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Where Are Global Economies Headed?

Darius joined our friend Ben Brey on this month’s Pro to Pro Live to discuss China, the federal budget deficit, the “K-shaped” economy, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. If Beijing Fails To Act Forcefully, China Will Slip Into A Structural Debt Deflation Akin to 1990’s Japan

China currently faces a difficult position. It has to balance its development goals against a high level of private sector debt, comparable to Japan’s before the 1990s. 

Moreover, in 2011, China’s investment as a percentage of GDP peaked near 50%, roughly 1500 basis points higher than Japan’s peak before its long-term debt deflation. 

China is caught between a rock and a hard place because it needs to both stimulate the economy to avoid a deflationary spiral and deal with the consequences of past capital misallocation from previous stimulus efforts. We believe the most likely outcome is that China will opt for more stimulus sooner rather than later to address these challenges.

2. The Fiscal Impulse Is Currently Negative, Which Is Likely To Contribute To The Pending Slowdown In Nominal Growth

As our 42 Macro Fiscal Policy Monitor demonstrates, we already see signs that the federal budget deficit is beginning to contract. 

Despite being significantly larger in 2023 compared to 2022, the federal budget deficit is now $51 billion smaller on a year-to-date basis through May-24.

This shrinking deficit could lead to a stronger dollar, negatively impacting global liquidity by making it more expensive for other countries to borrow and service debt in dollars. This scenario may lead to a more significant global economic slowdown than the consensus estimates, which currently predict an average of 3% growth this year and next.

3. The US Economy Is A “K-shaped” Economy And That Dynamic Had Bullish Implications To Date

The US economy is currently “K-shaped,” where different segments of the population experience divergent recovery paths. We are observing higher-income individuals experience significant growth in consumption while those in lower-income brackets continue to struggle or worsen. 

Our research shows that the lower part of the “K” has diminished in size, while the upper part, representing higher-income individuals, has grown larger. This is evident from consumer spending data, showing that the lower third of income earners accounts for only 15% of consumer spending, while the upper third accounts for 51%. 

As long as stocks remain in a bull market and credit markets support private equity and private credit, the wealthier segment will continue to drive the economy. We believe this disparity is currently preventing a significant decline in corporate profits and a contraction in the business cycle.

That’s a wrap! If you found this blog post helpful, explore our research for exclusive, hedge-fund-caliber investment insights you can act on today.

How To Navigate The Fourth Turning

Darius hosted our friend Kris Sidial on this month’s Pro to Pro Live to discuss the 42 Macro Positioning Model, inflation, the Fourth Turning, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Our Positioning Model Suggests Vulnerability In Equities

Our 42 Macro Positioning Model monitors 14 indices relative to their historical time series. By identifying the thresholds of each indicator that correspond to major bull market peaks and troughs, we can determine whether we are approaching cyclical tops or bottoms in asset markets.

Currently, six of the seven indicators related to equities are flashing red. Specifically, the AAII stock allocation, AAII bond allocation, AAII cash allocation survey, S&P 500 realized volatility, S&P 500 implied volatility correlations, and the S&P 500’s valuation have all breached historical thresholds observed at bull market peaks.

The positioning cycle is not ever the cause of breakdowns and breakouts in stock market momentum, but it does act as an accelerant once a catalyst(s) has triggered. That means investors should be on higher alert than normal for signs of rapidly deteriorating fundamentals. A better process would be to trust proven risk management signals that will help you book gains closer to the top than waiting for or even attempting to [oft-erroneously] predict those catalysts. 

2. Is 3% Inflation The New 2%?

At 42 Macro, we have conducted an in-depth analysis of the economic dynamics surrounding the Fourth Turning. 

Our findings suggest that over the next decade, investors should anticipate significant upside surprises in the growth of public debt relative to current projections and a marked increase in inflation compared to the pre-Fourth Turning baseline.

This conclusion aligns with a report we published in January 2022 featuring our secular inflation model. Our analysis revealed that the Core PCE trend from 2010-2019 was 1.6%. However, our models project that the trend for 2020-2029 is likely to be between 2.6% and 3.0%.

