Kathryn Rooney Vera, Chief Strategist, StoneX Group Inc.

[00:00:01] [SPEAKER_01]: Hello, this is Dean Curnutt and welcome to the Alpha Exchange where we explore topics

[00:00:06] [SPEAKER_01]: in financial markets associated with managing risk, generating return, and the deployment

[00:00:12] [SPEAKER_01]: of capital in the alternative investment industry.

[00:00:19] [SPEAKER_01]: Now that Chief Market Strategist at StoneX, Kathryn Rooney Vera comes from humble beginnings.

[00:00:25] [SPEAKER_01]: As a teenager she cleaned houses in order to contribute to her family's finances.

[00:00:29] [SPEAKER_01]: In college she changed her major to finance from liberal arts, seeing a more direct path

[00:00:35] [SPEAKER_01]: to a well compensated career.

[00:00:37] [SPEAKER_01]: She would ultimately settle into the study of economics, a craft she continues to refine

[00:00:41] [SPEAKER_01]: today in support of clients and colleagues at StoneX.

[00:00:45] [SPEAKER_01]: Our discussion surveys the process Kathryn uses to find value in markets.

[00:00:49] [SPEAKER_01]: She focuses on forecasting growth and inflation, the Fed's response to these variables and

[00:00:55] [SPEAKER_01]: the construction of trades that will capitalize on them.

[00:00:58] [SPEAKER_01]: We review some of the recent cross-acid volatility and the role that positioning played.

[00:01:02] [SPEAKER_01]: Kathryn rightly suggested that clients utilize protective option strategies in the period prior

[00:01:08] [SPEAKER_01]: to August 5th.

[00:01:09] [SPEAKER_01]: She's also seen value in curve steepeners, embedding a little bit of the SOM role motion

[00:01:14] [SPEAKER_01]: that the Fed may find itself behind the curve.

[00:01:17] [SPEAKER_01]: Lastly, she sees a favorable setup in the utilities sector, providing both the traditional

[00:01:22] [SPEAKER_01]: defensive property through its linkage to rates, as well as embedding an AI play that

[00:01:27] [SPEAKER_01]: can empower it should the boom continue.

[00:01:30] [SPEAKER_01]: I hope you enjoy this episode of the Alpha Exchange, my conversation with Kathryn Rooney-Vera.

[00:01:37] [SPEAKER_01]: My guest today on the Alpha Exchange is Kathryn Rooney-Vera.

[00:01:41] [SPEAKER_01]: She is the chief market strategist at StoneX.

[00:01:44] [SPEAKER_01]: Kathryn, it's great to have you on the podcast today.

[00:01:48] [SPEAKER_00]: Thank you so much, Dean.

[00:01:49] [SPEAKER_00]: It's a pleasure to join you today.

[00:01:50] [SPEAKER_01]: Well, you and I have only just recently met and you were kind enough to join my macro mines

[00:01:56] [SPEAKER_01]: conference.

[00:01:58] [SPEAKER_01]: We got a chance to chat a little bit there and I started following some of your work.

[00:02:01] [SPEAKER_01]: I thought, wow, this would be a great conversation to have, get some of your perspectives on

[00:02:08] [SPEAKER_01]: the recent vol in the markets.

[00:02:10] [SPEAKER_01]: You have a very cross-acid framework for looking at these things.

[00:02:15] [SPEAKER_01]: This has definitely been a very cross-acid risk event.

[00:02:18] [SPEAKER_01]: It would be an interesting backdrop against which we can have our conversation.

[00:02:23] [SPEAKER_01]: Let's first learn a little bit more about you, about your role at StoneX as chief market strategist.

[00:02:29] [SPEAKER_01]: Tell us about how you found your way into this wonderful world of high finance.

[00:02:34] [SPEAKER_00]: Awesome.

[00:02:35] [SPEAKER_00]: Happy to start there.

[00:02:36] [SPEAKER_00]: I started at StoneX here one year ago as the chief market strategist,

[00:02:41] [SPEAKER_00]: I reported to the holding company and support the various lines of business.

[00:02:45] [SPEAKER_00]: Principally, there are three.

[00:02:46] [SPEAKER_00]: There's commercial, which is generally commodities.

[00:02:48] [SPEAKER_00]: There's the retail area and then there's the securities division,

[00:02:51] [SPEAKER_00]: which is where I primarily focus my energies.

[00:02:55] [SPEAKER_00]: Here what I do is I publish a global macro cross asset strategy notes as an economist by background.

[00:03:02] [SPEAKER_00]: I like to consider myself more of a market economist, so I talk to institutional clients

[00:03:05] [SPEAKER_00]: primarily giving them my economic forecasts for the US and the globe with investment

[00:03:13] [SPEAKER_00]: and practical investment strategy recommendations they're in.

[00:03:16] [SPEAKER_00]: But just starting out, I come from New Jersey.

[00:03:19] [SPEAKER_00]: I consider myself a self-made woman.

[00:03:21] [SPEAKER_00]: I come from a middle class working class background in New Jersey.

[00:03:25] [SPEAKER_00]: I started college targeting a liberal arts degree or something fun like that,

[00:03:28] [SPEAKER_00]: political science or communications.

[00:03:31] [SPEAKER_00]: Thinking I'd be, I don't know, a syndicated columnist or maybe a senator.

[00:03:34] [SPEAKER_00]: And then 9-11 happened and my father was a pilot out of Newark airport.

[00:03:39] [SPEAKER_00]: And in those scary, very scary times,

[00:03:42] [SPEAKER_00]: those times were wrought with financial and emotional tumult and turmoil.

[00:03:47] [SPEAKER_00]: And I was the oldest of six kids.

[00:03:49] [SPEAKER_00]: I changed my major to finance to make money for the family.

[00:03:52] [SPEAKER_00]: Back in those times, I'd be investment banking.

[00:03:54] [SPEAKER_00]: All of that was where it was at.

[00:03:56] [SPEAKER_00]: So everybody wanted to make the big bucks on Wall Street.

[00:03:58] [SPEAKER_00]: And so that was very formative for me.

[00:04:00] [SPEAKER_00]: And in previous financial turmoil for the family,

[00:04:03] [SPEAKER_00]: I can proudly say that I helped my mother as the house cleaner.

[00:04:06] [SPEAKER_00]: I cleaned houses to help make ends meet for our family.

[00:04:09] [SPEAKER_00]: So talk about life lessons.

[00:04:10] [SPEAKER_00]: I think that was formative and that was impactful.

[00:04:13] [SPEAKER_00]: And I'm so thankful for all those experiences

[00:04:15] [SPEAKER_00]: because they made me strong, resilient, persevering,

[00:04:18] [SPEAKER_00]: and I like to call myself scrappy.

[00:04:20] [SPEAKER_00]: So that was kind of my upbringing.

[00:04:22] [SPEAKER_00]: But finance wasn't for me.

[00:04:23] [SPEAKER_00]: I found my true passion in economics.

[00:04:25] [SPEAKER_00]: And thinking strategically, I doubled major in Spanish,

[00:04:28] [SPEAKER_00]: lived in Spain and now I'm fluent in Spanish.

[00:04:31] [SPEAKER_00]: And today I give keynote addresses in Spanish

[00:04:33] [SPEAKER_00]: and regularly speak to Latin American clients

[00:04:35] [SPEAKER_00]: in their native tongue and appear on Spanish speaking television.

[00:04:38] [SPEAKER_00]: So that's a little bit of my background.

[00:04:40] [SPEAKER_00]: And then I started out at MetLife Investments right out of college.

[00:04:43] [SPEAKER_00]: I was an asset backed securities,

[00:04:45] [SPEAKER_00]: but I quickly found the right spot for me

[00:04:46] [SPEAKER_00]: in emerging markets research and spent 15 years in emerging markets.

[00:04:51] [SPEAKER_00]: I hunted down the best opportunities for me to enter sell side,

[00:04:55] [SPEAKER_00]: which is, I guess you could say where my assets are most complementary or my skill set.

[00:05:00] [SPEAKER_00]: I found myself identifying with Bear Stearns

[00:05:03] [SPEAKER_00]: just a couple of years before the collapse.

[00:05:05] [SPEAKER_00]: It's a hardworking blue collar culture of guys and gals

[00:05:08] [SPEAKER_00]: with their serious smarts and work ethic

[00:05:10] [SPEAKER_00]: could make good money and great careers for themselves and identified with that.

