Odd Lots - Matt King on the Hidden Forces Driving the Market Selloff

Episode Date: August 5, 2024

The Nasdaq is now in correction territory and the S&P 500 is down more than 2% so far this month. Analysts are blaming any number of things for the selloff, including a slowdown in the economy, the Federal Reserve being behind the curve on rate cuts, hedge funds rotating out of positions, and waning enthusiasm for AI. But Matt King, the former Citigroup strategist who's now founded his own research shop called Satori Insights, argues there's something else going on. He believes that the world's central banks have only really just begun to drain liquidity from the system, and that the market is still sensitive to the push and pull of their big balance sheets. In this episode, he explains how central banks have pulled the plug on risk assets, why stocks are faltering now, plus his general approach to analyzing markets. For more on what Joe and Tracy talked about in this episode:https://bloom.bg/3A2c6TVhttps://bloom.bg/4dpfVkzSee omnystudio.com/listener for privacy information.

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I didn't know that. Why is it your favorite time of year? I like August too. I love summer, but what's your reason? Well, actually, it's exactly that. I love summer, but... This is why we get along. There's an added layer. Can you just say, I don't like people who have favorite seasons of summer. I'm skeptical of that. You know what? I used to be... I judge people.

Okay, that's fine. I used to be exactly like that. However, I found that as I've gotten older, I've kind of come... Maybe as I've gotten older and acquired a house without air conditioning, I have also come to appreciate winter a little bit more. Okay. I didn't actually mean to start talking about the weather. But there's another reason I like August, which is I feel like that's the month when weird things in markets start to happen. Yeah. August through October feels like that's the three.

month stretch where anything can happen. Yeah, and August especially, you know, people are on their, like, mandated two-week leave. If you're a professional working at a bank or something like that, you have to go on leave for, I think, two weeks or something like that every year. And there's lots of illiquidity in the market. So, you know, tiny little things can end up having a big impact. And I feel like August is when you get some of those strange market moves. And speaking, Speaking of strange market moves or at least dramatic ones, in recent days and weeks, we have seen some interesting stuff happening in the market that has been different to the pattern that has played out for the past year or so. Totally. First of all, we've had a little bit of weakness. I've had a little bit of rotation that people are talking about some of those red hot tech stocks have come down. We're seeing a lot of moves on the curve. At the time we're writing this, the 10-year yield is back below 4%. So, I was just saying in the odd lots discord, which people should go and subscribe to and hang out,

I literally said this morning, macro feels like it's kind of getting interesting again. Absolutely. Both macro and markets, I got to say. And there is this ongoing conversation about how much of what is happening in markets at the moment is technically driven. So, you know, maybe some of those pod shops having to cut some positioning versus people actually reacting to changes in the macro outlook. And I should just say, we are recording this on August 1st, the day after the Federal Reserve meeting, where, as expected, they didn't cut interest rates, but they

certainly telegraphed an upcoming cut. So lots going on there as well. And the day before recording this the day before non-farm payrolls. So by the time you're listening to this, we'll know a little bit more about the labor market. Yes, we will. So there's a lot going on. It's August. There's the potential for even more stuff to happen, weird stuff sometimes. And I have to say when it comes to diving into the intricacies of the market and what's going on there, there's a person that I very much like to speak to. We've had him on the show before. It is Matt King, formerly of Citigroup, and he's now started his own research shop. It is called Saturi Insights, and he is the founder and global market strategist over there. So we're going to talk to Matt about what's going on in markets, what the outlook is right now.

Matt, thank you so much for coming back on all thoughts. Thank you for having me. You're much too kind. Well, we are very excited to be speaking to you again. There's a lot that's happened since we spoke to you last. I think it was maybe in March of last year. Talk to us about what's happened. So you've set out on your own.

You have this new thing called Satori Insights. What are you doing over there? I'm doing more or less what I was doing previously, which is trying to explain what markets have done and what markets are going to do, and generally doing it in a rather different fashion from everybody else, as far as I can see. And I love your description of August, in my experience, either nothing whatsoever happens or as you say, quite big stuff happens. But I think that the biggest puzzles that I see people wrestling with at the moment are frankly making sense of what markets have done year to date. And therefore, and that's the context in which you need to see the change now. On the one hand, yeah, the economy is much stronger than everyone was imagining.

