Julian Brigden: markets are at a huge inflexion point
Merryn talks to Julian Brigden of Macro Intelligence 2 Partners about the unwinding of the US stockmarket's super-bubble, and the risks and opportunities it poses for investors.
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Merryn Somerset Webb: Hello and welcome from MoneyWeek Magazine Podcast. I am Merryn Somerset Webb, editor in chief with the magazine. It is the 21st... No, it’s not. It’s 24th January 2022. It’s important. I’ve been getting in trouble for not giving the dates and then talking about things and people not being able to identify the point in the market when this happened. That’s why you get the date now. 24th January 2022.
With me today I have Julian Brigden who is co-founder of Macro Intelligence 2 Partners. Now, Julian, thank you for joining us.
Julian Brigden: Thank you very much for having me on the show, Merryn.
Merryn: Well, I hope it’ll be a pleasure, but we’ll find out because you are a first timer on this show.
Merryn: As you are a first timer, why don’t you tell us a little about your business and what you do before we get going?
Julian: We set the company up ten years ago. We are consultants I’d guess you’d call us in broad terms. Our clients are basically a plethora of hedge funds, real money accounts, some family offices, some high-net-worth individuals. But generally the thing that defines our guys is they’re reasonably active traders and they’re interested in making money and so are we.
We tend to start all our work off with the underlying economics, but really I’m not interested, I’m not an economist by training, and we are interested in making our clients money, not just pontificating about what we think the next GDP number will be. It seems to be a bit of a waste of time in my opinion.
So, that’s what we do. There’s a reasonably biggish team. We’re scattered all over the place. We’ve been using Zoom for years. I just wish I’d bought it at the lows when COVID broke out. I just was so used to it. It works very well.
We run it though very much like you would run a hedge fund trading book in the sense that we look at the trends that we see. We use our macro models to ascertain where we think growth is going, inflation going, etc., etc. Then we look at things like market positioning and the technicals to time the entry into the trades and then we help people manage them thereafter.
Merryn: Sounds interesting. You’re interested in making money, we’re interested in making money, what can possibly go wrong?
I will say again, it is 24th January. It’s been a horrible day in markets and I suspect it’s something that you’ve been waiting for for a while simply because looking at your Twitter account... By the way, everyone, he is JulianMI2 on Twitter if you want to go follow Julian later. One of the things you say is that there’s a quote from the Bible that you suspect will sum up this year and it is first will be last and last will be first. What do you mean by that?
Julian: We have been thinking for a couple of years and writing in the bigger picture pieces that we occasionally put out that we’re coming to a global inflection point. I think the pandemic has simply catapulted us to a point where, and judging, I would imagine by a lot of your listeners, readers that they’re a little older, like myself. We’re in the mid-50s and I remember barely, but I can, the miner strikes in the 1970s and how at that point we’d swung too far towards the left.
I think this time we’ve swung too far towards the right, laissez-faire, corporate capitalism, call it what you will, that there was an inflection point coming. That to some extent was the motivation behind Brexit, was the motivation behind the election of Donald Trump.
The man on the street was starting to feel a little left out. Given that he has a vote, we were naturally going to swing the other way. Politicians are always pandering to the last constituency and they got their fingers... Most of the socialists are no longer socialists, they’re champagne socialists. You can see it here in the democratic party here in the US, which is where I’m based.
But we were going to naturally get to an inflection point where people were going to demand wage growth, people were going try on policy changes that help them, people were going to start to take a tougher line on corporate monopoly or monopolistic pricing power that these guys have, particularly here in the States. That was one factor.
Globalisation is integral to that. If we swung too far we were naturally going to move the other way, certainly as we were moving into an increasingly Cold War situation with China. That meant reorientating again global supply chains, one of the more deflationary events that we’d seen following the collapse of the Berlin Wall in 1989. Which if you go and look at our one chart and you look at what happens to US CPI thereafter, it’s a really defining point in the beginning of globalisation.
