The Pomp Podcast - #1191 Darius Dale On Global Liquidity & Bitcoin Halving

Episode Date: April 25, 2023

Darius Dale is the founder & CEO of 42Macro. In this conversation, we talk about global liquidity, bitcoin, halving, what institutional investors are doing, and the President of the United States impact on financial markets. ======================= Pomp writes a daily letter to over 235,000+ investors about business, technology, and finance. He breaks down complex topics into easy-to-understand language while sharing opinions on various aspects of each industry. You can subscribe at https://pomp.substack.com/

What's up everyone? This is Anthony Pompliano. Many of you know me as Pomp. You're listening to the Pomp Podcast, which is my effort to find the most interesting people in the world and sit with them for hours while I ask questions in an effort to learn. We have no advertisers on this podcast, so it would mean the world to me if you would subscribe to the show on your favorite audio platform, watch episodes on YouTube, and tell your friends and family about the podcast. My goal is to help millions learn from the world's most interesting people. So let's get into today's episode. Darius Dale is the founder and CEO of 42 Macro.

In this conversation, we talk about global liquidity, Bitcoin, halving, what all the institutional investors are doing, and why the president may or may not matter to financial markets. I always enjoy talking to Darius, and I hope you guys enjoy this conversation. Here is my conversation with Darius Dale. This episode is brought to you by Accenture. When your advertising operations fall out of sync, everything else follows. Spotify and Accenture are working together to reinvent the rhythm of ad sales using automation, analytics, and smarter workflows to simplify campaign delivery and access better data across the business.

The result? Less time spent on operations, more time connecting brands with the moments and fandoms that matter most. Learn more at Accenture.com slash Spotify. Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his personal opinion. This podcast is for informational purposes only. All right, guys. Bang, bang. I've got Darius here in studio just swagged out. My number one question, like we talked about last time, is global liquidity. If global liquidity increases, asset prices go up. If it drains, asset prices go down. I am a simple, simple man. Which direction are we headed right now?

Uh, so let's, uh, let's take a trip down memory lane and talk about where we've been with global liquidity, because I think that really sets the stage for kind of the near-term and medium-term outlooks for the, for this particular variable. And there's a lot of variables, by the way, that drive asset markets. This, for the past, let's call it two to three years, has been the primary driver. So obviously it's a big deal. So if you go back into, so let's just take a step back in what the hell is global liquidity, right? We talk about liquidity all the time as investors, but we don't really have a, you know, real true academic consensus on what the concept of global liquidity is. So in the context of trying to understand this and understanding this from my

quantitative economics background you know I think there's a few statistics that we like to focus on that give you a general sense of kind of where this kind of squishy concept of global liquidity are. Number one you look at the aggregated central bank balance sheet you know particularly across the major you know kind of G20 economies U.S. you know the ECB the Fed the Bank of England PBOC the Bank of Japan Swiss National Bank etc. These kind of at least if you those six central banks they account for more than 90% of the total central bank balance sheet. So if you're going to spend any time aggregating this stuff, definitely start there and focus on there. The number two metric we would talk about is what I would consider to be private sector liquidity. So that's public

sector liquidity, liquidity coming from central banks. There's private sector liquidity, liquidity that comes from commercial banks. And the best way to track that, it's not necessarily a direct proxy, but the best way to track that is through M1 money supply, narrow money supply. Narrow money Supply includes the monetary base, but it's primarily driven by bank deposits, demand deposits in banks. And so if you look at both of those metrics, there's other metrics as well, like world FX reserves is less relevant, but those kinds of things do matter. When you go back and you look at the central bank, global central bank balance sheet, at right around $30 trillion, it had increased a couple trillion off the lows of late 2022. And so that, you know, part of what we've seen in this kind of year to date rampant Bitcoin, kind of the bottoming in the S&P type exposures, risk assets since, you know, kind of October of last year has really been a function of that uptick. Well, the one thing I would call out on that is that we've actually reversed negatively in recent months.

