WEBVTT - Why Historic Relationships in Markets Have Been Totally Upended 0:00:08.080 --> 0:00:11.760 Hello, and welcome to another edition of the Odd Thoughts podcast. 0:00:11.920 --> 0:00:16.400 I'm Tracy Allaway. My co host Joe Wisenthal is not 0:00:16.680 --> 0:00:20.320 with me today. Mr Wisenthal has gone off to Washington 0:00:20.600 --> 0:00:25.279 to do some very important Bloomberg related things, which means 0:00:25.360 --> 0:00:28.000 he's going to miss out on an episode that I 0:00:28.040 --> 0:00:32.440 am personally very excited about. Today. We are going to 0:00:32.800 --> 0:00:37.440 talk to one of my all time favorite analysts. And 0:00:37.479 --> 0:00:40.159 the reason he became one of my all time favorite 0:00:40.159 --> 0:00:45.120 analysts is because he wrote some very very interesting research 0:00:45.360 --> 0:00:47.800 in the run up to the financial crisis. You know, 0:00:48.200 --> 0:00:50.120 I think it was a few days or a week 0:00:50.200 --> 0:00:53.600 or two before Lehman Brothers collapsed, he basically wrote a 0:00:53.720 --> 0:00:59.040 note called are the Broker's Broken? Pointing out some weaknesses 0:00:59.280 --> 0:01:02.920 in the fun ending of US financial institutions. And since 0:01:03.000 --> 0:01:08.440 then he's gone on to write more broadly about the markets. Specifically, 0:01:08.680 --> 0:01:12.679 he's written about how markets have been functioning in the 0:01:12.800 --> 0:01:16.520 era of central bank liquidity. And as you all know, 0:01:17.440 --> 0:01:20.120 this is a hot topic because the Federal Reserve is 0:01:20.160 --> 0:01:24.000 in the process of tightening monetary policy reducing its balance sheet, 0:01:24.160 --> 0:01:28.080 which puts a giant question mark over the fate of markets. 0:01:28.160 --> 0:01:30.840 Are they going to be able to stand on their 0:01:30.880 --> 0:01:33.600 own two feet without the support of the FED and 0:01:33.720 --> 0:01:37.200 potentially some other central banks. So I won't keep you 0:01:37.240 --> 0:01:40.560 in suspense for any longer. Let's bring in Matt King. 0:01:40.760 --> 0:01:54.120 He is the global head of credit strategy at City Group. Matt, 0:01:54.240 --> 0:01:58.520 thanks for joining us, my pleasure. What a flattering introduction. Yes, 0:01:58.640 --> 0:02:01.120 I tried. I'm trying to make up for the fact 0:02:01.120 --> 0:02:04.840 that Joe isn't here, So this is my compensation. Let's 0:02:04.880 --> 0:02:08.160 start at the very beginning of how we actually got 0:02:08.240 --> 0:02:11.000 to know each other and how you became one of 0:02:11.040 --> 0:02:15.639 my favorite analysts. Two thousand and eight. You're at City 0:02:16.040 --> 0:02:20.840 I think you are covering the banks. Then I assume, no, oh, 0:02:20.880 --> 0:02:24.680 you weren't. So I was doing credit strategy then, kind 0:02:24.720 --> 0:02:27.320 of similar to what I'm doing now. But I guess 0:02:27.360 --> 0:02:29.440 the approach that we have always taken is to try 0:02:29.440 --> 0:02:31.960 and focus on whatever it is that really seems to 0:02:31.960 --> 0:02:35.359 be driving the market. But what we don't do is say, well, 0:02:35.360 --> 0:02:37.959 here's what the economists say about the outlook, and therefore 0:02:37.960 --> 0:02:39.680 here's what it means for our market. We always try 0:02:39.720 --> 0:02:41.880 and say, what is it really it's really driving the world, 0:02:41.919 --> 0:02:43.880 And so in O seven, I sort of had to. 0:02:43.919 --> 0:02:46.280 You know, we used to look at credit fundamentals of companies, 0:02:46.320 --> 0:02:47.959 but then in O seven we had to drop everything 0:02:47.960 --> 0:02:51.079 and suddenly start looking at sieves and conduits and structure credit. 