But on the other hand, markets have really done much, much better. And yeah, there's the whole AI story. But it sort of feels as though it's more than that. And I think the biggest puzzle is why financial conditions have eased so much, even as we've had ongoing QT, even as we've had rates at 23-year highs. And in fact, it was the main thing I was missing in the FOMC last night. Nobody asked Jay Powell about how they consider this easing of financial conditions, on one of the Bloomberg financial conditions in the CES just a couple of months ago,

we were showing easier conditions than 2007. And I think you need to get your head around what's been driving all of that before you can then come back and think about the outlook and what markets are doing at the moment. All right, what's the answer? Tell us the answer for the state of financial conditions, because it does seem weird. And, I mean, I think we've probably been talking about this for almost two years on the show, the surprise that perhaps Fed rate hikes and the slow wind down of the,

the balance sheet hasn't had at least here to four more of a deleterious effect. So at the risk of being cheeky, it's exactly that same thing, which I heard you say had been debunked on one of the previous episodes with one of your other guests. So thank you for listening. I appreciate, I'm glad. Even though I personally offended your approach, which I apologize, I appreciate your listening to odd lots and I appreciate you coming back. And I say that nothing has ever debunked in markets because I actually don't feel that way.

Joe is open-minded. And just to be clear, what we're talking about in terms of the debunking, it was the idea that central bank liquidity was driving asset prices. That was the idea, which Matt is very much your approach to analyzing markets. And I was not offended either. Indeed, you became the subject of a footnote in one of my research pieces making the counter argument. Life goal.

I think that the standard view. of what's been going on is, oh, the economy must be much stronger than everyone thought previously. It must be that R-star and neutral rates are higher. But then there are a couple of puzzles. It's like, oh, well, how come actually desire to borrow and credit growth are really quite limited? There's lots of gross issuance, but actually net borrowing is really rather lackluster. And how come many of the R-star models, the most comprehensive ones, don't really show this big pickup in neutral rates?

And then how do we make sense of the recent weakness, especially in things like credit and emerging markets? And so again, the sort of standard explanation is maybe, and there was a nice academic paper on this recently, which maybe QT is just not as powerful as QE. Maybe there's some big asymmetric effect going on. And it was a lovely argued paper that I happened to think drew all the wrong conclusions. And as usual, I start from not knowing anything about this. I just look at my charts of what markets are doing and I try and make sense of them. But the way it seems to me is that market sensitivity to central bank balance sheet changes, really hasn't changed at all, that most of the time when we thought we were doing QT, actually we weren't. And indeed, a lot of the time there was almost this stealth QE effect going on. And this is a lot of the reason why financial conditions have been so easy, notwithstanding all of the rate hikes. And the right way to think about this is in terms of not the security side of the central bank balance sheet, but the changes in reserves.

And once you start thinking in those terms, you look globally and you say, well, since 2009, We added $18 trillion worth of reserves or liquidity, and we've only dialed back about $500 billion worth. And even if we think more recently, as you say, more or less since last time I was on, since the last market trough in October 2022, even with the supposed ongoing QT, U.S. reserves have increased, not fallen by a net $250 billion, and global reserves have increased by $920 billion. And not only that, but the timing just fits so perfectly. And mostly, I think my charts argue better than I can here. But whenever reserves have actually fallen, so in 2022, markets fell.

