A Glimpse Into How 42 Macro Models Work
Darius sat down with Markets Policy Partners last week to discuss the details behind a number of 42 Macro models, inflation, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. A Look Into How 42 Macro Nowcasts The Current Macro Regime
Our Global Macro Risk Matrix is designed to provide a current snapshot of the market regime from a top-down perspective.
This is important for investors because in order to be consistently profitable, they should align their positioning with prevailing market conditions.
Our process evaluates 42 distinct markets, including broad baskets of assets such as equities, volatility instruments, commodities, currencies, and various fixed-income measures like rates, spreads, and yields, and incorporates a volatility-adjusted momentum signal to assess each market’s performance.
We update the data daily and aggregate the scores for each market.
Finally, the regime that accumulates the highest total score is identified as the prevailing top-down market regime.
2. Our Macro Weather Model Systematically Nowcasts Momentum Across The Principal Components of Macro
Understanding the current macro regime is just the starting point.
To be successful, investors must also anticipate the duration of the current market regime and anticipate the transition to the subsequent market regime – especially when a “RORO” phase transition (i.e., risk-on-to-risk-off or vice versa) is increasingly likely.
The Macro Weather Model is our process for analyzing several principal components of macro and translating those components into a 3-month outlook for major asset classes, including stocks, bonds, the dollar, commodities, and bitcoin.
This model monitors indicators that reflect both the real economy cycles and financial economy cycles:
- Real economy cycles: Growth, inflation, employment, corporate profits, and fiscal policy
- Financial economy cycles: Liquidity, credit, interest rates, and market sentiment indicators ‘fear’ and ‘greed.’
3. Our Models Indicate Inflation Will Likely Trend 100 to 140 Basis Points Higher This Decade Compared to The Previous One
Since 2020, most forecasting models used on Wall Street, including DSGE and auto-regressive models, faced significant challenges in predicting inflation due to such an unprecedented surge in various economic indicators stemming from the COVID-19 pandemic.
During the decade from 2010 to 2019, core PCE maintained an underlying trend of approximately 1.6%.
However, our models predict that Core PCE will likely average somewhere between 2.6% to 3.0% throughout the 2020-2029 decade.
An increase to those levels is likely to cause concern for the Fed and may lead to structural policy adjustments in the future.
That’s a wrap!
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Should Investors Be Positioning For Turbulent Times Ahead?
Darius joined Charles Payne on Fox Business last week to discuss the market outlook, investor positioning, and more.
If you missed the interview, here is the most important takeaway to help you navigate upcoming trends in asset markets:
Recent Data Was Supportive of GOLDILOCKS Continuing to Persist, And We Believe Equities Have Room To Run
- The market is currently pricing in GOLDILOCKS as a result of the growing consensus among investors that a ‘soft landing’ is the most likely outcome for markets. If the market begins to believe a ‘no landing’ or ‘hard landing’ is the most likely outcome, asset markets will likely experience a downturn.
- Despite retail traders currently being overweight in stocks, our analysis suggests that broader investor allocations are not at levels that have historically aligned with bull market peaks. This indicates that there is still room for stock market growth from a positioning standpoint.
- The recent December Jobs report and the December ISM Services PMI both support the ‘soft landing’ outcome for markets. Until the majority of key economic data stops supporting the soft-landing consensus among investors, the GOLDILOCKS Top-Down Market Regime is likely to persist.
That’s a wrap!
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What Should You Expect From The Bitcoin ETF?
Darius sat down with Anthony Pompliano last week to discuss the Bitcoin ETF, global liquidity, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. Our Wall Street Clients Are Closely Watching The BTC ETF Approval
BTC’s price appreciation throughout 2023 has fueled the excitement among Portfolio Managers and RIAs.
Generally, reception from our institutional clients for the BTC ETF has been warm, and we expect BTC to perform well over the long term as a result.
2. Favorable Market Conditions And An Increase In Tax Efficiency Support Flows to BTC
Many institutional investors have avoided BTC due to the complexities of tax reporting.
An ETF is a tax-efficient investment vehicle, so we expect it will increase inflows into the asset class.
With a vast multi-trillion dollar pool in investment advisory allocations, we believe there will be a shift at the margins from traditional alternative investments like gold, commodities, and real estate towards BTC.
Additionally, we believe the current GOLDILOCKS regime will support inflows into the asset class over the short term.
