Speaker 1: Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2: Hello and welcome to another episode of the Odd Thoughts podcast.
Speaker 2: I'm Tracy Alloway.
Speaker 3: And I'm Joe Wisenthal.
Speaker 2: Joe, it's my favorite time of year. It's August.
Speaker 3: Well, I didn't know that. Why is it your favorite
Speaker 3: time of year? I like August two. I love summer.
Speaker 3: But what's your reason.
Speaker 2: Well, actually it's exactly that. I love summer.
Speaker 3: But this is why we get along.
Speaker 2: There's an added flames say.
Speaker 3: I don't like people who have favorite seasons of the summer.
Speaker 3: I'm skeptical of that.
Speaker 2: You know what I used to be.
Speaker 3: I judge people.
Speaker 2: Okay, that's fine. I used to be exactly like that. However,
Speaker 2: I've found that as I've gotten older, I've kind of
Speaker 2: come Maybe as I've gotten older and acquired a house
Speaker 2: without air conditioning, I've also home to appreciate winter a
Speaker 2: little bit more. Okay, I didn't actually mean to start
Speaker 2: talking about the weather. But there's another reason I like August,
Speaker 2: which is I feel like that's the month when weird
Speaker 2: things in markets start to happen.
Speaker 3: Yeah, August through October feels like that's the three month
Speaker 3: stretch where anything can happen.
Speaker 2: Yeah, and August especially, you know, people are on their
Speaker 2: like mandated two weekly if you're a professional working at
Speaker 2: a bank or something like that, you have to go
Speaker 2: on leave for I think two weeks or something like
Speaker 2: that every year. And there's lots of illiquidity in the market,
Speaker 2: so you know, tiny little things can end up having
Speaker 2: a big impact. And I feel like August is when
Speaker 2: you get some of those strange market moves. And speaking
Speaker 2: of strange market moves, or at least dramatic ones, in
Speaker 2: recent days and weeks, we have seen some interesting stuff
Speaker 2: happening in the market that has been different to the
Speaker 2: pattern that has played out for the past year or
Speaker 2: so totally.
Speaker 3: First of all, we've had a little bit of weakness.
Speaker 3: I've had a little bit of rotation that people are
Speaker 3: talking about. Some of those red hot tech stocs have
Speaker 3: come down. We're seeing a lot of moves on the curve.
Speaker 3: At the time we're writing this, the tenure yield is
Speaker 3: back below four percon So I was just saying in
Speaker 3: the Odd Lots discord which people should go and subscribe
Speaker 3: to and hang out, I literally said, this morning, macro
Speaker 3: feels like it's kind of getting interesting.
Speaker 2: Again absolutely, both macro and markets, I gotta say, And
Speaker 2: there is this ongoing conversation about how much of what
Speaker 2: is happening in markets at the moment is technically driven,
Speaker 2: so you know, maybe some of those pod shops having
Speaker 2: to cut some positioning versus people actually reacting to changes
Speaker 2: in the macro outlook. And I should just say we
Speaker 2: are recording this on August first, the day after the
Speaker 2: Federal Reserve meeting, where as expected, they didn't cut interest rates,
Speaker 2: but they certainly telegraphed an upcoming cut, So lots going
Speaker 2: on there as well.
Speaker 3: And the day before recording this day for non farm payrolls.
Speaker 3: So by the time you were listening to this, we'll
Speaker 3: know a little bit more about the labor market.
Speaker 2: Yes, we will. So there's a lot going on. It's August.
Speaker 2: There's the potential for even more stuff to happen, weird
Speaker 2: stuff sometimes, And I have to say, when it comes
Speaker 2: to diving into the intricacies of the market and what's
Speaker 2: going on there, there's a person that I very much
Speaker 2: like to speak to. We've had him on the show before.
Speaker 2: It is Matt King, formerly of City Group, and he's
Speaker 2: now started his own research shop. It is called Satory Insights,
Speaker 2: and he is the founder and global market strategist over there.
Speaker 2: So we're going to talk to Matt about what's going
Speaker 2: on in markets, what the outlook is right now. Matt,
Speaker 2: thank you so much for coming back on all thoughts.
Speaker 4: Thank you for having me so much too kind.
Speaker 2: Well, we are very excited to be speaking to you again.
Speaker 2: There's a lot that's happened since we spoke to you
Speaker 2: last I think it was in maybe in March of
Speaker 2: last year. Talk to us about what's happened. So you've
Speaker 2: set out on your own. You have this new thing
Speaker 2: called Satory Insights. What are you doing over there?
Speaker 4: I'm doing more or less what I was doing previously,
Speaker 4: which is trying to explain what markets have done and
Speaker 4: what markets are going to do, and generally doing it
Speaker 4: in a rather different fashion from everybody else as far
Speaker 4: as I can see. And I love your description of August.
Speaker 4: In my experience, either nothing whatsoever happens or areas you say,
Speaker 4: quite big stuff happens. But I think that the biggest
Speaker 4: puzzles that I see people wrestling with at the moment
Speaker 4: are are, frankly, making sense of what markets have done
Speaker 4: year to date and therefore, and that's the context in
Speaker 4: which you need to see the change now, because on
Speaker 4: the one hand, the other economy is much stronger than
Speaker 4: everyone was imagining, But on the other hand, markets have
Speaker 4: really done much much better. And yeah, there's the whole
Speaker 4: AI story, but it sort of feels as though it's
Speaker 4: more than that. And I think the biggest puzzle is
Speaker 4: why financial conditions have eased so much even as we've
Speaker 4: had ongoing QT, even as we've had rates at twenty
Speaker 4: three year highs. And in fact, it was the main
Speaker 4: thing I was missing in the FOMCA last night. Nobody
Speaker 4: asked Jay Powell about how they considered this ease in
Speaker 4: your financial conditions on one of the Bloomberg financial conditions
Speaker 4: is just a couple of months ago we were showing
Speaker 4: easier conditions than two thousand and seven, And I think
Speaker 4: you need to get your head around what's been driving
Speaker 4: all of that before you can then come back and
Speaker 4: think about the outlook and what markets are doing at
Speaker 4: the moment.
