Raoul Pal & David Rosenberg: The Two-Year Recession

well we are in the early stages of what is probably going to be a two-year recession so that's where I think we are right now and the beauty about this call is that it is uh uh separates itself from the consensus view that uh we're going to experience a soft Landing um or a short and shallow recession um it could be shallow it's not going to be short that's where we are macro investing is a journey join me Ralph Howell as I go on a journey of Discovery through the macro landscape This is How I build my macro framework by talking to the smartest people in the world Dave great to get you back on real vision and exactly the person I wanted to speak to and I've got in your honor but by bonds wear diamonds well uh you know you could buy diamonds and you can wear bonds except uh I don't know how what that look is going to be but uh I appreciate you wearing that uh on uh on my recommendation yeah I mean I'm I'm the same way biased as you so I'm very much of a I'm focused on bonds right now well let me just tell you something that you wash that shirt in cold water and it will deflate so Dave I wanted to catch up with you what your thoughts are now where we are first bigger picture and then we'll zoom into exactly where we are in the cycle well we are in the early stages of what is probably going to be a two-year recession so that's where I think we are right now and the beauty about this call is that it is uh uh separates itself from the consensus view that uh we're gonna experience a soft Landing um or a short and shallow recession um it could be shallow it's not going to be short that's where we are so why so I've actually come from a different perspective I thought it's going to be sharper and shorter where where's the length come from is it the length of the bear Market potentially as earnings come down or the recession itself talk me through that framework how you've come to because you're the first person who's really talking about a long recession where does that come from in your framework well it really comes from what the catalyst is going to have to be to get us out of the recession uh which is it looks like it started even earlier than I thought I'll just say at the outset that uh although back to back negative quarters of GDP isn't the technical official nber defined recession uh it's a it's a Wall Street rule of thumb uh because it always works whenever you've had back-to-back negative quarters you've been in recession uh whenever you've had two quarters down out of three you've been in recession a hundred percent of the time so that's where we are um there's really no doubting it unless you want to attack the historical record um but you see the reason why I think it's going to be long is because it's already started and so is The Fad Tiding cycle just started in March and the peak impact on the economy from whatever the FED does whether it's easing or whether it's tightening there's lags involved because the economy ongoingly resets to a different interest rate regime that the lags are generally about 12 months and the FED only started raising rates in March and they've gone a long way they've gone 225 basis points uh and even once they pause they're still going to be undertaking balance sheet reduction so they'll still be tightening policy even after they move to the sidelines and interest rates and so once we acknowledge that we're in a recession and I think it's going to take the consensus sometime because when you really look back to say to the great financial crisis the recession wasn't acknowledged really until Lehman collapsed The View was that it was a soft Landing uh and you go back to the tech rack and uh people were surprised that the NBR actually called it a recession that started in March of 01 and ended in November the bottom line is that once you get into recession you need a catalyst to get out and there is no Catalyst from fiscal policy uh fiscal policy continues to operate in a way that is contractionary for the economy so the question is going to be uh what is uh the catalyst and I think ultimately the Catalyst will be a move back to disinflation that gives the fed the opportunity to ease monetary policy but that's not going to happen immediately and we have a situation where the FED has been shamed because it blew the recept the inflation call chose the wrong word because although they weren't wrong on transitory transitory doesn't have a time stamp in any definition um but they panicked uh the FED even in the face of back-to-back quarters of negative growth and it's a debate as to whether or not Jay Powell saw it you know today's GDP report yesterday the FED has been tightening into a recession uh which really only happened during the valkyrie era in the early 1980s when you had back-to-back recessions separated you know a year apart you could almost argue that that whole period was about a three-year recession and you have a central bank chief um who in March in front of Richard Shelby at uh a senate uh committee presentation uh Powell did not compare himself to Arthur Burns or William Miller uh or Alan Greenspan or Ben Bernanke he brought up the fact that uh Paul volcker was the greatest economic public servant uh who ever lived and um we know that volcker killed inflation by killing the economy so I'm getting a sense here that um you know what's remarkable you know people are questioning whether or not the FED is going to go again in September of course now they're they're data dependent they're no longer pre-committing but the bottom line is that even in the face of this economic malaise uh he retained a de facto tightening bias uh and that speaks volumes because it tells me that it is going to take a lot to get this fed to start to ease monetary policy again which means they have to stop quantitative tightening and cut interest rates I think that will be next to your story and then there's going to have to be a lag because historically the recession ends towards the tail end of the FED easing cycle the recession doesn't normally end in the early stages and I can see people would be shaking their heads what's he even talking about but it's an answer to your question we are in the early stages of recession and the FED is still tightening monetary policy why would anybody think this is going to be over quickly um the historical record is very clear uh you need a catalyst uh to stimulate the economy once a recession starts it's normally monetary policy frequently it's been monitoring fiscal policy fiscal policy is out the window and the bottom line is that it looks as though the Republicans are going to take the house and the senate in November there's no fiscal stimulus coming for a long period of time it's all going to be on the fed and it looks as though the fed's not going to do anything until it sees the whites of the eyes of inflation headline inflation heading back down towards its Target um so you could argue they relate they were late to Titan policy they're probably going to be late to ease policy um but that tells me that when I trace through the lags within what the FED does trace it through to what it means for the economy I think we're looking at a two-year recession uh I don't know so much about the magnitude so much that will depend I think on uh the extent to which we have a big negative wealth effect on spending if the housing market joins the equity Market uh in an asset price deflation I think that's quite possible uh the extent to which these uh High cash balances just stay as high cash balances on the household balance sheet instead of diverting its way into the real economy which is what most economists and the FED things it's so it's hard to say how deep it's going to be I am probably have more conviction over its duration and that's actually I think more important because there is no correlation between the severity of the recession and what the stock market does um it's much more important timing when the next recovery is going to start because historically the stock market puts in the fundamental low two-thirds of the way through the recession whatever that low is going to be will it be 10 down 20 percent down 30 percent down the major point is that instead of trying to pick at what point we bought them it's more important to identify when is the start of the next bull market uh