Lead-Lag Live

Darius Dale on Revolutionary Macro Risk Approaches, Market Timing Momentum, and Implications of Fiscal Policy Dynamics

• Michael A. Gayed, CFA

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Join us as Darius Dale, the visionary founder of 42 Macro, unveils his innovative approach to navigating the stormy seas of macro risk management. Discover why traditional market strategies are often shackled by outdated methodologies, and learn how 42 Macro is revolutionizing the field by closing the information gap between Wall Street and Main Street. Darius shares his captivating journey, highlighting the unpredictable events and rapid changes that have shaped the markets in recent years, from the COVID-19 pandemic to dramatic rate hikes.

Explore the evolution of market risk management through the lens of real-time analysis and the power of "nowcasting." As we dissect the limitations of conventional fundamental research, Darius emphasizes the importance of observation over prediction and presents zero DTE options and ETFs as natural evolutions in today’s financial landscape. Drawing on the strength of momentum as a key force in asset markets, he provides a compelling argument for its role in successful market timing, challenging the age-old skepticism about its effectiveness.

In this episode, we also touch on pressing risks and trends, such as the potential for an "equity winter" and the ramifications of fiscal retrenchment. We delve into the complexities of the federal budget, political influences, and global market dynamics, offering insights into how these factors could reshape economic stability. With Darius's expert perspective, you'll gain a deeper understanding of the nuanced landscape of market risks, the Federal Reserve's role, and the broader implications of U.S. election policies. Tune in to arm yourself with the knowledge needed to navigate today’s intricate financial environment.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Speaker 1:

We know we're going to get more tax cuts and deregulation and all that stuff, but what if that stuff takes longer to come and is like a second half of 2025 catalyst and in the first half of 2025, we're dealing with a ratcheting up trade war. We're dealing with a negative supply shock in the labor market that would ultimately reinflate unit labor costs and cause corporate profits to slow.

Speaker 2:

Most of the studies show that market timing doesn't work, and the reason market timing doesn't work is because the alternative is cash. Market timing doesn't work and the reason market timing doesn't work is because the alternative is cash, not another asset class. Cash has no momentum, which means if you're a false signal, you don't even have a chance at cop-pounding.

Speaker 1:

So I'll start by saying we think momentum is the most powerful force in asset markets, more powerful than liquidity, more powerful than options flows, more powerful than growth, inflation, monetary policy, fiscal policy the most important factor in asset markets at this moment.

Speaker 2:

That sticky inflation point is that primarily because of housing, I mean, what's causing the inflation to be sticky?

Speaker 1:

Michael, it's everything.

Speaker 2:

My name is Michael Dyett, publisher of the Lead Lag Report. Joining me here is Darius Dale. Darius, you know I'm a fan of yours. I've tracked your work for a long time, but for those who don't know your background, introduce yourself. Who are you? What have you done throughout your career? What are you doing now?

Speaker 1:

Yeah, I appreciate you, man. Thanks again for having me on. Always a pleasure to connect with you, man. You're one of my favorite people, you a big fan man.

Speaker 1:

So just a quick background by myself. I've been doing this for about 16 years now as an institutional macro risk manager, started 42 Macro about almost four years ago now with the express intent of delivering, creating and delivering a lot of the institutional macro risk management solutions that we built for our buy-side clients to kind of create a good process and help our investors on Main Street as well. What we believe in at 42 Macro Research is narrowing the information asymmetry between our top high-end institutional asset manager clients and our friends over on Main Street. We're big fans of the ethos that Jackie Robinson put into the world in terms of giving back and really believing in that and what we do, and so just kind of quick summary of what we do.

Speaker 1:

I would say macro risk management is the hallmark of what we do here at 42 Macro Research and note that that is very different than just quote unquote macro or macro predictions or macro narratives which a lot of folks use. What we do and what we built are highly sophisticated systems to help investors time markets that's what risk management is is market timing. And you know, not only are market timing signals proven very accurate, you know, they've also been weaponized by many of the top institutions across global Wall Street. So we're finding that a lot of our signals are starting to have a little bit market impact. And so, a, we're liking that and B, you know, we're just really blessed by that to see the growth of our business and the growth of our network.

Speaker 2:

Looking back, do you think it uh not exactly maybe the ideal type of last four years to just be involved and do the kind of research you're doing? I say that purely because it's been a really weird four years. Right, you got covid. You got the faster rate hike cycle in history. You got stimmy checks. You got, uh, no risk apparently in large casks, but risks and everything else.