0:02:51.160 --> 0:02:53.200 And then in two thousand and eight it seemed to 0:02:53.240 --> 0:02:56.520 me that repo financing and broker dealers were a critical issue, 0:02:56.560 --> 0:02:58.359 and so I spent a long time looking at them. 0:02:58.680 --> 0:03:00.840 And then in more recent years it's been things like 0:03:00.919 --> 0:03:03.600 the you know, with the European sovereigns, or it's been 0:03:03.639 --> 0:03:08.120 about China and credit creation more broadly. And then the 0:03:08.200 --> 0:03:11.440 dominant theme more than anything else for us at the moment, 0:03:11.480 --> 0:03:14.480 it's just about central banks and central bank liquidity. So 0:03:14.560 --> 0:03:16.560 I love that in two thousand and eight you managed 0:03:16.600 --> 0:03:21.000 to sort of out analyze the actual banking analysts then, 0:03:21.200 --> 0:03:23.200 and that was one of the things I liked about 0:03:23.280 --> 0:03:26.400 the crisis as a financial journalist is the fact that 0:03:26.440 --> 0:03:29.560 everyone was kind of learning at the same time. You know, 0:03:29.600 --> 0:03:32.240 no one had a really good grasp of the intricacies. 0:03:32.680 --> 0:03:36.120 Just before we move on to more contemporary topics, I 0:03:36.120 --> 0:03:38.520 want to press you on that note. So you're at 0:03:38.640 --> 0:03:42.360 City in September two eight, What were you feeling when 0:03:42.360 --> 0:03:46.320 you push the button on a research piece that basically said, hey, 0:03:46.360 --> 0:03:50.600 there's a massive funding issue at the U S. Pinks 0:03:50.640 --> 0:03:54.920 and specifically Leaman. I could feel at the time it 0:03:55.040 --> 0:03:57.720 was probably the most significant piece that I had written, 0:03:58.400 --> 0:04:03.360 And while couldn't say we predict that Lehman will go under, 0:04:04.000 --> 0:04:06.120 there was a chart in there that made it pretty obvious, 0:04:06.200 --> 0:04:08.240 and indeed we basically predicted that all of the brokers 0:04:08.240 --> 0:04:10.560 would have to change their models, and you know, and 0:04:10.600 --> 0:04:13.120 then Lehman happened two weeks later. I guess what was 0:04:13.200 --> 0:04:15.680 slightly surprising, and it to take me a long time 0:04:15.720 --> 0:04:18.840 to do, was that there was no particular immediate market reaction, 0:04:18.880 --> 0:04:23.120 in part because Freddie had just been rescued literally that weekend. 0:04:23.600 --> 0:04:26.000 And so while I did get quite a lot of attention, 0:04:26.800 --> 0:04:31.159 most of the attention actually came after Lehman, when people 0:04:31.200 --> 0:04:33.360 like you kind of went back and said, hey, actually 0:04:33.360 --> 0:04:35.400 this was really significant. Look, this guy spotted it at 0:04:35.440 --> 0:04:38.039 the time, so I knew it was important, and I 0:04:38.120 --> 0:04:41.240 made a big song and dance about it internally. But 0:04:41.480 --> 0:04:45.279 even then, you know, we couldn't see all of the repercussions. 0:04:45.279 --> 0:04:48.600 More broadly, Okay, if anyone wants to know more about 0:04:48.640 --> 0:04:52.279 what we're talking about just Google, are the Broker's broken? 0:04:52.560 --> 0:04:55.360 The pdf is still floating around on the Internet. It's 0:04:55.400 --> 0:04:58.799 a really good read, even more than ten years after 0:04:59.040 --> 0:05:03.680 the fact. Now, Matt, you mentioned muted market reaction when 0:05:03.760 --> 0:05:07.200 Lehman Brothers actually went under, and muted has kind of 0:05:07.240 --> 0:05:12.240 come to characterize the markets ever since, let's say, early 0:05:12.279 --> 0:05:15.159 two thousand nine, when the Fed first announced its big 0:05:15.600 --> 0:05:20.280 round of q E. Walk us through what changed in 0:05:20.400 --> 0:05:25.320 two thousand nine, So clearly and correctly at the time, 0:05:25.400 --> 0:05:28.920 the Central Bank stepped in with extraordinary facilities and liquidity, 0:05:29.279 --> 0:05:32.120 and to begin with this was undoubtedly a good thing. 0:05:32.400 --> 0:05:34.240 We needed to be rescued from a sort of self 0:05:34.240 --> 0:05:38.000 fulfilling loot to the to the downside. But gradually, and 0:05:38.040 --> 0:05:41.640 I would say from two thousand and eleven or so onwards, 0:05:41.720 --> 0:05:45.680 what we started finding was we went from rescuing the 0:05:45.720 --> 0:05:50.080 system and helping fundamentals to improve to a point where 0:05:50.120 --> 0:05:54.839 almost all of my favorite fundamental valuation frameworks in credit 0:05:54.960 --> 0:05:58.960 or inequities, or just more broadly basically started breaking down. 0:05:59.080 --> 0:06:03.520 Markets became expensive and carried on getting more