260681662 - 1_042ndgw5 - PID 1851201 Welcome to religion daily briefing. It's Friday, June 17th, 2020 to I'm Ash Bennington, joined today by Michael guy add, Portfolio Manager at two Rosso investments, where you're going to get to Mike on just 1 second, but first, a quick look at what's happening in US equity markets. Nasdaq composite is the big mover on the day one spot 6% up 1.6%. Everything else I would call like relatively flattish S and P 500, up about two-tenths of 1% on the day. But I wanted to take a look here at the weekly numbers. This is where the action is obviously an eventful week which we're going to talk about shortly. Nikkei, on the week, minus over 5% Euro Stocks 50 down about 4% on the week. Nasdaq on the week, minus roughly 13 quarter percent S and P 500 off over 4% on the week. Dow Jones Industrial Average off 4%. Russell 2000 off a shade under 6% on the week, nearly 6% decline in the Russell 2 K Michael guide, obviously an incredibly eventful week. The Fed hiking 75 basis points to target range of one spot five to one spot 75 on the federal funds rate. Lots of price action, lots of volatility across asset classes, fixed income equities and crypto, especially what's your overall frame for what's happening here? What's your big picture? Narrative, Michael? Yeah. So a few things. The peripheral I a I was early in saying that Monday, but I do maintain this belief that I think probably at some kind of a near term capitulation type of moment for both equities and bonds. As much as it's been, this has been a wildly difficult, painful week. I just saw a tweet from an old friend, Ryan Dietrich, who noted that the last time you had performance like this was pretty much a major lows. March 2020, 2011 following the summer crash. And I think it was a juncture in 03 I think he mentioned March March of phone own 09 rather. So as painful as it's been. My framework here is very simple. Everyone's convinced that things are only gonna get worse. Everyone maybe right about that. It doesn't mean they have to be right tomorrow. And you've already had so much destruction and devastation beneath the surface and there's enough indicator to you that would suggest you're probably at a bottoming of risk assets and the risk-free assets, meaning treasuries that the surprise me and a being that you end up having some positive catalysts nobody's thinking about, which could cause markets to rip higher and which would give the Fed some time to try to counter these concerns about hiking rates. Yeah. So we started with talking about stock markets, kinda jumping right to the effect over the cause. Let's talk about fixed income, bond markets, bills, notes. What are you seeing there? How do you frame it, particularly for equity investors who may not pay as much attention to the bond market except when things are moving. Yes. So credit spreads are now winding. They're not blowing out in a big way, but credit spreads basically, you think that is the differential between poor quality issuances versus high-quality risk-free type of treasuries, AAA versus triple C. What are abatement? The spread is Whiting right now. Usually, that is consistent with risk off periods because when you have high vowels, audience stocks spreads widen because there's suddenly fear of default risk premiums increasing. And the higher the interest rates go, the more the default risk premiums probably do increase. Because we know there's a lot of zombie companies which should no longer be around that have been alive, only kept the livelihoods of cheap credit. Right? Now. The problem that the Fed is going to be faced with, which is why I think you're going to probably have some kind of a, some kind of positive catalysts coming soon is that the wire credit spreads get, the more default risk reuse increase, the faster that brings down inflation probably at a speed that the Fed does not want to see. All right? Because if you were to have at some point real refinancing risk by some of these companies on higher rates to the point where these companies may not exist anymore. Well, that's a deflationary shock, right? That's a real deep recession. Unemployment suddenly pick it up. So my point here is that I think we are nearing a juncture where the Fed is going to start to try to cool off risk assets again to buy them time. Because if he were to persist at this rate, the reality is you risk a much deeper decline then what the Fed is hoping for with a soft landing ish type of, type of future. Yeah, let's, let's focus a little bit on credit spreads, particularly for people who don't have a lot of experience in the fixed income. We're talking about spreads between, for example, a triple B's and WA credits. Give us a sense of first of all, what this means, why we see these spreads rise and what metrics you look at specifically to determine where were you see the benchmark being for credit spreads. Yeah, so, so it's ultimately about the market's perception of whether a company is going to survive or not, which is the default risk premium, the risk of bankruptcy. Typically, companies that issue a lot of debt and don't