when will that start from whatever level it's going to be and historically that's two-thirds of the way through the recession that is actually when people say that nobody Rings The Alarm Bell at the lows well actually if you can try in time the Contours of the economy through the Lags from fed policy uh you can come up with a reasonable approximation as to when as opposed to what level but the timing of when it's going to be safe to dip toes back into the risk pool you know outside of these intermittent bear Market rallies what's the fundamental low the fundamental low takes place at the tail end of the FED easing cycle and the tail end of the economic recession so uh that's next to your story probably second half hi I'm Raul Powell the CEO and co-founder of realvision the financial world is a complicated world right now it's a really complicated macro picture and there's a lot of risks real vision and our YouTube channel help you navigate those risks so subscribe now to the channel and never miss an update there is simply too much going on so subscribe now thank you so one of the things I've looked at is that the markets and the commodity market so I I created an indicator of of um rate of change of rates rates of change commodity prices rates change at the dollar and we've had one of the largest sharpest tightenings in all history regardless of what the FED right the markets kind of did it for us and inflation did the rest and that when I look at that it gives me kind of ism getting down to 35. um now the question is is do the FED even matter will the Market's price test because you know I think the bond yields start falling and eventually the yield curve starts steepening again and the equity Market seems to sense this now whether it's too early or not different different matter for sure but the point being is do we even care about the fed or will the bond market be the truth well um you know it's like the chicken or the egg um yeah the the FED is extremely important without the FED there's no recovery in Risk assets in March of 2020 Okay so uh just as an example uh you know without the FED I started in the business on October 19th 1987 there's some of us I think that would remember that day there's just a absolute cataclysmic decline from those levels without the Fed uh and there's just countless other examples yes so so the FED it matters a lot and um there's no way you can make a call on a steeper yield curve uh without making a call on the FED um because the Curve will only steep in two ways either bond yields ratchet up and I guess that would happen if we had a another inflation scare or the curse deepens in a more benevolent way because the FED Cuts interest rates but what I'm going to say is that when you look at the Contours when you look at the Contours the business cycle um you know since the Fed was created in 1913 you'll see very clearly that um that the chart of interest rates and the chart of the economy uh there's a a near perfect correlation it's just one lags the other one lags the other um interest rates lead economic growth and the lags are long and variable but that's exactly uh what's happened so yeah I would say that we go back for example how did we do it March of 09 the stock market bottoms and uh then in June of 09 the recession ends and it took a lot uh without The Fad cutting rates to the Bone and without the fat juicing uh the markets like you mentioned before about financial conditions have tightened dramatically well you know going back into uh the opening months of 09 uh the Fed was dramatically easing Financial conditions well look what happens next so yeah the fact is um the FED is extremely important uh in all this and uh so I'd say that uh that you know that's what you need actually is the Fed if you're gonna if you're going to be bullish on the economy you need the FED to cut rates which they're not doing anytime soon uh and just be steep in the yield curve for what we're seeing right now we this is this is actually a bull market rally for pikers I mean good grief we had bear Market rallies that were 18 bear Market rallies repeatedly in the tech rack of 2001 2002 we had huge bear Market rallies they're fun to trade you know if you have the skill set that Paul Tudor Jones has go go run with that just make sure you have your exit strategy and you have your Hedges on we had countless the the biggest bear Market rallies the best days for the market of all time happened in in 2008 and 2009 most people don't realize that um so yeah we have a bear Market rally it is you can say maybe it's premised on this view that we're going to have a soft Landing if you have a view that there's a soft Landing then the market bottomed in mid-june uh that's not your view it's not my view if your view is that we actually have a recession on our hands and then the next leg is not going to be even so much the multiple but it's going to be earnings then you have at least another 20 down from here and that'll be consistent with the historical track record of how the stock market behaves around recessions there's a lot of psychology involved and the markets like what Powell had to say uh but the reality is this the reality is that we are in the early stages of a recession and the FED still has a tightening directive on its books uh we used to call this uh tightening bias back in the old days very few federal reserves would still be tidying monetary policy in this economic environment but we're dealing with a much different inflationary backdrop and the FED has been shamed and as a result they're going to be very slow I believe to cut rates to save the economy and by the way this might all be very deliberate we won't know till the transcripts come out years from now that this was a deliberate attempt to pull a Paul volcker and kill inflation by killing aggregate demand for the greater good short-term pain for long-term gain and that that might be the game plan you know anybody who's expecting Jay Powell to crap all over the economy yesterday during the press conference well why would he do that you know he's uh he is a politician uh you know the people think the FED is a politically independent agency how is that possible it's a construct of a Federal Reserve Act the FED chairperson is appointed by the president confirmed by the Senate oh but they're independent really so of course he was a cheerleader uh how what are you going to do raise rate 75 basis points and say look what I did in the face of this you know so come on but the thing is that look they're um it made it very clear that inflation is number one priority the the real economy is number two priority at some point that's going to shift they're going to cut rate three steep in the yield curve but it's the recovery is not going to happen overnight it's going to take some time uh because the recovery takes place really after the last weight cut so Raul what time frame are we talking about like second half of O3 and then the stock market the stock market will see it you know call up three months before it happens so maybe the lows will be in the mid part of next year but we're in a recession policy so huh is the euro dollar curve wrong then because the euro dollar curve suggests that the FED starts cutting first quarter of 23. I think there's a good chance that that will happen but it's going to be too late I mean so so the the the the future strip is telling you they're going to start to cut interest rates at that point I mean think about what you just said that the FED will start to cut rates the markets have the FED cutting rates a year after a recession starts and I don't think Paul volcker even waited that long so you see what that means that that they're going to be so late the the corollaries they're going to be so late to ease that's why this is going to be a really long recession they're going to be very late they're going to be very they're going to be very late to ease interest rates as far as the economy is concerned by the way we won't be belly aching about inflation anymore okay that's that's the positive out of this but it's going to be but you just you just mentioned it they're not going to cut rates till the first quarter of next year and then when do the recoveries usually start is more than a year after the first Ray cut so the recovery doesn't start till 2024. you know what's amazing is you have economists