Speaker 1:

It seems like it's kind of hard to navigate yeah, it's been very difficult to navigate uh specifically if you're using uh that are potentially in the process of going to becoming less stale or to becoming more stale, to becoming stale in general. So one of the things and I'll use a specific example of something that we got wrong as an example of something that I think we, as investors, need to be doing better of generally thing that I think we as investors need to be doing better of generally you go back to the fall of 2020, first couple of quarters of 2021, it became pretty clear that we were in an inflation cycle upturn From that point forward ourselves included ourselves and just about every single economist on global Wall Street. When you go back and you look at the forecast in terms of the next 12-month forecast horizon, we're projecting inflation to peak out mid-2021 and decelerate, and obviously that didn't come to fruition. The Fed itself, the Federal Reserve, was obviously surprised by the fact that those forecasts didn't come to fruition, and so to me, that was a great learning experience to realize that, hey, some of these more kind of time tested, if you will processes that we're using to forecast the economy and or forecast financial market risks, or now cast financial market risks, some of these frameworks may be dying in real time. Part of the reason they're dying in real time is because we are living in an era of great socioeconomic, economic, geopolitical and institutional change, and obviously we're in a fourth turning that, I think, even beyond being in a fourth turning, there's just a lot of stuff going on from an economic and policy standpoint that is very different than it was prior to COVID, specifically the advent of fiscal dominance here in the US and so it's our belief that, yes, this has been a very difficult time to navigate if you did not kind of know, kind of pick up on cues like the one, the cue we picked up on three and a half years ago, to recognize that some of the tools and frameworks that we were using probably weren't going to be very relevant in this kind of new regime and ultimately put the onus on the more observational aspects of our research process and took some onus away from the forecasting elements of what it is that we do.

Speaker 1:

I'll show a quick slide to kind of land this point home. If you go and kind of look at you know the what we do here at 42 Macro Research that, I would argue, is quite different than what most people do here that do what we do for a living is, you know we're very focused on on observations. You know how most investors kind of manage risk is usually as a result of a fundamental research. You know fundamental research belief becoming untrue and either usually having some sort of negative market event in their portfolio that kind of codifies the lack of truth, if you will, in their former fundamental research beliefs. What we're doing is a little bit different.

Speaker 1:

You know I think about. You know kind of how most investors manage risk. You know, going back to bit different, you know I think about. You know kind of how most investors manage risk. You know, going back to what I just said, it's kind of, you know, printing out a MapQuest map and then driving with the MapQuest map and if you get lost or there's traffic you're kind of stuck to that original. You know printout, you are aging yourself for ever seeing MapQu.

Speaker 1:

I think the gray hair is probably age of me already and then the receding hairline, but that's neither here nor there.

Speaker 1:

No, but you know what we decided to do, going back then and increasingly done since then that's a great success to great degrees of fiscal dominance and other big, significant institutional changes that we are in the process of observing.

Speaker 1:

One of the most important ones is sort of the Fed's positively revised inflation target, which we can talk about. So you know we've been really focused on observation as part of our research process now casting what the economy is doing, as opposed to constantly predicting what the economy is doing. Now casting what the market is doing and participating in that as opposed to constantly trying to predict what the market is doing and guessing. You know we we've kind of removed all the elements of guesswork from our risk management process and it's really served us and our clients really well. You know it takes a lot more work to to constantly be very basing about the economy and asset markets, but you know we're happy to do the work because it's creating really good outcomes in our clients' portfolios and really good outcomes in my portfolio. I certainly would not cook here at 42 Macro.

Speaker 2:

On that point about some of these things kind of dying in real time. I am curious if, since you mentioned institutional changes, if maybe just the mania around zero DTE, options trading, the manic behavior in some of these leveraged funds, the advent of retail flow, if that's what's muddying what used to work and that's not really working as well now.

Speaker 1:

I think it is. I certainly think it is, but to me, I don't look at it from the perspective of muddying right. I don't look at it from the perspective of muddying right. Muddying implies that there is a ideal state and that we need to be working towards this ideal state. What I think is happening is just that markets are doing what they've always done the entire time they've been in existence for thousands of years, which is they continue to evolve right.

Speaker 1:

The products that we create to transform and spread out financial market risk across the world continue to evolve themselves, much like with the advent of zero DTE options and you know the advent of, you know sort of things like, you know, etfs, for instance. You know that allow, you know, for a little bit of more distortion with respect to securities pricing in the stock market and the credit markets. You know, all this stuff is just. In our opinion, we don't view these things, as you know, sort of muddying or non-ideal states. What we view them as is just a simple evolution of how the markets in the world are evolving, and it's our job as professional investors is to constantly be abreast of those changes so that we can, you know, do the best possible job that we can at staying on the right side of market risk.