[00:05:14] [SPEAKER_00]: So Bear Stearns was awesome, but it was formative for sure.

[00:05:17] [SPEAKER_00]: I lived to see the $2 bill slapped on the door

[00:05:19] [SPEAKER_00]: after Bear went under the only place that was hiring.

[00:05:22] [SPEAKER_00]: I felt like I went to the dark side.

[00:05:24] [SPEAKER_00]: I went to the Fed as a bank oversight analyst

[00:05:26] [SPEAKER_00]: and jumped from there.

[00:05:28] [SPEAKER_00]: I didn't last long there.

[00:05:29] [SPEAKER_00]: I really wasn't for me jumped from there

[00:05:31] [SPEAKER_00]: to recreate the Bear Stearns Fixing Come Research Platform

[00:05:35] [SPEAKER_00]: at a boutique investment bank based here in Miami.

[00:05:37] [SPEAKER_00]: And I've been here for 15 years.

[00:05:39] [SPEAKER_00]: That's a bit of my background.

[00:05:41] [SPEAKER_01]: Fantastic. So many interesting things there.

[00:05:43] [SPEAKER_01]: And I'm particularly drawn to your humble beginnings.

[00:05:48] [SPEAKER_01]: And it's just great to hear a story like this

[00:05:50] [SPEAKER_01]: where you've become something just so much different than you started.

[00:05:54] [SPEAKER_01]: And I think it's a real testament to grit, as they say.

[00:05:57] [SPEAKER_01]: And I think the speaking Spanish,

[00:05:59] [SPEAKER_01]: especially delivering keynote speeches in Spanish,

[00:06:03] [SPEAKER_01]: boy, that's really interesting.

[00:06:04] [SPEAKER_01]: And you access, I mean, just commercially,

[00:06:06] [SPEAKER_01]: you're accessing an entirely new investor base,

[00:06:09] [SPEAKER_01]: really by virtue of your capacity to speak a different language.

[00:06:14] [SPEAKER_01]: So very, very cool.

[00:06:15] [SPEAKER_01]: You mentioned economics.

[00:06:17] [SPEAKER_01]: You mentioned finance and this idea of being a Wall Street economist.

[00:06:22] [SPEAKER_01]: It's very different than being an academically trained economist

[00:06:25] [SPEAKER_01]: or someone who lives and breathes in models and so forth.

[00:06:29] [SPEAKER_01]: Tell us just a little bit about, from your perspective,

[00:06:31] [SPEAKER_01]: the role of covering clients, institutional clients,

[00:06:36] [SPEAKER_01]: being a source of answers and insights, I'm sure,

[00:06:40] [SPEAKER_01]: for colleagues who are using your work in accessing clients.

[00:06:46] [SPEAKER_01]: Just talk to us a little bit about the day-to-day

[00:06:48] [SPEAKER_01]: in terms of your role at Stonex.

[00:06:51] [SPEAKER_00]: Well, a global macro is generally rates and effects.

[00:06:54] [SPEAKER_00]: But in my purview, it's much more than that.

[00:06:57] [SPEAKER_00]: So I rely heavily on models.

[00:06:59] [SPEAKER_00]: So I built them over my career and in my team as well.

[00:07:02] [SPEAKER_00]: We take big data and we synthesize.

[00:07:05] [SPEAKER_00]: And I think the most critical part

[00:07:06] [SPEAKER_00]: in how someone in my role can be successful, Dean,

[00:07:09] [SPEAKER_00]: is by taking a lot of complex ideas and numbers

[00:07:15] [SPEAKER_00]: and synthesizing them and coming up with a concise output

[00:07:20] [SPEAKER_00]: that you can communicate effectively to the client.

[00:07:23] [SPEAKER_00]: So taking a lot of data across global economies

[00:07:26] [SPEAKER_00]: and across asset classes and saying,

[00:07:28] [SPEAKER_00]: this is where I think you can make money.

[00:07:30] [SPEAKER_00]: And this is why.

[00:07:32] [SPEAKER_00]: So there's a lot, a lot in the background

[00:07:34] [SPEAKER_00]: in terms of the grunt work that you don't see behind the scenes,

[00:07:38] [SPEAKER_00]: especially for people like me who are much more front office

[00:07:42] [SPEAKER_00]: client-facing and media-friendly.

[00:07:44] [SPEAKER_00]: I can commiserate with other chief market strategists,

[00:07:47] [SPEAKER_00]: chief investment strategists who go on TV

[00:07:49] [SPEAKER_00]: and do a lot of high profile speaking engagements

[00:07:52] [SPEAKER_00]: because I get you, it's really not that easy

[00:07:54] [SPEAKER_00]: to take these complex ideas and make them into bite-sized talking points.

[00:08:00] [SPEAKER_00]: And I think that's one of the most important roles

[00:08:03] [SPEAKER_00]: is communicating, communicating these ideas

[00:08:06] [SPEAKER_00]: in a very understandable way.

[00:08:09] [SPEAKER_00]: And so in my role at Stone Axe,

[00:08:10] [SPEAKER_00]: who do I talk to?

[00:08:11] [SPEAKER_00]: Mainly you nailed it on the head.

[00:08:13] [SPEAKER_00]: I have two worlds.

[00:08:14] [SPEAKER_00]: I have the Latin American world

[00:08:15] [SPEAKER_00]: and I have the English speaking world.

[00:08:18] [SPEAKER_00]: Both of those are fun and it keeps them interesting,

[00:08:20] [SPEAKER_00]: to be honest with you.

[00:08:20] [SPEAKER_00]: So I travel quite a bit to Latin America

[00:08:22] [SPEAKER_00]: and I meet with all of the pension funds

[00:08:23] [SPEAKER_00]: and life insurance companies, as well as hedge funds

[00:08:26] [SPEAKER_00]: that are big players in that world,

[00:08:29] [SPEAKER_00]: that's central in South America.

[00:08:31] [SPEAKER_00]: And then add to that in Stone Axe,

[00:08:33] [SPEAKER_00]: we have a very large U.S. presence,

[00:08:35] [SPEAKER_00]: very large European presence.

[00:08:37] [SPEAKER_00]: And so the travel to Latin America

[00:08:39] [SPEAKER_00]: has widened out to travel to Tokyo and Singapore

[00:08:42] [SPEAKER_00]: and London and Frankfurt.

[00:08:44] [SPEAKER_00]: So it's been a really good ride

[00:08:45] [SPEAKER_00]: and all of those clients really want to know

[00:08:48] [SPEAKER_00]: in a nutshell, where are things now?

[00:08:51] [SPEAKER_00]: We get that.

[00:08:51] [SPEAKER_00]: But where do you see them going

[00:08:52] [SPEAKER_00]: and how can I make money off of that?

[00:08:55] [SPEAKER_00]: And that's where I consider myself

[00:08:56] [SPEAKER_00]: the market economist.

[00:08:57] [SPEAKER_00]: So for example, coming into this year,

[00:09:00] [SPEAKER_00]: the markets were anticipating the first cut in March.

[00:09:02] [SPEAKER_00]: So if you disagree with that,

[00:09:03] [SPEAKER_00]: based on economic analysis,

[00:09:05] [SPEAKER_00]: then you play the Fed Fund's futures market.

[00:09:08] [SPEAKER_00]: That would be a way to play that economic forecast

[00:09:11] [SPEAKER_00]: and that's the name of the game.

[00:09:13] [SPEAKER_00]: So I take an economic view,

[00:09:14] [SPEAKER_00]: I forecast out inflation numbers

[00:09:16] [SPEAKER_00]: and aggregate demand in their subcomponents

[00:09:18] [SPEAKER_00]: determine what the Fed is more or less likely to do

[00:09:22] [SPEAKER_00]: and try to find the best ways to execute in the markets,

[00:09:25] [SPEAKER_00]: whether it be in fixed income equities or FX.

[00:09:28] [SPEAKER_00]: How to best express that view?

[00:09:31] [SPEAKER_01]: Well, I had a chance to read some of your recent work

[00:09:34] [SPEAKER_01]: and so you had some research on Japanese yen

[00:09:38] [SPEAKER_01]: and you looked at the yen, I think,

[00:09:40] [SPEAKER_01]: from a purchasing power,

[00:09:42] [SPEAKER_01]: parity lens through that lens, the PPP lens

[00:09:46] [SPEAKER_01]: and what I see coming out of your work is a different PPP.

