Darius Dale (03:13):

And so that’s what we’re trying to do as macro risk management advisors is help people avoid those big potholes.

Clay Finck (03:18):

Like I said, we’ve originally started from the Warren Buffet school of thought. I started listening to TIP back in 2016, 2017 and joined the team in 2021. And over time, they’ve gone in the direction of paying more attention to macro, because it just seems so hard not to pay attention to it. Just in the last couple of years, you’ve seen the Russia-Ukraine situation, you’ve seen COVID, you’ve seen just this massive involvement of the Federal Reserve and such. So we’re going to be digging into all of that.

Darius Dale (03:45):

Yeah. Look, I hate to simplify it, but in terms of how we calculate net liquidity, which in terms of our analysis, we look at the Feds’ balance sheet plus or minus the Treasury General Account balance, those things work in opposite directions in terms of liquidity provision. And it’s a very, very tight correlation to the stock market over the last 10, 12, 13 years. And so it’s obviously you don’t want to boil down any macro process or any investment process to one thing, but I do believe it’s critically important to understand all the drivers that cause that line to go up or down because ultimately that’s the line that’s going to determine whether or not stocks are higher, crypto’s higher or lower, et cetera.

Clay Finck (04:21):

Let’s start with Russia and Ukraine. From a macro perspective, what sort of financial impact has the Russian invasion of Ukraine had on the markets?

Darius Dale (04:31):

Yeah, well, to me it’s really the secondary impacts as it relates to commodity price shock. We saw that. We’ve come off a bit, quite a bit, particularly in crude oil from the initial response to the invasion, but the reality is we’ve not come off nearly enough, if you look at it across some of the more thinly traded markets, base metals, particularly [inaudible 00:04:49] for instance as well. Those things continue to make higher highs and higher lows, partially as a function of this, but also partially as function of global stock piles being pretty tight for a lot of different markets. Let’s not forget Russia’s I think the world’s number two exporter of crude oil, number one exporter of nat-gas, number three exporter of steel, Ukraine’s the number two exporter in all kinds of cereals and grains. It’s a big deal that these two countries are fighting because it really is a potentially structural threat to commodity supplies and not only just supplies, but the entire infrastructure and supply chain associated with that.

Darius Dale (05:23):

It’s not just, “Hey, we got to get stuff out of Ukraine or out of Russia into somewhere else.” It’s these ships may be harbored and embargoed and preventing transactions that occur later on down the line and stuff like that. So it’s a messy situation. It’s a messy situation that could potentially get worse and will only get worse, the longer the conflict is prolonged.

Clay Finck (05:41):

Do you think the Russian invasion of Ukraine impacts the Federal Reserves’ hawkish stance of wanting to raise rates this year? How does this macro force impact the Fed’s ability to raise rates? Because it seems like a pretty bad time to raise rates when these inflationary pressures are coming in that weren’t foreseen a couple months ago.

Darius Dale (06:01):

No, that’s fair. I think that’s a very fair question. If inflation had three or four ways really since the initial lockdowns, it was on the first initial wave of reopening that we had the COVID scare in December 2020 and then we had a secondary wave of inflation that was largely a function of the fiscal stimulus package Joe Biden passed right after he got elected. And then we had the third wave of inflation that was the supply chain disruptions that we saw in the fall associated with reopening and Christmas purchases and all that stuff. And then we get in this fourth wave, that’s really just a function of Russia-Ukraine. The reality is from the Fed’s perspective, when you look at the measures that really matter to them from an inflation perspective, it’s core PCE, that’s their preferred inflation metric that has very little, there’s hardly anything that has anything to do with food and energy prices in that basket.

Darius Dale (06:47):

And we’re still tracking at levels that are multiples of what their target is. The target is 2.5%, if you think about it on a symmetric basis and we’re up at 4% or 5% and these metrics are still climbing actually, we’re still continuing to accelerate. If you look at the sequential momentum in the time series, it continues to be higher than the actual year over year print. So we’re still moving in the wrong direction for that needing CPI up at 6.5% on a three-month annualized basis, sticky CPI over six as well. These are things that have very little to do. I mean, obviously everything’s tethered together as relates to prices, but the Fed doesn’t have the convenient excuse, at least according to these metrics, these particular inflation metrics that they can sit on their hands and say, well, “Let’s wait out this crisis.” They don’t have that opportunity there because it’s telling them that data are telling them there’s really, it’s not just Russia-Ukraine, if anything, Russia-Ukraine is kind of a scarecrow relative to the real underlying inflation pressure we’re seeing in the economy.

