September 27, 2023 – FS Insider speaks with Simon Whitete, a macro strategist at Bloomberg LP and also the co-founder of the institutional research firm Variant Perception. Simon says we are currently seeing a weakening in both soft and hard economic data, not to mention a general complacency by investors regarding risks to the outlook which he believes are not currently priced into the market. Simon discusses Bloomberg's data on bankruptcy levels, which are hitting new records, and why he believes we are likely to see another inflationary wave emerge that will catch most investors off guard given the new 70s-like environment most have very little experience dealing with. This is definitely one interview you won't want to miss!
For accompanying slide deck for today's interview, click here.
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Timestamps:
00:00:00: Introduction and consensus view on US economic outlook
00:00:14: Introduction of Simon Whitete
00:01:32: Explanation of how recessions are defined
00:02:07: Discussion on economic shifts and recessions
00:03:14: Explanation of how a recession develops
00:04:11: Current stress in both hard and soft data
00:06:08: Likelihood of a recession based on the scrutinized indicators
00:06:25: Implications of a recession for stocks and bonds
00:07:12: Brief discussion on consensus of recession risks
00:08:05: Analysis of the market's response to recession
00:08:57: Speculations on an upcoming, unusual type of recession
00:10:01: Changes in the market due to inflation
00:10:44: Discussion on Phillips curve in an inflationary regime
00:11:13: Discussion on the breakdown of the stock bond ratio.
00:11:52: Driving factors of bond yields
00:12:08: Shift in oil prices
00:12:27: Overlooked inflation risks
00:13:14: Early signs of returning inflation
00:14:43: Tracking labor market impacts on inflation
00:15:34: Role of the Federal Reserve's policy on inflation
00:16:00: Analysis of oil prices and excess liquidity
00:17:36: Predictions for inflation reacceleration
00:18:44: Impact on the Federal Reserve's decisions
00:19:54: Market expectations of Federal Reserve's actions
00:21:05: Consensus view on recession risks
00:21:37: Preparing for long-term inflation
00:22:14: Analysis of credit markets
00:23:31: Trends in bankruptcy filings and high yield credit spreads
00:25:16: Analysis of the VIX and its implications
00:26:08: Rise of private credit markets and impacts on price discovery
00:26:55: Potential risks in credit markets leading to a quick recession
00:28:44: Impact of US Government's fiscal deficit
00:29:50: The concept of "Treasury Put" and its inflationary effects
00:31:55: Investment implications based on current outlook.
00:33:14: Considerations for multi-asset portfolios in the new environment.
00:34:17: Discussion on stocks and inflation
00:35:00: Summary of recession risks
00:35:24: Reflection on historical economic patterns
00:35:48: Investment implications
00:36:12: Summary of main discussion points
00:36:25: How to follow Simon's research
00:36:46: Acknowledgement and conclusion
Transcript:
Cris Sheridan: The consensus view for much of this year has been that the US would see a soft landing versus an outright recession. However, there's been a slight shift to that conviction in recent weeks. To discuss the current market and economic outlook with us today is Simon Whitete. He is a macro strategist at Bloomberg LP, also co founder of the institutional research firm Variant Perception. Simon, thank you for joining us on the show today.
Simon White: Thanks for having me, Chris.
Cris Sheridan: So we're going to have some charts that are posted where this interview is located at Financial Sense that we're going to go through. So I want to encourage all of you listening to refer to these charts, but let's talk about this idea of soft landing versus hard landing and what's your take on where things are at currently?
Simon White: Well, yeah, good starting question, Chris, because obviously that's something that has been going around interminably. The markets are always quite interesting. They jump from one thing to another quite quickly. And certainly over the last two or three months it's been what sort of landing scenario that we're going to have from whether it's soft or no landing or a hard landing. I'd also say that there's almost a way that everyone can be right because none of these things have hard definitions attached to them.
Simon White: Although I think if we have a hard landing it's probably going to be pretty clear. But as I'll get into, even then, I think when it comes to recessions, they're not clearly defined. I tend to use as the Arbiter being the NBER and they obviously give some guidelines about how they define a recession. But of course it's not a clear cut thing. And I think really to try and understand more fully about how economies work, a really good way to do that is to understand how recessions work.