[00:09:50] [SPEAKER_01]: I would say it's price positioning and protection.

[00:09:54] [SPEAKER_01]: I love that.

[00:09:55] [SPEAKER_01]: So those are three P's that I see prominently in your work

[00:09:59] [SPEAKER_01]: and so as you mentioned,

[00:10:01] [SPEAKER_01]: fading this idea that the Fed was set to cut

[00:10:03] [SPEAKER_01]: so early in the year,

[00:10:04] [SPEAKER_01]: that's really all about price.

[00:10:06] [SPEAKER_01]: You're looking at futures curves,

[00:10:08] [SPEAKER_01]: the yield curve and looking at what's actionable.

[00:10:11] [SPEAKER_01]: I've seen some of your recommendations on

[00:10:13] [SPEAKER_01]: SOFR option trades and on protection in the triple Q.

[00:10:17] [SPEAKER_01]: Let's run through your framework a little bit,

[00:10:19] [SPEAKER_01]: maybe with some of this in mind,

[00:10:21] [SPEAKER_01]: with positioning in mind.

[00:10:23] [SPEAKER_01]: I know that really comes up as part of your work

[00:10:25] [SPEAKER_01]: on dissecting the tumult of last week in yen

[00:10:30] [SPEAKER_01]: that flared out around the world.

[00:10:32] [SPEAKER_01]: Walk us a little bit through just your framework.

[00:10:34] [SPEAKER_01]: So obviously you're doing research on the economy

[00:10:36] [SPEAKER_01]: and forecasting, but there's an overlay of market prices

[00:10:41] [SPEAKER_01]: that figures prominently in your recommendations.

[00:10:43] [SPEAKER_01]: Talk to us a little bit more about that.

[00:10:45] [SPEAKER_00]: Oh, absolutely.

[00:10:46] [SPEAKER_00]: Well positioning is really of the most importance

[00:10:49] [SPEAKER_00]: when you're determining where institutional investors

[00:10:52] [SPEAKER_00]: could find value in the market.

[00:10:55] [SPEAKER_00]: So for example, when you look at how extreme

[00:10:58] [SPEAKER_00]: the levels were in terms of using the yen

[00:11:00] [SPEAKER_00]: as a funding currency

[00:11:03] [SPEAKER_00]: and leveraging that low zero yielding currency

[00:11:07] [SPEAKER_00]: to fund higher yielding bets across the asset classes,

[00:11:12] [SPEAKER_00]: the enormity of that positioning was so stark

[00:11:16] [SPEAKER_00]: that that is a major reason.

[00:11:18] [SPEAKER_00]: One of the major reasons that we saw the recent,

[00:11:21] [SPEAKER_00]: although temporary, market meltdown.

[00:11:24] [SPEAKER_00]: So we do look at investor positioning.

[00:11:25] [SPEAKER_00]: It's very important.

[00:11:26] [SPEAKER_00]: And then when you look at long dollar positioning,

[00:11:28] [SPEAKER_00]: that's also incredibly relevant.

[00:11:30] [SPEAKER_00]: So you have very short yen and generally you continue

[00:11:34] [SPEAKER_00]: to see real money accounts massively overweight

[00:11:38] [SPEAKER_00]: dollar and dollar denominated assets.

[00:11:41] [SPEAKER_00]: So positioning is absolutely critical

[00:11:42] [SPEAKER_00]: when we're looking at these types of trades.

[00:11:45] [SPEAKER_00]: And what I spoke about in the piece you're referencing,

[00:11:47] [SPEAKER_00]: which is the Bank of Japan resetting inflation rate

[00:11:50] [SPEAKER_00]: expectations, you can do a PPP analysis of the yen

[00:11:53] [SPEAKER_00]: and you can determine that it's still enormously undervalued.

[00:11:57] [SPEAKER_00]: And when you look at the dollar, you can do a similar exercise

[00:12:02] [SPEAKER_00]: to see that it's overvalued.

[00:12:03] [SPEAKER_00]: So I think that there are opportunities

[00:12:06] [SPEAKER_00]: and risks to this type of analysis, Dean,

[00:12:08] [SPEAKER_00]: the structural kind because just to give you an example,

[00:12:11] [SPEAKER_00]: I was having this debate here internally,

[00:12:13] [SPEAKER_00]: which is what happens to the dollar after the election

[00:12:15] [SPEAKER_00]: or what happens to the dollar when the Fed starts cutting?

[00:12:18] [SPEAKER_00]: You might think, oh, the dollar's going to weaken,

[00:12:21] [SPEAKER_00]: but not really, not really when you have these large,

[00:12:24] [SPEAKER_00]: even though they're getting smaller, these disparities

[00:12:27] [SPEAKER_00]: and interest rates between the dollar and the yen

[00:12:30] [SPEAKER_00]: or the dollar and really anybody else.

[00:12:32] [SPEAKER_00]: So yeah, the yen funded carry trades,

[00:12:34] [SPEAKER_00]: I think is really important.

[00:12:35] [SPEAKER_00]: So what am I looking at now?

[00:12:36] [SPEAKER_00]: We saw a lot of short covering on the yen

[00:12:38] [SPEAKER_00]: and CFTC data shows that net speculative positioning

[00:12:42] [SPEAKER_00]: in the yen has largely been covered.

[00:12:45] [SPEAKER_00]: Now what we're seeing is a re-accumulation of this trend.

[00:12:49] [SPEAKER_00]: And that's something that I think could warrant

[00:12:51] [SPEAKER_00]: additional caution on the horizon

[00:12:54] [SPEAKER_00]: if we get a resumption of this risk on trade funded by the yen.

[00:13:00] [SPEAKER_00]: And I think part of the problem here

[00:13:01] [SPEAKER_00]: is that the BOJ kind of ceded to the market meltdown

[00:13:05] [SPEAKER_00]: and market skeptics basically saying,

[00:13:07] [SPEAKER_00]: we're not going to be hiking rates anytime soon.

[00:13:09] [SPEAKER_00]: So what does that mean?

[00:13:11] [SPEAKER_00]: When you have a market that's almost completely recovered,

[00:13:13] [SPEAKER_00]: all of its meltdown, it means more risk on.

[00:13:16] [SPEAKER_00]: So these are things that on my team,

[00:13:18] [SPEAKER_00]: we certainly look at.

[00:13:19] [SPEAKER_00]: We look at purchasing power parity,

[00:13:20] [SPEAKER_00]: which is generally a structural issue,

[00:13:22] [SPEAKER_00]: but then near term positioning and risk appetite.

[00:13:26] [SPEAKER_00]: And from my perspective, Dean,

[00:13:27] [SPEAKER_00]: I know you've been reading some of my stuff.

[00:13:29] [SPEAKER_00]: I think there are inherent risks

[00:13:30] [SPEAKER_00]: that are underpriced in the market.

[00:13:33] [SPEAKER_00]: And so from my perspective,

[00:13:34] [SPEAKER_00]: I think it makes sense to protect your gains,

[00:13:37] [SPEAKER_00]: protect your gains in general.

[00:13:39] [SPEAKER_00]: It doesn't mean liquidate positions

[00:13:40] [SPEAKER_00]: that are heavy on risk,

[00:13:42] [SPEAKER_00]: but it certainly means to take advantage of opportunities

[00:13:45] [SPEAKER_00]: where you see euphoria or complacency

[00:13:48] [SPEAKER_00]: or even greed to put on counter cyclical portfolio policy,

[00:13:54] [SPEAKER_00]: which is how I call it.

[00:13:56] [SPEAKER_01]: One thing I think is interesting as you point to

[00:13:58] [SPEAKER_01]: that large long position in the dollar

[00:14:02] [SPEAKER_01]: for a long period of time,

[00:14:03] [SPEAKER_01]: I would say really the last two years,

[00:14:05] [SPEAKER_01]: it's really been a function of the Fed's tightening cycle.

[00:14:08] [SPEAKER_01]: You've seen a pretty consistent,

[00:14:09] [SPEAKER_01]: very positive correlation between the dollar and the VIX.

[00:14:13] [SPEAKER_01]: And we remember, let's call it late 2022,

[00:14:16] [SPEAKER_01]: where we kind of got close to a breaking point there,

[00:14:19] [SPEAKER_01]: where the dollar just rallied so ferociously.

[00:14:22] [SPEAKER_01]: It had a lot of folks off sides.

[00:14:24] [SPEAKER_01]: I think the VIX got into the 30s.

