The Pomp Podcast - #1234 Darius Dale | Central Banks Control The Stock Market

Episode Date: August 15, 2023

Darius Dale is the founder & CEO of 42Macro. In this conversation we talk about global liquidity, what drives it - both in private & public sector, and how to understand its future impact on asset prices. ======================= 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. ======================= 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 42 Macro. In this conversation, we talk about global liquidity, what drives it both in the public and private sector, and how you can understand global liquidity and its future

impact on asset prices. I always enjoy talking to Darius and this conversation was no different. I learned a lot and I hope you do as well. Here's 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. Such opportunities were once behind closed doors, reserved for those with connections or vast fortunes, but not anymore. StartEngine is tearing down that glass ceiling and making startup investments accessible to you and me. With Howard Marks, who co-founded

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Again, run over to StartEngine.com and you can explore those live investment opportunities today. 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?

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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. Darius, I thought a great place to start would be global liquidity. This thing seems to be driving all asset prices. What do you got for us? Yeah, absolutely.

So what I want to do just real quickly this week was help investors kind of understand what's going on with global liquidity. Every month in what we call our macro scouting report, we put together about 30 or 40 slides, particularly as it relates to global liquidity and U.S. liquidity. So I just wanted to give some of the key highlights from the most recent slide deck for your audience to give them a sense of kind of what we do, the kind of work we do on the subject. So as you mentioned, global liquidity is a key driver assets in the chart I'm showing our global liquidity proxy, which is the global central bank balance sheet,

plus global money supply, plus global FX reserves minus gold, showing that on a year-over-year rate change basis relative to global equity market cap and relative to Bitcoin. As you can see, it is a key driver of risk assets. So when we start to go look at the asset prices and asset markets and their response to this, what do you have? Yeah. So let's do that chart here. We show the blue line is our global liquidity proxy. We show that relative to the S&P, Bitcoin, Ethereum, U.S. Treasuries and U.S. corporate credit. And as you can see, those things are always co-integrated with global liquidity, i.e. when liquidity is high, asset market prices tend to be high. When liquidity is low, asset prices tend to be low. Those correlations can rise. As you

can see, they're very correlated in the last three or four years, particularly with respect to S&P. But if you look at the last two to three years with respect to bond markets, those things have become untethered to global liquidity as policymakers around the world have really changed their policy rate settings in the most recent quarters. And then when we look at what's driving the global liquidity, obviously we have dollars, we have FX volatility. What else are we looking at? Yeah. So you and I talked about this all the time, right? Like you can't just call out liquidity and use it as an investment process because you actually need to forecast liquidity in order to actually make money with this kind of information. And so what we show, what we do

at 42 Macro is really try to help investors understand what the drivers of liquidity are. And then we use our quantitative tools and our forecasting tools with respect to the economy and central banks to forecast what those drivers are likely to do in order to forecast what global liquidity is likely to do investable time horizons. And so what we show in this chart is the US dollar real effective exchange rate. As you can see, that's highly inversely correlated to global liquidity, and so much that currency volatility, which is the chart on the right, is inversely correlated to global liquidity as well. So if you can get the dollar right, you get currency volatility right, you're probably going to get global liquidity right.

And there's a variety of reasons for that, but we'll keep it brief for now. And then interest rates also seem to be driving global liquidity? Yeah, absolutely. Global liquidity tends to spike after interest rates spike, and typically it tends to fall after interest rates fall on a real basis. And it typically tends to follow the bond market volatility on an inverse basis as well. And so what we're trying to see, what we see here is this historical pattern of central banks chasing bond market volatility with more global liquidity, in so much that we

tend to see spikes and declines in global liquidity after bond market volatility has subsided. So these things of, you know, these things, these patterns, these relationships are very coincident and consistent across time, you know, going back to the dollar and FX volatility and moving on to interest rate volatility as well. You know, there's a few reasons why these things tend to be inversely correlated to global liquidity. The number one reason for that, in my opinion, is that, you know, a lot of what we see from global liquidity comes from the private sector. So we're all constantly focused on central banks. But the reality is private sector actors tend to create liquidity as well. And those actors find it very difficult, particularly when you're in international investment surplus economies like Europe and Japan. You know, these these these these economies tend to create a ton of liquidity globally from the private sector perspective.