Whenever they fell in, say, April this year, again, same thing. Risk fell back again. And that's a little of what's happened in July as well. Sorry, just to be clear on this, what are you looking at when you say that reserves haven't? Because if I look at just the pure chart of the Fed balance sheet on the Bloomberg, it's clearly gone down. It's lowest since 2020. So when you say reserves haven't gone down,

what measure should I be looking at? So for the Fed, you just want the straight reserves number that you're looking at, and you see a peak in April this year, and then levels have fallen off subsequently. And then I do the same thing globally by looking at reserves. Occasionally, it's slightly different, but basically reserves at other central banks, I make sure I don't introduce FX effects to the total,

and I look at the changes in those reserves. Again, you get a peat in April and then they've come off a little bit subsequently. But most of the time, the near-term market moves correspond really quite well with those. And even though we're getting a little bit of a decoupling at the moment and equities are trying to break away, it's interesting that you look at other asset classes, you look at credit, you look at emerging markets, you even look at things like Bitcoin. Basically, that correlation with the global reserves numbers carries on. All right, Tracy, just to clarify, if you look at the total size of the Fed bill,

sheet is gone down. But Matt is correct that if you look specifically at U.S. Reserve balances with the Federal Reserve, there was a peak in 2022. It fell and then it picked back up, peaked in April, and then gone down. So if you look at that measure, that's correct. And I should just say Matt mentioned his famous charts just then. And we're going to embed some of those in the transcript of this conversation. So if you are listening, then please check out the transcript as well because we will have those visuals to better illustrate the point. But Matt, just on the bank reserves point, could you walk us through preferably in excruciating detail exactly how an increase in bank reserves translates into higher asset prices? Is it the case that

when banks have more reserves, maybe they feel more comfortable lending? Maybe it changes people's risk preferences. How exactly does that translate into concrete market action? Wosa to the second than the first, but in general, I'm not sure anybody can do this properly. And I'm mostly looking at the charts and then reasoning backwards. So the most common explanations that you hear, and there's been another paper recently by Noriel Rubini, try and relate it to interest rate moves. And similarly, the Fed, when they talk about this, they always focus on the levels of reserves. And they kind of almost ignore changes in reserves once they assume that the level of reserves is adequate.

I think that is entirely the wrong way to think about it, intuitive though it may be. And likewise, I think thinking in terms of the impact on interest rates and then looking for that to cascade outwards, again, is wrong. And instead, the way I think you're supposed to think about it is that reserves are a neat way to capture the balance between how much money the private sector has gone. relative to how many assets are available to absorb that money. Now, in the case of standard QE or QT, that's kind of straightforward enough, you know that you are both giving the private sector more money in the form of reserves

and then giving them fewer government bonds or bills to hold. But I think this is also the reason why it's reserves and not securities that count, because even when it's other factors on central bank balance sheets going up and down, like the Treasury General account at the Fed, or like the reverse reprogram at the Fed, even when those things are seemingly innocuously moving up and down, they have this same effect. So if the TGA is going up because they have issued more T-bills and you have bought those T-bills, but then the money is locked away at the Fed in a higher Treasury balance, well, that's the sort of the same thing. You've taken money away from the private sector and there's less private money.

in markets, more securities needing to be absorbed. And as a result, what we get is a drop in the price of risk. And confusingly, where that shows up on all of my charts is not necessarily in a drop in the price of bond yields, where you might have anticipated or T-bill rates, actually instead, it shows up most clearly in the prices of equities, in the prices of credit spreads, and even occasionally in things like the prices of Bitcoin. And for me, the way you make sense of that, that's weird, because it's not like the Fed and the other central banks are buying and selling large amounts of credit or equities or certainly Bitcoin, but instead it's this ripple-through effect. It's that when they say it's the other way around and TGA is falling and I've just got more money

in my bank account because a T-bill matured, but there's no new T-bill for me to go out and buy, well, I get forced into buying something riskier. And you get this cascading effect where the guy that would have bought bonds buys credit and the buy that would have bought investment grade buys high-yield and the guy that would have bought but high yield buys equities. And you can't see all of those moving parts. It's sort of frustrating in that respect. But that's the only way I can make sense of these really quite consistent relationships, even from one week to the next, even when reserves are supposedly abundant, it's this shift in the bounds. And in fact, the chart of mine that I'm probably most pleased with this year