[00:14:26] [SPEAKER_01]: And I believe we were saved by a more benign CPI print.

[00:14:31] [SPEAKER_01]: I think Layle Brainard may have emerged

[00:14:34] [SPEAKER_01]: as a dovish voice within the Fed

[00:14:36] [SPEAKER_01]: and basically saying, let's slow this thing down here.

[00:14:40] [SPEAKER_01]: But you typically had dollar stronger VIX up.

[00:14:43] [SPEAKER_01]: And so what happened last week

[00:14:45] [SPEAKER_01]: is that wholesale reversal of that correlation,

[00:14:48] [SPEAKER_01]: at least against the yen,

[00:14:50] [SPEAKER_01]: the dollar sold off and the VIX absolutely spiked.

[00:14:54] [SPEAKER_01]: And I think it sort of speaks to this idea

[00:14:57] [SPEAKER_01]: that people in markets really just price

[00:14:59] [SPEAKER_01]: what they experienced recently.

[00:15:01] [SPEAKER_01]: When a correlation is in place,

[00:15:03] [SPEAKER_01]: the trades built around it become vulnerable

[00:15:06] [SPEAKER_01]: to a break of that correlation.

[00:15:09] [SPEAKER_01]: You mentioned just on the motivation for

[00:15:13] [SPEAKER_01]: this risk event.

[00:15:14] [SPEAKER_01]: Let's just say it starts really with

[00:15:16] [SPEAKER_01]: some weak economic data in the US

[00:15:18] [SPEAKER_01]: and then paired with the opposite in Japan,

[00:15:22] [SPEAKER_01]: maybe at least on the inflation side

[00:15:23] [SPEAKER_01]: and some hawkish commentary.

[00:15:25] [SPEAKER_01]: But then you had the deputy governor,

[00:15:27] [SPEAKER_01]: as you said in your note, stood down and said,

[00:15:29] [SPEAKER_01]: hey look, we're not going to do this

[00:15:30] [SPEAKER_01]: if market conditions are too volatile.

[00:15:34] [SPEAKER_01]: Do you think that sort of keeps the market

[00:15:35] [SPEAKER_01]: at bay for a period of time?

[00:15:38] [SPEAKER_01]: Are we at risk of this thing flaring up again

[00:15:42] [SPEAKER_01]: should Japan get an inflation print that's unwelcome?

[00:15:45] [SPEAKER_01]: Like where do you see this going from here?

[00:15:48] [SPEAKER_00]: It's a little bit of a moral hazard risk

[00:15:50] [SPEAKER_00]: because you're basically reigniting the fire in a sense.

[00:15:53] [SPEAKER_00]: And short-term traders are going to say,

[00:15:56] [SPEAKER_00]: oh fantastic, even though wages are surging in Japan,

[00:16:01] [SPEAKER_00]: even though the economy is doing very well,

[00:16:04] [SPEAKER_00]: tourism is near record highs.

[00:16:06] [SPEAKER_00]: And inflation expectations and inflation metrics

[00:16:09] [SPEAKER_00]: warrant higher rates.

[00:16:10] [SPEAKER_00]: BOJ is committed to not doing that explicitly,

[00:16:14] [SPEAKER_00]: committed to not doing it for the rest of the year.

[00:16:16] [SPEAKER_00]: So what have we seen happen?

[00:16:17] [SPEAKER_00]: We've already seen this new using the yen

[00:16:19] [SPEAKER_00]: as a funding currency trade come back into vogue.

[00:16:22] [SPEAKER_00]: So I think yes, I think it does open us up

[00:16:25] [SPEAKER_00]: to some more downside for guys and gals

[00:16:27] [SPEAKER_00]: that have positioned themselves or continue to lever up.

[00:16:31] [SPEAKER_00]: So definitely like I wrote in my piece,

[00:16:33] [SPEAKER_00]: I think there are inevitable bouts of volatility,

[00:16:35] [SPEAKER_00]: particularly as this yen carry trade fully unwound.

[00:16:39] [SPEAKER_00]: And now winds back up again.

[00:16:41] [SPEAKER_01]: Right. And what's so interesting,

[00:16:43] [SPEAKER_01]: and you had a very timely call on using puts in the QQ,

[00:16:47] [SPEAKER_01]: I think was at least one of the recommendation.

[00:16:50] [SPEAKER_01]: Obviously that hit, it hit quickly.

[00:16:52] [SPEAKER_01]: But what do we know about these markets

[00:16:54] [SPEAKER_01]: is you've really got to monetize your exposures.

[00:16:58] [SPEAKER_01]: Those gains can fade very rapidly.

[00:17:01] [SPEAKER_01]: So you had this really outsized pop in the VIX,

[00:17:04] [SPEAKER_01]: it's come back much more than I personally was expecting it to.

[00:17:09] [SPEAKER_01]: I knew it was set to reverse, but boy, that's substantial.

[00:17:13] [SPEAKER_01]: I think it's the fastest ever call it 10-day reversal

[00:17:16] [SPEAKER_01]: in the history of the VIX.

[00:17:17] [SPEAKER_01]: I'm almost positive that that's the case.

[00:17:20] [SPEAKER_01]: And so it sort of resets in some ways

[00:17:22] [SPEAKER_01]: the price of insurance from an entry point standpoint.

[00:17:25] [SPEAKER_01]: How do you think about protection on behalf of your clients

[00:17:29] [SPEAKER_01]: in the current state of pricing in the options market?

[00:17:32] [SPEAKER_00]: I think it opens up opportunities to protect those positions.

[00:17:36] [SPEAKER_00]: So this is a cautionary tale that I've been advising our clients

[00:17:39] [SPEAKER_00]: tactically to put on.

[00:17:41] [SPEAKER_00]: And as you mentioned, we did recommend protective options on tech

[00:17:44] [SPEAKER_00]: back on July 26th.

[00:17:46] [SPEAKER_00]: Those were 30-day NASDAQ sector options, 95%-85% moneyness rolled.

[00:17:52] [SPEAKER_00]: We closed this recommendation.

[00:17:54] [SPEAKER_00]: Actually, we closed it on August 5th

[00:17:57] [SPEAKER_00]: with more than 300% return

[00:18:00] [SPEAKER_00]: for those who would have executed it.

[00:18:03] [SPEAKER_00]: So I think that when you get a backward slide again in the VIX

[00:18:06] [SPEAKER_00]: as you highlighted correctly, then it opens up additional

[00:18:09] [SPEAKER_00]: opportunities because of course, when the fear index plummets,

[00:18:13] [SPEAKER_00]: then these options for equity analysts or equity portfolio

[00:18:18] [SPEAKER_00]: managers rather that have tech positions which tend to be

[00:18:22] [SPEAKER_00]: vulnerable, especially given valuations and especially given

[00:18:26] [SPEAKER_00]: underpriced risks on the economy and the potential for some

[00:18:30] [SPEAKER_00]: possible policy error on the Fed,

[00:18:32] [SPEAKER_00]: which neither of which are really discounted the markets at this point,

[00:18:35] [SPEAKER_00]: makes them attractive in my opinion.

[00:18:37] [SPEAKER_00]: So I think some froth came off the markets,

[00:18:40] [SPEAKER_00]: but I think there's probably more to come.

[00:18:43] [SPEAKER_00]: I think two weeks ago Friday in On Front Payroll's report

[00:18:45] [SPEAKER_00]: was confirmation that the markets are going to be highly attuned,

[00:18:49] [SPEAKER_00]: leveraged and very sensitive to high-frequency economic data.

[00:18:54] [SPEAKER_00]: And I've heard it called the Everything is Awesome trade.

[00:18:56] [SPEAKER_00]: But the days in my view are numbered.

[00:18:58] [SPEAKER_00]: And I think the perfect landing scenario that's baked in the markets

[00:19:02] [SPEAKER_00]: has really underpriced the real risks of the outlook.

[00:19:05] [SPEAKER_00]: I think that they're bipolar in nature, truly bipolar.

[00:19:09] [SPEAKER_00]: I mean, when you think about it, we're in a scenario where,

[00:19:12] [SPEAKER_00]: in my opinion, recession risk is at least double what it normally is

[00:19:16] [SPEAKER_00]: at any point in the economic cycle, which is about 20%.

[00:19:18] [SPEAKER_00]: So I think it's about 40% over the next 12 to 18 months.

