The Pomp Podcast - #1214 Darius Dale | Central Banks Are Secretly Controlling Stock Prices?!

Episode Date: June 21, 2023

Darius Dale is the founder & CEO of 42Macro, one of the best research shops in all of Wall Street. In this conversation, we discuss global liquidity, we talk about which of the central banks are pushing liquidity up, and which of the central banks are driving liquidity out of the system. The global liquidity is one of the most important inputs to understanding asset prices, and Darius does a great job of breaking that down. ======================= 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. 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. They're one of the best research shops in all of Wall Street. And if you haven't checked them out yet, I highly suggest that you do.

In this conversation, Darius and I discuss global liquidity. We talk about which of the central banks are pushing liquidity up and which of the central banks are driving liquidity out of the system. The global liquidity is one of the most important inputs to understanding asset prices, and Darius does a great job of breaking that down. 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. Got Darius here. Darius, global liquidity, we have been talking about it now for weeks. It looks

like we have finally bottomed, but the recovery is not so much a linear thing, or is it? How do you look at the global liquidity right now? Yeah. Hey, man, what's up? It's good to see you guys. So I'll start by saying we've had a significant increase off the lows in global liquidity. If you already showed chart number one, what I'm showing in this first chart is our global liquidity proxy. That's the blue line in the top panel. For those of you who are maybe not unfamiliar uh how we track global liquidity 42 macro uh we aggregate the us dollar sum the global central bank balance sheet global broad money supply and global fx reserves minus gold for a variety of different reasons we include those measures but the one thing we'd say is

if you look at the middle panel there where we show the max drawdown study for the blue line which again is our global liquidity proxy you know it recovered significantly off the lows of late 2024 2022 but as you can see in recent weeks and months it had that recovery process has really stalled down and we're actually moving in the wrong direction so this is something we've been calling out in our research we started making noise about this in kind of in the late april right around the year-to-date highs in bitcoin and we've not recovered that price we've obviously haven't really crashed lower but in our view a lot of what's kind of weighed on the the price of bitcoin and really all digital assets relative to like us equities is the fact that we've seen

this non-linear recovery process and global liquidity so when you start looking at asset markets. Obviously, these asset markets are a key piece to it. There's kind of the response to the liquidity, if you will. How are you looking at asset markets and what is that response? Yeah, great question. So the next chart we have for the viewers, we have our global liquidity proxy in the top panel with respect to the S&P 500 price and the Bitcoin price. And what we show in the kind of the second, third and fourth panels there is a trailing one year Z-score study. So we're normalizing these measures to kind of make them a little bit more comparable. And what you see is that if you look at a one-year Z-score of our global liquidity proxy, it's only at about a

0.2 sigma relative to its trailing one-year mean, whereas the S&P 500 is a plus 2.2 sigma and Bitcoin is a plus 1.1 sigma. So we're seeing a lot bigger recovery on a normalized basis in asset markets relative to the recovery we've seen in global liquidity, which again, is now moving in the wrong direction. So when we start looking at global liquidity impulse, that is something kind of a little bit different. You're going to have to explain to people what exactly the impulse component is and then what are you seeing there? Yeah, absolutely. So just a simplistic, we use big jargony words in finance, but the reality is all we're tracking is trailing through month momentum in these time series to identify whether the impulse is positive or not. You can obviously

pick your own duration, but we try to track the trailing through month seems to be the best in terms of fitting this with asset markets. And so as we show again, our global liquidity proxy in the top panel of this chart relative to world equity market cap. And as you can see, were kind of flat trailing three-month basis and global liquidity had been very positive, right? If you go back to the lows of, or sorry, had been very negative, then it became very positive. Now we're kind of flat. And so if you go back to the lows of 2022 last year, we had a minus $6 trillion trailing three-month impulse in the month of October. And that's obviously, it's a pretty significant decline, but that kind of swung all the way around to a plus $9 trillion-ish impulse,