Simon White: So I've kind of looked into this over the years in a lot of detail and where we are, I'll get to where we are right now, but just sort of standing back. Recessions are really, if you like, nonlinear shifts in economies. So economies, they don't go in a smooth way from a non recessionary to a recessionary state. They go in a very unsmooth and highly non linear way. And the reason behind that really is the interaction between hard and soft data.
Simon White: So soft data is market data, survey data, things like ism consumer confidence and hard data is really things like industrial production, retail sales, things like that. And recessions tend to happen when you get both of these hard data and soft data becoming stressed at the same time. And the linkage really is what happens is if you look at the chart on page two on the slides, you can see it quite clearly. You actually often get spikes in soft data stress quite regularly, but they turn into nothing. As in they don't turn into recession and they only turn into recession when you get the hard data stress as well.
Simon White: And then you get essentially a feedback loop so you have soft data stress, so the market survey data starts to deteriorate. And then if that bleeds into hard data, you can get this feedback loop developing where then markets start to concentrate on weakening hard data and then that feeds back into the soft data and then you get a cascading effect and then very quickly you can get a recession developing. And that's a real key point, I think that's misunderstood about recessions or not appreciated until it's too late, is that they are very sudden. So there's the three P's of recessions. They're pronounced pervasive and protracted.
Simon White: You could add in a fourth P as well that they are precipitate. And as I say, they tend to happen a time when most people think that the danger is over and then they very quickly occur. So where we are today, as you can see from the chart on page two, the right hand chart is that both hard data and soft data are currently stressed and above a threshold that has normally led to recession. And that obviously doesn't mean definitely 100% there will be one. But this, along with a number of other things that you can look at, are consistent with a recession.
Simon White: And obviously the cycle is difficult because a lot has happened that's been very unusual over the last three years. I think that doesn't mean that the old relationships are dead in the water. I think it has meant that things are operating in slightly different sequences, which means the timings are going to be a little bit odds than normal, but I wouldn't kind of throw out the baby with the bathwater with a lot of very robust relationships that have worked over many years. So if we have this interaction, this cascading effect, and you could see that very rapidly turn into a recession. And if you look at a number of other measures, for instance, GDI is already consistent with a recession.
Simon White: Another very good indicator if you look at state claims, so unemployment claims. Now this is where it gets very interesting because the pervasive part of a recession, it tends to happen in lots of places at the same time. So if you look at claims data by US state and you look at how many of them are deteriorating at the same time, that also is above a threshold that has previously been consistent with a recession. The same for continuing claims. And also the final point I think is really important to make about why recessions seem to happen abruptly is that often people are kind of flying using revised data.
Simon White: So the data that you tend to see now in real time is typically revised. But here's the kind of kicker is the revisions tend to be the biggest at turning points like recessions. So you often find that the data is most wrong just going into a recession. So I would say based on where we are today, that a recession is still more likely than not. Most, as I say of the indicators that I follow, are saying that a recession is very close to, close to imminent, but we won't know until after the fact.
Simon White: And then I'd say the next most important thing as an investor is it's quite academic talking about recessions. What does this mean for stocks and what does this mean for bonds? And that's something we can get into as well, if you want later in the conversation.
Cris Sheridan: Yeah, definitely. And we'll touch upon that. But as you said, recessions happen when hard and soft data weaken at the same time. We do see that currently, and you show that with one of the charts that we're going to have posted along with this interview. We did not necessarily see that after 2020.
Cris Sheridan: We were seeing soft data stress, but the hard data was tending to remain firm. But now we see both of those weakening. And also we have inflationary pressures somewhat reemerging as well with higher oil and gas prices. As you said, the recession risk is more than likely. When you look at the various data points that you review, where do you think the consensus is on that though?
Cris Sheridan: It seems like there has been a slight shift in the consensus view, especially when you think about some of the recent market turbulence and what happened with the Fed meeting recently. But would you say that the consensus is appreciating the recession risks currently?