All of those more structural things, demographics, another big one, starting to change, retirees, smaller workforce, etc., etc.
Merryn: So, just the big, sweeping changes that we’ve seen over the last 40 years or so, 30 years that have made companies so very rich and driven what you’re talking about, globalisation, very cheap labour, super low interest rates, these three things have been amazing for very large companies over the last 20, 30 years.
And so, the idea is that these huge trends are beginning to change, the pandemic has accelerated that and this will be the year when we start to see the effects?
Julian: Yes, I think so. I think that’s exactly it. The pandemic has really catapulted us to that inflection point. If you look back, this was one of the tweets that you picked up on, these fantastic papers written by the Bank of England and only the old lady could write something like this where she looks at a 600-year period of history and analyses what happens to real rates in this period.
But what was consistent in the work was just how we’d had nine of what they called these real rate depressions, so very low inflation-adjusted interest rates, and how they typically all ended after a pandemic or a geopolitical shock. Clearly COVID is arguably both of those. Then you went into a period in which rates rose and, yes, ultimately we would get back to the long-term decline, the disinflationary trend, which is a function of productivity, but it could be five or six years and that could change things very, very dramatically.
That’s kind of where my head is at the moment. We’ve been playing that. We’ve been playing the inflation game since actually the first trade we put on almost at the lows of March of 2020, was to put a bet on higher US inflation. For the first time we actually just reversed that trade today just because we’re getting more worried about the equity market.
Merryn: What was that play on high inflation?
Julian: We bought five-year breakevens. It’s quite a complicated... It’s the residual between conventional in our case five-year treasury bond yields and TIPS yields. It’s the spread differential. It’s really only an institutional product. You could trade TIPS and that’s something that I think a lot of people did, bought TIPS as a hedge. It’s been a fantastic trade, about the only corner of the bond market that you could have hidden in.
But in late November, early December we actually reversed our trade and said to people, time to get out. The trade is very crowded. The Fed is being a big buyer of these TIPS bonds. They’ve done extraordinary well. We think the dynamics are starting to change. We think the risks are entering the equity market and if they do enter the equity market, then inflation could... Just another reason to worry about the inflation picture.
Merryn: Let’s talk about inflation a bit before we talk about anything else. Where are you expecting inflation to go from here?
Julian: I hope that we are getting close to a peak in headline inflation, but I do not believe we’re close to a peak in core inflation. That actually at the end of the day is what central banks are most concerned about.
Because headline inflation, you can incredibly easily model it by looking at the rate of change of oil prices and it’s usually the year-on-year rate. If oil goes from 60 to 120, it doubles and then just sits, that’s a huge hit to inflation that one year. Then the following year if it sits at 120, inflation drops to zero again. That effect drops out completely.
It’s the core stuff that’s the most important and that I’m actually still extraordinarily worried about. I think particularly, well, really on both sides of the Atlantic. In the US we have a huge problem in that we now have very rapid wage growth coming through. We are going to see some peaking out of some of these headline rates.
But, for example, one of the big drivers has been trucking costs. There’s a company, one of the big trucking companies in the US called CAS put out an index of their own and a forecast. They just forecast that trucking cost were up 41% last year, but don’t worry, they’re only going to be up 25% this year. I mean, that’s not exactly deflation. Sure, it’s not 41, but 25 is still far too high and I think that’s the problem and the fundamental problem.
We’ve got huge problems in continental Europe, I mean ginormous problems in continental Europe. They’ve got PPI costs that are running at, I think I’ve tweeted this the other day, I think German was 24% or something PPI. German CPI, or HICP as they refer to it, is five. That gives you an 18% differential, which is using as far back as the data can go a six standard deviation from the mean. That is a bet that I will not bet against.
So, you have four outcomes. PPI miraculously disappears. It seems actually quite unlikely. Companies eat all of that margin compression. They absorb all the PPI inputs and don’t pass any on to the consumer. Well, you wouldn’t want to be long European stocks if that’s the case because margins would be non-existent.