expensive when 0:06:03.520 --> 0:06:06.720 previously they would have been reverted, and this prompted lots 0:06:06.720 --> 0:06:08.800 of soul searching on our side as to say, well, 0:06:08.839 --> 0:06:12.640 what's changed, what's driving things? Instead? Uh, and again I 0:06:12.680 --> 0:06:14.680 can take you through these the same At the same time, 0:06:14.760 --> 0:06:18.680 volatility again decoupled from metrics like some of the policy 0:06:18.720 --> 0:06:22.240 uncertainty in disease that are out there um and carried 0:06:22.240 --> 0:06:24.040 on getting lower instead. And so we we had to 0:06:24.080 --> 0:06:26.520 embark on this long hunt for what was driving everything, 0:06:26.839 --> 0:06:29.080 and all lines of inquiry led back to just one place, 0:06:29.080 --> 0:06:31.880 and that's the central banks. Wait, so walk us through 0:06:31.920 --> 0:06:35.560 the specific sort of I guess indicators that you're talking 0:06:35.600 --> 0:06:37.880 about here, What is it exactly that you're looking at 0:06:38.000 --> 0:06:41.640 in terms of something that would give you knowledge of 0:06:41.720 --> 0:06:47.520 valuations or potentially portender correction. So it's basically this is 0:06:47.520 --> 0:06:49.000 really hard to do on a radio show. You know, 0:06:49.800 --> 0:06:54.400 the relationships that we had tracked four years or decades 0:06:54.440 --> 0:06:57.560 which broke down. So, for example, I mentioned the VIX 0:06:57.600 --> 0:07:01.040 against policy uncertainty correlates beautifully until two thousand and two 0:07:01.040 --> 0:07:02.760 thousand and twelve, and then the VIX goes lower and 0:07:02.839 --> 0:07:06.320 uncertainty goes up. Credit spreads against corporate leverage. It used 0:07:06.360 --> 0:07:08.159 to be that when companies have lots of debt, spreads 0:07:08.160 --> 0:07:10.200 were wide and companies had not much debt spreads were 0:07:10.200 --> 0:07:13.480 tight Again works quite nicely over cycles, and then round 0:07:13.480 --> 0:07:16.760 about two thousand and eleven two thousand and twelve, corporates 0:07:16.760 --> 0:07:20.560 globally but especially US corporate started leveraging up, but credit spreads, 0:07:20.680 --> 0:07:24.400 rather than widening out with them, just decoupled and tightened 0:07:24.400 --> 0:07:28.200 in or, to take another one, credit spreads against inflation expectations. 0:07:28.200 --> 0:07:31.560 It used to be when there's a slightly higher inflation expectations, 0:07:31.560 --> 0:07:34.440 it was taken as a sign of kind of cyclical growth. Uh. 0:07:34.480 --> 0:07:37.520 And again that relationship has has sort of continued to track, 0:07:37.560 --> 0:07:39.520 but there's a break in the series in two thousand 0:07:39.560 --> 0:07:42.800 and eleven, two thousand and twelve. Or in equities, my 0:07:42.840 --> 0:07:46.480 favorite relationship was always earnings revisions, so the change in 0:07:46.520 --> 0:07:50.040 consensus earnings expectations, and again in every market we look 0:07:50.040 --> 0:07:53.360 at across multiple cycles, consensus goes up, the market ally's 0:07:53.400 --> 0:07:56.640 consensus goes down, market sells off, and around about two 0:07:56.680 --> 0:08:00.280 thousand eleven two tho twelve, earnings expectations were revised duly 0:08:00.320 --> 0:08:03.080 lower by analysts across the street for basically the next 0:08:03.120 --> 0:08:06.360 five years, and instead of selling off, markets rallied, so 0:08:06.520 --> 0:08:08.760 all of these breakdowns and all of them more or 0:08:08.840 --> 0:08:12.400 less at the same time. So isn't the counter argument 0:08:12.640 --> 0:08:16.800 to that just low interest rates? So, for instance, when 0:08:16.800 --> 0:08:21.160 you have increasing corporate leverage but credit spreads that are 0:08:21.160 --> 0:08:25.120 still tightening. The thing I always hear from analysts, from 0:08:25.160 --> 0:08:27.960 bullish analysts as well, you know, they can be more 0:08:28.000 --> 0:08:31.480 indebted because ultimately the debt burden will be less in 0:08:31.520 --> 0:08:36.040 an era of low rates. So that's a good argument, 0:08:36.080 --> 0:08:38.080 but I think it only gets us so far. So 0:08:38.120 --> 0:08:42.200 