The Pomp Podcast - #949 Darius Dale On Why Investors Should Be Very Nervous

Starting point is 00:00:00 What's up, everyone? This is Anthony Pompliano. Most of you know me as Pomp. You're listening to the Pomp Podcast, simply the best podcast out there. Now let's kick this thing off. Darius Dale is the founder and CEO of 42Macro, the leading macro risk management advisor. In this conversation, we talk about what's going on in the macro economy, what's happening in the financial markets, how Darius is looking at various metrics, and also what you at home should be thinking about as you invest your capital. I really enjoyed this conversation with Darius, and I hope you do as well. Before we get into this episode, though, I want to quickly talk about our sponsors. Today's episode is brought to you by Exodus,

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Starting point is 00:03:04 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. Darius, how are you, my friend? Tom, what's up, buddy? How you doing? I'm doing great. I miss you, by the way. I know that the Miami Darius is not here. You're back to New York City Darius,

Starting point is 00:03:26 but I'm hoping that you're going to come back and be Miami Darius at some point in the future. Yeah, yeah, man. With the bifurcation of regulation and taxes in this country, I'd probably be a Miami Darius at some point permanently, but we'll see for now. Hey, let's go. All right, so the Fed raised interest rates

Starting point is 00:03:41 by 50 basis points yesterday. This is what the market was expecting. we talked about it previous, I think you were expecting this as well. What's your read on kind of some of the commentary around the actual interest rate hike itself? Yeah, so I mean, it was it was mostly hawkish. He laid out a couple of things that were somewhat dovish. And that's why we had the market response that we saw yesterday, right? Big, big squeeze higher in the market, a big unwind of a lot of bearish options positioning into the event. But then when you peel back the onion, which I did immediately, and I think the market is very

Starting point is 00:04:11 much doing today, it was an incredibly hawkish event. I mean, effectively confirm, which is something that the market had not realized that this is a Federal Reserve that is very comfortable taking interest rates beyond neutral. And that will cause a panic, it will cause a recession, it will cause things in the financial ecosystem to break. So when you start to think about that idea of a recession, obviously, they're hiking interest rates, as we're seeing the economic contraction from q1 uh as they continue to increase the interest rate are we expecting them to actually accelerate the recession like if we were at a negative 1.4 percent growth in q1 is your expectation that it'll be something worse than that in q2 or will it stay kind of flat or

Starting point is 00:04:52 how do you read into that no it's actually so it's growth is likely to bounce in the second quarter right and part of the reason we saw you know recovery off the lows in february is that the rate of change of growth, the second derivative, actually improved from January through, let's call it March or April. We're seeing that in most of the economic statistics we track, with the exception of the PMIs that we got this week. We've seen a lot of strength in the hard data, you know, the retail sales, the consumer spending, the industrial production. So what we saw in the Q1 GDP report was really just a function of inventories and imports really dragging down and outweighing a very solid report from a consumer spending perspective. When we talk about the big slowdown

Starting point is 00:05:33 we see in the economy, from our perspective, that's something that looks like a third and fourth quarter event as opposed to a second quarter event. We're in this awkward transition phase from an economic standpoint where growth is slowing and is likely to start to slow at a much faster pace in the coming months, but it's coming from a high level that in that level gives the Fed and value-oriented investors a lot of confidence to, one, to keep hiking and two, to keep buying. And both of those parties are going to be wrong. Yeah, it's fascinating to watch this. Obviously, a lot of people, as you know, who listen to this are really invested in growth or risk assets, whether that's tech stocks, cryptocurrencies, etc. There's this

Starting point is 00:06:15 kind of drawdown of price that's occurring. We've seen reports that Tiger Global and some of these kind of tech oriented funds are down 40 plus percent year to date. Obviously, Bitcoin is down on the year. What's your read in the impact to risk assets or growth type assets as we continue into this kind of interest rate hiking type environment? Yeah, so it's interesting, right? Like, so there's there's the macro trade, which is pretty clearly and obviously negative. We're in a slowdown from an economic standpoint. Inflation continues to be at a level that is well much higher than the fed can tolerate or is politically allowed to tolerate and so they're likely to continue tightening policy but then you have to layer on the behavioral dynamics right

