August 5, 2024 • 41 mins
The Nasdaq is now in correction territory and the S&P 500 is down more than 2% so far this month. Analysts are blaming any number of things for the selloff, including a slowdown in the economy, the Federal Reserve being behind the curve on rate cuts, hedge funds rotating out of positions, and waning enthusiasm for AI. But Matt King, the former Citigroup strategist who's now founded his own research shop called Satori Insights, argues there's something else going on. He believes that the world's central banks have only really just begun to drain liquidity from the system, and that the market is still sensitive to the push and pull of their big balance sheets. In this episode, he explains how central banks have pulled the plug on risk assets, why stocks are faltering now, plus his general approach to analyzing markets.
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Episode Transcript
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Speaker 1 (00:02):
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Odd Thoughts podcast.
I'm Tracy Alloway.
Speaker 3 (00:23):
And I'm Joe Wisenthal.
Speaker 2 (00:24):
Joe, it's my favorite time of year. It's August.
Speaker 3 (00:27):
Well, I didn't know that. Why is it your favorite
time of year? I like August two. I love summer.
But what's your reason.
Speaker 2 (00:32):
Well, actually it's exactly that. I love summer.
Speaker 3 (00:35):
But this is why we get along.
Speaker 2 (00:37):
There's an added flames say.
Speaker 3 (00:39):
I don't like people who have favorite seasons of the summer.
I'm skeptical of that.
Speaker 2 (00:44):
You know what I used to be.
Speaker 3 (00:45):
I judge people.
Speaker 2 (00:46):
Okay, that's fine. I used to be exactly like that. However,
I've found that as I've gotten older, I've kind of
come Maybe as I've gotten older and acquired a house
without air conditioning, I've also home to appreciate winter a
little bit more. Okay, I didn't actually mean to start
talking about the weather. But there's another reason I like August,
which is I feel like that's the month when weird
(01:07):
things in markets start to happen.
Speaker 3 (01:09):
Yeah, August through October feels like that's the three month
stretch where anything can happen.
Speaker 2 (01:15):
Yeah, and August especially, you know, people are on their
like mandated two weekly if you're a professional working at
a bank or something like that, you have to go
on leave for I think two weeks or something like
that every year. And there's lots of illiquidity in the market,
so you know, tiny little things can end up having
(01:37):
a big impact. And I feel like August is when
you get some of those strange market moves. And speaking
of strange market moves, or at least dramatic ones, in
recent days and weeks, we have seen some interesting stuff
happening in the market that has been different to the
pattern that has played out for the past year or
(01:57):
so totally.
Speaker 3 (01:58):
First of all, we've had a little bit of weakness.
I've had a little bit of rotation that people are
talking about. Some of those red hot tech stocs have
come down. We're seeing a lot of moves on the curve.
At the time we're writing this, the tenure yield is
back below four percon So I was just saying in
the Odd Lots discord which people should go and subscribe
(02:18):
to and hang out, I literally said, this morning, macro
feels like it's kind of getting interesting.
Speaker 2 (02:23):
Again absolutely, both macro and markets, I gotta say, And
there is this ongoing conversation about how much of what
is happening in markets at the moment is technically driven,
so you know, maybe some of those pod shops having
to cut some positioning versus people actually reacting to changes
in the macro outlook. And I should just say we
(02:45):
are recording this on August first, the day after the
Federal Reserve meeting, where as expected, they didn't cut interest rates,
but they certainly telegraphed an upcoming cut, So lots going
on there as well.
Speaker 3 (02:57):
And the day before recording this day for non farm payrolls.
So by the time you were listening to this, we'll
know a little bit more about the labor market.
Speaker 2 (03:05):
Yes, we will. So there's a lot going on. It's August.
There's the potential for even more stuff to happen, weird
stuff sometimes, And I have to say, when it comes
to diving into the intricacies of the market and what's
going on there, there's a person that I very much
like to speak to. We've had him on the show before.
(03:25):
It is Matt King, formerly of City Group, and he's
now started his own research shop. It is called Satory Insights,
and he is the founder and global market strategist over there.
So we're going to talk to Matt about what's going
on in markets, what the outlook is right now. Matt,
thank you so much for coming back on all thoughts.
Speaker 4 (03:45):
Thank you for having me so much too kind.
Speaker 2 (03:47):
Well, we are very excited to be speaking to you again.
There's a lot that's happened since we spoke to you
last I think it was in maybe in March of
last year. Talk to us about what's happened. So you've
set out on your own. You have this new thing
called Satory Insights. What are you doing over there?
Speaker 4 (04:07):
I'm doing more or less what I was doing previously,
which is trying to explain what markets have done and
what markets are going to do, and generally doing it
in a rather different fashion from everybody else as far
as I can see. And I love your description of August.
In my experience, either nothing whatsoever happens or areas you say,
quite big stuff happens. But I think that the biggest
puzzles that I see people wrestling with at the moment
(04:28):
are are, frankly, making sense of what markets have done
year to date and therefore, and that's the context in
which you need to see the change now, because on
the one hand, the other economy is much stronger than
everyone was imagining, But on the other hand, markets have
really done much much better. And yeah, there's the whole
AI story, but it sort of feels as though it's
more than that. And I think the biggest puzzle is
(04:49):
why financial conditions have eased so much even as we've
had ongoing QT, even as we've had rates at twenty
three year highs. And in fact, it was the main
thing I was missing in the FOMCA last night. Nobody
asked Jay Powell about how they considered this ease in
your financial conditions on one of the Bloomberg financial conditions
is just a couple of months ago we were showing
(05:10):
easier conditions than two thousand and seven, And I think
you need to get your head around what's been driving
all of that before you can then come back and
think about the outlook and what markets are doing at
the moment.
Speaker 3 (05:20):
All right, what's the answer? Tell us the answer for
this date of financial conditions, because it does seem weird,
and I mean, I think we've probably been talking about
this for almost two years on the show, the surprise
that perhaps fed raid hikes and the slow wind down
of the balance sheet hasn't had at least here before
more of a deleterious effect.
Speaker 4 (05:40):
So, at the risk of being cheeky, it's exactly that
same thing which I heard you say had been debound
on one of the previous episodes with one of your
other guests.
Speaker 3 (05:50):
So well, thank you for so I thank you for listening.
I appreciate I'm glad even though I personally offended your approach,
which I apologize, I appreciate your listening to Odd Lives,
and I appreciate you coming back and I say that
nothing is ever debunked in markets, because I actually don't.
Speaker 1 (06:09):
Feel that way.
Speaker 2 (06:09):
Joe is open minded, and just to be clear what
we're talking about in terms of the debunking, it was
the idea that central bank liquidity was driving asset prices.
That was the idea, which Matt is very much your
approach to analyzing markets.
Speaker 4 (06:24):
And I was not offended either. In teacher became the
subject of a footnote in one of my research pieces
making the counter argument. But I think that the standard
view of what's been going on is, oh, the economy
must be much stronger than everyone thought previously. It must
be that our star and neutral rates are higher. But
then there are a couple of puzzles. It's like, oh, well,
how come actually desire to borrow in credit growth are
(06:46):
really quite limited. There's lots of gross issues, but actually
net borrowing is really rather lackluster. And how come many
of the arstar models, the most comprehensive ones, don't really
show this big pickup in neutral rates. And then how
do we make sense of the recent and weakness, especially
in things like credit and emerging markets? And so again,
the sort of standard explanation is maybe, and there was
(07:07):
a nice academic paper on this recently which maybe QT
is just not as powerful as QE. Maybe there's some
big asymmetric effect going And it was a lovely argued
paper that I happened to think drough all the wrong conclusions.
And as usual, I start from not knowing anything about this.
I just look at my charts of what markets are doing,
and I try and make sense of them. But the
(07:27):
way it seems to me is that market sensitivity to
central bank balance sheet changes really hasn't changed at all.
That most of the time, when we thought we were
doing QT. Actually we weren't, and indeed a lot of
the time there was almost this stealth Q effect going on.
And this is a lot of the reason why I
think that financial conditions have been so easy, notwithstanding all
(07:49):
of the rate hikes. And the right way to think
about this is in terms of not the security side
of the central bank balance sheet, but the changes in reserves.
And once you start thinking in those terms globally, and
you say, well, since two thousand and nine, we added
eighteen trillion dollars worth of reserves or liquidity, and we've
only dialed back about five hundred billion dollars worth. And
(08:09):
even if we think more recently, as you say, more
or lessons last time I was on, since the last
market trough in October twenty twenty two, even with the
supposed ongoing QT, US reserves have increased, not fallen, by
a net two hundred and fifty billion dollars, and global
reserves have increased by nine hundred and twenty billion dollars.
And not only that, but the timing just fits so perfectly,
(08:32):
and mostly I think my charts argue better than I
can here. But whenever reserves have actually fallen so in
twenty twenty two. Markets fell whenever they fell in say
April this year again, same thing. Risk fell back again,
and that's a little of what's happened in July as well.
