The Pomp Podcast - #1226 Darius Dale | Wall Street Is Calling The Fed's Bluff?!

Episode Date: July 18, 2023

Darius Dale is the founder & CEO of 42Macro. In this conversation, we talk about the S&P 500, bitcoin, consumer spending, manufacturing, capacity utilization, and what will the Fed do with interest rates later this year? ======================= Get Better Crypto Data: Do you want faster, easier crypto data? Sign up for Velo Data, a new product that we have been working on to solve this problem: velowaitlist.com ======================= Pomp writes a daily letter to over 250,000+ 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 Fortitude Macro. In this conversation, we talk about the S&P 500, Bitcoin, consumer spending, manufacturing, capacity utilization, and what the

heck is the Fed going to do later this year when it comes to interest rates. I always enjoy talking to Darius and I hope that you guys enjoy this conversation. I learned a lot and I think you will too. Here is my conversation with Darius Dale. Before we get into this episode, I also want to tell you about a brand new product called Velo. Velo is faster, easier crypto data. Everyone in the industry is always looking for what's the price? What's going on on the exchanges? Where are assets flowing or not flowing? How is things like open interest and derivatives actually playing out in the market? Well, that's where Velo comes in. It's faster and easier crypto data. You can go to VeloWaitlist.com today. Myself and a couple of friends, we invested in the business. We're

advising the founder, and we think it's pretty cool. This one is something that keeps me informed on a daily basis. So you should check them out at VeloWaitlist.com. That's V-E-L-O Waitlist.com. 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 back. Darius, a great place for us to start this conversation is around consumer spending.

We just got the numbers for June. And does it look good or does it look bad? What are the consumers doing? Looks great, man. It's great to see you, man. So something we've been talking about for almost a year now, going back to last August, which is the concept of the U.S. economy remaining resilient amidst all this recession fear. We've seen consumer spending, as you mentioned, accelerated in June. We got the June retail sales data this morning at 830. And on a headline basis, we accelerated to 4.6% on a three-month annualized basis. That's the highest print we've seen in four months on a control group basis. So this is excluding gas station sales, building materials like Home Depot, et cetera, is what they call core retail sales that

feeds directly into consumer spending. That number accelerated to 6.1% on a three-month annualized basis, highest number we've seen since June. And part of the reason we're seeing such a big pickup in retail sales broadly is we're having a pretty sizable increase in auto sales. We had auto sales accelerate to 23% plus three-month annualized, highest number we've seen in three months. So this goes very much in line with what we've seen out of the OPC data in recent months, which is the U.S. consumers remaining resilient. And part of the reason remaining resilient there's kind of two key reasons their balance sheets are very healthy and the labor market remains quite robust so when we see the consumer continuing to be strong on the

flip side we're seeing manufacturing and capacity utilization actually decreasing yeah absolutely so on the second chart we show that on the first top panel there we show industrial production so the broadest uh hard data measure of you know kind of manufacturing we have here in the u.s economy and that number decelerated on a three month annualized basis to 1.6 percent That's the lowest print I think we've seen in three or four months. And we saw capacity utilization number tick down to 78.9%. That's the lowest print we've seen in capacity utilization, which is the total share of our productive capacity that we're actually actively using to make goods.

That's the lowest number we've seen since October of 2021. But there's a reason why I'm not too concerned about the manufacturing side of the economy from the production standpoint. And it goes to the next chart. And the next chart where we show retail inventories. So in this chart, we show the year supply of retail inventories as a ratio of total goods spending. So the total amount of retail inventories that we have, and then we extrapolate that

on in terms of the annual consumption numbers. And right around, we are currently at 1.5 years supply of retail inventories. Now, that number has rebounded significantly off the lows that we achieved in the kind of late 2021. But as you can see, we are still structurally depressed with respect to the longer term time series. were actually lower in terms of the year's supply of retail inventories than we were at the depths of the great financial crisis, at the depths of the great recession in 2009. So this gives me