In fact, kind of peaked out in late January, early February at the previous year to date high in the S&P. And we have yet to kind of recover on that level. If you look at global narrow money supply, it's actually continuing to trend lower. If you look at it on a year-over-year basis, both are trending lower. World narrow money supply is very narrow, modestly negative at minus 0.3%. Domestic narrow money supply, because of the deposit outflow that we're seeing primarily from regional banks, but it's not just regional banks, it's large commercial banks as well here in the U.S., that's down about 6% on a year-over-year basis, and that's about as sharp as a contraction as you're ever going to see.

And so the improvement in global liquidity that was primarily driven by this inflection of central bank balance sheets, primarily driven by the Bank of Japan defending its yield curve control policy and the PBOC kind of trying to give the Chinese economy a little push when it was coming out of zero COVID a few months ago, that stuff's kind of reversed. It's kind of peaked out and topped out, and we are now starting to see global liquidity drain on a trailing three-month basis, kind of dated through March, dated through April. So there was a lot of debate about, let's say, the ECB, and they were bucking the trend of the Fed. So the Fed was saying one thing and the ECB was kind of fighting and say, yeah, we're not going to do that. They eventually capitulated. And now they're pretty much moving at least directionally in lockstep in terms of, you know, creating tighter financial conditions. Now, we saw out of Asia, that wasn't the case. We actually did, as you mentioned earlier this year, see them increasing the liquidity in the market. Who's in charge? Does the Fed lead kind of the global central bank strategy session, if you will? Does China or the BOJ or somebody else? How do we think about like, is there one central bank to look at and what they say will basically then ripple through the rest of the central banks? Or are each one of these central banks actually making individual decisions for themselves? It's a little bit of both. So no one's in charge, right? Like, let's be honest here, right? The Fed is primarily, partially in control of the dollar,

obviously, alongside the U.S. Treasury Department. And so you could say that given that we are on a global dollar reserve system and probably will be for an extended period of time, the Fed is technically in charge. But the reality is, A, none of these central banks is actually in charge of global liquidity. They all contribute individually, you know, to varying degrees and at various points in the cycle based on their own economic drivers. Why would a central bank either add or subtract liquidity from its own economy?

You can obviously infer the reasons for that, growth being above or below trend, inflation being meaningfully above or meaningfully below trend, et cetera, unemployment situation being pretty adverse. And what we're seeing right now, particularly with respect to the European economy, particularly with respect to the Chinese economy, these economies are actually improving pretty markedly in recent months. And so the probability that we need to see any sort of liquidity provision out of these localities is actually diminishing at the margins. In fact, the ECB balance sheet continues to be in pretty meaningful contraction.

It was the PBOC's balance sheet and the Bank of Japan's balance sheet that really contributed to that meaningful uptick in global liquidity. I want to say on a trailing three-month basis, it peaked in January at around $1.4 trillion, but in aggregate, it was somewhere around plus $2 trillion off the lows of last year. And so, you know, you can, a lot of folks want to make it easy. You know, again, so much of investing is like people trying to find shortcuts and cut corners. And I just want to remind users, you know, there are people spending billions of dollars on research and trading and all this stuff. It's not easy. I wouldn't try to cut corners. But in the context of this global liquidity discussion, I think you can, to some degree, you know, kind of focus on these primary large major central banks, these primary large major economies, because that's going to get you to at least 90, 95 percent of the total total outcome. So we've seen to the start of 2023, Bitcoin was the best performing asset in Q1 is about 70 percent or so. And we saw a lot of assets going up, right? It wasn't just a Bitcoin or a cryptocurrency thing. Should there be a belief that similar to what we saw coming out of 2020 into 2021, like when all asset prices rise, Bitcoin is just kind of an asset price on steroids and it's going to go up more?