positive impulse by the time we got into Q1 of this year. And that positive impulse has been steadily waning on a trailing three-month basis until we got to kind of April and May, which is now flat. So this is not, the equity markets sort of mirror this from the perspective of the momentum in the impulse itself. So the momentum of the momentum, but the reality is we're still growing in equity market terms, which is not necessarily something that we feel is sustainable. Now, one of the nuances when we start looking at this is there's public sector and private sector liquidity. And sometimes they move in kind of concert with each other. Other times they do not. Right now, it appears they're not. So explain the differences between public

sector and private sector. And then why are they almost operating at the opposite ends of the spectrum right now? Yeah, absolutely. So I'll start by saying the reason we look at global liquidity in terms of our global liquidity proxy, again, central bank balance sheet, global broad money supply, global FX reserves minus gold, is to sort of identify inflection points in the liquidity cycle by isolating, you know, kind of key factors. So private sector liquidity, which is liquidity created by commercial banks, tends to be very pro-cyclical. If growth's accelerating, liquidity is going to be accelerating. If growth's decelerating, liquidity is going to be decelerating. You know, banks effectively extend credit. Non-bank, you know, financial market

participants extend credit when things are getting better. They pull back on credit intermediation when things are getting worse. So we understand that this is a very key component of liquidity, private sector liquidity in terms of exacerbating trends. But what causes the trends to inflect is the public sector liquidity function, i.e. central banks, what's happening with respect to central bank policy. So that's why we spend so much time talking about central banks as market participants, because ultimately they can cause an inflection either to the upside from a negative trend or an inflection to the downside from a positive trend with respect to private sector liquidity and obviously broad liquidity when you amalgamate all these measures. And so right now

what's happening. We're seeing a modest increase in private sector liquidity on a trailing three month momentum basis. Again, that's the bottom panels in these charts. And then when you see the we're also seeing a negative trailing three month impulse in global private sector liquidity. So the private sector liquidity impulse is very much kind of mirroring the slow. We have a recession in the Arizona economy. We have a disappointing recovery in the Chinese economy that's kind of inflected negatively from an impulse perspective in recent months, in the most recent month. And obviously growth has been slowing in the us although albeit still very much not in the recession so that's kind of one thing we call out but again don't forget the global liquidity

impulse trailing through month is flat it's flash it's moving lower on a kind of a sequential basis and ultimately we expect that kind of trailing through month impulse to get uh that negative that flat trailing through month impulse to go negative in the coming months so let's go around the world here we can go east to west let's start with china and kind of the liquidity there what What are you seeing? Yeah, absolutely. So China is kind of bucking the trend as it relates to global liquidity. So right now, the Chinese liquidity impulse, that's chart five there, is actually currently negative, only modestly negative.

But they've done a series of measures in recent weeks that gives us confidence to say that that modest negative impulse is likely to inflect positive in the coming months. So they cut their benchmark seven-day reverse repurchase rate by 10 basis points that PBOC did last week. They also cut their one-year medium-term lending facility rate by 10 basis points last week. We've seen follow-through by Chinese banks this week. They're cutting their one-year and five-year loan prime rates by 10 basis points. And this kind of mirrors the series of easing measures we saw kind of in the middle to the second half of 2022 that really helped the Chinese liquidity impulse kind of inflect positively alongside, obviously, a lot of PBOC open market operations and medium-term

lending financing itself. And so that's something we would expect to see over the coming months and obviously would be a positive from a global liquidity perspective, given how dominant China, the Chinese economy is in that in that in that matrix. But the issue there is that you have liquidity impulses in the U.S. is likely to deepen the negative liquidity impulse in the U.S. is likely to deepen in the coming months. Eurozone is likely to inflect negative in Japan, potentially may become negative and deepen as well. So we can unpack each of those separately. Let's go now to the United States and their liquidity. What are you seeing there? And it almost feels like it's going to be opposite of China. Yeah, absolutely. So clearly, I mean, our liquidity cycle has been negative for quite a while now.