there saying the recession is not starting I had Megan green on my webcast yesterday saying that the recession is going to start in the second half of next year I went what uh I think second half of next year well I think by the end of next year we'll be talking about the recovery um but you see that's that's what's problematic here uh the FED is following lagging a contemporaneous indicators they're freaked out about inflation uh and they're still tightening into a recession uh and the Market's telling you yeah and they will not respond to the recession until the early part of next year so you're counting the recession starting beginning of this year so therefore by the end of this year it'll be Year One and the recovery will come sometime end of year two I when growth turns positive again is that kind of how you're thinking of it well the the markets will turn around before the economy turns around sure um but that I am saying you know they're being pinpointed to the month that that is probably going to be a second half 2023 story and uh so I think the economy will If the Fed does look I think the FED ultimately gets comfortable that it's killed inflation I refuse to believe people that say the the central bank has the tools to kill inflation we've seen that before and he Compares himself to volcker which is maybe maybe that's a good thing although I think that volcker himself overdid it it's different story uh the fed's given us a lot of information right now they're data dependent uh it's hard to know what they'll do in September I think they've I think they're either done or September is the last one the Jackson Hole will give us I think a window uh in August uh but we have to always pay respect to the lags right the fed the FED stops tightening in uh the spring of 2000. the stock market Bottoms in October 2002 more than two years later and the FED stops tightening and presses the pause button of course each one of these elicits a brief euphoric rally that isn't long lasting uh Ben Bernanke stopped tightening policy in the summer of 2006. when did the stock market fundamentally bottom well we know that above the march of 09 which is almost three which is almost three years later Greenspan finished tightening policy uh in uh in early 89. and the stock market bottoms two years later in 1991. and what about 2018 which was we were going into recession the yield covered inverted all the forward-looking indicators were going to recession the pandemic ended up being the recession but it was all pointed that way but the moment that the FED said we're kind of on hold the market took off because it has this pavlovian kind of recognition of what that means well I don't remember I don't know if the yield curve inverted in 2018 yeah I did the because I remember the inversion happened in August 2019 we actually rallied into the inversion but the reality is the reality the reality is that I don't remember the yield curve converting it yeah inverted once and then again in 2019. well um I'll assume I'll assume that you're right I remember just looking at the chart the other day where at the the yield curve has given us one head fake in the past and it was in the 98 Asian financial crisis when we rallied into an inversion and the FED cut rates and we you know we the recessive started two years later for different reasons but the reality is that even if you're right that the yield converted 2018 we didn't have a recession in 2019 so that's the difference between difference between a um a a a correction or Draw down uh more like a liquidity event uh even including October 87 and I started on October 1987 in the business the difference is um when you get a plain vanilla correction and it's based more on liquidity than the real economy you retrace 40 of the previous bull market condition uh and normally that's why you don't get much more than twenty percent decline which we had pretty well had back in the fourth quarter 2018. um but you see a recessionary bear Market is different because it's not just liquidity which affects the market multiple you actually in a recession get at least a 20 percent hit to earnings and that's what makes a recessionary bear Market different in a recessionary bear Market you reverse 83.5 percent of the prior bull market condition so that's what makes this beautiful because if you believe in the soft Landing if you believe this was just a correction and I think I saw Ed yardenny on Bloomberg TV saying that if you believe that this is a correction in a soft landing and that means a 40 reversal from the previous bear Mark bull market condition then we bought them to 3 700 back in mid-june arithmetically that works out perfectly if that's your view go run with it if it's a recessionary bear Market you reverse 83.5 percent that takes you down to 2700. uh on the S P so quite a different forecast that's why the recession call is such an important call because we haven't seen two things really we haven't seen the full um mean reversion of the price earnings multiple we a lot of work has been done not a full mean reversion mean reversion doesn't mean that you rest at the mean the mean is just a horizontal line through time mean reversion means going from one extreme to the other and historically by the way a recession trough multiple not a soft Landing trough multiple a recession trough multiple is 12. not 16. and then you gotta tack on what recessions do to corporate profits soft Landings don't do a lot to corporate profits recessions Crush corporate profits and so that's why there's a big difference there's a thousand Point difference between for the S P 500 between a soft Landing View and a recession view that's how important it is also I remember when I first met you and I was a GLG that was 2001. um two thousand two thousand one two thousand two when you used to come into the office over that period the market went up two-thirds more than it went down in terms of number of days people forget you know you talk about these bear Market rallies most of a bear Market is actually the price going up which which is really hard for people to get their heads around they're pretty terrifying to trade sometimes yeah you've had like I said you've had um the the biggest rallies of all time happen in the context of fundamental bear markets uh and so they are uh they are fun to trade the reality though is that uh you get these reflexive rebounds and and it's the power nor the normally in a in a bear Market rally it's it's it's short covering uh which is a different form of buying power than say just the retail investor coming in and buying ETFs short covering rallies can be vicious and uh if you're look if you're still short they can rip your face off um but they tend to be temporary I mean if we're going to call transitory um you know transitory normally they but they can last a few months right they can last a few months uh and uh this year we've had look we've had seven bear Market rallies uh since the Peak at the beginning of the year and um they've averaged to be you know six seven eight percent that's actually you know as you watch all these people on Bubble Vision they're all so excited we we you know you go back to the tech rack Market was down 50 just about the S P 500 you go back to the great financial crisis down almost 50 percent we had several we had several uh bear Market rallies that were bigger than 15 percent off the interim low so you know this this these bear Market rallies this year uh that gets everybody excited I mean these are for pikers this has been actually these have been disappointing bear Market rallies they get snuffed out around the 50-day moving average and the six seven percent gets people excited in the context of a market this year at the lows I mean the cervicals and the financials were down between 30 and 40 percent I mean the stock market basically handed it to you I don't know the FED is not following Market signals the FED is following contemporaneous macroeconomic indicators like the unemployment rate or jolt's job openings or non-farm payrolls non-farm payroll shows up in the conference boards index of coincident indicators uh they don't talk about the manufacturing work week that's the leading indicator uh he calls the claims to claims numbers claims numbers are shot up more than 50 percent that's the leading indicator uh and so the fed's telling you