is the one that then links through from changes in reserves or central bank liquidity globally to changes in the mutual fund flows, the mutual fund and the ETF flows. It's this crowding in and crowding out effect as a direct consequence of changes on central bank balance sheets, which I think has been much more important than is widely recognized. And even as you try and make sense of the mutual fund flows, this year has been the second biggest year on record after 2021. We've had $600 billion of overall inflows. Again, for me, until very recently, that was being driven directly by this crowding out effect from the global central bank. preserves numbers. A lot of short daily news podcasts focus on just one story. But right now, you probably

need more. On Up First from NPR, we bring you three of the world's top headlines every day in under 15 minutes because no one's story can capture all that's happening in this big, crazy world of ours on any given morning. Listen now to the Up First podcast from NPR. What is the role of rate policy in your thinking because again, one of the things we're talking about right now is the timing of possible rate cuts, which doesn't directly impact some of these monetary aggregates, such as the balance sheet or the reserves specifically. But there is a lot of anxiety in the market, particularly today, again, about whether the Fed is going to be too late in cutting rates or etc. How do you think about that? Is that just in your view totally irrelevant? I didn't used to

think it was irrelevant, but it's sort of looking that way this cycle, isn't it? How come we've had all these rate increases and then you've not had a massive slowdown? And I think the way I think about it is, so it's always about money creation. It's always about credit creation. And normally that would be driven by the private sector. It would be you and me deciding to borrow or not to borrow based on whether rates were restrictive or not. And this cycle, on the other hand, has been different. the surge in credit that we had never came from the private sector. It came, if anything, from fiscal policy. And likewise, the surge in, say things like fund flows and some of these market effects

and the M-Zero or the reserves numbers, again, that was never driven by the private sector. It was never driven by interest rates. It was driven directly by these central bank balance sheet effects. And so the flip side of what I'm saying is that just as the rate increases, maybe had a negative effect that's lurking in the background and there's a bit of a long lag and you begin to see delinquencies picking up. But when we eventually get to rate easing, I doubt that that is going to do very much to stimulate private sector credit growth either. And ultimately, we may end up with more easing than imagined. Just because we're still extremely sensitive to

balance sheet changes, there never was that much desire to borrow on the part of the private sector even before all of the rate increases. And when we go back to additional easings, I'm not sure that's going to stimulate lots of private sector borrowing either. And this is part of a longer term shift where even as rates have been coming down for decades, the borrowing that there's been, the money creation that there's been, has in fact come increasingly from fiscal authorities and from central banks directly. And rates themselves have been effectively pushing on a strain. Can I play devil's advocate for a second, which is this time last year, the world was a light with talk of a potential recession. And one thing you would hear over and over again is,

you know, yield curve inversion. We've never had an aversion without an ensuing recession. This year, there is much, much less discussion about the risk of a recession. Couldn't this all just be people have changed their minds about the macroeconomic outlook and that is driving asset prices? Like a very simple Occam's razor kind of explanation for what we're we're seeing? It could be, and that must play some role, but in general, the timing doesn't fit. In general, the rally in the markets has come first, and then the improvement in the economic conditions has come later. I guess you can make an argument that economic surprises went negative, but in general, and the people are starting to worry about a slowdown. But I argue, markets are

always supposed to anticipate, but it's been stronger than that recently, even when you take something like earnings revisions, for example. Earnings expectations have been gradually increasing, but they seem to be doing so in response to, they're almost chasing the equity market higher by a greater extent than previously. And as I say, I wouldn't expect to have anything like the correlations that I do with the central bank liquidity. I continue scratching my head as to whether the effect could be the other way around. It could be the market that's influencing the central bank number.

and while the lags are a bit variable, basically, no, it doesn't work that way. But for me, fundamentals have become very much a lagging indicator. And this for me is all part of a longer-term story whereby up until 2012 or so, I placed an awful lot more emphasis on fundamentals because it seemed to be driving the market to a much larger extent. Since 2012, many of my favorite relationships simply broke down. So the lending surveys were no longer a good guide to what spreads were doing and what defaults were doing. If anything, it was the other way around.