Speaker 3: All right, what's the answer? Tell us the answer for
Speaker 3: this date of financial conditions, because it does seem weird,
Speaker 3: and I mean, I think we've probably been talking about
Speaker 3: this for almost two years on the show, the surprise
Speaker 3: that perhaps fed raid hikes and the slow wind down
Speaker 3: of the balance sheet hasn't had at least here before
Speaker 3: more of a deleterious effect.
Speaker 4: So, at the risk of being cheeky, it's exactly that
Speaker 4: same thing which I heard you say had been debound
Speaker 4: on one of the previous episodes with one of your
Speaker 4: other guests.
Speaker 3: So well, thank you for so I thank you for listening.
Speaker 3: I appreciate I'm glad even though I personally offended your approach,
Speaker 3: which I apologize, I appreciate your listening to Odd Lives,
Speaker 3: and I appreciate you coming back and I say that
Speaker 3: nothing is ever debunked in markets, because I actually don't.
Speaker 1: Feel that way.
Speaker 2: Joe is open minded, and just to be clear what
Speaker 2: we're talking about in terms of the debunking, it was
Speaker 2: the idea that central bank liquidity was driving asset prices.
Speaker 2: That was the idea, which Matt is very much your
Speaker 2: approach to analyzing markets.
Speaker 4: And I was not offended either. In teacher became the
Speaker 4: subject of a footnote in one of my research pieces
Speaker 4: making the counter argument. But I think that the standard
Speaker 4: view of what's been going on is, oh, the economy
Speaker 4: must be much stronger than everyone thought previously. It must
Speaker 4: be that our star and neutral rates are higher. But
Speaker 4: then there are a couple of puzzles. It's like, oh, well,
Speaker 4: how come actually desire to borrow in credit growth are
Speaker 4: really quite limited. There's lots of gross issues, but actually
Speaker 4: net borrowing is really rather lackluster. And how come many
Speaker 4: of the arstar models, the most comprehensive ones, don't really
Speaker 4: show this big pickup in neutral rates. And then how
Speaker 4: do we make sense of the recent and weakness, especially
Speaker 4: in things like credit and emerging markets? And so again,
Speaker 4: the sort of standard explanation is maybe, and there was
Speaker 4: a nice academic paper on this recently which maybe QT
Speaker 4: is just not as powerful as QE. Maybe there's some
Speaker 4: big asymmetric effect going And it was a lovely argued
Speaker 4: paper that I happened to think drough all the wrong conclusions.
Speaker 4: And as usual, I start from not knowing anything about this.
Speaker 4: I just look at my charts of what markets are doing,
Speaker 4: and I try and make sense of them. But the
Speaker 4: way it seems to me is that market sensitivity to
Speaker 4: central bank balance sheet changes really hasn't changed at all.
Speaker 4: That most of the time, when we thought we were
Speaker 4: doing QT. Actually we weren't, and indeed a lot of
Speaker 4: the time there was almost this stealth Q effect going on.
Speaker 4: And this is a lot of the reason why I
Speaker 4: think that financial conditions have been so easy, notwithstanding all
Speaker 4: of the rate hikes. And the right way to think
Speaker 4: about this is in terms of not the security side
Speaker 4: of the central bank balance sheet, but the changes in reserves.
Speaker 4: And once you start thinking in those terms globally, and
Speaker 4: you say, well, since two thousand and nine, we added
Speaker 4: eighteen trillion dollars worth of reserves or liquidity, and we've
Speaker 4: only dialed back about five hundred billion dollars worth. And
Speaker 4: even if we think more recently, as you say, more
Speaker 4: or lessons last time I was on, since the last
Speaker 4: market trough in October twenty twenty two, even with the
Speaker 4: supposed ongoing QT, US reserves have increased, not fallen, by
Speaker 4: a net two hundred and fifty billion dollars, and global
Speaker 4: reserves have increased by nine hundred and twenty billion dollars.
Speaker 4: And not only that, but the timing just fits so perfectly,
Speaker 4: and mostly I think my charts argue better than I
Speaker 4: can here. But whenever reserves have actually fallen so in
Speaker 4: twenty twenty two. Markets fell whenever they fell in say
Speaker 4: April this year again, same thing. Risk fell back again,
Speaker 4: and that's a little of what's happened in July as well.
Speaker 3: Sorry, just to be clear on this, what are you
Speaker 3: looking at when you say that reserves? Heaven? Because if
Speaker 3: I look at just the pure chart of the FED
Speaker 3: balance sheet on the Bloomberg, it's clearly gone down. It's
Speaker 3: lowest twenty So when you say reserves haven't gone down,
Speaker 3: what measure should I be looking at?
Speaker 4: So for the FED, you just want the straight reserves
Speaker 4: number that you're looking at, and you see a peek
Speaker 4: in April this year, and then levels have fallen off subsequently.
Speaker 4: And then I do the same thing globally by looking
Speaker 4: at reserves. Occasionally it's slightly different, but basically reserves at
Speaker 4: other central banks. I make sure I don't introduce FX
Speaker 4: effects to the total, and I look at the changes
Speaker 4: in those reserves. Again, you get a peak in April
Speaker 4: and then they've come off a little bit subsequently. But
Speaker 4: most of the time the near term market moves correspond
Speaker 4: really quite well with those, And even though we're getting
Speaker 4: a little bit of a decoupling at the moment in
Speaker 4: equities are trying to break away. It's interesting that you
Speaker 4: look at other asset classes, you look at credit, you
Speaker 4: look at emerging markets, if you even look at things
Speaker 4: like bitcoin. Basically that correlation with the global reserves numbers
Speaker 4: carries on.