Speaker 3 (08:48):
Sorry, just to be clear on this, what are you
looking at when you say that reserves? Heaven? Because if
I look at just the pure chart of the FED
balance sheet on the Bloomberg, it's clearly gone down. It's
lowest twenty So when you say reserves haven't gone down,
what measure should I be looking at?
Speaker 4 (09:05):
So for the FED, you just want the straight reserves
number that you're looking at, and you see a peek
in April this year, and then levels have fallen off subsequently.
And then I do the same thing globally by looking
at reserves. Occasionally it's slightly different, but basically reserves at
other central banks. I make sure I don't introduce FX
effects to the total, and I look at the changes
in those reserves. Again, you get a peak in April
(09:27):
and then they've come off a little bit subsequently. But
most of the time the near term market moves correspond
really quite well with those, And even though we're getting
a little bit of a decoupling at the moment in
equities are trying to break away. It's interesting that you
look at other asset classes, you look at credit, you
look at emerging markets, if you even look at things
like bitcoin. Basically that correlation with the global reserves numbers
(09:50):
carries on.
Speaker 3 (09:51):
All right, Tracy, just to clarify, if you look at
the total size of the FED balance sheet is gone down.
But Matt is correct that if you look specifically a
US reserve balances with the Federal Reserve, it was a
peak in twenty twenty two, it fell and then it
picked back up, peaked in April, and then gone down.
So if you look at that measure, right.
Speaker 2 (10:12):
And I should just say Matt mentioned his famous charts
just then, and we're going to embed some of those
in the transcript of this conversation, So if you are listening,
then please check out the transcript as well because we
will have those visuals to better illustrate the point. But Matt,
just on the bank reserves point, could you walk us through,
(10:33):
preferably in excruciating detail, exactly how an increase in bank
reserves translates into higher asset prices. Is it the case
that when you know banks have more reserves, maybe they
feel more comfortable lending. Maybe it changes people's risk preferences.
How exactly does that translate into concrete market action.
Speaker 4 (10:54):
Well, such to the second than the first, But in
general I'm not sure anybody can do this properly, and
I'm mostly looking at the charts and then reasoning backwards.
So the most common explanations that you hear, and there's
been another paper recently by Noial Rubni try and relate
it to interest rate moves. And similarly, the FED when
they talk about this, they always focus on the levels
(11:15):
of reserves, and they kind of almost ignore changes in
reserves once they assume that the level of reserves is adequate.
I think that is entirely the wrong way to think
about it, intuitive though it may be. And likewise, I
think thinking in terms of the impact on interest rates
and then looking for that to cascade outwards again is wrong.
And instead, the way I think you're supposed to think
(11:38):
about it is that reserves are a neat way to
capture the balance between how much money the private sector
has got relative to how many assets are available to
absorb that money. Now, in the case of sort of
standard QI or QT, that's kind of straightforward enough, you
(11:58):
know that you are both giving the private sector more
money in the form of reserves and then giving them
fewer government bonds or bills to hold. But I think
this is also the reason why it's reserves and not
securities that count, because even when it's other factors on
central wank balance sheets going up and down, like the
(12:19):
Treasury General Account at the FED, or like the reverse
report program at the FED, even when those things are
seemingly innocuously moving up and down, they have this same effect.
So if the TGA is going up because they have
issued more tea bills and you have bought those tea bills,
but then the money is locked away at the FED
(12:40):
in a higher treasury balance, well that's the sort of
the same thing. You've taken money away from the private sector,
and there's less private money in markets, more securities needing
to be absorbed, and as a result, what we get
is a drop in the price of risk. And confusingly,
where that shows up on all of my charts is
not necessarily in a drop in the price off bond
(13:00):
yields where you might have anticipated or T bill rates. Actually, instead,
it shows up most clearly in the prices of equities,
in the prices of credit spreads, and even occasionally in
things like the prices of bitcoin. And for me, the
way you make sense of that that's weird because it's
not like the FED and the other central banks of
buying and selling large amounts of credit or equities, or
(13:22):
certainly bitcoin. But instead it's this ripple through effect. It's
that when say it's the other way around and TGA
is falling and I've just got more money in my
bank account because of a te ball matured, but there's
no new T bill for me to go out and buy. Well,
I get forced into buying something riskier, and you get
this cascading effect where the guy that would have bought
bonds buys credit, and the buyer that would have bought
(13:42):
investment grade buys high yeld, and the guy that would
have bought up high yield buys equities, and you can't
see all of those moving parts. It's sort of frustrating
in that respect, but that's the only way I can
make sense of these really quite consistent relationships, even from
one week to the next, even when reserves are supposedly abundant.
It's this shift in the balance and In fact, the
(14:03):
chart of mind that I'm probably most pleased with this
year is the one that then links through from changes
in reserves or central bank liquidity globally to changes in
the mutual fund flows, the mutual fund and the ETF flows.
It's this crowding in and crowding out effect as a
direct consequence of changes on central bank balance sheets, which
(14:24):
I think has been much more important than is widely recognized.
And even as you try and make sense of the
mutual fund flows, this year has been the second biggest
year on record after twenty twenty one, we've had six
hundred billion dollars of overall inflows. Again for me, until
very recently that was being driven directly by this crowding
out effect from the global central bank reserves numbers.
Speaker 3 (15:00):
What is the role of rate policy in your thinking,
because again, one of the things we're talking about right
now is the timing of possible rate cuts, which doesn't
directly impact some of these monetary aggregates such as the
balance sheet or the reserves specifically, but there is a
lot of anxiety in the market, particularly today again about
(15:22):
whether the FED is going to be too late in
cutting rates or etc. How do you think about that,
is that, just in your view, totally irrelevant.
Speaker 4 (15:30):
I didn't used to think it was irrelevant, but it's
sort of looking that way this cycle, isn't it. How
come we've had all these rate increases and then you've
not had a massive slowdown. And I think the way
I think about it is, so it's always about money creation,
it's always about credit creation. And normally that would be
driven by the private sector. It would be you and
me deciding to borrow or not to borrow based on
(15:51):
whether rates were restrictive or not. And this cycle, on
the other hand, has been different. The surge in credit
that we had, it never came from the private sector.
It came, if anything, from fiscal policy. And likewise, the
surge in say things like fun flows and some of
these market effects and the m zero or the reserves numbers, again,
that was never driven by the private sector. It was
(16:11):
never driven by interest rates. It was driven directly by
these central bank balance sheet effects. And so the flip
side of what I'm saying is that just as the
rate increases maybe had a negative effect, that's lugging in
the background, and there's a bit of a long lag
and you begin to see delinquencies picking up. But when
we eventually get to rate easing, I doubt that that
(16:34):
is going to do very much to stimulate private sector
credit growth either. And ultimately we may end up with
more reasoning than imagined, just because we're still extremely sensitive
to balance sheet changes. There never was that much desire
to borrow on the part of the private sector even
before all of the rate increases, and when we go
back to additional easings, I'm not sure that's going to
stimulate lots of private sector borrowing either. And this is
(16:56):
part of a longer term shift where even as rates
have been coming down for decades, the borrowing that there's been,
the money creation that there's been has in fact come
increasingly from fiscal authorities and from central banks directly, and
rates themselves have been effectively pushing on a string.
Speaker 2 (17:13):
Can I play Devil's advocate for a second, which is
this time last year the world was a light with
talk of a potential recession, and one thing you would
hear over and over again is, you know, yield curve inversion.
We've never had an aversion without an ensuing recession. This year,
there is much much less discussion about the risk of
(17:35):
a recession. Couldn't this all just be people have changed
their minds about the macroeconomic outlook and that is driving
asset prices. Like a very simple Oukham's razor kind of
explanation for what we're seeing.
Speaker 4 (17:50):
It could be and that must play some role, but
in general the timing doesn't fit. In general, the rally
in the markets has first, and then the improvement in
the economic conditions has come later. I guess you could
make an argument that economic surprises went negative, but in general,
and the people are starting to worry about a slow down.
(18:12):
But I'd argue markets are always supposed to anticipate, but
it's been stronger than that recently. Even when you take
something like earnings revisions. For example, earnings expectations have been
gradually increasing, but they seem to be doing so in
response to that. They're almost chasing the equity market higher
to buy a greater extent than previously. And as I say,
(18:37):
I wouldn't expect to have anything like the correlations that
I do with the central bank liquidity. I continue scratching
my head as to whether the effect could be the
other way round. It could be the market that's influencing
the Central Bank numbers, and while the lags are a
bit variable, basically no, it doesn't work that way. But
for me, fundamentals have become very much a lagging indicator.
(18:58):
And this, for me is all part of a longer
term story whereby up until twenty twelve or so, I
placed an awful lot more emphasis on fundamentals because it
seemed to be driving the market to a much larger extent.
Since twenty twelve, many of my favorite relationships simply broke down,
so the lending surveys were no longer a good guide
(19:20):
to what spreads were doing and what defaults were doing.
