Odd Lots - Here's What Just Happened to the Stock Market and the Economy

Episode Date: May 9, 2022

It's really been an extraordinary year for markets and the economy. Stocks are down, particularly, growth stocks which have gotten clobbered. Treasuries are down. Inflation is hotter than it's been in years. For the first time in ages, the Fed is hiking aggressively, having just moved by 50 basis points, with premises to do more. Plus there's a host of other shocks we're experiencing from the ongoing effects of the pandemic, the invasion of Ukraine, and the hard lockdowns in China. So how to make sense of it all? On this episode we speak with Neil Dutta, Head of Economics at Renaissance Macro Research and Luke Kawa, Allocation Strategist at UBS Asset Management, to make sense of what's going on, and what to watch next. See omnystudio.com/listener for privacy information.

Thanks for listening to Odd Lots. Follow the show on Amazon Music for more future episodes or just ask, Alexa, play the Odd Lots podcast on Amazon Music. Today's show is brought to you by Vanguard. To all the financial advisors listening, let's talk bonds for a minute. Capturing value and fixed income is not easy. Bond markets are massive, murky, and let's be real. Lots of firms throw a couple flashy funds your way and call it a day. But on Vanguard, at Vanguard, institutional quality isn't a tagline. It's a big line. It's a very big. It's a few. commitment to your clients. We're talking top grade products across the board of over 80 bond funds, actively managed by a 200-person global squad

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Bell, connection is everything. And welcome to another episode of the Odd Lots podcast. I'm Joe Wisenthal. And I'm Tracy Alloey. Tracy, it has been a week. Right? Isn't that a fair way to say? I am so tired.

I got about two hours sleep last night and there's just been so much that happened. We were both at Milken in Los Angeles. And for anyone who's ever been at Milken or any large conference for that matter, it is just a whirlwind of meetings and discussions. And we also recorded a couple episodes. And meanwhile, against that entire book, background. The news is actually happening. The Fed raised rates by 50 basis points. And the markets crashed. They did not have, they weren't, they had some rough days. That's for sure. Okay. Crash. Okay. The markets went down. The markets had some really rough days.

And particularly tech growth, that kind of stuff. It just continues to get absolutely killed. We also had a jobs report. We're recording this. What is, speaking of being really tired and out of it. May 6th. We're recording this May 6th. We also got a jobs report today, which seemed decent. There's a lot going on right now. And yeah, like we're at this conference. I kind of feel like I missed a lot of it. I almost wish I was just behind my computer the whole time. Yeah. That's a very Joe thing to say. Well, one thing that was interesting to me, so I was actually at a like a credit market panel right when the Fed raised rates. And I got my phone out and I started videoing the audience because I thought like maybe the headline would come out.

Right. Something would change in the room. Absolutely nothing happened. I mean, the 50 basis point increase was well telegraphed. But the really interesting thing was we didn't even really get much of an immediate reaction in the market. It wasn't until the next day on Thursday that everything started happening. Market soared on Wednesday. I think the NASDAQ was up like 3%. It was like, oh, coast is clear. They took 75 basis points off the table. Maybe Powell sees some signs of inflation turning a corner, and then the market's tanked. We have two great guests this time. Excellent commenters, both.

I want to welcome to the show, Luke Kawa. He is an allocation strategist at UBS asset management, as well as Neil Duda, head of economics at Renaissance macro research. And I think it's Neil's first time on the show, which is amazing because we've known Neil for years. and I've been big fans of his work. So thank you both for coming on the show. Neil, that's right. You haven't been on odd lots before. Is that correct?

I haven't, Joe. What took you so long? I know, I know. It really is shameful. But Big Week, and you are one of the names we needed to call. So hopefully that makes up for it. But let's start with you. Like, what's going on?

What's your read of everything? Put it in a tweet for us. Oh, I think the economy is fine. fine. You know, I think obviously if you look at just the total hours worked so far this year, it's running around 3 to 3.5%. So aggregate hours worked. So if you assume underlying productivity growth of, you know, conservatively around 1%, I think underlying economic growth is around four to four and a half. So I'm not particularly worried about the economy, but clearly there's an adjustment that's happening with respect to the interest rate outlook that's been going on really all a year.

And I think that's having some predictable consequences on equity markets. I don't know what happened one day. I mean, the Fed signaling something and the market rips and then the next day the market tanks. I mean, it's a very bizarre sort of situation. But generally speaking, what I can tell you and what I've learned throughout the years is that you know, the economy is a much slower moving entity than the financial markets and ultimately good economic news can help can help turn the financial markets. And, you know, my sense is that whatever sell-off we have seen and tightening of financial conditions we've seen isn't going to have

a significant impact on the economy. I mean, in the sense that relative to what's baked into the consensus, remember, the consensus expects a slowdown this year. That's what's pricing. in. If you look at the blue chip consensus, it's at 2.3 for this year. The Fed's at 28. So you're going to see some slowing. When the economy slows, there'll be some days where the news comes in good and some days when it's not. And, you know, in my mind, the data hasn't really deviated from that, you know, trajectory, really one way or the other. And if you had to put a gun to my head and say, you know, do you think growth is going to come in stronger than one of the consensus is for Q4, 2022, my guess would be probably yes.