Speaker 3: All right, Tracy, just to clarify, if you look at
Speaker 3: the total size of the FED balance sheet is gone down.
Speaker 3: But Matt is correct that if you look specifically a
Speaker 3: US reserve balances with the Federal Reserve, it was a
Speaker 3: peak in twenty twenty two, it fell and then it
Speaker 3: picked back up, peaked in April, and then gone down.
Speaker 3: So if you look at that measure, right.
Speaker 2: And I should just say Matt mentioned his famous charts
Speaker 2: just then, and we're going to embed some of those
Speaker 2: in the transcript of this conversation, So if you are listening,
Speaker 2: then please check out the transcript as well because we
Speaker 2: will have those visuals to better illustrate the point. But Matt,
Speaker 2: just on the bank reserves point, could you walk us through,
Speaker 2: preferably in excruciating detail, exactly how an increase in bank
Speaker 2: reserves translates into higher asset prices. Is it the case
Speaker 2: that when you know banks have more reserves, maybe they
Speaker 2: feel more comfortable lending. Maybe it changes people's risk preferences.
Speaker 2: How exactly does that translate into concrete market action.
Speaker 4: Well, such to the second than the first, But in
Speaker 4: general I'm not sure anybody can do this properly, and
Speaker 4: I'm mostly looking at the charts and then reasoning backwards.
Speaker 4: So the most common explanations that you hear, and there's
Speaker 4: been another paper recently by Noial Rubni try and relate
Speaker 4: it to interest rate moves. And similarly, the FED when
Speaker 4: they talk about this, they always focus on the levels
Speaker 4: of reserves, and they kind of almost ignore changes in
Speaker 4: reserves once they assume that the level of reserves is adequate.
Speaker 4: I think that is entirely the wrong way to think
Speaker 4: about it, intuitive though it may be. And likewise, I
Speaker 4: think thinking in terms of the impact on interest rates
Speaker 4: and then looking for that to cascade outwards again is wrong.
Speaker 4: And instead, the way I think you're supposed to think
Speaker 4: about it is that reserves are a neat way to
Speaker 4: capture the balance between how much money the private sector
Speaker 4: has got relative to how many assets are available to
Speaker 4: absorb that money. Now, in the case of sort of
Speaker 4: standard QI or QT, that's kind of straightforward enough, you
Speaker 4: know that you are both giving the private sector more
Speaker 4: money in the form of reserves and then giving them
Speaker 4: fewer government bonds or bills to hold. But I think
Speaker 4: this is also the reason why it's reserves and not
Speaker 4: securities that count, because even when it's other factors on
Speaker 4: central wank balance sheets going up and down, like the
Speaker 4: Treasury General Account at the FED, or like the reverse
Speaker 4: report program at the FED, even when those things are
Speaker 4: seemingly innocuously moving up and down, they have this same effect.
Speaker 4: So if the TGA is going up because they have
Speaker 4: issued more tea bills and you have bought those tea bills,
Speaker 4: but then the money is locked away at the FED
Speaker 4: in a higher treasury balance, well that's the sort of
Speaker 4: the same thing. You've taken money away from the private sector,
Speaker 4: and there's less private money in markets, more securities needing
Speaker 4: to be absorbed, and as a result, what we get
Speaker 4: is a drop in the price of risk. And confusingly,
Speaker 4: where that shows up on all of my charts is
Speaker 4: not necessarily in a drop in the price off bond
Speaker 4: yields where you might have anticipated or T bill rates. Actually, instead,
Speaker 4: it shows up most clearly in the prices of equities,
Speaker 4: in the prices of credit spreads, and even occasionally in
Speaker 4: things like the prices of bitcoin. And for me, the
Speaker 4: way you make sense of that that's weird because it's
Speaker 4: not like the FED and the other central banks of
Speaker 4: buying and selling large amounts of credit or equities, or
Speaker 4: certainly bitcoin. But instead it's this ripple through effect. It's
Speaker 4: that when say it's the other way around and TGA
Speaker 4: is falling and I've just got more money in my
Speaker 4: bank account because of a te ball matured, but there's
Speaker 4: no new T bill for me to go out and buy. Well,
Speaker 4: I get forced into buying something riskier, and you get
Speaker 4: this cascading effect where the guy that would have bought
Speaker 4: bonds buys credit, and the buyer that would have bought
Speaker 4: investment grade buys high yeld, and the guy that would
Speaker 4: have bought up high yield buys equities, and you can't
Speaker 4: see all of those moving parts. It's sort of frustrating
Speaker 4: in that respect, but that's the only way I can
Speaker 4: make sense of these really quite consistent relationships, even from
Speaker 4: one week to the next, even when reserves are supposedly abundant.
Speaker 4: It's this shift in the balance and In fact, the
Speaker 4: chart of mind that I'm probably most pleased with this
Speaker 4: year is the one that then links through from changes
Speaker 4: in reserves or central bank liquidity globally to changes in
Speaker 4: the mutual fund flows, the mutual fund and the ETF flows.
Speaker 4: It's this crowding in and crowding out effect as a
Speaker 4: direct consequence of changes on central bank balance sheets, which
Speaker 4: I think has been much more important than is widely recognized.