Starting point is 00:06:58 you know stocks start to go down that by enough cryptocurrency start to go down by enough you're going to start to see uh consumers businesses other investors demand liquidity at increasing paces right and so you're going to start to look around and say okay what hasn't gone down as much that I can liquidate to raise cash or, you know, to get myself back to flat from a positioning standpoint, right? That's an issue. Because, you know, people always in these times, they sell what they can, not what they should. And so, you know, let's say if you're, you know, if you're two levered long shit coins, for lack of a better term, you know, you might look around and say, hey, well, Bitcoin hasn't gone down nearly as much. So let me go sell some Bitcoin and raise cash,

Starting point is 00:07:39 right? Because I don't want to sell something down 90%, might as well just hold it. And so to me, I think, you know, I'm not sure that we're at that point of the game yet, but that's certainly a point of the game that we see coming just given our economic outlook. And so when you start to think about how this, uh, this plays out, if people are selling what they can, not what they should, uh, is it a fair statement that, you know, whether you're a value investor, you got a lot of liquidity, whatever, like now is the time for people to start investing or there's certain metrics or data points that you guys are looking at where you're like, yeah, we're going to try to actually wait a little bit more because

Starting point is 00:08:11 we think it'll only get worse. and you know there's not really true blood in the street like how do you think about uh either timing markets identifying bottoms or like when should the people who don't you know they're not forced sellers like when should they actually start to deploy capital or how do you like evaluate that from a framework standpoint great great question i think that's the the million dollar question and there's a couple of ways i think um as investors we we can answer that question my general framework on when do you deploy capital in times like these is is it's sort ignore the nonsense about you buy when there's blood on the streets that's that's wrong in fact

Starting point is 00:08:45 you're proven to lose money if you buy when there's blood on the streets it's called catching a falling light what typically works is you buy when you hear the sound of federal reserve ambulance sirens you know to clean up all the blood on the streets and right now this federal reserve hasn't even left the hospital they haven't even gotten in the truck and so that's my issue with in terms of you know buying assets at this particular juncture we i don't believe at least according to a lot of the indicators we track, whether it be financial conditions, whether it be credit spreads, you know, which are, you know, technically part of financial conditions. It's not, it's a belief that financial conditions have not tightened enough to warrant the Federal

Starting point is 00:09:21 Reserve, you know, those paramedics leaving the hospital, getting in the truck and going to wherever there is blood on the streets. You know, it's, you know, if you look at something like the Goldman Sachs Financial Conditions Index, which tracks credit spreads, the strength, they're really strengthened the dollar, sort of, you know, the equity risk premium, real interest rates. And I think there's one more indicator in there. But that that index, you know, even as of today, or it'll be updated as it's a little bit worse. But prior to this week, it was as loose and in terms of financial conditions being loose, as it was at the peak of the.com bubble. Like we already seen a 15% drawdown in the stock market, and financial conditions were as loose as they

Starting point is 00:09:59 were at the peak of the.com bubble. So we've seen nothing yet from a financial conditions a tightening standpoint, and this goes back to the comments I've been making on your show and on other shows for the last, let's go, four months, five months, which is, man, this is a Federal Reserve that is comfortable with pulling the rug out from under us from an asset market perspective. Now, they're going to get uncomfortable at some point, and that's when you want to be getting your cash ready to buy some things hand over fist. I mean, we'd love to see $28,000 on Bitcoin.

