I see a number of shocks coming that I think everybody needs to pay attention to.
The amount of positioning one way on that ship, the whole ship is going to shift dramatically
and has a risk of sinking.
I think this is something that is a higher probability chance than almost anybody expects
right now.
It’s basically a red alert.
So I’m Raoul Pal, I’m the CEO of real vision co-founder and also write The Global
Macro Investor, which is a macroeconomic research service.
The world hasn’t been very macro for a while now and it's left many of us kind of trying
to understand what's going on.
Equity markets have been going higher and things have been relatively contained.
Everything changed in February and volatility started coming back into the market and that
stopped people in their tracks.
I think now the macro environment is coming to the forefront and I see a number of shocks
coming that I think everybody needs to pay attention to.
The point being is, I'm not sure that these things are actually going to play out as is;
there's a number of probabilities and I'll come to that in a sec, but I think that there
is a high chance that things have changed entirely.
The easiest way to look at the world, I think if you just want one thing, if I drill the
whole world down to one chart, it's the chart of Google.
If you look at the chart of Google it bounced off this key support level.
The key support level happens also to be the 200-day moving average.
Now Google itself is not a macro story but it's what is happening to the flow of funds
around these stocks.
Bad news within Google which is about the use of data at Facebook, is an even bigger
story for Google.
People don’t understand the knock-on effect of this Russian Facebook story.
It's huge for Google.
Google captured every single piece of information about every single one of our lives all over
the web and even in your house.
I've got a nest cam at home.
I never realized what it was.
The little nest unit—I didn't realize what it was, until I bought this house with it
in.
And I realized that now Google could track me around the house, when I got up in the
morning, when I left the house they know everything about what I do.
And then there's been a lot more of this story brewing and this whole Google story is huge.
So Google is the knock-on effect of Facebook.
Okay.
That's not macro, but the equity market’s concentrated its risk in these FANG stocks.
We've seen what's going on with Tesla.
Tesla Bonds got downgraded.
There's a risk, something we've talked about in Real Vision repeatedly, is the risk to
Tesla in its ability to raise money.
It burns more money than it sells cars and it keeps doing it at almost an exponential
rate that can't go on.
So this is another darling of the market that's at risk.
Facebook is breaking down.
That's at risk too.
Today Donald Trump's on the tapes going after Amazon.
So now you have the largest market stocks in the world, the most widely followed stocks,
all coming under pressure.
This is important but it's not the macro picture; it’s part of the flow-of-funds picture.
The macro picture is to do with interest rates.
What's happening is the offshore dollar funding markets are drying up.
We've had many people on Real Vision talking about this, the LIBOR-OIS spread.
So that LIBOR spread is the cost of dollar funding abroad.
That’s been rising exponentially.
The chart is catapulting higher.
What that means is it's harder to get dollar funding from abroad.
And that means it's difficult for foreign corporations to get the funding that they
need because they've got around 13 trillion of dollar debts.
So that's something that makes it difficult for corporations at the margin and that starts
pricing into equity markets.
You've also got the kind of knock-on effects of the volatility that we saw in February
that hasn't washed itself through.
The VIX is now trading at an entirely higher range than it was before.
There’s some capital regulation requirements that have changed, and that meant that banks
who are able to sell volatilities at cheap exposure to markets for their capital regulatory
requirements, can't do that any longer.
And that meant that natural seller volatility is gone and the world blew up in February
because of it.
But now you don't have that dampening effect of these banks.
So the market is exposed to a real issue and what could happen because those sellers have
gone.
So that's a structural change that's happened.
The other thing that's happened is the monetary conditions index, the Goldman Sachs monetary
conditions index as a good example, has started tightening.
Now that's highly correlated to the ISM; if you invert the ISM and put that against the
chart, you can see they’re same thing.
What that means is that the Federal Reserve in its tightening of rates is starting to
tighten the economy and has a bite on the economy.
So we flip to the other side of the macro equation, which is the old industrial stocks.
And we've seen GE, GE has been imploding; something I've talked about for some time.
We also look at Ford.
It's imploding.
And we look at Exxon Mobil.
These are really big companies and they're falling sharply.