Speaker 4: And even as you try and make sense of the
Speaker 4: mutual fund flows, this year has been the second biggest
Speaker 4: year on record after twenty twenty one, we've had six
Speaker 4: hundred billion dollars of overall inflows. Again for me, until
Speaker 4: very recently that was being driven directly by this crowding
Speaker 4: out effect from the global central bank reserves numbers.
Speaker 3: What is the role of rate policy in your thinking,
Speaker 3: because again, one of the things we're talking about right
Speaker 3: now is the timing of possible rate cuts, which doesn't
Speaker 3: directly impact some of these monetary aggregates such as the
Speaker 3: balance sheet or the reserves specifically, but there is a
Speaker 3: lot of anxiety in the market, particularly today again about
Speaker 3: whether the FED is going to be too late in
Speaker 3: cutting rates or etc. How do you think about that,
Speaker 3: is that, just in your view, totally irrelevant.
Speaker 4: I didn't used to think it was irrelevant, but it's
Speaker 4: sort of looking that way this cycle, isn't it. How
Speaker 4: come we've had all these rate increases and then you've
Speaker 4: not had a massive slowdown. And I think the way
Speaker 4: I think about it is, so it's always about money creation,
Speaker 4: it's always about credit creation. And normally that would be
Speaker 4: driven by the private sector. It would be you and
Speaker 4: me deciding to borrow or not to borrow based on
Speaker 4: whether rates were restrictive or not. And this cycle, on
Speaker 4: the other hand, has been different. The surge in credit
Speaker 4: that we had, it never came from the private sector.
Speaker 4: It came, if anything, from fiscal policy. And likewise, the
Speaker 4: surge in say things like fun flows and some of
Speaker 4: these market effects and the m zero or the reserves numbers, again,
Speaker 4: that was never driven by the private sector. It was
Speaker 4: never driven by interest rates. It was driven directly by
Speaker 4: these central bank balance sheet effects. And so the flip
Speaker 4: side of what I'm saying is that just as the
Speaker 4: rate increases maybe had a negative effect, that's lugging in
Speaker 4: the background, and there's a bit of a long lag
Speaker 4: and you begin to see delinquencies picking up. But when
Speaker 4: we eventually get to rate easing, I doubt that that
Speaker 4: is going to do very much to stimulate private sector
Speaker 4: credit growth either. And ultimately we may end up with
Speaker 4: more reasoning than imagined, just because we're still extremely sensitive
Speaker 4: to balance sheet changes. There never was that much desire
Speaker 4: to borrow on the part of the private sector even
Speaker 4: before all of the rate increases, and when we go
Speaker 4: back to additional easings, I'm not sure that's going to
Speaker 4: stimulate lots of private sector borrowing either. And this is
Speaker 4: part of a longer term shift where even as rates
Speaker 4: have been coming down for decades, the borrowing that there's been,
Speaker 4: the money creation that there's been has in fact come
Speaker 4: increasingly from fiscal authorities and from central banks directly, and
Speaker 4: rates themselves have been effectively pushing on a string.
Speaker 2: Can I play Devil's advocate for a second, which is
Speaker 2: this time last year the world was a light with
Speaker 2: talk of a potential recession, and one thing you would
Speaker 2: hear over and over again is, you know, yield curve inversion.
Speaker 2: We've never had an aversion without an ensuing recession. This year,
Speaker 2: there is much much less discussion about the risk of
Speaker 2: a recession. Couldn't this all just be people have changed
Speaker 2: their minds about the macroeconomic outlook and that is driving
Speaker 2: asset prices. Like a very simple Oukham's razor kind of
Speaker 2: explanation for what we're seeing.
Speaker 4: It could be and that must play some role, but
Speaker 4: in general the timing doesn't fit. In general, the rally
Speaker 4: in the markets has first, and then the improvement in
Speaker 4: the economic conditions has come later. I guess you could
Speaker 4: make an argument that economic surprises went negative, but in general,
Speaker 4: and the people are starting to worry about a slow down.
Speaker 4: But I'd argue markets are always supposed to anticipate, but
Speaker 4: it's been stronger than that recently. Even when you take
Speaker 4: something like earnings revisions. For example, earnings expectations have been
Speaker 4: gradually increasing, but they seem to be doing so in
Speaker 4: response to that. They're almost chasing the equity market higher
Speaker 4: to buy a greater extent than previously. And as I say,
Speaker 4: I wouldn't expect to have anything like the correlations that
Speaker 4: I do with the central bank liquidity. I continue scratching
Speaker 4: my head as to whether the effect could be the
Speaker 4: other way round. It could be the market that's influencing
Speaker 4: the Central Bank numbers, and while the lags are a
Speaker 4: bit variable, basically no, it doesn't work that way. But
Speaker 4: for me, fundamentals have become very much a lagging indicator.
Speaker 4: And this, for me is all part of a longer
Speaker 4: term story whereby up until twenty twelve or so, I
Speaker 4: placed an awful lot more emphasis on fundamentals because it
Speaker 4: seemed to be driving the market to a much larger extent.
Speaker 4: Since twenty twelve, many of my favorite relationships simply broke down,
Speaker 4: so the lending surveys were no longer a good guide
Speaker 4: to what spreads were doing and what defaults were doing.
Speaker 4: If anything, it was the other way around. It was
Speaker 4: spreads would rally first, and then the lending standards was
Speaker 4: easy afterwards, and the defaults that should have been taking
Speaker 4: place didn't take place. Or same thing. In volatility space,
Speaker 4: there are nice relationships that used to hold with uncertainty,
Speaker 4: and since twenty twelve, uncertainty has often been quite high
Speaker 4: on uncertainty metrics, a number of references to uncertainty in
Speaker 4: the news and things like that, and yet volatility most
Speaker 4: of the time has been super low. And all of
Speaker 4: these dynamics, to my mind, go together with this money
Speaker 4: creation led pattern, but where the money creation has come
Speaker 4: directly from central banks, and that shows up in my
Speaker 4: relationships and the swings that we've had there are just
Speaker 4: really big relative to the sorts of swings that we
Speaker 4: get in money creation coming from the private sector, and
Speaker 4: that's why they end up dominating the market.