Simon White: I think they are probably underappreciating them and there's a number of kind of ways you can kind of it's obviously hard to really gauge sentiment unless, you know, people's positioning what's the old adage, don't listen to what people say, watch what they do. But you can look at basic things, for instance, searches and news for no landing or soft landing versus hard landing. There seems to be a lot more focus on soft landing right now. And I'd say the way the market is trading, the stock market isn't really trading in a way that is consistent with a recession. The stock market does tend to sell off before recession, but not as much as you might think, and then continue selling off through the recession, but it tends to bottom before the recession ends and then starts rallying.
Simon White: But if you look at, say, the median behavior of the stock market around recessions and you look at today, what the market is doing today, it's not really consistent. It's not kind of sold off. It's still basically consistent with the outcome, is that we don't get a recession. So I very much think that a recession would still catch a lot of people unawares. But I think the other thing to appreciate is that this wouldn't be the sort of recessions that people are used to, right?
Simon White: This is not going to be a garden variety recession. One of my views again we can touch upon it in more detail. Why is I think that we're in an inflationary regime and as much as inflation has come back down a reasonable amount from its peak I think essentially it's going to boomerang higher. Again, not necessarily new peaks but I think it's going to see a second rise and I think therefore this recession will be accompanied by elevated inflation and that's not something we've really seen for the last like three decades. So that means that I don't think that stocks and bonds will necessarily do what they normally do in one of these more garden variety recessions.
Simon White: And again I don't think people have adjusted their playbooks. I mean that's really one of my kind of overarching points that I've been trying to make in my columns is that recency bias is still really plaguing people and what they expect to happen. I think inflation is a huge game changer. It literally changes almost every kind of axiom or canonical kind of law of markets that I think anyone around right now has taken for granted as a rule of thumb. So it really kind of is going to upset the apple cart.
Simon White: So when the next recession comes people might think actually their stocks haven't fallen that much but they'll still be living in a nominal world. Stocks will tend to do much worse in real terms but people are more likely to still adhere to thinking in nominal terms because they're not used to elevated inflation. And similarly with bonds, bonds will not unlikely to be the same recession hedge that they are. I mean in a normal environment as in a non inflationary environment the Phillips curve essentially a negative relationship between unemployment and inflation you tend to get this kind of fairly stable linear Phillips curve relationship but in an inflationary regime the Phillips curve becomes nonlinear and unstable and that's kind of where we are. And again this is another really key .1 of the most important ratios in finance is the stock bond ratio.
Simon White: And really we're watching this breakdown right now. They are now correlated positively. For the last two decades they've been mostly correlated negatively. And so therefore when you get a growth shock people expect again recency bias bonds to be a recession heads because they should do the opposite thing. But if the growth shock is accompanied by an inflationary shock then both bonds and stocks both fall together.
Simon White: And I think that's another reason to suspect that people really haven't hugely changed their portfolio construction to take account of the new regime we are in. Maybe we're seeing some very tiny hints of it. At the minute term premium has been beginning to rise so that's one of the things that's been driving bond yields higher. But I think we're just very far off people really changing their mindset for what an inflationary regime means for markets and the economy.
Cris Sheridan: Yeah and it seems that that's been a slight shift more recently, especially in recent winks. I mean, we have seen again oil prices back up towards $90 a barrel. So that's playing a role in this. And then there's the whole higher for longer mantra now with the belief that of course the Fed is going to have to either raise rates again, perhaps one more time. But given what you said, it sounds like that investors are not appreciating the upside risk for inflation persisting for longer than what they've seen over the past decades.
Cris Sheridan: And especially if we think about the Fed itself also getting the transitory thesis wrong after the post 2020 collapse, saying that inflation was transitory. But you're saying the upside for inflation is likely to be with us here for longer. And you have a chart here we definitely need to touch upon this, but looking at oil prices and some leading indicators for oil. So can you tell us about where oil and global food prices fit into your larger macro outlook here?
Simon White: Absolutely, yeah. So I think these are two very interesting sort of manifestations of why I think inflation is showing early signs of coming back. But just to stand back a little bit, I think it's underappreciated really what has driven inflation lower so far. So inflation peaked in the US last June, just over 9%. And now I think we're down back around somewhere in the three handle.
Simon White: But the San Francisco Fed break up core PCE inflation into acyclical and cyclical components. So the cyclical components are all the components of PCE that have essentially a high correlation with Fed policy. And Acyclical components are everything that's left over. And this is really interesting is if you look at the two of them, almost all the decline in core PCE, and a lot of that obviously feeds into the headline number as well, has been driven by Acyclical inflation. And really what that's saying is that the Fed has had very little direct impact on bringing inflation down so far.