Speaker 2:

You mentioned the idea that risk management is market timing. I always have an issue with the term market timing only because most of the studies show that market timing doesn't work. And the reason market timing doesn't work is because the alternative is cash, not another asset class. Cash has no momentum, which means if you're a false signal, you don't even have a chance of cop pounding right, which is why I always advocate the idea of you're going to be long and be tying bearish sentiment. Then you do so with utilities, usually treasuries, gold, the dollar. I want to talk about whipsaws in the last four years, right, because it goes back to the point about it being a difficult period. You can argue that, obviously for the S&P 500, large caps, tech, there's been zero whipsaws. There's been straight momentum last two years, god bless. Talk to me about the other parts of the marketplace, timing-wise, if they've been as successful for you, really, small caps, emerging markets and bonds because I get the sense that no matter how good one's signals are, unless you have that tailwind man, it doesn't matter.

Speaker 1:

Yeah, 100%. Yeah, look what we built here at 42 Macro are a system of trend following tools, specifically through our KISS portfolio construction management. Our KISS portfolio construction process and our discretionary management overlay Dr Mo trend. And so I guess the genesis of your question is how much have other markets you know that are sort of not quote unquote center to the kind of core investing universe? How have those markets trended in recent years and have our signals been effective? Is that sort of the question you're asking?

Speaker 2:

Yeah, pretty much, because I think it's to your point. It's like that's the joke about momentum. You need to have momentum over there to be momentum.

Speaker 1:

Yeah, so I'll start by saying we think momentum is the most powerful force in assets. It's more powerful than liquidity, more powerful than options flows, more powerful than you know growth, inflation, monetary policy, fiscal policy the most important factor in asset markets moment in our opinion I mean not in our opinion, not, it's not just our opinion, this is the opinion shared by many of the world's largest and most important financial institutions. So we're just piggybacking off a lot of the research that they performed, that we performed. That kind of arrives at the same conclusion that this is the thing you need to get right. More so than growth, more so than liquidity, more so than flows, more so than dealer gamble positioning, more so than anything we spend all day talking about on Twitter, momentum is the thing you need to get right. And if you don't have sophisticated and or accurate enough signals to identify inflections and momentum early enough so that you can be at the front of the line as opposed to the back of the line when you're entering and exiting trades, then I dare say you're probably your research process, your risk management process, is not robust enough. You know, for lack of a better statement, and I don't mean that pejoratively, I just mean I'm trying to help people focus your focus, your focus budget, on the things that will make you the most money, and that's the genesis of that statement. And so, going back to the kind of broader question about momentum, one of the things we've done is so we built complicated not complicated sophisticated risk management systems that are quite simple to execute on, and what we found is that they're not equally accurate for every asset class. Right At the end of the day, the systems that we build, they're optimized for each asset class, but in terms of how they perform with respect to keeping clients on the right side of the risk in the asset class at any given period of time horizon, they're not necessarily the same.

Speaker 1:

So, for example, within US equities, our momentum signals, specifically from our discussion areas, from that overlay have a 94% upside capture ratio. When Dr Mo is recommending a long position in US equities, that upside capture ratio is 173% in global equities. So clearly there's a big divergence there. They're both very good numbers. You'll take a 94% upside capture ratio any day. That's fantastic.

Speaker 1:

But you can see that Dr Mo is even better at helping investors take advantage of momentum in the global equity market, and that probably is a function of the fact that we have not had as much trend uptrend in global equities as we've had in US equities. Right? What essentially Dr Mo is saying? If the US equity market is done like this, you've captured 94% of that uproof. But what Dr Moe is essentially saying is that if global equities have basically been doing this for four or five years, you've captured this, this and this and not participated in all that. And so this plus this, plus this, even though the market hasn't gone anywhere, means you actually did take advantage of the uptrend that you did, the limited uptrend that you did have in the context of those signals, so we're super proud of that.

Speaker 1:

It's a similar performance and dispersion across different markets 137% upside capture ratio in the US bond market. 120% upside capture ratio in the global bond market. 102% upside capture ratio in investment grade credit 113% upside capture ratio in high yield credit. Dollar is silly, I mean, this is a stationary object, so obviously you have a ridiculous upside capture ratio on high yield credit. Dollar is silly, I mean this is a stationary object, so obviously you have a ridiculous upside capture ratio there. Gold 147% upside capture ratio on gold. 247% in physical commodities, 229% in crude oil and then finally, 115% in Bitcoin, 169% on Ethereum.

Speaker 1:

So the key takeaway, michael, of what I just highlighted with respect to those backtests is suggesting that A market timing does work if you have good enough signals, and obviously the world's largest and it's you know best most sophisticated asset managers are using signals like the ones we feature in our discretionary mismanagement overlay to you know time markets and essentially manage risk appropriately.

