the years ahead.
Erik: Joining me now is Francesco Filia, founder of Fasanara Capital. Francesco has prepared a terrific slide deck for today's interview. Registered users will find the download link in your research roundup email. If you don't have a research roundup email, it means you're not yet registered at macrovoices.com. Just go to our homepage, macrovoices.com, click on the red button that says looking for the downloads.
Francesco, it's great to have you back on the show. It's been way too long, you know, something I've been thinking a lot about in the last year is DeFi, decentralized finance. It's going to completely totally change everything. And frankly, I think most people in the industry don't understand that yet. But exactly what form it's going to take. Who's going to be in charge and how we're going to sort out this intersection between new technology and an industry that's slow to change is going to be really interesting to watch. You've got a whole slide deck that talks about first the existing conditions in the economy and leads into where we're headed with DeFi. So I'm really excited about this one. Let's go ahead and dive into it.
Francesco: Thank you, Erik and thank you for the invite. It is a pleasure to be here and happy to start with the current situation in markets. And obviously here it's a little bit of a broken record from myself when it's about the expensiveness of both bonds and equities at the same time. And we've been researching this for several years now. We have spotted the conditions of a bubble, bubble financial markets in both bonds and equities for you know, several years now. And definitely we have been wrong in predicting the direction of travel because markets kept rising over this period. But still, you know, like our main point of contention is that evaluations make no sense. And it is becoming ultra hard for institutional investors, which apply rational investing to be involved with the public bonds and equities at current levels of valuations. And, you know, one word on bonds and one word on equities. Bonds since 2016 has been trading at close to zero interest rates if not deeply negative, and they've stopped, you know, functioning effectively. And our idea is that, as an asset class, it has been retired, and it may be considered the fund, you know, it has stopped to be sensitive to levels of inflations and level of economic activities since several years now.
And it's funny that we lament that rates may be rising at this point in time in the markets, when we are still talking about negative rates in most western market economies. Even in the US, we're talking about a 10-year rate at 1.5% and the 30 year rate below 2%. And if you ask me, these levels are very close to zero, and they are closer to zero than anywhere else. And then you know, the problem with this is that, you know bonds, they have a function within portfolios, which is to counterbalance the allocation to equities to save the day at times in which the equity have a very bad day. And they can no longer fulfill that function because they're just no longer there. A bond is a coupon bearing instrument, whose coupon are currently zero, and therefore is a zero coupon bond. But typically, a zero coupon bond is one that you buy below par, and you enjoy the pull to par. In this case, you buy it at par or sometimes above par. So you're looking at a bond that within your portfolio and within your wallet. But effectively, there is no bond there, what you're looking at is a quasi cash or quasi bond, but it's definitely a new instrument that you're not accustomed to. And there is nothing there.
So within all those balanced portfolios, where we have a 40 to 60% allocation to bonds then we can claim that the 40 to 60% of allocation really does not exist. Now there is a and we may claim that there is no reversion to mean either. Now there is a lot of talk about inflation, right. And inflation has been printing out very widely lately to 6% and over 6%. And obviously there is the fear of rising interest rates. But the problem that we're facing is that if our theory is correct, bonds will not react to that. And the rates will not move higher in any meaningful fashion. If it is true that the bond as an instrument has been retired and no longer fulfill the function of what it used to be. And obviously I'm making a big statement, I'm exaggerating, you know, to exaggerate the argument to make it visible. But basically my idea is that the so called the Lazarus trader, the trader mean reversion where rates go back higher may not be seen anytime soon, as a reflection of the fact that the linkage between bonds as an asset class and fundamentals is broken in a very fundamental way. And this is a problem. This is a problem because you cannot rely on bonds anymore for asset allocation.
And then obviously equities right, so a word on equities. Equities are also very expensive as known to most people after the pandemic, they went into more extravagant levels. We have seen the technology equity complex reaching 10 trillion in market valuation alone. If you include just FAANG stocks, and the like we have seen indices this year, rallying to new highs. The NASDAQ is 20% up over 20% year to date. But actually, when you take out the top five stocks within the NASDAQ, it's actually down 20%. So what you see is not only extreme valuations, but also extreme concentration. And so like, and there are multiple ratios, and I don't want to go into multiple ratios here during the call, but basically, like there are multiple data points that they showed that the market is as expensive as it has ever been compared to GDP, for example, i tis twice as expensive as during dotcom bubble. Obviously, if you're an institutional locator, it's very hard to cope with a market like this and not be in fear of fast and violent drawdowns.