Speaker 2: Since you mentioned timing just then, let's talk about that
Speaker 2: a little bit more. So. Reserves peaked back in April,
Speaker 2: it wasn't until relatively recently that we really saw significant
Speaker 2: market weakness. So why was there that gap. Why didn't
Speaker 2: we see equities falling earlier on as reserves started to
Speaker 2: come down?
Speaker 4: A couple of different things. So one of the reasons
Speaker 4: why Joe was sounding so skeptical on the previous podcast
Speaker 4: was because when if you just look at US reserves alone,
Speaker 4: sometimes they correlate, but they don't always, you get a
Speaker 4: much betefit with the global numbers. And some of what
Speaker 4: has been going on is that there have been liquidity
Speaker 4: editions by the BOJ and then recently from the PBOC
Speaker 4: that have some impact. I think though the biggest story
Speaker 4: is that the fund flows have been sort of making
Speaker 4: an effort to decouple, even as the central bank liquidity
Speaker 4: has faded to some extent that you often have lab
Speaker 4: especially when there's momentum driven markets as we've had recently,
Speaker 4: and there's a little bit of a lag before people
Speaker 4: realize that the momentum isn't there. And even now, I
Speaker 4: am impressed by how many inflows we've had, especially to equities,
Speaker 4: and it is plausible that this could just carry on
Speaker 4: by itself. It's plausible that that the belief in buying
Speaker 4: the dip is just so strong that actually this carries
Speaker 4: on regardless. And although we get a little bit of
Speaker 4: a liquidity drainage from central banks, even with the quarterly
Speaker 4: refunding announcement from the Treasure yesterday and a little bit
Speaker 4: more bill issuance, actually that could be another factor that
Speaker 4: drags a bit more money out of RRP and ensures
Speaker 4: we don't have too much liquidity drainage generally speaking, though,
Speaker 4: I think all of this is on much more fragile
Speaker 4: ground than it was in the first half of the year,
Speaker 4: and I think my whole way of looking at it
Speaker 4: takes you to a very different place from if you
Speaker 4: assume it's fundamentals driving markets and you assume people have
Speaker 4: been buying for fundamental reasons, And what many asset managers
Speaker 4: tell me is this fits frankly much better with where
Speaker 4: they've been for an extended period, which is there not
Speaker 4: buying because they think that equities are cheap or credit
Speaker 4: is cheap at two thousand and seven type levels. On
Speaker 4: the contrary, the reason they keep buying is because they
Speaker 4: keep having another inflow. And as I say, when you
Speaker 4: start looking at other asset classes or even even assets
Speaker 4: like bitcoin that are much more in line with the
Speaker 4: central bank liquidity numbers than the equity market is then
Speaker 4: that you re assess the whole narrowing of the market
Speaker 4: rally and the churn that we're getting at the moment
Speaker 4: and the effort to retain Is this instead a sign
Speaker 4: of a natural fundamental driven strength and the back of
Speaker 4: a trump trade that can run and run and run,
Speaker 4: or instead, is this actually a sign of a weakening
Speaker 4: level of support that can push up a smaller and
Speaker 4: smaller number of assets and ultimately is quite vulnerable to
Speaker 4: any deterioration in those fun flows. And that hasn't really
Speaker 4: happened yet, but I think if it does happen, then
Speaker 4: rate heasing in itself is not going to be sufficient
Speaker 4: to get everyone chasing back into risk again.
Speaker 2: Joe Matt just said that the reason funds keep buying
Speaker 2: is because there's another inflow. I feel like I have
Speaker 2: to mention here that Matt's work was the inspiration for
Speaker 2: flows before pros.
Speaker 3: Oh, so now we get, yeah.
Speaker 2: This idea that you know, flows can drive additional buying
Speaker 2: and where markets used to maybe be more value driven,
Speaker 2: so eventually you would say like, actually, this price isn't justified,
Speaker 2: and so investors would sort of self limit their behavior.
Speaker 2: Now that just doesn't happen as much.
Speaker 3: So I believe in the flows before pros thesis theorem
Speaker 3: saying to an extent, and I buy this, and that
Speaker 3: makes a lot of sense to me. But here's what
Speaker 3: I want to understand further, and that is how that
Speaker 3: explained certain sectoral moves. Because whenever I hear about okay,
Speaker 3: markets are divorced from fundamentals, or fundamentals don't work as
Speaker 3: well as they might have used to. I look at
Speaker 3: like the big winners within equity markets are companies that
Speaker 3: are just objectively doing really well. And that's also been
Speaker 3: the case since two thousand and nine, which is like, okay,
Speaker 3: we have these extraordinary moves in the handful of big
Speaker 3: tech companies. They're doing really well. They're really good businesses,
Speaker 3: They're making tons of money. Their growth rates continue to
Speaker 3: exceed anyone's expectations. Earnings are always being revised up. In fact,
Speaker 3: like no companies this big in history are showing growth
Speaker 3: rates like this given their size. So if it's all
Speaker 3: flows and all that stuff, why do we seem to
Speaker 3: see this connection between the companies that are frankly killing
Speaker 3: it and the stocks that are doing really well.
Speaker 4: I think that's a very fair point, And in general,
Speaker 4: I would say it's not that fundamentals have no role whatsoever.