Simon White: So after all these 500 basis points plus of rate hikes, the direct effect that they've had on inflation is actually probably fairly minimal, quite far. And all you have to do is look at slack in the labor market. That's the transmission mechanism that the Fed is supposed to go through to try and bring inflation down. We know that we've still got very low slack in labor markets. Now that leads on to what has been driving inflation down.
Simon White: Well, if you look at the cyclical component, it pretty much matches PPI in China extremely close relationship, leading relationship. So PPI in China leads the Acyclical component of core PCE. And that I think, is a big reason why inflation has not thus far come back. Inflation has fallen despite the Fed, not because of the Fed, but that obviously means that if Fed policy is not as effective as it was and there'll be some delayed impact we know obviously the long and variable lags with monetary policy. But if the other parts of inflation start to come back before really Fed's policy has had much of an impact, if indeed it's going to have a bigger impact as people expect it to, that will then feed back into the other portion of inflation and inflation would begin to rise again.
Simon White: But we're seeing that in other ways too and that's why you look at the oil price. So oil, everybody hated oil. Back in the summer sentiment was extremely negative but excess liquidity had been turning higher. Now there's lots of different ways of looking at liquidity but I prefer to look at excess liquidity. And that's the difference between real money growth and economic growth and it's quite an intuitive measure.
Simon White: Not only is it empirically lead risk assets like things like oil, it kind of makes a lot of sense because money is created by banks and by central banks and what isn't used up by the needs of the real economy is essentially excess and tends to find its way into risk assets. So that began turning up in kind of March April time and at that time when people were pretty negative overall it's kind of an inherently kind of contrarian indicator because it tends to be rising when people are actually quite negative. Inflation is a kind of lagging indicator. So inflation was falling and growth was still quite low and that ultimately meant that excess liquidity started to rise. So that pointed to not only to higher oil prices but it pointed to higher equity prices as well.
Simon White: And obviously over most of the last six to nine months or sorry, three to six months, we've had pretty buoyant time for risk assets. And the food prices as well is again another manifestation. Global food prices themselves tend to have a pretty good leading relationship with US inflation. So I think from a structural standpoint as in Fed policy has probably not had as much of a direct impact as is widely believed. And the fact that when China kind of gets back on stream, which I think it will, I don't think we're at that stage yet where it is going to hit its deflationary kind of black hole and doesn't come back, I think they still have a couple of cards to play.
Simon White: So you'll start to see growth and stimulus and inflation return there and that will ultimately feed back into inflation in the US. When at a time when people are expecting it know, you look at CPI fixing swap markets it's certainly not expected to re accelerate. So I think that will catch people unawares. And a big part of this is timing as well. I don't think this is necessarily going to happen by the end of the year.
Simon White: This could be something that is at some point over the first half of next year but in the interim period we could still see growth slow down much faster than inflation takes off. And that puts the Fed in a sort of tricky situation. So we could end up with the Fed unlikely it's going to cut in the near term, but really kind of pulling back in this higher for longer thing more than again than people expect because the growth deteriorates, but the inflation has not come back. But then the likelihood is, as I say, you get into next year and that then begins to change again because we see inflation reaccelerating.
Cris Sheridan: Well, it's very interesting too, because think about it, if you look back at the 70s, we saw subsequent waves of inflation. There's a first wave and then a second wave and even really a third wave if you look at the sticky prices of inflation. So it sounds like we've seen that first wave, post COVID crash with a lot of the stimulus, the supply chain problems getting up to 9.1% at the highs. It's decelerated. But perhaps we're in that troughing or basing phase before another reacceleration in inflation.
Cris Sheridan: Like you said, it may not go back to the same highs that we saw before at 9.1, but even just any type of reacceleration from current levels would be putting more pressure on the Fed to stay at this higher for longer. And of course, on the economy and markets as well. Is that kind of the view that you're giving here?