So there's a lot to unpack there. And before we do, why don't we bring in Luke? And I guess two questions for Luke, but one, do you share Neal's assessment of the economy that he just described? And then two, what do you think happened between Wednesday and Thursday? What was the trigger? Because it feels like that's what everyone's trying to figure out at the moment. So, you know, a couple of tough ones. First off, as a default, I think, you know, Neil's a great person to defer or two on the U.S. economic outlook in particular. Now comes the ship. Set them up.

All right. Now you're going to shift. No, no. No, I completely agree. All of the data, basically all the data we've got recently on the U.S. confirms the idea that the U.S. is decelerating, but to a level that's still consistent with nominal growth that's far superior than what we got last cycle. The problem is that just like that simply doesn't matter right now.

That simply is not the proximate mover of risk sediment of risk appetite right now. And what's even more concerning is it's very difficult to tell what actually is. So I know one phrase that, you know, Tracy loves to use is, you know, flows before pros, just this idea that, you know, money moving even from, you know, potentially, you know, unsophisticated investors can run over the more sophisticated crowd. Right now, the flows are the pros. So it's more of a story for me. about flows before pros, but PROSE.

There's no story we can use that is going to adequately explain why risk appetite changed on such a dime between Wednesday afternoon and Thursday morning. There's nothing that does it. So what we have to do as asset allocators, we have to take a step back and say, well, you know, there's there's really three big risks we see on the table. One is kind of fed tightening, which is going to be, you know, possibly if it's if it's too much, It's bad for growth, bad for risk assets. If it's too little, it's probably just bad for risk assets, financial assets, generally.

There's the Russia's invasion, which is just creating kind of persistent supply issues and threatening to exacerbate kind of some of the negative supply, commodity price issues we've seen way on forward consumption. And then there's China, which is both a supply and demand issue. And I think that's one thing that did spook people a little when the Chinese Yuan depreciated a bit there because it's like, okay, well, if China's supposedly, you know, everyone thinking is about to go on this decent credit, old school stimulus, but smaller binge as the public health situation improves, or if they're kind of more durably moving to a consumption-driven model, well, that doesn't comport with a lower currency at all. The lower currency comports with the

trying to be the demand sinkhole for the rest of the world and stop all of that up. So that's, you know, that's something that's concerning. All three of those risks are still there. And what we have to do in markets are this volatile, are demand a higher margin of safety, but take a step back, increase our time frames a little bit, and think about what are we pretty confident

is going to be working in a year from now because rates volatility is so high, macroeconomic uncertainty is so high, that trying to really nail that one in three month call seems like, you know, not something we should be devoting as much of our energy and our risk capital to right now. I want to zoom out for a second,

and I want to start this question with Luke, and then I want to get Neil's answer. But I want to zoom out because, yes, we don't know what happens day to day. It's hard to tell a story. But if we zoom out a little bit, obviously, these incredible tech boom that we've seen or the growth stock boom has clearly,

I think it's safe to say, like, come to an end. I mean, it's incredible contraction, hundreds of billions of tech wealth, lost. For a lot of people, like, this is something they've never seen before. We've arguably had like a 12-year tech bull market, a tech, a bull market and growth. Like, what's the big story about this rotation and the turn? So I think the big story does have a lot to do with the macro environment, aka the move and rates and the move in rates volatility. I think that's something just on a correlation basis. If you kind of plug in what you think should be moving,

stylistically based on what rates are doing, that rates are to a certain extent driving the bus. Before you go, just real quickly, for people who don't understand it, we talk about this link a lot. It's like, rates are going up so you sell Facebook or you sell ARC. It's not intuitive. Can you just walk through for listeners in a sort of brief form, like why there's this connection between rates or rates volatility and the sort of like violence of the tech market sell-off? Totally. So I think there's some competing explanations. I'll go with my preferred and it has less to do with like the, it has less to do with the long duration discounting stuff. This is, this is more about, I think generally speaking, our rising rates are a function of an environment in which nominal growth outcomes are, you know, expected to be improving and are, you know, fairly firm. You can, you know, quibble about that now, given how much of it is related to kind of negative supply shocks, potentially. But that's a kind of brief shorthand for why should rates rise?

Rates should rise because things are good and things are good enough for central banks to remove stimulus. And that's a generally speaking, you know, an okay environment for growth. If growth, if economic activity is doing well, then you don't need to focus on kind of the things that might be revolutionary or innovative or be, you know, turned from a who knows what it was into a verb like, Googled 10 to 15 years from now, you can focus on, okay, I know that energy companies are able to produce X oil with X margin, and they won't be producing more than that. So prices are going to stay within X range. And that looks very good for me right now. And we prefer that to speculating on something that might or might not be good 10 years from now. So that's my preferred explanation of how rates kind of affects the growth versus value argument or spectrum there.