It was spreads would rally first. And then the lending standards was ease afterwards. And the defaults that should have been taking place didn't take place. Or same thing in volatility space. There are nice relationships that used to hold with uncertainty. And since 2012, uncertainty has often been quite high on uncertainty metrics, a number of references to uncertainty in the news and things like that. And yet volatility most of the time has been super low. And all of these dynamics, to my mind, go together with this money creation-led pattern,

but where the money creation has come directly from central banks, and that shows up in my relationships. And the swings that we've had there are just really big relative to the sorts of swings that we get in money creation coming from the private sector, and that's why they end up dominating the market. Since you mentioned timing just then, let's talk about that a little bit more. So reserves peaked back in April. it wasn't until relatively recently that we really saw significant market weakness.

So why was there that gap? Why didn't we see equities falling earlier on as reserves started to come down? A couple of different things. So one of the reasons why Joe was sounding so skeptical on the previous podcast was because when, if you just look at U.S. reserves alone, sometimes they correlate, but they don't always you get a much benefit with the global numbers. And some of what has been going on is that there have been liquidity additions by the B.O.G. and then recently from the PBOC, that have some impact.

I think, though, the bigger story is that the fund flows have been sort of making an effort to decouple, even as the central bank liquidity has faded. To some extent, you often have lags, especially when there's momentum-driven markets, as we've had recently, and there's a little bit of a lag before people realize that the momentum isn't there. And even now, I am impressed by how many inflows we've had, especially to equities. And it is plausible that this could just carry on by itself. It's plausible that the belief in buying the dip is just so strong that actually this carries on regardless,

and although we get a little bit of a liquidity drainage from central banks, even with the quarterly refunding announcement from the Treasury yesterday and a little bit more bill issuance, actually that could be another factor that drags a bit more money out of RRP and ensures we don't have too much liquidity drainage. Generally speaking, though, I think all of this is on much more fragile ground than it was in the first half of the year. And I think my whole way of looking at it takes you to a very different place from if you assume it's fundamentals driving markets and you assume people have been buying for fundamental reasons. And what many asset managers tell me is this fits, frankly, much better with where they've been

for an extended period, which is they're not buying because they think that equities are cheap or credit is cheaper at 2007-type levels. On the contrary, the reason they keep buying is because they keep having another industry. inflow. And as I say, when you start looking at other asset classes or even assets like Bitcoin that are much more in line with the central bank liquidity numbers than the equity market is, then that you reassess the whole narrowing of the market rally and the churn that we're getting at the moment and the effort to rotate. Is this instead a sign of a natural fundamental driven strength and the back of a Trump trade that can run and run and run? Or instead, is this

actually a sign of a weakening level of support that can push up a smaller and smaller number of assets and ultimately is quite vulnerable to any deterioration in those fund flows. And that hasn't really happened yet. But I think if it does happen, then rate easing in itself is not going to be sufficient to get everyone chasing back into risk again. Joe, Matt just said that the reason funds keep buying is because there's another inflow. I feel like I have to mention here that Matt's work was the inspiration for Flows Before Pros. Oh, and now we get there. This idea that, you know, flows can drive additional buying and where markets used to maybe

be more value driven. So eventually you would say, like, actually, this price isn't justified. And so investors would sort of self-limit their behavior. Now that just doesn't happen as much. So I believe in the Flows before Prose thesis theorem saying to an extent. And I buy this and that makes a lot of sense to me. But here's what I want to understand further, and that is how that explains certain sectoral moves.

Because whenever I hear about, okay, markets are divorced from fundamentals or fundamentals don't work as well as they might have used to, I look at like the big winners within equity markets are companies that are just objectively doing really well. And that's also been the case since 2009, which is like, okay, we had these extraordinary moves in the handful of big tech companies, they're doing really well. They're really good businesses. They're making tons of money. Their growth rates continue to exceed anyone's expectations. Earnings are always being revised up. In fact, no companies this big in history are showing growth rates like this given their size. So if it's all flows and all that stuff, why do we seem to

see this connection between the companies that are frankly killing it and the stocks that are doing really well. I think that's a very fair point. And in general, I would say it's not that fundamentals have no role whatsoever. And in general, I would say my relationships fit best, or the central bank liquidity numbers fit best, the broader the number of assets that we assess them against. And the more we take any individual asset, the more scope there is for either idiosyncratic technicals or their own fundamentals to have an impact. Having said, that, though, I also observe a strong tendency for the correlations to be best with some of the names that have been hottest in the market, let's say, like LVMH or like Tesla or even like