And then if you go through the long tail of all the crypto assets, like they'll have higher and higher price appreciation? Or is there something different in the way that you analyze Bitcoin versus maybe some of the traditional assets? I will say since the March regional banking panic here in the U.S., there has certainly become a greater store of value bid in the Bitcoin asset class than I think it had previously before. You know, I don't know that we can say what percentage of Bitcoin's price change, price fluctuations are being driven by store of value versus risk appetite, global liquidity, et cetera. But I certainly think that whatever that pie chart looked like in terms of global liquidity, global risk appetite, you know, global or, you know, sort of store of value. I think the pie slice associated with the shore value has certainly increased in recent months. And part of the reason we're seeing that is because we have various metrics that kind of track whether or not, hey, is liquidity improving? Is risk appetite improving vis-a-vis sector and style factor dispersion in the equity market?

We can certainly look at the bond market, whether it be yield curves or forward spreads or et cetera, to give us an idea. okay is you know growth expectations rising or people wanting to take more risk and want to speculate more and the reality is we've not seen all those traditional drivers of the bitcoin price you know really improve in fact i would argue we've seen them actually deteriorate in recent months obviously this negative inflection global liquidity from kind of the january february highs of that of those time series has actually gotten worse we've seen you know degradation and fixed income curves and money market curves. We have this really nasty record inversion in the one month T-bill minus the three month T-bill is signaling a lot of stress in the collateral

system, in the repo system, in the repo market. So I would argue global risk appetite has not really improved either alongside global liquidity. Global liquidity is down, risk appetite at best is flat. But we've seen the Bitcoin price rally pretty sharply off the March lows of the March lows of 2023. And in our opinion, I think that's got to be some deposit flow instead of saying, hey, just give me an Uncle Sam piece of paper, a money market T-bill fund. Let me put some of this in a digital asset like Bitcoin as a longer term store of value. And it's no surprise to me that this is happening, given the BOSIT situation at Silicon Valley Bank, right? The signature bank. These are institutions, these are companies and people and individuals and founders who believe

in these assets from a longer term perspective. So I think they came to a fork in the road and said, well, if my depository institution is going bust, where do I put all this money? I can put some of it into T-bills, but I can also put some of it in something like Bitcoin. Earlier, we were talking about Bitcoin and the halving. That's about a year away or so. And you had mentioned some things in the analysis that you've done in terms of Bitcoin's price and the volatility going into the halving. Talk a little bit about that. Yeah.

So one thing that's kind of really made, you know, so we talked about this a couple of weeks ago and I was last on the program, which is, you know, we have this concept of the phase two credit cycle downturn ahead of us. And for those of you who, I don't want to rehash it for too much, but the reality is when you go into a recession, particularly in the U.S. economy, because we are the world's dominant economy, dominant asset markets, dominant reserve currency, typically what happens, you have this sort of nasty blowout in credit spreads. You have this really nasty sort of repricing in sector and style factors version of the equity markets. And, of course, you have a crash in the equity markets themselves, and risk assets tend to correlate with that outcome. So that's an outcome that we still see ahead of us, you know, more than likely commencing in the second half of this year, probably by late Q3, given the timing with which we anticipate a recession to develop in the U.S. economy. We have a bunch of different models on kind of timing where we are in the business cycle here in the U.S. And kind of the modal outcome of those models suggests Q4 is probably the highest probability starting point for a recession.

So we were assuming that, you know, sometime in Q3 and Q4, we're going to be in the middle of pricing or at the beginning of pricing in that phase two credit cycle downturn. One thing that sort of has me with respect to Bitcoin specifically that has me sort of concerned about anticipating that's going to spill over into Bitcoin in the context of this kind of store value discussion is the fact that we have a halving next spring, right? I want to say in April or May of 2024. And obviously, halvings tend to be this very, very bullish event for Bitcoin. And at least that's what I thought initially in my speculation. So I'm sitting here thinking, is Bitcoin even going to go down in this phase two credit cycle downturn? Let's say the SPY gets to, you know, down 20% from here, it'd be like $3,200 or something. Does Bitcoin go to $17,500 again or does Bitcoin stay where it is or even appreciate because that'll be very close to that, you know, springtime halving? So I did a little work, you know, this morning kind of trying to identify, okay, is there a history of volatility in Bitcoin heading into the halvings or is the kind of the halving the catalyst for the kind of record appreciation on the other side of that? And the results of the study that I did suggest that there tends to be a lot of volatility in the year into Bitcoin.