that uh that the labor market is strong but they're not really looking at the forward-looking indicators uh the stock market this is what you see whether or not you you like Greenspan or not and the serial bubble blower I'll tell you if you go back and read the speeches he gave when he was chairman and you go back and you read the transcripts of what he would say at the meetings this is what I do for fun okay um that and a tall glass of single malt Greenspan Greenspan was uh but Greenspan understood the symbiotic relationship between the markets and uh and the economy but he was a real Market practitioner and I'll take anybody on who wants to criticize Alan Greenspan look nobody's perfect but if you go back to you go back to Yellen go back to volcker you'll see that Greenspan was absolutely just I would say a genius and Bernanke Bernanke by the way is an economic genius but um I don't think there's ever been a central Banker that I knew that understood the markets as much as Alan Greenspan did and he used the markets as a forward-looking barometer because as a price it's giving you a forward-looking signal this fed I don't know this fed I think that we should all collectively uh put some money in and buy them a Bloomberg terminal I mean what do you think I mean you know but come on Raul it's hilarious you know the yield curve in verse I actually wrote I said here's my forecast for the year when the yield curve reverts the mass the the intelligency is going to say ignore the yield curve and so Pella gets his economists find me a part of the yield curve that's not inverted oh well what do you know it's the three month 18 months out and okay that's great that's not inverted okay oh that's great now the yoker is not inverted I said they're going to dismiss the yield curve it's got an 85 track record but we'll ignore it and then I said I said yet again I said when we get back to back quarters of negative GDP uh these clowns are going to find a way to say yeah it's not a recession it's not a recession I'm not gonna say who there's a an anchor on Bubble Vision who said I'm gonna wait I'm gonna wait for the nber to come out after the recession gee thanks thanks for do you know that if I went when I was at Merrell and I went to the bond desk and I said I'm gonna wait for the nber um you know I I think that uh well I probably would have been killed and uh you know the thing the NBR the NBR told us that the recession started in December of 08. thank you thank you it was 12 months old but the recession is here thank you very much uh you know you know historically historically the nber the MBR tells you we're in a recession when we're already seven months knee-deep in it uh so gee I'm gonna wait for the Envy this is not an nber to find recession Okay the reason why people look at the back to back quarters GDP is because it is simple the GDP numbers are in front of us we don't have to look at every single nook and cranny of the economy it just happens to work you got back-to-back quarters run a recession oh no no no no no no I mean so anyway but anyway the thing is that I love the call because you know even though but I say that those are my two best calls this year yoga is going to invert everyone's going to say this best deal curve but how do you dismiss how do you dismiss that the cyclical stocks most of them in the consumer space were down between 30 and 40 percent this year now how does any Economist is the Fed even aware of what the stock market's telling you about a consumer-led recession so you don't like the yield curve that's fine oh you don't like GDP oh okay but stock market and especially the ratio between cyclicals and defensives that's telling you a very powerful story unless you're going to say ah you know what uh the stock market doesn't matter matter either uh I say this to people my own clients they're portfolio managers ah you know but the stock market doesn't always get it right yeah but you're a long only Equity manager I mean aren't you so uh it's funny and that's just basically let's face it Rel we're in a business where optimism it wins out over pessimism 90 of the time and then a dozen 10 of the time and you have these economists and look I spend most of my life on the sell side what the like why would you why would unless you hate your job why would you jeopardize your career by making a recession call you know I got I saw I don't know I saw Brian Moynihan on CNBC today talking about how great the economy is if I was still at Merrell well I guess it's called make America now I don't think I'm not gonna I'm not gonna go against the CEO oh everything's just great back-to-back quarters are negative oh don't worry it's only inventories and it's only consumer spending on durables and it's only housing and it's only capex don't worry about it Hey listen Dave question inflation right so I'm looking at inventories which are super high and need to get liquidated and that usually means prices need to get cut I'm saying commodity prices coming down oil is a glass shooter drop obviously wages tend to be lagging but everybody's still yelling about inflation my actual core core view is becoming not 100 there yet that we go to deflation in 18 months time just mathematically now maybe not a headline at a core level but at the headline level right where are you on inflation have we peaked out you know what what's your whole structural Beyond this well I I certainly think that we peaked I hope at nine percent plus outside of no landish call how far how fast look firstly inflation oh we're all consumed with inflation uh it's a lagging indicator and in fact one of the components of the conference boards index of lagging economic indicators is service sector CPI which is dominated by what by rents and you look so much of the CPI Al Greenspan called it in one of these transcripts going back in 1996 these are very interesting the transcripts read like a Shakespearean play or agree tragedy and these having a back and forth with Janet Yellen and he calls the CPI of flawed statistic uh which is why he relied more on Market variables um I think you're right I think what's more important is the why is the five-year five-year forwards back down towards two percent why are the 10-year break 10 year break evens at 2 30. when you look at the at the 10-year break-evens on a core basis when you consider what food and energy have done it's below two percent um so I always thought boy it's interesting everybody's talking about fed credibility well the Dollar's been in a bull market we have a flat to inverted yield curve uh we've got these breakevens have been coming down now commodity price is rolling over we've had dollar strength normally if the fed's credibility was under attack look it's been under attack from Larry Summers and from uh Bill Dudley Academia the media the FED has felt a lot of the heat except from the markets right um and we would have had the mother of all uh bear market steepeners and would have had a faltering US dollar if we were actually we're turning into Zimbabwe we just basically I think you're right on the money look it's been very unfortunate we've been hit with a series of of shocks supply-side shocks that were inflationary uh Omicron and the impact on the participation rate and then we had china shutting down 400 million people in Keyport cities affecting Global Supply chains and of course the impact on global food and energy uh from the Russian invasion of the Ukraine and that's just catapulted now before that inflation was already Rising because the economy reopened far faster than anybody thought and of course we had these both under Trump and Biden these massive stimulus checks so yeah we had a sclerotic inelastic supply curve bumping against uh fiscal and monetary stimulus and here we got the inflation coupled with all the supply bottlenecks but you know what that's all in the rear view mirror right now inflation like I said is a lagging indicator uh the 30 percent of the CPI is rents um which the oer part of that owners equivalent rent is a survey it's such a funky statistic the CPI so much of it is imputed the rents will come down with a lag I don't know if the deflation is 18 months but you could be right uh I I'm sympathetic to that view it could be 24 months the rents will be slow and they're such a big weighting but they will follow the housing market lower that is going