3. We Expect Global Liquidity to Continue Increasing Over The Medium Term
Over the past two quarters, our 42 Macro Net Liquidity model, which is calculated by taking the Federal Reserve Balance Sheet and subtracting the Treasury General Account (TGA) Balance and the Reverse Repo Program (RRP) Balance, has maintained an upward trend.
Similarly, our 42 Macro Global Liquidity Proxy, which is derived by summing the Global Central Bank Balance Sheet, Global Broad Money Supply, and Global Foreign Exchange Reserves ex-Gold, has also shown an upward trend in the past few quarters.
This model is particularly significant for projecting asset market performance.
In addition, there are a number of leading indicators that support robust private-sector liquidity creation.
Based on these factors, we anticipate a continued increase in liquidity over the medium term.
That’s a wrap!
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Is It Time To Book Gains In Asset Markets?
Darius sat down with Adam Taggart on Thoughtful Money last week to discuss liquidity, investor positioning, the probability of a soft landing, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. Rising Liquidity And Policy Support Are Bullish For Asset Prices
Liquidity is rising both domestically and globally.
Although the recovery since the bottom of the liquidity cycle in the fall of 2022 has not been linear, the overall trend is higher.
Key indicators that typically lead the liquidity cycle, such as the US dollar, currency volatility, bond market vitality, and crude oil, all point towards a growing supply of liquidity from the global private sector.
This environment creates a highly bullish context for asset markets – especially if sustained by these indicators and complemented by potential interest rate cuts from the Federal Reserve
2. Our Positioning Model Suggests The Rally Can Continue
Our 42 Macro Positioning Model tracks a variety of indicators, including:
- Non-commercial net length as a percentage of total interest across various asset classes
- Year-over-year cash growth rate
- AAII bulls and bears %
- AAII bull-Bear spread
- AAII stock, bond, and cash allocations
- S&P 500 realized volatility
- S&P 500 price/NTM EPS ratio
Currently, the S&P 500 Price/NTM EPS multiple is in the 80th percentile of readings, a level dating back to the 1990s, often associated with bull market peaks.
However, this signal is not supported by other indicators like the AAII Stock, Bond, or Cash allocations.
This suggests that while the market appears overvalued based on the S&P 500 Price/NTM EPS multiple, it may become even more so as investors are forced to chase positive stock market returns by increasing their allocation to equities.
3. There Is A Rising Probability of A Soft Landing in The Economy
Over the past two quarters, many economic indicators have evolved in a manner that increases the probability of a soft landing.
Among these, the acceleration in Nonfarm Productivity stands out, rising to 2.4% on a YoY basis, which is roughly 50 basis points higher than the long-term trend.
This uptick in productivity growth lessens the pressure on corporations to cut labor costs through workforce reductions or offset these costs by raising consumer prices.
Furthermore, our corporate profitability model suggests we will likely avoid a deep earnings recession.
This reinforces our views that corporations will not need to resort to mass layoffs or above-trend price increases to protect profit margins.
That’s a wrap!
If you found this blog post helpful:
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How Should Bitcoin Fit Into A Traditional Portfolio?
Darius sat down with Anthony Pompliano last week to discuss our KISS Model Portfolio, the outlook on interest rates, Bitcoin, and more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. We Believe Investors Should Keep Their Investment Process Simple And Systematic… And It Should Include Bitcoin
In January, we made a strategic shift to our investment approach to our KISS Model Portfolio process, transitioning to a long-only strategy.
The new process is designed to help traditional investors, RIAs, family offices, and other money managers outperform the conventional 60/40 portfolio in the long run by integrating trend-following strategies and a consistent allocation to Bitcoin.
The portfolio follows a 60/30/10 allocation, comprising 60% SPY, 30% AGG, and 10% BITO.
For serious investors considering adding a Bitcoin allocation, we emphasize the importance of systematic risk management to navigate this process and achieve smoother returns.
2. There Is A Significant Amount of Policy Rate Easing Priced Into 2024
The market is currently pricing in a 90+ percent chance of a rate cut by the end of Q2 2024.
This expectation is reflected both in overnight index swaps and federal funds futures, where a considerable amount of policy rate easing is priced throughout next year.
Moreover, we believe the concurrent rise in both stocks and bonds is fueling expectations of a disinflationary ‘soft landing’ in the months ahead.