Simon White: Yeah, exactly. I think the curve is kind of interesting because it's not obviously just about what the Fed does, it's what the market thinks the Fed will do. And obviously for most of the cycle that the market has been sort of saying when the Fed goes higher for longer, it's like, okay, we'll give you higher, but we're not giving you longer. And if you look at like the sofa curve or the Fed funds curve, the peak would rise as it had to because the Fed kept raising rates, but the pivot would remain, if you like that sort of cut priced into later dated stuff. Now that's started to come up again as the Fed has kind of pressed its assertion again on this higher for longer thing.
Simon White: But I think that we're getting to the limits of how far that can go. And even if the Fed holds at the front and the growth data starts to weaken, or we very quickly look like we're going into a recessionary scenario, the Fed will hold for as long as it can so it doesn't lose any credibility that it's just weakening on one bit of bad growth data or a hint of a recession. But the sofa curve should then start to reinvert again quite quickly, I would say. As the market basically says, the Fed is going to have to go at some point.
Cris Sheridan: When we were talking about the consensus view and the fact that they're probably not appreciating the recession risks here currently, part of that has to do with, like you said, with recency bias and thinking that inflation is going to return back to normal, that we're going to get back to that 2% range or so. And that's not the environment that we're probably looking at here, especially given what you outlined and some of these charts that you're discussing. We also have the view that investors should be prepared for higher than average inflation for the long term. Whether or not that's in that three to 4% range or even getting back as high as 5%, it's hard to say exactly, but I don't think we're going to be remaining in that 2% for the long term in the years ahead. That being said, you do have something that I think is important when it does come to understanding where the consensus may be not pricing in things correctly, and that's looking at credit spreads.
Cris Sheridan: And this is one of the charts that you have here. Can you tell us about what you're seeing with the credit markets and where things may be either mispriced or where there's a disconnect?
Simon White: Yeah, sure. Credit is really intriguing right now because, again, like a lot of things isn't really behaving in the way it normally does. And there's a number of potential reasons for that which I can get into. But standing back, I was trying to figure out, okay, why is it that credit spreads perhaps are not really reflective of some of the other things that I was seeing in credit markets? I mean, normally, for instance, when banks are tightening credit conditions, that tends to coincide with rising credit spreads.
Simon White: And we weren't really seeing that banks were tightening conditions, but high yield spreads remained quite contained. Another really kind of eye opening one, which we have the chart there on page five on the right hand side, is you can track bankruptcy filings. So that's something that Bloomberg tracks, I think, from court filings. They look at any company in the US with, I think, liabilities of over $50 million and then count how many there are, and then that tends to lead Chapter Eleven. So when things actually, I guess, officially go into bankruptcy.
Simon White: But what's really interesting is if you look at that bankruptcy filings graph with credit spreads, that they've completely kind of disjointed. So they tend to move fairly closely together. And when you get spikes, which you see at recessions, both tend to move up together. But this time around, we've had this spike in bankruptcy filings, and that really hasn't been matched at all by particularly big rise at all in high yield credit spreads. So I was trying to figure out what might be behind this and one relationship that I'm sure a lot of people are aware of.
Simon White: You look at high yield spreads and the VIX, they tend to move very closely and kind of makes sense that they're quite close to each other on the capital structure. Equity is just essentially a sliver of capital between assets and liabilities. So when the capital structure gets stressed, the equity has to bear a lot of the brunt of that. And so the equity volatility tends to rise. And given high yield spreads or high yield debt sorry, or just a little bit above, they tend to feel that stress too.
Simon White: But there's actually a more direct linkage too, because in terms of how do people model credit spreads. But one of the ways you model credit spreads is using the Merton distance to default model. The way that works is you assume that the equity is a perpetual call option on the solvency of a firm and you take the equity implied volatility, essentially the VIX, as an input, and then you use black shoals and then you spit out something that you can't observe, which is the volatility of the asset base. And so that is essentially used to help price credit spreads. So VIX has been very low.
Simon White: And then the reasons, and there's been a lot of discussion about this, why is the VIX so low? There's a number of reasons. Implied correlations have been very low and that's perhaps due to the sort of narrowness of the rally we've had. Obviously we've had this AI driven rally. So I think that's kind of driven implied correlations down and that tends to mean implied volatility is also lower.
