Erik: Joining me now is Charlie McElligott who heads up the cross-asset Macro Strategy Group at Nomura. Charlie and his team assembled a short slide deck to accompany today's interview. Listeners will find the download link in your research roundup email. If you don't have a research roundup email, just go to our homepage macrovoices.com, look for the red button that says looking for the downloads. We'll be focusing most of today's interview on the first two charts, but I recommend perusing the remainder of the short deck at your convenience.
Charlie, it's great to have you back on the show. It's been too long, I want to start by just going way back out high level, big picture here. We've got this fed tightening cycle. A lot of people are saying hey, the Fed has no way to get out of this at this point. The markets gonna crash. It's just got to be you know 20, 30, 40% down before the Fed put will kick in and the Fed will change its stance. Is that the right way to think about this and what does history teach us about what happens in these tightening cycles?
Charlie: Well, it's certainly good to be back and speak with you guys. It has been too long, fully agreed. Look, inflation has been this macro regime change catalyst. Inflation, as I've said, I think prior meetings with you folks years ago, is the driver of cross-asset volatility. Simply on account of what it does with regards to a forced capitulation from global central bank's away from the persistent easy money policy, large scale asset purchases dynamic of the past, you know, decade plus since the financial crisis. And what that led to and why the last year, you know, last half year to a year has been so tumultuous is that almost all legacy cross-asset leadership and positioning and performance has been tied to that dynamic where it was all about Goldilocks economic environment, not too hot, not too cold with growth and inflation. And that inflation skepticism or cynicism then allowed for outperformance of duration sensitive assets and stuff that's sensitive to interest rates.
And investors parked in long duration assets. They parked in stuff from the equity side that could grow profits in earnings without a hot cycle. And in you know, the treasuries or rates side that meant long treasuries, bull flattening and curves, negative real yields. So, which is a very highly speculative environment which meant persistently low volatility and long gamma, short skew, all of these dynamics really crowded us into trades that were proxies of the same thing. Long secular growth, expensive, high multiple equities are equivalent to long, you know 10 year or 30 year Treasury type of dynamic and ultimately created to the fact that US is this secular growth engine versus rest of the world being very cyclical, very value. We created this US exceptionalism trade, and that shift over the past, you know two years frankly right that from the COVID double whammy of the monetary policy and the fiscal policy response, and then the exit from that period, really supercharged and unanchored inflation and that's where we are right now.
Erik: Joining me now is Bianco Research founder, Jim Bianco. Jim, it is great to get you back on the program. It's been so long, I want to start with the subject that I know is near and dear to your heart and mind, which is okay, this whole big picture of inflation and the credit market and what's going on with fixed income. And here we are, you know 2% on the 10 year yield. Some people say this is the beginning of the end. The bond markets about to crash. Alex Gurevich told us last week, no, no, no it's actually time to buy bonds not to sell bonds. And there's something kind of fascinating to me, which is I've seen this narrative floating around where people are saying, hey, wait a minute, if you look at what's going on with the stock market's reaction to inflation, you kind of think that inflation is not transitory and about to run away. But if you look at the credit markets, reaction to inflation, then it looks like the credit market is not really persuaded that this is going to be non transitory, secular inflation. Is that right? And a lot of people think the credit markets smarter than the stock market, what's going on here?
Jim: Yeah, so a couple of things. Let me start at the beginning of your question about inflation. So obviously, everybody knows that we've got a seven and a half percent inflation rate, and it's a 40 year high. We also know from the inflation statistics, given where we saw the numbers in March, April, May, June of last year, .6, .9., .6. That unless we continue to put up point .6-.9, we'll probably have a peak in the year over year numbers. Now, that's not a sign that inflation is over. Because I think the story in the second half of the year, is going to be that how fast does inflation descend? And count me in the camp that is not very fast, and that we're going to still wind up with a very elevated number.