to happen it's a matter of lags I think that you're right in the sense that the swing Factor look when we go back how we swung from inflation and when oil was touching 150 dollars a barrel in the summer of 2008 have you told anybody a year later that the CPI was going to be negative two percent year over year we're going to swing from plus six to minus two you know as well as I do that you'd have been carried out in a gurney because I think they tried to do that when it was on the bond desk at Merrell telling the story uh and we swung from plus six to minus two and it wasn't rents didn't deflate and uh Services don't typically deflate they're very sticky that much is true but you see 40 percent of the CPI is goods and we're going to have lagged impact of the supercharged US dollar uh and we already by the way you're starting to see this already in the core crude PPI which was negative which is uh negative two percent in June there was negative four percent in May that's a leading indicator uh the core crude ppi is a great lead indicator for goods people always tell people talk about rents rents rents rents are 30 of the CPI yes I know that but guess what stuff material Furniture appliances uh Autos um they are 40 of the CPI and they will be deflating and that's the swing Factor if you look at the year over year percent change in services it will slow in a recession but it does deflate the swing factor is just as you said it's the 40 of the CPI called goods and the combination now of all these Commodities I think everything except for eggs is lower now than it was before uh the war started in the Ukraine these Commodities have come way off we haven't seen the peak impact of the dollar just yet this is all Cascade you're 100 right in good sector deflation and the question will be how much of this will offset whatever lingering service sector inflation we're going to see uh but I I agree with you I think inflation is going to come down materially uh in the next year uh it's it's just that it's just that my problem is that the FED has become a little dogmatic in this respect once once burnt twice shy so you see what I mean once more twice side they're going to be purposely slow because they don't want to get burnt again on transitory that that is unfortunate that's what's going to lead to another policy mistake they made one already it's hard to know if it's a mistake this all might be deliberate to send the economy into recession but this comes down to how much longer the recession will be because I could tell you this fad is going to be deliberately slow when it comes time to having the East policy to put a floor under GDP let's talk about this for a bit though because there's a whole bunch of Market participants we're all splitting into two camps right now one is that my view which is inflation is not a problem because of debt demographics technology but there's a whole group that think it's secular because supplies Supply chains and commodities are broken for longer there's not enough Supply and that um reassuring of businesses is going to drive up um costs and demand for materials and therefore this is a secular inflation cycle and Raul you're an idiot this inflation is only going to come down to five percent and then we're stuck with inflation the bond markets toast the equity markets toast this thing's going on for another five years what's your view on that kind of cyclical versus secular inflation they might be right I don't know if there's going to be a lot of onshoring um they'll be near Shoring I think Mexico is going to be a big recipient of those direct investment influence and it's already starting Mexico is a low-cost producing country you know people were saying this back look 10 years ago when when China's working age population started to go down and their wages were going up people were saying oh well China is no longer a source of global disinflation that proved to be dead wrong remember people were saying that and uh that China was becoming a higher cost producer but it never really showed up in the data we're going back more than 10 years people were saying that but I'll be respectful in the sense that uh it makes sense in some Industries not all Industries but certainly in Pharmaceuticals and in semiconductors and food uh that um that security of supply has become a a national uh security issue for for every country okay I'll buy into that but the what is really the impact is so imperceptible over time that that's not an inflation shock is it something that um is against our view me and you at the margin okay I'll buy that but the demographics are certainly disinflationary people talk about demographics and the impact on the supply side and availability of Labor um but as you said before over time technology is taking over that and the capital labor ratio is going up it's not going down so there is ongoingly labor displacement I mean most the only labor shortters in the United States are really in low value add low-skilled service sector industries that are a relatively low percentage share of the economy so aging demographics I mean demographics is Destiny and as Richard cool would say and um people talk to me about the impact on inflation from aging demographics it's It lines up more and there's an impact by the way on both supply and demand but the demand overwhelms the supply and you've seen that in Japan the two oldest nations are Japan and China they have the lowest inflation rates consistently why is that well I wonder why because of the impact it has on accurate demand because as you get older uh your shifting patterns uh tend to uh tend to change and that's why a lot of the inflation of the 1970s that people talk about all was about Arthur Burns and about Richard Nixon lots of mistakes were made but we had a vibrant young uh Baby Boom population that was fueling demand people people don't quite understand that in the so-called sclerotic what is horrible 1970s uh that even with three recessions from 1970 1980 aggregate demand in real terms averaged 5 percent per year when was the last time the US economy averaged five percent per year for a decade 1970s actually now of course we had three fed induced recessions we had an inflation problem a lot of that was about demand so I guess when you when these people come back and say well so these are the forces of the supply side globalization so on and so forth the question comes down to what's happening with demand and because you can't just forecast inflation with one curve you need to have a supply curve on a demand curve everyone's a supply side person and nobody looks at demand it commodity Market but that that's the shifting story if we were if we had a white board behind us and we were pretending we were economic 101 professors we would be showing what's changing this year is the demand curve okay by the way the supply curve is becoming less in elastic not more in elastic that's a new story too but it's the demand curve this year the demand curve and that's what's going to overwhelm the supply curve and that's why your deflation call is going to come to fruition I can't say for sure if it's 18 months or if it's 36 months but I think that we're going to go back into deflation as well the demand is Contracting we have we have never I got data back to 1960 we have never seen a period where we've had monetary and fiscal contraction like this simultaneously you know the same yahoos that were talking about the money supply numbers this time last year when they were running if not double that is triple digits nobody's talking about the municiple anymore the Monterey base is actually deflated four straight months it's negative year on Year and that is the root of all monetary creation money the money supply and M1 and M2 have collapsed in terms of their growth rates they're back to where they were pre-covered when we weren't really talking much about inflation so I would say that what's changing right now is the demand curve and the FED is doing this deliberately that so many things have changed now you can go back a year 18 months ago and say well we missed this too we miss the fact that the supply curve was becoming more inelastic so aggregate supply globally is Shifting to the left and we have rampant monitoring fiscal stimulus so we have Rising demand bumping against constricted Supply chains and hence we get big