have necessarily the right balance sheet, will be rated lower because the risk is higher, right, in terms of their ability to pay off that, that liability. The initial phase of this decline in risk assets this year, bond sold off very aggressively. But what was odd is that you saw a bond selling off with a credit spreads really whitening. Meaning you end up having a strange scenario where it was more about duration and conservative bonds and are doing far worse than on a relative basis. Them high yield junk debt issuances. This second phase here seems to be more classic in that sense that now spreads are widening as bond markets across the globe are still selling, often yields are rising. The Fed does not really care so much about the stock market only to the extent that the stock market impacts the bond market. That's something that I think a lot of people really don't understand when they say they care about the **** cares about markets. What they really care about is spread movement because if spreads wide and that means there's liquidity that's harder and harder to get because there's a degree of fear that's even getting priced into, into bond yields. And that's often where you end up having me about faced by policymakers. Yeah. So let's talk a little bit. When we talk about duration, we talk about what's happening in government treasury markets right now, I'm looking at a chart in front of me. This is the US to year treasury yield chart. I'm looking here to date. Boy, it's, it's, you know, this is not unexpected given what we've seen from the FOMC. But you're looking at about two hundred and forty two hundred and forty basis points or so, coming starting in the year at about 75 bits there about trading right now at a yield of 3.1. So obviously, you see these, these, these, these rates rising very dramatically, the yields rising very dramatically down to your treasure is talk to us a little bit about the transmission mechanism and the impact that you see that happening. Yeah. So it's actually right because the, the, the real transmission mechanism isn't really from a shorthand is from the long end. It's because the 30-year which is, which is which is what housing mortgage rates are ultimately based off of. It's what a lot of longer finance type of projects assets are financed off of. So when you see a real spike in the long end of the curve is where it really gets to be dangerous. And I've used this line many times on Twitter before that. This has been my ****, right? In the sense that I've got these three funds. You see in my background, eight extra row, Jojo. All three funds are designed to benefit from this historically proven relationship where when stocks go down and there's high volatility, Treasury yields drop on the long end. Treasuries actually do well as the so-called quote unquote risk off, safe haven asset. Instead of risk off has acted like risk on. The curation has been pretty much one for one, the drawdown in equities has matched and in some ways it's been less than the drawdown and treasuries, which is really normal even though from the seventies that transmission mechanism, right? Wow, that translates ultimately into the economy is in the price homes, right? Which I think now it's very clear we're about to see a pretty significant at about face. I do an under these spaces like you guys do. And I had a home builder analysts on earlier today. And he was saying, yeah, no, there's like there's like a very sudden and aggressive slow down. The demand just suddenly dry it up and makes sense because now mortgage rates are so much higher than they were at the start of the year. Now, just like the saying is that the Kyoto high prices, high price when people talk about it for commodities. Or the cure for high price of cost of capital is high price for cost of capital, meaning at some point, the market is going to see this spike in yields as being an opportunity to actually bet that they go down again because of the sudden realization that you just killed off housing. Yeah, by the way, we should talk about us 30 year treasury yield jumped right now. Trading on a yield basis at about 3.28%. That's up about a 120 basis points from the beginning of the year. So you see that obviously more sensitivity to the front end of the curve, which is of course to be expected. Fed has a great deal more challenge with the backend of the curve. But let's talk about the real, real quick. I think it's, it's an important thing you just kinda allude to that the challenge or the back of the curve where the quantitative tightening, right, because I would argue could be a positive catalyst, which nobody's really anticipating. The Fed wants to lessen the balance sheet, right? They want to unload some of these bonds, okay? That's what quantitative tightening as well. Good luck doing that with this type of a disruptive environment happening in bonds, right? They'll make it even worse. So they say they're going to be fixed amount per month. It seems very plausible to me. And I think this is actually going to be a very positive catalyst. If that's the case. It seems plausible