Why do we have inflation? I might give you a little different answer as to why we're going to have inflation. Every generation has a financial event. This generations financial event was that we sent everybody home for a year. Last generations was the great financial crisis, the one before that was the tech bust of 2000. Because we send everybody home for a year, I think what we're not appreciating is, a lot of secular changes have occurred in work patterns, purchase patterns, and in the general economy. Now, do not mistake that for saying that it's dystopian, it doesn't have to be dystopian, and I don't think it is necessarily bad. And what I mean by that is, we went home for a year, we showed work from home as a viable alternative, a remote work is a viable alternative. And for a lot of people, it's preferred. And we're having a very difficult time getting people to go back to the office.
In fact, their stories, even this week, HSBC being the latest, that the raising banker pay a lot, because one of the things that New York City banks want is they want you in the office five or six days a week, 10 hours a day. So they have to bribe you to do that. Because a lot of people don't want to do that anymore. And because we working at home, our consumption patterns have changed a lot. We need more stuff, as opposed to services, cuz we're now remote. And that is leading to a general confusion among shippers and manufacturers. What am I supposed to make? What am I supposed to ship? I have this schedule of what it used to be in 2019. But that doesn't seem to work anymore. Obviously, the 2020-21 schedules were lockdown schedules of what people wanted. I don't assume that's going to work. I don't know what they want. So I order everything. And that's why we have this perpetual supply chain problem as well too.
And the reason I bring that up is because it seems like a lot of economists like to say as far as the inflation problem is a supply chain problem. Yes, that's true. So therefore, do nothing, just stand there and wait, and the supply chain will resolve itself. No, it won't. It won't until we have an introspection of what is the post-pandemic economy look like? And I think the answer is it doesn't look like 2019. And so the sooner we understand that, the better we can go about starting to understand what this new economy is. In the meantime, inflation is going to stay elevated. There's a friction in the economy, a mismatch. There's a friction with supply. And we've also overstimulated the economy with too much stimulus checks and too much fiscal stimulus as well, too. So that's why I think that the inflation rate is going to stay up.
Erik: Joining me now is HonTe Investments, founder and chief investment officer, Alex Gurevich. Alex has a brand new book out and no surprise considering it's Alex, it shot straight up. Right now at number six on the Wall Street Journal's Best Seller list. So you're not gonna want to miss this new book, which is called "The Trades of March 2020 - A Shield Against Uncertainty." We'll talk about the book a little bit later on in the interview.
But Alex, it's great to have you back. It's been too long as you know, because I know you listen to the show yourself frequently. I've been asking almost everybody to talk to me about inflation and its relationship to the bond market and interest rates. And as we're speaking this week, I don't know if we hit 2% yet, but I was looking at one spot 98 on the 10-year yield earlier this morning. So if we're not already there, we're getting awfully close. What's going on? Is the bond bull market over does this mean that we're seeing the beginning of secular inflation that's going to collapse the bond market or is this something completely different?
Alex: Well, first of all, it is good to be back. I'm thankful to you for having me over at the podcast again. It's always fun and good conversation. Now, of course, this is the topic du jour. The dramatic shift in central bank policies that occurred over the last few months which led to dramatic raising an expectation of short term interest rates in most developed market countries. It also, as you mentioned, even longer dated yields are beginning to back a little bit even though most of the curve trading was flattening. And I think that is very important to notice over the last few months. As for my view on the bond bull market. When they came out of 2020, I wrote a lot about the enormous amount of money printing which was at that time combined with the Fed focusing on just US central bank policy, combined with the Fed being very adamant that they will wait, that they will let inflation run hot in this post COVID, post pandemic transition period and see what happens. And that kind of created some concerns for me that the yield curve might be much steeper and that the yields could go higher. Even though I was not necessarily thinking that that was going to happen but I had a concern. I would say that this concern is alleviated. I'm no longer concerned about inflation and I'm no longer concerned about end of the bond bull market because historical pattern. The pattern of how markets have traded is telling me otherwise.