Clay Finck (07:39):

I keep seeing talks of inflation peaking, which catches me by surprise, but I’m definitely no macro expert with the sanctions put in place by the Russian government, you think that if Russia isn’t exporting some of these goods, there could be massive inflationary pressures, even greater than what we’ve already seen. So I’m curious why is there such a strong view that inflation has peaked if there is this uncertainty around Russian exports?

Darius Dale (08:07):

Yeah. That’s a phenomenal question Clay. And this goes back to the discussion centering around base effects. And that’s just the relationship between momentum of the time series versus the changes in momentum of time series on the lagged basis of what we observed last year and the previous years. And so when you get into April in particular, the base effects curve really steepens and so all things being equal, you need to actually accelerate in order to maintain the same year over year rate of change. It’s just basic math. The reality is it’s unlikely that unless we see something incremental out of Russia and Ukraine, it is unlikely that we maintain in a sequential momentum in the time series month over month, three month over three month in the time series to keep inflation prints accelerating on a year over year basis.

Darius Dale (08:50):

Now that doesn’t mean anything from my perspective, because not only does the Fed expect inflation to be lower on a year over year basis, one year out, two years out, consensus Bloomberg, consensus the economist on Wall Street, including myself, we think it’s going to come down as well. The problem isn’t that the year over year is coming down. The problem is that the sequentials continue to be way higher than the actual targets. As I mentioned, the three month annualized for all those different indicators that I highlighted earlier, median CPI, sticky CPI, core PCEs up in the 5% to 6% range. We’re talking about in a country that has a 2% inflation target and we are building momentum in the 5% to 6% range. So I think the year over year is really noise in the context of the question you just asked because it’s not really telling anything but that the fact that base of that is steepening, what we care about is inflation going down or up.

Clay Finck (09:36):

The most recent CPI print that we saw was around 8%. And when I look at the treasury yields, I see yields at roughly call it 2% on a one or two year basis. Why would someone want to hold some of these very short-term treasuries to achieve a yield that’s not even close to even the CPI inflation? So I’m curious what your thoughts are regarding why the yields on some of these shorter term bonds are so low? Is it just people that just want that guaranteed return? Whatever the market gives them, they’ll just take it and it’s just a matter of that.

Darius Dale (10:12):

Well, no, it’s a function of arbitrage. And so, the reason the whole entire interest rate curve looks like it does is because it’s partially a function of market based expectations on the Fed policy rate and the projected path forward of the Fed policy rate. And so it’s never going to materially diverge from that expected path forward. And if it does materially diverge, then you’re going to get a ton of people coming in, arbitrage that spread out of the market. And so this is why rates continue to remain fairly well anchored certainly relative to eight on its way to probably nine or 10% inflation rate, right? Because it’s really just a function of the Feds’ forward guidance and the market’s expectations they’re in. There’s also a lot of regulatory reasons why just a general level of interest rates, not just in the U.S. economy, but also in the European and Japanese economies are so low.

Darius Dale (10:54):

There’s a lot of regulatory pressure from regulators to kind of, I wouldn’t necessarily say force, banks and dealers into these types of assets and asset managers in these types of assets, but it certainly reads that way. The net outcome is that way in terms of something like [inaudible 00:11:10] for instance, you can have asset A on a balance sheet, which is a credit or what we call spread product, high yield credit or emerging market debt or something like that. And you have to reserve a lot more from a fraction of reserve banking perspective to main to hold onto that kind of exposure or something like treasury bonds or German [inaudible 00:11:27] if you’re in Germany or JGBs if you’re in Japan, you don’t have to reserve anything. And so it’s a lot cheaper for you to build up a balance sheet with these types of securities than it is for those types of securities. And so that’s just one of the kind of mini regulatory tailwinds for the treasury market and for global sovereign debt markets broadly.

Clay Finck (11:43):

When I’ve tuned in to some of these macro discussions, one term I hear a lot is a “Fed put,” could you explain to our audience what a Fed put is?

Darius Dale (11:53):

Absolutely. Fed put comes from this post GFC status with respect to the Federal Reserve prior to the GFC, you can make the case that the Fed really only cared about growth through the lens of labor market and its labor market mandate. And it only really cared about inflation through its inflation mandate. Maximum employment and stable prices are the exact words written into the Federal Reserve mandate. Since the GFC, the market has really interpreted the Fed is having a tacit third mandate, which is financial stability and maintaining, making sure asset markets function well from the perspective of the stock market, making sure it goes up over time, more or less, so that’s sort of Fed put, if you will, is the concept amongst investors whereby and much like how a put would give you this return profile.

