Oil vs. the Yield Curve Welcome to Trade Ideas. I'm Alex Rosenberg, here with Nick Colas, Co-founder Datatrek Research. Nick, thanks for joining us today. Absolutely. Today, as we're recording this around midday, S&P up about one percent seems to be a pretty good day for the markets. As you look at these moves today, but over the past few weeks really, what questions do you think the market is trying to figure out and decide as we see these big vacillations, the upside and the downside? Of the biggest issue, the last score is 72 hours and will be the case for the next day or two is what is J-Pal going to say at Jackson Hole? Fed funds features clearly think the Fed is going to cut rates by 25 beeps at every meeting through the rest of the year. It's a very specific outlook the Fed funds features, and it's really coalesced around that expectation and the past call of the week. Before then, people were thinking maybe at 50 some point or not. Now, it's very clear; 25, 25, 25. Markets are setting up to want to hear that from power on Friday. Trouble isn't probably not going to say that. Now, it's interesting because when your colleague Jessica was here two weeks ago, she talked about looking for expectation of a 50 basis point caught at the next meeting, as one of the things you would want to see in order to know that that market was bought and that it was a dip to buy. So we're not saying that. What does that indicate to you about the path between here and that meeting? Yeah, exactly right. It tells me that we're still in a for more volatility. I think the market said, okay, 50 is off the table. We get that, that's too extreme. But how about communicating to the market that you're there for the market by cutting rates consistently and not being a one-end done or a mid-cycle adjustment the way Paul described it at the July 31st Fed press conference. So markets are shifting, still hoping for some relief from the Fed, but at the same time, how do the Fed's going to go that far out on a limb when things still don't look all that bad and according to the data that they watch? Now, I'm glad we have you here because you're known at least to those of us that the financial media community for finding different ways of looking at what's going on the economy. Unconventional ways, I think you've looked at Berger sales, you've looked at I think blood plasma, plus salespeople selling their own blood. What are those Google searches as well? What did those indicators tell you about where we are if this is an economy where it's appropriate for the Fed to be continuing to eat? Yeah, you're right. We look at the standard data, but we also spend a lot of time looking everywhere and anywhere for anything that might give a tell on the economy and find an edge on that topic. The thing that we look at right now, a lot is Google Trends, is something that any one of your subscribers can do. Just go to Google Trends and you can see how many times a given word is searched for. The two we look at most often right now is the word coupon and the word unemployment. Coupon indicates the beginning of some stress in household budgets. Perhaps, because somebody is not working as many hours or somebody has lost a job. Unemployment is a good leading indicator of when people begin to fear unemployment. These were two things that began to take higher ahead of the last recession, long before the yield curve inverted, long before anybody was talking about it, and it gave a nice about six month window where it was taking higher. You could say aha, there's something going wrong. There's something amiss in the US economy. So far, Google Trends for coupon and unemployment are both rock solid or declining. So again, shows at least from that level, consumer confidence were not yet clearly going off a cliff. We had some retail earnings that were pretty that surprised the market to the upside as well. So indications about the consumer may be it'll look a little better now than perhaps a month or two months ago. It does feel that way. Look at it should feel that way. We still do have very low ozone employment. We have some wage growth that we have in the last cycle, one percent then, three percent now, but still pretty good. Confidence should be good, be really worrisome if you had a lot of big retailers at some point in this. On the other hand, the market signals have been less good. A lot of people learned what the yield curve was. Over the past week, I was watching the Sunday morning politics round table shows and people try to explain the yield curve, was a little bit painful I have to say, but as that's come to the fore as a potential indicator of recession as a signal that's always worked apparently, what do you make of that whole debate about the importance of it this time around? It's an interesting indicator and certainly has somewhat a track record. For the same time, my personal view, it is super lazy to just look at the yield curve and say, "Aha, recession is coming, turn out the lights, sell your stocks and go home." There's so much more in the economy that matters than just interest rates. What are the some of the things that we're now looking at as much that