If anything, it was the other way around. It was
spreads would rally first, and then the lending standards was
easy afterwards, and the defaults that should have been taking
place didn't take place. Or same thing. In volatility space,
there are nice relationships that used to hold with uncertainty,
and since twenty twelve, uncertainty has often been quite high
on uncertainty metrics, a number of references to uncertainty in
(19:42):
the news and things like that, and yet volatility most
of the time has been super low. And all of
these dynamics, to my mind, go together with this money
creation led pattern, but where the money creation has come
directly from central banks, and that shows up in my
relationships and the swings that we've had there are just
really big relative to the sorts of swings that we
(20:03):
get in money creation coming from the private sector, and
that's why they end up dominating the market.
Speaker 2 (20:07):
Since you mentioned timing just then, let's talk about that
a little bit more. So. Reserves peaked back in April,
it wasn't until relatively recently that we really saw significant
market weakness. So why was there that gap. Why didn't
we see equities falling earlier on as reserves started to
(20:27):
come down?
Speaker 4 (20:28):
A couple of different things. So one of the reasons
why Joe was sounding so skeptical on the previous podcast
was because when if you just look at US reserves alone,
sometimes they correlate, but they don't always, you get a
much betefit with the global numbers. And some of what
has been going on is that there have been liquidity
editions by the BOJ and then recently from the PBOC
that have some impact. I think though the biggest story
(20:51):
is that the fund flows have been sort of making
an effort to decouple, even as the central bank liquidity
has faded to some extent that you often have lab
especially when there's momentum driven markets as we've had recently,
and there's a little bit of a lag before people
realize that the momentum isn't there. And even now, I
am impressed by how many inflows we've had, especially to equities,
(21:13):
and it is plausible that this could just carry on
by itself. It's plausible that that the belief in buying
the dip is just so strong that actually this carries
on regardless. And although we get a little bit of
a liquidity drainage from central banks, even with the quarterly
refunding announcement from the Treasure yesterday and a little bit
more bill issuance, actually that could be another factor that
drags a bit more money out of RRP and ensures
(21:34):
we don't have too much liquidity drainage generally speaking, though,
I think all of this is on much more fragile
ground than it was in the first half of the year,
and I think my whole way of looking at it
takes you to a very different place from if you
assume it's fundamentals driving markets and you assume people have
(21:55):
been buying for fundamental reasons, And what many asset managers
tell me is this fits frankly much better with where
they've been for an extended period, which is there not
buying because they think that equities are cheap or credit
is cheap at two thousand and seven type levels. On
the contrary, the reason they keep buying is because they
keep having another inflow. And as I say, when you
(22:17):
start looking at other asset classes or even even assets
like bitcoin that are much more in line with the
central bank liquidity numbers than the equity market is then
that you re assess the whole narrowing of the market
rally and the churn that we're getting at the moment
and the effort to retain Is this instead a sign
of a natural fundamental driven strength and the back of
(22:40):
a trump trade that can run and run and run,
or instead, is this actually a sign of a weakening
level of support that can push up a smaller and
smaller number of assets and ultimately is quite vulnerable to
any deterioration in those fun flows. And that hasn't really
happened yet, but I think if it does happen, then
(23:00):
rate heasing in itself is not going to be sufficient
to get everyone chasing back into risk again.
Speaker 2 (23:06):
Joe Matt just said that the reason funds keep buying
is because there's another inflow. I feel like I have
to mention here that Matt's work was the inspiration for
flows before pros.
Speaker 3 (23:17):
Oh, so now we get, yeah.
Speaker 2 (23:19):
This idea that you know, flows can drive additional buying
and where markets used to maybe be more value driven,
so eventually you would say like, actually, this price isn't justified,
and so investors would sort of self limit their behavior.
Now that just doesn't happen as much.
Speaker 3 (23:36):
So I believe in the flows before pros thesis theorem
saying to an extent, and I buy this, and that
makes a lot of sense to me. But here's what
I want to understand further, and that is how that
explained certain sectoral moves. Because whenever I hear about okay,
markets are divorced from fundamentals, or fundamentals don't work as
(23:58):
well as they might have used to. I look at
like the big winners within equity markets are companies that
are just objectively doing really well. And that's also been
the case since two thousand and nine, which is like, okay,
we have these extraordinary moves in the handful of big
tech companies. They're doing really well. They're really good businesses,
They're making tons of money. Their growth rates continue to
(24:20):
exceed anyone's expectations. Earnings are always being revised up. In fact,
like no companies this big in history are showing growth
rates like this given their size. So if it's all
flows and all that stuff, why do we seem to
see this connection between the companies that are frankly killing
it and the stocks that are doing really well.
Speaker 4 (24:42):
I think that's a very fair point, And in general,
I would say it's not that fundamentals have no role whatsoever.
And in general I would say my relationships fit best,
or the center bank equidity numbers fit best. The broader
the number of assets that we assess them against, and
the more we take any individual asset, the more scope
(25:05):
there is for either idiosyncratic technicals or their own fundamentals
to have an impact. Having said that, though, I also
observe a strong tendency for the correlations to be best
with some of the names that have been hottest in
the market, let's say, like LVMH, or like Tesla, or
(25:27):
even like bitcoin as an asset class, and to some
extent that applies to the Magnificent seven as well. And
even as we look at those names, Yes, for Nvidio
in particular, the growth and earnings of the growth in
free cash flow has been phenomenal, but you still compare,
for example, forty or fifty times growth in net income
with gains in marketcap and share price of well over
(25:49):
one hundred times, or you do that same analysis for
some of the other techniums that haven't had anything like
the same growth in net income and free cash flow,
and still their market caps and share prices are up
by ten or twelve times. I think this is where
exactly that flows before pros seems to apply, and the
momentum effects have come to dominate markets, and the extent
(26:12):
of the rally that we're getting is more than you
can justify on the back of those underlying fundamentals. And
that's where people are just beginning to get concerned about
the Magnificent Seven. At the moment. The current earnings are great,
but actually where most of the growth is is not
in spot earnings. It's in the future years of earnings,
and we could easily end up questioning that if we
start to doubt the extent to which all of the
(26:34):
take investment that's taking place at the moment is actually
yielding profits.
Speaker 2 (26:52):
I want to step back for a second, and I
can't remember if we've ever actually asked you this question directly,
but we've I've been talking a lot about the uniqueness
of your approach to analyzing markets. Can you maybe talk
a little bit about how you developed that approach? Because
when I think back to when I first became aware
(27:14):
of your research, and we've certainly talked about this on
the show before, but it was the note from I
Think the summer of two thousand and eight Are the
Brokers Broken? Which turned out to be exceptionally prescient, but
was very different to what you are writing about and
doing today. So how did you come to take this
(27:34):
particular analytical framework?
Speaker 4 (27:37):
I make it up as I go along, and the
difference between me and other people is that I know
that I don't know anything, and therefore I have to
look at the charts and reason backwards, whereas other people
seem to they start with a theory and then they
keep flogging that theory even when it's not working in practice.
And so you're right, maybe it's because I used to
do credit strategy, and so I was always worried about
(27:57):
things blowing up. But back in two thousand I was
looking at corporate leverage because that was what was driving
the market. And then in seven and eight we were
looking at sieves and CDOs of abs and then brokers
and repo because that seemed to be what was really
important and was driving the market. And maybe yes, I
was lucky with the timing on that piece, but I've
shifted approach steadily, and as I say, where I've been
(28:20):
for the last decade is looking at all of the
central bank stuff just because that fits when nothing else does.
And it's in this period where mean reversion and value
investing has died and investors have herded into already expensive
strategies and momentum has dominated. And I hope that I
will not be doing this indefinitely, but as a strategist
(28:43):
and not an economists, I need to go with what
fits and then develop the theory around it. And if
the theory sounds plausible and the approach is still working,
then you continue to go with that. I fear at
some point I may need to come back and focus
on politics and debt levels and some of the really
slow burning really scary things, but hopefully not yet.
Speaker 2 (29:02):
Okay, Well, let's talk about politics and how I guess
uncertainty geopolitical uncertainty might be showing up in the market.
There seems to be a bit of a debate at
the moment. In fact, we recorded an episode last week
with Victor Schwetz from McCrory, and we asked him whether
or not some fear, for instance, was being priced into
(29:23):
the treasury market, maybe into futures, given that markets now
seem to be pricing in like seventy basis points worth
of cuts this year, But where do you see political
risk showing up, if at all.
Speaker 4 (29:37):
In general, markets are really bad at pricing political risk,
and especially the risk of regime change, and that inability
has if anything, become worse over the last decade, where
we haven't managed to price any risk premier appropriately at all,
never mind political risk premium. So the standard view is
(29:59):
that in theory, markets should price to a mean expected
outcome and consider all the different possibilities and reflect that
in the market price. In practice that is just too
difficult for people. Everybody goes off the modal forecast. If
you have been systematically hedging all of your downside risk,
as you probably should have done, giving the growing geopolitical
(30:21):
concerns and the mounting debt pile around the globe. Then Fadi,
you've gone out of business at this point, or at
least had a really difficult time because all of those
risks have been suppressed, And yet that doesn't mean that
they're not there. And I think all of this supplies
to an even greater extent than usual thanks to the
build up in debt levels, and even where private sector
is delivered a little bit, aggregate debt levels have mostly increased,
(30:44):
especially in the US, but also in places like China,
and you do get this worrying combination of ever more
elevated asset prices backed by ever larger amounts of debt,
and the scope for extreme regime changes or loss of confidence.
