A Massively, Massively, Massively Overvalued Market-Julian Brigden
In this episode, we delve into a comprehensive discussion with Julian Brigden, a renowned global macro strategist. Brigden shares his insights on the current state of the US equity market, the economic implications of the Goldilocks narrative, the potential risks of the bond market, and the future of global economies like the UK, Europe, and Japan. This episode offers a deep-dive into the complexities of global economics and financial markets.
- Brigden’s perspective on the US equity market being massively overvalued compared to the rest of the world
- Discussion on the dominant narrative of the Goldilocks soft landing and its statistical rarity
- Insights into the potential risks and consequences of the Fed’s rate cuts
- Analysis of the resilience of countries like Australia, Canada, and the UK in the face of high rates
- Brigden’s views on the structural bear market in fixed income and its implications
- Discussion on the potential for growth and inflation to run hotter than consensus
- Insights into the political and economic state of Japan and the potential for autonomous growth
- Discussion on the potential trades and market trends to watch out for
This episode provides an in-depth analysis of the current state of global economies and financial markets. Brigden’s insights offer valuable perspectives for anyone interested in understanding the intricacies of global macroeconomics and financial strategies. The audience will gain a deeper understanding of the complexities of global markets and potential future trends.
This is “ReSolve Riffs” – published on YouTube every Friday afternoon to debate the most relevant investment topics of the day, hosted by Adam Butler, Mike Philbrick and Rodrigo Gordillo of ReSolve Global* and Richard Laterman of ReSolve Asset Management.
The US equity market is presently in a state of extreme overvaluation compared to the rest of the world, estimated at four standard deviations. Despite this, the market remains a hotbed for investment, though investors are paying a higher premium. The overvaluation stems from a self-sustaining cycle where the purchase of stocks drives wealth, employment, and consequently, the value of the dollar. This overvaluation, while not sustainable, is unlikely to change unless there’s a significant decline in the dollar’s value or the market bubble bursts. The current market scenario seems to be banking on a Goldilocks soft landing – a state of high real growth, lower inflation, and high levels of employment. However, this is far from the norm; historically, only four out of twelve tightening cycles have resulted in a soft landing. Given the current low unemployment rate of 3.7 percent, the odds of achieving a Goldilocks soft landing are considered lower than one in three. While the overvaluation of the US equity market is a significant concern, other regions are not without their share of problems. The UK faces economic vulnerability due to Brexit, and Japan has its own political turmoil to contend with, both of which can significantly hinder growth. Even Australia, Canada, and the UK, countries that have shown resilience in the face of high rates, may be compelled to cut rates due to their currency shorts. In the same vein, the correlation between bond and equity prices has shifted dramatically since 1998, resulting from the actions of Alan Greenspan who shifted the focus from inflation to deflation. This shift has created a structural change in the market, making predictions and navigation more challenging for investors. In conclusion, the US equity market’s current overvaluation and the hope for a Goldilocks soft landing present significant investment risks. The shift in correlation between bond and equity prices also indicates that the market landscape is unlike what it was before 1998. With the overvaluation unlikely to change unless the dollar value declines or the market bubble bursts, caution and adaptability are key when navigating today’s market. The market’s resilience, despite the potential for a structural bear market in fixed income and ongoing fiscal deficits, is impressive but also makes the prospect of a Goldilocks soft landing more unlikely.
1. US equity market overvaluation
The US equity market is currently experiencing a massive overvaluation compared to the rest of the world. It is estimated to be four standard deviations overvalued. This overvaluation is unlikely to change unless there is a decline in the value of the dollar or if the market bubble bursts. Despite the high valuation, there are still some good companies in the market, although investors are paying a premium for them. The current situation in the US equity market is characterized by a self-reinforcing cycle, where the purchase of stocks drives wealth, employment, Fed rate hikes, and the value of the dollar. This cycle is unlikely to end soon, as there are no signs of a recession or a burst in the bubble. The US equity market’s overvaluation is a reflection of the ongoing dynamics and the belief that the market will continue to perform well. However, this overvaluation is not sustainable in the long term and poses risks to investors. It is important to consider the possibility of a structural inflationary environment, similar to the period before 1998 when the correlation between bond and equity prices was different. In conclusion, the US equity market is currently overvalued, and its high valuation is unlikely to change unless there are significant shifts in the value of the dollar or a burst in the market bubble.
2. The feasibility of a Goldilocks soft landing in the current economic conditions
The dominant narrative of a Goldilocks soft landing is statistically unusual and not the norm. The Fed’s opportunistic disinflationary policy framework and the need for higher unemployment to achieve soft landings in the past, raise doubts about the feasibility of a Goldilocks scenario. The Goldilocks soft landing refers to a scenario of high levels of real growth, lower inflation, and high levels of employment. However, historically, soft landings have been rare, with only four out of twelve tightening cycles resulting in a soft landing. The Fed’s policy framework in the late 1990s, characterized by opportunistic disinflation, allowed for aggressive rate cuts when inflation was falling, leading to a Goldilocks scenario. However, the current economic conditions pose challenges for achieving a Goldilocks soft landing. With unemployment at 3.7 percent, it would be difficult to find enough workers to drive higher real growth. Additionally, the Fed’s focus on slowing down growth and the labor market suggests a need for slower growth rather than a Goldilocks scenario. The current robust growth and low interest rates do not appear to be sufficient to bring about the broad slowdown that the Fed desires. Therefore, the odds of a Goldilocks soft landing are considered to be lower than one in three.
3. Interest rates and economic growth
The interest rates don’t appear to be sufficiently tight to restrain GDP growth and bring about the broad slowdown that the Fed desires. The resilience of countries like Australia, Canada, and the UK in the face of high rates suggests that higher rates may not prompt the expected cuts by central banks. The Fed’s pursuit of a Goldilocks soft landing, characterized by high levels of real growth, lower inflation, and high levels of employment, may not be achievable given the current economic conditions. In previous tightening cycles, soft landings were rare, with only four out of twelve resulting in a successful outcome. Additionally, these soft landings were typically preceded by higher unemployment rates, which is not the case in the current economic climate. The Fed’s focus on slowing down growth and the labor market may be difficult to achieve without finding enough workers to support higher real growth. The bond market’s response to average early earnings taking off and core inflation rising further complicates the situation. The market’s singular focus on inflation while the Fed emphasizes the need for slower growth and a slower labor market raises questions about the sustainability of a Goldilocks scenario. The structural bear market in fixed income and the ongoing fiscal deficits in the 6-8 percent range further contribute to the uncertainty surrounding interest rates and economic growth.
4. Fiscal deficits and political concerns
Fiscal deficits in the 6-8% range and political concerns pose risks to countries like the UK and Japan. Brexit is seen as a structural headwind for the UK, while political messiness in Japan could hinder autonomous growth. The UK’s vulnerability is attributed to Brexit, which is expected to be a long-term challenge for the country. The consumer market in the UK is also considered to be at risk. In Japan, the political situation is described as a mess, which could potentially have negative consequences for the country’s growth. The political instability in Japan is seen as a potential hindrance to autonomous growth. The participants also discuss the resilience of countries like Australia, Canada, and the UK in the face of high interest rates. It is suggested that these countries may be forced to cut rates due to their good currency shorts. The conversation also explores the possibility of a structural bear market in fixed income, with Julian believing that we are currently in such a market. The correlation between bond and equity prices is discussed, with Julian noting that prior to 1998, negative correlation between the two was not observed. He also mentions the potential impact of the dollar and the need for the dynamics of the US equity market to change in order for other trades to become attractive.