Starting point is 00:10:27 I don't think we're going to get there because there's a lot of smart people like myself that are waiting on that level. But yeah, I mean, that's when you take out both hands and back up the truck. So you got these charts here that you sent over, and some of it is this volatility risk premia, and then you've also got this dispersion. Let's take the first one, this idea of crowding. Explain what this is showing us here. Yeah, absolutely.

Starting point is 00:10:48 So this chart, in my opinion, is why we're seeing a lot of the pain that we're seeing today. In fact, together, they do well. So I'll unpack them both. And so the chart on the left shows crowding. And what we mean by crowding is we're looking for extremes in options market positioning that we can take the other side of because those tend to be unwound in a pretty forceful way. And one thing we flagged in our morning note and our lead-off morning note today for our clients at 42 Macro was the fact that large swaths of the equity market, in particular the SPY, the Qs, size as a style factor, and pretty much every major style factor where all the market cap is concentrated, sort of had a very deeply negative volatility risk premium. And so in translating that in layman's terms, you know, you typically in these events like Federal Reserve or election events, typically investors build up these sort of large, short-dated put positions into the event to protect themselves from that near-term downside from that catalyst.

Starting point is 00:11:42 Well, when the catalyst comes and goes, the dealers who sold those investors puts get to unwound those, unwind those hedges, you know, those short futures contracts, short index, short equity contracts. Well, we got that unwind yesterday. But when you refresh the data as of this morning, it's like there's no more of that positioning left. There's nothing left to unwind. And so now we just have to reassess and say, hey, look, what are the fundamentals? And so that kind of translates to the second chart, which shows our dispersion analysis. We're looking at month-over-month sharp ratios across 54 U.S. equity sectors, style factors, and industries to get a sense of sort of pod shop flows. These are the largest hedge funds. These are the hedge funds that control 60%, 70%, 80% of the sort of equity market turnover on any given day. And what that analysis indicated to me in terms of the pro-psychicality of the composition of the upper quintile leadership, it signals to me that, hey, the hedge fund community already front ran the short squeeze that we would normally see after an FOMC event. In fact, we got a massive short squeeze in the March FOMC leading all the way up to the highs that we saw across most of their risk assets in April. Well, they already did that.

Starting point is 00:12:52 And oh, by the way, if you go back and look at the left chart, we don't have any more sort of, you know, positioning left to unwind that could be bullish for the market. And this is exactly why the market is shitting the bed here today, for lack of a better word. When you start to think about the Fed interest rate hikes through the end of the year, the market's still pricing in 2.75%, 3% as kind of our end result. Do they get there? Can they hike that aggressively this quickly? or will they have to call the dogs off at some point

Starting point is 00:13:19 and kind of just let it be? Yeah, no, they're going to call the dogs off. I assure you of that. This is a Federal Reserve that wants to talk tough and sound tough on inflation, principally because I do believe, just based on Jay Powell's characterization of how much the Fed cares

Starting point is 00:13:36 about low to medium income consumers yesterday, I think this is a Fed that does care about the harmful impacts of inflation, right? Like you think about what the unemployment rate is, And it's causing pain and hardship for, let's call it, three to seven percent of the economy at a time, whereas something like inflation, you know, really significantly harms, you know, 50, 60, 70, sometimes 100 percent of the economy. So these guys are very concerned about, you know, the impacts of inflation. But I also think this is a Fed that has some face saving left to do. Don't forget this. They're fresh off what is arguably the second worst call in Federal Reserve economic history. Right. Going back to 2006, I think Bernanke said we've arrived at a new normal volatility, a low volatility in 2006, which is probably worse call on finance history.