3. A Higher Inflation Trend Will Have Important Implications For Investors’ Portfolios

The inflation outlook during the Fourth Turning has significant implications for the stock-bond correlation and investors’ portfolios. 

In periods of 1-2% Headline CPI, as experienced over the past decade, the stock-bond correlation tends to be negative. Conversely, in periods of 2-3% Headline CPI, the correlation becomes positive, and increasingly positive beyond those levels. 

If our Fourth Turning thesis holds true, a traditional 60/40 portfolio is likely to underperform more thoughtful asset allocation strategies over the next decade. Investors will need to consider alternative instruments, such as volatility products, to hedge their portfolios effectively. Investors should consider the 42 Macro KISS Model Portfolio, which is already being relied upon to deliver superior investment performance for thousands of investors around the world. 

That’s a wrap! 

If you found this blog post helpful, explore our research for exclusive, hedge-fund-caliber investment insights you can act on today.

How Do Retail and Institutional Investors Differ?

Darius recently hosted our May 2024 Pro to Pro Live to discuss the current Market Regime, the US consumer, key differences between retail and institutional investors, and more. 

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Investors Should Position According To The Current Market Regime

Our 42 Macro Risk Management Process transforms complex market dynamics into a clear and straightforward three-step approach:

  1. Position for the Market Regime
  2. Prepare for regime change using quantitative signals with our Macro Weather Model
  3. Prepare for regime change using qualitative signals via our fundamental research

We have remained in a REFLATION Market Regime since March. However, our quantitative and qualitative risk management processes indicate a growing probability of transitioning to a risk-off INFLATION Market Regime.

Investors should understand the key portfolio construction considerations for each Market Regime. If you need help understanding these high-impact portfolio pivots, we are here to help.

2. The Difference Between Retail And Institutional Investors 

The key difference between the average retail investor and institutional investor lies in their approach to market signals. Institutional investors have robust observational processes that allow them to adjust their positions when signals change. 

In contrast, retail investors usually build their portfolios based on their [oft-erroneous] predictions about the future, and when data disconfirms their narratives, they lack a robust-enough observational process to help them reposition their portfolio in time to make or save money.

We offer our clients these robust observational tools, helping them recognize when market and/or economic conditions shift so they can adjust their portfolio positions accordingly.

3. The West Village-Montauk Effect Is Contributing To The Resiliency Of The US Consumer

The “West Village-Montauk Effect” can be summarized as follows: With a substantial stock of savings, there is less pressure to save a significant portion of your disposable income. 

We are witnessing this effect in relation to the US consumer. Since the close of 2019, households have experienced a boost in wealth:

To date, this business cycle features household cash, net worth, and nominal disposable personal income each having grown at rates that have exceeded inflation.

That’s a wrap! 

If you found this blog post helpful, explore our research for exclusive, hedge-fund-caliber investment insights you can act on today.

How Will The Election Year Impact Asset Markets?

Darius joined Victor Jones this week to discuss the impact of the PBOC’s policies, inflation, the election year, and more.

If you missed the interview, here are the three most important takeaways from the conversation that have significant implications for your portfolio: 

1. Policies Coming Out Of The PBOC Have Had A Meaningful Impact On Asset Markets This Year

Since December of last year, we have called for Beijing to implement front-loaded policy support as we entered 2024. 

That is what we have witnessed, and that front-loaded policy support has had two significant impacts on global financial markets:

  1. It has contributed to the uptrend in global liquidity, as evidenced by our 42 Macro Global Liquidity Proxy, an estimate for global liquidity calculated by summing the Global Central Bank Balance Sheet, Global Broad Money Supply, and Global Foreign Exchange Reserves ex-Gold. 
  2. It has supported a rebound in Chinese PMI, suggesting the narrative around the Chinese economy being a black hole is changing at the margins. 

2. The “Immaculate Disinflation” Theme Is Likely to Persist For Another Quarter Or Two

Over the past two months, we have seen Headline PCE, Core PCE, and Sepercore PCE Deflator accelerate to well above trend rates on a three-month annualized basis.