Speaker 4: And in general I would say my relationships fit best,
Speaker 4: or the center bank equidity numbers fit best. The broader
Speaker 4: the number of assets that we assess them against, and
Speaker 4: the more we take any individual asset, the more scope
Speaker 4: there is for either idiosyncratic technicals or their own fundamentals
Speaker 4: to have an impact. Having said that, though, I also
Speaker 4: observe a strong tendency for the correlations to be best
Speaker 4: with some of the names that have been hottest in
Speaker 4: the market, let's say, like LVMH, or like Tesla, or
Speaker 4: even like bitcoin as an asset class, and to some
Speaker 4: extent that applies to the Magnificent seven as well. And
Speaker 4: even as we look at those names, Yes, for Nvidio
Speaker 4: in particular, the growth and earnings of the growth in
Speaker 4: free cash flow has been phenomenal, but you still compare,
Speaker 4: for example, forty or fifty times growth in net income
Speaker 4: with gains in marketcap and share price of well over
Speaker 4: one hundred times, or you do that same analysis for
Speaker 4: some of the other techniums that haven't had anything like
Speaker 4: the same growth in net income and free cash flow,
Speaker 4: and still their market caps and share prices are up
Speaker 4: by ten or twelve times. I think this is where
Speaker 4: exactly that flows before pros seems to apply, and the
Speaker 4: momentum effects have come to dominate markets, and the extent
Speaker 4: of the rally that we're getting is more than you
Speaker 4: can justify on the back of those underlying fundamentals. And
Speaker 4: that's where people are just beginning to get concerned about
Speaker 4: the Magnificent Seven. At the moment. The current earnings are great,
Speaker 4: but actually where most of the growth is is not
Speaker 4: in spot earnings. It's in the future years of earnings,
Speaker 4: and we could easily end up questioning that if we
Speaker 4: start to doubt the extent to which all of the
Speaker 4: take investment that's taking place at the moment is actually
Speaker 4: yielding profits.
Speaker 2: I want to step back for a second, and I
Speaker 2: can't remember if we've ever actually asked you this question directly,
Speaker 2: but we've I've been talking a lot about the uniqueness
Speaker 2: of your approach to analyzing markets. Can you maybe talk
Speaker 2: a little bit about how you developed that approach? Because
Speaker 2: when I think back to when I first became aware
Speaker 2: of your research, and we've certainly talked about this on
Speaker 2: the show before, but it was the note from I
Speaker 2: Think the summer of two thousand and eight Are the
Speaker 2: Brokers Broken? Which turned out to be exceptionally prescient, but
Speaker 2: was very different to what you are writing about and
Speaker 2: doing today. So how did you come to take this
Speaker 2: particular analytical framework?
Speaker 4: I make it up as I go along, and the
Speaker 4: difference between me and other people is that I know
Speaker 4: that I don't know anything, and therefore I have to
Speaker 4: look at the charts and reason backwards, whereas other people
Speaker 4: seem to they start with a theory and then they
Speaker 4: keep flogging that theory even when it's not working in practice.
Speaker 4: And so you're right, maybe it's because I used to
Speaker 4: do credit strategy, and so I was always worried about
Speaker 4: things blowing up. But back in two thousand I was
Speaker 4: looking at corporate leverage because that was what was driving
Speaker 4: the market. And then in seven and eight we were
Speaker 4: looking at sieves and CDOs of abs and then brokers
Speaker 4: and repo because that seemed to be what was really
Speaker 4: important and was driving the market. And maybe yes, I
Speaker 4: was lucky with the timing on that piece, but I've
Speaker 4: shifted approach steadily, and as I say, where I've been
Speaker 4: for the last decade is looking at all of the
Speaker 4: central bank stuff just because that fits when nothing else does.
Speaker 4: And it's in this period where mean reversion and value
Speaker 4: investing has died and investors have herded into already expensive
Speaker 4: strategies and momentum has dominated. And I hope that I
Speaker 4: will not be doing this indefinitely, but as a strategist
Speaker 4: and not an economists, I need to go with what
Speaker 4: fits and then develop the theory around it. And if
Speaker 4: the theory sounds plausible and the approach is still working,
Speaker 4: then you continue to go with that. I fear at
Speaker 4: some point I may need to come back and focus
Speaker 4: on politics and debt levels and some of the really
Speaker 4: slow burning really scary things, but hopefully not yet.
Speaker 2: Okay, Well, let's talk about politics and how I guess
Speaker 2: uncertainty geopolitical uncertainty might be showing up in the market.
Speaker 2: There seems to be a bit of a debate at
Speaker 2: the moment. In fact, we recorded an episode last week
Speaker 2: with Victor Schwetz from McCrory, and we asked him whether
Speaker 2: or not some fear, for instance, was being priced into
Speaker 2: the treasury market, maybe into futures, given that markets now
Speaker 2: seem to be pricing in like seventy basis points worth
Speaker 2: of cuts this year, But where do you see political
Speaker 2: risk showing up, if at all.
Speaker 4: In general, markets are really bad at pricing political risk,
Speaker 4: and especially the risk of regime change, and that inability
Speaker 4: has if anything, become worse over the last decade, where
Speaker 4: we haven't managed to price any risk premier appropriately at all,
Speaker 4: never mind political risk premium. So the standard view is
Speaker 4: that in theory, markets should price to a mean expected
Speaker 4: outcome and consider all the different possibilities and reflect that
Speaker 4: in the market price. In practice that is just too
Speaker 4: difficult for people. Everybody goes off the modal forecast. If
Speaker 4: you have been systematically hedging all of your downside risk,
Speaker 4: as you probably should have done, giving the growing geopolitical
Speaker 4: concerns and the mounting debt pile around the globe. Then Fadi,
Speaker 4: you've gone out of business at this point, or at
Speaker 4: least had a really difficult time because all of those
Speaker 4: risks have been suppressed, And yet that doesn't mean that
Speaker 4: they're not there. And I think all of this supplies
Speaker 4: to an even greater extent than usual thanks to the
Speaker 4: build up in debt levels, and even where private sector
Speaker 4: is delivered a little bit, aggregate debt levels have mostly increased,
Speaker 4: especially in the US, but also in places like China,
Speaker 4: and you do get this worrying combination of ever more
Speaker 4: elevated asset prices backed by ever larger amounts of debt,
Speaker 4: and the scope for extreme regime changes or loss of confidence.