specifically on corporates, Yes, there is an argument that maybe 0:08:42.200 --> 0:08:44.920 we should be looking at interest coverage rather than net 0:08:44.920 --> 0:08:47.800 debt to EBITDA. Let's say, even though it was actually 0:08:47.880 --> 0:08:51.520 net debt to EBITDA that always correlated well historically, and yes, 0:08:51.600 --> 0:08:55.839 interest coverage, So firstly, yeah, the better historical correlation is 0:08:55.880 --> 0:08:59.000 with leverage. But secondly, interest coverage, although it did improve 0:08:59.040 --> 0:09:02.240 steadily for several years as interest rates were falling, actually 0:09:02.320 --> 0:09:07.160 that started deteriorating round about two thousand and fifteen. And 0:09:07.200 --> 0:09:11.400 again credit spreads did do some widening then, but it's 0:09:11.440 --> 0:09:15.080 not like that's an obviously better series that that that 0:09:15.200 --> 0:09:20.160 helps explain everything. Or again, if we take volatility for example, 0:09:20.679 --> 0:09:23.880 again it's not obvious why volatility in markets should be 0:09:23.920 --> 0:09:28.240 lower just because interest rates are lower, or again, for me, 0:09:28.640 --> 0:09:31.080 it almost fits with the anecdotal evidence as I go 0:09:31.240 --> 0:09:34.000 round and I visit investors. I mean, the way I 0:09:34.000 --> 0:09:36.800 put it is, frankly, it's been years since I went 0:09:36.880 --> 0:09:39.600 to see any investor in any asset class who was 0:09:39.640 --> 0:09:42.560 buying things because the analyst was telling the portfolio manager, Hey, 0:09:42.559 --> 0:09:44.200 I've got this really cheap asset, we should go and 0:09:44.320 --> 0:09:47.079 buy it. It's always the PM telling the analyst where 0:09:47.080 --> 0:09:49.680 we've got to put the money somewhere, And so for 0:09:49.800 --> 0:09:52.160 me or again, all of those things fit fit together. 0:09:52.480 --> 0:09:54.840 In addition, if interest rates have so much to do 0:09:54.880 --> 0:09:56.840 with it, you know, maybe you can make this argument, 0:09:56.880 --> 0:10:00.240 but you know, why aren't pees on Japanese equity so 0:10:00.320 --> 0:10:02.360 much higher than everywhere else in the world, If if 0:10:02.360 --> 0:10:04.800 it's low interest rates that allows us to do a rerating, 0:10:05.360 --> 0:10:08.000 or if Japan is a special case, and you could 0:10:08.000 --> 0:10:10.920 make that argument, why areps in Switzerland much higher than 0:10:11.120 --> 0:10:14.080 everywhere else and so, or why in periods when the 0:10:14.200 --> 0:10:15.920 looks as though we might have broken out from this 0:10:16.000 --> 0:10:18.679 low rate regime and yields have been backing up, has 0:10:18.679 --> 0:10:21.360 that not been associated with a D rating, and so 0:10:21.679 --> 0:10:24.760 again I think that is part of the explanation, but 0:10:25.000 --> 0:10:27.320 relative to some of the other things we look at, 0:10:27.800 --> 0:10:31.959 I find it an unsatisfying explanation. So is the simple 0:10:32.600 --> 0:10:40.160 corollary of this just that valuations don't matter anymore? Well, certainly, 0:10:40.200 --> 0:10:42.600 if you're a professional investor and you're a slave to 0:10:42.640 --> 0:10:45.720 near term performance and you're worried that if you underperform 0:10:45.800 --> 0:10:47.720 then the money will be taken away and given to 0:10:47.720 --> 0:10:49.560 to an e t F, then that seems to be 0:10:49.559 --> 0:10:52.160 the conclusion that people are drawing. And you can see 0:10:52.320 --> 0:10:56.080 David Einhorn and an others you're making references to this, 0:10:57.000 --> 0:10:58.760 and I guess this, for me is one of the 0:10:58.880 --> 0:11:03.000 disturbing thing um from a market's perspective. It's to see 0:11:03.040 --> 0:11:06.600 investors giving up, just capitulating and saying, I know it's expensive, 0:11:06.679 --> 0:11:09.120 but it's all because of the the inflows or or 0:11:09.160 --> 0:11:11.920 the foreign money coming in, or whatever the explanation is, 0:11:11.960 --> 0:11:14.400 and then just capitulating and feeling like they have to 0:11:14.440 --> 0:11:17.679 buy anyway. And I think what we know more broadly 0:11:17.840 --> 0:11:21.040 is that that valuations do matter. They're indeed the most 0:11:21.080 --> 0:11:24.120 important factor, but only over the long term, and it 0:11:24.200 --> 0:11:28.080 often takes some sort of catalyst or or change in 0:11:28.160 --> 0:11:32.880 the technical for investors to return to those valuations um 0:11:32.960 --> 0:11:37.160 and again for me, it's it's this valuation is not mattering. 