Bitcoin as an asset class. And to some extent, that applies to the magnificent seven as well. And even as we look at those names, yes, for Invidia in particular, the growth in earnings, the growth in free cash flow has been phenomenal, but you still compare for example, 40 or 50 times growth in net income with gains in market cap and share price of well over 100 times, or you do that same analysis for some of the other tech names that haven't had anything like the same growth in net income and free cash flow, and still their market caps and share prices are up by 10 or 12 times. I think this is where exactly that flows before pros seems to apply.

And the momentum effects have come to dominate markets, and the extent of the extent of the rally that we're getting is more than you can justify on the back of those underlying fundamentals. And that's where people are just beginning to get concerned about the Magnificent 7 at the moment. The current earnings are great, but actually where most of the growth is, is not in spot earnings. It's in the future years of earnings. And we could easily end up questioning that if we start to doubt the extent to which all of the tech investment that's taking place at the moment is actually yielding profits. The news doesn't stop on the weekends. context changes constantly.

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Saturdays and Sundays starting at 7 a.m. Eastern. Make us part of your weekend routine on Bloomberg Television, radio, and wherever you. get your podcasts. I want to step back for a second, and I can't remember if we've ever actually asked you this question directly, but we've been talking a lot about the uniqueness of your approach to analyzing markets. Can you maybe talk a little bit about how you developed that approach? Because when I think back to when I first became aware of your research, and we've certainly talked about this on the show before, but it was the note from, I think the summer of 2008, are the brokers broken, which turned out to be exceptionally prescient, but was very different

to what you are writing about and doing today. So how did you come to take this particular analytical framework? I make it up as I go along. And the difference between me and other people is that I know that I don't know anything, and therefore I have to look at the charts and reason backwards, whereas other people seem to, they start with a theory and then they keep flogging that theory, even when it's not working in practice. And so you're right, maybe it's because I used to do credit strategy. And so I was always worried about things blowing up. But back in 2000, I was looking at corporate leverage because that was what was driving the market. And then in 0708, we were looking at SIVs and CDOs of ABS and then brokers and repo, because that seemed to be what was really

important and was driving the market. And maybe, yes, I was lucky with the timing on that piece. But I've shifted approach steadily. And as I say, where I'm... I've been for the last decade is looking at all of the central bank stuff just because that fits when nothing else does. And it's in this period where mean reversion and value investing has died and investors have herded into already expensive strategies and momentum has dominated. And I hope that I will not be doing this indefinitely. But as a strategist and not an economist, I need to go with what fits and then develop the

theory around it and if the theory sounds plausible and the approach is still working, then you continue to go with that. I fear at some point I may need to come back and focus on politics and debt levels and some of the really slow burning, but really scary things, but hopefully not yet. Okay, well, let's talk about politics and how, I guess, uncertainty, geopolitical uncertainty might be showing up in the market. There seems to be a bit of a debate at the moment. In fact, we recorded an episode last week with Victor Schwetz from McCory, and we asked him whether or not some fear, for instance, was being priced into the treasury market, maybe into futures, given that markets now seem to be pricing in like 70 basis points worth of cuts this year.

