Transcripts
Erik: Joining me next on the program is Artemis Capital founder, Chris Cole. Chris is an expert on volatility in equity markets. We’re going to focus the interview primarily on that subject.
Chris has written an excellent article called “Volatility and the Alchemy of Risk,” which is available in the public domain. But, for your convenience, we’ve also linked it in your Research Roundup email.
Also linked in your Research Roundup email is a slide presentation (which is not public domain), and Artemis has asked us to remind you to please observe their request on the first page that this is intended only for MacroVoices listeners. Please don’t post it on the internet, forward it, or otherwise redistribute it.
Chris, in the beginning of the presentation you start with this ouroboros, I believe it’s called, which is the symbol of the snake eating itself. Tell us why you start the presentation with that particular graphic and how it relates to the market.
Chris: The ouroboros is a Greek word meaning “tail devour,” and this is one of the oldest symbols in civilization. It essentially shows a snake consuming its own body in perfect symmetry. This is actually based on a real phenomenon. In nature, when a snake becomes overheated and is unable to regulate its body temperature, it will have a spike in metabolism leading to a state of mania.
And in this state of mania, the snake will look at its own tail and see it as prey. And the snake will begin to self-cannibalize itself until it dies. To me, the ouroboros as a symbol is a metaphor for the financial alchemy driving this modern bull market.
Volatility across asset classes is at multi-generational lows. But there is now a dangerous feedback loop that exists between ultra-low interest rates, data expansion, central bank stimulus, and asset volatility. And then financial engineering that’s allocating risk based on that volatility.
This is leading into a self-reflexive loop where lower volatility feeds into lower vol. But, in the event that we have the wrong type of shock to the system, I believe this can reverse violently where higher volatility then reinforces higher vol.
This is a much bigger risk in today’s market environment, and it’s one that is not being correctly discounted.
Erik: Joining me next on the program is Mark Cudmore, who is a macro strategist with Bloomberg and runs Bloomberg’s live blogging service.
Mark, thanks so much for joining us, I know you’ve got a really busy schedule.
I want to start with the US dollar because, obviously, everything is so dependent on it. But, particularly, in the last week we finally saw this resolution of a new lower low, below the 91-prior print on the dollar index. Is this just a little trade, or are we looking at a major secular trend?
I think you’ve actually been bearish on the dollar for quite a long time before it suddenly became in vogue recently. Give us a little bit of history of why you’ve had that view and what you see coming from here.
Mark: Thanks. I think this year it’s kind of a mirror image of 12 months ago when I really became very structurally bearish on the dollar. Just to give some context to why that change happened then, first of all I think the market was extremely bulled up. And that’s the opposite of this year where everyone’s quite negative.
But they were also very bullish on a slightly suspect framework. And there was this whole narrative that there was going to be this global reflation trade led by the US. And, actually, what happened in 2017 is the US was very much middle of the pack in terms of growth amongst the G10 economies. It wasn’t one of the leaders at all.
And also there was the fact that the US 12 months ago still had very negative real yields. Most of them were at the curve. Yet there was this narrative that, because hikes were coming, they were going to have this real yield support. But that just wasn’t there.
Suddenly, now we’ve had quite a bit of a change in the US. So this year, 2018, based on consensus forecasts, not anything out of the ordinary, it is expected that the US will be one of the fastest-growing developed market economies. Amongst the G10 it will only be beaten by Australia and New Zealand, based on consensus forecasts.
So, suddenly, the US is leading developed market growth this year. And yet people are much more bearish.
On top of that, we’ve had like a 70 basis point climb in two-year yields in the last four months. And so, suddenly, that massive negative real yield you had in the US has kind of disappeared. So both the rates argument and the growth argument are much more supportive of the dollar this year than 12 months ago. And yet the kind of positioning and sentiment have switched massively.
Now I should say that this is kind of making me feel that the dollar is vulnerable to probably a sustainable bounce that could last several weeks, several months. But I think overall, structurally, in the much more longer term, I do kind of stick by my call from January of last year that the dollar is in a multi-year down trend.
And the background picture here is that the dollar still makes up roughly 63.5% of global reserves. And yet the US economy is a slowly shrinking part of the global economy. It’s currently about 24.5%.
Now, the US is the world’s reserve currency. It’s always going to retain a premium in terms of large financial markets. But that premium is going to shrink more and more. So the fact that it’s still 63.5% of reserves seems too high.
So I think, structurally, the world is still long dollars and will slowly start trimming that position. And that’s going to be a headwind for the dollar. But for the next couple of months I think people are maybe over their skis and being bearish, and I think there’s a chance of a bounce. That’s the dynamic I’m looking at, at the moment.
Erik: Joining me next on the program is Josh Steiner who heads up the entire financials research department at Hedgeye. Part of that, of course, is housing sector research, and that’s what we’re going to focus on today. Patrick has been looking for a guest for some time who could really talk intelligently to the various different housing bubbles that we see forming around the world.