However, investors do not need to be highly concerned about those increases at the current juncture because:

We believe the “Immaculate Disinflation” theme may persist for another quarter or two before inflation bottoms at an unpalatable level relative to the Fed’s mandate. At that point, we believe the narrative around inflation is likely to change, and asset markets are likely to be impacted.

3. Fiscal Policy Is Likely To Continue Supporting Asset Markets Heading Into The Election

One reason we have been bullish on risk assets is that we believed President Biden and Treasury Secretary Yellen would implement favorable fiscal and net financing policies this year, supporting our “Resilient US Economy” theme and US liquidity. 

We believe the election remains a risk-on catalyst for now. However, asset markets are likely to face headwinds after the election. 

Sometime in Q4, we anticipate the RRP balance to have declined to at or near zero and the TGA balance to have decreased by $250B from current levels. Those estimates represent dangerous starting points ahead of another round of debt ceiling negotiations on the horizon is poised to induce volatility in asset markets.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

China’s Role In The Global GOLDILOCKS Market Regime

Darius joined Nicole Petallides on Schwab Network last week to discuss the outlook for asset markets, China, inflation, and more.

If you missed the interview, here is the most important takeaway from the conversation that has significant implications for your portfolio: 

Although There Is An Elevated Risk of A Short-Term Correction, We Are Unlikely to Exit The Risk-On Market Regime Until Mid-year, At The Earliest

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

What The Pivot to A REFLATION Market Regime Means For Asset Markets

Darius sat down with Julia La Roche last week to discuss the recent transition to REFLATION, inflation, rate cuts, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. REFLATION Is Now The Top-Down Market Regime

Last week, we experienced a Market Regime shift from the perspective of our 42 Macro Global Macro Risk Matrix from GOLDILOCKS to REFLATION. 

REFLATION introduces a distinct set of Market Regime guidelines that investors should consider for their portfolio construction:

Given that both GOLDILOCKS and REFLATION are both risk-on regimes, investors may not need to make significant adjustments to their portfolios for this particular regime transition.The big pivot investors must make in a GOLDILOCKS-to-REFLATION phase transition is being incrementally longer of Risk Assets relative to Defensive Assets. 

2. “Sticky Inflation” Is Likely To Be A Consensus Theme By The End of The REFLATION Market Regime

The January CPI Report revealed signs of sticky inflation:

Given the apparent lack of restrictiveness of the current policy in place by the Fed and the resilience of the labor market, a return to 2% inflation seems unlikely at this current juncture.

Moreover, a divergence between CPI and PCE Deflator statistics has emerged in recent months. We believe this divergence is likely to persist for another one to two quarters, allowing the “immaculate disinflation” theme to continue and asset markets to rally during this period.

3. Money Markets Are Pricing In A More Aggressive Rate Cutting Cycle Compared to The Fed’s Dot Plot Projections

The conventional wisdom among average investors is that rate cuts are only observed when the Federal Reserve begins to lower the policy rate. However, the reality is more nuanced – asset markets, not just in the US but across major economies, are deeply influenced by broader financial conditions rather than solely relying on the observed level of the policy rate. 

At 42 Macro, we review policy rates set by the Fed, ECB, Bank of England, and Bank of Japan, as well as the overnight index swap rates relative to the policy rate, which reflects market expectations regarding rate hikes or cuts over the next 3, 6, 9, and 12 months. For the past six months, we have consistently observed negative spreads across OIS curves for the Fed, ECB, and Bank of England. 

From our standpoint, this suggests that the rate cuts have effectively already occurred. Looking ahead to the next quarter or two, we anticipate observing incremental evidence of eased financial conditions.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

How Long Will The Fed Hold?

Darius sat down with Maggie Lake last week on Real Vision’s Daily Briefing to discuss the recent transition to REFLATION, NVIDIA earnings, China, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. The Market Regime Transitioned From GOLDILOCKS to REFLATION Last Week

We utilize the 42 Macro Global Macro Risk Matrix to nowcast the prevailing Top-Down Market Regime. We do this via scoring the 42 most crucial macro markets globally via our Volatility Adjusted Momentum Signal (VAMS) and GRID Asset Market Backtests. These scores are then tallied, with the regime encompassing the highest number of markets emerging as the Top-Down Market Regime.