Speaker 1:

And, at the end of the day, this is maybe something I'll put back to you and to your, your, your client base and your community. Not everybody wants to manage risk, right? I had a long conversation with the crypto community last week about 100,000K Bitcoin and reminding them that, hey look, bitcoin, every four to five years, loses like 75 to 80, 90% of its value. So while you guys are high-fiving about 100K Bitcoin and I certainly am, too, being maxed along Bitcoin in our case before construction process and in my own portfolio as a function of that signal we need to recognize that there will be a crypto winter ahead of us, that we need to manage risk good and in like 50% of the replies to that tweet were like absolutely, you're spot on, thanks for this. We're going to take advantage of this opportunity to actually, you know, transform unrealized gains into realized gains.

Speaker 2:

And then the other half was like no, that's stupid, I'm going to huddle, I'm going to just go, I'm going to huddle, I'm going to huddle so the next time we have this big drawdown, but you know, we're going to huddle all the way down and I'm just and it's more of a tactical sentiment type of dynamic- when an investment becomes a religion, it's time to lose faith, and what I'm addressing there is the idea that people get so attached to something because the momentum is so strong that it becomes its own cult, and the peak of the cult sentiment is always at the peak of the asset class, right, when it seems like, when there's no risk to your points. Now you mentioned crypto winter. I'm curious to hear your thoughts on the possibility God forbid of an equity winter Because, let's face it, valuations are pretty high, right, and I'm sure you've seen a lot of the data around. You know 10-year forward returns probably are going to be subpar, just given the starting point of where valuations are. Does any of this matter from your perspective?

Speaker 1:

Yeah, 100%, you know. So I'll start by saying completely in agreement with respect to the forward risk that we have in asset markets, specifically through the lens of our position model, which we use, refresh daily for our clients to help them assess the probability of significant reversals in momentum in asset markets across multiple time horizons. And when we refresh this model, we're noticing a lot of sort of forward-looking risk from the perspective of where we are in the positioning cycle through the lens of the indicators that correspond to a medium to long-term time horizon. So, for example, the AI stock allocation survey is in the 83rd percentile currently the most recent readings. When you go back and you look at this time series study, this time series with respect to major bull market peaks and major bull market troughs, we understand that we've already breached the median value that we've typically observed in major bull market peaks in the context of that particular indicator. We've already breached the median value we've already observed at major bull market peaks in the AI cash allocation survey. We've breached the median value in S&P 500 realized volatility, which we interpret as a proxy for systematic fund exposure to the asset markets. We've breached the median value that we observed at major bull market peaks for implied vol correlations, which we interpret as a proxy for market neutral hedge fund exposure to growth to risk assets. We're in the 95th percentile price in X12 month earnings multiples. That's obviously breaching the median value we've observed at major bull market peaks in so much that investment-grade credit spreads in the first percentile are already breaching the median value they've observed in major bull market peaks. So that's a lot of breaching the median value that we've observed in these particular indicators that we've observed at major bull market peaks. Now that doesn't mean we have to have a major bull market peak today, tomorrow, next week or even next month. What it does signal is that when something changes, when something in one of the core cycles that really matters to asset markets and flex specifically growth, inflation policy, corporate profits and liquidity if any one of those five cycles moves in a way, in an adverse enough manner, that that would cause investor positioning to really start to move.

Speaker 1:

You're talking about the market, so the starting point being investors are broadly on one side of the boat, and so that's what you got to be concerned about as an investor. And so when I think about kind of you know unpack, or sort of you know trying to, trying to sort of triangulate where the market risk lies. How much risk is there when the risk might show up on the x-axis? I start by thinking from how do we build that asymmetric positioning to begin with? Where did the asymmetric positioning come from? How do we get to these price and valuation levels in asset markets? And so, ultimately, whatever caused those price and valuation levels becoming less true or untrue is what's going to cause the risk off market regime. And so we think about having had the great fortune and benefit of being very right, for the very right reasons, I would argue. I don't think there's anybody on global Wall Street that's been more right than Darius Dell has been since November of last year, for all the right reasons, than I have, and I don't mince words about that because it's probably true. And the reason I say that is because you think about what's caused the asymmetry in the positioning cycle to get us to these points in asset markets.

Speaker 1:

The two things that we've pounded the table on for the past 14 months our resilient US economy theme and our Jay wants a soft landing thing which highlights the Fed's asymmetrically dovish reaction function. Those are the reasons we are here and so, pill, you need to make one or both of those themes untrue. And one thing that can make the Jay wants a soft landing theme untrue is our sticky inflation theme starting to create more problems in the minds of investors and in the minds of Federal Reserve policymakers. That essentially forces Jay Powell to give up on his, you know, sort of legacy oriented desire for a soft landing. And then you have our triple S's thing, which is new, as a function of the US election.