inflation big inflation but that's yesterday's story so we've got to continuously focus on what's changing at the margin well actually when you look at the anecdotal evidence you're going to see that the supply delivery delays and practically every manufacturing survey uh is going down now is it back to where it was pre-covered no but it's going down order backlogs are going down look at the Baltic dry index it's down like 40 percent you're seeing Freight rates coming down this is a different now the supply curve is still in elastic but what I'm saying because change is always at the margin it's less inelastic than it was at a time when demand is Contracting so what is anything that you've ever seen in theory or in practice that would tell you that when demand is going down faster than Supply you get more inflation no no no no no no you get less inflation and the question is going to be how much now admittedly the way that the CPI is constructed and of course I'll tip my head again to Powell that the PC deflator is really what they focus on more but let's just say both indices are dominated by Services which are slower to react to changing economic circumstances the good side is really where we're going to be seeing the deflation in your story and I think that inflation next year is going to surprise a lot of people to the low side that will be the Catalyst ultimately that will be the Catalyst for the FED to ease policy aggressively and it's not going to be to bail out the stock market or bail out investors it's going to be naturally the natural course of events in a business cycle interest rates are cyclical people are going to say oh there they go again they're going to be cutting weights well they're going to be following the bond curve the bond market is going to be telling the fed you have to start cutting rates you're telling me right now the Futures curve is telling the FED you're going to be cutting rates next year but only a couple of times no no how many times in the past is the Fed cut rates a couple of times in a recession no they could wait a couple of times in a soft Landing in a recession the FED Cuts rates 500 basis points the FED Cuts rates 500 basis points the reason why they've had to do QE the past couple years is because they they're not going to cut them below zero and kill the money market mutual fund industry which is the Cornerstone of funding uh for short-term funding for the corporate sector so they create the synthetic negative interest rate by doing QE oh well let's just put that way out into the future but the reality is that and this is what we should be asking ourselves we are in a recession okay I am not one of those guys that has my head in the sand okay I don't suffer from career longevity I could say what I want I'm not going to get fired you know why I'm not gonna fire myself so there's so many so much information that we have they cut we should be asking ourselves how do they get out we have no fiscal stimulus fiscal policy is Dead on Arrival okay the Republicans are taking over the shop in November it's done in fact Joe manchin just think about it signs this deal now it's got to go to the Senate where the tax increases are bigger the revenue increases are bigger than the spending increases so Schumer and matcha just signed on to ratified a fiscal contraction at a time when the fed's Tidy monetary policy and so the question is in next year how far will the FED have to go to cut rates what will they do for an encore what other rabbits are in the Hat now remember the sort of QE that they did last time they they have to get Congressional approval uh to do what they did to like to to buy I had people asking me they're going to buy equities will they pull a bank of Japan and buy equities um well the only reason they were able to even by corporate debt and go outside the realm of AAA rated Securities was they needed to have Congressional approval uh that's unless things get really bad that's not going to happen again so I had and you know what maybe there's something to be said maybe we'll find out in the transcripts of all along once again they were talking about harvesting bullets we go to harvest bullets go to harvest bullets I always wonder about harvesting bullets to fight the next procession it's like you know what oh it's like the surgeon will amputate your leg and then reattach it the next day okay gee thanks very much you know we're gonna collect bullets that we're gonna have to but I mean that's just the reality situation interest rates are cyclical this isn't about we're going to be hearing oh there they go again bailing out well I don't know if we go back to 2700 in the s p or if you're right that we fully reverse look half of the recession bear markets post-world War II and this is where you're probably going to be right I think um half of them you had a hundred percent reversal you went back to where you started from in the previous bull market that takes it back down to like 2300 I'm not as negative equities I'm kind of somewhere between 13 40 but I'm not that negative equities in this I am negative the economy and I think it's Deeper Than People imagine from my forward-looking stuff but we'll wait and see but this does lead us into okay we've talked about growth is imploding we've talked about the likelihood of inflation imploding we've talked about a Troublesome Equity Market so that leaves the standout trade which is bonds yeah and people when I mention this a lot of people who are not used to bonds I mean you and I have been around a while and we know how we know how bonds work like are you crazy buying bonds with nine percent inflation I said that's exactly the time to buy bonds talk you through you you're also bullish bonds I take it very much the the the inflation rate is a lagging indicator so I don't really formulate forecasts um based on the inflation rate you know do I wish that I would have known we're going to go from two uh or basically zero to uh you know nine percent I wish I wish I was that good I would have known that was going to happen I don't know if we call that a three standard deviation event uh oil oil the front month contract for oil in the spring of 2020 is negative and then we go to one then we go to 120. well one one point about that how do I if if you'd have known it was going to nine percent I would we would have said okay where are bond yields we'd have probably said six and they went to three and a half that's got to tell people something right there is a structural issue here much larger than people expect because every Bond there basically got this wrong a few people nailed the early move confirmative for a point it's a free and look we got stopped out at three and a half the the peak the peak in the tenure note uh was in April 2010 in the last cycle and we peaked at 4.01 we're there for one day in early April of 2010 most people don't know that and um and so and it's interesting we got stopped out at three and a half this time around uh because the pattern of hitting lower highs and lower lows is still intact which is why the second or bull market is intact until otherwise don't a fight it's not about the size of uh of Bill gross's uh pencil and uh ruler okay the sequence pattern of lower highs and lower lows and yield remains intact you know I think that the way you put it I think is very very accurate uh very elegant way of putting it and you're right that we got stopped out and look and I think as the bond market is actually quite sophisticated it realized that yes we had in a series of Supply shocks that are not permanent and I guess that's what transitory means it's not permanent look we have the first shooting war in 80 years in Europe we've had these recurring Supply shocks complicating it was um really quite unnecessary fiscal stimulus for the most part stimulus checks that got spent right away exacerbated for a period of a year you know it's funny that uh Jay Powell says yeah you know we've had this inflation now and it's lasted about a year it's lasted a year he makes it sound like a year is a long time I'm there thinking because I'm I fancy myself as an economic historian a year in the overall annals of economic Financial history I don't know I think that might well be transitory you know look the last time sample size of one and that we had um a war and a Health crisis that went Global uh was back