It is frankly, really difficult to affect in my core prices.
And what we've seen historically is that even when the
(31:06):
market does do this, it's not slow and steady and rational,
even with the election of a new government, let's say,
it's only as the market itself loses confidence. We had
this in Italy historically, we had it with list Trust's
government in the UK, there's just this moment where you
realize this isn't a tail ris this is actually happening,
and actually nobody else is buying, and therefore I shouldn't
(31:26):
be buying either. That's where you get this sudden repricing.
And so people are beginning to look at the moment
are things like the lack of term premium in the
US and how that might change and maybe it ought
to increase, and especially as we worry about increasing interest
payments in future. And yet for me, it's less about
the arithmetic of interest payments and the appropriate compensation for them,
(31:51):
and it's much more about are you actually being irresponsible
with fiscal policy? Are you actually willfully interfering with the
independence of the fad That's when you can have your
abrupt free pricing. And that's where markets have to go
from being able to ignore the politics entirely to finding
that the politics is the only thing. And I hope
we don't get there, but a number of long term
(32:14):
historical studies that I really respect do point to exactly
those risks becoming elevated.
Speaker 3 (32:19):
Yeah, I've kind of been thinking about this lately, which
is that you know, there's all kinds of reasons to
have political anxiety. I don't mean just like this election,
but just you know, social and lack of trust and
all that stuff. But I've kind of been thinking as like, well,
you know, as long as like it doesn't break, then
probably everything is going to be fine. But maybe one
(32:40):
day it's gonna be break and it's gonna be really
hard to put back together again, and then it'll be
really bad in me anyway, So do we buy ourself?
Where's the market going? Like we've had this rally, it's
pulled back a little bit, but we're still having a
pretty great year in stocks. As of right now when
I'm saying this, the SMP is of fourteen point four
to four percent, which would be a great year if
(33:00):
we ended here. No one's going to complain about that.
What do you see happening now?
Speaker 4 (33:05):
I am almost as uncertain about this as J. Powell
was last night, and I do think we need to
look at the numbers as we're going along for the
fun flows for the central mark liquidity. What I can
say with confidence is that I think the massive tailwind
that we had in twenty twenty three and in the
early part of this year is basically gone, and if
anything is likely to reverse slightly, I think the balance
(33:27):
of risk is therefore for higher volatility for at least
not rallying equities. I'd be happy to position for a
further rotation within the equity market. Again, the whole tech sector,
to my mind, does look stretched at this point. But
even there, it's not that I'm outright bullish on the
value sectors and the banks and the things that are
doing well at the moment and might benefit if there's
(33:49):
a further Trump trade. To my mind, everything ends up
rather more vulnerable than it has been because of this
tailwind is just no longer there.
Speaker 2 (33:57):
I realized we'd be very remiss if we had Matt
King on the podcast talking about the impact of central
bank driven liquidity and balance sheets on the market and
we didn't talk about what's going on in repo at
the moment. So we have seen, for instance, the secured
overnight funding rate, so the libor replacement ticking up quite
(34:20):
a bit. Recently. There's been talk about lots of drama
in the repo market, and there's been this ongoing discussion
about whether or not some of what's happening there could
lead the FED to have to reconsider things like quantitative tightening,
or maybe at least tweak that approach. Is this something
that's been on your radar?
Speaker 4 (34:39):
Yes and no. So yes, insofar as the changes in
the level of RRP, the reverse reproprogram at the FED
are a direct driver of reserves, and that feeds through
directly into my view of where markets are going. And
therefore I do look quite closely at the things I
(35:02):
think are driving RRP, namely the pickup on T bills,
and yes, the levels are private sector reaper in general,
though I am much less worried about things breaking, especially
with some of the new emergency facilities which are available
in than other people are. And that's because for me,
(35:24):
it's not that there's some magic level where reserves are
adequate and if we drop below that then bad things
happen and you see it in a spike and rate.
For me, instead, it's about that balance between the as
I say, the amount of money in private markets and
the assets available to absorb them, and that's reflected in
a much more continuous fashion with changes in reserves, even
when liquidity is supposedly abundant. So yes, I'm monitoring all
(35:47):
of this, but I don't have quite the same worry
about things suddenly breaking that perhaps some other people do.
And if anything, my guess would be the fact that
they've tapered the QUT means they probably will go on
for longer, and ultimately, other things being equal, that is
likely to drain reserves and is likely to lead to
(36:08):
a weaker market. But it would take quite a severe weakening,
I think, especially following the tapering, for them to want
to abandon the QT entirely. And indeed, i'd argue that frankly,
in almost in some broader sense, what we're wrestling with
is too much froth in markets and too much asset
price inflation. And my concern is a bit more the
(36:29):
opposite that they keep turning a blind eye to that,
and if we could take some of that froth out
of markets, yes, it might weaken the outlook a little
bit in the neartom, but it would lead to a
much more stable outlook over the long term.
Speaker 2 (36:40):
All right, Matt King from satory insides, It was so
lovely being able to catch up with you once again.
Thank you so much for coming back on the show.
Speaker 4 (36:49):
My pleasure. Thanks for having me, Joe.
Speaker 2 (37:03):
I really enjoy talking to Matt I should just emphasize
again that throughout that entire conversation, even though we couldn't
see him, he was bringing up charts because he always
brings up his charts, and I kind of love it,
and I will include them in the transcript of this
conversation so everyone can see them.
Speaker 3 (37:20):
Yeah, we should put out the transcript early when this
comes out, so maybe people you know, or people can
download this and then pause it and then wait for
the transcript to come out and then give it a listen.
I always enjoy Matt too. I respect how he sort
of characterized the evolving nature of his approach to looking
at markets, which is, if something isn't working, stop focusing
(37:42):
on that and start looking for things that are working.
And if there are relationships between measures of liquidity and
what's happening with risk assets, and they continue to work,
and they work in back tests and they work and
forward tests, then it would certainly make sense to me
to keep looking at them.
Speaker 2 (37:57):
I do think he's sort of put his finger on
something important and fundamental, and I'm pretty sure I've said
it on the show before in one way or another.
I know I've written about it in the newsletter, but
it does feel like we've seen the price of money
go up via higher benchmark interest rates, but that doesn't
(38:18):
mean that its availability has been limited. So you know,
liquidity is still pretty abundant. It seems like people can
borrow if they need to, And so I do think
it's a valid question to be asking why there seems
to be this disconnect between interest rates the price of
money versus its availability.
Speaker 3 (38:39):
No, I mean, it is really wild, right, It's a
mystery even as this price of money seems to have
gone up. I mean you could make the argument, yeah,
the price of money has gone up, but inflation's gone up,
so maybe it hasn't gone up as much. I remember
that was certainly a talking point for a while, maybe
in like twenty twenty two or twenty twenty three. But look,
no one's coming out great from the last four years,
(38:59):
or for the most part, nobody's theories are holding up
that well, and the market and the economy continue to
surprise people. So I do think it's important to look
at other perspectives.
Speaker 2 (39:09):
What will be really interesting is when we do finally
have rate cuts and seeing if like any of the
more recent patterns actually hold, or if stuff starts to
break again.
Speaker 3 (39:18):
Actually, it is funny because right in theory, the market
wants raid cuts, right like right, like we all sort
of it's just duh. But it's like the stock market's
done incredibly well during a period of rising and elevated rates,
that's right. So like you do wonder ultimately whether like okay,
something big could shift soon in terms of the direction
(39:40):
of the Fed. Now, of course the FED would say,
you know, it's changing directions because the underlying macro has changed.
But it is interesting, right, We've had the straight line
up and now we seem to be perhaps it's some
sort of macro turning point, and so you got to wonder,
then is the line going to also turn in some way?
Speaker 2 (39:55):
Yeah? All right, shall we leave it there.
Speaker 3 (39:57):
Let's leave it there.
Speaker 2 (39:58):
This has been another episode the au Thoughts podcast. I'm
Tracy Alloway. You can follow me at Tracy Alloway and.
Speaker 3 (40:04):
I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our producers Carmen Rodriguez at Carman Ermann, desh O
Bennett at Dashbot and kill Brooks at Kilbrooks. Thank you
to our producer Moses On. For more odd Laws content,
go to Bloomberg dot com, slash odd lots. We're have transcripts,
a blog, and a newsletter and you can chat about
all of these topics, including all of Matt's charts in
(40:26):
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dot gg, slash od.