But where do you see political risk showing up, if at all? In general, markets are really bad at pricing political risk, and especially, the risk of regime change, and that inability has, if anything, become worse over the last decade where we haven't managed to price any risk premium appropriately at all, never mind political risk premium. So the standard view is that, in theory, markets should price to a mean expected outcome and consider all the different possibilities and reflect that in the market price. In practice, that is just too difficult for people. Everybody goes off. the modal forecast. If you have been systematically hedging all of your downside risk, as you probably

should have done, giving the growing geopolitical concerns and the mounting debt pile around the globe, then frankly, you've gone out of business at this point, or at least had a really difficult time, because all of those risks have been suppressed. And yet that doesn't mean that they're not there. And I think all of this applies to an even greater extent than usual, thanks to the buildup in debt levels. And even where private sector has de-leveled a little bit, aggregate debt levels, have mostly increased, especially in the US, but also in places like China. And you do get this worrying combination of ever more elevated asset prices backed by ever larger amounts of debt. And the scope for extreme regime changes or loss of confidence is frankly really difficult to

affect in microprises. And what we've seen historically is that even when the market does do this, it's not slow and steady and rational, even with the election of a new government, let's say, it's only as the market itself loses confidence. We had this in Italy. Historically, we had it with Liss Trust's government in the UK. There's just this moment where you realize this isn't a tell risk, this is actually happening, and actually nobody else is buying,

and therefore I shouldn't be buying either. That's where you get this sudden repricing. And so people are beginning to look at the moment of things like the lack of term premium in the US and how that might change and maybe it ought to increase, and especially as we worry about increasing interest payments in future. And yet for me, it's less about the arithmetic of interest payments and the appropriate compensation for them. And it's much more about are you actually being irresponsible with fiscal policy?

Are you actually willfully interfering with the independence of the Fed? That's when you can have your abrupt repricing. And that's where markets have to go from being able to ignore the politics entirely to finding that the politics is the only thing. And I hope we don't get there, but a number of long-term historical studies that I really respect do point to exactly those risks becoming elevated. Yeah, I've kind of been thinking about this lately, which is that, you know, there's all kinds of reasons to have political anxiety. I don't mean just like this election, but just, you know, social and lack of trust and all that stuff. But I've kind of been thinking as like, well, you know, as long as like it doesn't break, then probably everything is going to be fine. maybe one day it's going to be break and it's going to be really hard to put back together again

and then it'll be really bad. Anyway, so do we buy or so where's the market going? Like, we've had this rally. It's pulled back a little bit, but we're still having a pretty great year in stocks. As of right now when I'm saying this, the SMP is up 14.44%, which would be a great year if we ended here. No one's going to complain about that. What do you see happening now? I am almost as uncertain about this as Jay Powell was last night. And I do think if you need to look at the numbers as we're going along for the fund flows, for the central bank liquidity. What I can say with confidence is that I think the massive tailwind that we had in 2023 and in the early part of this year is basically gone and if anything is likely to reverse

slightly. I think the balance of risk is therefore for higher volatility for at least not rallying equities. I'd be happy to position for a further rotation within the equity market. Again, the whole tech sector to my mind does like that. look stretched at this point. But even there, it's not that I'm outright bullish on the value sectors and the banks and the things that are doing well at the moment and might benefit if there's a further Trump trade. To my mind, everything ends up rather more vulnerable than it has been because of this tailwind is just no longer there. I realize we'd be very remiss if we had Matt King on the podcast talking about the impact of, you know, central bank driven liquidity and balance

sheets on the market and we didn't talk about what's going on in repo at the moment. So we have seen, for instance, the secured overnight funding rate, so the LIBOR replacement ticking up quite a bit recently. There's been talk about lots of drama in the repo market and there's been this ongoing discussion about whether or not some of what's happening there could lead the Fed to have to reconsider things like quantitative tightening or maybe at least tweak that approach. is this something that's been on your radar? Yes and no. So yes, insofar as the changes in the level of RRP, the reverse repo program at the Fed,

are a direct driver of reserves, and that feeds through directly into my view of where markets are going. And therefore, I do look quite closely at the things I think are driving RRP, namely the pickup on T-bills, and yes, the levels are private sector reaper. In general, though, I am much less worried about things breaking, especially with some of the new emergency facilities which are available than other people are. And that's because for me, it's not that there's some magic level where reserves are adequate, and if we drop below that, then bad things happen and you see it in a spike in rates. For me, instead, it's about that balance between the