And, Josh, I’ve got to hand it to you. I love interviewing Hedgeye guys, because you always come with fantastic slide decks. Folks, you’re not going to want to miss this download. If you are a registered user at macrovoices.com, the download link is in your Research Roundup email. If you’re not yet registered, just go to macrovoices.com and look for the link to get the downloads, next to Josh’s picture on our home page.
Josh, before we dive into your excellent slide deck here, I want to start with a really high-level picture, which is what is the macroeconomic thesis of why is it that it seems like these resource-rich countries like Canada and Australia are very prone to having housing bubbles. And that these bubbles seem to just keep blowing up for a long time.
What’s going on here with the big picture?
Josh: I think it’s a good question to start with, but I would actually disagree slightly with the premise. I think most people look at countries like Canada and Australia and tend to think of them as being resource-driven economies. And I think up until about 10–15 years ago that was definitely the case.
But our work has shown that really in the last ten plus years, especially in the last five years, these are largely FIRE-driven economies. We’ve looked at the contribution to both the economy at large – the share of growth in the economy from financing, insurance, real estate, construction, across both Australia and Canada. And we’ve sort of likened them to one-cylinder engines where, really, the bulk of growth is being derived from appreciation in collective property values, the financing of it, the insuring of it, the construction of it, and the wealth effect created thereby.
So I think, definitely, looking back through time, there’s certainly a resource-driven component, and that’s still there. But when you really dissect the source of new growth for these countries over the last half decade or decade, it is pretty surprising just how much of it has come from the property markets.
Hosted by Erik Townsend and starring Jeffrey Snider, Mark Yusko and Luke Gromen
January 4, 2018
My next question is: What signposts we should be monitoring along the way to gauge how this dollar end game is progressing. To illustrate my point, I’ll start with a couple of my own.
First one, I will be watching the open interest when this new yuan-denominated crude oil contract starts trading. To my thinking, if this thing gets traction, and a year from now we’re talking about how the Brent contract lost a considerable part of its market share to the new yuan contract for trading oil, okay, that tells me this thing is on like Donkey Kong. It’s accelerating and it’s time to really think about the end is nigh for the dollar.
On the other hand, if this turns out to just be a purely symbolic gesture, where we say, okay, theoretically, it’s possible to trade oil in yuan, but nobody really ever does. Okay, that tells me that we’re still in the buildup phase. It’s an important symbolic gesture. But it’s just a symbolic gesture.
Another major signpost that I’m going to be watching for is a decoupling of the usual relationship between interest rate differentials and the dollar index. In other words, if Treasury yields are going up at the same time that the dollar index is going down, things are getting serious. Because that means, as long as there’s rising Treasury yields and that continues to attract international capital flows into the US, the system is basically working the way it used to.
If it breaks down to where rising relative – relative to other sovereigns around the world – the US is paying better Treasury yields than anybody else, and that’s not attracting international capital flows into the US Treasuries and into the dollar, that tells me the end game is on.
Now those are just two examples.
What are the signposts that you guys think we should be watching for to gauge how this story is unfolding? And, particularly, what signposts tell us that this thing is really on now, it’s not just a buildup, it’s really happening?
Luke, why don’t we start with yours, because I think you’ve got quite a bit of research on this point.
Hosted by Erik Townsend and starring Jeffrey Snider, Mark Yusko and Luke Gromen
December 30, 2017
Luke: If you were moving in that direction you’d expect to see things like – you would need the new reserve asset, you would need that to move to the right people, right? A big problem a lot of gold investors make – gold bugs, however you want to call it – is everyone wants to think of gold as actually like a market asset. It is not. It is a political asset. And so –
Jeff: And it’s concentrated in very few hands. It’s not distributed widely.
Luke: Exactly, right? So if you were going to resolve this issue the way I described, the way the World Bank hinted at, the way the IMF talked about, you would expect to start to see things like gold flowing to those nations. If that’s going to be a new reserve asset, then the United States needs to have a lot. The Europeans need to have a lot – and when I say the Europeans, the Germans need to have a lot.
And what have the Germans been doing? They’ve been asking for their gold back, haven’t they? You would need the Chinese to have a whole lot. And how do you do that? One way to do it is you make sure the price of gold doesn’t move in dollars, because Americans don’t buy something that’s not rising – it’s cultural. Chinese buy more. Indians buy more when it falls. Americans, they won’t buy something that’s not moving in price.
In addition to these very powerful institutions, Western institutions advocating for these things, you’re seeing actual movement since they advocated for them of things that would support that. Now, again, is gold it? Is it gold going into the SDR? Is it SDRs getting revalued much higher and that filters through to gold? I don’t know. But it has to be a neutral settlement asset to fix the system.
And – to your point, Jeff, of we don’t know how big it is – that just tells you how big it’s eventually got to be. Like, you know, what we’ve been saying is gold is the credit default swap trade of this cycle.
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