I can just read these off. Sorry to not have these off the top of my head. I'm usually better than this. But so into the November 2012 Bitcoin halving, we saw a minus 39% max drawdown in February of 2012. And so I'm looking at the year prior to the halvings. And we saw a minus 27% drawdown in August of 2012. In the July 16 halving, we saw a minus 30% drawdown in August 15. We saw a minus 25% drawdown in November 15.

We saw a minus 20% drawdown in February 16. And we saw another minus 20% drawdown in June of 16. And then lastly, into the May of 2020 halving, we saw a minus 48% drawdown into December 19. And then another minus 53% drawdown kind of during COVID in March of 2020. So that's a lot of crashes, man, in the year leading up to the halving. And so I just want to put that out there and say, hey, look, I know this is going to be a very positive event. I think if we're having this conversation 18 months from now or 20 months from now at the end of 2024, Bitcoin's probably at $200,000, if not higher. And I definitely would fully

buy into that view. It's just the path to getting there, if you're trying to build a big position to take advantage of that, is likely to be very volatile. At least that's what history suggests. So basically, the idea would be, yes, when the halving occurs within 18 months or so of that halving, you have this kind of record price appreciation. But in the year before, the 12 months prior, there are these kind of big 20 to 40, 50% drawdowns in price. And so again, history could serve as a guide. Maybe it's not perfect, but it would tell us that when you see those drawdowns, then those historically have been great buying opportunities versus waiting until the halving or anything like that. Yeah. The key takeaway I'm trying to make is,

we don't know, but we assume Bitcoin is probably going to be very much higher in price by in 20 months. The problem is if you're buying it today at $30,000, you need to be aware that, hey, there's a long time series history of these material drawdowns, very significant drawdowns, you know, capital destroying drawdowns into that event. And we also have this phase two credit cycle downturn that is completely separate and apart from anything that's going on in the cryptocurrency ecosystem. So as a risk manager, and that's kind of what our clients, you know, kind of task us to do at 42 Macro, the number one thing we're trying to preach right now is patience and prudence. We're not trying to get people to run out and short Bitcoin or short the stock market. What

we're trying to do is to have them understand, hey, look, there's going to be a better buying opportunity ahead of us, probably sometime in the next call at two to three quarters, and take advantage of that buying opportunity. But between now and then, the goal was not to get rich quick. It's to get rich smart over a longer period of time. I don't know if I agree with 20 months, but 24 months, which basically would give you one year till the halving um you know give or take so maybe actually even longer than that uh and then 18 months because like one of the things that's interesting to me right is like you get the price appreciation we go back uh may of 2020 we get the halving and it took a couple of months

maybe till like august september and then you started to see okay here we go right and we went from 10k to 30k very quickly yeah and i remember from 30 to 60 happened from i think literally bitcoin hit 31 000 on december 31st like it was going up a thousand dollars a day and it was like $27,000 on December 27th, $28,000 on December 28th, right? I don't remember that very well. It was crazy, right? It was crazy. And so it went from $30,000, $31,000 to $64,000 by March.

And so in literally 90 days, it doubled in price, right? Which is this incredible run. Now, it had a huge drawdown, 50%. But it kind of just returned right back to where it had been in December, right? Which was still 300% higher than where it had been at the halving point, maybe a little bit more. I think it was like $8,500 or so when it hit the halving. And if that had been the whole thing, like, wow, we went from, you know, $8,500 to $64,000. And that is this, you know, really crazy kind of appreciation.