But when they have interest rate volatility, when they have currency volatility, it makes it very difficult for those private sector agents to sort of, you know, continuously increase the amount of dollars that's applying across global capital markets. So that's when you tend to see global liquidity weighing at the margin from, again, from from private sector actors. And then when we start looking at these downturns in growth, it seems like global liquidity is a second order effect or kind of lags behind. Yeah, absolutely. So so we just spent a few minutes talking about what drives private sector liquidity vis-a-vis currency volatility, interest rate volatility on inverse basis. And then what tends to drive public sector liquidity, i.e. central bank liquidity, tends to be the sort of cyclical upturns and downturns in growth. So you tend to get more global liquidity when, you know, after a growth slowdown. Obviously, that tends to be it's pretty obvious there's cause and effect there. But we also have that in terms of how it lags cyclical upturns in inflation.

So the next chart where we show declines in global liquidity tend to lag cyclical upturns in inflation. So if you want more global liquidity, you tend to want a slowing economy from a public sector or from a private sector or public sector standpoint. Pardon me. If you want more liquidity from central banks, you want to slow down in growth and a slowdown in inflation. You want less liquidity from the central banks. You want a rise in growth and a rise in inflation. You want more liquidity from private sector actors. You want a falling dollar, falling interest rate volatility, falling currency volatility. You want less liquidity from private sector actors. You need a rising dollar, rising interest rate volatility, rising currency volatility. When we look at the liquidity cycle, you are showing that it has bottomed in 2022. What does that mean for investors? Yeah. So, you know, I think we've talked about this ad nauseum. Other guests have talked about this as well.

But, you know, we're in a liquidity cycle upturn, you know, with very much bottom had a pretty secular low. back in October of 2022. But one thing we've been consistent about calling out this year, particularly when we got towards the year-to-date highs in Bitcoin back in April, which is saying, hey, look, global liquidity is not this sort of linear recovery that we've historically seen in previous liquidity cycles. Typically, you see a bottom and it's just up, up, and away for liquidity for several quarters or several years. And that's just not the case. That's what we're observing here in 2023, which is that middle panel there where we're showing our global liquidity proxy. That's the blue line in the top panel. We're showing on a max

drawdown basis in the middle panel. And as you can see, it's very clearly not a linear recovery process, much like what we've seen in previous cycles. When we look at the impulse, what are we seeing here? Yeah. So we track the same statistics, global liquidity proxy, world equity market cap again, showing in the middle panel and the bottom panel there, the three-month momentum in each of those time series. And as you can see, over the last four months, we've seen global liquidity actually wane over the last three, four months or the last four months. we saw a minus kind of $4 trillion-ish hit to global liquidity on a trailing three-month impulse basis in June. That number rose to minus $2.4 trillion in July. It's still not quite what

we want from the perspective of global liquidity, but it's definitely getting better at the margins. And that makes a lot of sense. We're moving past the worst of it as it relates to TGA rebuild and all that stuff here in the US. Now, when we start to go and look at this next chart, I don't understand this. You're going to have to explain this one to me. We've got global liquidity is driven by counter cyclical and pro cyclical factors. What exactly is this showing us? Yeah, absolutely. So as I mentioned earlier, you know, it's again, when we talk about liquidity, a lot of, you know, the kind of the Twitter community is really focused on liquidity from central banks. But the reality is, if you want to get asset markets, right, you need to understand

liquidity for both private sector and public sector actors. So the central banks, a lot of folks care about because they have the ability to inflect the trend, i.e. if you're in a cyclical downturn, and you're, you know, cyclical downturn and growth and inflation, you know, central banks can step in and say, hey, look, we're going to do something with our policy that makes it easier for private sector actors to kind of take that and reflexively create liquidity on the other side of that. So that's why we really care about central banks a lot. But the reality is, you know, the dominant force in global liquidity is the private sector. And so you really do need to understand kind of how these private sector flows and how they're impacting asset markets. And so what we're

seeing here on the trawling three-month momentum basis is that, you know, if you go back and you break open our global liquidity proxy in terms of the features in that central bank balance sheet is contracting globally. You have a slightly smaller contraction in global abroad money supply. And then you're still having this very modest build on global FX reserves on a trailing three-month impulse basis. So again, as I mentioned, the liquidity impulse has been negative for four months. It's getting slightly less negative at the margins, and that's partially due to improving private sector liquidity conditions. Now, let's talk about these market conditions that continue to support rising private sector liquidity. This is obviously