[00:19:21] [SPEAKER_00]: And then on the flip side, you have the reality,

[00:19:23] [SPEAKER_00]: which is that the US economy is growing at about 2.8%,

[00:19:28] [SPEAKER_00]: which is nearly one full percentage point in above potential growth,

[00:19:32] [SPEAKER_00]: which itself is inherently, when you think about it, inflationary.

[00:19:36] [SPEAKER_00]: So on the one hand, you have that fat tail risk of the possibility

[00:19:39] [SPEAKER_00]: that corporations start to make big layoffs

[00:19:42] [SPEAKER_00]: because they need to shore up their bottom line and cut costs.

[00:19:44] [SPEAKER_00]: And the quickest way to do that is by cutting the fat

[00:19:46] [SPEAKER_00]: and unloading the job hoarding phenomenon that occurred over COVID,

[00:19:49] [SPEAKER_00]: and that would lead to recession.

[00:19:50] [SPEAKER_00]: Then on the other hand, you have the reality,

[00:19:52] [SPEAKER_00]: which is the economy's doing pretty darn good right now.

[00:19:55] [SPEAKER_00]: And there could be a recency bias, as you had alluded to before.

[00:19:59] [SPEAKER_00]: But the truth is the economy is growing very strong.

[00:20:01] [SPEAKER_00]: So let's say we're pro-growth policies to be implemented

[00:20:04] [SPEAKER_00]: in a potential next administration.

[00:20:06] [SPEAKER_00]: That sounds fantastic, but at the same time,

[00:20:08] [SPEAKER_00]: you want counter-cyclical fiscal policy

[00:20:11] [SPEAKER_00]: rather than pro-cyclical.

[00:20:13] [SPEAKER_00]: So if we juice the economy even more,

[00:20:15] [SPEAKER_00]: we could get a re-acceleration of inflation.

[00:20:18] [SPEAKER_00]: To me, those are the two fat tail risks.

[00:20:21] [SPEAKER_00]: And I think there's ways to do that.

[00:20:22] [SPEAKER_00]: And I think it's not just to put recommendation on the NASDAQ

[00:20:25] [SPEAKER_00]: and the S&P.

[00:20:26] [SPEAKER_00]: You can do it for at one month, you can do it at 12 months,

[00:20:28] [SPEAKER_00]: whatever your horizon is, doesn't matter.

[00:20:29] [SPEAKER_00]: But there's other options as well.

[00:20:31] [SPEAKER_00]: You can buy defensive such as utilities,

[00:20:33] [SPEAKER_00]: which has been one of my top performing recommendations

[00:20:35] [SPEAKER_00]: near to date.

[00:20:37] [SPEAKER_00]: It's defensive, but it's also a second derivative

[00:20:39] [SPEAKER_00]: to the AI trade.

[00:20:40] [SPEAKER_00]: So it could work under both fat tail risks.

[00:20:43] [SPEAKER_00]: That's why I love this sector.

[00:20:44] [SPEAKER_00]: It makes sense to me.

[00:20:45] [SPEAKER_00]: It's inherently defensive, so it should do well in downturns.

[00:20:51] [SPEAKER_00]: But if you think the everything is awesome trade

[00:20:52] [SPEAKER_00]: is going to continue and has legs,

[00:20:55] [SPEAKER_00]: then you might want to look at the tailwind.

[00:20:58] [SPEAKER_00]: Sectors that have not outperformed to that extent,

[00:21:00] [SPEAKER_00]: which can benefit from, if you're a believer in this,

[00:21:03] [SPEAKER_00]: the ongoing froth in the AI trade.

[00:21:06] [SPEAKER_00]: Those two things I think are utilities

[00:21:08] [SPEAKER_00]: and industrial real estate.

[00:21:10] [SPEAKER_00]: So I think that's a way to be defensive.

[00:21:12] [SPEAKER_00]: And then finally, I would say the belly of the US Treasury

[00:21:14] [SPEAKER_00]: curve two to five years makes sense to me as does cash.

[00:21:18] [SPEAKER_00]: I mean cash is still yielding more than 5%.

[00:21:20] [SPEAKER_00]: And I think that once the Fed starts cutting rates,

[00:21:22] [SPEAKER_00]: all the $6 trillion that are sitting in money market funds

[00:21:25] [SPEAKER_00]: team, those are going to move into some of it

[00:21:27] [SPEAKER_00]: will move into equity.

[00:21:28] [SPEAKER_00]: Sure. But is equities really a complementary asset class

[00:21:31] [SPEAKER_00]: to cash?

[00:21:33] [SPEAKER_00]: No.

[00:21:33] [SPEAKER_00]: What is a complementary asset class that also benefits

[00:21:36] [SPEAKER_00]: from a drop in Fed funds?

[00:21:38] [SPEAKER_00]: It's the short end of the Treasury curve.

[00:21:40] [SPEAKER_00]: So two to five year paper, I think makes sense.

[00:21:42] [SPEAKER_00]: That's also a trade that's done very well.

[00:21:44] [SPEAKER_00]: And I also like steepeners from a more structural perspective.

[00:21:47] [SPEAKER_01]: Yeah. I mean, it's not hard to think about the option value

[00:21:51] [SPEAKER_01]: of cash up here at the 5% plus, especially when equity market

[00:21:57] [SPEAKER_01]: vol gets higher.

[00:21:59] [SPEAKER_01]: The utilities is interesting.

[00:22:00] [SPEAKER_01]: I wanted to explore it a little bit more with you.

[00:22:03] [SPEAKER_01]: And we're all looking for more than one way

[00:22:05] [SPEAKER_01]: to win in an exposure.

[00:22:07] [SPEAKER_01]: Utilities have developed some beta to the AI theme.

[00:22:12] [SPEAKER_01]: I was looking at the XLU, its performance last Monday,

[00:22:17] [SPEAKER_01]: Monday, August 5th.

[00:22:19] [SPEAKER_01]: And it wasn't great.

[00:22:19] [SPEAKER_01]: It was down 2.8%, I want to say.

[00:22:22] [SPEAKER_01]: And that was a day, obviously, that the bond market

[00:22:24] [SPEAKER_01]: rallied a fair amount.

[00:22:25] [SPEAKER_01]: And so that was interesting to me.

[00:22:27] [SPEAKER_01]: It told me that the AI concept won or lost for the XLU

[00:22:32] [SPEAKER_01]: that day.

[00:22:33] [SPEAKER_01]: But just be curious to learn a little bit more

[00:22:35] [SPEAKER_01]: about how you think about the first and second derivatives,

[00:22:38] [SPEAKER_01]: the drivers of the XLU today versus how we know that sector

[00:22:43] [SPEAKER_01]: to traditionally relate to things like interest rates.

[00:22:47] [SPEAKER_00]: Well, yeah.

[00:22:47] [SPEAKER_00]: So far it's had a good run.

[00:22:49] [SPEAKER_00]: Utilities is third best performing sector in the S&P

[00:22:52] [SPEAKER_00]: year-to-date.

[00:22:54] [SPEAKER_00]: The AI trade is obviously largely best reflected

[00:22:57] [SPEAKER_00]: in first order beneficiaries.

[00:22:59] [SPEAKER_00]: Everyone knows about this trade.

[00:23:01] [SPEAKER_00]: I think it's generally priced in more than priced in

[00:23:03] [SPEAKER_00]: for the promising future for AI and the economy and society.

[00:23:06] [SPEAKER_00]: All of that is true.

[00:23:07] [SPEAKER_00]: But in my opinion, really AI has to deliver now.

[00:23:10] [SPEAKER_00]: And I'm not convinced that corporations that talk as much

[00:23:15] [SPEAKER_00]: as they do on their earnings calls about AI

[00:23:17] [SPEAKER_00]: as the zeitgeist buzzword.

[00:23:19] [SPEAKER_00]: I don't think that they have deployed it to the extent

[00:23:22] [SPEAKER_00]: they've talked about it.

[00:23:23] [SPEAKER_00]: So I'm a little suspicious of those

[00:23:25] [SPEAKER_00]: who say that this improvement in productivity

[00:23:28] [SPEAKER_00]: that we've seen is already due to AI.

[00:23:31] [SPEAKER_00]: Of course, some of it is.

[00:23:32] [SPEAKER_00]: But I do think that AI does have to deliver

[00:23:34] [SPEAKER_00]: on the productivity front.

[00:23:35] [SPEAKER_00]: And that, I have to say, as a little corollary

[00:23:38] [SPEAKER_00]: will have repercussions for the labor market.