confidence that we may be on the precipice of a fresh inventory cycle. Now, when we talk about manufacturing, we also see that there's some leading indicators here where you think that there's a potential bottoming. Explain a little bit about kind of what a bottoming would mean and why there's leading indicators and which ones you pay attention to and maybe which ones you're ignoring. Yeah, absolutely. So kind of the best leading indicator for the broader manufacturing cycle here in the U.S. economy, and really almost by extension global economy, or not necessarily the global economy, but certainly for the U.S. economy, is the ISM manufacturing PMI. We're all familiar with that statistic. It's, you know, widely followed, one of the most widely followed

economic indicators out there with data going all the way back to the late 1940s. And so in this chart here where we show the red line is the headline ISM manufacturing PMI. And as you can see in the most recent month, the June data we got earlier this month, ticked down to 46.0. That was a fresh cycle low in the ISM manufacturing PMI. But what we also see is the blue line in this chart, which is a short-term leading indicator, kind of like a three to six-month leading indicator for the ISM manufacturing PMI, which is the spread between the ISM manufacturing new orders PMI and the ISM manufacturing inventories PMI. That number is a leading indicator for the red line, and that number has bottomed at kind of like eight in the second half

of last year, minus eight rather, in the second half of last year, and it's bounced, you know, staged a cyclical rebound to plus two. So that's to suggest that, you know, we're probably going to see a bounce in the coming months in ISM manufacturing PMI to, you know, somewhere right around 50-ish or thereabouts, you know, nothing pretty, you know, nothing that looks like a raging, you know, fresh bull market in terms of the economy, but certainly that's something that looks like it could be supportive at the margins of, you know, this kind of equity bull market that we continue to see and participate in. So the next slide that you have here is the aggregated cross-asset positioning. You have the latest, and then you go back to October of 2022

and you compare. I'm not smart, but I see that the pink bars, there was lots of cash, or I'm sorry, there was no cash, and then now there's lots of cash. Explain what's going on in these two comparisons. Yeah, absolutely. So very complicated chart. So let me take it and just explain it in layman's terms. What I'm showing here is the sort of the investor positioning on an aggregated basis across asset classes. And then I'm showing it on a percentile raking, you know, with a longer term time series relative to each of those longer term time series. And there's a couple of key takeaways. As you can see, investor positioning in equities is only in the 18th percentile of data going all the way back to 1998. And that's actually lower than it was in the lows of October,

which means investors have actually gotten more bearish since October, since the lows of October. And so you rightly called out that cash component, that pink bar there. And we show it on a year over year rate of change and then take that year over year rate of change time series and manipulate it into a percentile time series. And so the current year over year rate of change of money market fund exposure, I think it's somewhere around up like, you know, 19 or something. so those ish percent, don't quote me on that, but somewhere in that area code, that plus 19-ish percent in that area code is in the 82nd percentile of data going all the way back to, I want to say, the 80s in terms of the year-over-year rate of change of money market fund exposures. And obviously, it's well up from where we were in the October 22 lows. And so what we've seen here

is that the institutional investor community has broadly sort of fought this tape. It's really not just institutional investors, this also includes retail investors as well. Again, we're showing the underlying time series for the U.S. equities, U.S. rates, U.S. dollar commodities is the non-commercial net length as a percent of total open interest in the futures and options market. So that also includes retail investors as well. So what the key takeaway of this slide is, is that investors have been fighting the tape. They have not gotten that longer into this rally. They've actually gotten that shorter and have raised cash into this rally, which, you know, if you thought a recession was going to materialize, you know, kind of in the first half of

2023, which was the consensus expectation heading into 2020, heading into the year, we were very much pushing against that. We were extremely on the other side of that expectation since dating back to last fall. You know, investors have been, you know, kind of wrong footed in terms of expecting the recession to materialize in the very near term. And that's, in our view, part of the reason we continue to see this, you know, massive institutional performance chase in the equity market. Because again, the recession just didn't show up on time. And as a function of the recession not showing up on time, what we've replaced in the general narrative amongst investors in terms of recession discussions, we've replaced those discussions with soft landing discussions.