3. Our Models Indicate Only A Low-To-Middling Probability Of A Near-Term Recession In the US Economy
At 42 Macro, we monitor several key indicators that give our clients the ability to spot a developing recession in real-time.
One of these indicators has crossed its recession-signaling threshold, suggesting a low-to-middling probability of a near-term recession.
However, it is important for investors to maintain perspective.
Our research indicates that stock markets typically peak around the same time as a breakout in jobless claims and the unemployment rate. Our research also indicates the stock market is typically very buoyant in the months leading up to that peak.
Therefore, there is no urgency for investors to put on a recession trade prematurely at this juncture.
That’s a wrap!
If you found this blog post helpful:
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3. Have a great day!
Will Santa Claus Bring Gifts For Investors This Year?
Darius appeared on Schwab Network last week to discuss the US economy, the probability of a recession, the US consumer, and more.
If you missed the interview, here is the most important takeaway to help you navigate upcoming trends in asset markets:
Both Technicals and Economic Data Suggest The Market Should Continue to Rally Well Into January
- The conditional seasonality research we conduct at 42 Macro suggests the dip will likely be bought until late January.
- This sentiment aligns with the recent economic data, which confirms the market’s consensus for a soft landing. We believe the market has fundamental reasons to continue rallying.
- We believe that the Federal Reserve has completed its rate-hiking cycle. While we think that market expectations might be slightly ahead of themselves regarding when the Fed will begin cutting rates, we do not foresee this having significant negative implications for the stock and bond markets at the current juncture.
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.
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3. Have a great day!
Where Are Asset Markets Headed?
Darius joined Charles Payne earlier this week on Making Money to discuss where markets are likely headed.
If you missed the interview, here is the most important takeaway to help you navigate upcoming trends in asset markets:
Over The Next Few Months, We Believe The Stock Market Will Continue to Rally, And Dips Will Be Shallow.
- Asset markets recently transitioned to a Goldilocks regime, where stocks typically perform well. As a result, we believe the path of least resistance in stocks is higher over the next couple of months.
- Investor positioning remains light going into year-end, as many investors are under-exposed to equities. We believe any dips are likely to be shallow as many investors are forced to chase positive performance.
- The AAII Investor Sentiment Survey shows the % Bull-Bear spread, a metric that represents the difference between the percentage of investors who are bullish and those who are bearish. It moved from an extremely bearish reading in the 4th percentile to an extremely bullish reading in the 91st percentile, the largest four-week move in history. This does not indicate that the bull market has peaked; rather, we believe it suggests a continuation of the recent consolidation over the near term.
That’s a wrap!
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Why We Are Likely To Have A Worse Recession Than Investors Now Anticipate
Darius sat down with Julia La Roche last week to discuss inflation, the Fed, and the likelihood of a recession.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. A Recession Has A High Probability Of Commencing Over The Next 6-9 Months
Our team has conducted extensive backtests on recession timing after the inversion of the 10-year/3-month treasury yield curve.
We found the 13 – 18 month forward interval has the highest probability of GDP contraction and a rise in the unemployment rate.
The 10-year/3-month yield curve inverted in October 2022, indicating the period between Nov-23 and Apr-24 has the highest probability of the start of a recession.
2. Inflation Will Likely Bottom At A Level Inconsistent With The Fed’s 2% Mandate
Our research suggests Core PCE will likely trend 50% – 100% higher throughout this decade.
In the last decade, the underlying trend of Core PCE YoY was 1.6%. We project that trend will increase to somewhere between 2.5% to 3.1% over the next decade, and prolonged conflict in the Middle East may cause a spike in commodity inflation and push it even higher.
We believe the Fed will need to revise its inflation target upwardly to between 2.5% and 3% to account for the upcoming higher trend.
3. Sticky Inflation Will Force The Fed To Sit On Its Hands
Wall Street survey data shows an increasing number of investors believe the probability of avoiding a recession is high.
We challenge that view. We believe a recession is likely to begin with inflation measures tracking at levels uncomfortably higher than the Fed’s 2% inflation target. That means the Fed will likely be forced to sit on its hands and maintain higher rates until inflation declines.
If that happens, the recession will likely be worse, and asset markets will likely decline further than most investors now expect – after having been dead wrong the US business cycles and asset markets all year.
That’s a wrap!
