The Pomp Podcast - #1231 Darius Dale | US Economy Is VERY STRONG Right Now

Episode Date: August 2, 2023

Darius Dale is the founder & CEO of 42Macro. In this conversation, we talk about consumer spending, durable goods, whether the economy is heading to a recession, what the Fed possibly could end up doing, and what it means for the US economy to be resilient. =======================Sign up for a StartEngine account today using the link below and explore live investment opportunities where you can start investing with as little as $100:https://invest.startengine.com/?utm_source=podcast&utm_medium=anthonypomp&utm_campaign=startengine-own The information provided in this marketing material is for illustrative purposes only and should not be considered as financial advice. Past performance, including the success of certain individuals, is not indicative of future results. Investing in any market, including startups, involves risks, and there is no guarantee that similar opportunities will yield comparable returns.Number of Users is determined by counting user profiles with unique email addresses which are active and have been confirmed*Includes $760M in funds raised as of May 9, 2023 via Reg. CF and Reg. A+ combined through StartEngine’s funding portal and broker dealer, StartEngine Capital, LLC and StartEngine Primary, LLC respectively, as well as StartEngine’s own raises. Also includes $470M in funds raised previously through offerings conducted on http://www.seedinvest.com outside of the StartEngine platform. In May 2023, StartEngine acquired assets of SeedInvest, including email lists for SeedInvest’s users, investors and founders seeking to raise funds. ======================= 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 42 Macro. In this conversation, we talk about consumer spending, durable goods, whether the economy is headed towards a recession,

what the Fed possibly could end up doing, and what exactly it means for the U.S. economy to be resilient. I always enjoy talking to Darius, and I hope you guys enjoy this conversation. It's as informative and entertaining as always. Here is my conversation with Darius Dale. This episode is brought to you by StartEngine. The biggest fortunes aren't made on Wall Street. They're made way before startups hit the stock market. Consider Mike Walsh. He was just a regular guy, but then he invested $5,000 into Uber. And that investment money, it grew to a staggering $24.8 million.

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All right, guys. Bang, bang. I've got Darius here. Darius, everyone has been saying that the world is going to end, that we're headed to a recession, and then the GDP number just dropped, and it absolutely blew away expectations. What the hell is going on? Yeah, man. It kind of reminds me of the old school Mortal Kombat.

You remember we had the finish him move, the GDP data, and also the PC report that we got on Friday was kind of like the finish him for the ultra bearish narrative. And so I think a lot of folks who have been fighting this equity bull market, the bull market we've seen in credit year to date, I think a lot of folks are going to have to throw in the towel and capitulate in the second half of the year. So let's start with this first chart here where we show real GDP accelerating and beating consensus expectations in the second quarter. Real GDP came in at 2.4% on a quarter-for-quarter annualized basis. That's the highest print we've seen since the fourth quarter of last year. If you go down to the third panel in this chart where we show the I component, so gross private domestic investment, that number accelerated to 4.8% on a quarter-over-quarter annualized basis and contributed 100 basis points to that headline GDP figure of 2.4%. That's the highest number we've seen since the first quarter of last year.

So economy is doing quite fine. Now, when we go and we look at June numbers specifically, there's some nuanced data here that's kind of telling a story that I think reinforces the macro GDP number. What are you seeing in the June data? Yeah, absolutely. So if you look at this chart here where we show industrial production, capacity utilization, manufacturing and trade inventories, but specifically want to focus your eyes to the bottom two panels where we show durable goods, new orders, as well as core capital goods, new orders. And just by way of reference, when you see these charts from us, the blue bars indicate the quarter-over-quarter or three-month annualized rate of change, and then the red line just shows the year-over-year rate of change. But we're primarily focused on the sequential, the three-month annualized rates of change here, 42 macro, because really that's where more market information lies. But again, if you go back and you look at the June durable goods print, came in at 32.4% three-month annualized. That's the highest number we've seen since September of 2020.

And then core capital goods new orders came in at 5.7% on a three-month annualized basis. So that's the highest number we've seen since August of 2022. too. So wherever you slice and dice it, whether it be GDP, whether it be durable goods, capital goods, new orders, the U.S. economy very much looks like it's growing quite as robust, quite robustly. Now, you can look at all of the actual goods themselves, but if you just go look at what consumers are doing with their pocketbooks, they're spending. What are we seeing here? Yeah, that's what we've been saying, man. And look, the U.S. economy is a consumption-oriented economy, right? We know that 68% of GDP is consumer spending. And on Friday, we got the