They pass it all on in which case German CPI is going to 18% and if Madam Lagarde thinks she’s getting rebellion from the north, the Teutonic north now, she won’t have seen anything yet. Or we get some sort of combination of the two where PPI comes down a bit, but companies still are able to pass through price increases and you get close to double-digit German headline inflation, and I think that’s entirely possible.
Merryn: …and even in the UK PPI is running close to 10%.
Merryn: And the CPI at say 5%. It still suggests, even if you’re right and we go halfway through, it suggests that headline inflation is going to be something like 7.5%, 8% and that’s going to be a hideous shock.
Julian: It’s going to be a hideous shock. And that’s before you even, in the US you’ve obviously got all these abnormalities because of rents and how they’re heavily weighted in the CPI and how those could feed through. As I said, we’ve got 6% wage growth here basically with very few signs that that’s going to go away.
That’s why I think this is now the big risk to markets and I think a fundamental disconnect which equities have not up until, well, arguably the last few days understood, is this is not a debate team or about addressing headline inflation. This isn’t a debate about a Fed or a Bank of England that’s basically achieved both of their objectives in terms of inflation. You could actually give them and A++ for achieving their inflation objectives. But even on the unemployment side in the US you could give them an A star.
Now, that means they actually have to slow the economy down, Merryn, physically slow it. I think the US economy is growing at six. I think it needs to be growing at three. They actually need now to slow it down. Even if those headline inflation rates peak, the bottom line is you’ve really actually got to keep tightening rates to slow growth.
Merryn: Will they do that though? Are they brave enough or will they tolerate more inflation than perhaps you think they should?
Julian: I think they will tolerate some. But I did hear from, I used to work for one of these policy consultancy groups who go off, at one point in my career, and go off and meet central bankers and read the tea leaves and charged an absolute fortune. $250,000 for a subscription and that was the beginner price. And I’ve got buddies who are still in the space.
Merryn: And that, by the way, listeners, is how other people make money.
Julian: Yes, exactly. Trust me, I’m not nearly that expensive. But I’ve still got friends who are in that space and talk to these guys and one came back and said this is a federal reserve, that J Powell decided he wasn’t going to be the next Arthur Burns, which is the Fed president who basically accommodated 1970’s inflation.
He is determined to try and address that. You can see as soon as he was renominated this very abrupt turn in his stance. I think they’re quite determined. Will they accommodate? Yes, clearly they have accommodated this. The difficulty is unfortunately, I think it’s arguable that we have a bubble in the US equity market.
And so, we have a turn of phrase, we have a phrase that we say that the Fed has created a crack addict to whom they have become beholden. As soon as they try and take the crack away, they guy gets, i.e. the equity market gets naturally distraught and has a way of circumventing their plans quite quickly.
Merryn: Which means they have to come back and hand over the crack.
Julian: Yes, exactly.
Merryn: Which is what people are already waiting for.
Julian: You see, now I think this is too early, unfortunately. I think this is way too early to do this. I think, and I don’t want to get overly complicated, but when you’re trying to slow an economy down, you’re not interested in interest rates per se.
No one cares what the Fed pays via fed funds to banks in their overnight deposits with the Fed. The Fed raises fed funds or the Bank of England raises base rates in order to ripple across the broad economy and the way that they do that is to impact what they call broad financial conditions.
There’s basically five metrics in a broad financial conditions index: short-term interest rates, call it two years; long-term, call it ten; some sort of metric of credit spreads and of costs, it costs a corporation in other words to borrow money; some sort of currency element because if your currency goes up and down, that tightens or slows monetary conditions; and then finally the equity market.
If you look at the one that stands out like a sore thumb here in the US, it is the equity market because everything else is not too far out. Our calculations is two-year yields, if you go back to where I think they need to go as part of financial conditions to slow the economy growth from let’s say 63, which is what we think is necessary, would take about 1.5% on two-year yields. They’re 90 basis points at the moment, so another 60 basis points, not the end of the world.