0:11:37.160 --> 0:11:49.680 You always say that at your peril. So how do 0:11:49.720 --> 0:11:53.880 you think the real economy factors into market behavior right now? 0:11:53.960 --> 0:11:57.240 Because again it's getting late in the year, which means 0:11:57.280 --> 0:12:00.440 we have all the cell side analysts now releasing their 0:12:00.440 --> 0:12:03.960 two thousand eighteen outlooks, and one of the consensus themes 0:12:03.960 --> 0:12:07.520 that is emerging is that we're unlikely to get a 0:12:07.559 --> 0:12:11.199 big market correction unless we really see the economy take 0:12:11.200 --> 0:12:13.439 a hit and we see a recession, and most people 0:12:13.960 --> 0:12:18.280 think that's unlikely. So how are you viewing the actual 0:12:18.360 --> 0:12:22.280 economy at the moment. So it's hard to argue against 0:12:22.320 --> 0:12:23.920 all of the good data that's out there, the upward 0:12:23.920 --> 0:12:27.000 divisions to people's growth expectations. Similarly on the earnings front, 0:12:27.240 --> 0:12:30.120 and so I do sympathize when people say we don't 0:12:30.120 --> 0:12:33.559 see fundamentally whether shop comes from. The natural thing is 0:12:33.600 --> 0:12:36.440 to extrapolate the good performance that we've had this year. 0:12:37.400 --> 0:12:39.960 At the same time, I think you have to think 0:12:40.000 --> 0:12:43.199 back to that the indicators are always at their best, 0:12:43.400 --> 0:12:46.400 just before you hit a down town, whether it's two 0:12:46.440 --> 0:12:50.640 thousand and six sven or whether it and what's more, 0:12:50.640 --> 0:12:52.400 and so that doesn't mean that just because things are good, 0:12:52.400 --> 0:12:54.400 there's gonna be a sudden deterioration. But I think the 0:12:54.440 --> 0:12:56.880 specific way I put it is, are we sure that 0:12:56.920 --> 0:12:59.400 it's the economy which is driving the market rather than 0:12:59.400 --> 0:13:02.840 the market which risks driving the economy. I mean, one 0:13:02.880 --> 0:13:05.599 of the so that the obvious examples are think back to. 0:13:06.920 --> 0:13:09.320 It's not that the economy tanks and drags down the 0:13:09.320 --> 0:13:12.280 equity market. It's the market moving first, economy following later. 0:13:12.480 --> 0:13:14.120 Same thing in No. Seven oh eight. It's not the 0:13:14.160 --> 0:13:16.360 economy driving the real estate market. It's the real estate 0:13:16.400 --> 0:13:19.680 market driving the economy. And even with the more recent 0:13:19.840 --> 0:13:23.679 wobbles from European sovereign debt or emerging markets and oil 0:13:23.760 --> 0:13:28.120 in again, one of the striking things is that market 0:13:28.200 --> 0:13:31.800 movements which at least in theory should not have been destabilizing, 0:13:31.840 --> 0:13:34.960 did turn out to be destabilizing. Now that still doesn't 0:13:34.960 --> 0:13:38.160 necessarily pin down the exact timing of this, but I'm 0:13:38.280 --> 0:13:41.840 much given again these expensive valuations across the board and 0:13:41.840 --> 0:13:44.840 what we think are driving them, I'm much more cautious 0:13:44.840 --> 0:13:47.600 than most people are from simply extrapolating this economic strength 0:13:47.640 --> 0:13:50.079 and then and saying okay, and therefore we're bullish on 0:13:50.120 --> 0:13:52.680 markets even if they look a bit expensive. I feel 0:13:52.720 --> 0:13:56.600 like this is a really fundamental thing that we should 0:13:56.679 --> 0:13:59.800 know at this point, like our markets following the economy, 0:13:59.880 --> 0:14:03.360 or does the economy follow markets? Why? Why is there 0:14:03.400 --> 0:14:06.880 even a question mark over that? It's always hard to disentangle, 0:14:06.920 --> 0:14:09.760 and especially at the moment. I can see why people 0:14:09.800 --> 0:14:13.120 will make a case for the fundamentals driving markets because 0:14:13.160 --> 0:14:15.080 you can see all this good data across the board. 