Darius Dale (12:38):

If the market goes down enough, eventually we’re going to get a policy response that kicks in and starts to get you paid on the long side of risk assets, similar to owning a put. If the market goes down enough, eventually the put will come into money and you’ll be able to monetize the put for some intrinsic value. And maybe even some time value to extend it, you can monetize it sooner. That’s the market effectively saying, look, “I’m hedged because I know the Fed is going to bail me out at a certain price.” And the core thesis heading into this year was that the strike price of the Fed put is significantly lower now than it has been at any point in time in this post crisis era. You go back to Q4 ’18, the Fed put we determined that we learned by a process of trial and error that the Fed put was down 20% on the S&P 500, recall Jay Powell, after that Christmas massacre in 2018, he pivoted very quickly after making very hawkish comments.

Darius Dale (13:28):

And that really caused the market to rally throughout 2019, we saw the Fed put kick in around 20% or around 10, 15% in 2020, it was like we were starting to get 10% down days and so ultimately it turned out to be a more of a 34% decline, but based on our math, and we could unpack any of the tools that we used to get to this number, but our model suggesting that the Fed put is somewhere around down 30%. And so that’s the bare minimum at least 10% lower than it has been in recent years. And that’s something that in our opinion, asset markets are going to have to find out the hard way.

Clay Finck (14:00):

Yeah. So the Fed’s objectives or stated objectives is to minimize unemployment and have price stability, correct? And then you’re saying there’s a third objective, which is to keep financial markets in check, especially the stock market propped up. So back in 2018 timeframe, we saw 20% draw down and with the Fed now tightening like they were during that period, is it just inevitable over the coming year or two that eventually the stock market’s going to deflate and come down a little bit, you’re saying 30% or so, and they’re going to have to do this another term where we see a lot is the Powell Pivot or the Fed Pivot?

Darius Dale (14:38):

Okay. And here’s the issue with the asset markets as it relates today, because everything you said is correct. The problem is inflation is not going to come down fast enough for them to give you a pivot anytime soon. Now, if the stock market starts really sniffing, you’re having a real material problem, let’s call it three or four quarters from now, inflation will be much lower three or four quarters from now and it will give them enough scope to pivot. The problem is in this window of time that we have, this sort of six to seven month window of time between now and Q4 where inflation is likely, even though it’s probably going to be coming down on a year of year basis, it’s still going to be very elevated, both from a levels’ perspective, but also from a momentum perspective because they haven’t really done anything to cause that to go down yet from a monetary tightening standpoint, we’ve only seen 25 basis points of rate hikes thus far.

Darius Dale (15:25):

And so, the issue is as long as we’re in this window of time where they really realistically can’t pivot, that’s where you can see a lot of downside risk in the market because we’re also walking into a scenario and we can unpack this as well, where growth isn’t been modestly decelerating for a while now, really going back to the summertime of last year, but it’s likely to start to decelerate it at much faster pace. And in terms of how we’ve back tested this at 42 Macro, that really does matter in terms of, well, “I’ll give you a few stats on this,” when the U.S. Economy is slowing, and we look at composite leading indicators as our proxy for growth, and we look at headline inflation as our proxy for inflation within our grid model, grid regime process. When you’re in a decelerating grid regime and growth’s only slowing modestly, stock market actually has a positive expected value, it’s right around plus 5% on an annualized basis.

Darius Dale (16:13):

And you’re slowing at a moderate pace that plus 5% swings over to minus six. When you’re slowing at a meaningful pace, minus 30 is the annualized rate of change for the S&P and so we’re heading into a period where we’re going from slowing at a modest pace, slowing at a moderate pace to slowing at a meaningful pace over the next six months. That’s a problem.

Clay Finck (16:31):

It’s the level of involvement in the markets by the Federal Reserve, I almost question how reliable past data is, especially over the past 40 years or so? I’m curious what your thoughts are around that.

Darius Dale (16:45):

There’s a number of ways to contract back testing, and this is why we’re so keen on rate of change in our process, because rate of change is agnostic to the level of activity, your kind of the general comings and goings of what’s going on. The second derivative acceleration or deceleration in a growth or inflation time series is the same in 1970, as it is in 2023. Now the level of inflation might be different or the level of growth nominal or real might be different, but the actual delta, the direction and the magnitude of the change on an absolute basis relative to its trailing sample is the same. So we construct all of our back tests to be agnostic to the time period, we just want to know the kinds of influences that really mattered asset markets.