Speaker 1:

You know, we don't know anything about the size, sequence and scope of the President Trump's policy implementation. And I think if you're a Republican, you hear tax cuts and deregulation and more energy production, and you're just ragingly bullish. Regulation and more energy production, and you're just ragingly bullish. But if you're not a Republican or you probably hear things like tariffs and mass deportations, potentially causing a negative stagflationary shock in the economy, and so both of those things could be true.

Speaker 1:

By the way, it's just a matter of okay, what's the size, sequence and scope of how all this comes together from a policy implementation standpoint? And it could come together in a way or in a sequence or in a shape or size that is not favorable for asset markets, and it could come together in a way that is favorable for asset markets. So to me, landing the plane on this discussion, you have to either make the triple S's theme very, very negative and very big the sticky inflation theme has to get rid of our J1 to self-landing theme or the economy just has to become less resilient in a way that really causes investors to be very concerned about hard landing risk, and we don't obviously see that as a high probability outcome.

Speaker 2:

That sticky inflation point is that primarily because of housing? I mean, what's causing the inflation to be sticky? Michael, it's everything.

Speaker 1:

I know that's not a good answer, but I'll answer why that is the answer it is everything. So I'll start by saying inflation is the most lagging indicator of the business cycle and it is unlikely to return globally to trend absent a recession. So what you see here in these charts is the median trailing 10-year Delta adjusted Z-score for each of these cycles in months before and after recession. So what we did in this analysis is we stacked each of those cycles on top of each other in the post-war US economy. So I want to say there's 12 business cycles to analyze and what these plots represent is the median path that that particular cycle takes late in the business cycle. And so how the sort of business cycle really works is and this is a really important finding that we found determined from this, you know, very deep dive empirical study, of which there are hundreds of indicators that gave us to. You know, what we were trying to figure out is okay, what leads the business cycle? What lags the business cycles? You would love that, as the poster child of lead lag. So we wanted to figure out which cycles led the broader business cycle and which cycles lagged the broader business cycle and, specifically, as it relates to forecasting a recession or forecasting a recovery out of a recession. And what we found from that deep dive empirical study is that, okay, you typically have policy breakdown let's call it four to five quarters out of a recession, followed by corporate profits which tend to break down three to four quarters out of a recession. Then liquidity tends to break down around three quarters out of a recession. Then growth and stocks break down right around two quarters out of a recession. Employment breaks down right around when the recession starts. Credit breaks down right around when it's roughly a quarter into the recession. And then, finally, which is the key takeaway from this slide, inflation. If you look at the median path that inflation has taken in the 12 post-war US business cycles, inflation has broken down durably below trend four to five quarters after a recession started. So it's our belief that a function of our US economy theme, which similar analysis is like this, is leading us to conclude we don't see a recession as a high probability event over medium term time horizon, which ultimately means we don't see inflation breaking down durably below trend over the medium term time horizon if the way the business cycle has historically worked is still true. If the business cycle continues to work this way, then it's unlikely we'll see a breakdown in inflation, and that's exactly what we're seeing.

Speaker 1:

I'll go and look at something like underlying inflation. Underlying inflation is at 3.6% on a median CBI basis, three-month average or three-month annualized. We're flattening out at plus 4% on a year-over-year rate of change basis. We're flattening out at plus 3% on both the year-over-year and three-month annualized basis and trim mean CBI. If you look at core PCE, we're at 2.8%. We've been basically flat all year, like around the high twos, low threes. And then you look at super core CPI, we've been essentially flat at around three and a half percent on a year-over-year basis. For the past, you know kind of, you know almost 18 months and you look at on a three-month annualized basis, we are now at 3.5% and accelerating. So it's, by the way, when you look at these charts, the light blue dotted lines represent the 2015 19 trend that we're trying to break down below, and so it's our belief that if we continue to grow the economy and you potentially have some stagflationary impulses from tariffs and from mass deportations or, at the bare minimum, just tighter immigration policy, you're probably not going to have the kind of disinflationary impulses that we require to durably break inflation down below trend in order to maintain the same trend.

Speaker 1:

And one final thing I'll say on this before I shut up is leading indicators are already supporting our hawkish outlook for inflation, right, If you look at core PPI, we bottomed in core PPI at 2% in December of last year and has been accelerating in an uptrend, and it's now 3.1%.