say from 1916 to 1920 you know we we back then the war started first then the Spanish Flu we had four years where inflation average fifteen percent per year now we didn't have like social media back then uh but we had we had inflation that wasn't nine percent uh for a year we had 15 percent Over a four-year period because we had a series of Supply shocks Wars historically tend to be inflationary and we had a Global Supply shock on top of that from what happened with the Spanish Flu once those pressures subsided and they didn't last indefinitely okay there are no new eras excesses are never permanent once those pressures subsided we went through 10 years of deflation from 1920 to 1929 and then of course we've got the mother of all deflation starting in October 1929. you know I can't remember the exact year that Scott Fitzgerald rolled a Great Gatsby I think it was 1926. nothing in there on the great inflation it was only five six years earlier right but memories faded and so I would say that this inflation that we had was transitory if you're willing to be charitable on how you want to define it um and I think that we are going back into a deflationary period I think 100 right and I think that the FED is is going to exacerbate that uh and remember that and and people got to remember that the lags between what the FED does and time a and the peak impact on the economy in time Z the lags are long variable and in this particular situation very Insidious and that's what I mean is that the recession is already started I'm wrapping my head around this the recessions already started the fed's still tightening policy and the peak impact is not going to be until the mid part of next year so we're we're just going to say we are locked into right now there's no turning back we are locked into a six quarter recession and it might even be longer than that that's where I come down and so I'll tell you this much even in the 1970s we had a recession in 1970 73 75 1980 in recessions guess what even in the stagflation era of the 70s in recessions demand gets so weak that inflation melts the question will be and the question of the 70s was that when the recession ended inflation went right back up again well as as you said uh what was technology back in the 70s what was that like an IBM Mainframe and a transistor radio from Panasonic I mean where productivity was non-existent and uh you had a different labor market a different level you know people talk about you know it's funny that you did you mentioned globalization you didn't talk about the return of Labor power the return of Labor power please because these young people are job hopping in the restaurant and accommodation sector you know that despite all the hype and rhetoric about oh well you know Amazon workers here uh they're certified now the union and Starbucks over here you know that you know what is it it's over 300 million Workforce and you you read the headlines of the Wall Street Journal wow we got the return of Labor power that's not happening it's happening in a few sectors it's not happening in fact the share of the private sector Workforce that's unionized last year went to a new post-world War II low so there you go in the in the 1970s it was yeah I mean inflation was almost institutionalized because uh the the economy was unionized and everybody had cost of living allowances and also Dave as you know the labor force participation rate is super low because of demographics if the group of people in a job gets a five percent wage increase half of the labor force is out of the job so therefore you have to half the total aggregate demand of the wage increase which is two and a half percent not five percent the round the proof of the pudding is in the eating I mean the the the participation rate you know the participation rate in the United States it peaked 20 years ago yeah before covet and all these Supply shocks inflation was like two percent Donald Trump could actually cut interest or give us a trillion dollar tax cut and the FED could continue re-embark on QE in 2019. with three and a half percent unemployment rate at the lows and inflation was two percent and so yeah you're 100 correct on that uh that uh but it's it's like I said before aging populate it's all about the people talk about the great with the great retirement yeah okay so there's the great retirement as long as that lasted now people have seen their 401ks depleted they'll come back into the labor market but be that as they made the participation rate's been going down for over 20 years and there was no perceptible inflationary impact whatsoever and don't forget when they and when they come back into the labor force they're competing with their kids and they're doing part-time work and they'll do it cheaply because they're only topping up income which is a natural lower of aggregate wages because you know the 70 year olds coming in and he's doing Uber driving and and all the all he or she needs to do is do it for you know 20 hours a week to top up their their pension and so that takes away from the net unemployed the net employment of the 32 year old who's their kid you know it's people don't look at this stuff they just look at headline numbers and never think through what's actually actually happening well there's something else that is going to feed into this uh because you know we're talking about the labor market and I find it very fascinating for example that we get the GDP numbers for the second quarter uh private sector GDP was negative 0.7 annualized but we know that labor input uh aggregate hours worked was up 2.7 percent so it falls out of that is negative 3.4 percent uh on productivity quarter on quarter this will be the third decline in productivity in the past four quarters and it would mean the productivity in the world's most dynamic economy is negative two percent when people say to me so what do you make of today's uh GDP number I said I'll tell you what I make of it it means productivity contracted again uh you can count on your hands a number of times uh in the past 60 years that productivity was negative 2-0 year over year uh and each time we were in a recession the question becomes how did the corporate sector respond to that because you see what happened here is and this comes down actually to the fed you know it's funny rail that that everybody criticizes the Fed uh for missing the boat on inflation but everybody seems to be giving the FED a pass on missing the boat on the real economy because we went into this year the Fed was in his projections was saying we're going to have real GDP growth of four percent uh at the June meeting when they produced their last set of forecasts it was 1.7 for this year I'm telling you right now it's going to be zero maybe there's an outside chance it'll be freshly negative but you can see that if you're a business executive and you're following the FED they have 300 PhD economists on staff you went into this year with the FED telling you plus four on real GDP you had to be thinking I have to pre-order I have to build my inventory I gotta hire more but look what happened look what we can see in the retail and wholesale sectors in particular massive excess of uh over stockpiling we have an inventory problem but you see not just an inventory problem they hire too many workers I mean can you imagine the context of the first half of this year the economy actually contracted and yet over the past 12 months the average non-farm payroll number was plus 520 000. we went into this year over stockpiled by all the pre-ordering now that's got to be liquidated 100 right but what about employment because I've got to tell you that if we're going back to a situation where the corporate sector is going to have to right-size their productivity or they're going to lose it on margins big time so unless we get a Revival in output which seems next to Impossible because we know that the conference board's leading economic indicator is down four months in a row and so we have more economic pain ahead and so there is a misalignment between company order books production schedules and Staffing so what's going to happen when you do the arithmetic and what it will mean to right-size productivity um and you're already starting to see it happen but not in bodies but hours worked or started to come down and that's a great leading indicator hours