Darius Dale (17:23):

The rate of change to growth and inflation are the number one and number two principle components for asset class returns across most asset classes. And then obviously the change in policy expectations are realized policy, I would argue the expectations are more important. The change in policy expectations would be the third principle component of most asset class returns. So if you can get growth, inflation and policy right in rate of change terms and in magnitude terms, you can definitely do some damage in terms of ultimately constructing portfolios to deal with some of these risks.

Clay Finck (17:51):

Asset prices were really running hot late 2021. I’m curious why the Fed was so late to the game in raising rates. It wasn’t until, call it March 2022, where they were actually taking action, it was just 25 basis points raise in the Federal funds, right? So I’m curious why they were so late to the game on this?

Darius Dale (18:13):

I hate to be overly critical because I think these guys have a really difficult job, particularly in this awkward post pandemic economy that we’re not really quite sure what’s structural and what’s cyclical yet from that perspective, but they got the call wrong on inflation. I mean, it’s just as simple as that. It was transitory, it was transitory, it was transitory until it wasn’t transitory. And so, I mean, like just based on that call alone, they thought that they had scope to maintain a very aggressive easing monetary policy setting and they did. And part of the reason they did that is goes back to the pivot that they made with respect to their mandate back in the summer of 2020, [inaudible 00:18:46] Jackson Hole into the fall of 2020, where they amended their employment mandate to this that include maximum and inclusive employment.

Darius Dale (18:53):

And that was a political response to the zeitgeist to the economy at the time, which was, “Hey, look man, you guys always pull out the punch bowl when like these disaffected groups, Latino Americans, females, Asian Americans like the labor market tends to heat up for those groups slower.” And at a later date than it does for let’s call it white males or something like that and so the Fed adopted its mandate a little bit or it mended its mandate a little bit to allow them to be easier for longer to allow these other disaffected pockets of the labor market to heal to a much better degree. Now, fast forward to Q3, Q4 of last year, even Q1 of this year, you’re desperately trying to maintain that, trying to hang on to that new policy framework while at the same time they’re getting royaled on inflation and they’re saying, no, it’s transitory, we got to help these folks out, it’s transitory, transitory, transitory, and guess what, they’re wrong on that call. So now they got to speed up and do a whole lot of tiding in 2022.

Clay Finck (19:47):

I almost feel like the Feds’ playbook is to try and let inflation run hot, but hide the real effects of the inflation we’ll have on economy, especially with as high as the federal debt levels are.

Darius Dale (20:02):

I can go both ways on that. And here’s why, so it doesn’t strike me that anyone on the Fed specifically is focused on helping the fiscal authority delever. It doesn’t to me, it seems to me that that’s more of a regulatory ordeal, going back to what I mentioned with respect to bank balance sheets, that the regulatory framework around who needs to own what and who needs to have what treasuries as collateral, to me that seems to be the preferred tool among policymakers to effectively allow the government. I wouldn’t necessarily say did it allow the fiscal authority to delever, because I’m not sure that you need to delever ever of your reserve currency, the issue is not the leverage for the reserve currency, the issue is what does this all this incremental debt mean as it relates to the riskiness are within the economy, the illustration we type of see, it tends to be deflationary actually.

Darius Dale (20:49):

You have a large outstanding stock of debt. So that going back to this Fed, what they really wanted to do was just get the labor market to a place where they can say, “Aha, we did it, we fixed it.” We’re now awoke, we fixed it and everybody’s high fiving each other, and every pocket of the labor market, and guess what, they just got the inflation call wrong. And so, as it relates to allowing the fiscal authority to delever, I don’t really think that’s really part of their mandate or not part of their mandate. I don’t think that they’re really focused on that. To me, I think what they’re really focused on these economic outcomes and as a byproduct of that focus, you tend to get this narrative amongst investors that the Fed is trying to [inaudible 00:21:25] in cahoots with the fiscal authority to delever. There is no need to delever. The U.S. is the reserve currency. They can issue as much debt as they want, as far as I can see until that status is threatened.