All of the immaculate disinflation that we've seen has contributed to rising soft landing expectations. Those rising soft landing expectations have caused investors to reassign to re-rate equity multiples. It's causing investors to support earning or analysts to support earnings expectations, particularly as we look into 2024. And so this is something, this process, in our view, is likely to continue into the second half of the year. Now, you've got one more chart here that shows S&P 500, Bitcoin. What is this telling us? Yeah, absolutely. So this is a multi-factor correlation study. So we're trying to do in this analysis. Again, these last couple of charts we put in our daily lead off morning note in our

weekly around the horn here to help investors understand the positioning cycle and what's driving asset markets. So on the chart of the left, what I'm showing is the one day percentage change correlation between the S&P 500 and various macro factors as indicated by the indicators listed below. And so at any given time, what can be driving the asset market? The S&P is cyclical growth expectations, structural growth expectations, cyclical inflation expectations, structural inflation expectations, the terminal Fed funds rate, the floor Fed funds rate, the US dollar liquidity or global liquidity. And what we see now is the light blue bars, the trailing three-month correlation. The thing that's most driving the S&P over the last few

months are cyclical growth expectations and to a positive degree, i.e. as investors have gotten more positive, more sanguine on the economy from a cyclical standpoint, the S&P has risen. And what we see is Bitcoin, what's driving Bitcoin, that's the chart on the right, it's not the same in terms of, you know, it's often not the same, quite frankly. So we always lump risk assets in this broader bucket. But the reality is a lot of times there is a divergence, you know, in asset markets. We've seen that in multiple, you know, multiple Bitcoin cycles. And so what's driving Bitcoin right now the most on a trending basis are structural growth expectations and on an inverse basis. And so what it means is that right now, the equity market is celebrating the rise of soft landing expectations or at the bare minimum, the delaying of recession expectations relative to that misguided consensus that we call it out at the beginning of the year.

Meanwhile, Bitcoin is actually cheering on the potentiality for having a recession, right? Bitcoin wants the recession because ultimately what it means is that we're going to have a Fed and other central banks globally capitulate into supplying the market with that sort of unencumbered linear recovery and liquidity that, you know, so many are hoping for. And we ultimately see coming down the pike in 2024. Now, I'm already out there on the tape saying I think Bitcoin will close 2024 north of 100,000. You and I talked about this going back to this winter. I think there's a rocky path to getting towards that. But ultimately, I think the investors in the crypto market have their eyes on the prize as it relates to what's ultimately going to cause the central banks to give us the kind of liquidity that we need to get Bitcoin from $30,000 to north of $100,000 by the end of next year. So I have two other questions for you.

The first is the Fed is going to make a decision. Should they continue to raise rates? Should they pause? Should they maybe cut through the end of this year? The consumer is strong. There's some other data points maybe that are concerning. What do you think that they're going to do and maybe what data points support either direction? Yeah, so if I were the Fed, the Fed has the liberty to wait, right?

We've seen a significant amount of immaculate disinflation, even surprising to ourselves. I mean, we were calling for transitory Goldilocks and going back to January with citing the immaculate disinflation that we were observing and likely continue observing. But it's surprised even us to the downside in terms of how much disinflation we've actually achieved in this business cycle. And so if I were the Fed, you know, if I were the Fed, this is not what I think the Fed will do. I think they will hike interest rates next week, next Wednesday. But in our view, that should probably be it, because you're talking about taking the Fed funds rate to five and a quarter, five and a half percent, you know, that corridor. And ultimately, what it ultimately means is that we're probably going to finally get the policy rate into restrictive territory from the perspective of nominal GDP, from the perspective of nominal employee compensation, which means they probably don't have to go much further. They can just afford to sit on their hands and wait and allow the long and variable lags of monetary policy to tighten and catch up to the broader economy. They will catch up to the broader economy. We're still on the tape and expecting a recession that's likely to start in Q4 of this year or Q1