Ten-year yields aren’t that far away, 2%. Credit spreads are reasonably okay. the dollar is reasonably okay. But the one that stands out like a sore thumb, and you cannot engineer much of a slow-down in growth unless you get this, is the equity market which is 30% higher we think than it needs to be. Not today. It’s closer to that 30% as we talk, but it’s still...
Merryn: Well, it’s 20% today.
Julian: Yes, exactly.
Merryn: Does that mean that you generally buy the super bubble argument, that the US stock market has been building up to super bubble levels and now has to somehow revert to its valuation mean?
Julian: Yes, I think there are certainly sectors that definitely are. One of the things that we’ve talked to our clients about is this just utter dependence on what’s euphemistically called the FANG stocks, the big tech names, Facebook, Apple, Amazon, etc., etc.
If you look at their performance versus the broad Nasdaq, really since COVID hit these guys have exploded in relative value, which means that the broad Nasdaq is more dependent on these names than ever before. God forbid that they disappoint in their earnings this week or the market just breaks.
I think right here right now, today at 12:26 my time in the afternoon of the 24th, I think you could see a bounce. We’ve got turnaround Tuesday. You’ve heard that expression, Merryn, where the market always bounces on a Tuesday. We’ve got the Fed, you get some short covering, we’ve got month end, you’d expect some balancing out of bonds and into equities. That may hold us up.
But when I look at this from a big picture perspective, I think it’s entirely possible that we’ve had what I refer to as a big boy bubble. A big boy bubble, three things are necessary. The first thing is a great story. I think we’ve had a great story in corporate America. It could justify higher prices, call it innovation, productivity, buybacks, whatever.
Julian: Much better. But then when you stand back and you go, really, at the end of the day, are these companies so much better than world-class companies in the rest of the world? Is Ford really any better than Toyota? All of these things. But nonetheless, great story.
The second thing you need for a big bubble is you need liquidity and we’ve had that in spades. Because if you don’t have the cash but a great story, the story means nothing. But we’ve had that and we’ve pumped those up.
Then the third thing is you need a trend in your currency. Stepping back from the US example, one of the reasons for example we had a bubble in Japan in the late 80s was that we had in the mid-80s a thing called the Plaza Agreement.
The Plaza Agreement was an agreement with global central banks that the dollar was too high. And so, every single day they would come in for almost two years and sell dollars, every single day in the currency market and they would drive the dollar down and the yen up, the pound up, the Deutschmark, if anybody can remember that thing, up.
So, there’s a natural proclivity for global investors to want to be long yen and Deutschmarks. Well, the big thing that was going for the yen was that they had also this technological burst in Japan with things like Sony inventing things like the Sony Walkman. I don’t know how old you are, Merryn, you might remember it. I bought one when I was 19 years old and it cost me £120 back then and I thought I was the coolest man on the planet.
Merryn: You were.
Julian: And they had Trinitron TVs. They were buying up Rockefeller Centre, the Japanese. We were learning about them at business school and telling that this is the way to run the world. Really what it was though was a great story, a lot of liquidity, because the BOJ was keeping rates very easy.
But then this trend that drove the yen up every single day and so foreigners wanted to be long yen, they piled on top of the domestic money, they buy Japanese stocks, they get the yen strength and you get this truly Sorosesque reflexive. If you don’t understand what reflexivity is, look it up on the web, it will tell you.
But the bottom line is by the purchase of the asset itself you actually underpin the fundamentals underpinning that asset. So, it becomes self-reinforcing cycle and in this case what we’re talking about is great trend in US stocks, outperformance and a rising dollar which gives foreigners two for one. When you go to the theatre in the States they call it twofers. You get two tickets for the price of one. And it becomes incredibly sexy and it drives things to extremes.
That’s where I feel we are actually now. Anything that comes along that undersets that balance of that virtuous self-reinforcing circle could turn into a vicious circle if an unwind, if either the dollar gives way and/or US equity performance starts to give way.