Speaker 2 (40:31):
Lots and if you enjoy all thoughts. If you like
it when we do these types of market discussions, then
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And remember, if you are a Bloomberg subscriber, you can
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(40:52):
Bloomberg channel on Apple Podcasts and follow the instructions there.
Thanks for listening in
Bloomberg Audio Studios, Podcasts, radio News.
Speaker 2 (00:18):
Hello and welcome to another episode of the Odd Thoughts podcast.
I'm Tracy Alloway.
Speaker 3 (00:23):
And I'm Joe Wisenthal.
Speaker 2 (00:24):
Joe, it's my favorite time of year. It's August.
Speaker 3 (00:27):
Well, I didn't know that. Why is it your favorite
time of year? I like August two. I love summer.
But what's your reason.
Speaker 2 (00:32):
Well, actually it's exactly that. I love summer.
Speaker 3 (00:35):
But this is why we get along.
Speaker 2 (00:37):
There's an added flames say.
Speaker 3 (00:39):
I don't like people who have favorite seasons of the summer.
I'm skeptical of that.
Speaker 2 (00:44):
You know what I used to be.
Speaker 3 (00:45):
I judge people.
Speaker 2 (00:46):
Okay, that's fine. I used to be exactly like that. However,
I've found that as I've gotten older, I've kind of
come Maybe as I've gotten older and acquired a house
without air conditioning, I've also home to appreciate winter a
little bit more. Okay, I didn't actually mean to start
talking about the weather. But there's another reason I like August,
which is I feel like that's the month when weird
(01:07):
things in markets start to happen.
Speaker 3 (01:09):
Yeah, August through October feels like that's the three month
stretch where anything can happen.
Speaker 2 (01:15):
Yeah, and August especially, you know, people are on their
like mandated two weekly if you're a professional working at
a bank or something like that, you have to go
on leave for I think two weeks or something like
that every year. And there's lots of illiquidity in the market,
so you know, tiny little things can end up having
(01:37):
a big impact. And I feel like August is when
you get some of those strange market moves. And speaking
of strange market moves, or at least dramatic ones, in
recent days and weeks, we have seen some interesting stuff
happening in the market that has been different to the
pattern that has played out for the past year or
(01:57):
so totally.
Speaker 3 (01:58):
First of all, we've had a little bit of weakness.
I've had a little bit of rotation that people are
talking about. Some of those red hot tech stocs have
come down. We're seeing a lot of moves on the curve.
At the time we're writing this, the tenure yield is
back below four percon So I was just saying in
the Odd Lots discord which people should go and subscribe
(02:18):
to and hang out, I literally said, this morning, macro
feels like it's kind of getting interesting.
Speaker 2 (02:23):
Again absolutely, both macro and markets, I gotta say, And
there is this ongoing conversation about how much of what
is happening in markets at the moment is technically driven,
so you know, maybe some of those pod shops having
to cut some positioning versus people actually reacting to changes
in the macro outlook. And I should just say we
(02:45):
are recording this on August first, the day after the
Federal Reserve meeting, where as expected, they didn't cut interest rates,
but they certainly telegraphed an upcoming cut, So lots going
on there as well.
Speaker 3 (02:57):
And the day before recording this day for non farm payrolls.
So by the time you were listening to this, we'll
know a little bit more about the labor market.
Speaker 2 (03:05):
Yes, we will. So there's a lot going on. It's August.
There's the potential for even more stuff to happen, weird
stuff sometimes, And I have to say, when it comes
to diving into the intricacies of the market and what's
going on there, there's a person that I very much
like to speak to. We've had him on the show before.
(03:25):
It is Matt King, formerly of City Group, and he's
now started his own research shop. It is called Satory Insights,
and he is the founder and global market strategist over there.
So we're going to talk to Matt about what's going
on in markets, what the outlook is right now. Matt,
thank you so much for coming back on all thoughts.
Speaker 4 (03:45):
Thank you for having me so much too kind.
Speaker 2 (03:47):
Well, we are very excited to be speaking to you again.
There's a lot that's happened since we spoke to you
last I think it was in maybe in March of
last year. Talk to us about what's happened. So you've
set out on your own. You have this new thing
called Satory Insights. What are you doing over there?
Speaker 4 (04:07):
I'm doing more or less what I was doing previously,
which is trying to explain what markets have done and
what markets are going to do, and generally doing it
in a rather different fashion from everybody else as far
as I can see. And I love your description of August.
In my experience, either nothing whatsoever happens or areas you say,
quite big stuff happens. But I think that the biggest
puzzles that I see people wrestling with at the moment
(04:28):
are are, frankly, making sense of what markets have done
year to date and therefore, and that's the context in
which you need to see the change now, because on
the one hand, the other economy is much stronger than
everyone was imagining, But on the other hand, markets have
really done much much better. And yeah, there's the whole
AI story, but it sort of feels as though it's
more than that. And I think the biggest puzzle is
(04:49):
why financial conditions have eased so much even as we've
had ongoing QT, even as we've had rates at twenty
three year highs. And in fact, it was the main
thing I was missing in the FOMCA last night. Nobody
asked Jay Powell about how they considered this ease in
your financial conditions on one of the Bloomberg financial conditions
is just a couple of months ago we were showing
(05:10):
easier conditions than two thousand and seven, And I think
you need to get your head around what's been driving
all of that before you can then come back and
think about the outlook and what markets are doing at
the moment.
Speaker 3 (05:20):
All right, what's the answer? Tell us the answer for
this date of financial conditions, because it does seem weird,
and I mean, I think we've probably been talking about
this for almost two years on the show, the surprise
that perhaps fed raid hikes and the slow wind down
of the balance sheet hasn't had at least here before
more of a deleterious effect.
Speaker 4 (05:40):
So, at the risk of being cheeky, it's exactly that
same thing which I heard you say had been debound
on one of the previous episodes with one of your
other guests.
Speaker 3 (05:50):
So well, thank you for so I thank you for listening.
I appreciate I'm glad even though I personally offended your approach,
which I apologize, I appreciate your listening to Odd Lives,
and I appreciate you coming back and I say that
nothing is ever debunked in markets, because I actually don't.
Speaker 1 (06:09):
Feel that way.
Speaker 2 (06:09):
Joe is open minded, and just to be clear what
we're talking about in terms of the debunking, it was
the idea that central bank liquidity was driving asset prices.
That was the idea, which Matt is very much your
approach to analyzing markets.
Speaker 4 (06:24):
And I was not offended either. In teacher became the
subject of a footnote in one of my research pieces
making the counter argument. But I think that the standard
view of what's been going on is, oh, the economy
must be much stronger than everyone thought previously. It must
be that our star and neutral rates are higher. But
then there are a couple of puzzles. It's like, oh, well,
how come actually desire to borrow in credit growth are
(06:46):
really quite limited. There's lots of gross issues, but actually
net borrowing is really rather lackluster. And how come many
of the arstar models, the most comprehensive ones, don't really
show this big pickup in neutral rates. And then how
do we make sense of the recent and weakness, especially
in things like credit and emerging markets? And so again,
the sort of standard explanation is maybe, and there was
(07:07):
a nice academic paper on this recently which maybe QT
is just not as powerful as QE. Maybe there's some
big asymmetric effect going And it was a lovely argued
paper that I happened to think drough all the wrong conclusions.
And as usual, I start from not knowing anything about this.
I just look at my charts of what markets are doing,
and I try and make sense of them. But the
(07:27):
way it seems to me is that market sensitivity to
central bank balance sheet changes really hasn't changed at all.
That most of the time, when we thought we were
doing QT. Actually we weren't, and indeed a lot of
the time there was almost this stealth Q effect going on.
And this is a lot of the reason why I
think that financial conditions have been so easy, notwithstanding all
(07:49):
of the rate hikes. And the right way to think
about this is in terms of not the security side
of the central bank balance sheet, but the changes in reserves.
And once you start thinking in those terms globally, and
you say, well, since two thousand and nine, we added
eighteen trillion dollars worth of reserves or liquidity, and we've
only dialed back about five hundred billion dollars worth. And
(08:09):
even if we think more recently, as you say, more
or lessons last time I was on, since the last
market trough in October twenty twenty two, even with the
supposed ongoing QT, US reserves have increased, not fallen, by
a net two hundred and fifty billion dollars, and global
reserves have increased by nine hundred and twenty billion dollars.
And not only that, but the timing just fits so perfectly,
(08:32):
and mostly I think my charts argue better than I
can here. But whenever reserves have actually fallen so in
twenty twenty two. Markets fell whenever they fell in say
April this year again, same thing. Risk fell back again,
and that's a little of what's happened in July as well.
Speaker 3 (08:48):
Sorry, just to be clear on this, what are you
looking at when you say that reserves? Heaven? Because if
I look at just the pure chart of the FED
balance sheet on the Bloomberg, it's clearly gone down. It's
lowest twenty So when you say reserves haven't gone down,
what measure should I be looking at?