Clay Finck (21:36):

With the high inflation we’ve seen, I was curious how asset classes performed in past inflationary periods. I took a look back at the 1940s and 1970s, and this is an idea I pulled from Lyn Alden, she believes that the current period will be more similar to the 1940s because we have interest rates much lower than CPI inflation. While in the 70s, we generally had a premium on interest rates to at least cover that CPI inflation rate. Given that I was curious how stocks perform specifically during the 1940s and I saw that in January of 1940, the S&P 500 was trading at around $245 into the decade at 205, so negative return on the S&P 500 and just a ton of volatility along the way with the inflation moving up and down throughout that period. Now with that, do you believe that there is still a case for investors to be heavily allocated towards equities? I’m going to assume you’re going to say diversifying to some other asset classes, at least at this point.

Darius Dale (22:37):

Yeah. Let’s go back to the 40s and 70s or so, one thing that was…. That is a lot of stuff to unpack. Let me start by differentiating the 40s from the 70s, the 40s was a fiscal authority driven inflation, similar to what we have today in terms of the fiscal authority, just dumping a ton of money into the real economy and really causing a supply demand imbalance on the productive sector of the economy. The 70s was more of a supply shock driven inflation associated with a labor market, a wage price sprawl that we saw in the labor market, mostly as a function of price controls and unions. And so it’s a very different kind of….. Those are two very different setups, but they both had the same outcome as it relates to the financial market response, which is stocks very volatile, having some big drawdowns and actually some big recoveries as well.

Darius Dale (23:19):

We had a couple times in the 70s don’t quote me on the dates, but we had inflation peak in just want to say, 1944, 1945. It came down quite a bit and the stock market had a meaningful rally as a function of that. And then ultimately we had a secondary wave of inflation in the latter part of the decade. And ultimately that caused another crash in the market. And we had to rally from that as well. So that flat performance was rife with some pretty big accelerations in the stock market and some massive crashes as well. And ultimately we wound up flat. That’s similar to what happened in the 70s as well, but the one thing that’s different with respect to the 70s is that commodities were the place to be, commodities, gold, that’s where you really got paid as an investor.

Darius Dale (23:58):

Treasuries obviously did very poorly in that decade, alongside stocks, certainly on a relative basis to commodities as well. So taking this to the answer your question, I ask that allocation front, we don’t have the view that we’re going to maintain this sort of very aggressive, persistently high level of inflation. We’ve built a dynamic factor model here at 42 Macro [inaudible 00:24:17] inflation model looks at basically everything that drives inflation that we know to be a driver of inflation, globalization, automation, the dominance of tech in the economy, money supply, all these critical variables. And right now that model suggesting that inflation is somewhere around a hundred basis on the high end of that projection range, somewhere around a hundred basis points higher on average than it has been in the recent trailing 10 year period. That tells you that we’re going to have a decent amount more inflation.

Darius Dale (24:42):

It’s roughly about 40% more inflation than we’ve been used to in the previous decade, but 40% more inflation relative to the previous decade is nothing like the 1940s or nothing like the 1970s. We just happen to be in a very inflationary period of that time now. So inflation’s likely to come down. Is it going to go back to where it was prior to COVID? No, absolutely not. And our model suggesting it’s probably unlikely to do that. However, is it going to stick around these levels that continue to cause investors to invoke memories in 1940s or 1970s? Probably not, at least not according to what our models were saying currently.

Clay Finck (25:16):

Yeah. One of the reasons I was just curious about your thoughts on inflation in the markets is millennials. A lot of them might just believe, “Hey, I’m just going to go 100% stocks,” because stocks only go up because that’s all they’ve seen over the past 10 years, but if you look at some of these other periods, there are decades where stocks have done very poorly and I believe the 10 year return on the S&P 500 is something like 15% give or take. And that’s a just exceptional and you’re going to need a lot of things to go right to achieve double digit returns over the next decade, after accounting for whatever inflation ends up being.

Darius Dale (25:52):

Yeah. So I mean, think about this. So the starting point, this we know, valuation is not a catalyst. It does not cause markets to go up or down. Valuation tends to really only work on longer durations, so three years out, five years out, 10 years out. In fact, the further out you go, the hot, the better, the correlation between whatever the valuation metric you’re looking at and the projected return profile. We know we’re starting at a very precarious point from a lot of valuation metrics, whether you look at markets, price to book, you look at it on price to earnings, you look at it on market cap to GDP, pick your valuation metric. One of my favorite metrics is looking at the earnings yield to the S&P that’s the reverse of the price to earnings ratio and then it’s inflation extracting inflation from that.