[00:23:41] [SPEAKER_00]: So maybe it's already occurring,

[00:23:42] [SPEAKER_00]: but it's really impossible to define as of yet.

[00:23:45] [SPEAKER_00]: So what am I saying?

[00:23:46] [SPEAKER_00]: I'm saying that if AI truly has been deployed,

[00:23:49] [SPEAKER_00]: and I don't think it's been deployed

[00:23:50] [SPEAKER_00]: into its maximum extent, part of the rollover

[00:23:54] [SPEAKER_00]: that we've seen in unemployment could be from

[00:23:56] [SPEAKER_00]: this tenacious investment in labor-saving technology

[00:24:01] [SPEAKER_00]: that AI has afforded companies.

[00:24:04] [SPEAKER_00]: And I think that makes sense.

[00:24:05] [SPEAKER_00]: So just going back to the idea.

[00:24:08] [SPEAKER_00]: So AI relies heavily, of course, on energy.

[00:24:11] [SPEAKER_00]: And so when I think about who could potentially benefit

[00:24:14] [SPEAKER_00]: from a positive scenario where AI and tech leaders

[00:24:17] [SPEAKER_00]: continue to lead the market,

[00:24:20] [SPEAKER_00]: I think the sectors, the bond proxy of utilities

[00:24:23] [SPEAKER_00]: and its fuel qualities and its lower valuation

[00:24:25] [SPEAKER_00]: just make sense.

[00:24:27] [SPEAKER_00]: You have AI-driven, generative, large language models

[00:24:29] [SPEAKER_00]: like chat GPT.

[00:24:31] [SPEAKER_00]: That requires massive computational power,

[00:24:33] [SPEAKER_00]: orders of magnitude more than a normal Google search.

[00:24:36] [SPEAKER_00]: And you need space,

[00:24:39] [SPEAKER_00]: or you need data center construction and expansion.

[00:24:42] [SPEAKER_00]: You have that happening from tech giants,

[00:24:44] [SPEAKER_00]: Microsoft, Amazon, Google Meta.

[00:24:46] [SPEAKER_00]: So I think that you have that informed.

[00:24:48] [SPEAKER_00]: They're extremely power hungry.

[00:24:50] [SPEAKER_00]: If you think that this is an area

[00:24:51] [SPEAKER_00]: that's going to continue to drive the S&P,

[00:24:54] [SPEAKER_00]: which by the way, a third of it is already attached to tech,

[00:24:57] [SPEAKER_00]: then I think it makes sense to look at utilities.

[00:24:59] [SPEAKER_00]: Although really I'm looking at RSI right now

[00:25:01] [SPEAKER_00]: and it looks a little overbought at the moment.

[00:25:03] [SPEAKER_00]: But utilities may perform well, as I mentioned,

[00:25:05] [SPEAKER_00]: under the opposite tail risk scenario,

[00:25:07] [SPEAKER_00]: which in a strong growth or a no growth scenario,

[00:25:10] [SPEAKER_00]: risk assets rise.

[00:25:11] [SPEAKER_00]: Utilities could benefit from the second order effects of AI,

[00:25:14] [SPEAKER_00]: but they historically perform better

[00:25:16] [SPEAKER_00]: in a hard landing scenario

[00:25:17] [SPEAKER_00]: because it's a defensive sector and it acts as a bond proxy.

[00:25:21] [SPEAKER_00]: And that often outperforms during recessions

[00:25:23] [SPEAKER_00]: and bear markets.

[00:25:24] [SPEAKER_01]: And so there is more and more attention, I think,

[00:25:27] [SPEAKER_01]: on the real economy.

[00:25:29] [SPEAKER_01]: We clearly spent most of 2022 and into 2023 focused on inflation dynamics.

[00:25:37] [SPEAKER_01]: Inflation got higher.

[00:25:38] [SPEAKER_01]: Whenever that happens, it becomes more volatile.

[00:25:41] [SPEAKER_01]: I focus a lot on things like the VIX.

[00:25:43] [SPEAKER_01]: There's the one day VIX.

[00:25:45] [SPEAKER_01]: The day before the CPI, the one day VIX could be as high as 40.

[00:25:49] [SPEAKER_01]: I mean just gigantic risk premiums in 2022 ahead of this CPI day releases

[00:25:56] [SPEAKER_01]: because it was so uncertain and the Fed's policy response was very much in flux.

[00:26:01] [SPEAKER_01]: That's really not a thing anymore, not nearly to the extent.

[00:26:05] [SPEAKER_01]: But what has picked up is the beta of the market to growth shortfalls,

[00:26:10] [SPEAKER_01]: whether it's a soft NFP, that sort of thing.

[00:26:14] [SPEAKER_01]: And so it's a different environment.

[00:26:16] [SPEAKER_01]: When you step back and you look at the big picture of the growth

[00:26:20] [SPEAKER_01]: and inflation dynamics in the US,

[00:26:24] [SPEAKER_01]: there's a lot of focus on the someral as an example.

[00:26:27] [SPEAKER_01]: It's a little bit retrofitted to find something that works,

[00:26:30] [SPEAKER_01]: but I kind of like it because it makes a statement that I agree with,

[00:26:34] [SPEAKER_01]: which is once something increases, it's not likely to just stop.

[00:26:40] [SPEAKER_01]: I mean, that doesn't happen with vol.

[00:26:42] [SPEAKER_01]: It doesn't happen with inflation.

[00:26:44] [SPEAKER_01]: It basically says the Fed's got a very tough job.

[00:26:47] [SPEAKER_01]: And so when you look at the robustness of the US economy,

[00:26:51] [SPEAKER_01]: are you more concerned that we could be experiencing a shortfall?

[00:26:57] [SPEAKER_01]: You were commenting that things look pretty good.

[00:26:59] [SPEAKER_01]: How do you look at the next six to 12 months in terms of the US economy?

[00:27:04] [SPEAKER_00]: I think the path ahead is complicated for the US economy,

[00:27:07] [SPEAKER_00]: especially as you mentioned, Dean and Claudia Somm,

[00:27:11] [SPEAKER_00]: so fabulous economists and the person who created the Someral,

[00:27:15] [SPEAKER_00]: of course, has depicted this very well.

[00:27:17] [SPEAKER_00]: When you look over history,

[00:27:18] [SPEAKER_00]: the unemployment rate historically jumps or drops.

[00:27:22] [SPEAKER_00]: It doesn't gently tick up the summary of economic projections from the Fed shows.

[00:27:27] [SPEAKER_00]: That's not a historical reality.

[00:27:31] [SPEAKER_00]: I guess I think the risk that I view is in the labor market.

[00:27:35] [SPEAKER_00]: I think the labor market dynamics would ultimately affect an economy based on consumption.

[00:27:41] [SPEAKER_00]: So it comes down to how does the labor market fare?

[00:27:44] [SPEAKER_00]: Do companies start to unwind the job hoarding phenomenon that occurred over COVID?

[00:27:50] [SPEAKER_00]: Because we really haven't seen that yet.

[00:27:52] [SPEAKER_00]: To be able to cut costs in the face of a decelerating US consumer, I think they do.

[00:27:59] [SPEAKER_00]: So I think that risk is there.

[00:28:01] [SPEAKER_00]: I think the Som rule is useful.

[00:28:03] [SPEAKER_00]: But Claudia Somm is a friend of mine and lovely, and we've talked about it.

[00:28:08] [SPEAKER_00]: And what she's been clear is on saying is that it's not an economic rule.

[00:28:12] [SPEAKER_00]: This is a tool that we use over time.

[00:28:14] [SPEAKER_00]: And yes, it does have a very high accuracy hit ratio, but it has misguided in the past.

[00:28:20] [SPEAKER_00]: For example, early, I think 1960s, it triggered and the US economy didn't enter a recession,

[00:28:25] [SPEAKER_00]: but it did six months later.

[00:28:27] [SPEAKER_00]: So we can't be complacent.

[00:28:29] [SPEAKER_00]: The Someral triggered.

[00:28:30] [SPEAKER_00]: There are dynamics at play here.

[00:28:32] [SPEAKER_00]: There are certainly increased firings.

[00:28:34] [SPEAKER_00]: But as we all know, there are massive new entrants to the labor force.

[00:28:37] [SPEAKER_00]: And this comes from immigration.

[00:28:38] [SPEAKER_00]: So there's a lot of people out there looking for jobs and that pushes up the unemployment rate.