Speaker 4 (09:05):
So for the FED, you just want the straight reserves
number that you're looking at, and you see a peek
in April this year, and then levels have fallen off subsequently.
And then I do the same thing globally by looking
at reserves. Occasionally it's slightly different, but basically reserves at
other central banks. I make sure I don't introduce FX
effects to the total, and I look at the changes
in those reserves. Again, you get a peak in April
(09:27):
and then they've come off a little bit subsequently. But
most of the time the near term market moves correspond
really quite well with those, And even though we're getting
a little bit of a decoupling at the moment in
equities are trying to break away. It's interesting that you
look at other asset classes, you look at credit, you
look at emerging markets, if you even look at things
like bitcoin. Basically that correlation with the global reserves numbers
(09:50):
carries on.
Speaker 3 (09:51):
All right, Tracy, just to clarify, if you look at
the total size of the FED balance sheet is gone down.
But Matt is correct that if you look specifically a
US reserve balances with the Federal Reserve, it was a
peak in twenty twenty two, it fell and then it
picked back up, peaked in April, and then gone down.
So if you look at that measure, right.
Speaker 2 (10:12):
And I should just say Matt mentioned his famous charts
just then, and we're going to embed some of those
in the transcript of this conversation, So if you are listening,
then please check out the transcript as well because we
will have those visuals to better illustrate the point. But Matt,
just on the bank reserves point, could you walk us through,
(10:33):
preferably in excruciating detail, exactly how an increase in bank
reserves translates into higher asset prices. Is it the case
that when you know banks have more reserves, maybe they
feel more comfortable lending. Maybe it changes people's risk preferences.
How exactly does that translate into concrete market action.
Speaker 4 (10:54):
Well, such to the second than the first, But in
general I'm not sure anybody can do this properly, and
I'm mostly looking at the charts and then reasoning backwards.
So the most common explanations that you hear, and there's
been another paper recently by Noial Rubni try and relate
it to interest rate moves. And similarly, the FED when
they talk about this, they always focus on the levels
(11:15):
of reserves, and they kind of almost ignore changes in
reserves once they assume that the level of reserves is adequate.
I think that is entirely the wrong way to think
about it, intuitive though it may be. And likewise, I
think thinking in terms of the impact on interest rates
and then looking for that to cascade outwards again is wrong.
And instead, the way I think you're supposed to think
(11:38):
about it is that reserves are a neat way to
capture the balance between how much money the private sector
has got relative to how many assets are available to
absorb that money. Now, in the case of sort of
standard QI or QT, that's kind of straightforward enough, you
(11:58):
know that you are both giving the private sector more
money in the form of reserves and then giving them
fewer government bonds or bills to hold. But I think
this is also the reason why it's reserves and not
securities that count, because even when it's other factors on
central wank balance sheets going up and down, like the
(12:19):
Treasury General Account at the FED, or like the reverse
report program at the FED, even when those things are
seemingly innocuously moving up and down, they have this same effect.
So if the TGA is going up because they have
issued more tea bills and you have bought those tea bills,
but then the money is locked away at the FED
(12:40):
in a higher treasury balance, well that's the sort of
the same thing. You've taken money away from the private sector,
and there's less private money in markets, more securities needing
to be absorbed, and as a result, what we get
is a drop in the price of risk. And confusingly,
where that shows up on all of my charts is
not necessarily in a drop in the price off bond
(13:00):
yields where you might have anticipated or T bill rates. Actually, instead,
it shows up most clearly in the prices of equities,
in the prices of credit spreads, and even occasionally in
things like the prices of bitcoin. And for me, the
way you make sense of that that's weird because it's
not like the FED and the other central banks of
buying and selling large amounts of credit or equities, or
(13:22):
certainly bitcoin. But instead it's this ripple through effect. It's
that when say it's the other way around and TGA
is falling and I've just got more money in my
bank account because of a te ball matured, but there's
no new T bill for me to go out and buy. Well,
I get forced into buying something riskier, and you get
this cascading effect where the guy that would have bought
bonds buys credit, and the buyer that would have bought
(13:42):
investment grade buys high yeld, and the guy that would
have bought up high yield buys equities, and you can't
see all of those moving parts. It's sort of frustrating
in that respect, but that's the only way I can
make sense of these really quite consistent relationships, even from
one week to the next, even when reserves are supposedly abundant.
It's this shift in the balance and In fact, the
(14:03):
chart of mind that I'm probably most pleased with this
year is the one that then links through from changes
in reserves or central bank liquidity globally to changes in
the mutual fund flows, the mutual fund and the ETF flows.
It's this crowding in and crowding out effect as a
direct consequence of changes on central bank balance sheets, which
(14:24):
I think has been much more important than is widely recognized.
And even as you try and make sense of the
mutual fund flows, this year has been the second biggest
year on record after twenty twenty one, we've had six
hundred billion dollars of overall inflows. Again for me, until
very recently that was being driven directly by this crowding
out effect from the global central bank reserves numbers.
Speaker 3 (15:00):
What is the role of rate policy in your thinking,
because again, one of the things we're talking about right
now is the timing of possible rate cuts, which doesn't
directly impact some of these monetary aggregates such as the
balance sheet or the reserves specifically, but there is a
lot of anxiety in the market, particularly today again about
(15:22):
whether the FED is going to be too late in
cutting rates or etc. How do you think about that,
is that, just in your view, totally irrelevant.
Speaker 4 (15:30):
I didn't used to think it was irrelevant, but it's
sort of looking that way this cycle, isn't it. How
come we've had all these rate increases and then you've
not had a massive slowdown. And I think the way
I think about it is, so it's always about money creation,
it's always about credit creation. And normally that would be
driven by the private sector. It would be you and
me deciding to borrow or not to borrow based on
(15:51):
whether rates were restrictive or not. And this cycle, on
the other hand, has been different. The surge in credit
that we had, it never came from the private sector.
It came, if anything, from fiscal policy. And likewise, the
surge in say things like fun flows and some of
these market effects and the m zero or the reserves numbers, again,
that was never driven by the private sector. It was
(16:11):
never driven by interest rates. It was driven directly by
these central bank balance sheet effects. And so the flip
side of what I'm saying is that just as the
rate increases maybe had a negative effect, that's lugging in
the background, and there's a bit of a long lag
and you begin to see delinquencies picking up. But when
we eventually get to rate easing, I doubt that that
(16:34):
is going to do very much to stimulate private sector
credit growth either. And ultimately we may end up with
more reasoning than imagined, just because we're still extremely sensitive
to balance sheet changes. There never was that much desire
to borrow on the part of the private sector even
before all of the rate increases, and when we go
back to additional easings, I'm not sure that's going to
stimulate lots of private sector borrowing either. And this is
(16:56):
part of a longer term shift where even as rates
have been coming down for decades, the borrowing that there's been,
the money creation that there's been has in fact come
increasingly from fiscal authorities and from central banks directly, and
rates themselves have been effectively pushing on a string.
Speaker 2 (17:13):
Can I play Devil's advocate for a second, which is
this time last year the world was a light with
talk of a potential recession, and one thing you would
hear over and over again is, you know, yield curve inversion.
We've never had an aversion without an ensuing recession. This year,
there is much much less discussion about the risk of
(17:35):
a recession. Couldn't this all just be people have changed
their minds about the macroeconomic outlook and that is driving
asset prices. Like a very simple Oukham's razor kind of
explanation for what we're seeing.
Speaker 4 (17:50):
It could be and that must play some role, but
in general the timing doesn't fit. In general, the rally
in the markets has first, and then the improvement in
the economic conditions has come later. I guess you could
make an argument that economic surprises went negative, but in general,
and the people are starting to worry about a slow down.
(18:12):
But I'd argue markets are always supposed to anticipate, but
it's been stronger than that recently. Even when you take
something like earnings revisions. For example, earnings expectations have been
gradually increasing, but they seem to be doing so in
response to that. They're almost chasing the equity market higher
to buy a greater extent than previously. And as I say,
(18:37):
I wouldn't expect to have anything like the correlations that
I do with the central bank liquidity. I continue scratching
my head as to whether the effect could be the
other way round. It could be the market that's influencing
the Central Bank numbers, and while the lags are a
bit variable, basically no, it doesn't work that way. But
for me, fundamentals have become very much a lagging indicator.
(18:58):
And this, for me is all part of a longer
term story whereby up until twenty twelve or so, I
placed an awful lot more emphasis on fundamentals because it
seemed to be driving the market to a much larger extent.
Since twenty twelve, many of my favorite relationships simply broke down,
so the lending surveys were no longer a good guide
(19:20):
to what spreads were doing and what defaults were doing.
If anything, it was the other way around. It was
spreads would rally first, and then the lending standards was
easy afterwards, and the defaults that should have been taking
place didn't take place. Or same thing. In volatility space,
there are nice relationships that used to hold with uncertainty,
and since twenty twelve, uncertainty has often been quite high
on uncertainty metrics, a number of references to uncertainty in
(19:42):
the news and things like that, and yet volatility most
of the time has been super low. And all of
these dynamics, to my mind, go together with this money
creation led pattern, but where the money creation has come
directly from central banks, and that shows up in my
relationships and the swings that we've had there are just
really big relative to the sorts of swings that we
(20:03):
get in money creation coming from the private sector, and
that's why they end up dominating the market.