0:14:15.400 --> 0:14:18.120 It's almost it's more in twenty eleven to sixteen, when 0:14:18.160 --> 0:14:21.240 earnings growth was much weaker and when GDP growth was 0:14:21.320 --> 0:14:24.720 much weaker and markets were rallying anyway, that some of 0:14:24.760 --> 0:14:28.000 the other relationships that I look at do a better 0:14:28.080 --> 0:14:31.840 job effectively or are more obviously the only driver. So 0:14:32.120 --> 0:14:37.000 for me, the main reasons why again I'm so convinced 0:14:37.000 --> 0:14:41.080 about central bank related distortions driving things is because it's 0:14:41.080 --> 0:14:43.720 not that there's no improvement in the fundamentals, but when 0:14:43.760 --> 0:14:46.400 we look at when we look at the patterns of 0:14:46.400 --> 0:14:49.000 market movements, it's a bit less that we're following the 0:14:49.040 --> 0:14:51.920 areas where earnings expectations are being revised upwards, and it's 0:14:51.960 --> 0:14:54.760 a bit more like an indiscriminate rally and everything. And 0:14:54.800 --> 0:14:58.440 what's more, when we do actually almost embarrassingly simple things 0:14:58.520 --> 0:15:01.000 like just plotting what the global central banks are buying 0:15:01.040 --> 0:15:03.720 each month and plotting that against the change in equity 0:15:03.720 --> 0:15:06.080 prices or the change in credit spreads, we come out 0:15:06.120 --> 0:15:08.960 with these really really good relationships without looking at any 0:15:08.960 --> 0:15:12.360 fundamentals whatsoever. And so especially in the year like this, 0:15:12.480 --> 0:15:14.640 it's hard to tell, but at a minimum, I think 0:15:15.080 --> 0:15:17.560 this year, both the fundamentals and the central bank purchases 0:15:17.600 --> 0:15:20.720 have been a big driver of markets. And next year 0:15:21.240 --> 0:15:24.320 the central banks are significantly pulling back and the fundamentals 0:15:24.440 --> 0:15:27.280 really have to stand on their own. Yeah, so I 0:15:27.320 --> 0:15:31.200 wanted to press you on this point. Um. A lot 0:15:31.200 --> 0:15:34.160 of people are talking about Janet Yellen's legacy now that 0:15:34.320 --> 0:15:36.640 she's set to depart from the FED, and one thing 0:15:36.680 --> 0:15:39.320 that keeps coming up as well, Actually, she's done a 0:15:39.320 --> 0:15:43.120 pretty good job of beginning the navigation of the exit. 0:15:43.240 --> 0:15:46.400 She's raised interest rates, and the Fed has embarked on 0:15:46.640 --> 0:15:50.480 its tightening of its balance sheet or the reduction of 0:15:50.520 --> 0:15:55.000 the balance sheet. Are you implying that this is nothing 0:15:55.080 --> 0:15:57.680 and that the real test is going to be um 0:15:57.800 --> 0:16:00.560 later on, maybe when we start to see places like 0:16:00.600 --> 0:16:02.640 the e c B or the b o J actually 0:16:03.360 --> 0:16:08.280 withdrawal liquidity. So firstly, full credit to her. It's not nothing. 0:16:08.400 --> 0:16:11.840 She's already got significantly further than I previously thought would 0:16:11.840 --> 0:16:17.000 be possible. But I think there is it's it's absolutely 0:16:17.000 --> 0:16:20.000 it's maybe unsurprising that there still disagreement about how QUI 0:16:20.080 --> 0:16:24.520 affects the economy. What's amazing to me is that after 0:16:25.720 --> 0:16:30.840 eight years into the crisis, there's still so much disagreement 0:16:30.880 --> 0:16:34.560 about how quee affects markets. And for me, a lot 0:16:34.560 --> 0:16:35.920 of the reason the FED has been able to get 0:16:35.960 --> 0:16:38.600 this far is because of the e c B and 0:16:38.640 --> 0:16:42.320 the b o J having ramped up their purchases and 0:16:42.320 --> 0:16:44.760 and so this is one of the sources of disagreement. 