Darius Dale (26:31):

So you’re looking at what’s the cost of the market on a real basis makes it apples to apples, to other financial instruments. And not only is this the lowest print we’ve ever had, but there’s only been six negative inversions, six negative prints in this time series, going back to the late 1960s and the median S&P 500 drawdown from those negative prints when the earnings yield is negative on a real basis is minus 41%. I mean, that’s a big drawdown. By the way, median of those six episodes is minus 41%. So obviously you had quite a few that are couple that were worse. And so that’s a long wind way of saying this market is in, just if you’re a millennial investor and you’re someone who kind of looks at the chart of the stock market and say, well, why would I pay for risk management services?

Darius Dale (27:14):

Why would I pay for active management? I can just put all my money in stock market or crypto and YOLO. And the reality is a lot of the drivers of getting us to that point, they’re not here anymore. We don’t have enough Federal Reserve that’s going to be able to maintain that high level of a Fed put strike price anymore. That strike price is much lower now. And so you have to deal with a lot more two-way volatility, a lot more downside deviation risk in this kind of longer term path forward from here. And so that makes it a much more challenging environment to sit there, make it long, risk assets, YOLO, et cetera, et cetera. That’s kind of a thing of the past at this point.

Clay Finck (27:49):

Another thing that’s been on my mind on why I’m personally concerned about inflation persisting is just the negative spread on the treasury yield curve. The 30-year treasury rate is…. Let’s stick with the 10 year. The 10 year treasury is 2.7% and the CPI inflation’s 8%. I would expect those bonds to sell off and inevitably the Federal Reserve will have to step in and stop that sell off from occurring and they’ll step in and buy those. And that’s more money printing that’s into the system. So that’s one of the reasons I’m concerned about inflation personally, but again, I am definitely no macro expert. So I’m curious what your thoughts are around that idea.

Darius Dale (28:31):

This we know, inflation tends not to come out of the direct monetary channel. Inflation tends to come more from the fiscal channel because at the end of the day, what inflation really is a misalignment between supply and demand. And so you actually need to stimulate supply. I mean, in theory, if the Fed starts to ease its balance sheet again, and it really cause the stock mark to rise, then there is a wealth effect, but it’s a much more indirect effect in terms of perpetuating inflation than actual fiscal stimulus or something of that nature. So from that perspective, I’d be much more worried about inflation persisting if we continue to seize, something that looked like a very aggressive fiscal agenda. It’s very unlikely we have an aggressive fiscal agenda, going back to the fall of last year, it became pretty clear to us at 42 Macro with that.

Darius Dale (29:14):

We weren’t going to get a dime more of fiscal stimulus, this sort of tech that then tertiary wave of inflation, now we’re onto our fourth wave, that third wave of inflation really took Joe Manchin, Senator Sinema out of the fiscal stimulus discussions which they are very much needed given how tight the margins are, the senate’s tight as ever been, it’s as tight as ever been in the house in terms of the Democrats winning or democratic majority. And so without that majority, you’re not going to get another dollar of stimulus, at least not until we get to the other side of whatever down cycle we’re heading into the economy. And so that’s probably from my perspective. Again, inflation’s not going back to where it came from. It’s going to be roughly 40% higher on average than it had been in the prior decade. That’s just not runaway inflation. It’s not 1940 style inflation. It’s the 1970 style inflation. We don’t have the changes in the drivers of inflation that we’ve observed thus far to get us to that point. We could, we just haven’t seen it yet.

Clay Finck (30:08):

Lately, we’ve seen the inversion of the treasury yield curves. I pulled up the three year treasury rate and the 10 year rate, the three year today is around 2.7% and the 10 year rate is also around 2.7%. What does the inversion of the yield curve indicate for what’s going on in the markets?

Darius Dale (30:28):

Yeah, so there’s really three treasury curves that matter to the professional investors on Wall Street. There’s the 5/30 curve that really tells you how scared the market is about inflation. The 10s/2s curve really tells you how scared is the market about growth. And then the three-month, 10-year curve tells you is the economy about to go into a recession over the near term. And so right now we’ve seen obviously an inversion in the 10s/2s curve. We saw an inversion in both 5/30s and 10s/2s. The 10s/2s is the one that has more people and concerned as in race to their investment portfolios, because it ultimately is signaling that the countdown clock is now officially on for a recession over the next one to two years. Now, that’s in my opinion, one to two years is a really long timeframe.