Merryn: Which one of those are you expecting to happen, or both?
Julian: I think the dollar is the second shoe that drops potentially. My model suggests the potential for a much, much weaker dollar this year and I think it’s possible.
The way it would have to happen is you would expect to see European money managers, and they’ve been the main funder of this success since 2020, that would come in every single day and they would start to take profit on their Nasdaq stocks, their Dow, whatever it is. Then they will take their unhedged money, because it is broadly unhedged, and then they would buy euros as they repatriated. You get a weakening dollar and a relative weaking of the US equity performance, certainly versus the rest of the world.
Right here right now you can’t really see it, although there are signs it’s beginning to happen. Because we’re caught in this, oh, the dollar goes up when assets sell off because it’s a risk off, what people refer to as a risk off dollar rally. Not sure that lasts very long. If this thing really gets going, then I think price actually will start to get very interesting.
Merryn: So, what do we do?
Julian: Look, I think we’ve been, another podcast that I’ve done I’ve been suggesting to people that they have some cash. I don’t think it’s a time to be running to the hills. If you want to sell something short term I’d give it till the end of the week. This feels a bit today like a panicky low in the market. We could get a decent bounce, 10% bounce from here. If you’ve been wanting to sell something, sell into that. But have some cash on the side, broadly speaking. Because you always want to buy dips, you never want to just be in cash the whole time.
I do think though that the days where you automatically just pile your money back into the US... It’s been an amazing trade for a decade now. It’s completely killed the performance of every other market on the planet. I think those days are increasingly over. I think where you allocate your money is bets that are angled towards a weak dollar and US underperformance relative to the rest of the world. So, at some point commodities, precious metals, UK equities as opposed to just being in the US emerging market equities, etc., etc.
Merryn: So, you don’t think this is a collapse of global equity markets? You think this is the beginning of quite a big underperformance in the US?
Julian: Look, this is where things get tough and we’ve struggled with this as well. I believe we’re at a point of a rotation now where the US underperforms and the rest of the world outperforms. Now, I need the dollar to move to start to break down for that. It hasn’t yet. As I said, that’s partly a function of just it could be osmosis or it could be just acceleration.
But what’s unclear, Merryn, at this point is the nature of the rotation. By that I mean, is it nice or is it nasty? The nice rotation is that the US kind of just loses steam and every day it’s flat to sideways and European equities and EM equities are up 0.5%, 1%, that kind of move. The nasty way is the Nasdaq bubble bursts, it drops 50% and European equities are down 20.
Merryn: Some would say the Nasdaq bubble is already bursting. It’s down a lot.
Julian: Yes, and that’s the problem, I’m afraid. We just don’t know and that’s why I’ve got cash which I would like to deploy at some point in the next few months, but it’s not necessarily, I’m not going to jump back straight into US growth stocks because I think that story is over.
Merryn: What do you think you will jump back into? You said when the time comes, UK equities, precious metals. Are you interested in gold?
Julian: Yes. I mean, I’m more interested in silver. Much more interested in silver. We bought silver back along with the inflation trade. Silver was the first trade that we did in March of 2020. We bought it at 12.65, rode it up to I think on balance 26 was the average where we got out. We’re looking to pick it up.
I would love to get it below $20 an ounce in some sort of broader market selloff where everything, even the good things that you want to own gets hurt a little bit because they’re owned and funds have to what we refer to as de-risk. So, if they cut total holdings down and sell even their winners, throw the baby out with the bathwater. I would love to own that.
I would love to own, some of these emerging market stocks I think look great, but we need dollar weakness then and for that to flip, that means a Fed that reverses policy. And we’re not there yet, clearly, so you’ve got to create some more pain before you get there.
Merryn: So, a couple of dangerous months ahead we think?
Julian: I think so. Look, what I would say to people, as I said, very short term, 24th, 12:30 in the afternoon, it’s entirely possible that we’ve seen a short-term bottom. This is a big selloff today. Big, big selloff. We get a bounce for the next few days and maybe even the next few weeks.