5. The shift in correlation between bond and equity prices after 1998
The correlation between bond and equity prices underwent a significant shift after 1998. Prior to this period, there had never been negative correlation between the two. However, the actions of Alan Greenspan, who shifted the focus from inflation to deflation, changed this dynamic. The central banks became more focused on preventing deflation, which had a dramatic and unprecedented effect on the correlation between bond and equity prices. This structural change poses challenges for investors as it makes it difficult to predict market movements. Currently, the US equity market is considered massively overvalued compared to the rest of the world, but this overvaluation is unlikely to change unless there is a decline in the dollar or a burst of the bubble. Additionally, the robust growth in the market contributes to the ongoing self-reinforcing cycle. It is important to note that we are currently in an “everything rally”, which suggests a structurally inflationary environment. This environment resembles the period prior to 1998, where bond and equity prices had a positive correlation. Overall, the shift in the correlation between bond and equity prices after 1998 has created a new landscape for investors, making it crucial to navigate the market with caution and adapt to the challenges posed by this structural change.
6. Resilience of US equity market
The US equity market has shown remarkable resilience despite being massively overvalued compared to the rest of the world. The market’s overvaluation is unlikely to change unless there is a decline in the dollar or a burst of the bubble. However, neither of these scenarios seems likely at the moment. The ongoing self-reinforcing cycle in the US equity market is driven by the purchase of assets, particularly stocks, which supports wealth, employment, Fed rate hikes, the dollar, and the valuation of US stocks for foreign investors. This cycle creates a reflective and Soros-esque dynamic that is difficult to see ending. Janet Yellen, the head of the Federal Reserve, seems to understand the importance of maintaining this cycle and has taken actions to support the market’s stability. The US equity market’s resilience is in contrast to the Chinese equity market, which is experiencing significant challenges and could potentially drop further. Despite the risks and overvaluation, the US equity market continues to perform well, supported by the actions of the Fed and the perception of its stability.
7. Currency and trade opportunities
Currency and trade opportunities are discussed in the conversation. Julian mentions that the US equity market is overvalued compared to the rest of the world and that the dynamics are unlikely to change unless the dollar declines or the bubble bursts. The UK economy is seen as vulnerable due to Brexit, which is considered a structural headwind. He believes that the US equity market is in an ongoing, self-reinforcing cycle that is unlikely to end soon. He also mentions the potential strength of the dollar and the opportunity in currency pairs, like dollar-max. However, the need for cash to fund the US current account deficit makes it challenging to bet big on macro trades. Overall, the discussion highlights the overvaluation of the US equity market, the vulnerability of the UK economy, and the challenges in making macro trades due to global dynamics.
Co-founder & President
Macro Intelligence 2 Partners LLC
Julian Brigden is the Head of Research at Macro Intelligence 2 Partners, a firm he co-founded in 2011. He leads a six-person team of research and market professionals to publish independent macroeconomic research that is both ahead of market consensus and timely. Julian has over 30 years of experience in financial markets including positions in market and policy focused consulting to institutional investors as well as FICC sales.
Julian is a trusted advisor to many top money managers who use MI2 Partners’ research to guide their investment process. He has extensive experience with macro data analysis, broad fixed income, equity market (not individual stocks) and currencies. He is particularly skilled at exploring correlations in the economy and financial markets vital to a vast array of investment decision-makers. As a global macro strategist, Julian’s primary focus is understanding and explaining macroeconomic and policy-related developments to tell clients what is important in markets and what to fade.
Julian spent five years at Medley Global Advisors from 1999 to 2004, a leading macro policy intelligence firm, as the Managing Director of the G7 Client Team, providing timely trading recommendations. From 2004 to 2011, he served as North American Head of Hedge Fund Sales at Crédit Agricole. He has worked in London, Zurich, New York and Vail at UBS, Lehman Brothers, HSBC, Drexel, Credit Suisse, and Salomon Brother in foreign exchange and precious metals.
Throughout his career, he has been featured on many big media outlets such as Bloomberg, CNBC, Fox News Business, Real Vision, the New York Times, Wall Street Journal, and Barron’s. Discussing macro research topics that are driving prices in global bonds, equities, commodities, and currencies.
[00:00:00]Julian Brigden: And the reality of the situation is this is just a hyper bubble, but there are some obviously good companies still left. You’re paying an awful lot for them, and the reality of the situation is, is when I look at the US equity market, I think this is a massively, massively, massively overvalued market, versus the rest of the world, right?
Like four standard deviations overvalued, versus the rest of the world. But those dynamics are unlikely to change until either the dollar declines, and that hurts foreign investors who’ve got their money in the US, and/or the bubble bursts because it just runs out of puff, let’s say. Doesn’t look like that’s the case.
Or we go into recession, and that doesn’t look like the case either. And so for me, you’ve got this sort of ongoing, self-reinforcing, truly reflective type cycle going on in the US equity market where the purchase of the asset, in this case stocks, underpins wealth, underpins employment, underpins Fed rate hike, underpins the dollar, underpins the valuation of US stocks for foreigners. You know, it’s a, it’s a very self-reinforcing, literally reflective in the true Soros-esque sense of the world.
[00:01:40]Adam Butler: Julian Brigden, welcome to ReSolve Riffs. How you doing today, man?
[00:01:47]Julian Brigden: Doing well. Doing well. I’m in Colorado again. So, we actually had some snow. So I’m, you know, a happy camper.
[00:01:56]Adam Butler: Excellent. Let’s, just you and me today with the other degenerates who sometimes join us are off on various productive activities. So, we get to have all the fun.
[00:02:07]Julian Brigden: There you go. Perfect.
[00:02:08]Adam Butler: Yeah. So what has been on your mind? What are you focused on at the moment?
[00:02:14]Julian Brigden: So, you know, the thing that’s really been occupying our thoughts is this sort of dominant, let’s put it like that, narrative of this Goldilocks soft landing. And I think the thing that I struggle with is that, first off, statistically, that’s a very odd, unusual event. It’s not the norm. You know, the norm is, we’ve had 12 tightening cycles since the 60’s. We’ve had eight recessions. We’ve had four arguable soft landings. The problem that I have, and obviously the one that everyone quotes, is this ‘95 sort of one, onwards. Now, it’s fair, I think, to assume that the Fed is pursuing the same sort of policy framework that it did in the late 1990’s, but, and we refer to it, this is opportunistic disinflationary policy framework.
And I think, you know, this is one of the ones that we discussed with you guys when we were last on the show. And this idea of you, that when you have inflation of this sort of magnitude, there are truly two approaches you can take.
The first one is you do what Volcker did. And you, you create deliberate disinflation. So you kind of kill the economy. And the second one is you choke the economy, but not to the point of death. Um, just enough that over time you can grind inflation lower. Now the issue with that is, it did work in 1995. That’s true, and that’s certainly what they are trying to pursue, but there’s a couple of problems with what’s priced into markets based upon that.
The first one is, is if you never killed the economy, if you didn’t strangle, if you didn’t deliberately annihilate it, and Waller actually referred to this in his recent speech, if you don’t break anything, there’s no need for you to immediately start to hack rates, right? Which is what we’re pricing in markets, right?
You can fine tune them so that real rates don’t get too constrictive, but you don’t need to slash them. And that’s why, interestingly, the Fed forecast, so the Fed’s central forecasts are pricing in 75 basis points of cuts. And that’s exactly what Greenspan did between the beginning of 1995 and the end of, and the beginning of 1996.