you're talking about Rel you're talking about in the next year two million jobs are going to be lost I mean Amazon made this clearer Amazon are about as good a company on Earth is managing inventory of people products and everything else and they came out in q1 and said we've wildly over ordered uh overstuffed and that was the signal to me it's like oh my God if the Amazon they were the first to say it that's endemic it's endemic it's everywhere yeah it's everywhere well so this you see this is what's interesting is that is that Powell says why why no recession according to the FED is because labor Market's so strong um it's a it's an illusion uh and the question really is what's the labor market looking like three and six months from now um nobody talks about the fact that we are in a huge productivity recession it is not sustainable unless you believe we're going to have a rebound and output which don't be the indicator or suggestion we're going to employment is going to have to be right size now in the past year we've created six million jobs I'm not saying all six million go by the wayside but a third of that is going to go by the wayside and if that's the case which I think is going to be normal and an actual part the reality is that the business sector everybody made mistakes and if you follow the fed's forecast at the end of last year not on inflation but he bungled it on the real economy nobody talks about the fact that the it's all about transitory nobody talks about the fact that they had a four percent growth forecast and now GDP world for the year is going to be zero companies over hired now they have to basically correct that process it's going to be pretty painful 2 million job loss in the next year is um is going to be pretty painful it means employment rate is going to beat is going to head back up to five percent from three and a half and that alone when you trace out what that means for wages as you build more excess capacity and what used to be a tight labor market wage growth goes from five percent to two and a half percent so you see what you were saying before I mean let's hope they mean getting inflation down is going to be very important because wage growth is going to be dissipating and so you got to get inflation below two and a half percent of the next year to start creating the process for real incomes start to expand again so what I'm saying is that in the next year even as inflation goes down wage growth is going to go down just as much and we're going to maintain the cycle of negative real personal income which represents 70 percent of the economy otherwise known as real consumer expenditures and that's why this thing is going to last I think at least for another year it's a lock I just hope it doesn't last much longer than that but a lot is going to depend on the fed's reaction function the signals are giving us right now I mean you got to be very disappointed Raul that you're telling me that the Market's got two cuts for next year in the context of recession that's already started wow that tells you that's that's telling you right there that the Market's telling you the FED is going to be too slow to react as far as the real economy is concerned final question where do you think bone deals go in the next 12 months I think that the 10-year I think we're going to break below 2 percent I think that we probably will get to one and three quarters and I'll just say that if you're bullish on equities you have to know that at the lows historically the the 10-year note yield and the dividend yield tend to converge that's when the alarm ball that's when you get the real relative evaluation supports for the equity Market well what's the dividend yield is 1.6 uh the tenure node is call it uh 2.8 um well maybe there's a meeting of the minds in between but either the 10-year note goes to 1 6 or the S P might have to go to well it would have to basically go down around 2200 to or there's a meeting of the mines in between but everything that I'm seeing by the way you need to get if you're bullish on equities you have to be bullish on bonds first there's never been a recession low inequities that wasn't followed by a huge rally in treasury so when people say to me what do I do buy bonds first and I think that I think that I think in an overshoot to the downside we can get to one and a half percent um but I'm I'm thinking we're going to break below two percent and at that point I'll make up my mind as to whether or not it's time to uh take the BET off the books or uh double down on it it'll be situational predicated on where we are in the cycle the reader which my call has worked out or hasn't worked out but I think it's as much as there's anything uh as a a no-brainer of a call and they don't typically exist but I say that in recessions in recessions by the way in recessions inflation goes down yes how much that's the question mark But in every recession bond yields go down there's there's really never been a recession where bonds didn't make you money total return now it's more challenging today in the sense that you don't have the coupon but then again the convexity gives you uh a nice uh capital appreciation if I'm right on where the 10-year note is going to go in the next year and not even say I'm not saying I mean you can go and buy long data zeros you know or just buy long bonds I'm just talking about the 10-year note um 14 Total return in the next year of my call uh comes to fruition Dave as the fantastic to speak to really interesting let's see how it all plays out but it's going to be a very interesting 12 months I think could I look did I lose you there no you no no it was just that um you you started to slow your words so I was saying that uh you know you should uh hide that bottle of tequila but uh I think it was just your microphone yeah I think you finished off with about the you mentioned the word interesting year it reminds me of uh of when the Chinese uh the Chinese proverb about may you live in interesting times uh and people say that without knowing that it's a curse not a blessing laughs exactly Dave as ever really appreciate your time and your thoughts my pleasure all so what do we learn from Dave today what we've learned is Dave has a varying perception on where the economy goes from all of his work he thinks that growth is going to be weaker he thinks people are focused of backward looking data but he also thinks the Federal Reserve might be slower to cut rates now mainly people would think well that means that bond yields are going up but it's not because what Dave's saying is bond yields are going to start pricing in the fact that they're too late in cutting rates and therefore bone yields come down well before the Federal Reserve does Dave also thinks that the equity Market needs to price in further recession and that this recession is already six months or eight months in and it's going to go for two years before we get to recovery again so it's a longer process but we're already in the thick of it Davis also has sympathy with My Views that inflation probably comes lower like me he hears the argument that maybe some of the supply issues could be more structural but again he kind of thinks it's going to be overwhelmed by the secular themes of debt demographics deflation globalization and those other issues so lots to get out of this and again we join all of the macro Dots here of how the economy all fits together all the component parts what's leading what's lagging and it comes out to a very simple proposition by bonds where diamonds we hope you enjoyed the video at real Vision we help you understand the complex world of Finance business and the global economy with in-depth analysis from real experts Join the Revolution at realvision.com

Channel: Real Vision

Views: 309,586

Keywords: Finance, Markets, Economy, Stock Market, Investing, Trading, Financial Literacy, Recession, Interview, Conversation, Strategy, Analysis, Short Seller, Real Vision, Equities, Raoul Pal, Inflation, Stagflation, Monetary Policy, Money, Federal Reserve, Fed, david rosenberg, dave rosenberg, bonds trade, buy bonds wear diamonds, six quarter recession, two year recession, 2 year recession, early recession, stages of a recession, raoul pal interview, tightening policy, dollar power, energy crisis

Id: gl-HSCb1htA

Length: 71min 14sec (4274 seconds)

Published: Tue Aug 30 2022