So that's that's the headline story there. But I also think there's a broader issue, both related to growth, but also related to the idea that the kind of there's a bit of growth convergence to be expected as you as you come out of COVID. I think this is something that, you know, you've covered a lot, Joe, in that just the kind of the pandemic premium, both in multiples, is kind of come back. But it's coming back in earnings as well. And when you have more and more tech companies talk about kind of, you know, right sizing staffing levels or things like that, that to me translates into environment in which, you know, growth companies are no longer prioritizing growth. They're turning on some other tap, but it isn't gross. So it's a bit of a stylistic change that the group itself is undergoing right now. And, you know, when when there's style drift within a cohort that might get investors to question whether the, you know, whether the thesis they've applied to the group is still valued. valid and that's something we see as an ongoing process right now. I mean, Neil, I'm curious your take on that. I mean, you've been talking about the reopening a lot. I've had a million IBs with you where you point out that like Peloton is going down and Planet Fitness, the actual gym where people

go and work out in person has been surging. I'm curious, sort of your take on the same question of this sort of like bigger shift that we've seen in markets really since, I guess, November. Well, I think, I mean, I think a lot of this just comes down to the policy response, right? I mean, the policy response following the financial crisis period was not particularly robust, I think you could say. And as a result, you had a very, very, you know, not weak, but just a not particularly strong nominal growth environment. I think we were basically hovering around four and a half percent for years. So that kind of churned the wheels of a very steady recovery. So things are always getting better, but we never really had that V-shaped recovery.

And so as a result, I mean, in that kind of environment, growth is not widespread. And so you have performance in the markets kind of narrow to a specific group of companies that can drive growth in that kind of an environment. By contrast, I think in this period, we had a very robust response. I think through a myriad of sort of fiscal support programs, I mean, the government was basically able to deliver, you know, a higher minimum wage to people without actually doing it legislatively. And, you know, the Fed basically put both of its feet, planted firmly on the accelerator. And so, you know, I think that's been one reason why you've had such a strong nominal growth backdrop. And so growth is more widespread.

And so as a result, it's not going to narrow to a handful of mega-cap tech names. Obviously, the pandemic is important, as you mentioned. I mean, I sort of pose that question to our clients as well. It's like, what if what we're seeing is really just the last gasp of the pandemic unwinded? You know, I mean, I think it's more to it than that. But, you know, I mean, remember back in 2020, I mean, people were making the argument like the stock markets are just whistling past the graveyard. And in reality, I think the stock markets were actually following a script that made a lot of sense. I mean, if you look at online retail sales, they were very strong.

Guess what? Those companies did really well in 2020. And by contrast, brick and mortar retailer didn't do particularly well. Restaurants didn't do particularly well. And they were punished. So it wasn't like the market was just, you know, turning a blind eye at all these things. I mean, the market, frankly, I think, was evolving the way you'd expect. And, you know, now a lot of that's working in reverse, right? And that is probably better for the economy, but it's not necessarily the best thing for some of these trades that had been put on over the last number of years.

Neil, you mentioned financial conditions at the start of this conversation. And this is something that a lot of people are talking about as well, this idea that the Fed has explicitly said that it wants to tighten financial conditions. And one part of tightening financial. conditions or one component of financial conditions. One of the things that hadn't moved that much or tightened that much was stocks. So I guess my question is, how is the Fed thinking about stocks at the moment or how do you think the Fed is thinking about stocks? I think they're probably encouraged to some degree that the multiple has come in quite a bit. I mean, obviously the earnings backdrop is quite strong still. And I believe projected earnings have continued to go up. And so you know, I think they're probably looking at the sell-off inequities as a good thing. Obviously, if demand is running really hot and financial conditions ease more,

that means that demand is going to get even stronger, which means that their inflation outlook will deteriorate in their mind, right? So I think they welcome some tightening in financial conditions. And as I mentioned, I mean, the financial conditions tightening that we've seen so far is not enough, in my view, to really send the unemployment rate meaningfully higher. I mean, you know, we can talk about the folks over at Cameo laying off some tech workers. But, you know, I just don't see it as enough to really weigh on the unemployment rate. At best, the unemployment rate probably flattens out in response to this tightening of financial conditions over the back half of the year.

But, you know, I think in my mind, I mean, the Fed welcomes the tightening. And given the kind of inflationary environment that we're in, this sort of idea that there's this, you know, put out there that the Fed will have your back. I mean, the strike price on that put is a lot lower than it used to be. And that's, again, it goes back to this idea that, you know, in previous episodes, when the equity markets were faltering, the growth outlook was faltering quite substantially as well. I don't think that that's as compelling this time round. And in an environment where inflation is still high, I think it's really a no-brainer. As Powell mentioned this week, their goals aren't in tension. Right.