And these were kind of then fine tuning. And then, what’s remarkable is then he left rates unchanged for the best part of 30 months. I mean really, 30 months. Now, he also got extraordinarily lucky, and I’m not saying this couldn’t happen. And he got the, the going that we saw as we ran up into the dot-com revolution. And maybe, over time, we can get that from AI. But the question is, is it this year? CFPB, is it year after? Because if it isn’t this coming year, then this idea that the Fed is going to be able to, you know, slash rates aggressively because inflation is falling and give you kind of the Goldilocks, and the Goldilocks is accelerated or high, let’s say high levels of real growth, lower inflation and high levels of employment.
And the other problem that we have is that in every other one of those quote/unquote soft landings, or at least, let’s say in three of those quote/unquote and four soft landings, right, out of the 12 tightening cycles, every single one started with higher unemployment.
And this is the problem that we see. If you try and accelerate growth from here, if you go from, you know, earnings growth being down 3 percent to up 11 or 12 next year, which has to be driven by higher real growth in the economy. Okay. The problem is, is where are you going to find the bloody workers to do that with 3.7 percent unemployment, unless you’re willing to take the risk of higher wage growth, which typically feeds straight into core service inflation.
Now, those four soft landings, which I think is where we’re running, and looks most likely, and it looked like a soft landing, I don’t classify it as a soft landing. It looked like a soft landing because for at least nine months, things went according to plan, and that was the only other time in history where we tried to accelerate growth or in post-war history, we tried to accelerate growth from this level of unemployment.
And that was the late 1960s. And what happened is, inflation came down. The Fed had a little, they’d been tightening quite aggressively in ‘66 because inflation had broken out of a well established range. They then had a little mini credit crisis which was somewhat idiosyncratic in nature related to …, but it caused a big slowdown in housing and then they prematurely eased, and they eased into ongoing fiscal spending, and unemployment never rose.
It kind of flatlined for like nine months, and then it started to go back down again as growth picked up, and what you ran into straight away was, average early earnings took off, core inflation went, and the bond market went again. And when I look at the world, that I think, is the real danger. I think the growth is just too robust. And I look at where rates are and they don’t appear to be sufficiently tight to restrain GDP growth, and to bring about that broad slowdown that the Fed is talking about. Because while the market is just singularly focused on headline inflation or core inflation or inflation in general, the Fed keeps talking about wanting to see growth slow down, wanting to see the labor market slow down, right? And these are much broader issues.
So even, even if you get Goldilocks, the question is, is Goldilocks in what, right? Do you just get Goldilocks in inflation for nine months and then it re-accelerates as real growth except, right, it picks up. Or do you need to see slower growth, because as I look at things, and I know that we’ve been, more and more people are jumping on this bandwagon, but we were pushing it at the end of last year, it looks to us that cyclical growth is actually re-accelerating and I sit here and I go, I’m struggling with the justification for the Fed to do 75, right, let alone the double that, that the market’s got priced it. So I think that’s what’s really sort of grabbing my attention, and how does that pan out in markets?
[00:09:14]Adam Butler: Yeah, I mean, so really the templates are the McChesney Martin 1966 pivot into the 1970’s stagflation, the Greenspan pivot in ’95. Remind me, I don’t like, so the ‘89 to ‘94 scenario was major run-up and over-leveraging of the commercial real estate market. They set up a bad bank, they put hundreds of banks in receivership, right? Walk me through what happened there from sort of ’89 to ’94, and let’s see if we can tease out the dimensions of that that are similar today and what might be different. Like, I remember there was a bond massacre in ‘94, right?
[00:10:08]Julian Brigden: Correct. And that was, you know, that was another classic example where the bond market got kind of ahead of itself, and on these assumptions, and then got proved utterly wrong by a Fed that flipped on them. And, you know, this is the sort of risk I think that we run because we’d had a big slowdown in 1990, right? We had a recession in 1990 and growth kind of picked up. And then CPI had been reasonably well behaved, and was actually, but was still by Fed standards, a little high. And this is the point, right? I mean, they were dealing with inflation that was stuck, basically. It had come off the highs of around 6%, but it kind of got stuck in ‘94 into ‘95, at around this sort of 3%, and so Greenspan came along and he sort of decided that what he was going to try and do was kind of grind this out, and he did have the foresight to believe that productivity could allow this to happen and, you know, productivity is the get out of jail free card.
[00:11:22]Adam Butler: Economic…
[00:11:24]Julian Brigden: So, productivity starts to pick up very rapidly as we’re moving into the dot-com period, and what that enables you to do is kind of get the best of all worlds. You get falling inflation, right? Inflation, falls, you know, from those 3% levels that down to below 2% in ’99, and, it’s great for the bond market.
It also enables you to have great nominal GDP growth, kind of around the levels that we are now, around six, which is fantastic for corporate earnings because that’s what they do. And unemployment as well, also continued to fall because we come from this relatively high level in the early 90’s when we were, you know, we got to 7.6%. So that was the big, and unemployment starting when he moved into this opportunistic disinflation, he started at sort of five and three quarters and you got all the way down to the current level 3.7. So that’s, you were coming out of this recessionary kind of backdrop, and inflation just proved a little too stubborn, and so the Fed kind of sat there and allowed them, played this game where they ground the thing out. And I said, the big difference is, in three of those four soft landings that you look at since the 1960’s is that we always started with higher unemployment.
[00:12:52]Adam Butler: Well, was there a material fiscal impulse then coming out of that? So they absorbed all these banks, they went into receivership. Like, what caused that impulse coming out of the 1990 recession, this sort of real estate based recession that drove inflation higher? Was there anything structural about it?
[00:13:11]Julian Brigden: No, it was, it was sticky. I mean, inflation wasn’t significantly higher. I mean, if you look at where, CPI, CPI did come down, I’m just looking at it now and still get the right numbers, right? So if you look, inflation had hit in 1990, 6%, 6.2%, just over 6…
[00:13:27]Adam Butler: And then…
[00:13:28]Julian Brigden: … and then it dropped.
[00:13:29]Adam Butler: Did Greenspan insist on raising rates in, like, big surprise raise in ‘94?
[00:13:34]Julian Brigden: I mean, in a way, it was proving sticky, right? Because it was stuck between ‘92 and ‘90, and the ‘96, at kind of 3%. And so he came up with this idea that what you need to do is you just nudge rates up a little bit, to just kind of grind it out. And that’s what they did. They cut them in, as we move into recession in the early ‘90s, they cut rates from eight and a quarter, basically down to three.
[00:14:06]Adam Butler: Yeah.
[00:14:06]Julian Brigden: And then in late ‘94, when the inflation proves resilient, in early, late ‘93 and into early ‘94, they then raise them back up again…
[00:14:16]Adam Butler: Right.
[00:14:16]Julian Brigden: … to, you know, basically six. So they double them
[00:14:20]Adam Butler: Right.
[00:14:21]Julian Brigden: And we’ll, and it’s just to kind of grind it out, right.
[00:14:26]Adam Butler: Okay. So, the economy was humming at that point. It was back on its own two feet because they’ve absorbed all those bad debts that, written it down. So the government …
[00:14:38]Julian Brigden: … the balance sheet up, essentially allowed everything to sort of function properly again, and I think you could, you can see it. I find it quite intriguing this morning, to see the story that we got on Bloomberg about, I don’t know if you saw it, about the banks starting to duke it out with private credit to fund all this leveraged buyout debt that’s coming due, right? So the banks had all been sort of squeezed out of this space last year and the year before, and private equity basically funded all these deals. And now the banks are trying to get back into that space, now that rates are lower and so on and so forth.