[00:28:43] [SPEAKER_00]: So this time could be different.

[00:28:45] [SPEAKER_00]: I generally despise that phrase.

[00:28:47] [SPEAKER_00]: I think this time is almost never different.

[00:28:50] [SPEAKER_00]: I think that COVID and the massive fiscal stimulus and the massive monetary stimulus

[00:28:55] [SPEAKER_00]: that resulted from it, I think probably kicked the can down the road.

[00:28:59] [SPEAKER_00]: But the truth is one of my strongest conviction is that the economic cycle is intact.

[00:29:03] [SPEAKER_00]: There is an economic cycle.

[00:29:05] [SPEAKER_00]: It's intact.

[00:29:06] [SPEAKER_00]: And I think that the recession has been delayed and we haven't just jumped into some new

[00:29:13] [SPEAKER_00]: alternate plane of economic reality.

[00:29:16] [SPEAKER_00]: What I'm getting at here is, I think that recession is part of the cycle.

[00:29:22] [SPEAKER_00]: Impossible predict when it will occur.

[00:29:24] [SPEAKER_00]: But I think it makes sense to investors to consider that as they're positioning going into 2025.

[00:29:30] [SPEAKER_01]: If we think about Fed policy cycles, whether they're easing or tightening cycles,

[00:29:37] [SPEAKER_01]: you can have them go one of two ways.

[00:29:40] [SPEAKER_01]: And each has different implications for, let's say the VIX of interest rates.

[00:29:44] [SPEAKER_01]: We'll use the move index.

[00:29:46] [SPEAKER_01]: The feds tightening fast in 2022 and the move is going up and it's going up quite a bit.

[00:29:54] [SPEAKER_01]: If the feds tightening in 2017, the move was as quiet as could be.

[00:29:58] [SPEAKER_01]: They're slowly, slowly taking things back after a long, long period of very low rates.

[00:30:06] [SPEAKER_01]: And they're really just adjusting.

[00:30:09] [SPEAKER_01]: They're not chasing inflation.

[00:30:10] [SPEAKER_01]: In fact, inflation's quite low and very stable back then in 2022.

[00:30:14] [SPEAKER_01]: It's obviously they're fighting it.

[00:30:16] [SPEAKER_01]: And the opposite is also the case.

[00:30:18] [SPEAKER_01]: And this is what I wanted you to reflect on.

[00:30:20] [SPEAKER_01]: The Fed's going to start easing.

[00:30:22] [SPEAKER_01]: We know that that's coming.

[00:30:24] [SPEAKER_01]: We don't exactly know the magnitude of it.

[00:30:26] [SPEAKER_01]: But the open question is, are they easing because they've got this permission structure

[00:30:30] [SPEAKER_01]: that's on hand from the inflation achievement?

[00:30:34] [SPEAKER_01]: Call it 2.9%-ish.

[00:30:37] [SPEAKER_01]: Looks reasonable and they're starting from a very high funds rate.

[00:30:41] [SPEAKER_01]: So that's easing because you can.

[00:30:43] [SPEAKER_01]: And then the other scenario is you're easing a little faster because you have to.

[00:30:49] [SPEAKER_01]: Growth is deteriorating.

[00:30:50] [SPEAKER_01]: And that's probably associated with a different vol regime.

[00:30:53] [SPEAKER_01]: I'd love to just hear you talk out loud about how you think about those quadrants, so to speak.

[00:30:59] [SPEAKER_00]: To the extent the Fed can cut rates based on price stability,

[00:31:03] [SPEAKER_00]: the inflation side of their mandate, as opposed to the maximum employment side of their mandate,

[00:31:09] [SPEAKER_00]: that determines where we are in the economic cycles as a soft landing or hard landing.

[00:31:13] [SPEAKER_00]: If the Fed is able to launch a loosening cycle because inflation is giving them

[00:31:18] [SPEAKER_00]: the opportunity not because the unemployment rate is jumping, then that's great.

[00:31:23] [SPEAKER_00]: I think that's where we're still as yet unclear and no one can really know.

[00:31:27] [SPEAKER_00]: I think if you look 43% of the time, 3 out of the past 7 instances,

[00:31:31] [SPEAKER_00]: this is something that in my team we looked at,

[00:31:33] [SPEAKER_00]: recession occurs within the following 12 months after the first Fed cut.

[00:31:37] [SPEAKER_00]: So 3 out of the past 7 instances, we've seen that occur.

[00:31:41] [SPEAKER_00]: So it's not an insignificant risk.

[00:31:44] [SPEAKER_00]: And really when we see recession is when the Fed starts cutting,

[00:31:47] [SPEAKER_00]: the question of course is you can only answer this later.

[00:31:50] [SPEAKER_00]: Did the Fed cut for which part of their mandate,

[00:31:53] [SPEAKER_00]: for the inflation or the employment part of the mandate?

[00:31:56] [SPEAKER_00]: If the economy doesn't enter recession over the ensuing 12 month period,

[00:31:59] [SPEAKER_00]: the S&P averages nearly 20% up over that time.

[00:32:02] [SPEAKER_00]: If the economy does enter recession over the ensuing 12 month period,

[00:32:06] [SPEAKER_00]: the S&P averages minus 10% over that time.

[00:32:10] [SPEAKER_00]: And that's 12 month periods.

[00:32:11] [SPEAKER_00]: I mean we can look peak to trough drawdowns in those 3 recessions where we had bear markets.

[00:32:16] [SPEAKER_00]: They were between 39% and 57% negative.

[00:32:20] [SPEAKER_00]: So things can get ugly quick.

[00:32:22] [SPEAKER_00]: And I think that's one of the messages that I'm advising our clients just to consider

[00:32:28] [SPEAKER_00]: that when we talk about those quadrants,

[00:32:30] [SPEAKER_00]: we have the inflation quadrant with the Goldilocks quadrant,

[00:32:34] [SPEAKER_00]: we have the disinflation quadrant, we have the stagflation quadrant.

[00:32:37] [SPEAKER_00]: Everybody alive today in the financial markets working in the financial markets,

[00:32:42] [SPEAKER_00]: we've lived the vast majority of our lives in the Goldilocks environment.

[00:32:44] [SPEAKER_00]: Low inflation, high growth.

[00:32:46] [SPEAKER_00]: So our behavioral economics piece of it

[00:32:49] [SPEAKER_00]: mean reverts us to believe that that is our base when in fact these things really are cyclical.

[00:32:55] [SPEAKER_00]: And so what happens if we go into some sort of stagflation or recessionary environment,

[00:32:59] [SPEAKER_00]: fixed income outperforms and large cap underperforms?

[00:33:01] [SPEAKER_00]: So I think that's just something to keep in mind.

[00:33:04] [SPEAKER_00]: And with regard to the Fed, I think it's very unlikely that the Fed is able to hit their 2%

[00:33:09] [SPEAKER_00]: target and their long run neutral rate in the current environment of above trend growth.

[00:33:17] [SPEAKER_00]: So more likely than not, they start cutting in September, I bet they go 50.

[00:33:21] [SPEAKER_00]: And but they do 250 basis point cuts.

[00:33:23] [SPEAKER_00]: That would be my guess.

[00:33:25] [SPEAKER_00]: And I think next year they may do 100 for a total of 150.

[00:33:29] [SPEAKER_00]: So that doesn't get them to where the Fed sees their long run neutral rate at.

[00:33:34] [SPEAKER_00]: I think it's probably going to be higher.

[00:33:36] [SPEAKER_01]: I have in my notes for our discussion to talk to you a little bit about the fiscal side.

[00:33:43] [SPEAKER_01]: And all of this discussion around the Fed tightening so much and the US economy

[00:33:48] [SPEAKER_01]: holding up so well, it's sort of to me at least potentially some elephant in the room

[00:33:54] [SPEAKER_01]: is, well, yeah, you're running a 7% deficit with the sub 4% unemployment rate.

[00:34:00] [SPEAKER_01]: It's going to be a little hard for those rate hikes to really bite.

[00:34:06] [SPEAKER_01]: I mean, they're going to undo some of it.

[00:34:08] [SPEAKER_01]: You also have the circumstance where think on the housing front,

[00:34:13] [SPEAKER_01]: everybody's got this super attractive mortgage rate.

[00:34:16] [SPEAKER_01]: So I feel like businesses and consumers are just not as exposed to higher rates

[00:34:20] [SPEAKER_01]: as they were perhaps in 2006 as an example.