So, Luke, I want to bring you in on this point because, I mean, to me, the Fed never explicitly said that we want the stock market to go down, I mean, for obvious reasons. But they said financial conditions need to come down. the only thing in the financial conditions indices, as I mentioned, that had been staying up was stocks. Why did it take so long for the market to sort of accept this message? Because it did feel like Neil just put it as a bit of a no-brainer. Yeah, I find it interesting in that, you know, stocks were, and you can argue they still might be, but since, you know, more or less early February or late January stocks have been kind of stuck in a boring range. You've just been going.

from the bottom to the top of that range. I think it was more about the inertia with that. I also think it had to do with, you know, despite all of this and despite a, you know, pretty big re-rating early in the year, like earnings have been coming in, you know, quite, quite fine. The guidance outlook might be getting a little more dower in part because of the strengthening of the U.S. dollar. There's your financial conditions right there, as well as, you know, headwinds related to China

and Ukraine. but I think it was a lot of complacency about the range we're in. But our view was that as we were getting to, you know, around those levels, around top of range, that those are good places to be selling stocks. What became more challenging is like when we get to the bottom of this range, as we had lately, like does it still make sense to be underweight stocks? And the view there is that, you know, although we've had multiple compression, a lot of it, We've had multiple compression at the index level, essentially to pre-COVID levels.

We also have rates more than 100 basis points higher. So your layman's equity risk premium would suggest that you're still not being compensated enough for the risk that either the Fed over tightens, that China is a persistently larger drag on the global growth outlook for longer, or that's kind of supply constraints. Twain. It's Twain. It's Luke's dog, Twain, who's adorable. Yes, you can hear how adorable he is.

But, yeah, so or you have essentially, you know, Russia, Ukraine, exacerbating, you know, supply constraints there. So, you know, our view, though, has been, even at the start of April, say, when you had, you know, stocks doing pretty well, even then you still had dollar at, you know, highs of the year, 10 year yields at highs of the year, mortgage rates rising. The kind of tightening that's going to show up more in the forward outlook is going to come to come. much more from what's happened, you know, in mortgage rates and the kind of knock on effects to housing, then it will from the S&P 500 going from 4,600 to, you know, 4,200. So in terms of the Fed tightening the type of financial conditions that matter in a way that kind of influences the forward growth outlook, a lot of that, you know, we'd argue was in place even before kind of stocks woke up to the idea that, you know, can't sustain these kind of multiples at

at these kind of rates with the growth outlook that's, you know, still positive, but slowly. You know, on the mortgage rate back up, I mean, I think it's worth pointing out that this is a highly unusual housing market. And I think Luke would obviously agree with that. Certainly Twain agrees with it. But what I will say is that when as economists, business economists, when we talk about housing, we're really talking about three things, right? I mean, it's residential investment. that's what is booked into GDP. And residential investment is really three things. It's sales, which is broker commissions, and then it's construction and housing renovation

spending. Those are the three things that go into residential investment and the broker commission piece of it or the sales piece of it. That's only a fifth, okay? The rest of it is renovations and construction. So what I think it's important for viewers to know is that even though rates are backing up, residential investment, the likelihood is that it's still growing. It's still contributing to GDP. If you look at the gap between housing starts and building completions, there's still a yawning gap.

That means mechanically that units under construction will continue going up. And as units under construction keep going up, that means construction spending will keep going up, which means that residential investment will keep going up. And to the extent that rates have backed up and that's creating some spatial lock-in effects, you know, you can make a pretty compelling argument that, you know, people that wanted to move, maybe they spend more money on their existing home. I mean, I certainly think that's consistent with a lot of the anecdotal stuff that I'm sitting here in my neck of the woods. But, you know, look, I mean, I get why Luke is so concerned. He's a potential first-time buyer.

That's not everyone. For most people, your real cost of shelter is collapsing because your mortgage rates are fixed and everything and your mortgage your mortgage monthlies are fixed. You know, we know that adjustable rate mortgages are not nearly as substantial in terms of a share of debt outstanding as they were back in the 0405 period. You know, so your real cost of shelter is declining for most people. So it's not, you know, as I said, I mean, yeah, the rates back up, yes, that's an unambiguous negative. But I would be a little bit careful about extrapolating how much that's going to do to overall residential investment, which will still be, in my mind, descending in real terms. Yeah, hey, I'll definitely agree with, you know, someone was asking me, because I've been,

I've been pretty optimistic about the economy, but it's heard to get a little more pessimistic. And they're asking me why. And I said, you know, I'm essentially the modal millennial. I thought I was convinced that this cycle was going to be the one where I got into homeownership. And now I'm no longer convinced. And, you know, extrapolate that across the economy. Now I'm a, now I'm a little less, less optimistic. So I, I, I do agree that this could be certainly a case of me over extrapolating my personal circumstances and definitely agree. Neal's been quite rightly banging the drum that there's a lot of pent up production coming

to housing in particular. But the counterfactual of rates having not done what they've done due to the kind of the Fed signaling a quick and expeditious move higher in rates, it would have been in a definitely a brighter environment, both for home prices and for first time. potentially activity going forward on both ends. So, you know, I think it's, you know, the counterfactual is, seems also clear. Today's show is brought to you by Vanguard.