perhaps we should? Look, the key issue is oil prices. Because yes, the yield curve is inverted ahead of every recession since 1973. But if you look at the change in oil prices, year over year, over the entire timeframe from 1970 to now, you will see that ahead of every recession, every single one, oil prices doubled over the course of a year, and sometimes a lot more in going into the Saudi embargo and 73 oil prices actually went up by 500 percent. Then ahead of the Russian revolution, in '79, same thing. When Iraq invaded Kuwait, same thing. Even in 2007, people forget, but oil prices hit $140 a barrel and had doubled over the course of a year. So it isn't just enough to say, "Okay, we've got the yield curve inverting. Therefore, recession is inevitable." What we don't have is oil price is doubling. We don't even have oil prices going up, they're going down. If you ask the average person on the street, what's the Fed funds rate? They will look as you like you have two heads, but if you ask them, how much they pay for gasoline last week? They would know down to a nickel and they would know the general trends. So to my thinking, it isn't just the yield curve, we have to look at fundamental factors as well. Oil prices are just as good indicator of future recession risk as the yield curve. I think a lot more explanatory about how consumers really behave. This is a very hard question, but help us explain the relationship between the shape of the yield curve and oil. Is it not coincidental that the yield curve tends to invert as we see oil prices spike? Yeah, no. I'll put it this way. An inverted yield curve is like a lot of dry tinder sitting in a fireplace. The spike in oil prices is the spark that actually gives us the flame for a recession. So right now, yes, a lot of dry tinder around. That's why the market is volatile and rightly so. I don't want to dismiss what's going on, but at the same time, if you want to tie it to an actual fundamental issue that matters to everybody. Oil prices is in the look out and oil prices is simply aren't providing that spark right now. It seems to me at least that you always hate to say that we can't have a geopolitical event that sends oil price to make predictions about this can't happen because it's easier to remember those. But it seems to me that we're just in a different world when it comes to oil, where Strait of Hormuz is in the headlines again, yet oil prices don't care, the market doesn't care, it's a geopolitical story rather than an economic story, just because the US makes so much more oil than they used to. I guess, when you look at oil specifically, if that's going to be the oil that likes this spiral up to continue the metaphor. Do you see anything that would indicate that oil prices would spike and that would set this Tinder ablaze? Yeah, okay. I think you've got the right sentiment about it, which is you can never say never. It certainly could happen. The Middle East has been a geopolitical mass for my entire lifetime, 50 plus years and I don't think it'll change over the rest of my lifetime. So is there a lot of risk to it? There always will be. But you're right. Oil production in the US has roughly doubled over the past decades. So we have a brand new technology that gives us a better supply. That does at least alleviate the worries about availability, which really is what killed the economy back in '73, and '74, wasn't just prices, but you couldn't actually buy the stuff. So now we have a better setup, is not a foolproof setup, but it's a better setup. The one other thing I'd say is, look at energy stocks, energy stocks even five years ago where 10 percent of the S&P. Now, they struggled to hold five percent. That group is super beaten up. So in terms of thinking about how you hedge and how you think about risk, one thing you might want to be stay long at least neutral weight is energy, because then, if you do get something bad that happens in the rest of the market pulls in, energy stocks will at least finally start to work. Five percent of the S&P, I think is a record low. I don't think it's ever been lower. Yeah. Maybe it goes to three, but if things do spark up and at least, it goes to 10 again. If you were concerned, what other sector would you pair against that as a sector to maybe underweight? Consumer discretionary, tech, anything at the top of the cap table based on the S&P is going to wax. Correlations between the different sectors run heaviest in technology right now and in consumer discretionary. It might also look at Staples is defensive as more of a yield play, energy is that geopolitical hedge. Gold obviously, should work as well. It's interesting. We've heard a lot of ideas for hedges, recently as people were worried about this chance of a recession and we've heard about Eurodollar futures, and we've heard about volatility, and gold certainly has come up as well. But going along energy as a way to almost, I've heard of energy as a revenge trade where you go long energy in case your oil prices go up, but as a way to hedge against the broader market is very interesting. So Nick Colas of Datatrek research, thanks for bringing it to us here real vision. Thank you.