But it goes back to if you are trying to slow an economy down, and this isn’t just about headline inflation anymore, which it isn’t. We’ve hit this employment component, they can’t let the employment market continue to grow at this rate because you will engrain inflation into the system, then you need to tighten broad financial conditions.
Part of that, at the bare minimum, bare, bare minimum means the equity market can’t keep going up anymore. It needs to go bare minimum flat, probably down. That’s why I think the best days are behind us.
Merryn: Okay, well, I think that pretty much covers it. Everyone will be pretty depressed by now, but I think we knew at the beginning of this podcast that that was going to be the result, didn’t we?
Julian: Yes. Look, as I said, I think there are great opportunities at some point. When the Fed does pivot and is forced, because they’ve created this crack addict, you’re going to get amazing opportunities I think for trends that are really only in their infancy. Commodities are really only in their infancy.
If the dollar is going to do what I think it’s going to do over the next year or two, in other words, a steady 30 sort of percent decline, which may sound alarmist, ladies and gentleman, but that’s what we did between 2002 and 2008 and the world didn’t end, I seem to remember, then this commodity trade that we’ve done so far is only really, it hasn’t even finished the first half of the match. There’s much more that can come through this.
I think silver goes to $50 again, 25, maybe you can pick it up below 20. You buy silver miners or gold miners you’re going to get a lot more money. So, they’re definitely things that you can trade, but as I said, the first will become last and last will become first. So, the things that you’ve automatically bought on a dip in the last decade, I do not believe that’s where you put your money for the next decade.
Merryn: Okay, don’t buy any more of those, everybody. Julian, thank you so much. That was so interesting and so helpful. This podcast normally goes out on a Friday, but because we’ve had such a time-sensitive conversation we will try and get it out more quickly. I don’t want you to be absolutely right, but people won’t know how right you were until Friday. That would be terrible.
Julian: Oh gosh, no pressure then.
Merryn: Awful, right. Also, if you’re completely wrong, I also don’t want people to know that on Friday. As you know, if you’re completely wrong, I do want them to know that on Friday. Oh God, now I’ve [unclear] all about whether you’re right or wrong. This is awful. I think we’ll get it out quickly anyway.
Julian: Thank you.
Merryn: Thank you so much for being with us today, we really enjoyed it. Everybody, don’t forget what I told you earlier about where you can find Julian on Twitter, JulianMI2. Anywhere else you’d like people to look for things that you do at the moment?
Julian: Look, if people are interested in talking to us on a more professional basis, whether it’s for our institutional product or our retail product that we do with the boys at Real Vision, ping us at firstname.lastname@example.org
Merryn: Perfect, thank you. And if you would like to hear more from MoneyWeek, you know where we are, moneyweek.com, and there you can sign up for our daily newsletter often written by the brilliant John Stepek. Tomorrow it’s possibly written by me if I get around to it. You can follow us on Twitter @MoneyWeek or follow me on Twitter @MerrynSW and John, @John_Stepek.
Please do leave a review for the podcast if you enjoyed it. It’s only by leaving us reviews that we get popular and we get all the brilliant people on that we get on. As one final aside, if you’re interested, please do remember that my new book, Share Power, has just been published and there is, in the short-term at least, a reader offer on the website, moneyweek.com.
Thank you very much and thank you, Julian, I hope we’ll have you on again.
Julian: Pleasure. Thank you, Merryn.
Merryn’s new book, Share Power: How ordinary people can change the way that capitalism works — and make money too, is now out through Short Books. We have negotiated a 40% discount for MoneyWeek readers – although you will have to pay postage. To claim the offer (£6 for Share Power, £3.10 for the postage) please contact Hachette Distribution with the discount code MWJan22 at email@example.com or phone 01235 759555 Monday to Friday, 9am – 5pm UK time. Pending availability, you should receive your order within three to five working days from receipt of payment.