to me that the Fed is going to change the way they plan on doing quantitative tightening. Whereby instead of a fixed amount per month, it's a range. But I think the ECB recently alluded to this idea that they're going to have a range of, of the cell off of their balance sheet per month. If you make it variable based on quote unquote market conditions, if the Fed were to allude to that, that would probably stabilized bonds do a lot to stabilize bonds because then the feeder suddenly comes out that the Fed will look at pressure to issuances when bond yields are spiking. Well, if they're going to be dynamic. And with which they they do QT. That would take a lot of fear out. I think. Yeah. What we're talking about debt. I wanted to take a listen to a conversation on religion that touches on something that you and I talked about, Michael on our Twitter spaces. This is from a conversation called great traits during tough times Lessons from a Master, Mark Ritchie, The second hosting, hosted by Mark Ritchie. So father and son conversation here. This is available on the plus and pro tiers. Let's take a listen. Right now. Everybody in this country has some debt. We've all got some debt, whether it's car, dad or house debtor or credit card debt or something like that. It's debt we can manage. Do you think anybody in Washington knows how to get this government can deal with? I'm going to answer that because I think everyone else, of course you're not. Yes. It's a rhetorical question. It's a rhetorical question. So you ask the question, how bad can things get? You know, I was in the pit when somebody came along and told me that the Federal Reserve had just raised the interest rate from 22 to 24 percent. One-shot. That's what it says. The advantage that it's a specifically being old, I then nobody in this room can remember that I'm proud of as yet. That's for sure. Can things get worse? Oh my gosh. Certainly. So Mark Ritchie senior talking with his son on real vision, talking about debt Michael, you and I just talked about this on our Twitter spaces. In essence, they're discussing the challenges of a rising debt stock. Give us a little bit of context on what some of the risks are there. Well, okay, So this is this important, and this is why I, I put out a tweet not too long ago saying be careful what you wish for on the narrative that 60, 40 is dead. Because when you have rising debt and spending which is not ever stopping, and you have higher interest rates and you have collapsing risk assets. You have a double whammy that only makes the debt load increase even further, right? Even in the absence of new spending, which is to say that you have, you'd have to keep on rolling over that, which means the cost of capital, the interests, ends up being a lot higher. So you gotta, you gotta pay for higher cost of capital. And then again, it free verse gases don't rebound yet. Capital gains receipts are going to be a lot lower. You're going to have higher unemployment. So you're going to have a double whammy on the deficit, right? This is the challenge of the Fed ultimately has to face because they've got to stop the inflation monster that you can argue they created. They also have to try to buy time for supply chains to resolve themselves. But they have to also do so in a very gingerly type away, which is I believe a CFA Level 4 term. Gingerly to have a way to make sure doesn't cause a real, real systemic event for government debt. Now you can argue that because of the reserve currency, none of that matters. Well, we know that's not true because look at where we are now. Yeah, like I want to do CFA Level 6. That's the that's the easiest one. Yes. Is you never have to sit for it. Michael, what else is on your dashboard as you look at these markets, as we talked about the top of the show, obviously a lot of moving parts, a lot of moving pieces. Tell us what else you're looking at right now. Alright, so let's talk about sentiment for a moment because again, this has been a very difficult and frustrating environment, have gone through severe drawdowns in my funds. And anecdotally, I would say that I had a few e-mails from shareholders in my funds saying that your approach has not worked for a year and a half, this market going a lot lower. I'm going to bomb out of your mere strategy. Now, I've seen this before. I've seen when the sentiment is so vitriolic and to the point where was literally insulting me as a portfolio manager when it's a rules-based approach where I am like everybody else just watching. What the rules are saying is far to where to allocate for eight x rho of Giotto, what you're going to have nasty drawdowns. But the last year and a half has been very unusual. And this year it's very clear it's an anomaly in the White Sox and treasures obeyed. Okay, so I've seen that when you have sentiment that so vitriolic and end points of the person, not in the context that tends to be a major inflection point. Now I can't prove that other than to say subjectively, I've gone through that, that before. But let's think it's but then another flame, the flame index. Yeah, right. Right. But