Starting point is 00:14:22 But, you know, this this transitory nonsense that we got last year, which is why we're in this position to begin with, is an issue. This Federal Reserve should have started hiking interest rates a year ago when the Biden administration passed that two trillion dollar tax or two trillion dollar spending package. We were dumping kerosene on top of an already overheating economy, and instead of sort of removing some of that policy accommodation in terms of the Fed's balance sheet and the interest rates, the Fed actually kept adding more kerosene to the bonfire. And so now we got this huge-ass bonfire that the Federal Reserve is understanding that it's complicit in creating, and now they got to do something about it at precisely the wrong time. When you think about these same Fed interest rate cuts, you think they'll cut interest rates before the end of the year? Ooh, that's a good question. Will they cut interest rates for the end of the year? No, they're only going to cut interest rates if the labor market gets to a bad enough place to cause to really to really threaten their maximum inclusive bandaid. we are probably a year to 18 months away from that. The issue for markets now is that the economy is starting to slow at a place that tells the investors like me and tells business owners

Starting point is 00:15:31 like myself and other business owners that we should probably stop doing stuff, stop investing, stop hiring. And that's what creates the bigger slowdown that we see coming in the first half of next year. So my bet is that they're going to cut interest rates, specifically exact reason why you're saying it which is uh everyone right now is like whoa this is gonna get really bad i know multiple venture funds moratorium on investing i know a lot of hedge funds pausing private investing or pulling back from uh from public markets i know a lot of entrepreneurs are saying hey let's go ahead let's cut head count let's stop spending here let's conserve cash let's do they're just contracting contracting contracting and because that occurs they're going to keep

Starting point is 00:16:12 hiking interest rates which i think you and i agree through the summer as they do that all of sudden midterm elections start coming and i think that they're going to get way more pressure than we probably all are guessing from politicians being like hey we can't go into midterm elections in a recession are you guys crazy stimulate and i don't think that they'll have the political will to get true like stimulus packages through i think we've seen them try to do some of this and it feels like that's hard but the federal reserve to just do one single 25 basis point cut as like a kind of like a gut check on the market of like, you guys thought we were going to just raise, you know,

Starting point is 00:16:48 till the cows came home, if you will. Here's a little cut for you just to kind of get everyone back going again. Which like, I don't know how abnormal that would be. Or if it's just like, yeah, like that's kind of the game they play here, right? It's like, they do have to play this game of like short-term decision-making

Starting point is 00:17:07 because the market may not listen to what they're saying to some degree. Yeah, the market's way out ahead of them. Again, this is the Federal Reserve. That's a year late to doing all the stuff that they should have done a year ago, right? So the Fed is basically stuck in May of 2021, where the markets are in May of 2022, right? And so the Fed is literally responding to the economy the way I would have suspected they would have responded a year ago. And so they're going to be late to pivot to cut interest rates. They're going to be late to stop.

Starting point is 00:17:36 First, they've got to start quantitative tightening. That starts next month. They're going to ramp that up and probably have to ramp it back down three to six months later. Yeah, I think there's a don't forget, though, there's a cadence to this. You got to respect the x axis when it comes to the finance economics. You know, it's not like we're going to go from above potential above trend growth, you know, as recently as you know, March, April, to below trend growth as quickly as something like July or August. For now, we're going to go to below trend growth by the end of the year, the early part of next year. And the path of getting there is what's scary for markets, because you don't know what that terminal downside is, especially with the Fed pulling up pulling away the rug on accommodation. Are you changing anything in your portfolio given the last two weeks or so? Not a damn thing. I just tweeted out I am now up 1% year-to-date. It is the hardest 1% I've ever generated in my entire career, but I'm very proud of that because I look around.

Starting point is 00:18:28 There's not a lot of things that aren't down double digits year-to-date from an asset class perspective. So, no, we're definitely not changing anything. If anyone wants to go check out what's the word we're long and short in that portfolio construction, just check us out at 42 macro so may 5th is when we're recording this uh you're up one percent as you said most portfolios are down double digits uh many of the the largest hedge funds etc uh what has been the biggest driver of that one percent return is there like a specific asset that that has kind of outperformed everything else and really kind of kept you positive yeah we got lucky on on you know you put yourself in a position to get lucky um in terms of your

Starting point is 00:19:05 process but you know we got lucky on a few sort of catching a few commodity trades um you know i think we were a little bit later to the party on commodities and some analysts you know i think of lynn alden uh comes to mind really great analysts out there uh tony tony greer over at tg macro uh they were riding this commodity bull for for for much longer uh than i have and so that's been a nice positive attribution uh we definitely made some we traded well as well um you know we've made we sold you know we sold the highs at equities a couple times this year um you know We've made some good shorts at those highs a couple of times as well. So the timing associated with the trades, not just the exposures, but the actual execution of getting in and out of some of the exposures has been helpful.