Speaker 1:

And the reason I call that out, specifically the level that it bottomed at, is because if you bottom and this is basic math if you bottom at 2%, then the mean of the time series is no longer going to be 2%. If that's the minimum value, then the mean of the time series can't be 2%. And so we're concerned that we're starting to see levels in core CBI and core PCE that looks like we want to bottom at levels that are wildly inconsistent with a mean core PCE. That looks like we want to bottom at levels that are wildly inconsistent with a mean, a longer run mean, of 2% inflation. And so if that's the case, and we think we could be having a very different conversation about inflation, let's call it one, two quarters from now, when a lot of this stuff becomes more obvious to the average investor Is there a chance that the sticky inflation can get unstuck because of Musk having Trump's ear around government efficiency and kind of cutting back on a lot of waste.

Speaker 2:

I mean, I'm skeptical, but I don't know about you, man. Every single post I see on x, on the algorithm, is elon musk and it's usually something about debt.

Speaker 1:

Yeah, no, uh, geez louise. I mean how this man literally bought twitter just so he can just just like, spew us with his views all day long. I don't even follow the guy and like literally every time I lap on twitter. It's one of his thoughts like can we, is there a way you can like unsubscribe to elon permanently?

Speaker 1:

like I don't know, sorry, sorry, elon it's called blue sky, it's called threads, it's yeah, exactly yeah, I mean, that's that I don't want to sorry to start a hijacked conversation, but I I'm obviously very sick of Elon's thoughts, you know. You know populating my Twitter feed, but so, yes, the answer is yes, michael. So if you, in the context of you, know, could we get a meaningful enough fiscal retrenchment to take some pressure off the economy from a nominal GDP perspective? Yes, of course, the answer is yes. Do we believe that that is the highest probability outcome? No, so I'll give you the kind of takeaway on. So, yes, they can, and that may very well be, you know, as it relates to that SSS theme and with respect to the size, sequence and scope, if we got that, then it may create some really positive dynamics in the bond market. That would ultimately be quite supportive for liquidity, which could also create more upside in asset markets. Not through the lens of an improving economy, just from the perspective of improving liquidity conditions. Liquidity conditions, because you're talking about eradicating term premium in the bond market. You're talking about toning down bond market volatility. You're talking about potentially toning down US dollar strength. All those things would be, from this starting point, potentially positive for asset markets through the guise of more liquidity. I'm not entirely sure that that is the highest probability outcome, for two reasons. One, I just don't see where they're going to cut, and actually not one.

Speaker 1:

Let me start with the other chart because it'll take me back to the chart I was just on. So this chart here shows slide 86, labor share of national income and capital share of national income through the lens of corporate profits. Labor share of national income, which we take as nominal employee compensation divided by gross domestic income, that metric is now 52% and it's down from a mean of 56% from 1960 to 2000. Capital share of national income, specifically corporate profits, is now 13% and that's up from a mean of 0.9%. So we've declined 400 basis points from the mean in labor share of national income. We've increased 400 basis points from the mean the long run mean of labor share of national income. We've increased foreign basis points from the mean the long run mean of capital share of national income. And that foreign basis point swing doesn't sound like a lot but it is having an enormous impact on the average American family and it's having an enormous impact in terms of the US political cycle and that's why we've seen a lot of volatility in our political cycle and in the most recent election why the entire electoral college map was red, because people are pissed off about this, this, this, the, what they feel as a function of this analysis. And so again, that form of basis point swing is about $1.2 trillion in gross domestic income. That $1.2 trillion is basically an annualized $9,000 of lost income per private sector employee. So you're talking about basically shaving off 11 percent of the median household income every year as a function of this.

Speaker 1:

You know ridiculous. You know kind of policy outcome. This is an outcome of very deliberate policy. In 1993, the US decided to start shipping our jobs to Mexico via the NAFTA, and in 2001, the US policymakers decided to start shipping our jobs to China in the form of letting China join the WTO, and obviously we've had a lot of negative political ramification of that. And so enter Donald Trump in 2016. Steve Bannon basically convinced them to run for president under the guise of the four turning, which is the seminal work for my one of my former colleagues and one of my mentors, neil Howe. Got him to basically understand what I'm showing on this chart, which is, if you go, speak to the people whose jobs we sent to Mexico and China and tell them you're going to give them jobs back. You'll become a very popular and powerful political figure here in the United States of America, and that obviously has become incredibly true over the past eight years.