let's talk about the numbers. So sentiment, is it a wildly negative, right? And the people we say that when you see simply being negative and equities, it's a time to buy S10. They never seem to apply that to fixed income because they're sedimenting even worse when it comes to bonds which have gone through an auteur crash with this yield spiking. I think the market and individuals are underestimating the potential for some positive catalyse. All right. That there could be the surprises on father Suarez don't always have to be negative, right? You can't have these partners prices, okay? So I mentioned one of them earlier, which is there's a positive surprise of the Fed could cool off concerns about a fixed amount of selling of bonds through cutie to somebody. It's more variable. Alright, that alone will probably be a positive catalyst for stocks and bonds because I suspect that if you're going to have a reversal, it has to happen in both asset classes because they both went down in the same way. Alright, so the initial recovery would probably be on both treasuries and stocks. Okay, so that's one positive for that trick Alice. Another one is, which may explain some of the oil move. Is oil could suddenly break down because let's face it, and Biden needs a when he's going to Saudi Arabia next week. Now I hear everybody's arguments around capacity. I'm fairly confident that if if opec wanted to find more capacity, they probably can. Okay. And it wouldn't surprise me at all if some kind of backroom deal or something is done where Biden basically claims victory oil prices breakdown very suddenly very sharply, that would cause a breakdown of inflation expectations cause stocks rally yields to drop, right? Right. The, the, the final catalyst, which there are some rumblings about this, okay? Which you can say is positive or negative, but at least for equities are probably positive, is apparently the administration's basically internally saying to themselves, Let's try to push his Alinsky to give up some land to Russia. Now, you can say that that's bearish. You can say that that's not what we want to see. But the reality is if the expectation is that that does happen, if it does happen, that's going to cause us a ceasefire, at least for a moment in time, and there will be a relief rally just based on that. So my point is that I keep going back to this line. Opportunity exists when the crowd thinks it knows an unknowable future. Everybody that I see now, everything that I've seen says that everybody is convinced that this is only gonna go straight down. But again, bear markets, as I've said before, make fools of Bulls and Bears. The final thing I'll say is it really is true but were bombed out here as far as the movement beneath the surface, breath peaks in February of last year, this has already been ongoing for awhile. You look at the percentage of stocks in the nasdaq Composite, they're trading above their Tuesday moving average. As of yesterday, only 9 something percent of stocks are above their Twitter day moving average. You are pretty much the only time was lower was post Lehman. And at the absolute depths of 2020 and now by him, but by that much, so you have had severe devastation on the surface. And I look at that, I say it myself. Interesting, You know, what if you get a positive surprise catalysts and given that the sentiment is so bearish and you've had so much devastation. It seems possible that you could have an enormous rally suddenly out of nowhere, and then maybe ultimately go lower. Okay, because I do believe that housing is going to be a drag for risk sentiment for several, several months and maybe a few years. But not before some kind of real rally app before him. Yeah. I'm taking a look here in the YouTube chat window. Lots of great questions coming in. Actually a number of questions that I can see our viewers, you're thinking along similar lines. To me. My next question for you was going to be tell me what you think is happening from the BAHA. We had a question from Al Shaw from YouTube. Yen, Yen, Yen counterparty risk big-time, I guess not so much a question as a statement, obviously. But what's going on? What's your take with BAHA obviously, continuing the ultra accommodative monetary policy, continuing yield curve control. Essentially the only central bank in the world. Right now that seems to maintain this ultra accommodative posture. What's your take and what's the significance for the broader macro economy and for US equities? Yes. So I've used this line before that. We may look back and say that Japan was the biggest story of 2020 to write in the way that the Yen as has behaved here. All the more reason by the way, for why you've gotta get oil prices to vary suddenly, aggressively go down because if the BAG is not going to stop yolk or control The, you're going to have some real energy crisis because Japan very much imports all of its energy, right? So that I am certain that, that has all kinds of impacts on bonds, right? Because oftentimes when you end up having currency manipulation, the transmission mechanism is through