Erik: Joining me now is Ronnie Stoeferle, managing partner and fund manager for Incrementum. He prepared a terrific slide deck for us. Listeners, you'll find the download link in your research roundup email. Now if you don't have a research roundup email, it means you haven't registered yet at macrovoices.com. Just go to the homepage at macrovoices.com. Look for the red button that says looking for the downloads. Ronnie, it's great to have you back on the show. I'm looking forward to diving into this precious metals focused slide deck. But boy, what a week in in the markets. Why don't we start with the big picture? What happened? What's going on? Why the sudden return of volatility and how do you see this market environment?
Ronald: Hi, Erik. First of all, I don't know if it's if it's too late. But anyway, Happy New Year to you and all your listeners. Well, it seems that that volatility is finally back. I mean, we all knew that the market was pretty expensive. And you know, we went into the new year with the largest forward P/E discount for emerging markets relative to develop markets ever. We were trading at a 40 times Cape multiple, which is a I think Dave Rosenberg wrote it. That's a three standard deviation event that we lost had in November 2000. And we all know that the next year so 2001, the market was down 18% to everyone's surprise. And it's you know, it's not only the P/E ratio, it's also, you know, the S&Ps price to sales ratio. It is at three times! It's a price to tangible book ratio at 15 times. So the market was very, very expensive. And I think that the market participants realized after this tremendous year of 2021 where the S&P I think made 17 new all time highs with very very low volatility. It was the lowest realized volatility since 2017.
It realized, first of all that, you know, Jay Powell seems to get really serious and the three to four rate hikes plus tapering plus quantitative tightening is not really something that the market really looks forward to. So this terrible taper, this tapering on steroids. Yeah, I mean, it's something that obviously caused this major and brutal correction. But from my point of view, I'm seeing it fairly relaxed. And first of all, one of the reasons is that there was a great chart that I retweeted yesterday, it's by the guys that 314 research, it shows that if the sell off should continue, the Fed will probably stop hiking before it before it started. So history says that in 71% of all Fed hikes, they have come when the market is within 6% of its 12 month high. So I think the market now is, is already kind of discounting that the three to four rate hikes won't really happen. From my point of view, it will be a one and done. And I think, you know, coming back to the to the equity markets, I think market participants seem to forget that household ownership of equities is now at 45 trillion. That's an all time high. That's actually twice the size of the US economy and way above the historical norm, which I think is 13% or 14%.
So that means that a 20% drawdown in this cycle and you know, 20% corrections are just something normally normal usually. A 20% drawdown in this cycle will feel more like a 60% plunge. So therefore, I think that it's almost impossible for the Federal Reserve to do three or four rate hikes this year. I think they will have to do the U turn pretty soon. And this will be the point in time when they completely lose the rest of their reputation. So I think it's a highly interesting development that we're seeing at the moment. And I think that gold is perfectly reacting to this whole development. It's already kind of sniffing out that the Federal Reserve will have to reverse its course.
Erik: Joining me now is Viktor Shvets, Head of Global and Asia Pacific strategy for Macquarie. Viktor, it's great to have you back on the show. Last time we had you on, the episode was titled, The Inflation-Deflation Pendulum. And at that time, there was still a huge amount of debate, a lot of people thought there was going to be no inflation. And of course, sure enough, we've gone from a situation where everybody questioned whether there was ever going to be any inflation to a lot of people now think it's running away and it's going crazy from here. Is it still a pendulum and where are we in this story?