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Can I ask about one area where I, another area where I think you guys disagree a little bit and correct me if I'm wrong. But I think Luke at this point in time is more bearish on what's going on with China and the Chinese economy than Neil is. Could you maybe explain your, I guess your respective thinking around what's going on in China? We've seen, you know, parts of the country basically shut down because of COVID-Zero policies. We've seen some supply chain issues and things like that. And there seem to be varying opinions about how much that actually matters for the global economy, how much of those troubles are going to be exported to the rest of the world. So why don't we start with Neil?

Sure, Tracy. Well, I'm not, I don't consider myself an expert on China. I try to stick to my knitting. But what I will tell you is it's hard for me to see conditions in China getting some substantially worse than they are right now. And so for me, it's about what the blowback is to the U.S. economy. And so, you know, my sense is that the situation in China can't possibly get any worse than it is right now.

And, you know, my sense is that it gets somewhat better from here. And that'll be a tailwind, I think, for global demand and will help loosen supply chains in 2023. So that's sort of how I'm thinking about it. Lou? Yeah, I think I think my main difference is that just there's a somewhat of a degree of caution warranted. And it's kind of almost similar to the inflation story. When inflation surprises to the upside for so long, so long, so long, and forecasts are slow to adjust, then the burden of proof is higher on the other side. The burden of proof for thinking inflation has come down should be higher because you've been kind of beaten over the head with the mistakes of the past. I think that's very much the case. right now from a global macro perspective in terms of in terms of looking at China. I think, you know, pretty much everyone could point to five or six forward-looking catalysts that would have inspired a lot of optimism on China over the past, you know, five or six months.

And it's been the kind of the story of Lucy pulling the football away from Charlie Brown each time, whether it's the, you know, underperformance so large in 2021 that, you know, forward performance should be good. Hey, you've got the, the Chinese Party Congress. coming up in November, you're probably going to get kind of firming of growth and the stock market ahead of that. Or hey, coming out of the Beijing Olympics, you should really see this kind of, you know, this end of blue sky policy, this pickup of industrial production in a way that kind of supports and underpins the real estate market. A lot of these things can still happen, but I think the thing is when China has kind of consistently disappointed on the macro side,

and in a lot of cases, through no fault of its own. But in a lot of cases, through policy responses that global investors do not have a lot of visibility into, then I think the threshold then for saying, hey, China's decisively turned around should be higher. It is something that you should approach with a little more caution, even if, you know, I would tend to agree with Neil that, you know, the six months, 12 month, are things better or worse? Probably better. But how bad can things get in, you know, two to three weeks in China? I think we've seen in the volatility in that market, things can move quite abruptly to the downside. So, you know, I think it's a case of why not be a little late to the China upside surprise party.

Right. I mean, I would just point out, though, that I think it is worth pointing out that outside of China, emerging Asia looks quite good. I mean, if you look at, you know, for example, the PMI data outside of China looks pretty healthy. If you look at mobility data outside of China, it's been up into the right. So factories and the rest of Asia are open. A lot of final assemblies already leaked out of China, which could be one of the reasons why the supply chain effects of this haven't been as onerous, frankly. I mean, at least on the U.S. economy. I mean, the impact of the Delta variant spreading all over Asia was a lot worse for U.S. you know, producers delivering goods to consumers here than what we've seen later.

lately. So, you know, I think if the U.S. I mean, the way for me I remember guys, I'm trying to bring it back to the U.S. Because that's my, right. That's, I'm trying to stick to my knitting here. And my sense is that China will reaccelerate. I mean, whether that happens in one month, two months, six months, it's going to happen. We know that Europe is, frankly, a lot more connected to China than, than the U.S. is. I mean, Europe is a very large open economy that does a lot of trade with China. So if China is improving, it stands to reason that Europe will as well. I think that's a 2023 story. But that, remember, that dramatically, dramatically undercuts this idea that the U.S.

isn't going to go into a recession in 12 to 18 months. You want to call for a recession in the U.S. at a time when China and Europe may be accelerating? That to me is ridiculous. us. Okay. And so we're obviously not going into recession this year. And so I think that's something to keep in the back of your mind. And that may be, you know, I mean, this is why, again, it goes back to what we've talked about earlier to start the program, right, is that it's a very bizarre period for financial markets. I mean, the moment the bond market basically priced the recession probability out is the very moment the stock market started pricing one in. Well, so actually, so I want to actually

talk about U.S. assets again and start with Luke because obviously a lot of people are looking at their portfolios. Maybe they're looking at their 401Ks. Maybe they're looking particular at their target date retirement funds and they're obviously sitting on a lot of losses so far year to date. And what's when you know, we talk about financial markets being weird. What's new is not just that stocks are down because stocks sometimes fall. It's that the bond portion of people's portfolios is also down what for what used to across the last several years performed as this nice hedge stocks go down bonds go up has not working it stocks down and bonds down because of the rate increases what does that do luke how does that change the thinking of portfolio management when the sort of these asset allocation