And to me, you know, this is indicative of this easing of financial conditions that we’ve seen. The question is, you know, is that justified? And I question that. I’m very much of the opinion that the labor market in broad aggregate terms, so how much people earn, how many people are working, that sort of thing, in, you know, in totality, if you look at, the labor market basically dictates nominal GDP because it’s, you know, consumption is 60 percent of GDP.
And if you look at it, it suggests nominal GDP is still around six. And so, you know, this is where I have this problem of, how do we sustain 6 percent nominal GDP with 3.7 percent unemployment? And the risks are, as I think, see things at the moment, if you go back to that Goldilocks analogy, the porridge is too hot still. It isn’t just right, and the risk is, for whatever reason, the Fed seems to be happy with that, which I think is a long-term threat to the long end of the bull market.
But let’s assume that they get it wrong. The data that they think is softening, which they do, doesn’t soften, as my model suggests is not going to be the case. And then they turn around to us in March and they go, no rate cut. And then they turn around to us in June and go, no rate cut. And they turn around to us in September and go, no rate cut.
Then, the risk is then, that at some point by holding rates here, you actually will do more damage, because as the re-fi’s come up, and we know the commercial real estate problems, et cetera, et cetera. And then the risk is that you’ll actually tip over the employment market and the thing will become too cold. But you know, because it’s the bottom line, I think, I mean, bottom line I’ve been pushing to my clients is look, Goldilocks is not the base case. Statistically, it’s at best, one in three, and given the three of those four occasions when we did end up with it, it started with much higher unemployment, and the one where the unemployment started at the current levels and it wasn’t really a sustainable Goldilocks scenario, as I said, it lasted for like nine months and then went horribly wrong again as inflation soared. I think the true odds of Goldilocks are far lower than one in three.
[00:17:51]Adam Butler: Yeah, Julian. I mean, what’s not really talked about so much is the fact that we’ve got unemployment that’s so low. We’ve got inflation that seems to be sort of, have almost troughed, and you know, it looks like maybe moving higher again, and we’ve got fiscal deficits in the 6, 7, 8 percent range, as far as the eye can see.
[00:18:18]Julian Brigden: Correct, correct, correct.
[00:18:20]Adam Butler: What I don’t understand is why everyone thinks that the economy is going to be so weak, as to prompt any cuts at all. To me, the risk is on the right tail, not the left.
[00:18:33]Julian Brigden: Now, I mean, that’s, look, that’s my view. I think from an economic perspective, I don’t see how the Fed can justify even what I would call the sort of fine tuning cuts that they are foreseeing, right? Remember, they have unemployment rising to 4.1 percent in the SEP’s, and they have, growth falling to 1.4 percent this year. And that’s the reason to justify, and inflation falling. And that’s the reason to justify 75 basis points. But as I think, see things setting up, none of those are happening, right? I see unemployment that the labor metrics, which are anything, you’re at risk of re-accelerating, and a lot has, that has to do with this effect that we call hyper-financialization.
So this relationship between basically equity markets and the real economy, whereby the equity market in this bizarre, fucked up US world that we live in actually leads, because the only thing that CEOs care about is their stock price. So the, so the ditty that we have is, one is very simple, you know, equities rise, they fire. Equities, so equities fall, they fire. Equities rise, they hire. And equities have been rising again. So you know, all that weakness that you saw in 2022 when stocks and the labor market metrics, so things like the challenger layoff numbers, the claims numbers that were all going, looking like recession, recession, recession. Last year, as stocks recovered, those things, all that weakness is just reversed.
[00:20:05]Adam Butler: In this economy, companies do not lay off staff when the stock price is at these kind of multiples, right? They lay off when the market is telling them that the economy is weak. They’re taking their cues from the market. If the market’s telling them the economy is strong and earnings are going to be strong, they’re not going to lay off workers. If they’re not laying off workers, how are we, how are we slowing demand again with fiscal deficits in the six, seven percent range?
[00:20:36]Julian Brigden: Correct. Correct. I mean, I love listening to the calls from the PMI guys, right? And there’s a couple of the, there’s a couple of places you can sort of follow them online. And Tim Fiore, who’s the current chairman of the ISM manufacturing survey, they did their sort of semi-annual outlook and it was reasonably upbeat.
But what was interesting, it was done before the pivot, and Tim is very good at calling the economy. I really do put a lot of weight on what the guy said. In fairness to him, you know, back in last summer, when everyone was really bearish, he was going, I don’t think it’s going to, I think this thing is okay, actually, right? Looks actually okay. He just came out and he went right, I mean this wasn’t a bad survey even before they pivoted.
Now they’ve just given us the green light to just go for it, and I think we’re going to have ISM back at, you know, 52-53 by March, and what’s actually interesting about that, you’ve got to go back 30 years to find an occasion where the Fed cut when ISM came back up above 50.
[00:21:48]Adam Butler: Yeah.
[00:21:49]Julian Brigden: They stop cutting, or they hike.
[00:21:52]Adam Butler: Right.
[00:21:53]Julian Brigden: So it’s going to get, I think, really, really interesting, and the question is, is having arguably screwed it up again in terms of their economic forecasting, do they have the, are they willing to pursue the cuts anyway, because I think there are. There is some rationale to say that there’s something else going on here.
There is another driving force behind some of the cuts. I don’t know the answer if they do it, but if they do, then there’s, look, they can do what the hell they like. But as I always say, this, I don’t judge people. I just like to figure out what the consequences are of their action, right? So, I could see them still in an environment where growth is still relatively robust, still trying to justify, you know, 50, right. But if they do, and my models are right, and the equity market holds up, which is another thing we need to discuss, then I think it doesn’t bode well for the long end of the bond market in an environment where I fundamentally believe we’re in a structural bear market in fixed income. And if it hadn’t been for COVID, that started in 2016.
[00:23:18]Adam Butler: Yeah, so if the, if the trajectory of rates ends up being less dovish, so let’s first of all, let’s explore. I mean, we’ve explored some of the reasons why that might be the case already. I mean, I think there’s a very strong case for why growth and inflation are both going to be run considerably hotter than consensus.
[00:23:42]Julian Brigden: And you, look, fiscal is a huge part of this, right? I mean, it’s just huge. I mean, you go, you want to go back to that late 60’s analogy when we were fighting the Vietnam War, which was a big driver of that. I mean, we’re arguably fighting three wars now, right, if not four?
[00:23:59]Adam Butler: Yeah.
[00:24:00]Julian Brigden: We’ve got two kinetic wars, Russia and Ukraine, and the Middle East. We’ve got a climate change war, and we’re in a cold war with China. I mean, it’s hugely bloody expensive, all of those things, hugely expensive. So I struggle to see how fiscal…
[00:24:20]Adam Butler: Well, the other…
[00:24:21]Julian Brigden: … continue to expand, let alone gets addressed,
[00:24:25]Adam Butler: Well, that actually might be a bit of a clue, right? I mean, it could be that the Fed is sort of seeing the writing on the wall that deficits are going to continue at this pace, even, in the event of a Trump presidency, that he may ratchet back on direct investment, but preserve the tax cuts, right? So, whether you’ve got supply side or demand side, the fiscal situation is unlikely to change dramatically. The other thing that I think it’s been a really interesting surprise this cycle, is how the interest sensitives haven’t responded at all. We’ve gone from basically zero rates to 5 percent and homebuilders are on fire, right? Auto manufacturing on fire. Like, which area of the economy is going to respond to higher rates? That would prompt the kind of cuts that the Fed is suggesting.