of next year. We've had that view since November of last year when we performed our yield curve analysis. And so that view hasn't changed. And so ultimately, we still believe that those long and variable lags will start to manifest kind of again, late 2023, early 2024, Q4, Q1 is kind of our expectation there. It may take a little bit longer. It may take a little bit next. We don't think it's going to take shorter. We think we have a high degree of conviction that we're not going to see a recession commence in Q3. And if anything, if you think about the shape of that distribution, whether the modal outcome, the highest peak of the distribution is a recession that starts in Q4 of this year or Q1 of next year. The second highest part of that distribution,

the second highest peak would be a recession that starts later than that or significantly delayed so much that investors start to believe in the soft landing scenario. I think it's of the very low probability that we actually walk into a recession in Q3 of this year. And part of the reason for that is that we're actually probably going to see a significant rebound in that inventory cycle. Going back to the charts we just discussed about the inventory cycle, if you look at inventories in terms of their contribution to real GDP growth over the last four quarters, on average, inventories have shaved off nearly 100 basis points from GDP on average over

the last four quarters. Yet we're talking about a consumer that is actually accelerating its spending on goods while it's maintaining its spending on services. And so ultimately, we may be kind of on the precipice of a fresh inventory cycle. Now, it may not be like a true bottomed out recession level start of a new business cycle inventory cycle, but it could be a mini inventory cycle that delays recession even further, again, relative to those consensus expectations, which I would argue since the last couple of months they have kind of morphed towards more of the soft landing camp or at the bare minimum

delayed recession camp you know a lot of what's been um you know a lot of a lot of the process of consensus being wrong-footed on that view has been priced in we think it still has a little bit further to go though last question for you is are you doing anything differently right now with the portfolio compared to what you're doing earlier this year uh no so i mean we run a we run we implemented a systematic uh long-only process uh in january of this year thank god we did that because we if you recall we came into the year first couple weeks of the year we were raging bears um despite having the view that the recession would take um not till q4 q1 of this year to to materialize and part of the reason we're rating bears because we thought inflation

would prove even though we had that you know that we know so we subsequently adopted the immaculate disinflation view but prior to adopting that the first couple of weeks of january we thought inflation was going to prove stickier than it has ultimately shown to be throughout the first half this year. Fortuitously, we were able to make that intellectual pivot going back to mid-January when we implemented transitory Goldilocks, citing the immaculate disinflation process that we continue to observe. So nothing has changed from that perspective in terms of running this systematic long-only portfolio approach. One thing I call out is we're at 83% of our max exposure to equities in that process currently. We are at 0% of our max

exposure to fixed income in that process, and that's due to what we call our bottom-up risk management overlay. And we're also at 0% of our max exposure to macro asset classes, again, due to our bottom-up risk management overlay. And what we call macro is crypto commodities and currencies and volatility are those macro asset classes. So the process, it has had us pretty long stocks for a while, and it's likely to continue having us pretty long stocks for a while because I don't really see anything coming down the pike in the very near term that's going to derail, you know, this rise in cyclical growth expectations that's driving the equity market higher. Eventually, you know, we will see those cyclical growth expectations peter out and kind

of give way to something more draconian, but that could be, you know, one, two, perhaps as long as three quarters away. Where can we send people to find you on the internet or find more about 42 Macro? Always a pleasure, man. So thanks again for having us. Come check us out at 42macro.com. Put out a bunch of research for institutional investors and high net worth retail investors. I mean, we have a ton of crypto clients as well because obviously as you probably figured out if you're watching this program, you need to know macro.

You need to do macro really well to do crypto really well. So hopefully folks come check us out. And then obviously follow me on Twitter at 42MacroWeather. And we have our private Twitter, 42MacroWhere, but that's exclusively for 42Macro members. Awesome.

Thank you so much for doing this. I always enjoy it. I always learn. We'll definitely do it again. Absolutely, brother. I'll see you next time. Cheers. Thanks for watching!