Where's the Pain Trade? Welcome to Trade Ideas. I'm Alex Rosenberg here with Michael Purves of Tallbacken Capital Advisors. Before we get into everything, we're going to talk about today, what's a Tallbacken? Thank you for asking. Thank you for having me back, Alex. So Tallbacken is the name of my new firm. It's an obscure sweetest phrase referring to a null with a large pine trees on it. Actually, it's a slightly obscure reference but when I'm fond of. As you know, for the last several years, I had been at Weeden company broker dealer. The way the sale side is changing, is that it's really bifurcated. There is either trade execution over here, if you will, which is increasingly favoring large scale, heavy technology or there's just content. There's an unbundling of how content and trade execution is happening. So for me, it just looking prospectively, looking at some of the trends in Europe with method and so forth. It just made, it was eminently clear that just going to a pure content model that were the institutional clients are just paying a monthly or quarterly fee for high-quality advice. Let's get some of that advice here. Okay. Last time you roam within June, you talked about this divergence between what the bond market and what the equity markets seemed to be looking at. You said it was almost like they were looking at two different sets of economic data with the bond market looking for much slower growth maybe even recession, equity markets a lot more sanguine. A lot's happened this week. We've gotten the Fed statement, we got Powell talking about how he's insurance cut, we got another tweet about tariffs from the president, and then today, Friday, we got to jobs some of it. Pretty good overall, pretty substantial wage growth at least. So given all that, who has the upper hand? Who's winning this fight between stocks and bonds? I think one of this enduring things is this enduring gulf between the bond market. When I say the bond market, I'm talking about the treasury market. On the one hand, then, the equity market. I'll put credit with that as well, high yield investment grade credit over here. You asked me who's winning? Well, in a sense I guess they're both winning, because the S&P have 20 percent year to date. If you went long treasuries, you've been doing great. But within that both are winning condition, the question is, what is the story between those two? Because still, Apollo gave us 25 basis points and it would seem to be a little bit more of a nudge that, "Hey, we're not starting a cutting cycle but, we can easily do more than just this one cut." So between those two areas trying to thread a few different needles, which was quite candidly. For all the criticism, the Powell gets. He has a very hard job. When on the one hand, there's an enormous gulf between where the rates markets, the bond market, the treasury markets decided to go over the last several months. On the one hand, there where his economic forecasts are. Which are pretty much by the way right in line with Wall Street Consensus forecasts as well and most other institutional forecasts, whether it's IMF or World bank, and so forth. There are variances, but they're usually marked by 10 or 20 basis points in terms of 20-20 GDP in inflation. Then, on the other hand, Powell also has to fight this battle in a sense with the White House. Because sure enough, right after Powell came on Wednesday, there was [inaudible] out there commenting that, "Hey, look he's not playing ball here." This morning, Larry Cutler was in the media discussing how lucky that we've had highly restrictive monetary policy for the last two years. So he doesn't have an easy job. He's fighting a war on two fronts, the White House and the markets. With a huge gap between that, I think it's how this gap gets resolved is going to require a lot of finesse from Powell. Finesse that a lot of people would say he hasn't actually mastered yet there. But frankly, you could have the most articulate and nuanced Fed chair ever in this role. It's a hard job to navigate that. Because on the one hand, if he doesn't give us a cut in September because the economic data is strong and the bond market is still heavily bullish raids, meaning they're expecting yields to be lower for longer across the curve. Well, that's almost giving a rate hike in a sense to the markets in terms of its jarring and therefore, he drives up the VIX. He's going to put a little bit more financial stress and it's a little bit circular, because there's enough financial stress as one reason for him to cut. It's a very difficult condition there. I think there's another dimension of this whole rates rally here, which is really important. I've touched on it in June, but I think it's worth talking about again. Which is that the global rates market has been one that's been even more extreme, of course. Look at the bond market where 10-year bonds, or minus 40 basis points, say keep. Somehow making fresh loss. Now, we can debate the economic rationale, buying a bond for 10 years with a negative 40 point yield on it. But nonetheless, that's where the markets are actually pricing that particular security. So one of the things that I think is a real conundrum for Powell is that, he's talking about rest of world issues, rest of world weakness, Euro-zone, China, and so forth as being this principal rationale for the insurance cut we just got. Effectively, for any dovish policy, we get prospectively. But my question to Powell would be, but sure a bit, a lot of that stuff is already reflected in this foreign bond markets. So would bonds are crazy low, that's reflecting real bad, real persistently weak economic condition in Germany and Europe, and so forth. Those bond yields have been dragging down our treasury yields with it right now. Clearly, there's the treasury market, the Eurodollars' market, the Fed funds markets are very focused on what Powell's policies going to be with respect to the Fed funds rate. Nonetheless, the correlation between the bonds and the 10-year treasury yields has been spiking hugely as both yields came lower together. There's always some correlation, but the correlation are really, really strong here. So play out a scenario into later this summer or fall, where it sounds hard to imagine right now. But what if there's a big economic uptake in some of the Euro-zone data? What if those bond yields start climbing back to zero or up to positive 10, 20, 30 basis points? Where they were for a lot of the last several years? Even though the Euro-zone data never got that great. In 2017, it was picking up but it never really got back up. But still from minus 40, 60 basis points, is the scenario you have to consider. Given how strong the correlation has been with rate's coming down together, is that going to lift the, certainly at least the 10-year backup. Also, not only re-deepen our yield curves, but also throw yet another monkey wrench into how Powell is processing all this data and all this market data, economic data, and the market data. So if it seems like the bond market and the stock market are looking at different things, perhaps is because they are maybe rings and the economy in the US is strong enough for equities to remain bid while the bond market, that's a pull in investors are thinking, "Do I want to buy US Treasuries or do I want to buy bonds at negative rates?" So I guess if you're thinking about the