[00:25:32]Julian Brigden: Well, I think in fairness to the Fed, they’re not, right? I’ll read you a quote from Chris Waller, which I thought was quite interesting, from last week. So he said, in many previous cycles, there, which began after shocks to the economy, either threatened or caused, causing a recession, the FOMC cut rates reactively, and did so quickly and often by large amounts. This cycle, however, with economic activity and labor markets in good shape and inflation coming down gradually to 2 percent, I see no reason to move quickly as quickly or cut as rapidly in the past.
So I think this goes back to a large extent, what they are trying to do, this opportunistic policy, disinflationary policy framework, which is what Greenspan did, but they’ve done an absolute appalling job at explaining this to the markets, for whatever reason.
So we, they keep saying things – well, the market can do what the market wants, and we’ll see which one’s right. We’re right or they’re right, you know, and I just think it’s so self-defeating, and so I don’t understand why they don’t have, and we discussed this on a policy call this morning internally, where they don’t have the balls basically to come out and say the sort of things that you see from other central bankers, where the other central bankers just go, no, it’s too early.
I mean, one thing I think has been quite interesting is something that’s got me thinking a lot is comments from the Bank of England, who have highlighted the fact that sure, goods inflation is zero or negative, right? But goods inflation is always zero or negative. And what’s more important is service inflation.
And you know, the Bank of England said, you can just forget it because service inflation is still miles above where it should be.
And, you know, when we look at it, I know everyone gets their knickers in a twist about, oh, owner’s equivalent rent, and it’s going to come down. Sure. It’s probably going to come down. But as a fact, when you look at the dynamics versus the overall service thing, it could still come down and overall service inflation could remain relatively high. I’m not saying it’s not going to come down a bit. Could it, but it could remain uncomfortably high.
[00:28:01]Adam Butler: Yeah. And we haven’t even really seen any kind of self reinforcing labor cost spiral, right? I mean, it’s been miraculous how labor has been completely neutered in this cycle. They haven’t had any negotiating power at all.
[00:28:19]Julian Brigden: They’re, I mean, you still, but you have got, a lot of wages, which I like, still running above five, and that’s still pretty bloody brisk, right?
[00:28:29]Adam Butler: Sure. I mean, but they’re still far behind.
[00:28:32]Julian Brigden: Yeah, no, no, no, no, but I think they, yes, exactly. They’re still far behind, but I think they’re going to, I see no reason why they don’t catch up.
[00:28:39]Adam Butler: Which would be another inflation impulse, right?
[00:28:43]Julian Brigden: I just can’t see politically how wages don’t, over time, and this is the big political problem that Biden faces, right? He’s, the economy’s in great shape, right, he’s just getting the blame for that 20 percent haircut you took in the real disposable income essentially, as the US corporate sector ripped your bloody heart out in terms of price increases, because we live in this highly uncompetitive economy.
And so what has to happen now is over time, wages need to play catch up to rebuild that 20 percent or you’re going to have a shit load of political turmoil in this country, which I think you’re going to have anyway. But you know, I don’t see wage, I don’t, none of our models are suggesting wage pressure really drops all that much.
It still looks to me like it’s stuck at five and change, well into 2024, which, that’s why I struggle to find any rationale for the Fed to really cut at all, and certainly to go beyond, you know, a couple of 25’s, which have either justified because they’ve cocked it up, and they don’t want to ride it back and say, oh no, we were wrong again.
Or, and I do believe this is the case, and I hear this from policy friends, out of fear of Trump, right? There is a large institutional fear in the Fed, and you can see it in all the global elite, I mean, just look at what Madame Christine Lagarde said about Trump. I mean, she broke every single protocol to come out and criticize Trump. A central bank governor should not, not under any circumstances, certainly a foreign one, say anything about a US president. And yet she did. And I think that to me is just indicative of the angst in those policy circles and all that global elite.
[00:30:50]Adam Butler: So how do you think of Trump?
[00:30:51]Julian Brigden: Go 25, 50 on the back of that to ensure there is no slowdown, and that we’d run this economy hot into the election, because Janet Yellen, sure as hell, her behavior is, she’s doing everything to frustrate the Fed’s attempt to slow this economy down by the equity market. You know I don’t know, but as I said, you can do what you like, but it just has consequences. In that environment. I don’t want to be long the bond market.
[00:31:16]Adam Butler: Yeah. How does a Trump presidency change things, if at all?
[00:31:22]Julian Brigden: So it’s something that I’ve been reaching out and starting to examine with policy friends. I mean, I’m very worried in this world. Not, it doesn’t impact markets immediately, but it will impact us on an ongoing basis. I’m very worried about it, what it does to the geopolitical side.
Look, I think he, to your point, I mean, he rolls over his tax cuts. He won’t increase taxes, so you don’t address the fiscal problems. I mean, they could even get worse. But I do think there is a risk that he entrenches US isolationism, which is exactly what we saw in the 1930’s and you can already see with this acceleration in global conflict that we got, that we’re going back to a world that looks more like the 1970’s, right?
When I grew up as a kid there were wars all over the shop. There was conflict and coups and every other week in Latin America. There was proxy wars being fought in, you know, Latin America between Cuba, there was a proxy for Russia, and funding various rebel groups in Latin America, and the US on the other side, right?
You had the same going on in Africa, right. And I look at this thing and it looks, and one of the reasons it ends up looking like that is because no one’s afraid of the bloody global policeman anymore, because he has proved to be either incompetent or unwilling to take the steps to actually enforce law, right? And partly, that’s because we live in a much more connected world, and it’s no longer possible to do what the English did and roll up the battleship into the port, and blast the capitals a bit, right? Or to shoot rioters in the streets.
That’s a problem when it comes to imposing that, and we’ve just seen the difficulties of the British and the Americans have found, taking on these Houthi rebels, right? Your modern weaponry at two million bucks a missile, against some bloody drone and a bunch of camels, right? And guys with AK 47’s.
I mean, these are some of the longer term inflation trends, which really, really do worry me. And it’s one of the reasons, not the main reason, but one of the reasons why I am a structural bond bearer and I just don’t, I think it’s very, very difficult to address these problems in the West.
[00:34:07]Adam Butler: Have we seen the trough in rates for this year, do you think?
[00:34:11]Julian Brigden: I think at least for the next three to six months, I think, yes. We’re short, you know, we got shorted around 3.92 in 10 year Treasuries, a kind of target probably 4.25 first off, and then sort of 4.40, 4.50, and it’s part of this sort of reset and this tightening, this offsetting, moving, tightening financial conditions, that, if the equity market will not give up the ghost, right?
And as I said, I don’t think Janet Yellen has any, she understands this type of financialization, this relationship between stocks and employment, right? She’s not willing to let this thing go. And she’s got some pretty big tools that she can deploy, right? She’s done a great job at basically pushing refunding into the front end of the curve and then draining liquidity from the reverse repo.
[00:35:16]Adam Butler: What an unbelievable hit to taxpayers this is to continue to front load funding. Like, honestly…
[00:35:26]Julian Brigden: Yeah, but come on, we’ve got to win the election, right? We’ve got to fight. The fear of the orange man is much greater than the fiscal survivability of the US long term. I mean, this is all just fiddling while Rome burns type shit, right? That’s where it becomes scary when you look at this and go, really? Is that what our politicians have really got, come down to, and I think the answer is, I hate to say it, I think yes.
[00:35:51]Rodrigo Gordillo: Sorry to interrupt, but I did want to take a quick second to remind listeners that while we do absolutely love providing our audience with world class guests and weekly investment insights, we wanted to remind you that we actually do our best work outside of this podcast. And we try to do this by providing cutting edge, globally diversified, and systematic investment strategies that are designed to be broadly non correlated to traditional equity and bond portfolios.