It's not no secret to anyone that's obviously doing quantitative tightening. You know, clearly we have an issue in the banking sector as it relates to extending credit, certainly not extending credit nearly at the pace that we had been in recent quarters. And so that's likely to get worse in our view for a couple of reasons. One, we have clearly the rebuild of the TGA. We've talked about this months ago. So it's not no secret. I think it's pretty consensus now that's draining liquidity at the margins because we have not seen the decline in the reverse ruble facility balance fully offset the rise in the TGA. You know, Treasury Secretary Yellen, which is something we've talked about maybe a month or two ago on the program, did a good job of kind of concentrating T-bill issuance, you know, kind of really hitting the market heavy and hard with T-bill issuance, very short-dated T-bill issuance to kind of drain a lot of funds out of the Fed's reverse

re-roll facility program and transition those into the TGA. So that's obviously offset the rise and the potential drain in liquidity that we've seen in terms of the rise of the TGA post debt selling. That process is not being fully offset. So at the margins, you're seeing a little bit of decline in liquidity in the US. But what I think is the bigger issue and the more structural issue is the fact that we're running with these sort of record non-war, non-recession budget deficits in the U.S. economy. We are currently tracking at minus 8% of GDP as it relates to our budget deficit as a percent of nominal GDP. That's the most recent month, this May, that we have the data for. And so what that ultimately means is that they're going to be issuing a lot of debt

regardless. And the reason we bring this up is because the Fed has been doing quantitative tightening on autopilot in recent months. Recall that we hit the debt ceiling in mid-January and really haven't issued debt on a net basis since then. And so the return of Uncle Sam, international capital markets is likely to coincide with a significant uptick in coupon issuance from effectively net zero to something that's a lot less, a lot greater than net zero in the context of this structural deep negative budget deficit. So this is, in our opinion, it's going to give quantitative tightening its teeth back as it relates to potentially draining bank reserves again, which is something quantitative tightening has not done since the beginning of the

year, the very, you know, kind of middle of January. So this is something we're calling out as a very likely negative impulse on global liquidity in the coming months. Let's jump back over to the Eurozone. Obviously, the liquidity there, they kind of seem to be doing their own thing to some degree. But what are you seeing on that front? 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. Yeah, so last week, so last week was a big week, right? We got the Fed on Wednesday, the Eurozone on Thursday, China on Thursday, and then the PBOC on Thursday, and then obviously

the Bank of Japan on Friday. So as it relates to the Eurozone, we got a lot of important updates as it relates to their liquidity cycle. Obviously, they hiked interest rates. Madame Lagarde was extremely hawkish with respect to the guidance, which allowed terminal policy rates, with respect to ECB, to back up pretty meaningfully week over week last week.

And so the ECB is doing a good job of kind of pushing through tighter interest rate expectations through the kind of global financial system. But one thing that's also, they called out last week, is that we got 477 billion euros, So over $500 billion of pandemic-related financing for banks that's going to mature next month that they're not going to roll over. So we know the ECB's balance sheet is going to decline by roughly $500 billion next month. But we also have them no longer reinvesting the proceeds from their asset purchase program, which is about $3 trillion thereabouts.

And so that's, you know, it's not quite QT, but it's certainly it's that balance sheet runoff is going to be kind of negative from the perspective of global liquidity out of the Eurozone. So it's very likely that this kind of very modest, we're more or less flat, you know, this very modest kind of positive trailing three month impulse in Eurozone liquidity is likely to go negative and get potentially very negative in the coming months, you know, particularly around the summer. Can you talk about Japan? You mentioned them earlier. What's going on with their liquidity? Yeah, absolutely. So Japan is kind of an interesting wildcard, right? So the Bank of Japan stood pat on its yield curve control program last Friday. Governor Ueda continues to kind of anchor on wages as opposed to inflation as what's really driving that process.