June PCE report, which I happen to find is this outside of the jobs report, arguably the most important economic statistic that comes out on a monthly basis. And when you look at the top panel there, where we show a headline PCE, so real personal consumption expenditures, they accelerated to 2.9% in June. That's a three-month high. And it was driven primarily by a rebound in goods consumption, where we saw real goods PCE accelerate to 5.4% on a three-month annualized basis. that is also a three month high. Now, when we look at income growth, I think this is one of these metrics where like real wages have been down for like two years because of inflation being so high. And obviously people start to politicize those numbers. But when we look at income growth,

that seems to be telling a pretty positive story as well. Yeah, a hundred percent, man. So real wages, let me just take a quick second to take a step back there. Real wages have been negative in terms of just specifically wages, or at least they had been prior to 2023 for a while. But the reality is consumer income has not been negative because, again, we're seeing total growth in employment. It's not just wages. You also have employment as well. You have government transfers and other avenues in terms of supporting income growth. And so if you look at income growth specifically in the PC report, so again, we get consumer spending in that report. We get consumer income in that report. And we also get inflation as it relates to the consumer economy in that

report. So let's start with the income here. So personal income, this is nominal employee compensation. So it's the broadest and most nominal measure of income that we receive from the labor market on a monthly basis. That number accelerated to 6.2% through month annualized in June. That's the highest number we've seen since September of last year. And that really matters because in nominal employee compensation or employee compensation is right around 60 or a little bit over 60% of total income growth. Another interesting statistic I threw out from this particular chart here, if you go down to the fourth panel there, where we show personal interest income, that number accelerated to 8.8% three-month annualized in June. That's the highest

number we've seen since January of this year. So when you put those two factors together, nominal employee compensation, interest income, you're talking about 70% of consumer income is growing somewhere between 6% and 9% on a three-month annualized basis. That just does not sound like an economy that's anywhere near a recession. Now, when we start thinking about the U.S. economy more broadly, this idea of it being resilient keeps coming up or like a resilient economy theme. Describe a little bit what some of the factors that feed into that are. Yeah, absolutely, man. So you and I've been talking about this for almost a year now. We created the theme in August of 2022. It's August of 2023. We've added some things to the

list, but primarily most of the stuff was readily available if you were doing the research back last summer to understand that the U.S. economy is likely to remain resilient for longer than the average investor understood. And the reality is, so there's eight factors that we see as independent factors, but all being very relevant. There's number one is near record cash on household balance sheets. Number two, you have near record cash on corporate balance sheets. Number three, you have private sector income and wealth have outpaced inflation on a structural basis. So clearly the big issue is, okay, inflation is very high. We had the negative wage growth that you cited earlier. But the reality is since the inflation episode started,

going back a couple of years ago, we're still seeing income and measures of wealth like household net worth, for instance, those numbers have actually grown faster than inflation has on a cumulative basis. Number four, we've limited credit cycle vulnerabilities. I mean, I'm sure you've heard this a thousand times, how credit card debt, blank, you know, credit card debt, blank. But I'll throw a couple of statistics at you just specifically as it relates to consumer leverage. So if you look at household debt relative to a domino disposable personal income, so that the broadest measure of income we have as consumers here in the U.S. economy, me, that number is 85.5% in June. That's exactly the same as the trailing 10-year mean. So there's

been no sort of degradation in terms of consumers getting over levered in any stretch. And even when you look at it specifically as it relates to credit card debt, that number is right around 4.9% as the percent of nominal disposable personal income. That's below the trailing 10-year mean. So you could take all those tweets about credit card debt and stuff, which is what I said a year ago, and put it in, light it in a dumpster fire with all the other bad economic statistics that people keep trying to cite with this faulty bearish narrative. The reality is that we got a few more here to get through. So we have limited exposure to the volatile manufacturing sector. Manufacturing sector is way more volatile relative to the services sector. It accounts for about 98%

of net job loss in a recession on a median basis going all the way back to the post-war U.S. economy. We have longer, long and variable lags, at least according to our estimates, based on how much, what was the percent of debt that's been sort of termed out both within the the household sector and also in the corporate sector as well um you know you also have this you know these record spreads between not or not record but near record spreads between you know let's say a marginal mortgage relative to the effective mortgage rate that everyone's paying or relative to um the yield on corporate credit instruments relative to the coupon that the corporates are actually paying so what's happening is folks aren't going to the market to buy a new

house they're not going to the market to issue new debt and so ultimately what it means is that monetary policy is just going to take longer to really hit the economy because we're seeing that stasis develop. And lastly, we got Bidenomics. This is something we saw in last Thursday's GDP report. But if you look at government investment, it's growing plus 11% on a three-month annualized basis. It's also growing plus 11% on a year-over-year basis as well. So it's been pretty persistent, that trend of government investment. And then lastly, you have labor hoarding, which is something we've talked about on the program as well. Labor hoarding in the sense that it's very difficult because we've seen this structural decline in the total labor force relative to

uh prior to the pandemic it's been very difficult for u.s firms to attack attract and retain talent and so as a function of that they've probably just been more unwilling to fire people in this particular business cycle than they otherwise would have given how much you know kind of tightening we've seen thus far by dynamics is still the uh most hilarious title of all time because it feels like it's used both for positive and negative descriptions but regardless of what but what people have from a perspective. It's just the policies have led to the results and you can judge them for yourself.