This dichotomy of a market is troublesome and tends to lead to the rest of the market
cracking, and we may be seeing that in Facebook and others.
Across the pond over in Europe, we’ve got an equity market that's also struggling.
If we look at the Euro stocks it seems to have made a large top out.
That's probably to do with the Euro, and I’ll come onto currencies at the end of all of
this.
But the Euro is a big issue.
It's too expensive.
And that's causing monetary conditions to tighten in Europe.
Inflation's coming off sharply and the forward looking PMIs are coming off as well.
So European growth is falling, and that's left Europe looking dicey and the banking
sector exposed.
Deutsche Bank, one of the key indicators of global issues, is falling.
Now what's interesting about Deutsche Bank, if I invert the chart of the OISLIBOR spread,
they’re the same thing.
And it’s suggesting that Deutsche Bank has further to fall and sharply so.
So that means that the problems within Europe are coming to the surface.
There's more of a deflationary shock than people expected.
They expected some kind of inflationary shock in Europe, but it now looks the other way.
And that leads me to the larger macro picture of the deflationary story.
The narrative was, inflation is rising, wages are rising, and tariffs plus tax cuts are
all inflationary.
Everybody in the bond market’s been looking one way, which is inflation.
It's coming, but we know that.
We know it.
It's priced into markets.
The real issue is, what needs to be priced in going forward.
What needs to be priced in is the fact that the Australian dollar is looking weak.
It's looking like it could be breaking its corrective pattern.
That's kind of a forward-looking indicator for deflation/inflation.
It's saying something.
If we spin over to China, the Chinese stock market’s doing the same.
This is not looking inflationary.
The conditions within China themselves are slightly tighter than people expect and the
economy’s slow.
So you haven't got the engine of growth.
They're trying to shrink some of the liquidity in China.
You can see it happening in the Australian dollar.
You can see it happening in iron ore.
You can start to see it happening also in copper.
Copper broke its 200-day moving average.
It doesn't look very good.
You can see a little bit in gold too.
So we got a number of commodities that are starting to look concerning and suggest that
the Fed have raised rates, the LIBOR issue has created such tightness that the financial
conditions are tightening…
That should drag down ISM, that should bring down commodities further, and this creates
a shift in narrative.
And it leads me to think about, has everybody again got it wrong in the bond market?
I did a piece—in fact it was the biggest piece in the history of Real Vision actually,
behind Carl Bass's piece.
The second biggest piece, which was about, has everybody got it wrong in bonds, and people
tend to try and want to extrapolate some kind of 1970s-style inflation scenario.
We've got an aging population, I don't think that's possible.
But I think that the market is the most positioned short of bonds in all history.
And that makes me concerned that the bond market is at risk of yields falling sharply,
and bonds rallying, which is completely the opposite of what the market expects.
And again that's coming from my view of what's happening in commodities.
Now this is all very early days.
I'm not sure how it's going to play out, but it feels that way.
Going back to Google and the equity market even the S&P at its 200-day moving average.
There's kind of a big fight going on at these key levels.
The question is, if they break all these key levels, then things change quickly.
But there is a good chance of a bounce.
These things tend to bounce.
Everyone like me is very nervous of calling the bigger top, although I think the probability
of the big top is in, is actually higher than most people expect.
But we have to see.
So the next few days and weeks are going to be crucial to find out how they’ll react
around those 200 day moving averages.
And the key trend lines are in place.
If it goes, the world changes very quickly.
I think the high probability is that we rally for a bit, it looks like the market's going
to go to new highs.
We have this tremendous battle between the bulls and the bears, but I think the bears
might win, as financial conditions tighten more as the Fed are on this path to try and
raise rates.
And they've made that clear in their dot plots.
And that in itself starts to affect the commodity market.
So that's the next key knock-on effect of what's going on here.
The unintended consequences is how I like to look at these things.
The big risk out there, the big VAR shock—so that's the shock to banks and hedge funds
books—is actually the oil market.
It's something I've looked at before and something I've pointed out repeatedly is the speculative
positioning of oil is at all-time record highs.
It is completely off the charts, versus anything I've ever seen before in any market ever.