But we also know that if you look at their forecast for inflation in Japan, particularly for the current fiscal year, they're down at 1.8%. Whereas if you look at where core CPI is tracking in Japan now, it's about 200 basis points higher than that. And so we know that when we get to July, which is when they're going to publish their updated version of their summary of economic projections, the Japan's version of that, it's very likely they have a significant positive revision to their inflation forecast. Now, if that significant positive revision to the current fiscal year inflation forecast is married by a meaningful positive revision in the out year inflation forecast, it's very likely that they're going to have to start kind of talking about or at the bare minimum tweaking yield curve control again. I don't know if we know enough that they're going to do it in July, but it's certainly something that could potentially happen in the coming months. You know, maybe it happens in September thereabouts as it relates to, you know, potentially, you know, kind of changing that program.

And why that's relevant for global liquidity is because if Japan alters its yield curve control program, it reduces the amount of pressure that the Bank of Japan will have in terms of defending the yield peg in Japanese bond market and ultimately in the global bond market. So this is something that, you know, go back to the kind of the fall of last year to the early part of this year. The defense of that peg was one of the things that really caused global liquidity to really spike higher, you know, from Q4 to Q1 of this year. Right. And so ultimately, if we don't have that kind of market speculation because the peg is more, I guess, in line with global sovereign debt yields, then ultimately you might you might see Japan's liquidity impulse kind of get incrementally negative in the coming months. So when you sum it all up, you have Chinese liquidity is going to be improving. We pretty much know with, I wouldn't say there's no certainty in financial markets, but there's a reasonable degree of reasonably high probability that liquidity in the U.S. gets worse from here in the coming months.

The liquidity in the Eurozone gets worse from here in the coming months. And there is a strong possibility that Japanese liquidity may get worse in the coming months. And so when you pad up what's happening in the U.S. and the Eurozone alone, it's likely to offset what we're likely to experience in China. But when they are on Japan, which is obviously a very large economy of its own right, that may actually kind of make that offsetting process a little bit worse and may potentially cause some volatility in asset markets this summer, which has been our baseline view. I don't think this is the end of the kind of bull run that we've seen really since the fall of last year, because ultimately, we still think the average investor is very much offsides with respect to the timing of recession. you know the two we've been you're not on top of this for a long time now but we have been since the last summer of the view that a recession if it was going to commence in the U.S. economy that Q4 of 2023 was the highest probability outcome with the second highest probability

outcome of a recession starting in the U.S. economy is Q1 of next year and the reason that's important as it relates to the understanding the market cycle is that asset markets tend to squeeze very aggressively into the end of the business cycle the median return on the S&P 500 if you go back and look at the 12 recessions, post-war recessions that we have, the median return to the S&P 500 in the year leading up to the peak end and around the recession is plus 16% with an interquartile range of 14 to 20%, plus 20, 14 to plus 20%. There are no non-double digit numbers in that entire 12 cycle sample. So this is a, you know, with that understanding, we understand that if we're right on the timing of recession being Q4, Q1, we could see markets rallying to, I don't

october even january um between now and then so ultimately we do this correction will be bought uh this summer if we're right on the liquidity cycle we're right that we get a correction as a function of the deep uh and then you know kind of adverse liquidity cycle developments and ultimately you probably want to buy a dip heading into a year end or maybe even to your q4 year end because ultimately we're not quite ready for that recession phase two credit cycle downturn so when you start looking at that recession um it's kind of like the most most telegraphed recession of all time, right? In terms of like, everyone's talking about everyone's talking about everyone's waiting for the shoe to drop, whatever. Is there a scenario where