Viktor: Yes Erik, I still believe we are in the pendulum. I think the last time we spoke and I tend to look more at G5 inflation, which is US, UK, Eurozone, Japan and China, which is much more representative of a global inflation requirement. I think I was arguing that inflation will peak at the very end of 21, early 22 at around 4%. Now, we now have December numbers, and it actually in December was 4.5%. So did we have a much more significant surge? and the answer is yes that particularly applies to US, to a lesser extent the UK. But we did have a much much stronger sort of jump in inflation. The question, however, is why do we have inflation? I usually tell us people, were you really concerned in December 2019 that we're going to run out of people. Were you really concerned in December 2019, that suddenly we will have shortages of goods? Well, the answer is that you did not. And if you think of real global demand, it's only slightly ahead where it was at the peak of December 19. More so in the case of the US less so in other countries. But what actually happened? We had a collapse and recovery. Now that recovery mostly shifted towards goods, depending on the country, the goods demand is about 10 to 20% higher than what it was prior to COVID. So if you think about the trend line, we're about 10-20% higher. But if you look at services demand, it's about 10% lower than it was in the past. So it's not necessarily that we have explosion of demand. But rather we had a significant relocation of demand between goods as well as services. And so as a result, we suddenly start running out of truck drivers, our warehouses are bulging. Suppliers could not properly estimate what demand will be. And so they are underinvested or they go out of business or they were hoarding. And so the result was, to me that most of the inflation we have experienced, it's still the case that demand and supply curve have not moved in tandem or in unison over the last couple of years.
And so the question becomes, as we go forward, do you think that's going to happen, or that's going to get fixed? Now, if you think of most numbers, whether it's New York Fed, a global supply index, whether you look at ISM indexes globally, including US, what you started to see is some easing of pressures. around November-December. It's really picked looks like around October. Now, nobody could argue that if suddenly we have another COVID, or we have another sets of disruptions, it can get worse. But at this stage, it looks like it's starting to ease. So the question to me as we progress through 2022. Yes, G5 inflation was higher. As I said, it's I think it's going to peak around four and a half. I don't think it's going to go much higher. The core inflation is about three, I think it's going up a little bit more in the next couple of months. But beyond that, it really comes down to the fact, can we get demand and supply curves moving relatively in unison? My answer is yes. And I think the last time I spoke on your program, I was saying by the middle of 22, a lot of supply and demand issues should get much easier. And by the end of 22, we're going to get surpluses of goods rather than shortages. The only exception to that will be anything to do with digital economy. In other words, cobalt lithium, rare semiconductors. But most of the other things, I believe we're more likely to be in surplus by the end of 20 to early 23. The other big question mark, is that can you continue stimulating demand, that's when you go to fiscal and monetary policies. And my view remains the same that we picked in the fiscal support around July August of 2021. We've already been coming off for about six months, but that sort of erosion will accelerate as we go through 22 and 23. Pretty much every country wants to control their deficits wants to control their debts.
So if you think of again, G5 economies we peaked at about 11-12% fiscal deficits in 21. That's going to be down to maybe around 6% in 22 and maybe closer to five in 23. Now, that's a biggest fiscal contraction since World War Two. And unless something terrible is going to happen, I think that contraction will be a real. Nobody is going to go for primary surpluses, nobody is going to be doing crazy stuff that we used to do. But nevertheless, fiscal delta will remain very negative. And the same applies to monetary delta. Almost every central bank is now believing that they are behind the curve, which I disagree with. But nevertheless, that's what they feel and so monetary delta will be declining exactly the same time as a fiscal delta. And so without fiscal and monetary support, without really cyclical recovery, the way we had nearly 21 I think both reflation and inflation will start coming off. And so both growth and inflation at the end of 22 will be lower than at an earlier part of the year. Now how far lower? I think G5 will end up with probably around 2%, down from 4.5%. Even more inflationary countries like US and UK, probably will have inflation at least 300-400 basis points lower.
Now, how can we go wrong in this thesis? Well, a couple of things can go wrong. Number one, supply and demand curve don't move together. There are other disruptions, things happen, and you just can't get ahead of the curve just like we couldn't in 21. The other problem will be if central banks as inflation persist into early 22. Just overdue sayings in other words, they really commit a sequence of policy errors that will very quickly extinguished both growth and inflation at the same time. And the third area is really external factors. We did that we can't control things like geopolitics. Nobody is factoring in right now anything to do with Russia versus Ukraine, or South China Sea or anything else. So don't say a question, Erik, I'm stealing the pendulum. I'm basically arguing that without public sector, without strong fiscal and monetary support, disinflationary forces are stronger than inflationary. And so if you remove those props, inflation will go down, our gross will go down. And the question then becomes really whether you should start stimulating again into 23.