Simon White: And also we've just had massive option speculation. So hedging from option dealers, gamma trading. I think that's also repressed the VIX. So you have a very low VIX that maybe is not well, it is what it is, of course, but it's not necessarily reflective of where credit markets are. And so that's why I think you've ended up with that disconnect.
Simon White: But that sort of means that credit spreads are not really representative anymore of maybe what's actually happening in credit markets. And that's further obscured by the massive rise of private credit markets. So the private credit market in the US is now something like one and a half trillion dollars. All sorts of leverage loans and NAV loans and things like that. And I think that's obscuring price discovery.
Simon White: So my concern really is that on the surface, credit might look okay if you just happen to be looking at things like high yield spreads, but under the surface things are likely much worse or reasonably amount worse than credit spreads would betray. So that's certainly a risk that again, I don't think is properly appreciated because people just don't really have visibility on the credit market as they did before. And that would be another way, if you like, that a recession could happen quickly rather than slowly, would be suddenly a lot of the kind of underlying pain in credit spreads manifests itself and people realize that the credit markets are actually a lot worse than people think they are. And that would be, I'd say, one way right now I don't see a deep recession but I'd say that would be the major risk if my old recession maybe would return into a much deeper recession, is if the credit markets are considerably worse than maybe anybody thinks. And I think that would have the potential to really drive the hard data and soft data relationship I was talking about earlier on.
Simon White: Credit spreads are a real big vector of that. And if credit spreads really were suddenly a lot worse than people expected, that would really drive recession risk and recession debt quite quickly. So it's really important to pay close attention to credit spreads right now and the credit market.
Cris Sheridan: One of the interesting things about all this is when we're talking about the leading economic indicators continuing to decline, when you're talking about credit risks that are not being appreciated in the market, when the disconnect between the data that you track at Bloomberg, looking at bankruptcy filings, which are much higher than what the credit markets are appreciating. I mean, there's all these different things out here that are lining up for recession, and yet it seems that overshadowing all of this is the fact that the US. Government is just spending like a drunken sailor with $6 trillion in US. Federal spending. And so that's helping to just paper over a lot of these issues, especially when you consider the fact that the amount of spending currently that's taking place is what we typically see within the context of a recession.
Simon White: Yeah, I mean, it rightly point out, I mean, it's a huge fiscal deficit, way bigger than you would normally get unless you're in a recession or in a war. So I certainly think that's been inhibiting the Fed's transmission mechanism for its interest rate rises. And on top of that, another aspect to that is that the Fed is still warehousing an enormous amount of duration risk on its balance sheet, which is another thing that's softening the blow, I think, of interest rate hikes do. I think you could avoid a recession altogether with these fiscal deficits. Obviously it reduces the risk, but you always have that underlying risk of the fiscal cliff.
Simon White: And it wouldn't even be a cliff necessarily now you go from minus seven and a half percent deficit to minus four, which is still a huge deficit. But as far as the markets and the economy go, that's a major fiscal cliff. So you could certainly still get recession, whether it can be a super deep recession or more likely to be one, probably not. But as I referred to earlier, you certainly can't rule it out. And I think it's a bigger issue here really in terms of we now seem to have governments, not just in the US.
Simon White: That are willing to run perpetually large fiscal deficits outside of downturns. And it's really, if you like, the existence or the coinage, if you like, of a treasury know, we've had the Fed put, which we had for many of the years. After the GFC and that essentially underwrote financial assets. And now we have shifted because traditional or sorry, quantitative easing and normal monetary policy kind of ran out of road. Governments started spending.
Simon White: Central banks still had huge balance sheets. The result was inflation. But if you have governments where the expectations of them now are much higher and for instance the Pandemic I think hugely changed what regular people expect from their governments and what they expect to be covered. It's not just job loss, it's disease, it's health. It's a whole manner of things which is going to make it very difficult for governments to kind of get back to maybe running much smaller deficits.
Simon White: So this Treasury Poop is inflationary because if you have governments running persistently large fiscal deficits which they will have to be partly helped by their central banks to do that, that combination is very inflationary. And so where the Fed Poop protected financial assets, I'd say the longer term impact of the Treasury Poop is that real assets are going to be the ones that outperform financial assets. In inflationary environments, financial assets tend to do quite poorly whereas you look at real assets which are extremely cheap relative financial assets, like on a multi decade basis, they tend to outperform financial assets. So I think there's a real key sort of very macro change, again that's kind of happening under our feet that hasn't been fully appreciated by most.