Speaker 2 (20:07):
Since you mentioned timing just then, let's talk about that
a little bit more. So. Reserves peaked back in April,
it wasn't until relatively recently that we really saw significant
market weakness. So why was there that gap. Why didn't
we see equities falling earlier on as reserves started to
(20:27):
come down?
Speaker 4 (20:28):
A couple of different things. So one of the reasons
why Joe was sounding so skeptical on the previous podcast
was because when if you just look at US reserves alone,
sometimes they correlate, but they don't always, you get a
much betefit with the global numbers. And some of what
has been going on is that there have been liquidity
editions by the BOJ and then recently from the PBOC
that have some impact. I think though the biggest story
(20:51):
is that the fund flows have been sort of making
an effort to decouple, even as the central bank liquidity
has faded to some extent that you often have lab
especially when there's momentum driven markets as we've had recently,
and there's a little bit of a lag before people
realize that the momentum isn't there. And even now, I
am impressed by how many inflows we've had, especially to equities,
(21:13):
and it is plausible that this could just carry on
by itself. It's plausible that that the belief in buying
the dip is just so strong that actually this carries
on regardless. And although we get a little bit of
a liquidity drainage from central banks, even with the quarterly
refunding announcement from the Treasure yesterday and a little bit
more bill issuance, actually that could be another factor that
drags a bit more money out of RRP and ensures
(21:34):
we don't have too much liquidity drainage generally speaking, though,
I think all of this is on much more fragile
ground than it was in the first half of the year,
and I think my whole way of looking at it
takes you to a very different place from if you
assume it's fundamentals driving markets and you assume people have
(21:55):
been buying for fundamental reasons, And what many asset managers
tell me is this fits frankly much better with where
they've been for an extended period, which is there not
buying because they think that equities are cheap or credit
is cheap at two thousand and seven type levels. On
the contrary, the reason they keep buying is because they
keep having another inflow. And as I say, when you
(22:17):
start looking at other asset classes or even even assets
like bitcoin that are much more in line with the
central bank liquidity numbers than the equity market is then
that you re assess the whole narrowing of the market
rally and the churn that we're getting at the moment
and the effort to retain Is this instead a sign
of a natural fundamental driven strength and the back of
(22:40):
a trump trade that can run and run and run,
or instead, is this actually a sign of a weakening
level of support that can push up a smaller and
smaller number of assets and ultimately is quite vulnerable to
any deterioration in those fun flows. And that hasn't really
happened yet, but I think if it does happen, then
(23:00):
rate heasing in itself is not going to be sufficient
to get everyone chasing back into risk again.
Speaker 2 (23:06):
Joe Matt just said that the reason funds keep buying
is because there's another inflow. I feel like I have
to mention here that Matt's work was the inspiration for
flows before pros.
Speaker 3 (23:17):
Oh, so now we get, yeah.
Speaker 2 (23:19):
This idea that you know, flows can drive additional buying
and where markets used to maybe be more value driven,
so eventually you would say like, actually, this price isn't justified,
and so investors would sort of self limit their behavior.
Now that just doesn't happen as much.
Speaker 3 (23:36):
So I believe in the flows before pros thesis theorem
saying to an extent, and I buy this, and that
makes a lot of sense to me. But here's what
I want to understand further, and that is how that
explained certain sectoral moves. Because whenever I hear about okay,
markets are divorced from fundamentals, or fundamentals don't work as
(23:58):
well as they might have used to. I look at
like the big winners within equity markets are companies that
are just objectively doing really well. And that's also been
the case since two thousand and nine, which is like, okay,
we have these extraordinary moves in the handful of big
tech companies. They're doing really well. They're really good businesses,
They're making tons of money. Their growth rates continue to
(24:20):
exceed anyone's expectations. Earnings are always being revised up. In fact,
like no companies this big in history are showing growth
rates like this given their size. So if it's all
flows and all that stuff, why do we seem to
see this connection between the companies that are frankly killing
it and the stocks that are doing really well.
Speaker 4 (24:42):
I think that's a very fair point, And in general,
I would say it's not that fundamentals have no role whatsoever.
And in general I would say my relationships fit best,
or the center bank equidity numbers fit best. The broader
the number of assets that we assess them against, and
the more we take any individual asset, the more scope
(25:05):
there is for either idiosyncratic technicals or their own fundamentals
to have an impact. Having said that, though, I also
observe a strong tendency for the correlations to be best
with some of the names that have been hottest in
the market, let's say, like LVMH, or like Tesla, or
(25:27):
even like bitcoin as an asset class, and to some
extent that applies to the Magnificent seven as well. And
even as we look at those names, Yes, for Nvidio
in particular, the growth and earnings of the growth in
free cash flow has been phenomenal, but you still compare,
for example, forty or fifty times growth in net income
with gains in marketcap and share price of well over
(25:49):
one hundred times, or you do that same analysis for
some of the other techniums that haven't had anything like
the same growth in net income and free cash flow,
and still their market caps and share prices are up
by ten or twelve times. I think this is where
exactly that flows before pros seems to apply, and the
momentum effects have come to dominate markets, and the extent
(26:12):
of the rally that we're getting is more than you
can justify on the back of those underlying fundamentals. And
that's where people are just beginning to get concerned about
the Magnificent Seven. At the moment. The current earnings are great,
but actually where most of the growth is is not
in spot earnings. It's in the future years of earnings,
and we could easily end up questioning that if we
start to doubt the extent to which all of the
(26:34):
take investment that's taking place at the moment is actually
yielding profits.
Speaker 2 (26:52):
I want to step back for a second, and I
can't remember if we've ever actually asked you this question directly,
but we've I've been talking a lot about the uniqueness
of your approach to analyzing markets. Can you maybe talk
a little bit about how you developed that approach? Because
when I think back to when I first became aware
(27:14):
of your research, and we've certainly talked about this on
the show before, but it was the note from I
Think the summer of two thousand and eight Are the
Brokers Broken? Which turned out to be exceptionally prescient, but
was very different to what you are writing about and
doing today. So how did you come to take this
(27:34):
particular analytical framework?
Speaker 4 (27:37):
I make it up as I go along, and the
difference between me and other people is that I know
that I don't know anything, and therefore I have to
look at the charts and reason backwards, whereas other people
seem to they start with a theory and then they
keep flogging that theory even when it's not working in practice.
And so you're right, maybe it's because I used to
do credit strategy, and so I was always worried about
(27:57):
things blowing up. But back in two thousand I was
looking at corporate leverage because that was what was driving
the market. And then in seven and eight we were
looking at sieves and CDOs of abs and then brokers
and repo because that seemed to be what was really
important and was driving the market. And maybe yes, I
was lucky with the timing on that piece, but I've
shifted approach steadily, and as I say, where I've been
(28:20):
for the last decade is looking at all of the
central bank stuff just because that fits when nothing else does.
And it's in this period where mean reversion and value
investing has died and investors have herded into already expensive
strategies and momentum has dominated. And I hope that I
will not be doing this indefinitely, but as a strategist
(28:43):
and not an economists, I need to go with what
fits and then develop the theory around it. And if
the theory sounds plausible and the approach is still working,
then you continue to go with that. I fear at
some point I may need to come back and focus
on politics and debt levels and some of the really
slow burning really scary things, but hopefully not yet.
Speaker 2 (29:02):
Okay, Well, let's talk about politics and how I guess
uncertainty geopolitical uncertainty might be showing up in the market.
There seems to be a bit of a debate at
the moment. In fact, we recorded an episode last week
with Victor Schwetz from McCrory, and we asked him whether
or not some fear, for instance, was being priced into
(29:23):
the treasury market, maybe into futures, given that markets now
seem to be pricing in like seventy basis points worth
of cuts this year, But where do you see political
risk showing up, if at all.
Speaker 4 (29:37):
In general, markets are really bad at pricing political risk,
and especially the risk of regime change, and that inability
has if anything, become worse over the last decade, where
we haven't managed to price any risk premier appropriately at all,
never mind political risk premium. So the standard view is
(29:59):
that in theory, markets should price to a mean expected
outcome and consider all the different possibilities and reflect that
in the market price. In practice that is just too
difficult for people. Everybody goes off the modal forecast. If
you have been systematically hedging all of your downside risk,
as you probably should have done, giving the growing geopolitical
(30:21):
concerns and the mounting debt pile around the globe. Then Fadi,
you've gone out of business at this point, or at
least had a really difficult time because all of those
risks have been suppressed, And yet that doesn't mean that
they're not there. And I think all of this supplies
to an even greater extent than usual thanks to the
build up in debt levels, and even where private sector
is delivered a little bit, aggregate debt levels have mostly increased,
(30:44):
especially in the US, but also in places like China,
and you do get this worrying combination of ever more
elevated asset prices backed by ever larger amounts of debt,
and the scope for extreme regime changes or loss of confidence.