But that drawdown happened to coincide with China kicking out a bunch of the miners and more than 50% of the hash rate going off. Summer of 21. Summer of 21. And all summer long, it basically was just flat, kind of hanging around $30,000. And then when we got into Q3, all of a sudden, here we go again. And obviously, it peaked at $69,000 back in November of 21. And so when you look at that, what I always wonder is like how much of the quote unquote, you know, price appreciation happened really between like September of 20 and March of 21. And that was driven by the halving versus if it had the full 18 months, like you actually get a little bit of a higher price.

But if that hash rate getting kicked out of China doesn't happen, would it have gone higher? Like what would have been different? We'll never know. but like to me that is like one of the more under discussed things is just like you basically had this price appreciation that was occurring kind of right on schedule yeah then you get this external shock from china making this decision 50 of the hash rate leaves right it's a pretty big deal but yet you still even got another all-time high before the end of the year totally i mean it's kind of crazy to think about now yeah no i mean that was that was a very wonderful time for me

uh you know i bought my first bitcoin in october of uh 2020. that was good that was a good run a very good run um yeah i think i know i mean you and i were on your program back then saying i think bitcoin's going to 100 000. yeah and quite frankly i think it would have gone to 100 000 had it not had that you know you know exogenous catalyst in china um you know so you know i think this asset class is going to be you know for a long period of time fraught with sort of exogenous events whether it be regulatory i mean mostly regulatory obviously that was a regulatory event in China. We're not the only ones who can regulate, by the way. But this is, I think, the underlying message of the resiliency of the asset class. And I don't necessarily mean

resiliency from the price appreciation standpoint. I mean resiliency from the perspective of this thing ain't going anywhere, right? Like we had FTX and Celsius and Luna and all this other stuff happened in the last kind of 12 months. And not one time did I see anyone really question the longer term viability of Bitcoin throughout this entire process. I mean, we've seen people blow up and left and right, put in handcuffs left and right. And to me, so I'm very proud of the asset class for that particular perspective. I just, I think, you know,

just from a risk managed perspective, I think, you know, there's the path to getting to this, you know, rainbow and puppy dog type outcome is, you know, you got to walk through the, got to walk through the hood for a little bit. What are the institutions doing right now? Are they mostly in cash? Are they looking at Bitcoin or cryptocurrencies?

Are they in equities, oil? Like where are they kind of tactically looking? So that's a phenomenal question. And so I'll bucket this into different categories of institutional investors. They're sort of your long-only kind of, you know, just, you know, longer term, you know, 12 to 18-month time horizon on any holding style investors. There's your kind of large mutual funds, pension funds. And then you have your sort of, you know, kind of hedge fund-oriented strategies. You know, these folks tend to, you know, they kind of generally need to be making money on a month-to-month basis at the bare minimum,

not having, you know, drawdowns in excess of 3% to 5%, you know, particularly these large multi-manager market neutral players. The latter category, these market-neutral, pod shop-type hedge fund vehicles, to a man, woman, and child, everyone I talk to, and we have many clients across the space, they are all trading with a higher frequency than they ever have in their entire career. The short-termism in that community of investors has never been more ferocious. And I think that's part of why—ignore Bitcoin for a second. Just look at the chart of the S&P 500. You know, since May of 2020 of last year, it's going to almost be a year. We've been bouncing around more or less between, let's call it 4,200 and 3,800. You know, we went to 4,300 in August, and then we went to like 3,500 in October.

But for the most part, we've been flat. You pull up a year-long chart of the S&P, it basically hasn't gone anywhere. But what it has done, it's been very violent. You know, we've seen like a 10% rally, then a 15% drawdown, then a 20% rally, then a 10% drawdown. These are like annual returns. So we've had like five or six years worth of returns to carve out if you're a good trader, if you're a good active manager to take advantage of. So that community of investors is extremely kind of narrowly focused on, you know, kind of what's really happening right in the here and now.