Cris Sheridan: Okay, and I think that leads to my last question, which you just basically touched upon here, is what are some of the investment implications given your outlook and what we discussed today?
Simon White: Yeah, 100% real assets I think will outperform financial assets. Now that doesn't help a lot of big managers. Of course financial assets absolutely dwarf the size of the commodity market so that's going to be a real issue. So I looked at this recently. I think as I mentioned earlier, the stock bond ratio is one of the most important ratios in finance.
Simon White: And now that stocks and bonds are correlated positively they tend to be moving together. I think that's going to create a lot of kind of chopping and changing. So what do you replace your bond, your treasury allocation in your traditional kind of 60 40 portfolio? If you look at, there's really no good alternatives in terms of risk adjusted returns. The only one that really provides a better risk adjusted return on a 60 40 basis is substituting corporate bonds for your Treasuries.
Simon White: Pretty much everything else, whether you look at commodities or gold or just holding cash, none of these things really come up to scratch. So you're kind of left with a whole bunch of bad options and it might just be the case especially now in a positive correlation environment when stocks and bonds are positively correlated, cash tends to be much higher. So you kind of be looking to maximize your returns. If you're running these sort of multi asset portfolios. And you might just think, do you know what the best option here is?
Simon White: Just to buy more equities. So that could be one consideration or one outcome, if you like, of this new environment. Obviously that's not great for long term financial stability if people's concentration risk has risen and they're in more equities. But again, that's something if you're reasonably good at market timing, that's something you can try and incorporate into your trading. But I think that's going to certainly have a big impact.
Simon White: And as you say, if you don't have any sort of institutional constraints, then real assets, if you look at the 70s, they did very well and I don't imagine, I don't see any reason why it should be significantly different in this regime. Here we're in an elevated regime of inflation regime. So real assets outperforming financial assets and obviously gold tends to do well in that environment as well. So I think they're the main things within stocks as well. I would say again, right now the market is not trading as if inflation is going to be a problem because a lot of duration, high duration sectors like tech are still leading, whereas energy, which is much lower duration, tends to be lagging.
Simon White: So I still think we could see like a much bigger rerotation because at one point energy was leading back in 2021 sort of time rerotation into lower duration stocks like energy and utilities and away from things like tech. Again, all depends when the penny drops that this is not the environment that we're used to.
Cris Sheridan: Well, Simon, I want to thank you for coming onto our show again. And just to summarize what, you know, recessions happen when hard and soft data weaken at the same time that is happening currently and you believe the recession risk is a bit higher than what the consensus expects. You do think that we're going to see a bit of a reacceleration in inflation and again, the consensus is really thinking that we're going to see a return to what we've seen in the past few decades, but we should be thinking more along the lines of the 1970s. Of course, history does not repeat, but it does rhyme, as Mark Twain said. And one of the things that we can look at that is a risk is credit risk, not appreciating the level of bankruptcies that we see currently.
Cris Sheridan: So if we do see a repricing of that, that could lead to more downside, something that we need to keep on watching when it comes to the investment implications. Real assets, you believe, will outperform financial assets, especially given a number of the charts and things that you outlined in today's show. Part of that may also be with the stock bond correlation here, that investors, large institutional investors, are going to be reweighting their portfolios more towards equities and alongside of that would be equities that have some exposure to real assets. Does that about COVID some of the main points of what we discussed today?
Simon White: Yeah, that's perfect. I mean, I could put it any better myself.
Cris Sheridan: All right, perfect. Well, I'm glad that we were able to get your view for our listeners today. As we close, what would be the best way for our listeners to follow some of your excellent research?
Simon White: So my research goes on the Bloomberg terminal. The column I have twice a week is called Macroscope, and I also go into the markets live blog and I contribute posts to the called markets live blog on Bloomberg.
Cris Sheridan: Perfect. All right, well, once again, we've been speaking with Simon White, Macro strategist, Bloomberg LP, also co founder of the institutional research firm Variant Perception, and definitely highly recommend you follow his work at Bloomberg if you get a chance.