Speaker 4: It is frankly, really difficult to affect in my core prices.
Speaker 4: And what we've seen historically is that even when the
Speaker 4: market does do this, it's not slow and steady and rational,
Speaker 4: even with the election of a new government, let's say,
Speaker 4: it's only as the market itself loses confidence. We had
Speaker 4: this in Italy historically, we had it with list Trust's
Speaker 4: government in the UK, there's just this moment where you
Speaker 4: realize this isn't a tail ris this is actually happening,
Speaker 4: and actually nobody else is buying, and therefore I shouldn't
Speaker 4: be buying either. That's where you get this sudden repricing.
Speaker 4: And so people are beginning to look at the moment
Speaker 4: are things like the lack of term premium in the
Speaker 4: US and how that might change and maybe it ought
Speaker 4: to increase, and especially as we worry about increasing interest
Speaker 4: payments in future. And yet for me, it's less about
Speaker 4: the arithmetic of interest payments and the appropriate compensation for them,
Speaker 4: and it's much more about are you actually being irresponsible
Speaker 4: with fiscal policy? Are you actually willfully interfering with the
Speaker 4: independence of the fad That's when you can have your
Speaker 4: abrupt free pricing. And that's where markets have to go
Speaker 4: from being able to ignore the politics entirely to finding
Speaker 4: that the politics is the only thing. And I hope
Speaker 4: we don't get there, but a number of long term
Speaker 4: historical studies that I really respect do point to exactly
Speaker 4: those risks becoming elevated.
Speaker 3: Yeah, I've kind of been thinking about this lately, which
Speaker 3: is that you know, there's all kinds of reasons to
Speaker 3: have political anxiety. I don't mean just like this election,
Speaker 3: but just you know, social and lack of trust and
Speaker 3: all that stuff. But I've kind of been thinking as like, well,
Speaker 3: you know, as long as like it doesn't break, then
Speaker 3: probably everything is going to be fine. But maybe one
Speaker 3: day it's gonna be break and it's gonna be really
Speaker 3: hard to put back together again, and then it'll be
Speaker 3: really bad in me anyway, So do we buy ourself?
Speaker 3: Where's the market going? Like we've had this rally, it's
Speaker 3: pulled back a little bit, but we're still having a
Speaker 3: pretty great year in stocks. As of right now when
Speaker 3: I'm saying this, the SMP is of fourteen point four
Speaker 3: to four percent, which would be a great year if
Speaker 3: we ended here. No one's going to complain about that.
Speaker 3: What do you see happening now?
Speaker 4: I am almost as uncertain about this as J. Powell
Speaker 4: was last night, and I do think we need to
Speaker 4: look at the numbers as we're going along for the
Speaker 4: fun flows for the central mark liquidity. What I can
Speaker 4: say with confidence is that I think the massive tailwind
Speaker 4: that we had in twenty twenty three and in the
Speaker 4: early part of this year is basically gone, and if
Speaker 4: anything is likely to reverse slightly, I think the balance
Speaker 4: of risk is therefore for higher volatility for at least
Speaker 4: not rallying equities. I'd be happy to position for a
Speaker 4: further rotation within the equity market. Again, the whole tech sector,
Speaker 4: to my mind, does look stretched at this point. But
Speaker 4: even there, it's not that I'm outright bullish on the
Speaker 4: value sectors and the banks and the things that are
Speaker 4: doing well at the moment and might benefit if there's
Speaker 4: a further Trump trade. To my mind, everything ends up
Speaker 4: rather more vulnerable than it has been because of this
Speaker 4: tailwind is just no longer there.
Speaker 2: I realized we'd be very remiss if we had Matt
Speaker 2: King on the podcast talking about the impact of central
Speaker 2: bank driven liquidity and balance sheets on the market and
Speaker 2: we didn't talk about what's going on in repo at
Speaker 2: the moment. So we have seen, for instance, the secured
Speaker 2: overnight funding rate, so the libor replacement ticking up quite
Speaker 2: a bit. Recently. There's been talk about lots of drama
Speaker 2: in the repo market, and there's been this ongoing discussion
Speaker 2: about whether or not some of what's happening there could
Speaker 2: lead the FED to have to reconsider things like quantitative tightening,
Speaker 2: or maybe at least tweak that approach. Is this something
Speaker 2: that's been on your radar?
Speaker 4: Yes and no. So yes, insofar as the changes in
Speaker 4: the level of RRP, the reverse reproprogram at the FED
Speaker 4: are a direct driver of reserves, and that feeds through
Speaker 4: directly into my view of where markets are going. And
Speaker 4: therefore I do look quite closely at the things I
Speaker 4: think are driving RRP, namely the pickup on T bills,
Speaker 4: and yes, the levels are private sector reaper in general,
Speaker 4: though I am much less worried about things breaking, especially
Speaker 4: with some of the new emergency facilities which are available
Speaker 4: in than other people are. And that's because for me,
Speaker 4: it's not that there's some magic level where reserves are
Speaker 4: adequate and if we drop below that then bad things
Speaker 4: happen and you see it in a spike and rate.