As of last week, REFLATION, characterized by a risk-on environment where investors tend to be rewarded for assuming higher risks due to perceived acceleration in nominal economic growth or better than expected economic performance without policy constraints, now holds the largest share of confirming markets. 

We anticipate that this risk-on Market Regime is likely to persist until around midyear. For consistent performance, investors should align their portfolios in accordance with the prevailing Top-Down Market Regime.

2. The Tech Bubble Is Likely to Persist At Least Until Around Midyear

In its quarterly earnings release last week, NVIDIA reported a revenue of $22.1 billion, surpassing analysts’ estimates by $1.7 billion, which had projected revenue to be $20.4 billion. 

Prior to the release, the 42 Macro Positioning Model indicated that positioning data from commodity trading advisors (CTAs) and market-neutral hedge funds indicated a probability of a further short-term market correction. The earnings release indicated NVIDIA beat their revenue estimates by 8%, and despite a temporary dip in response to the news, the stock surged by 24% over the next two days.

We don’t believe the tech bubble is likely to become unwound at this current juncture, especially if REFLATION persists as the Top-Down Market Regime over the next quarter or two.

3. PBOC Policies This Year Have Largely Supported Asset Markets 

Since December, we’ve called for Beijing to implement front-loaded policy support as we entered 2024. 

That’s what we’ve witnessed, as the PBOC has been actively implementing monetary policies to support the economy. Its balance sheet is expanding, claims on banks are rising, and it is reducing the loan prime rate while committing to providing additional lending to specific sectors of the economy. 

Through these measures, the PBOC is attempting to revive the Chinese economy. Instead, it is positively contributing to global liquidity, bolstering the risk-on Market Regime in asset markets.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Navigating Shifts In Global Liquidity

Darius sat down with Gordon Johnson last week to discuss the macro outlook for asset markets, the fourth turning, China, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. US Liquidity Is Likely to Peak Around Midyear 

The Federal Reserve has significantly increased the supply of Treasury bills, accounting for 69% of the total net marketable borrowing on a TTM basis through the first quarter. 

This has led to a reduction in the RRP and an injection of liquidity into the financial system, supporting asset markets. However, this trend is likely to shift in Q2, with the proportion of Treasury bills in net marketable borrowing dropping to 49% on a TTM basis. 

As a result, the drain on RRP will likely be halted, potentially impacting the favorable liquidity conditions supporting the stock market’s recent positive performance.

2. During The Fourth Turning Regime, Inflation Is Likely to Remain Elevated

Our research indicates that Headline CPI typically exhibits faster growth during Fourth Turning regimes, averaging 2.1%, in contrast to the 1.2% observed during the First, Second, and Third Turnings. 

As a result, we anticipate a shift towards a more inflationary climate over the next decade, diverging from the relatively stable price levels experienced in recent decades.

Consequently, this evolving landscape is likely to prompt the Federal Reserve to engage more actively in debt and deficit monetization, a trend we believe is likely to intensify over the coming decade.

3. China’s Structural Liquidity Trap

China is currently facing a structural liquidity trap, similar to the situation Japan encountered starting in the early 1990s. In this structural liquidity trap, additional credit growth in China is not effectively fueling economic expansion. Instead, it is primarily being used to roll over existing debt, allowing them to refinance current obligations.

Moreover, the expansion of the PBOC’s balance sheet has been largely driven by China’s foreign exchange reserves, a trend that halted in 2015. That said, incremental policy adjustments such as reducing the reserve requirement ratio (RRR), cutting loan prime rates, and bolstering medium-term financing are creating positive global liquidity conditions. 

These policy measures have had a positive impact on asset markets and have been contributing to the current GOLDILOCKS Market Regime. 

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Will Global Liquidity Push Bitcoin To All-Time Highs?

Darius sat down with Anthony Pompliano last week to discuss the outlook on asset markets, global liquidity, Bitcoin, and more.