models that worked extremely well one part goes down while the other part goes up are no longer working. First off, if you're in an environment where more things aren't working, it's, you know, it's gross down. It's not being, it's, you know, not taking large tilts in any one direction. It's kind of, it gets back to a, you know, more of a risk control and prioritizing relative value environment. That's, that's step one. Step two, though, is expanding the kind of the range of possibilities. And one reason, obviously, why bonds have been doing so poorly is because commodity prices have been doing so well. So our view is that both as a kind of a defensive ballast in portfolios, as well as kind of the structural growth opportunities, particularly in the industrial

metal space, that, you know, commodities are still a good place to be. Right now with kind of questions about demand, it's not necessarily something, you know, aggressively adding to at the moment. But kind of on a forward-looking basis, you know, think of it this way. It's almost, it's almost incompatible to think, you know, inflation is going to normalize all the way to 2 percent and that we're going to have the necessary investments in developing commodities and in using them to support the green revolution that we're able to get, you know, some semblance of energy independence. Those two things seem, you know, fairly incompatible. So in that kind of environment, that augurs for more of a structural increase in allocation into commodities,

which have been a very unloved asset class for such a long period of time. So that's something that's helped offset the correlation go-to-one environment that we found ourselves in. They say abs are made in the kitchen. Cool, but who has time for three hours of meal prep and a fridge full of Tupperware? That's why I started using Factor. Factor delivers fresh, never-frew. frozen, ready-to-eat-eatian designed for balanced science-backed nutrition. No prep, no cleanup.

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A new era of 5 TV. It's streaming, but it's still TV. Well, glad that's settled. Bell, connection is everything. Well, Neil, I mean, obviously, you know, we were talking about mortgages earlier, But where can rates go? Can they keep going higher? I mean, particularly at the long end? You know, you know, I think so. Why? I think we're in a strong nominal growth environment. And, you know, look, I mean, if you think about where rates were the last time, I mean, the Fed ended 2018 at 2.37, right, I think it was a two and a quarter or two and a half. That's where the funds rate was. And we were in a four and a half percent nominal growth environment at the end of 2018.

And the Fed promises to, well, not promises, but they're guiding for something like that this year. And we'll probably be, I mean, you know, let's say inflation is around three to three and a half percent. I think real growth will be around three, right? That may be a little bit more. So you're talking about something north of a 6 percent nominal growth environment. So if you're going to ask me, do I think equilibrium funds rate is higher? Yes, I do. Remember, it wasn't that long ago where the Fed thought,

When they first started doing this, you know, the SEP, the summary of economic projections, they thought that they thought equilibrium funds rate was four and a quarter, four and a quarter. With debt service ratios a lot worse than they are now, with labor markets a lot more sluggish than they are now, with business investment a lot weaker than it was than it is now. Oh, and by the way, households are sitting on, you know, an excess savings pile, you know, over $2 trillion. and us hitting the most favorable demographic patch that we've seen in our careers. So yes, if you're going to ask me, do I think equilibrium rates are higher, the terminal funds rate is higher, yes, I do.

And that makes me crazy, you know, so be it. But, you know, I mean, I think in the near term, there's probably some opportunity for fixed income, right? I mean, you know, it's one of these funny things that you've seen, right? It's like, it's not risk parity. It's risk parity. But, you know, I do think, I mean, look, I don't think there's much more the markets can price in for the Fed right now. And I think that probably, you know, helps, you know, the soft landing, the softish landing case that the Fed wants to tell.

But I think whatever pause we see, you know, after they get to neutral is, you know, the next move after that is going to be additional hikes. So to like to piggyback somewhat on what Neil saying and you know for right now right now our stance is that you know better to be neutral the long end just by virtue of you know how much has been priced in already. But one thing that's clearly different this cycle versus the last one is that the the global nature of central bank tightening and what that's doing to global term premium. So you know starting in 2012, you have the you know, BOJ really cranking up QE. You have the ECB, BEO, joining not too long, really cranking it up. After that, this cycle, that's essentially all going in reverse. And even in the face of a pretty big shock to potentially real incomes and growth, the ECB is telegraphing a move out of negative interest rate policy,

this is something that is, you know, clearly going to push global term premium higher and has the lot. So if you go back to Lale Braynard's speech about quantitative tightening in early April, a lot of people were focusing on is, you know, this is something that's going to drive, you know, global bond markets. Well, boons have underperformed since that period of time. We're in an environment where the fact that the ECB is kind of signaling what it's signaling, and it seems that every day there's a kind of pulling forward of some kind of ECB-related tightening messaging, that's what's driving still the busts in global bonds. So if you look at lately, And one thing that honestly, I found a little bit confusing in the aftermath of the Fed is that U.S. bond volatility, implied volatility, hasn't really calmed down too much. And it might be that U.S. bond volatility can't calm down because of what's happening across the pond.