And so like, you know, my point is that the job of an allocator looking at traditional asset classes like equity and bonds has become extremely difficult to navigate these markets from now on. And to be able to, you know, to have faith in markets at these levels. You have bonds that they cannot save the day, equities goes down, you have equities that are ultra expensive and the risk of a drawdown is extreme and you are left a little bit between a rock and a hard place. Now after this big rally in levels, we are facing a January 2022 which may be like I'm not trying to predict here a big crash. I think that there is something more interesting to do in the current market than just predicting the next three months. But if we look at the next three months is that there is a possibility that the January 2022 looks a little bit like one of the previous January's that we've been through. January 2000, January 2008, January 2018 and January 2020. And we know of those January's that they proceeded faster, faster drawdown so dotcom was followed by the dotcom implosion and the 2008 is obviously linked to the Lehman moment. 2018 saw a faster down especially on the February VIX complex implosion, and obviously January 2020 was then followed by a very heavy March following the lockdown as a response to the pandemic.
And now again, we may be seeing a blow off top followed by some sort of a drawdown. But in the trigger tweet, it's not even that relevant. It could be interest rates following inflation, I don't think so. Or it could be something else like a market falling under its own weight. But we already know what is the reaction function of policy makers. And we already know that if there is a fallout in prices, it would be followed by an even more forceful monetary printing and market intervention. And it's probably going to be recouped. And the probably another buy the dip is going to show up and the market is going to pick up from those levels. What we have learned over the past over 10 years is that markets have lost their function of allocating to the real economy, because they've completely been confined into a space in which they are self referencing. So whenever there is some fallout, there is an immediate intervention by policymakers and the market has been unable to develop the anti corpse against those fallout to recover on its own merit.
And then there is one slide in this big deck that is on page 11 that tries to draw the linkage between these different market phases and the real DNA of the market as we see it. And it goes from depicting actually like I think that the big disease in the market is a one of short termism and it can be seen in the markets but also in societies at large. And the way I look at it is that, you know, the full lockdown after the pandemic, but also quantitative easing, also talks of modern monetary theory and even populism. They're kind of symptoms of the same underlying theme and the theme is a short termism. It's basically an attitude to swap, you know, short term solutions for long term problems is an attitude of not being able to endure like duress in markets, as much as in society. And therefore to always look for the easy solution that is able to trigger the positive very short term effect, but always at the expenses of a longer term, a bigger problem.
These fundamental disease and these fundamental medical condition, let's say of the markets but those of society at large has led into an investment community which has been, which has gone through a retailification, I call it so everybody's playing as a retail. Both retail and institutional investors trying to survive to some extent or fund management. And so like in retail, we know the new generation of Robinhood to the new generation of reddit has driven investment investments, which is kind of less driven by fundamentals and more by momentum and by emotions to some extent as well. But you know, what is more interesting to analyze is the institutional side of things. The institutionalized asset management world, which in an in an attempt to survive, as endorsed some of the attributes and attitudes of the retail community and therefore has been going from being an Hedge Fund and investing into long only, even when you are a long short equity of a very big beta correlation and a very big net exposure. And you know, very few are really shorting stocks these days in any successful fashion at least. And then, you know, in the buy, the dip mentality has completely spread around and is affecting most market participants.
Following this retailification, you have the Bitcoinization of markets. And what I mean by that is basically, in a place where public markets have become video gaming, and where effectively like there is no reference to the real economy anymore. The reference to the real economy and to fundamentals is lost. And as a consequence of that the main function of markets has been lost as well, which is allocating resources to the real economy to support both consumers and corporations. And this is reflected also in the current levels of interest rates and in the current level of equities.