When we think about transitory Goldilocks, I know that's something that you've been thinking a lot about. What are we seeing here? At Desjardins Insurance, we know that when you own a nail salon, everything needs to be perfect from tip to toe. That's why our agents go the extra mile to understand your business

and provide tailored solutions for all its unique needs. You put your heart into your company, So we put our heart into making sure it's protected. Get insurance that's really big on care. Find an agent today at Desjardins.com slash business coverage. Yeah, absolutely. So you go back to January of this year when we identified the transitory Goldilocks theme. It was based on our realization that, hey, look, this immaculate disinflation is real.

We had the resilient U.S. economy theme since going back to last summer, but it became pretty clear to us in January. And I think, you know, we were you know, we were among other investors who kind of came up with that at the same time. I shot my man Bob Elliott over at Limited. You know, it's hey, we actually are experiencing this immaculate disinflation because what tends not to happen in the U.S. business cycle is inflation breaking down before a recession. But we've that's exactly what we've seen. So on Friday, we've gotten PCE, the PCE report within that we get the PCE deflator. So this is the broadest measure of inflation specifically for the household sector in the U.S. economy or for the consumers in terms of consumer spending. And so there's four statistics that are

really important in that particular report. I'll start with the one, two, three, four, the fifth panel, which is core PCE inflation. So that's the Fed's preferred measure of inflation. This is the one that the Fed cares about the most. That number decelerated to 3.3% on a three-month annualized basis. That's the lowest print we've seen since February of 2021. So that's pretty robust. And what's likely to happen in the coming months is that the year-over-year numbers are going to continue to chase the three-month annualized rates of change lower. That should certainly happen as well for super core PC inflation, which is the bottom panel there. So super core PC inflation is core services. PC inflation X housing, this is the one that

Powell keeps citing at all these FOMC press conferences. And that number decelerated to 3.2% on a three-month annualized basis. That's the blue bars in these charts. That's the lowest print we've seen since July of last year. We're also seeing it on a broad base measure as well. So if you kind of go back up a couple of panels where we show median PCE and trim mean PCE, those numbers came in at 3.8 and 3.4% respectively. Both of those are the lowest numbers we've seen since August of 2021. So we're making significant progress as it relates to, you know, getting inflation under control. And it's coming from some pretty important avenues as well. If you go to the next slide.

Now, when we look at things in the private sector, you've got a couple of panels here. What's going on? Yeah. So this chart here, just following up on this immaculate disinflation discussion here. So obviously, the resilient economy, that's the first collection of charts. Second collection of charts here is just kind of updating investors on where we are in this immaculate disinflation process. And I'll draw your eye specifically to the bottom panel in this chart, where we show the private sector employment cost index. And so that's the broadest measures, wages and salaries that are released on a quarterly basis. And that's the one the Fed kind of really cares about to kind

anchor monetary policy on. And so, you know, historically we were kind of trending around two, two and a half percent. That's, that's pretty much, you know, anything right around two and a half percent is pretty much consistent with 2% inflation. So we're clearly very north of that. But we are making decent progress. If you look at it on a quarter over quarter annualized basis, the private sector employment cost index decelerated to 4.1% in the second quarter. That's the lowest print we've seen since the second quarter of 2021. So if we continue to make this kind of progress, you know, it's definitely going to call into question whether or not the Fed is going to be able to continue to hike interest rates in September. Don't forget,

we got two more CBI reports between now and the September meeting. I think we have one more PC report and then we have two more jobs reports. So they're going to be busy in terms of interpreting this data. Now, when you start looking out kind of at what the Fed is seeing here, we obviously got the interest rate hike. Is this something where they can just keep hiking forever or are they pretty much saying to themselves, look, we get the green light because the economy is strong and we can go higher? Is it a wait, we're going to over-rotate? How are you thinking about this? Yeah, it's a great question, man. So I think they're done for now. They may go on what may ultimately feel like a long-handed pause, because I don't think between now and the September meeting,