I have what is perhaps a dumb question. But can everyone tighten at once? I mean, I know everyone can technically tighten at once. But does it have the same impact? Because back when we were easing many, many years ago, we used to talk about competitive. QE and sort of competitive devaluations and things like that. So does it have the same impact if everyone is doing this at the same time? I would argue that because like last time you had a much more focused impact on the U.S. because essentially, you know, the U.S. was the only one tightening, dollar up, and then you know, dollar up also kind of exports tighter credit conditions to the rest of the world. So we have everyone going this time, but the dollar still, uh, with a lot of strength and largely due to still like very good growth differentials and the kind of possibility of more left tail economic risks in

Europe and China that still, you know, exist to varying degrees. But, you know, I would think conceptually in theory, an environment where everyone's tightening is on net kind of is less tight than the counterfactual. It's actually easier to go if it's synchronized rather than if it's kind of one country in particularly U.S. centric. Yeah, I mean, the one thing I would just add, I would tend to agree. I guess the one thing I would add to that is, you know, when you look at the dollar performance, you know, right now versus, you know,

let's say back in 2014 when, you know, like Stan Fisher was making speeches about what the dollar impact is on GDP growth and inflation, you know, what's interesting now is just, I guess is the differentiation that I'm seeing in some of the in some of the dollars performance. I mean, obviously, uh, the dollar back then was like rallying against pretty much everything in, um, you know, and here it feels like, uh, it's more like DM related. I mean, so it's obviously the dollar is very strong against the euro. It's very strong against the yen. But if you look at some of the emerging market commodity currencies, I mean, to Luke's point about how well commodities are done, those currencies are actually hanging in

there, you know, um, and that's been something that's been a bit different, um, than what we've seen, you know, saw before. So I just think that that's interesting. But generally speaking, yes, I think it's much easier on the Fed if everyone's also hiking. I know we have a few more minutes here. You know, again, people looking at their portfolios, obviously we've talked about it a ton, tech and growth getting clobbered, et cetera. Luke, when, and you know, you're talking about, okay, in this environment, maybe the answer is commodities exposure. It's sort of like the one thing that's breaking the all correlations go to one. But, you know, and I look at some of these tech names and SPAC names and all this stuff, I just see like a complete, like, in some cases,

it's a much bigger massacre than probably people are ever imagining. And stocks down 95% in many cases for brands that people know. What would be the conditions in which one would start looking back to this area that's gotten hit so hard? What would be the sort of either macro conditions or flows that you'd look for, to say like, okay, maybe this has been enough and start looking for opportunities. So the, and the difficulty in so doing just as a starting point is the fact that, you know, if you go from a, you know, 100 P to a 50 P, well, you're still a 50P. Not exactly. So that, you know, that's, that's a bit of a challenge here.

What would, what would kind of warrant it is a, is a larger pricing of a recession risk, certainly. So right now in terms of like if you look at what's the, you know, what's the hump in the in the euro dollar curve or anything, it's not it's not material. It doesn't suggest, you know, traders ascribing a lot of odds to a material cutting cycle from the Fed after this kind of quick series of hikes. If that were to grow larger at the same time as you get as the same time as you get kind of more visible slowing in. in the U.S. and the global economy as well, you know, that would be, that would certainly be something. Goods demand clearly coming off the boil. And it, to be to be fair, goods demand, you know, in terms of PCE basis, like hasn't really, you know, done too much for, for about, for about a year now. You know, that's something that, you know, should the, should that side of the, you know, economy slow more, that's something that's going to, I would suggest probably prompt investor attention to turn back more to growth names.

But I think the fact that it hasn't happened yet is one of the signals, along with the Euro dollar curve, that there's not a lot of recession risk being priced right now. And that's something that's odd to think about as stocks being as volatile as they are. But I think that's something to hang your hat right on right now in terms of looking at the forward outlook. Neil? Yeah, thanks, Tracy. Well, I would just, I mean, look, the equity markets, the setup really does look very much like a late cycle type of dynamic. Now, obviously, there can be multiple sort of market cycles within a broader economic one.

But if you look, I mean, for example, defenses are outperforming cyclicals. We've seen utility stocks better bid, staples, better bid. we've seen significant selloffs and discretionary. I would just say that there's only so long that the markets can price in a late cycle dynamic and then not actually happen in the economy. So if you're thinking about something like strategic asset allocation, my view would basically be to use rallies and defensive positions as opportunities to add to cyclical ones, because I do think that's probably the next leg of the market cycle.