Darius Dale (31:08):

As we’ve just seen with the markets up basically or a 100% over the last two years, there’s a lot of stuff can happen in two years’ time, right? And so as investors, we need to be a lot more specific than that, but it lets us know that we’re on that path. And so it’s our job as investors to start to look for incremental clues, incremental evidence along the way that tells us, “Hey, this path is getting truncated.” We actually now need to start worrying about recession, as opposed to just merely talking about it, as relates to what we brought up earlier that inversion of the curve is a signal. And again, we are now on that path forward and so the next thing we should be looking for as investors is inversion in the three-month 10-year curve.

Darius Dale (31:45):

Now we’re not going to get inversion in the three-month 10-curve anytime soon, because we need to see the Fed actually hike interest rates to get three month bills to reprice higher in yield terms. So that process in terms of getting to a potential inversion in that curve, that’s something that could be two, three, four or five quarters away, perhaps maybe even on the shorter end of that range, if growth starts to slow at a more material pace, because that’ll put a cap on the long end of the curve and really start to maybe even cause values to go down on the long end of the curve. We’re not at that point yet in the process, but I’m certainly got my eyes glued to that over the next few months, of course.

Clay Finck (32:18):

I was listening to We Study Billionaires podcast interview with Preston Pysh and Lawrence Lepard. They were talking all macro and they mentioned that the Russian sanctions were a giant advertisement for gold and Bitcoin. Why do you think the prices of these two assets have remained stagnant for the most part, despite these sanctions?

Darius Dale (32:40):

Well, part of the Bitcoin is it’s a risk asset. And so, I mean, I think it’s like trailing 90-day correlation of the NASDAQ somewhere around like 0.69 or something like that. It’s become a higher beta expression of tech stocks. That’s obviously not the intent of the asset class. There’s obviously a lot more going on there, but for now it’s a risk asset. And this is something I’ve been talking about for the last two years, which is if the bull case for crypto is institutional adoption, then institutional adoption, when you pull it into the traditional finance, [inaudible 00:33:06] into the market, it’s going to be subject to all the risk management parameters and rules and other asset classes are. There’s VAR, there’s value at risk. There’s all these models that effectively say, “Hey, look, this asset’s doing too much, I got to reduce my exposure to it.”

Darius Dale (33:19):

And I think that’s partially why we’re seeing crypto trade more in lockstep with the broader market, because those are decisions, systematic decisions that are being made at the margins. With respect to gold, I mean, gold’s been somewhat confounding, but one thing that’s really caused gold and quite frankly, I think gold is trading quite well given what I’m about to say, but real interest rate in the country just went from minus 109 basis points of minus 1.09% to minus 13 basis points. We almost had a 100 basis point rise in the 10-year tip shield. The 10-year real interest rate in a matter of a month. And gold is basically flat. And so to me, that’s a big deal because that is the real interest rates tend to be the key driver of gold.

Darius Dale (33:57):

And so for the fact that gold is flat, to me, it’s telling you that there’s a real structural, underlying bid to the asset. I’d be concerned about gold if we saw just making new lows as a function of that, but the fact that we’re not even making new lows in the context of that big movement, real interest rates tells me, but what we’re talking about with respect to Bitcoin and gold and that advertisement that this [inaudible 00:34:15] what I would consider to be regulatory overreach out of these authorities, that regulatory overreach is actually is catalyzing some inflows in the gold. And by the way, the one thing I thought was very positive for crypto, we didn’t make new lows in crypto. We bought them, I want to say in January of this year, we didn’t make new lows in February. We didn’t make new lows and stocks made new lows in early March.

Darius Dale (34:35):

And so to me, I think much like what I said about gold, you can tell that there is an underlying structural bid there. We can see it on on-chain data as well. It’s been very, quite positive in terms of wealth accumulating supply, short term holders going back into the green and all that stuff. So it’s been positive at the margins. It’s just that the asset class itself is trading heavy, alongside broader risk assets.

Clay Finck (34:58):

I’m curious to ask you, are there any assets or asset classes that you think are good risk reward today, given what you know about the macro forces in the markets?

Darius Dale (35:10):

Yeah cash. Cash is probably one of the best, it sounds boring as all hell, but when you’re in a bear market, as we thought we’ve been in a bear market going back to January, you’re in a bear market and there’s two things we said at the beginning of the year. One, by the end of the year, everyone’s going to be talking about the “R word,” it’s already April and everyone’s talking about the “R word,” which is recession. And then number two, the market’s probably heading into a bear market. Now there’s two types of bear markets. We go down 20% really quickly in over like a matter of weeks or months or there’s the longer term structural bear market that looks more like ’07 to ’09 or 2000 to 2002, which people have forgotten those exist, where you don’t make new highs for really long period of time.