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. While There Is An Elevated Risk of A Short-Term Market Correction, The Outlook For Asset Markets Remains Bullish Over The Medium-Term

The 42 Macro Positioning Model indicated that retail positioning had been heavily overweight stocks.

However, after the recent correction, that overweight positioning has dissipated. Despite this, current positioning data from commodity trading advisors (CTAs) and market-neutral hedge funds suggest the possibility of a further short-term market correction.

Looking ahead, the medium-term perspective is likely to be more optimistic. We are still in GOLDILOCKS, and the 42 Macro Weather Model indicates the Top-Down Market Regime has a high probability of remaining in a risk-on condition, either GOLDILOCKS or REFLATION, over the next three months.

2. Global Liquidity Heavily Influences Asset Markets

The 42 Macro Global Liquidity Proxy, an estimate for Global Liquidity, is calculated by summing the Global Central Bank Balance Sheet, Global Broad Money Supply, and Global Foreign Exchange Reserves ex-Gold.

The 42 Macro Global Liquidity Proxy is highly correlated to most assets, including corporate bonds, treasury bonds, crypto, and stocks. Only trend stationary markets like currencies and commodities fail to have a significantly high degree of correlation and/or correlation to the 42 Macro Global Liquidity Proxy.

Understanding the drivers of global liquidity, such as potential shifts in central bank policies, variations in credit growth across different economies, and other pivotal factors, is crucial for investors. By closely monitoring these drivers and tracking leading indicators of global liquidity, investors can better position themselves to navigate market risks and capitalize on emerging opportunities.

3. Bitcoin Is Likely To Appreciate Significantly Due To Fourth Turning Tailwinds  

The flows into the various Bitcoin ETFs over the past couple of weeks suggest growing investor confidence in Bitcoin’s viability. We believe this momentum is likely to continue. 

In the context of the Fourth Turning regime, which is likely to span the next decade, our research suggests an environment marked by structurally elevated inflation and budget deficits. These conditions are likely to spark a surge in demand for alternative assets like Bitcoin. 

Although there will be periodic downturns, we maintain a long-term outlook that Bitcoin’s value is likely to appreciate significantly.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!

Green Shoots or Rising Risk?

Darius sat down with Ash Bennington last week on Real Vision’s Daily Briefing to discuss the probability of a soft landing, the outlook for asset markets, and more. 

If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio: 

1. The Recent Inflection in The Sovereign Fiscal Balance to Nominal GDP Ratio Indicates A Slightly Less Bullish Outlook for Asset Markets

Our models indicate asset markets are becoming less bullish at the margins.

We have seen a notable shift in the Sovereign Fiscal Balance to Nominal GDP Ratio, transitioning from a negative to a positive trend. This shift indicates a reduction in the fiscal stimulus that has previously bolstered the resilience of the US economy. 

While these changes signal a more cautious outlook for asset markets at the margins, they do not pose significant concerns at the current juncture.

2. The Probability of A Soft Landing Remains High

Recently, we have witnessed a rebound in productivity growth.

This upswing in productivity is significant because to achieve a soft landing, at least two of the following three conditions are typically required:

  1. Sustained at-trend or above-trend productivity growth
  2. Supportive monetary policies from the Federal Reserve
  3. At-trend or above-trend government expenditures

Encouragingly, all three conditions have been met in recent months, significantly boosting the likelihood of a soft landing. As of now, the outlook remains positive, with few indicators suggesting the GOLDILOCKS regime is likely to change in the short term.

3. Throughout 2024, Strength Across The Major Global Economies May Cause An Upside Surprise in Asset Markets 

The latest January Global Composite PMI data indicates a bottoming in the UK, Eurozone, Japan, and Global PMIs, signaling a collective upswing in economic activities across these regions.

Additionally, signs are emerging that point towards potential factors that may lead to growth surprises, which in turn could bolster asset markets vis-a-vis a weakening dollar, enhanced global liquidity, and improved earnings projections.

That’s a wrap! 

If you found this blog post helpful:

1. Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.

2. RT this thread and follow @DariusDale42 and @42Macro.

3. Have a great day!