buying and selling US treasuries. So that is a complicating factor. I don't know behind the scenes what they are necessarily thinking. I don't think that they themselves know what they're thinking. They're trying to basically choose the lesser of two evils from their standpoint, they're going to have higher rates. One of the highly indebted economy, or you're going to have a collapsing currency. You can have one without the other, right? So I think that created the stabilizing aspect to risk assets. But again, if I get, I got to the point that I think a lot of people are aware of this and may not be as big of a deal only because we're talking about it. Right. It's already been ongoing for a while. I think there's still bigger risks longer-term, but everything from my standpoint always about the sequence of returns and worst sentiment flips. Could very well be that you have to go with this idea that maybe your oil starts to break down, that relieves some of this inflationary pressure. That maybe yield curve controls not going to be as severe of an issue for the Bank of Japan and then the end rebounds possible. I don't know. Yeah. As you said, when we were talking about this in our Twitter spaces, you can control the yield curve. You can control the currency, but you can't control them both at the same time. I'm looking right now to three-day chart of dollar yen, USD, JPY up. Now, again, close, too, close to the all-time highs at around just a shade under 131, the 135, 134 spot 99 on my screen. Hi, looks like 135, 50. You know, obviously this is dollar, dollar strength, yen weakness that you know, the implications of what you're talking about here, the potential imbalances. Does this seem as though we're setting the stage for something? Japan, that looks like I don't want to be melodramatic in the way I phrase this, but looks like something that could be a shift in regime potentially to the downside. Yes. A we had an Asian crisis before in 1998, I believe, right? It wouldn't surprise me if that's coming up. I'd be that point before the way the dollar itself has been behaving. It's almost like there is some kind of sovereign getting crisis incoming began the time. He is always what's tricky with us, right? So I do agree that there is the behavior is very concerning and could be a catalyst for something much bigger to come. No disagreements there. The disagreements around when. Right. And yeah, maybe it is going to be sooner than not. But again, juxtapose against all this other center that I'm seeing, which is a wildly bearish yeah. It just seems to me that it could get delayed. Yeah. And also talking of things that I was going to ask about that our viewers are also thinking about something you alluded to oil, which is the energy market. This comes from, is this it, oil sentiment was extra bullish until today. We should say just as a little bit of a framework where we get a bit about 16 charts open on my screen here, let me get the right one. So looking at the Bloomberg terminal, generic first month AWS, CLI, futures on, on basically front month crude, WTI on the day. On the day down pretty significantly about 6.5%. Yeah, it could be a bullet. Point is very valid. I mean, it's always interesting when on Twitter in particular, and if you don't follow my lead lag apart, you should always ask me that. When you end up having people creating hashtags around and investment theme that ends up being kind of a warning sign to me. That sense of it is, it's so extreme because there's almost a cult like behavior that happens. And I've been using it, pointed the acumen, using the line, when an investment becomes a religion, it's time to lose faith. And I use they want to come to, comes to some of these old coins have used that when it comes to Tesla. And I can maybe somewhat Use the line when it comes to oil now because you've got can eat oil gang as one of those kind of hashtags are one of those trending type of topics. And nearly everything one of these spaces for the last 56 months, everyone's talk about energy. Now, I agree a 100 percent with this idea that they're under investment, that there's a longer term secular case be made for commodities relative to equities for the energy sector relative to everything else, especially tech. But again, I go back to path, doesn't, path matters more than prediction. When the sentiment is that extreme, at least in the short-term, it tends to actually reverse, right? You can still have higher highs, but not without a higher law first. Alright, so I agree, I don't know if it's, I don't think of it in terms of the secular case, in the secular momentum. Yeah, I do agree that the sentiment, I think got very extreme very quickly on commodities. Yeah. Yeah. As we have this conversation, I know you mentioned the funds of course, are rules-based. But as you think about this setup and positioning for what you see potentially coming next, or how you think about those range of possibilities. What's your take going forward? More broadly speaking, from an asset by asset class basis. Okay, So I'll give you, I'll give you the ideal scenario that