0:16:44.880 --> 0:16:47.320 It's is are the effects local as the central banks 0:16:47.360 --> 0:16:49.280 like to think, if only because it's convenient for them, 0:16:49.600 --> 0:16:52.400 or are they global? Which is what all the correlations 0:16:52.400 --> 0:16:54.960 in markets that we find point to. We get much 0:16:55.040 --> 0:16:57.400 better explanations for US credit spreads or U S equities 0:16:57.400 --> 0:16:59.440 if we look at global que and same thing when 0:16:59.480 --> 0:17:02.400 we're looking at European credit spreads in European equities. It's 0:17:02.440 --> 0:17:05.439 that global pattern that fits, and that in a in 0:17:05.440 --> 0:17:08.280 a funny sense, is actually the smallest of disagreements. The 0:17:08.400 --> 0:17:11.520 bigger disagreement is between whether there are a couple more. 0:17:11.520 --> 0:17:13.600 But but is it flow or is it stock? The 0:17:13.760 --> 0:17:18.119 central bank the central banks think that markets should not 0:17:18.160 --> 0:17:22.040 be destabilized because their policies are still super accommodative, and 0:17:22.080 --> 0:17:24.919 because in the Fed's case, it would argue the market 0:17:24.960 --> 0:17:28.960 has discounted things ahead of time because markets are reasonably efficient, 0:17:28.960 --> 0:17:30.959 and therefore they've told us about the balance sheet reduction, 0:17:31.000 --> 0:17:33.520 and that's why it can run in the background as 0:17:33.600 --> 0:17:36.479 just a little technical detail that nobody needs to to 0:17:36.480 --> 0:17:40.320 worry about. Again, though, as we look at what has 0:17:40.400 --> 0:17:43.920 correlated in the past, what we find is that actually 0:17:43.920 --> 0:17:46.399 it's very clearly the flow that matters are not the stock, 0:17:46.920 --> 0:17:49.640 and that even if the e c B is reducing 0:17:49.680 --> 0:17:53.040 its purchases, into its mind, is still easing. Nevertheless, that 0:17:53.080 --> 0:17:55.440 reduction in the flow, at least at a global level, 0:17:55.520 --> 0:17:59.160 has historically been associated with periods of weakness in risk assets, 0:17:59.400 --> 0:18:01.560 and so again for us, what significant is Bank of 0:18:01.640 --> 0:18:04.639 Japan purchases have already harved with the shift away from 0:18:04.760 --> 0:18:07.680 QUEI or pure que to yield targeting, and so you've 0:18:07.680 --> 0:18:09.399 got the B O J kind of having moved, and 0:18:09.440 --> 0:18:11.119 then you've got the E C B moving and the 0:18:11.160 --> 0:18:14.760 FED moving all at the same time. And it's that combination, 0:18:15.119 --> 0:18:19.760 which again we think is potentially destabilizing or at a 0:18:19.800 --> 0:18:22.280 minimum makes it much harder than the FED would have 0:18:22.280 --> 0:18:25.880 thought from just looking at history in the U S alone. Okay, 0:18:25.920 --> 0:18:29.200 but here's my other question. If it is so easy 0:18:29.280 --> 0:18:31.639 to show that it's all about the flow of that 0:18:31.760 --> 0:18:37.240 liquidity rather than the absolute level, then why don't central 0:18:37.240 --> 0:18:41.120 bankers realize that? Why are you the only one sort 0:18:41.160 --> 0:18:43.400 of pounding the table on this, Because while you are 0:18:43.440 --> 0:18:48.040 one of my favorite analysts, I'm sure people like Janet 0:18:48.080 --> 0:18:51.240 Yellen or Mario Droggy have a whole team of smart 0:18:51.320 --> 0:18:54.440 people who are examining exactly this kind of thing. Why 0:18:54.440 --> 0:18:56.880 aren't they coming up with the same conclusions that you are. 0:18:58.200 --> 0:19:00.800 So I don't think I'm the only Lots of people 0:19:00.800 --> 0:19:02.399 in the market will tell you it's the flow, and 0:19:02.440 --> 0:19:04.040 it's kind of obvious to them that it's the flow, 0:19:04.040 --> 0:19:08.080 and it's obvious that it's dominating. But it's almost embarrassing 0:19:08.080 --> 0:19:09.359 to say, because we do say the same thing to 0:19:09.400 --> 0:19:11.600 the central banks, but to quote one of them that 0:19:11.640 --> 0:19:17.159 I met recently, the somehow they look at the correlations, 0:19:17.240 --> 0:19:19.600 but then they're dismissive of them. And the reason they're 0:19:19.600 --> 0:19:22.959 dismissive is because it doesn't fit with theory. It's not 0:19:23.000 --> 0:19:25.600 it doesn't fit their model of how the world is 0:19:25.600 --> 0:19:28.320 supposed to work. And one of my colleagues cheekily said, 0:19:28.359 --> 0:19:30.119 these are doubtless the same models that have have been