Speaker 1:

Getting back into why I don't think Elon and Vivek Ramaswamy will be and even, to some degree, scott Bessant will be particularly successful in getting a significant, meaningful, achieving meaningful deficit reduction, is because I still see where they're going to cut it from, especially in the context of what is the most populist president since FDR right. So you go back and you look at the US's fiscal situation through the lens of the various federal revenue categories, federal expenditure categories and, ultimately, the budget deficit. When you look at some of the things that we know will be politically unpopular, cut specifically things like Medicare, national defense, net interest and social security. That's what our mutual friend, luke Grohman over at Forest of the Trees calls a true interest expense. True interest expense, of which those four categories are combined, is roughly $4.2 trillion, 61% of total expenditures, roughly 14% in nominal GDP. It's grown $335 billion in 2022. It grew $559 billion in 2023, and it grew $373 billion in 2024. And, by the way, it's compounded at a plus 13% CAGR over the past three years. So the stuff that we know there's zero political will to cut is compounded at a plus 13% CAGR at 61% of the budget over the past three years. So that tells you that just in order for the budget deficit to stop growing, you have to basically find 13% CAGR's worth, or more than that, because we're talking about the other 40% of the budget. You probably have to find like 16, 17% CAGR's worth, negative CAGR's worth of stuff to cut. And so you look at the rest of the budget.

Speaker 1:

I would argue the most populous president since FDR is probably gonna be does not have a Medicaid or, sorry, does not have a national mandate to cut programs like Medicaid, which obviously provide health services to people who cannot afford health services. You probably won't be able to cut welfare, which provide income support for people who lack income, and then obviously veterans benefits and services. You probably won't be able to cut welfare, which provide income support for people who lack income, and then obviously veterans benefits and services. We just don't think that the most populous president since FDR is going to have a mandate or even the political will to go cut those programs. And so when you add those programs into a true interest expense, well, I would say.

Speaker 1:

This is probably everything that Donald Trump will feel comfortable cutting.

Speaker 1:

That's about $6.2 trillion, 90% of the federal budget, 21% of GDP.

Speaker 1:

It's grown $500 billion in 2023, grew $373 billion in 2024, and it's compounding at plus 3% over the past three years. So if you cut every single thing else that the federal government did to zero, like literally everything else to zero, that's only about $712 billion. It's about 10% of total federal expenditures. You have a 2% of GDP's worth deficit reduction, which would still wind up. You'd still have a minus 4% deficit to GDP ratio if you cut everything single thing that the federal government did outside of those seven categories I've highlighted to zero. So that's a long-winded, data-driven way of answering the question, michael, which is can they do it? Will there be political will to do it? And the answer is no in both cases. In our view, it may change. We may be forced into now casting, observing the change, and if we have to now cast and observe the change, then it's likely that the trend-following risk management systems that we built to keep our clients on the right side of market risk will actually beat my fundamental understanding of those changes to taking place.

Speaker 2:

Speaking about Trump's mandate, if you had to guess which would outperform the other, you think the next four years are going to be dominated by large caps or by small caps.

Speaker 1:

Large caps more than likely small caps. I mean, if you think about that just in the context of an America first policy agenda, you're potentially talking about, you know, dollar strength and policies that could potentially, you know, be very positive for element of the market that you know most investors don't have a tremendous amount of exposure to. But again, to me it's. I think that's sort of a false choice. If you will Not saying that, you're presenting that to me, but I think the average investor is looking at it from the perspective of a false choice. Like small caps represent like 7% of US equity market cap. Like any one of the max seven stocks is more than that than the entire small cap index. So, like forcing investors to choose between small caps or large caps, it's like forcing investors to choose between which of the max seven stocks versus the rest of the market. Like why are you making that choice? I don't know. It seems like a very false choice to make to me.

Speaker 2:

What else are we missing? I mean, it sounds like you're obviously you're much more constructive bullish. I mean very short term. Everyone's obviously assuming that the year is done, december is going to be fine. I have said I'm still nervous about the next few weeks, purely because of Japan. I myself still think the reverse carry trade is out there again. We saw it momentarily August 3rd, august 5th. Everyone turned bearish, I turned bullish. Everyone forgot about the reverse carry trade. Let's talk about the sort of exogenous risk factors.

Speaker 1:

What are you seeing? Yeah, 100%. So I agree with you. I don't feel that Japan, specifically, is exogenous, though, because the market is it's appropriately priced, or at least much more so than it was this summer is appropriately pricing the outlook for Bank of Japan monetary policy. So if you look at what JPY money markets are pricing in with respect to their next 12 month policy prescription, it's about two rate hikes over the next 12 months, and that's as high as it's been at any point in time in the last what, probably 30 years, in terms of what markets are pricing in from a hockey standpoint out of the Bank of Japan.