I hope to see because that would be phenomenal, at least I think for all three of my funds. And by the way, as much as I have gone through such a severe draw it out, I keep making a point that the best way to avoid a drawdowns after 12 already taken place. This goes with this is a fact, but then he comes to any investment. People who never went by low. But that's often where you get the best performance and you want to buy dislocations. And this has been unequivocally a dislocation. Okay. So I think the setup is therefore a pretty strong short-term multip day because again, I go back to the center and so severe, he at any one of these positive catalysts happening and suddenly it's game on for both equities and bonds both recovering, okay? Now, I think at some point then you start to see real risk off behavior. A real divergence then takes place, meaning treasuries, rally and price drop and yield and stocks go down, which is really desperately what I need because that's really what risk on, risk off is about. It's about an inverse correlation during high-stress periods inequities. And again, I go back to, I think the driver if that's going to be housing. So if we went through this everything, bubble correction for crash wherever you want to call it. Well, you're probably going to have everything bubble recovery to a point. And then I think is when after that you'd see some, some real divergence and real cause and effect coming back into play. That's not an argument to buy tech. That's not an argument to go all into anything from an asset allocation perspective unless you're being tactful, but a certain approach and stretch like I am. But I do believe that when you have this type of a one-sided belief, the paled, it has to be higher on betting the other way. It's not about being the training for the sake of being contrary. You can see it everywhere in the sentiment. Yeah. I'm reading through some of the comments. I can see some, some skepticism from some folks who've gotten gotten really hurt in this, in this market. For all the reasons that you lift listed in terms of the breakdown in historical correlations, the inability to hedge during these times using traditional methods. What is the nightmare scenario here and how will you know if it's playing out? I mean, the real nightmare scenario is that boy goes to three hundred four hundred, in which case that's a depression. Right? Because it's defense, it's not gonna do anything about that. And maybe you end up having a war with China, Taiwan and the US getting involved who the **** knows right there. A lot of exogenous shocks that are certainly still out there, right? But honestly, I mean, the nightmare scenario is what's happened this year. Because to your point, diversification has a work except for commodities. And it's funny because people are talking about commodities non-stop, and commodities could have been a risk off asset. Now that's not true. Prior to put commodities in any kind of rules-based approach where you're a defensive posture is commodities, its goal, it doesn't work. Try to go back and you ain't got a rules-based approach even in the seventies, where you're defensive posture is shorting, doesn't work, is gold, doesn't work, is cash. Does it work? This year has been a nightmare because you do any kind of historical work. And you see it's ever happened in history in terms of these relationships being so bizarre in the way they're behaving. So, you know, it's not I'm trying to be evasive with the question, but I think if people don't think about what's happened this year as not being the nightmare. I don't know what the real nightmare is. Yeah, I might go. We've got about 60 seconds left. Final thoughts, key takeaways that you'd like to leave our audience with. Yeah, so what I would say is again, there's a lot of uncertainty, but I go back to, I think there's enough positive surprises out there that could suddenly shock markets. All markets, equities and bonds higher. Which also means commodities were correct in that period because it's all one big trade at the end. Everyone go through door drawdowns. Everyone has times where their portfolio, their strategy, their approach is just not working. God knows, I'm going through that myself. That doesn't mean that you abandon a strategy or signal because it didn't work in a single roll the die. People have to get out of this small sample way of thinking. And the one thing I wish people would keep in mind is that drawdowns only matter. If you need the money. You don't need the money. Drawdowns don't matter because being an investor me as being in something for more than a month, a year, three years. It's about longer term allocation mindset of this kind of things are down. I'm going to sell now. Well, who cares? If you don't need the money? If you haven't no longer time-frame, you'll come back. Yeah. Michael guide, obviously troubling times, difficult times. A pleasure to have you here walking us through the way you see the world. Thank you so much for joining us, and I appreciate that you guys. Thank you for watching everyone have a great weekend.