Speaker 4: For me, instead, it's about that balance between the as
Speaker 4: I say, the amount of money in private markets and
Speaker 4: the assets available to absorb them, and that's reflected in
Speaker 4: a much more continuous fashion with changes in reserves, even
Speaker 4: when liquidity is supposedly abundant. So yes, I'm monitoring all
Speaker 4: of this, but I don't have quite the same worry
Speaker 4: about things suddenly breaking that perhaps some other people do.
Speaker 4: And if anything, my guess would be the fact that
Speaker 4: they've tapered the QUT means they probably will go on
Speaker 4: for longer, and ultimately, other things being equal, that is
Speaker 4: likely to drain reserves and is likely to lead to
Speaker 4: a weaker market. But it would take quite a severe weakening,
Speaker 4: I think, especially following the tapering, for them to want
Speaker 4: to abandon the QT entirely. And indeed, i'd argue that frankly,
Speaker 4: in almost in some broader sense, what we're wrestling with
Speaker 4: is too much froth in markets and too much asset
Speaker 4: price inflation. And my concern is a bit more the
Speaker 4: opposite that they keep turning a blind eye to that,
Speaker 4: and if we could take some of that froth out
Speaker 4: of markets, yes, it might weaken the outlook a little
Speaker 4: bit in the neartom, but it would lead to a
Speaker 4: much more stable outlook over the long term.
Speaker 2: All right, Matt King from satory insides, It was so
Speaker 2: lovely being able to catch up with you once again.
Speaker 2: Thank you so much for coming back on the show.
Speaker 4: My pleasure. Thanks for having me, Joe.
Speaker 2: I really enjoy talking to Matt I should just emphasize
Speaker 2: again that throughout that entire conversation, even though we couldn't
Speaker 2: see him, he was bringing up charts because he always
Speaker 2: brings up his charts, and I kind of love it,
Speaker 2: and I will include them in the transcript of this
Speaker 2: conversation so everyone can see them.
Speaker 3: Yeah, we should put out the transcript early when this
Speaker 3: comes out, so maybe people you know, or people can
Speaker 3: download this and then pause it and then wait for
Speaker 3: the transcript to come out and then give it a listen.
Speaker 3: I always enjoy Matt too. I respect how he sort
Speaker 3: of characterized the evolving nature of his approach to looking
Speaker 3: at markets, which is, if something isn't working, stop focusing
Speaker 3: on that and start looking for things that are working.
Speaker 3: And if there are relationships between measures of liquidity and
Speaker 3: what's happening with risk assets, and they continue to work,
Speaker 3: and they work in back tests and they work and
Speaker 3: forward tests, then it would certainly make sense to me
Speaker 3: to keep looking at them.
Speaker 2: I do think he's sort of put his finger on
Speaker 2: something important and fundamental, and I'm pretty sure I've said
Speaker 2: it on the show before in one way or another.
Speaker 2: I know I've written about it in the newsletter, but
Speaker 2: it does feel like we've seen the price of money
Speaker 2: go up via higher benchmark interest rates, but that doesn't
Speaker 2: mean that its availability has been limited. So you know,
Speaker 2: liquidity is still pretty abundant. It seems like people can
Speaker 2: borrow if they need to, And so I do think
Speaker 2: it's a valid question to be asking why there seems
Speaker 2: to be this disconnect between interest rates the price of
Speaker 2: money versus its availability.
Speaker 3: No, I mean, it is really wild, right, It's a
Speaker 3: mystery even as this price of money seems to have
Speaker 3: gone up. I mean you could make the argument, yeah,
Speaker 3: the price of money has gone up, but inflation's gone up,
Speaker 3: so maybe it hasn't gone up as much. I remember
Speaker 3: that was certainly a talking point for a while, maybe
Speaker 3: in like twenty twenty two or twenty twenty three. But look,
Speaker 3: no one's coming out great from the last four years,
Speaker 3: or for the most part, nobody's theories are holding up
Speaker 3: that well, and the market and the economy continue to
Speaker 3: surprise people. So I do think it's important to look
Speaker 3: at other perspectives.
Speaker 2: What will be really interesting is when we do finally
Speaker 2: have rate cuts and seeing if like any of the
Speaker 2: more recent patterns actually hold, or if stuff starts to
Speaker 2: break again.
Speaker 3: Actually, it is funny because right in theory, the market
Speaker 3: wants raid cuts, right like right, like we all sort
Speaker 3: of it's just duh. But it's like the stock market's
Speaker 3: done incredibly well during a period of rising and elevated rates,
Speaker 3: that's right. So like you do wonder ultimately whether like okay,
Speaker 3: something big could shift soon in terms of the direction
Speaker 3: of the Fed. Now, of course the FED would say,
Speaker 3: you know, it's changing directions because the underlying macro has changed.
Speaker 3: But it is interesting, right, We've had the straight line
Speaker 3: up and now we seem to be perhaps it's some
Speaker 3: sort of macro turning point, and so you got to wonder,
Speaker 3: then is the line going to also turn in some way?
Speaker 2: Yeah? All right, shall we leave it there.
Speaker 3: Let's leave it there.
Speaker 2: This has been another episode the au Thoughts podcast. I'm
Speaker 2: Tracy Alloway. You can follow me at Tracy Alloway and.
Speaker 3: I'm Joe Wisenthal. You can follow me at the Stalwart.
Speaker 3: Follow our producers Carmen Rodriguez at Carman Ermann, desh O
Speaker 3: Bennett at Dashbot and kill Brooks at Kilbrooks. Thank you
Speaker 3: to our producer Moses On. For more odd Laws content,
Speaker 3: go to Bloomberg dot com, slash odd lots. We're have transcripts,
Speaker 3: a blog, and a newsletter and you can chat about
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