The good story is that there is an emerging trend which substitutes these, let's say, all asset classes, and that at least tries to produce an alternative to them, although not in total, not in full, but for some partial in some partial ways. And that the alternative is, you know, ways to access the real economy in a most in a more decentralized fashion. And I'm not talking only about decentralized finance in the ways of cryptocurrencies and blockchain. I'm also talking about platforms and the platform economy, the so called the India utilize another audible term, which is a platformification of credit, and the economy. And this represents, in my personal opinion, the new capital markets, that they can offer an alternative to institutional investors, but also to, in general, to market participants. And when I talk about platforms, I mean, FinTech, the FinTech trend, in all these new ways to reach out to the real economy to originate loans and receivables to both consumers and corporations. And that they can form an alternative to bonds at a time in which bonds have disappeared and they are trading at zero.
Erik: Joining me now is MI2 Partners founder Julian Brigden. Julian prepared a terrific slide deck for today's interview, registered users will find the download link in your research roundup email. If you don't have a research roundup email, it means you're not yet registered at macro voices.com. Just go to our homepage macrovoices.com Click the red button that says looking for the downloads.
Julian, it's great to have you back on the show. It's been way too long. The inflation-deflation debate rages on. Just last week, I had David Rosenberg on telling us that the three Ds those being debt, demographics, and disruptive technology assure a disinflationary backdrop for years to come. And that this inflation will be transitory, what say you and feel free to reference your charts as we get into it.
Julian: Well, here’s the thing - look, I'm not going to answer that myself. I'm going to lean on the world's oldest central bank, the Bank of England, and they wrote a piece which we picked up on and we discussed with our clients the other week, and probably other month, and we said, the title of the piece was, it's always transitory, a 700 year history, Because I think there's a real temptation for us to get lost in a very short term perspective. And by short term, I mean, you know, 20-30 years, right, that's our kind of our frame of reference. I mean, even if you're an old geek like me, right? He's been in markets, you know, for 30 odd years. Right? I mean, it's very easy to just get my optically focused on those last 30 years and lose the longer frame of reference. And what the Bank of England discovered, was that basically, when they look at the risk free asset, and they look at returns and inflation. That basically since the mid 1460s, we've been in a disinflationary world, David, so I like to kind of use that word, as opposed to deflation.
And, you know, the drivers are pretty consistent, right? I mean, productivity, you know, demographics, etc, etc. And I think there's always this tendency to get very, very excited about developments, you know, that are sort of today, right? To think that the technology we have today is just so utterly transformative. And, you know, I was reading this piece by Barry Ritholtz, who's the sort of equity guy, and he's very, very good. And he wrote this thing and said, sort of, you know, it's all really changed since the mid 80s. And I was like, really, you know, if you actually look at productivity since the mid 80s, it's actually not the case. Right? Actually, arguably it's been lower than it than it was in the 60s in the 70s. And also, we shouldn't forget, you know, the world quite transformative events historically. I mean, even in a relatively short period of history. I mean, you know, penicillin, the aeroplane, right? The internal combustion engine, the light bulb, right? I mean, all these things have been bloody transformative, right? So just to assume that, that Salesforce or cloud computing, all these things are just so much greater. You know, is that really, right?
So what the Bank of England did was, they look at all these trends. And they say basically, even though we've been in this disinflationary period, since the mid 1400s, they've actually been eight periods. And this would be the ninth, where we've had extended what they call real rate depressions, so incredibly low levels of real rates. Now, they come up with some reasons as for that, but what's interesting is what causes those 10. And, and the point is, what causes them to end is essentially two things typically. Firstly, some sort of geopolitical shock. And then secondly, and this is quite remarkable, particularly some sort of pandemic some sort of big shock. And you can understand why I mean, you basically rejig the world, particularly after a pandemic, you actually reset expectations of workers, you've obviously, certainly in cases, things like the Black Death, right? You've wiped a lot of your workers out, right? So, you know, wages tends to rise. But there's all these sorts of factors that are remarkably consistent over this hundreds of year period. And I think we tick that box now. Ultimately, even these bouts of inflation proved to be transitory when we go back to that long term, disinflationary trend. So I think the disinflationists are ultimately going to be right. But let's say this bout is typical last seven years, right? And we're two years into it, maybe. Do you really want to be long fixed income for the next five years because you're gonna get hosed? I mean that's a life, that's a career. Right?
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