something that you've been really, really spending a lot of time on this year. What are you seeing here? Yeah, absolutely. So what I show on this chart, the chart on the left shows the trailing 10-year correlation to each of those particular factors to the year-over-year rate of change of our global liquidity proxy. The chart on the right shows the Z-scores of each of those leading indicators, the latest value of each of those leading and coincident indicators on a Z-score basis. There's a cyclical Z-score, which is a trailing three years. There's a structural Z-score, which is a trailing 10 years. And what you see is that growth and inflation, which we can proxy using the OECD Composite Leading Index, we can proxy using the year-over-year basis point of

change in unemployment rate, or we can proxy sort of those two things will help us proxy growth. And obviously, inflation, we use core CPI on a year-over-year basis. What we see there is that based on what those current things are reading on the chart on the right, we should not expect a significant amount of public sector liquidity over the next six months, based on the correlations between those particular indicators relative to the global liquidity proxy on a six-month lead basis. But on a coincident basis, we see that things like the move index, the currency volatility, the US dollar, we see Brent crude oil, real 10-year yield, all those things are actually down on a year-over-year basis from the perspective of the cyclical Z-scores. So that's telling you

that the steel is a decent enough environment for private sector agents to continue creating liquidity at the margins should they choose to, obviously animal spirits being the kind of dominant force in that process, if and when central banks aren't there kind of leading the charge. Last question, macro narratives, obviously those things change.

With the wind, what are you seeing here and what is this chart showing us? Yeah, great question. So every morning we refresh this table for our clients. This is our global liquidity monitor where we're tracking this growth, inflation and policy across all these major economies that feed into our global liquidity proxy, and what we show there on the right are the systematic trade ideas, which are born out of certain setups with respect to

growth, certain setups with respect to inflation, or certain setups with respect to policy. And as you can see, from the equity side, China's got a bear signal. We got a new bear signal in the Eurozone this morning from Eurozone equity perspective, new bear signal in Switzerland from that perspective. And how you get bear signals from the perspective of our systematic process is when you have growth slowing on a trending basis vis-a-vis the leading indicators, and you also have negative economic surprises with a negative impulse in global liquidity.

That's kind of like a bearish trifecta for outcomes. And obviously, if growth was accelerating, you had positive economic surprises, you had positive impulse in global liquidity, that would be bullish for stocks. We had bullish signals for places like India and Brazil for quite some time, but those things have recently dissipated

to neutral signals in recent weeks. So that's something to call out to the extent you know anyone is on long india and brazil um on the f on the fixed income side our model spotted the um the breakdown that we're seeing in japanese uh the japanese government bond market and ultimately that pivoted while the yoke curve control tweak uh because it spotted a negative setup uh with respect to japanese bonds so how you get a negative setup on the fixed income market is you have headline and core inflation accelerating with a negative impulse in the particular country's global liquidity proxy or not global that particular country's

liquidity proxy because we run that same analysis for each country and we amalgamate them to get to our global liquidity proxy. And so obviously, if you want to be bullish on bonds, you want to see headline and core inflation decelerating with the liquidity proxy that's rising. And then lastly, with respect to FX, our model has been all over the bearish Chinese yuan story all year. We're seeing with respect to the Chinese yuan, you have policy rate that's trending lower. You have a fiscal balance that's trending lower as a percent of GDP. You have current account balance that's trending lower as a percent of GDP. Those things are all negative for the currency and conversely if those things were rising at the same time you'd have a bullish outlook for

the currency so a lot of red a lot of down arrows in this table right now there was a lot of green arrows in this table you know going back a a few months ago but those things have obviously dissipated to more neutral signals where can we send people to find you or 42 macro yeah as i mentioned so we refresh all this analysis on a you know every day and every not every day everything is worthy of calling out but certainly this uh this table here that we just spoke to we refresh that every day six days a week for 42 macro customers and we do a big deep deep dive as i mentioned on global liquidity every month at the beginning of the month in our macro scouting report so definitely come check us out we're 42 macro.com if you can't afford our research we'd

like to think that we price it very very affordably but if it's a little bit over your head then just just follow us on twitter we're 42 macro weather do a fantastic job i literally learned something every single time we talk so i appreciate you doing this periodically and we'll do it again of course brother i appreciate you man you be good