FOMC meeting, that they're going to get any data that has a material change in terms of its flavor. We have this immaculate disinflation. It's probably going to slow down the pace of the immaculate disinflation. But ultimately, as we show on chart eight, I'm actually quite concerned that you know by the time we get roll the clock three to six months from now you know you know beyond the fed meeting i think that the air of inflation can very much shift from immaculate disinflation to sticky uh inflation and that might ultimate ultimately you know kind of cause the fed to to um you know to get off this high horse and and implement another uh rate hike or so so we'll see i don't know that they really i don't really have a strong opinion on that but what i do have

a strong opinion on is that as we show here in chart eight if we continue to see this rally in and energy, food and energy prices. We have WTI on the left chart there. It just recently broke out to bullish from the perspective of our volatility, just a momentum signal. We have agriculture, which has been bullish for maybe a little bit over a month now, relative to our volatility, just a momentum signal. If those bullish VAMs kind of conditions persist for the next few months, we will see another surge in inflation, just similar to kind of what we saw in the first half of 2022. So that's something that's concerning me. But another thing that's concerning me, I think we might've talked about this on the program as well, which is

immaculate disinflation was probably going to run out at some point anyway in the second half of the year, just based on where we are in the U.S. business cycle and the likelihood that it's very unlikely that we see inflation return back to 2% prior to a recession. We do believe inflation is heading back to 2%, but we also ultimately think that we got to go through recession to get to that. So if you play the clock forward in terms of how the market narrative might change between now and let's call it the end of the year, right now it's saying economy's resilient, it. We've got immaculate disinflation. You put those two things together, we have transitory Goldilocks. I think between now and the end of the year, some point in Q4, maybe even it spills

over to Q1. But I think the narrative around the resilient economy will dissipate. And part of the reason the narrative around really the driving force behind why the narrative on the economy being resilient would dissipate is because the narrative surrounding immaculate disinflation will change. And if we shift back to something that looks like sticky inflation and ultimately a Fed that has to do more tightening that gets pushed the economy into a recession, that's going to cause the resilient economy narrative to unwind. So I think six months from now, it's probably going to be a very different feel in asset markets. It could be sooner. I don't have a crystal ball on when that actually is going to come up. But I do believe

when we get into the fourth quarter, some of the data is probably going to look a little bit different than it does today. When you look at asset prices, you see the Fed's actions. We go into the end of the year, there's this whole thought process of may hit and go away. Is that true? Or do you think asset prices got a shot through the rest of the year? Oh, I think they do. I think we're going to make all-time highs in the SPY. We said this last week a couple of times. And based on our analysis of this data, it's very unlikely we see a significant change in the conditions of these kind of themes, immaculate disinflation, resilient U.S. economy, equus transitory gold deluxe. I think if we have another three months

of that, we are going to make all-time highs in the SPY. I mean, you just see what happened over the last three months. It could very easily add another 200 S&P points in a matter of a couple of months. So I do believe all-time highs in the S&P are very likely, but that doesn't necessarily mean it's the start of a new raging bull market. Because again, I still think the market is going to have to price in at some point between now and the first half of next year, into the first half of next year, something we call a phase two credit cycle downturn, which is the process of the market trying to find the lows, trying to find the low in earnings and corporate profitability in a recession. And the correction in valuations that we typically see that allows different

businesses, different investors to capitalize businesses and take over new businesses. That process is months, in our view, it's probably months away. The earliest probably four or five months away, and the latest probably seven, eight months away. And so if you think about how long, how much time that is in risk management terms, you think about, just think about where we were four to five months ago in pricing terms, seven, eight months ago in pricing terms and you can kind of roll the clock forward on that. When we have to look out over 2024, obviously the economy is, some people think it's going to go into a recession at the end of this year, beginning of next year. There's this positive kind of undertone to it. Housing prices is the

last thing I want to talk about real quick. What we've seen is they're pretty resilient and now there starts to be some softening in it. How much of economic pain could potentially just be lagging a lot of the interest rate decisions versus some of the data points we've talked about today you think can overpower that stuff and actually we're on our way back kind of up as an economy and the fed uh will give it quits and walk away no that's a great phenomenal question man so um we've been doing this for how long of course i ask phenomenal questions that's true i think you're one of the world's best man i appreciate uh being on with your community so um in terms of answering the question i i think so we we believe a recession is still the most likely probability uh our model

since November of last year has been centered on the six-month interval between Q4 of 2023 and Q1 of 2024, as when a recession is most likely to start. So that's still our baseline scenario. You know, we'd have to go through Q1 of 2024 for us to now cast our way out of that. And so in terms of like the resiliency that we've seen since then, this wasn't an impulse. There was not like a new thing that created the resiliency. It's just that the economy was always resilient. It was just being underreported.

And the market, the change in the market price year to date has really forced the mainstream media to, you know, to stop doing whatever the hell it is that they're doing all day and actually acknowledge the fact that the economy has been resilient. You know, this is the stuff we do every single day. It seems boring, you know, trying to figure out what the three-month annualized rate of change of durable goods is, is boring as hell. But you got to do it in order to get these things right. Where can we send people to find you on the Internet or find out more about 42 Macro? Yeah, I appreciate it, man. So definitely come check us out, 42macro.com. 42 macro weather is my twitter handle pretty active on there as well so definitely give us a

job i appreciate you i learned something every time we'll do it again appreciate you man thank you so much