Starting point is 00:19:45 But let's not – again, let's not celebrate like 1% actually means anything in the grander scheme of things. It's just not down 15 to 20 like a lot of folks are, and that's a testament to the process. So when you think about this, it feels like some of those trades – I don't believe in luck. I think that luck's a psychological concept and probability, obviously, is the mathematical one. But when you think about the commodity trades, is that a place where people are going to have to continue to look for alpha moving forward? Like there's just so much volatility in commodities that that's going to be probably the most important place to look? Or do you think that the equity market will remain kind of the main focus for most investors? Yeah, so we are now in an era where the likelihood that inflation makes higher highs and higher lows at each subsequent cycle is greater than the likelihood that it makes lower lows and lower highs.

Starting point is 00:20:39 We've been in a pattern for the last 40 years of inflation making lower highs and lower lows, and that's dragged bond yields down, it's dragged equity valuations up. And so you had this perfectly good Goldilocks type scenario from a strategic asset allocation perspective to be long, you know, the 60-40 or some version of that, depending on what target date fund you're in. We are no longer in that regime. We're in a regime where the bond yields are likely to rise, you know, structurally over the next, you know, it's called 10, 20 years as a function of that change in the pattern of inflation. Now, that doesn't mean bond yields are going to go up significantly from here. They're going to continue to cycle associated in terms of where we are in the growth, inflation cycle, and liquidity cycles. But that just means you're probably going to see a higher low in bond yields relative to what we saw in March of 2020 in terms of where we bottomed in bond yields in this down cycle that we haven't really started yet for bonds. We certainly started it for equities.

Starting point is 00:21:31 Yeah, it's fascinating to kind of think through the ramifications of this. uh for people who want to know how the hell you got one percent positive return uh or kind of how you guys are thinking about what's coming next uh where should we send them to uh to find you or find some of the research you guys are putting out yeah no let's be clear that the one percent is just treading water until we get to an opportunity to buy some things right we like i said i've been saying this every week on the show we are not yet at the point in time where you really want to be making big asset allocation bets and backing the truck up and stuff i think we're going to get one of those opportunities uh at some point let's call in the next six to nine

Starting point is 00:22:03 months, maybe even sooner if the Fed really botches it. But I think sometime between the next six to nine months, we're going to take that 50% plus cash we have in the 42 macro portfolio and put it to work. It'd be no different than putting it to work in March of 2020 or December 2018 or March of 2009. You've got to be strategic about these moves and you can't kill yourself and blow yourself up along the way so you don't ruin those opportunities. But go check us out at 42 macro.com. I'm on Twitter, 42 macro D Dale. Appreciate being on the show. Catch you back next week my friend you're killing it just keep just keep doing exactly what you're doing you're my favorite wall street analyst is not because we're friends you just you just get it so i

Starting point is 00:22:40 appreciate the work that you're doing anyone who uh who isn't yet subscribed go check out 42 macro.com and we'll talk to you next thursday appreciate you brother thank you so much man i see you guys later buddy thanks so much for listening to today's episode i really hope you guys enjoyed this one make sure you're subscribed on apple spotify or your favorite podcast player and if you're looking to try to transition to get a new job in the Bitcoin or crypto industry we've got you covered head over to palmscryptocourse.com

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The Pomp Podcast - #949 Darius Dale On Why Investors Should Be Very Nervous

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