If you found this blog post helpful:
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Get Ready For ‘Markets Gone Wild’
Darius sat down with Adam Taggart, founder and CEO of Wealthion, last week to discuss Bitcoin, the stock market, the probability of a recession, and much more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. The US Equity Market Still Has Significant Right Tail Risk Over The Next 3-6 Months
The stock market has historically performed well heading into a recession:
- The median Return of the S&P 500 in the year leading up to the peak around recessions is +16%, with an interquartile range of +14% to +20%.
- More than half of the median return comes in the final three months leading up to the recession.
Our research currently indicates a blow-off top in equities in the months ahead given – especially given the starting point of severely depressed investor sentiment.
2. We Believe The Most Likely Path Forward Is For The Economy to Devolve Into A Mild Recession
Prior to deep recessions, credit typically increases as banks extend credit to less credit-worthy borrowers.
Then, when the economy experiences a tightening of monetary or fiscal policy, the effects are amplified by the large amount of credit present in the financial system.
Today, we have limited credit cycle vulnerabilities, indicated by:
- The Private Sector Credit to GDP ratio of 152%. This ratio has declined throughout this business cycle.
- The Private Sector Credit to GDP ratio trailing five-year z-score of -0.7.
These indicators suggest the recession will likely be moderate because the economy has not experienced the rapid build-up of credit that usually occurs before deep recessions.
3. Bitcoin Will Underperform Stocks Until A Recession Or Sovereign Debt Crisis Forces Central Banks To Pivot
We expect Bitcoin to struggle over the next few quarters until we find a bottom amidst the recession.
If stocks experience a drawdown of 24%, their median drawdown in a recession, Bitcoin will likely fall orders of magnitude further.
Our 42 Macro Global Liquidity Proxy, measured by the aggregated sum of the global central bank balance sheets, global broad money supply, and global FX reserves minus gold, has been trending lower and will likely decline further over the medium term.
Still, we believe Bitcoin will trend significantly higher in the coming years. But we likely will not see a meteoric rise without a recession or significant problem in the sovereign debt markets that causes the stimulus to put Bitcoin on that path.
That’s a wrap!
If you found this blog post helpful:
- Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.
- RT this thread and follow @DariusDale42 and @42Macro.
- Have a great day!
Stocks To Surge & Bonds To Sell Off Before Recession Hits By Early 2024
Darius sat down with Adam Taggart, founder and CEO of Wealthion, last week to discuss inflation, the labor market, the probability of a recession, and much more.
If you missed the interview, here are three takeaways from the conversation that have significant implications for your portfolio:
1. A Resilient US economy Leads to A Resilient Labor Market
The labor market has remained relatively resilient:
- The Private sector employment experienced a three-month annualized growth rate of 2.3% for August.
- Private sector wages are growing at a three-month annualized rate of 3.9%.
- Private sector labor income is growing at a three-month annualized rate of 6.2% and is above its pre-covid trend.
Labor market conditions are likely to remain robust until the spring of next year.
2. “Immaculate Disinflation” Will Give Way To “Sticky Inflation” In The Coming Months
We believe the Immaculate Disinflation that has occurred will likely run out in the coming months. Historically, the US economy has always required a recession to bring inflation back to a below-trend level.
Our HOPE+I framework looks at how unique baskets of indicators representing the housing, orders, production/profits, employment, and inflation cycles have historically behaved around recessions.
The framework shows that inflation typically breaks down 6 – 8 months after a recession starts.
There is no historical evidence to anticipate anything other than inflation exhibiting a similar pattern in this business cycle.
3. The Spread Between Labor Demand And Labor Supply Will Likely Remain Positive For Several Quarters
The most recent US Total Labor Force SA reading was 168 million people – a value below its 2009 to 2019 trendline.
Conversely, Gross Domestic Income recovered its trendline approximately two years ago and remains above it.
Looking at the spread between labor demand and labor supply, we found that labor demand outpaces labor supply by approximately 2.5 million workers.
This spread will likely take a few quarters to return to zero and has sticky implications for workers’ bargaining power for their wages because the spread has historically been correlated to the annual change in the Private Sector Employment Cost Index.
That’s a wrap!
If you found this blog post helpful:
- Go to www.42macro.com to unlock actionable, hedge-fund-caliber investment insights.
- RT this thread and follow @DariusDale42 and @42Macro.
- Have a great day!