chance of improving economic data in Europe, leaving those rates to go higher obviously, negative for the bond market in the US as well, I guess, how correlated do you think that global economic data is? Especially, we're in a world with deep increasing trade tensions, increasing divergences between the political outcomes. I mean, just look at Brexit and all the other things that are happening in Europe, that are not necessarily related to what factories are producing in the US. Yeah. I guess how does that economic correlation playing into the market correlation? Yeah. That's a great question. Thank you for asking it. But the stock answer about the US, is that we're relatively insulated, relative to certainly economies like China, the Euro-zone and so forth. It's just we're a lot more self-sufficient and that's true. Having said that if you talk about the US Equity complex, that is not insular. I mean that is, for discussions, I just pretend the S&P is one giant company. It's a global multinational company, where nearly 50 percent of its revenues come from overseas. Right. So even if our economy is more like 25 percent, the S&P is more closer to 50 percent. Right. So when you talk about the U.S economy and you talk about the U.S stock market, you have to first start with appreciating that difference there. The other thing you were touching on, is that this economic correlation across countries, and clearly the U.S has been the out-performance story relative to the rest of the world, still is, that's sort of saying the pace of it that these correlations are relatively weak. But there's also things that tend to lag. The correlations have been remarkably strong between Euro-zone, particularly a lot of the German manufacturing data and a lot of the Chinese economic data. Right. Those correlations tend to be really stickier and stickier. So in the mist of this global situation where stocks and bonds, and maybe looking at different things of how the global economy is as we discussed, where is the greatest pain trade, do you think? Is it in stocks, is it in bonds? Yeah. Or is it in some other asset, and which way does that go? It's hard to figure out how people are, when so many people are looking at different things, it's not like everyone's on one side of the board necessarily. That is a great question, like several minutes ago you asked me, "So who's winning, bonds or equities?" I said both. I would say though, in terms of where the Pain Trade is, and I think that's a really good question and a way to frame this discussion; where is the asymmetric risk to the downside? I would say candidly it's a tough call to make, given how strong this bond market rally has been. But to my mind, I think there's still a very good case for rates in the United States to be going higher here. We talked about some of those scenarios where, what if the Euro-zone data gets better? What if the China's stimulus starts taking hold and that ricochets into the Euro zone data, and that lifts yields higher that will be exported into our market over here, and then you'll see a quick rise up higher here? At the very least, there's a lot of sentiment buildup on that whole Treasury notion, 10-year yields are going to one percent and all that and some people are even saying zero percent. I'm not quite convinced that's the case. Then, when you talk about, where are people, how are people positioned? Well, look at the Euro dollars positioning. If you look at the net speculative positioning relative to the total open interest, they're at 70 or high. Basically, post great financial high. So basically, in the money markets, everyone and their grandmother seems to be long Euro dollars right now. That to me is a risk factor, that people are heavily on one side of the boat. Equities on the other hand. We've had a year-to-date rally, 20 percent, we came off those December lows, we're supposed to be this ''My God, we're going to be part of that whole like, we have trade and pals are going to hike us into a recession." We've had a really solid risk rally here, but I'm not convinced that it took everyone with it, I don't see a lot of sentiment gauges where we're like, "My God." It's not like every taxi driver started screaming about, get it long in Amazon. That condition I don't see it either in the retail space or the institutional space, right now I think there's that, partly because of this bond market bid, there's a healthy skepticism about, "My God, do I really want to play here, do I want to be buying the market 20 percent up year to day when the bond market seems to be telling me is, there's recession in 2020." So I think a lot of large-scale allocators have been de-risked equities last year, thinking it was top the thinning of this economic cycle, and some of them have come back in, like the Norwegian Sovereign Wealth fund was public about buying that dip on late December, which [inaudible] y was a brilliant trade. But I don't know how many of them are there. I think there's a lot of people that are still being very careful with risk right now, which means that there's room for the market to rally further, or at least that if it does sell off, that maybe perhaps then those guys will come back in and be dip buyers. So I think right now my landscape is that, if there's asymmetric risk to the downside, it's more on the bond market than there is in the equity market. I think people are really going to appreciate this perspective, because we've had a lot of people come on real vision to be on, what it sounds like, is the consensus at trade. John Burbank coming on talking about buying call options on Eurodollar futures for instance, which is his way of play, this potential recession, lower rates even going down to negative rates potentially outlook. Yeah. So first of it'd be really great to hear the other side. I think it's really useful just from a high level. If you were to advise anything tactical to play off of this allegation and this idea that people are playing for these lower rates, that if data turns round especially in Europe, it could really turn the other way first. How would you think about that tactical? Well. I think look if you're using ETFs simply speaking, you can look at the TLT and shorting that or buying puts on the TLT would be an obvious way of rates going higher in the United States play. With inequities, I think if rates do go higher utilities will have an extraordinarily aggressively bad, just like Euro dollars have been aggressively bad. It's effectively the same trade. Those have a lot of torque to the downside if rates do in fact break, the getting long banks would probably play as well, particularly if the back-end increases higher and you see those yield curves in arranging a little bit more dynamically to the upside. Very good. Well. Michael, thank you for sharing this contrarian perspective. I think the way you look at the world and make sense of the way assets are correlated and the way economies make sense together is just going to be really useful for folks. So Michael, thank you so much for joining us. So Michael fears bonds may be over bought and specifically, he thinks the potential for an uptick in global economic data could drive treasury yields higher and bond prices lower. He recommends playing the set-up with put options on the TLT. That was Michael Purves of Tallbacken Capital Advisors. For Real Vision, I'm Alex Rosenberg.