[00:34:25] [SPEAKER_01]: How does the fiscal side make its way into how you think about growth dynamics,

[00:34:29] [SPEAKER_01]: inflation dynamics and the Fed's mission?

[00:34:32] [SPEAKER_00]: It's interesting that you mentioned the mortgage market.

[00:34:34] [SPEAKER_00]: It's so true.

[00:34:35] [SPEAKER_00]: And that's how I think about the credit cycle.

[00:34:37] [SPEAKER_00]: Usually at this point, after 550 basis points of hikes by the Fed,

[00:34:41] [SPEAKER_00]: we would have some form of credit cycle,

[00:34:44] [SPEAKER_00]: meaning you would have some default in the most risky assets,

[00:34:47] [SPEAKER_00]: leveraged loans, high yields, emerging markets.

[00:34:50] [SPEAKER_00]: We haven't seen it.

[00:34:50] [SPEAKER_00]: Same thing with the mortgage market.

[00:34:52] [SPEAKER_00]: And why is that?

[00:34:53] [SPEAKER_00]: It's because the Fed kept rates for so low for such a long extended period of time

[00:34:56] [SPEAKER_00]: that smart guys and gals what they did was refi.

[00:34:59] [SPEAKER_00]: So the effective rate is so low,

[00:35:01] [SPEAKER_00]: it makes very little reason to sell your house

[00:35:04] [SPEAKER_00]: when you can't buy an equivalent comparable equivalent because prices have surged

[00:35:08] [SPEAKER_00]: and you would lock in a rate that's two to three times what you currently have.

[00:35:13] [SPEAKER_00]: So same thing with the high yields.

[00:35:14] [SPEAKER_00]: So what corporates did was they pushed out the maturity wall.

[00:35:18] [SPEAKER_00]: So we haven't seen that credit crunch.

[00:35:19] [SPEAKER_00]: Doesn't mean it won't happen.

[00:35:21] [SPEAKER_00]: It just means it hasn't happened because there was that refinancing opponent.

[00:35:24] [SPEAKER_00]: But I love the fiscal part of the conversation.

[00:35:27] [SPEAKER_00]: I think it's so important to talk about it because I think it doesn't get enough airtime.

[00:35:30] [SPEAKER_00]: When I look at interest expenditure of our country versus GDP,

[00:35:35] [SPEAKER_00]: it is just skyrocketed.

[00:35:37] [SPEAKER_00]: I mean, it's just a very little, very, very little acknowledged visual.

[00:35:41] [SPEAKER_00]: But I have it myself and back in 2022,

[00:35:45] [SPEAKER_00]: interest payments as a percentage of GDP in the United States were a little under 2.4%.

[00:35:50] [SPEAKER_00]: And that has jumped to 3.8% in about a year and a half.

[00:35:56] [SPEAKER_00]: Of course, we have to issue debt to cover our massive deficits.

[00:36:01] [SPEAKER_00]: We've never seen anything like running this level of deficits in an economy

[00:36:04] [SPEAKER_00]: that has completely covered its output gap.

[00:36:08] [SPEAKER_00]: So we're in a positive output gap now.

[00:36:10] [SPEAKER_00]: And at the same time, and this is a point I'd really like to make

[00:36:13] [SPEAKER_00]: and thank you for giving me the opportunity to do so,

[00:36:15] [SPEAKER_00]: is that China is holding fewer US treasuries in elastic to price.

[00:36:19] [SPEAKER_00]: So you have price sensitive buyers gaining proportional importance

[00:36:24] [SPEAKER_00]: in terms of treasury holdings at the expense of price insensitive

[00:36:28] [SPEAKER_00]: or price in elastic buyers.

[00:36:32] [SPEAKER_00]: Price in elastic buyers are central banks.

[00:36:35] [SPEAKER_00]: They're the Fed, it's China, it's Russia, it's Saudi Arabia.

[00:36:38] [SPEAKER_00]: These are entities that are buying fewer treasuries

[00:36:41] [SPEAKER_00]: at a time when we're issuing more of them.

[00:36:44] [SPEAKER_00]: And we need to issue more because we have enormous

[00:36:48] [SPEAKER_00]: fiscal deficits.

[00:36:50] [SPEAKER_00]: And so this to me just says structurally term premium,

[00:36:53] [SPEAKER_00]: we're just going to go much higher and it leaves US treasuries

[00:36:56] [SPEAKER_00]: to be increasingly absorbed by price sensitive buyers,

[00:36:58] [SPEAKER_00]: which are you and me.

[00:36:59] [SPEAKER_00]: We care about the price.

[00:37:01] [SPEAKER_00]: Fed doesn't care about the price.

[00:37:02] [SPEAKER_00]: China, Russia, Saudi Arabia, they don't care about the price.

[00:37:05] [SPEAKER_00]: So since the US put sanctions on Russia, what happened?

[00:37:07] [SPEAKER_00]: China said, hold up, if I'm not in the friend zone,

[00:37:09] [SPEAKER_00]: I'm vulnerable here.

[00:37:10] [SPEAKER_00]: So what did they do?

[00:37:11] [SPEAKER_00]: They started buying gold.

[00:37:12] [SPEAKER_00]: And that's why gold went up.

[00:37:14] [SPEAKER_00]: It's not because retail guys and gals were holding gold.

[00:37:16] [SPEAKER_00]: It's because the central banks were holding gold.

[00:37:18] [SPEAKER_00]: So when I look at those numbers, it causes me concern.

[00:37:21] [SPEAKER_00]: And I have to tell you, I do also like gold as a defensive.

[00:37:24] [SPEAKER_00]: I think it makes sense.

[00:37:25] [SPEAKER_00]: I think people are going to start looking at it increasingly so.

[00:37:28] [SPEAKER_00]: But when you look at Federal Reserve and foreign central banks,

[00:37:31] [SPEAKER_00]: together they owned a combined 70% of US treasuries in 2015.

[00:37:36] [SPEAKER_00]: Now combined today, they own less than 50%.

[00:37:39] [SPEAKER_00]: So treasury issuance is, as I mentioned,

[00:37:42] [SPEAKER_00]: being increasingly falling on price sensitive domestic private sector.

[00:37:47] [SPEAKER_01]: There was a Bloomberg article months ago about essentially three or four people

[00:37:53] [SPEAKER_01]: at three or four giant hedge funds being responsible for an incredibly sizeable amount of

[00:38:01] [SPEAKER_01]: the bid to treasuries at auctions, essentially setting up the cheapest to deliver basis trade.

[00:38:08] [SPEAKER_01]: That's the buyer base.

[00:38:09] [SPEAKER_01]: They're buying it against another asset.

[00:38:11] [SPEAKER_01]: They're not buying it because they see value or business plan and rectifying what you rightly

[00:38:17] [SPEAKER_01]: identify as pretty scary interest rate dynamics.

[00:38:20] [SPEAKER_01]: It's just shocking to me, the CBO forecast this stuff out.

[00:38:24] [SPEAKER_01]: And even without superimposing the inevitable, which is a recession and tax receipts falling,

[00:38:32] [SPEAKER_01]: the numbers even without that look absolutely frightening.

[00:38:36] [SPEAKER_01]: And so I think when you talk about term premium, and I think some of your work on curve steepeners

[00:38:43] [SPEAKER_01]: as a defensive asset also, I think that resonates quite a bit with me.

[00:38:49] [SPEAKER_01]: So interesting, such an interesting time.

[00:38:52] [SPEAKER_01]: And I think Catherine just to be able to have this cross asset framework and bring it all together

[00:38:57] [SPEAKER_01]: makes a real value.

[00:38:59] [SPEAKER_01]: I really enjoyed this conversation.

[00:39:01] [SPEAKER_01]: I'm very glad we had a chance to connect and learn a little bit more about

[00:39:06] [SPEAKER_01]: how you think about the world, the work you're doing at StoneX on behalf of your clients.

[00:39:11] [SPEAKER_01]: So Catherine, thanks so much for taking the time.

[00:39:13] [SPEAKER_00]: Dean, my absolute pleasure.

[00:39:14] [SPEAKER_00]: Thank you so much.

[00:39:16] [SPEAKER_01]: You've been listening to the Alpha Exchange.

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[00:39:25] [SPEAKER_01]: As we aim to utilize these conversations to contribute to the investment community's

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[00:39:39] [SPEAKER_01]: Thanks again and catch you next time.