It is frankly, really difficult to affect in my core prices.
And what we've seen historically is that even when the
(31:06):
market does do this, it's not slow and steady and rational,
even with the election of a new government, let's say,
it's only as the market itself loses confidence. We had
this in Italy historically, we had it with list Trust's
government in the UK, there's just this moment where you
realize this isn't a tail ris this is actually happening,
and actually nobody else is buying, and therefore I shouldn't
(31:26):
be buying either. That's where you get this sudden repricing.
And so people are beginning to look at the moment
are things like the lack of term premium in the
US and how that might change and maybe it ought
to increase, and especially as we worry about increasing interest
payments in future. And yet for me, it's less about
the arithmetic of interest payments and the appropriate compensation for them,
(31:51):
and it's much more about are you actually being irresponsible
with fiscal policy? Are you actually willfully interfering with the
independence of the fad That's when you can have your
abrupt free pricing. And that's where markets have to go
from being able to ignore the politics entirely to finding
that the politics is the only thing. And I hope
we don't get there, but a number of long term
(32:14):
historical studies that I really respect do point to exactly
those risks becoming elevated.
Speaker 3 (32:19):
Yeah, I've kind of been thinking about this lately, which
is that you know, there's all kinds of reasons to
have political anxiety. I don't mean just like this election,
but just you know, social and lack of trust and
all that stuff. But I've kind of been thinking as like, well,
you know, as long as like it doesn't break, then
probably everything is going to be fine. But maybe one
(32:40):
day it's gonna be break and it's gonna be really
hard to put back together again, and then it'll be
really bad in me anyway, So do we buy ourself?
Where's the market going? Like we've had this rally, it's
pulled back a little bit, but we're still having a
pretty great year in stocks. As of right now when
I'm saying this, the SMP is of fourteen point four
to four percent, which would be a great year if
(33:00):
we ended here. No one's going to complain about that.
What do you see happening now?
Speaker 4 (33:05):
I am almost as uncertain about this as J. Powell
was last night, and I do think we need to
look at the numbers as we're going along for the
fun flows for the central mark liquidity. What I can
say with confidence is that I think the massive tailwind
that we had in twenty twenty three and in the
early part of this year is basically gone, and if
anything is likely to reverse slightly, I think the balance
(33:27):
of risk is therefore for higher volatility for at least
not rallying equities. I'd be happy to position for a
further rotation within the equity market. Again, the whole tech sector,
to my mind, does look stretched at this point. But
even there, it's not that I'm outright bullish on the
value sectors and the banks and the things that are
doing well at the moment and might benefit if there's
(33:49):
a further Trump trade. To my mind, everything ends up
rather more vulnerable than it has been because of this
tailwind is just no longer there.
Speaker 2 (33:57):
I realized we'd be very remiss if we had Matt
King on the podcast talking about the impact of central
bank driven liquidity and balance sheets on the market and
we didn't talk about what's going on in repo at
the moment. So we have seen, for instance, the secured
overnight funding rate, so the libor replacement ticking up quite
(34:20):
a bit. Recently. There's been talk about lots of drama
in the repo market, and there's been this ongoing discussion
about whether or not some of what's happening there could
lead the FED to have to reconsider things like quantitative tightening,
or maybe at least tweak that approach. Is this something
that's been on your radar?
Speaker 4 (34:39):
Yes and no. So yes, insofar as the changes in
the level of RRP, the reverse reproprogram at the FED
are a direct driver of reserves, and that feeds through
directly into my view of where markets are going. And
therefore I do look quite closely at the things I
(35:02):
think are driving RRP, namely the pickup on T bills,
and yes, the levels are private sector reaper in general,
though I am much less worried about things breaking, especially
with some of the new emergency facilities which are available
in than other people are. And that's because for me,
(35:24):
it's not that there's some magic level where reserves are
adequate and if we drop below that then bad things
happen and you see it in a spike and rate.
For me, instead, it's about that balance between the as
I say, the amount of money in private markets and
the assets available to absorb them, and that's reflected in
a much more continuous fashion with changes in reserves, even
when liquidity is supposedly abundant. So yes, I'm monitoring all
(35:47):
of this, but I don't have quite the same worry
about things suddenly breaking that perhaps some other people do.
And if anything, my guess would be the fact that
they've tapered the QUT means they probably will go on
for longer, and ultimately, other things being equal, that is
likely to drain reserves and is likely to lead to
(36:08):
a weaker market. But it would take quite a severe weakening,
I think, especially following the tapering, for them to want
to abandon the QT entirely. And indeed, i'd argue that frankly,
in almost in some broader sense, what we're wrestling with
is too much froth in markets and too much asset
price inflation. And my concern is a bit more the
(36:29):
opposite that they keep turning a blind eye to that,
and if we could take some of that froth out
of markets, yes, it might weaken the outlook a little
bit in the neartom, but it would lead to a
much more stable outlook over the long term.
Speaker 2 (36:40):
All right, Matt King from satory insides, It was so
lovely being able to catch up with you once again.
Thank you so much for coming back on the show.
Speaker 4 (36:49):
My pleasure. Thanks for having me, Joe.
Speaker 2 (37:03):
I really enjoy talking to Matt I should just emphasize
again that throughout that entire conversation, even though we couldn't
see him, he was bringing up charts because he always
brings up his charts, and I kind of love it,
and I will include them in the transcript of this
conversation so everyone can see them.
Speaker 3 (37:20):
Yeah, we should put out the transcript early when this
comes out, so maybe people you know, or people can
download this and then pause it and then wait for
the transcript to come out and then give it a listen.
I always enjoy Matt too. I respect how he sort
of characterized the evolving nature of his approach to looking
at markets, which is, if something isn't working, stop focusing
(37:42):
on that and start looking for things that are working.
And if there are relationships between measures of liquidity and
what's happening with risk assets, and they continue to work,
and they work in back tests and they work and
forward tests, then it would certainly make sense to me
to keep looking at them.
Speaker 2 (37:57):
I do think he's sort of put his finger on
something important and fundamental, and I'm pretty sure I've said
it on the show before in one way or another.
I know I've written about it in the newsletter, but
it does feel like we've seen the price of money
go up via higher benchmark interest rates, but that doesn't
(38:18):
mean that its availability has been limited. So you know,
liquidity is still pretty abundant. It seems like people can
borrow if they need to, And so I do think
it's a valid question to be asking why there seems
to be this disconnect between interest rates the price of
money versus its availability.
Speaker 3 (38:39):
No, I mean, it is really wild, right, It's a
mystery even as this price of money seems to have
gone up. I mean you could make the argument, yeah,
the price of money has gone up, but inflation's gone up,
so maybe it hasn't gone up as much. I remember
that was certainly a talking point for a while, maybe
in like twenty twenty two or twenty twenty three. But look,
no one's coming out great from the last four years,
(38:59):
or for the most part, nobody's theories are holding up
that well, and the market and the economy continue to
surprise people. So I do think it's important to look
at other perspectives.
Speaker 2 (39:09):
What will be really interesting is when we do finally
have rate cuts and seeing if like any of the
more recent patterns actually hold, or if stuff starts to
break again.
Speaker 3 (39:18):
Actually, it is funny because right in theory, the market
wants raid cuts, right like right, like we all sort
of it's just duh. But it's like the stock market's
done incredibly well during a period of rising and elevated rates,
that's right. So like you do wonder ultimately whether like okay,
something big could shift soon in terms of the direction
(39:40):
of the Fed. Now, of course the FED would say,
you know, it's changing directions because the underlying macro has changed.
But it is interesting, right, We've had the straight line
up and now we seem to be perhaps it's some
sort of macro turning point, and so you got to wonder,
then is the line going to also turn in some way?
Speaker 2 (39:55):
Yeah? All right, shall we leave it there.
Speaker 3 (39:57):
Let's leave it there.
Speaker 2 (39:58):
This has been another episode the au Thoughts podcast. I'm
Tracy Alloway. You can follow me at Tracy Alloway and.
Speaker 3 (40:04):
I'm Joe Wisenthal. You can follow me at the Stalwart.
Follow our producers Carmen Rodriguez at Carman Ermann, desh O
Bennett at Dashbot and kill Brooks at Kilbrooks. Thank you
to our producer Moses On. For more odd Laws content,
go to Bloomberg dot com, slash odd lots. We're have transcripts,
a blog, and a newsletter and you can chat about
all of these topics, including all of Matt's charts in
(40:26):
the Discord twenty four to seven with fellow listeners Discord
dot gg, slash od.
Speaker 2 (40:31):
Lots and if you enjoy all thoughts. If you like
it when we do these types of market discussions, then
please leave us a positive review on your favorite podcast platform.
And remember, if you are a Bloomberg subscriber, you can
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Thanks for listening in
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Joe Weisenthal
Tracy Alloway
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