And the point being is, if this deflationary shock starts to make waves into the oil market,
there is a huge gap in price to come.
And again with that, the amount of positioning one way on that ship, the whole ship is going
to shift dramatically and has a risk of sinking.
You see, oil is incredibly important.
It is the rise in oil prices that is, and particularly the refinery output in America,
that is causing the ISM to be so high.
The business cycle is highly elevated right now.
But the risk is, if oil falls then that changes quickly.
So we have to really focus on the oil market because that has a big macro-dynamic shift
that's important to understand.
But there's another knock-on effect—this is why at a very macro environment.
The other knock-on effect is the dollar.
The dollar is something, as most people know that I've been very bullish on, then I became
neutral and I've been sitting by watching.
I've now noticed the dollar has stabilizing near its lows, but the speculative short positioning
in dollar overall, is one of the largest in all recorded history.
So the risk again, is a wash-out of dollar positions.
So what happens if something ignites that?
Maybe it’s the Fed raising rates maybe it's a falling of the oil market, because the oil
and the dollar have this kind of symbiotic relationship where they're linked.
If we start to unwind the oil market and unwind the dollar market at the same time, you're
going to see a screaming higher dollar.
That will also unwind emerging markets.
So we are at the precipice of a very high risk event.
We need to be ultracautious again I'm not saying all of these things will happen but
they can happen and the probabilities are not insignificant.
So the dollar is ultraimportant to watch here because the dollar may go first and that will
crack oil.
Now let me let you into a little secret.
If you look at the LIBOR-OIS spread against the dxy with a three-month lag, you can see
that it exactly forecast where we think the dollar’s going to go.
That spread suggests the dollar's going to get a lot stronger rapidly.
The market is not ready for this.
There's one small chance that we get away with it, and that's that this LIBOR tightening
is being driven by the massive issuance of T-bills that's happened over the last couple
of months.
This is the market narrative and the hope of everybody that's been watching this spread
who say that it's nothing.
We have to wait and see.
After Easter we'll get an idea to see whether these spreads come in, and how the dollar
reacts to it.
But again, all I'm saying is there is a risk, it's not a certainty.
There's a risk that the dollar starts moving higher and does it rapidly because of the
market positioning, and how the Fed is still hawkish in this environment.
So let's put all of this together because there's a lot going on right now and it's
super important.
We have the market leaders breaking.
We have key levels in Google.
We have key levels in the S&P.
We have the old economy stocks tanking, so we have something that we haven't seen before,
which feels like the market dynamic has shifted.
Volatility has risen to a new paradigm, which tells you the structure of the market’s
change.
We then look at the interest rate market.
We've got a Fed that wants to raise rates.
They may continue to do so unless the equity market cracks.
So let's say equity market doesn't crack yet, well the Fed is going to keep going, and that
increases the probability of cracking the market.
If we remember that the Fed raising rates tightens financial conditions then its relationship
with the ISM means the ISM comes lower too, which is basically GDP growth.
If the ISM comes lower, GDP growth comes lower.
What happens is bond yields start falling unexpectedly.
People are overpositioned in bond yields, in which case the chances of seeing bond yields
falling sharply is much higher than the market expects.
Additionally, the oil market is also concerning.
The oil market has massive speculative positioning again and is at risk of an unwind.
That could happen with or without the U.S. dollar, which also has this gigantic speculative
positioning.
Now those things would tend to happen if this deflationary shock plays out.
Again, go back to the Australian dollar, go back to the other commodity markets, and you
need to look at the whole picture to see how these linkages come together.
If some of these things start to go, I think everything goes.
And this is the risk that happened in 2000, 2001.
The market was expecting one thing.
There was some dramatic battle between the bulls and the bears, and suddenly the economy
tanked in the middle of it.
And I think this is something that is a higher probability chance than almost anybody expects
right now So it's basically a red alert.
It's basically: Google is the most important stock, and also keep your eye on everything
that's going on.
You need to keep your eye on a lot of moving parts and assess your probabilities.
I'm not saying these are certainties, but the risks are as elevated as I've seen for
probably two and a half years, three years, when oil last broke back in 2014.