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[00:36:33]Adam Butler: so why isn’t gold running in this environment?
[00:36:39]Julian Brigden: But I think part of the problem. I think gold has performed quite well, right? If you look at it against the S&P, it’s actually held its own for quite a long time. But I think the big disappointment is, when you look further down the kind of periodic table and you look at things like silver, which doesn’t look good and it really shouldn’t. You know, you break much lower than this, and it could start to get, look quite ugly, and I think the big problem there is that we built in lots of rate cuts into the dollar. And the dollar is now starting to look a little better as we price out some of these rate cuts, right? Such an aggressive stance on rates. And I do think, you know, when you look at the data, even though I don’t think the ECB will cut anywhere close to what’s also priced into their curve, I do think there’s much more justification for, and in the UK, for some rate cuts, versus arguably, I don’t think any rate cut in the US, as I said, depending on exactly how the Fed plays it, we will see, and that will determine exactly how strong this dollar gets. But it looks, I think that’s the immediate thing that’s weighing that, and the higher rates is weighing on gold at the moment.
[00:37:54]Adam Butler: And internationally, so you’re just talking about Europe and the UK, how is the European economy looking? How’s the UK economy looking? I mean, is it gaining strength in the same way as…
[00:38:09]Julian Brigden: No, I mean, I think the UK looks quite vulnerable. I mean, it’s really, you know, Brexit was an enormous … it’s been, it’s a structural headwind for the UK and it’s something that we talked about for the next decade, basically. The consumer is very vulnerable given the mortgage structure, and the lack of fixed rate mortgages is going to become increasingly vulnerable to these high rates.
She’s got a structural problem to some degree because we lost a lot of skilled craftsmen post-Brexit. They went back to Eastern Europe, and they were keeping a lid on some of these costs. Some of it’s being offset by short term visa issues, but, you know, we have, there just aren’t enough workers there.
I mean, the same problem is the US, the same problem is Australia. You know, a very large Australian bank there, their Treasury team the other day and talking about how do we grow again with 3.7% unemployment in the US and they said, you know, it’s exactly the same in Australia, right?
They just, there aren’t enough workers, right? And so this idea that everything just picks up again, unless you get that productivity burst, is going to be, it’s going to be problematic. So I think for the UK, that gives us sort of a stagflationary-esque kind of overtone.
Continental Europe is a little more interesting actually. I think, when I look at my models, they’ve done a much better job at dropping inflation. And I think the primary reason for that, and it’s something that we talked about or hinted, touched on a few minutes ago, and that was continental Europe is much more competitive, so the ability of corporates in Europe to price gouge to the same degree that US corporates have done, is just not there.
There are many practices which in the United States are deemed legal, which are really price collusion, that in Europe would end you up in jail, You know, I don’t know when last time you did your kitchen up, right, but I’m sure when you did, your wife said, there’s three appliance makers we’re going to buy, darling.
You know, one of them is going to be Wolf. One of them is going to, and Sub-Zero, the other one is going to be Miele. And you go to the dealer and you go, well, I want the dishwasher and the oven and the cooktop and the extraction fan and the blah, blah, blah. And the guy goes, yeah, 20,000 bucks, probably 30 now.
And you say, yeah, but I’m buying all of them from the same manufacturer. So what’s the deal and which one’s going to be better? Can I get a better deal in the Wolf or the Sub-Zero or whatever? And he goes, no, they’re 50 bucks difference. And I can’t negotiate because if I do, I’d lose my license, right?
I mean that’s price collusion. I mean, that’s price fixing, right? In Europe, you go to jail for that shit, and you can go and buy your Miele online, basically, and haggle between about five different providers. So, it’s, when I look at inflation in Europe, it really looks to me like they’ve, they’ve vanquished it.
Now, don’t get me wrong, they’ve also got some labor problems, wages have been sticky and high by European standards, four and a half percent, so not as high as the US, but pretty high. But it does look to me that those have started to show signs of peaking. When you look at growth levels relative to inflation, I’m sorry, relative to rates, growth levels relative to rates, you could argue the case that if you rank those three economies, that the ECB has the tightest policy to the tune of about, by our calculations, about a hundred basis points.
So they could ease to, you know, a hundred basis points. The Bank of England is easing by about a hundred basis points, and the Fed is easing by 200 basis points. So the economy that is growing the most has the easingest policy. So I think they can tweak a little bit. Encouraging signs that I see, in Europe.
And I think this could become a surprise, not immediately. And there are still steps that I need to be completed. You know, Europe is very heavily focused, particularly the Germany, which tends to drive a lot of our sentiment around Europe to obviously the manufacturing cycle, and the manufacturing cycle is itself very sensitive to the inventory cycle and the CapEx cycle.
And there is absolutely no doubt whatsoever that, as we’ve seen in the US with, you know, the weakness that we’ve seen in US manufacturing that could be coming to an end, that they got themselves caught up with this bloody great big inventory overhang. And so we’ve written, you know, 18 months ago, we’d sort of said, this manufacturing sector is going to go from inventory shortage to, from famine to feast to hangover, right?
So we’re dealing with the hangover now, right? In the US I think that hangover looks like it’s partly addressed. Europe, it’s, Germany, it’s certainly got more to do. But when we look at one of our favorite kind of canaries in the coal mine, Sweden, it looks like she has totally got on top of our inventory overhang, and now her inventories are running under her orders. And so that suggests to me that as we move into beginning of Q2, even in Europe, you could start to see the manufacturing cycle start to pick up again.
[00:44:12]Adam Butler: And how dependent is that on Chinese growth? I mean, Europe has migrated most of…
[00:44:20]Julian Brigden: Yeah, but remember, and yes, that will be important. And I think China does look is a wild card and does look kind of messy, but you’re actually, what China I think is going to try and do, and you can see already, she’s going to try and export her way out. So, you know, oh, part of the problems that she’s facing, and certainly when you look at the Chinese equity market, I’ve tweeted this, it’s like a bloody train wreck. I mean, there’s a, we just broke a trend, a multi-month, a multi-year trend line on a monthly basis that goes back to like 2005, in the Shanghai Composite, and it looks like that thing could drop another 30%, 25, 30%.
So, yeah, it’s a risk, but it’s, as I said, I think growth, certainly from just from an inventory restocking perspective, could push us cyclically in some of these manufacturing PMI’s back into expansion territory in Q2. And that I think is going to come as a bit of a problem for some of these central banks.
[00:45:27]Adam Butler: Are you surprised at how resilient countries like Australia, Canada and the UK have been in the face of these high rates, given the high level of mortgage debt on household balance sheets and the fact that those mortgages reset on average every two or three years?
[00:45:43]Julian Brigden: Yes, I am. I am. And I think it’s, and as I said, I think in the UK it’s going to start to bite. And I think, you know, in some of these other countries it’s going to start to bite. The US is in that sense, a little bit of a special case. But even when you look at some of these markets, I think we have to remember there’s a lot of accumulated wealth, even in, they’re less equity focused than some of these other markets, but people have got a lot of money, right? There’s a lot of money that you can use to cushion some of this blow.
[00:46:17]Adam Butler: And I think so much of it is, is, is in houses though, right? Like there’s a lot of…
[00:46:23]Julian Brigden: Yes, for the vast majority of people, right, it’s in housing, right? That’s your biggest asset, but there’s shortages of houses, right? They’re everywhere, right? Everywhere there’s shortages of houses. You know, you can see every single government looking at, and they just did it in, I think it was in Canada, where they just imposed this thing on all the guys doing short-term rentals, right? They were like, oh, you know, we’re going to tax you higher. Every single country is trying to loosen up its housing market because they just aren’t.