And that concerns me from a medium term perspective because their foresight on, you know, the phase two credit cycle downturn, some of these longer term like kind of macro cycle risks that I think, you know, we're likely to start to rear their ugly head towards the back end of the year. I just don't think you're going to have enough investors focused on that, which will allow you to have kind of a market crash style outcome. When you're talking about the long only institutional money managers, everyone is positioned for down dollar, you know, short the dollar and every derivative trade of shorting the dollar, whether it be improving global growth, whether it be emerging market outperformance over U.S. equities, whether it be commodities over, you know, hard assets, you know, commodity physical assets over digital assets. You know, we've seen a little bit of a crowding back into the tech space, but by and large, you know, those investors and I've been having these same conversations really for the past kind of four or five months, which is, you know, how do I take advantage of down dollar up global growth without actually just being long China be given all the regulatory and geopolitical concerns that are emanating out of that economy. So there's a lot of consensus across, you know, kind of what I would consider traditional Wall Street right now, whether it be just like knife fighting for, you know, basis points on a daily, weekly basis, or whether it be just, you know, short the dollar. both of those things, I think, could be proven very wrong, you get to kind of one to two quarters from now. Maybe not one quarter now, but certainly I think by the end of Q3, this concept of down dollar, you know, everything up global growth, I think will fall by the wayside. At least that's

what our models are suggesting. And then the concept of, I don't really have to worry about medium term risk, you know, being in the right exposures from a medium term perspective on the, kind of the shorter term pot shop exposures, our head managers, that to me is a big worry to me. Because again, when you get into the back half of the year, everyone's going to start to recognize the deterioration in the labor cycle, you know, kind of, okay, we actually are, might be heading into recession, but they can't all get out of the same pipes at the same time. You can't all go buy a Procter & Gamble at once and sell everything else you own, because this is how markets crash. Markets are very, they've been very illiquid for a few years now. When you look at the current market situation, we are headed into next year, a presidential election. We know that the Fed, they are not an elected official. They are appointed. Does the president matter? We hear a lot of debate, Trump tax cuts or Biden this and sometimes it's tax positive things, tax negative things, both sides of the aisle, like there's all these debates. Does the president matter? Increasingly so, but not at all on an absolute basis.

On a relative basis, they're certainly gaining share. This really goes back to the Obama administration. Obviously, Trump kicked it into steroids. But this concept of executive orders, and mostly because we've seen so much grit lock in Congress that you can't really get anything done that's from a lasting budgetary perspective. So executive orders have been kind of the way

we've enacted policy here in the U.S. for quite a long time now, for over a decade now. And so we're seeing Biden with the most recent executive order, you know, banning investment to Chinese industries, you know, high-tech industries as well. I think we're going to continue to see more of that in the context of this, you know, hyper-gridlocked, you know, D.C. economy. I mean, we have a potential U.S. sovereign debt default on our hands in a few months, and neither side is willing to negotiate, or at least, you know, Democrats are unwilling to negotiate, and the Freedom Caucus is unwilling to negotiate unless

they get what they want, which is clearly not a negotiation. And so, to me, I think, you know, the president does the president matter yes do they really matter in terms of asset markets probably not you know if you you know in terms of ranking this clearly the fed is is sacrosanct to investments in the u.s economy given you know their control they don't control but they materially contribute to the ebbs and flows of the liquidity cycle um obviously congress would be number two in the context of them being the institution that determines the budget they're the ones that determine the size of the budget deficit the timing of payments on this all this stuff you know where the money is getting allocated in the economy the redistribution

or lack thereof and the economy and so i think you know those two institutions and for a long time they're they're going to matter a lot more than the president but the president matters as much as it has in my career as much as it has today or today it matters as much as it has ever in my career yeah that's crazy where can we send people to find you on the internet oh appreciate you man always a pleasure to come uh come top it up with you man love the office really proud of you guys uh so come check us out 42 macro uh you know we do as as you can clearly tell uh we do institutional uh research for every investor that's that that's our model 42 macro.com 42. and then we're on twitter i'm on twitter at uh 42 uh macro weather uh we have a private twitter account 42 macro

aware for our for our subscribers awesome i learn every single time appreciate you macro.com everyone go check it out we'll do it again always a pleasure man thank you