it couldn't happen? What would have to be the kind of inputs into that situation where, as of right now, we think it's going to happen, but what could change that then gets us in a situation where we avoid a recession? Yeah, no, it's not that what could change, it's that what can continue to go right. So, you know, we've identified sort of five things that have really contributed to the resiliency of the US economy. And as a function of that, the resiliency of the U.S. inflation cycle, which has caused obviously a lot more tightening by the Fed since we initially outlined the call back, I want to say it was August of last year. And so ultimately, those two of those things are, you know, record cash on corporate and near record

cash on, I'm sorry, record cash on household and corporate balance sheets in the U.S. If you look at cash, checkable deposits as a share of total assets in the U.S. for the household sector and the corporate sectors right around, you know, kind of 3% for each, we haven't seen this high ratio of cash relative to total assets for both parties since going back to the kind of mid to late 1960s. So that's kind of what step one. Step two, you know, obviously you've seen a lot of monetary policy tightening through the lens of the policy rate. And ultimately that's caused a backup in bond yields and whatnot. But the reality is it's just harder for that stuff to really impact the economy. These long and variable lags may have gotten longer in the context of how

much sort of low cost fixed rate debt we have in the US economy right now. With data through, I want to say Q1 of this year, the effective mortgage rate on the total stock of mortgage debt in the US economy is still down at 3.55%. Obviously, the marginal mortgage rate, if you're in the market to buy a house is north of 7%, but most people aren't trading their 3.5% mortgages for 7% mortgages. So it's not the monetary policy impact of that really is muted because no one's really moving as a function of that. And so that's kind of step three. Step four is we've seen our reason number four is we've seen a significant decline in manufacturing as a share of both the labor market and as a share of GDP. You know, we used to be, I want to say somewhere

around 45% in the 40s in terms of manufacturing as a share of total employment. Now we're down at 14%. You know, manufacturing as a share of GDP is only 18%. And the reason this is important is because manufacturing, if you look at the net job loss that we experience in recessions, manufacturing on a median basis, since going back to all the post-war recessions we have data for, manufacturing on a median basis accounts for 98% of the net job loss we tend to see in recession. So that tells you that, like, hey, this is the cyclical sector of the economy. If it is declined as a share of total employment and share of GDP, obviously you need to have a much more significant downturn in the manufacturing sector in the U.S. economy to actually affect a real recession across

the broader services-dominated U.S. economy. And so the final reason, number five, is we've seen a significant amount of labor hoarding in this cycle. If you sort of look at the delta between the current level of the current size of the total labor force here in the U.S. relative to the pre-COVID or the post-GFC trends, we're right around 5 to 6 million workers shy of that trend line. So what's not shy of the trend line has been the recovery in gross domestic incomes. We're north of that trend line. And so we've seen a significant recovery in income, you know, particularly for, you know, US businesses, but we have not seen a significant recovery in labor supply. And this is as a function of that, you know, you're seeing a very tight labor market

that's been extremely resilient to Fed tightening. And part of the reason for that, you know, being extremely resilient to Fed tightening is the fact companies may just be reluctant to fire people in this particular cycle, they may have to see a significant, much larger kind of a hit to their profitability and outlook for their profitability before they feel comfortable firing people because they know that in the next business cycle, it's going to be very difficult to find and retain talent, find, train, and retain talent. So this is something that's kind of delaying the process as well.

Darius, I learned something every time we talk. Where can we send people to find you on the internet or find out more about 42 Macro? I appreciate you, man. So definitely come check us out at 42macro.com. Obviously, you know, research out for all top institutions, asset managers, central banks, et cetera, across the global economy. We make that same research available to retail investors

at the same price point, very, very low price points because we ultimately believe that knowledge is power and we want to help as many people as we can. So check us out at 42Macro. And then follow us on Twitter as well. My public Twitter is 42MacroWeather. We have a private Twitter account as well for our subscribers and our members.

So I spend most of my time in that private account, but we definitely do publish our public account as well. Awesome. I appreciate it. We'll definitely do it again in a couple of weeks. Absolutely, brothers. Great to see you guys. Cheers. We'll be right back.