So I think that the resilience of the house price thing, and it goes back to your home builders comments, right? No one’s moving in the US. Existing home sales have dried up. So by default, the homebuilders have to do well in a very, very unusual move. I mean, one that, to be honest, we got wrong, didn’t cost as much because you run, that’s what stops are for. And they did move in our favor, at least initially. So, but, you know, there’s a lot of things that are resilient.
And if you, if you look at some of the economic papers that people are writing, some of these effects start to kind of wane. It’s quite possible a lot of, two thirds of the rate increases that we’ve seen have essentially already worked their way through the economy. And I think the other thing that people need to bear in mind, and this is, it’s going to sound un-PC, but I don’t mean it like this. The vast majority of consumers don’t count.
[00:47:59]Adam Butler: Right.
[00:48:00]Julian Brigden: The majority of consumers spend every red cent that they have from their income. It doesn’t matter whether they spend it on, all on food or on all on medical costs, right? It does if you if you’re trying to pick which ones are the winning sectors within the equity market, right? Is it the food companies or is it the insurance companies, the health insurance companies, right? But it doesn’t matter from a GDP perspective.
[00:48:24]Adam Butler: Yeah. No, it’s more from a marginal spending by the middle class who in Australia, UK and Canada have been bolstered so substantially by paper housing wealth, right? And, you know, if your house appreciates at a multiple of the rate of your labor income savings every year, then, you just, you feel like you have a lot more money to spend. If you believe that that trend is going to continue, and any sign of that cracking, you know, it also, this has to come out from a mathematical standpoint. Sure, people need to buy homes and form families and there’s a shortage of homes and so home prices stay higher. That means that a much larger portion of people’s income is going to mortgage payments, that’s not going to other purchases of goods and services, right?
[00:49:14]Julian Brigden: So that, yeah, so..
[00:49:16]Adam Butler: A valve has to come from somewhere.
[00:49:18]Julian Brigden: Yes, so that has an impact as I said on when you look at consumer discretionary stocks, right, you would expect they’re not going to buy, oh Christ, what’s that bloody brand they all buy up near me. I live in Boston, Alo, right? You know, they all walk around with Alo, you know, it’s one of these millennial brands and they all, and you go in there and you’re like, 150 bucks for a pair of sweatpants.
Are you bloody insane, right? But these kids all seem to wear it and you know, yes, as they get squeezed out because they have to pay their student loans back, or their rent goes up, or they’re trying to buy a house and all that sort of thing. But from abroad, because they’ve got no, they don’t have that many stocks, right. But from a broad consumption expenditure, from a GDP perspective, it doesn’t make any difference, right? What really makes the difference is how the wealthy spend, right? And the wealthy are locked in. They’ve locked in their mortgage and their stock portfolio keeps going up, right? The amount of wealth…
[00:50:17]Adam Butler: Canada and Australia, right? I mean, they’re…
[00:50:20]Julian Brigden: Less so, less so.
[00:50:22]Adam Butler: You know, the wealthy have already paid off such a substantial portion of their mortgage, right?
[00:50:28]Julian Brigden: Right. And the same here in the US, right? I mean, a third of homes are being bought with cash.
[00:50:33]Adam Butler: Well, and you, the US is a totally different case because only a small fraction of the mortgages reset, right, because everything’s at like 20, 30 year fixed-terms.
[00:50:43]Julian Brigden: Yeah, correct. So look, I think it all comes down to this, whether we see, it all comes down to me, to this labor market, right? That’s what will dictate Goldilocks, and it’s also why I think Goldilocks is so insanely difficult to achieve.
[00:51:00]Adam Butler: Yeah, I’m just wondering, I’m more talking about Canada, UK. And because…
[00:51:04]Julian Brigden: And as I…
[00:51:05]Adam Butler: I wonder if they’re, with their good currency shorts, you know, I wonder if, like, I think …
[00:51:09]Julian Brigden: I do. Yeah, I…
[00:51:11]Adam Butler: …they might be forced to cut.
[00:51:13]Julian Brigden: They are. I do think they will be forced to cut. Will they cut? And as I said, look, if you rank them, and I, you know, Australia, I haven’t done this, but if I rank the big free currency pairs, yen doesn’t really come into play because the BOJ’s on a, still on its different planet kind of thing. But if I would look at relative growth, relative to rates, right, and say who’s running the tightest, where, and given that growth is picking up, who’s, where the biggest surprise is going to be? The biggest surprise would be in the US, where rates should not get cut, and if anything, do need to go up arguably more.
So that’s dollar supportive. Then the next one is sterling. And then the worst one should be Europe. And I think there’s a case to be saying that you could end up with quite a weak, I don’t think it’s as weak as, you know, necessarily some people think, because I do think growth is, will pick up a little bit, but the ECB can easily justify cutting rates. And then you put a Canada and Australia in there, they’re in somewhat similar circumstances, I think, to the UK.
[00:52:30]Rodrigo Gordillo: Sorry to interrupt, but I did want to take a quick second to remind our listeners that the team works really hard on these podcasts. We spend a lot of hours trying to get the right guests, and we do a lot of prep work to make sure that we’re asking the right questions. So if you do have a second, just do hit that Subscribe button, hit that Like button, and Share with friends, if you find what we’re doing useful. Thanks again. Now back to the podcast
[00:52:51]Adam Butler: Yeah, okay. Equities, leave the best to last. So, I mean, what are you, what are you seeing on the equity front here?
[00:53:00]Julian Brigden: I mean, look, if you, broadly look at the S&P. It’s gone nowhere for two years, right? Last year it was down until the fourth quarter. Then Janet Yellen rather deftly slewed all the issuance to the front end of the curve, drew liquidity back into the system as a result out of the reverse repo into the liquidity metrics, which set the level of the equity market. And we got this everything rally, right?
We’ve got an everything rally. And I think this is an important thing that people need to bear in mind if we are in a structurally inflationary, higher inflationary environment, which I believe is the case. You are back into an environment that basically existed prior to 1998.
1998 was a year in which Alan Greenspan, for the first time, shifted from focusing on inflation to focusing on deflation. Because even in 1998, he was beginning to talk about the risk of the zero bounce at this point, in which, you know, the central banks would lose, out of ammo. And so they became much more focused on preventing deflation.
And that did something really very dramatic and unprecedented. It slewed the correlation between bond and equity prices. So prior to 1998, and there’s a Bank of England study that goes back and looks at 250 years of bond pricing, bond and equity pricing. So prior to that period, you’d never ever, ever seen negative correlation between bond and equity prices. So both assets either went up or down together. So bonds rallied, yields fell and stocks rallied, or vice versa. And from 1998 onwards, that relationship changes. You move to focus on deflation. I think we’re moving back into that positive correlation environment. It’s certainly been the case since 2020.
We’re about where we’ve gone back into negative correlation, but Q4 was all about a positive correlation rally, right? An everything rally now, that got people quite excited by this idea of the reflationary cycle. So we had people thinking about, do I buy the Russell? Do I buy the blah, blah, blah? Do I buy the blah, blah, blah? You know, do I buy cheap things? Are we going to rotate into stuff? But the reality of the situation is, I struggle with that thesis.
I think it could pick up a little bit in Q2, is if we start to see these PMIs come back, but if, you know, but then, you know, from, about some of those names like Tesla, I think is a classic bubble.