Darius Dale (35:49):

In fact, I wrote a note in February of 2013 about celebrating that the fact that the market had made a new high, finally. It had peaked in November 2007 prior to me even joining Wall Street. I started my career in Wall Street in 2009 after I graduated. And in February of 2013, I wrote a note about how the market had finally made a new high, so this is what I mean, like you can have these sort of long term bear markets where your dead money or losing money or flat money for a really long period of time. And I think that January high in the S&P is probably something that November high in crypto, there’s going to be some highs that we have to deal with for a long time as investors to the extent that folks did risk manage that poorly.

Darius Dale (36:29):

Let me summarize, I sound pretty bearish, but my goal isn’t to scare people and shorting everything and doing everything. What we’re trying to do is help investors just be thoughtful about the kinds of risk they’re taking, but also the overall amount of risk they’re taking because those are two very different things, right? And so, as it relates to now, we’re just in a part of the cycle where it’s basically the opposite of what we had from 2020 to 2021. We were as bearish as I sound now and you can all fact check me on this. I was saying the exact opposite, going back to 2020. We were like, “Hey, we’re about to have five things happen that almost never happened together.” One, you’re going to have accelerating growth, accelerating inflation, aggressive expansion or aggressive monetary easing, aggressive fiscal easing and corporate profit growth, accelerating margins widening and all that good stuff.

Darius Dale (37:11):

We’re basically have all five of those things moving in reverse now with the exception of inflation, but at the end, it’s about the peak. So you’re going to have all five of the things that caused the massive rally in crypto, massive rallying in stocks from the lows of 2020 through the highs of 2021, or even into the early part of this year, those things are all working in reverse and they’re going to be working in reverse for an extended period of time. So why would you as an investor expect anything but the opposite of what we experience in positive price appreciation terms over the medium terms. So it’s just understanding that, it’s going to be a lot difficult to make money. This is an alpha market, it’s not a beta market. A beta market is where you can be long assets and you don’t have to trade them as much.

Darius Dale (37:48):

The alpha market is a market that you need to trade a lot more actively to the extent you want to be participating. If you don’t want to be participating, you can just, like I said, raise cash and look to buy things back at a cheaper price in a much better valuations. But if you want to remain actively participating in financial markets, you’re going to have to tighten up your duration in some of these holdings and be willing to be flexible, creating, booking gains along the way and things of that nature. So we can certainly help with that at 42 Macro. But even if it’s not us, just be aware of all these dynamics as we progress throughout the year.

Clay Finck (38:17):

Awesome. Yeah, it definitely seems like a time to at least a bit more cautious as an investor. Darius, with that, it’s been a true honor to have you on the show. I really can’t thank you enough for taking the time to join us today. Before we close out the episode, where can the audience go to connect with you and 42 Macro?

Darius Dale (38:37):

I appreciate you Clay, man. It’s an honor to join you as well, my friend. 42macro.com, come check us out. We have all of our research out there, I got sample reports of everything. We definitely cover crypto. What we’re really trying to do at 42 Macro is take our institutional knowledge of all of those systems and processes that Wall Street’s top hedge funds use to manage risk and distill that information for everyone so that everyone can manage risk at a high level, as opposed to getting run over in these big crashes and things of that nature. So 42macro.com, come check us out, I’m on Twitter. I’m pretty prolific on Twitter @42MacroDDale. Appreciate you.

Clay Finck (39:12):

Awesome. Thank you Darius.

Darius Dale (39:14):

I appreciate you Clay, man, thank you.

Clay Finck (39:16):

All right. I hope you enjoyed today’s episode. Please go ahead and follow us on your favorite podcast app. So you can get these episodes delivered automatically. If you’ve been enjoying the podcast, we would really appreciate it. If you left us a rating or review on the podcast app you’re on, this will really help us in the search algorithm, so others can discover the show as well. And if you haven’t already done so, be sure to check out our website, theinvestorspodcast.com. There, you’ll find all of our episodes, some educational resources as well as our TIP finance tool that Robert and I use to manage our own stock portfolios. And with that, we’ll see you again next time.

Outro (39:52):

Thank you for listening to TIP. Make sure to subscribe to We Study Billionaires by The Investor’s Podcast Network. Every Wednesday, we teach you about Bitcoin and every Saturday We Study Billionaires and the financial markets. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.