protecting 0:19:30.160 --> 0:19:32.080 inflation would pick up for several years now, and we're 0:19:32.119 --> 0:19:36.720 predicting that wage goes would be much higher. That's really harsh, 0:19:37.160 --> 0:19:41.000 but I think there is this. It's it's I've always 0:19:41.119 --> 0:19:44.280 I'm a strategist, not an economist, and so I don't 0:19:44.400 --> 0:19:46.880 start from the theory. I just start from what correlates 0:19:46.880 --> 0:19:49.600 in the market, and then I see if there's a 0:19:49.600 --> 0:19:53.880 plausible explanation. And when we get a these staggeringly good 0:19:53.880 --> 0:19:57.600 correlations with the flow and be there's an associated plausible explanation, 0:19:57.680 --> 0:19:59.960 which is look at the net supply number. Central bank 0:20:00.080 --> 0:20:02.639 have basically bought all of the available net supply of 0:20:02.680 --> 0:20:07.920 securities across global markets. In seventeen, which is a big 0:20:07.960 --> 0:20:10.280 difference from say, two thousand and six, two thousand and seven, 0:20:10.480 --> 0:20:12.879 and that creates an imbalance where people are still saving, 0:20:12.920 --> 0:20:14.840 there's still demand, but there's no supply, and so what 0:20:14.880 --> 0:20:17.159 do you get, But you get markets where prices go up. 0:20:17.200 --> 0:20:19.359 And that's exactly what we've had in every asset class 0:20:19.359 --> 0:20:21.480 on any given week. Unless there's something to panic about, 0:20:21.680 --> 0:20:24.000 the price has been going up. Next year that doesn't 0:20:24.000 --> 0:20:29.159 fall apart entirely the the as the ECB and the 0:20:29.480 --> 0:20:31.440 and the and the FED pool back, there's about a 0:20:31.480 --> 0:20:34.240 trillion dollars more of global net supply, and we think 0:20:34.280 --> 0:20:37.000 that will make for more balanced markets. So in one sense, 0:20:37.200 --> 0:20:39.520 they should be looking more closely, and it's it's their 0:20:39.520 --> 0:20:42.040 own effect, it's the portfolio balance effect, and it's just 0:20:42.080 --> 0:20:46.600 worked way more strongly than than they imagined. But in 0:20:46.640 --> 0:20:49.639 another sense, yes, I think they're almost completely blind to 0:20:49.720 --> 0:20:53.399 it because it's just convenient for them to continue to 0:20:53.400 --> 0:20:55.439 toe out the same theory and and it's just in 0:20:55.480 --> 0:20:57.199 the same way as they think that the super low 0:20:57.280 --> 0:20:59.800 level of rates should have been really really similated for 0:20:59.840 --> 0:21:02.600 a time now, and then every so often they're confronted 0:21:02.600 --> 0:21:05.919 by how markets actually behave, and and they're disappointed that 0:21:06.280 --> 0:21:10.600 relatively minor changes on their part produce outsize movements in markets. 0:21:10.640 --> 0:21:13.840 And I think there's at a minimum significant risk that 0:21:13.840 --> 0:21:16.840 that is what we get again, and the outlook is 0:21:16.840 --> 0:21:20.080 not nearly so straightforward as as they would like to think. Okay, 0:21:20.119 --> 0:21:22.600 on the outlook point, we did see a sell off 0:21:22.640 --> 0:21:26.640 in markets this month in November. It got a lot 0:21:26.680 --> 0:21:28.520 of attention, but in the end, I think it only 0:21:28.640 --> 0:21:31.960 ended up being like one five percent or something like that, 0:21:32.040 --> 0:21:35.320 which historically, you know, before the crisis, would have been 0:21:35.320 --> 0:21:38.440 relatively muted. Are we just going to have to get 0:21:38.560 --> 0:21:42.959 used to the return of volatility and the idea that 0:21:43.040 --> 0:21:45.720 asset prices can go down as well as up. Is 0:21:45.760 --> 0:21:49.760 that in our near future? I certainly hope so, because 0:21:49.800 --> 0:21:52.200 I think a more balanced market is a much more 0:21:53.200 --> 0:21:56.479 resilient market. And I do worry that what's happened at 0:21:56.480 --> 0:22:00.679 the moment is that we the central banks have effectively 0:22:00.680 --> 0:22:03.960 created one way markets that grind higher with very low 0:22:04.040 --> 0:22:06.840 volatility and then are at risk of of large amounts 0:22:06.840 --> 0:22:08.399