Speaker 1:

So, in, in order for them to, in order for them to create problems in asset markets, they need to tighten faster than that, and it's not our, it's based on our forecast for uh, with the japanese. Um, well, I can see the japanese economy. We have inflation moderating over the next 12 months. Uh, we don't have. We have growth accelerating, but, you know, kind of getting to a kind of trend type level over the course of our next 12 month time horizon. Within the next calendar 12 months, we don't think Bank of Japan will have any real economic pressure to accelerate their policy normalization agenda. They will tighten policy and it will probably cause a modest retracement, a modest uptrend in the end, but it's probably not going to be what we saw this fall. That's our belief. I mean, we may be wrong on that, but that's our belief. The thing that I'm probably most concerned about, as it relates to the next four or five months, to me, the biggest upside risk in asset markets that still not enough people are talking about is the fact that we're going to hit the debt ceiling moratorium on January 1st, and what ultimately means that the Congress will be without borrowing authority starting January 2nd. And so if you're a Democrat lawmaker, if you're the lawmaker in the minority party, it behooves you to use the debt ceiling, and so the Democrats are probably going to put up a fight, just like we've always seen when the minority party has been weaponizing the US debt ceiling to achieve whatever political objectives that they want to achieve. It's our belief that we will have another multi-month debt ceiling fight and ultimately, throughout that process of the multi-month debt ceiling fight, we're going to drain the TGA towards zero. We saw that in 2021. We saw that in 2023. And ultimately, though, the Treasury's decision to drain the TGA in both of those instances created a tremendous amount of positive liquidity in the US financial system. Obviously, we had a raging bull market in 2021, had another raging bull market in 2023. And we could potentially see that the TGA drain contributed to raging bull markets in those windows, and we do believe that, if we're correct, that there will be a debt ceiling impasse, we probably are going to see some raging bull market type activity to begin the first few months of the year. But what I'm concerned about is you could easily see them decide to punt on that, ie extend the debt ceiling moratorium in the future, which ultimately means you're probably entering 2025 without this really ubiquitously positive catalyst, and so what markets will start to focus on then.

Speaker 1:

Is goes back to what we talked about earlier, which is the size, sequence and scope of President Trump's policy agenda policy agenda. And if, again, none of us knows how, I don't even think Donald Trump knows what the size, sequence and scope of his policy agenda is going to be, because obviously he has to bring Congress along for the ride with respect to any taxing and spending changes to law, and then he obviously has to get the markets on board with respect to whatever he's trying to do with respect to tariffs or anything, and immigration, et cetera. He may not even decide to get the markets Again. This is a second term president. It's not like he needs to win an election again. So you know he may be very full full bore. You know America first Donald Trump agenda and it may work and I'm hoping it works. I'm an American patriot, I'm an American person. I'm hoping he does really well.

Speaker 1:

But the risk, going back to where we started the conversation, the risk may be the case that it may be that it does not go well.

Speaker 1:

You know any, any gaffe, any. You know when you, when positioning and sentiment are this asymmetric changes should be scary to begin with, but it may be the case that the change is actually negative. Like again, you think about what could potentially go wrong from the perspective of the timing, the size, the sequence, the scope of the policy implementation. You know, we know we're going to get more tax cuts and deregulation and all that stuff. But what if that stuff takes longer to come and is like a second half of 2025 catalyst and in the first half of 2025, we'reate unit labor costs and cause corporate profits to slow, which is something we think is a very likely risk in the context of, you know, the policy guidance we've seen on the border To me. I just I'm worried about the beginning of next year in the absence of TGA spend down feeling very, very negative, especially in the context of what could potentially be a global refinancing air pocket next year. That may materialize anyway, irrespective of what happens with the US policy implementation.

Speaker 2:

Sounds like a credit event which I put a prey wrong on. Obviously, darius, for those who want to try more of your thoughts, more of your work, where would you point to?

Speaker 1:

Yeah, absolutely so, 42macrocom, come check us out. Like I said, we pride ourselves on delivering high class, accurate, actionable risk management systems for investors around the world. We have many of the top institutions in the world subscribe to our research. We have thousands of retail investors also subscribe to our research. Kiss our construction process. We use that to keep the retail community on the right side of market risk and our discretionary risk management overlay. We use that to keep our institutional clients on the right side of market risk and our discretionary risk management overlay. We use that to keep our institutional clients on the right side of market risk. And so both client bases are very happy. 100% of our customers can cancel at any time without penalty. Literally, 100% of 42 macro customers can cancel any time without penalty, and so that tells you if we have thousands of customers, that continues to grow rapidly. They very must be very heavy community, so we're really grateful for them. I'm really grateful for the opportunity to come chat talking up with your base as well, my friend.

Speaker 2:

Everybody, make sure you follow Darius Dale. I've got another live episode literally in four minutes and I'll see you all shortly. Thank you, Darius, Appreciate it.

Speaker 1:

God bless you guys. Man, Happy holidays. Catch you guys back here next year.

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Michael A. Gayed, CFA

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