as I say, the amount of money in private markets and the assets available to absorb them. And that's reflected in a much more continuous fashion with changes in reserves, even when liquidity is supposedly abundant. So yes, I'm monitoring all of this, but I don't have quite the same worry about things suddenly breaking that perhaps some other people do. And if anything, my guess would be that the fact that they've tapered the rate of QT means they probably will go on for longer,

and ultimately other things being equal, that is likely to drain reserves and is likely to lead to a weaker market. But it would take quite a severe weakening, I think, especially following the tapering, for them to want to abandon the QT entirely. And indeed, I'd argue that, frankly, almost in some broader sense, what we're wrestling here with is too much froth in markets and too much asset price inflation. And my concern is a bit more the opposite, that they keep turning a blind eye to that. And if we could take some of that froth out of markets, yes, it might weaken the outlook a little bit in the near term, but it would lead to a much more stable outlook over the long term. All right, Matt King from Satory Insides. It was so lovely being able to catch up with you once again. Thank you so much for coming back on the show.

My pleasure. Thanks for having you. Joe, I really enjoy talking to Matt. I should just emphasize again that throughout that entire conversation, even though we couldn't see him, he was bringing up charts. because he always brings up his charts and I kind of love it. And I will include them in the transcript of this conversation so everyone can see them. Yeah, we should put out the transcript early when this comes out. So maybe people, you know, or people can download this and then pause it and then wait for the transcript to come out and then give it a listen. I always enjoy Matt too. I respect how he sort of characterized the evolving nature of his approach to looking at markets,

which is if something isn't working, stop focusing on that and start. looking for things that are working. And if there are relationships between measures of liquidity and what's happening with risk assets and they continue to work and they work in back tests and they work in forward tests, then it would certainly make sense to me to keep looking at them. I do think he's sort of put his finger on something important and fundamental. And I'm pretty sure I've said it on the show before in one way or another. I know I've written about it in the newsletter. But it does feel like we've seen the price of money go up via higher benchmark interest rates. But that doesn't mean that its availability has been limited. So, you know, liquidity is

still pretty abundant. It seems like people can borrow if they need to. And so I do think it's a valid question to be asking why there seems to be this disconnect between interest rates, the price of money versus its availability. No, I mean, it is really wild, right? It's a mystery. Even as this price of money seems to have gone up, I mean, you could make the argument, yeah, the price of money has gone up, but inflation's gone up, so maybe it hasn't gone up as much. I remember that was certainly a talking point for a while, maybe in like 2022 or 2023. But look, no one's coming out great from the last four years, or for the most part, nobody's theories are holding up that well, and the market and the economy

continue to surprise people. So I do think it's important to look at other perspectives. What will be really interesting is when we do finally have rate cuts and seeing if like any of the more recent patterns actually hold or if stuff starts to break again. Well, actually, it is funny because right, in theory, the market like wants rate cuts, right? Like we all sort of. It's just duh. But it's like the stock market's done incredibly well during a period of rising and elevated rates. That's right. So like you do wonder ultimately whether like, okay, something big could shift soon.

in terms of the direction of the Fed. Now, of course, the Fed would say, you know, it's changing directions because the underlying macro has changed. But it is interesting, right? We've had the straight line up, and now we seem to be perhaps at some sort of macro turning point. And so you've got to wonder, then, is the line going to also turn in some way? Yeah. All right.

Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Allo. And I'm Joe Wisenthal. You can follow me at the stalwart. Follow our producers, Carmen Rodriguez, at Carmen Armand Dashobin at Dashbot and Kail Brooks at Kail Brooks.

Thank you to our producer, Moses, on Dom. For more Oddlots content, go to Bloomberg.com slash oddlots, where we have transcripts, a blog, and a newsletter. And you can chat about all of these topics, including all of Matt's charts in the Discord 24-7 with fellow listeners, discord.g.g. And if you enjoy Oddlots, if you like it when we do these types of market discussions, then please leave us. positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes, absolutely ad-free. All you need to do is connect your Bloomberg account with Apple Podcasts. In order to do that, just find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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