I mean, I just tweeted out and I know, well, I will tweet out I’m just, I know I’m going to get shit from the apostles of Tesla, which is I think the fundamental problem. There are investors, they are believers, but to me, Tesla is a narrative that’s been fit to a price action and a price action that was created by QE, and you can see the domes when Tesla started to perform, and it was exactly when the Fed did in 2019, not QE if we remember that, and then we had the COVID QE, and it peaked, exactly at peak Fed liquidity, right? And since then it has not managed to recoup its thing and people are like, oh, but you know, it’ll come back, it’ll come back and he’ll build a bloody robot and he’ll decide on the truck and all this bullshit.
And the reality of the situation is this is just a hyper-bubble, but there are some obviously good companies still left. You’re paying an awful lot for them, and the reality of the situation is, when I look at the US equity market, I think this is a massively, massively, massively overvalued market versus the rest of the world, right?
Like four standard deviations overvalued versus the rest of the world. But those dynamics are unlikely to change until either the dollar declines, and that hurts foreign investors who’ve got their money in the US and/or the bubble bursts, because it just runs out of puff, let’s say. Doesn’t look like that’s the case.
Or we go into recession and that doesn’t look like the case either. And so for me, you’ve got this sort of ongoing, self-reinforcing, truly reflective type cycle going on in the US equity market where the purchase of the asset, in this case, stocks underpins wealth, underpins employment, underpins a Fed rate hike, underpins the dollar, underpins the valuation of US stocks for foreigners. You know, it’s a very self-reinforcing, literally reflective in the true Soros-esque sense of the word.
[00:58:29]Adam Butler: Mm hmm.
[00:58:31]Julian Brigden: And I struggle to see that ending and I particularly struggle to see the ending because I said, I think Janet Yellen since the, you know, really since Q3 of last year has understood that she can’t, she’s only got one job, right? And it’s radically different from the job that she used to do. Her job these days is to just get her boss reelected. And if, as I think, she understands this, stocks determine what goes on in terms of employment, then you have to keep this equity market buoyed up, and she has, between her ability to slew issuance and control the reverse repo, and this other big pot of cash that she hasn’t tapped, the Treasury General Account. If she sees stocks wobble at all, she could just pump liquidity into the system.
And that’s just another reason. So I kind of struggle with seeing a big bearish move. I mean, could you get a 10%, sure. You can get one of those any day of the week, right? But a big bear market between now and the election, it doesn’t look, it doesn’t feel that way. It doesn’t feel that way.
[00:59:51]Adam Butler: Um hum.
[00:59:52]Julian Brigden: Why another reason to be bearish bonds, right? Because if stocks aren’t going to do any of the heavy lifting to try and tighten financial conditions, has to be bonds.
Maybe the dollar, maybe the dollar plays a bit of a role going forward, you know, in the next couple of months, that would help a bit, but it’s going to have to be, it’s going to have to be bonds a lot.
[01:00:14]Adam Butler: So is there a sleeper trade besides being net short fixed income? Are you interested in, are you looking at Japan here, Japanese…
[01:00:27]Julian Brigden: Look, I like, I do love Japan. I do love Japan, but there’s a couple of concerns I have about Japan. So the first one is the politics is a bloody mess, right? And so I think, I mean, a real mess, a real, real mess. We write about this a lot, with clients. We’re one of the few shops, I think, that have anyone who really has experience in Japan and follows Japan.
And Jeff is being very good on this one. The politics are real mess. It could end up over the next couple of years, really destroying sort of the LDP’s iron grip over Japanese politics. So that could get really quite interesting. But the impact of that for markets is it probably delays the BOJ’s normalization of, or the end of negative interest rates. We don’t think they can really probably move until July.
So some of the euphoria that you kind of see around some of the banks, which have been great trades, brilliant, brilliant trades, and really one of the driving forces behind the Nikkei, that kind of, May, retest that, but I would buy on any day. The other thing that I’m a little concerned about in Japan is not, if you go back and you look at history and you go and look at back like 2007 and the dot com bubble, over this interesting factor before the whole global equity market goes, right? And that is, it seems that equity investors go, oh yeah, the US is a bit expensive.
Bloody hell, have you seen how cheap Japan is? I’ll have me some of this. And you get this major like, final like, woohoo! Japan is the final like, hurrah, where you pile into this thing. Now, that said, I have a line, I have a little chart that I’m watching. We’re not there yet. I’m looking at the Japanese banks, in dollar terms. I think it’s the best piece of chart porn that I’ve got. And you can draw a multi-year line that comes in at $2 for the Japanese banking index. And if we can crack above that, and we haven’t, then I think it can double or triple from there. But until it does, I’m not playing.
[01:02:51]Adam Butler: Would you be a buyer of Japanese equities, hedged or unhedged?
[01:02:56]Julian Brigden: I would be inclined to do them unhedged. When I buy it, I want to buy it unhedged. And that’s, that’s another reason why, you know, look, we’re still in this game where, you know, oh, you buy Japanese equities because the yen is weaker, and they are really just a yen play at the moment. And that is in itself, is just a Treasury trade.
And, you know, it’s all, when you start running the correlations across the book, you find out that by being short Treasuries, you’ve got a lot of the same trades on. And as I said, I think Japan is an interesting story. Is it there yet to have autonomous growth? Eh, I don’t know. And as I said, the problem is that as long as the US is growing so rapidly and that means running a very large current account deficit, we need all the world’s cash to fund it. And so until those dynamics change, it’s kind of tough to buy other things. I’d love to, I’d love to, but you need either the dollar to break down, and that’s makes Mr. and Mrs. Watanabe go why am I not making money on my US stocks? Oh, because the yen is going up. Okay.
Or you need to go into recession in the US. That current account deficit shrinks and the money goes home, or we just need to burst the bubble in US stocks in one day. You know, we just find out NVIDIA can’t grow at 2500 percent per annum, or whatever the hell, you know, the equity analysts have penciled in for this week, right?
[01:04:28]Adam Butler: Yeah. Uh, is there any trade, no matter how niche that we didn’t touch on that is worth mentioning?
[01:04:36]Julian Brigden: You know, we don’t really get involved in very niche-y stuff. We’re pretty plain vanilla macro, and we’re looking at some stuff. The oil markets this morning we were discussing, crude kind of looks quite interesting, potentially for a move to the top side, which would get a little interesting. But not, there’s nothing much really, really compelling outside. All our CTO models are long now, pretty much every stock market, with the exception of FTSE and we’re short most bond markets, and the dollar looks quite interesting for further strength.
I mean, one of the ones that’s had a big run is Dollar/Mex. We’ve come down to like multi-year trend lines on the dollar against Mexican peso and down here, if anything, you’re probably supposed to be a bit, a little bit long,
[01:05:40]Adam Butler: Yeah.
[01:05:41]Julian Brigden: But it’s not like, it was easy in ’21. You just shorted bonds because inflation was going way up. You know, last year was a choppy macro year. I think this will show us its hand, but it doesn’t look like this is a market where you’re supposed to be betting big yet on macro, outside probably fixed income.
[01:06:05]Adam Butler: Right. Awesome. Julian, before we go, where can people find you?
[01:06:12]Julian Brigden: So, you can find us if you, if you’re interested in the institutional product, reach out to Support@MI2partners.com. And if you want to, if you want to follow what Raoul and I both do on Real Vision, because we obviously produce a joint product there, you can use the same email address.
And if you just want to follow me on Twitter, @JulianMI2. Thanks.
[01:06:39]Adam Butler: All right. Well, thank you so much again. Always a powerhouse of a guest and an awesome conversation. So, until next time.
[01:06:49]Julian Brigden: Thank you very much indeed.
*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.