So that's sort of how I'm thinking about it. When I look at the broader economy, as I say, I mean, bringing it back to the U.S. economy, there's really, you know, my concern dial is not particularly high. I mean, it's sort of interesting to see like cell side analysts tripping over themselves to see who can pencil in the highest recession probabilities over the next two years. But, you know, in my mind, it's really no higher than it normally is. I mean, what would actually decline if you were to have a recession? like housing is we're talking about how we don't have enough cars and we don't have enough homes so what goes down commercial real estate that's already as low as it could possibly be relative to GDP so i mean it could be i guess you could make the argument of durable goods but even there you know things like motor vehicle sales have basically you know as a share of of consumption they've already kind of reverted to trends so you know i just don't really see it i mean what are we going to talk about the great household furnishing recession of 2020. It just doesn't make a lot of sense to me.

And that's why I say, if you're in, if your asset allocating here, I think we're at a point now where it's probably, to me, it makes sense to pick up some of these cyclical names that have been quite beaten down. And as I say, I mean, this is something that Luke pointed to earlier. But if you think about the markets, it's been three things, right? It's been. in the Fed. It's been Russia, Ukraine. So the situation in Eastern Europe, it's been China. Okay, so like take each of those in turn, the Fed. The Fed, in my mind, is going to be less a source of instability for the financial markets over the remainder of the year. I mean, Powell has basically given us forward guidance for the first time in a while, right? I mean, basically 50

basis point moves followed by there's a little bit more certainty in the Fed outlook than there has been. And, you know, we talked about China. I think I even got Luke to, again, is that China will look better in the next 12 to 12 months. But if China's looking better in the next 12 months, then Europe will too. Right. So those three areas that have been beating down the markets and creating this sort of instability and volatility that we've seen, I think that's likely to obey. So that's why I say, if I have to make a market call, that would be it.

Well, you guys are great. This could go on a lot further, but we've got to leave it there. Neil and Luke, so much appreciate you. coming on odd lots to help us understand what's been. I mean, we say it's been a busy week, but really an extraordinary year so far overall. So thank you for coming on and helping us make sense of the world. We're going to stay on and keep bickering. Yeah, okay. Please record it. Then send us the audio. Thanks so much, guys. That was really fun. Thank you. You know what that conversation made me think this is going to be a meta point and then we could get to the substance. The best sort of

discussions are between guests who agree on a lot and share a lot of the same premises, but disagree on a few key things. Right. You have to sort of like share a common like assumption about how the world works. Those are the best conversations. Right. Because otherwise it's often two people talking past each other. Exactly right.

And that was not, they were not talking past each other. Well, I got to say, I can't believe we hadn't had Neil on before, but he's great, obviously. And Luke, every time we have Luke on, I'm so proud because Luke used to be our colleague. And I just love actually, you know, he used to write for our team. And I love the fact that he's now a guest on all thoughts talking so knowledgeably about macro. Yeah, a little tear coming to my eyes thinking about Luke's trajectory. But yeah, no, I thought that was really helpful.

I mean, so many like interesting points. I mean, you know, Luke brought this up that I hadn't really thought of. But, you know, it's interesting for all of the double dip or not double dip, but like, soft landing, hard landing fears, like actually so far, like the classical recession signals, and they talked about the Eurodollar curve, like the market is not really pricing one in yet. Right. It seems like stocks have overreacted compared to fixed income. But the other thing, I mean, the other thing I keep thinking is just how, I don't want to say obvious, but yes, obvious is the word, how obvious it was that there would be a correction in stocks at one point.

Because, I mean, the Fed, we spoke about this. The Fed hasn't explicitly said it wants stocks to go down, but it talked about tightening financial conditions. And then, you know, for years, we were talking about valuations were frothy, that this was something that was going to start reverting once interest rates start hiking. And then, lo and behold, they did. Right. Like, I think the surprising thing, it's never easy in real time to make trade.

So you're just never like, oh, now here comes an easy trade. But I would say the sort of surprising thing is if you look at it, you know, at this sort of narrative of what happened this year, it's kind of straightforward. Inflation picked up and the Fed said, okay, now we're going to go in a hiking cycle. Oh, and P.S., the way that we control inflation is through financial conditions. And so we're going to like do this. And stocks are part of those. And the stocks are like a key part of financial conditions. It was the obvious trade. Just teleport me back to November or January when the Fed started pivoting and I could have been a genius.

Yeah, I guess it's like the timing aspect is the most mysterious of all of this and why, you know, why we saw a rally on Wednesday after the hike actually happened. And it wasn't until Thursday that stock started dropping off. That's the only thing that remains something of a head scratcher. Yeah, the week was super weird. That's for sure. Yeah, it was. Shall we leave it there? Let's leave it there. Let's go take a break and, you know, let's head into the weekend. All right. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway. And I'm Joe Wisenthall. You can follow me on Twitter at the stalwart. Follow our guests, Luke Kawa. He's at LJ. Kala. Neil Duda isn't technically on Twitter, but I think he often contributes to the handle of his firm Renaissance Macro. They're at Renmac LLC. Follow our producer, Carmen Rodriguez, at Carmen Armin. Follow the Bloomberg head of podcast, Francesca Levy, at Francesco today and check out all of our podcasts at Bloomberg under the handle at podcasts. Thanks for listening.