Darius Dale - Global Macro Series - August 17th, 2022

[00:00:07] Darius

I don’t think we know, I don’t think we have the right answers. I think the most important thing we can do is just be humble and Bayesian about this entire process. And understand that, hey, we’re probably going through regime change. Some of the things that we’re used to doing are probably going to continue to work, some of the things that we’re used to doing are probably going to stop working. But it’s very important for us to be very present and open and honest about that process in real time, so that we can do less of what’s going to stop working and do more of what’s going to continue to work.

[00:00:39] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

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Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:35] Niels

A new world order is emerging. And in our global macro series, I along with my co-hosts, Cem Karsan, want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro driven world may look like. We want to explore their perspectives on a host of game changing issues, and hopefully dig out nuances in their work through meaningful conversations.

Our guest today is someone who combines the world of global macro with a rigorous data driven framework when it comes to macro risk management frameworks as well as processes. He’s a frequent guest on many of the well known media outlets, and like us, has a deep passion for helping investors navigate this uncertain environment by sharing lots of actionable research that you can understand. So, please enjoy our conversation with Darius Dale.

Darius welcome. And thank you so much for joining Cem and I today, for what I’m sure will be a fun, passionate and perhaps unpredictable conversation as part of our global macro series. How are both of you guys doing, how are things where you are?

[00:02:43] Darius

I’m so blessed man, thanks for having me. Really big fan of the show, so I can’t wait to unpack it with you guys.

[00:02:49] Niels

Yeah, what about you, Cem, where are you?

[00:02:51] Cem

Well, Darius interviewed me, maybe, six months ago. So I’m excited to kind of return the favor.

[00:02:58] Darius

You absolutely nailed that interview, by the way, and the market call. So congratulations.

[00:03:01] Cem

No pressure, no pressure.

[00:03:04] Niels

So let me just say for a little bit of housekeeping here, we have a little bit of audio problems with Cem. That’s why he may sound a little bit different, but I’m sure the words that he speaks will be very familiar. But anyways, Darius, it’s all about you today. And since it’s your first time on our podcast, perhaps I could ask you to just set the stage and provide a little bit of context for our conversation by maybe sharing some of the highlights, and perhaps maybe some of the unusual twists and turns in your journey to where you are today. And then I think that’s going to be useful for our listeners. And then we’ll go into lots of different macro topics, of course.

[00:03:40] Darius

Yeah, absolutely. So I’ll start by saying. I’m a macro strategist, or macro Risk Manager by trade certainly was not anything that I thought I would be doing for a living. Going back to school, I went to Yale as an undergrad, and joined finance sort of right at the lows of the industry. I was very fortunate at the time to go to work at a start-up firm called Hedgeye Risk Management, which is now no longer a startup. You know, we helped grow that firm to a pretty big size firm, but I would say, my sort of core contribution to that firm and probably why I’m sitting here today was sort of, kind of recreating a very, very, very watered down version of Bridgewater’s sort of all weather system as an asset allocation framework for the Hedgeye clients and sort of been thinking about the world to this loop regime segmentation lens ever since then. I sort of left Hedgeye… I did leave Hedgeye about a year and a half ago to start 42 Macro. I thought there were a lot of different things that I could do better and do differently and ultimately call the shots on my own, and knock on wood, things are going quite well in that regard.

[00:04:47] Niels

Yeah, no, absolutely. And of course, everybody should go and check out Darius’ work and also a little bit more about his background because it is quite interesting and people should certainly be aware of that. Maybe, as a starting point, Darius, maybe we could talk a little bit about your current macro framework, but I want to put a twist to it a little bit. And that is, maybe you could also talk about how it may have changed in the last six to 12 months, just so we know, you know how strongly or how weakly the current convictions are held, compared to what the markets have been doing for the last year or so.

[00:05:24] Darius

Yeah, great. Great question Niels. So I’m a big believer in studying the time series and respecting the x-axis. So it’s a great question to give the listeners context on kind of where we’ve been. So, as I mentioned, we look at the world through this regime segmentation lens. We sort of call it the GRID. GRID is short for Goldilocks Reflation, Inflation and Deflation. Whereby Goldilocks is growth, accelerating, inflation decelerating. Reflation is where both growth and inflation are trending higher, simultaneously. Inflation, which is where we’ve been since July of 2021, is where growth is trending lower, and inflation is trending higher. And it’s our current view, that in the month of August, we’re transitioning to deflation, which is where growth and inflation are trending lower.

We’ve been in this sort of very high probability realized inflation regime, in terms of the size of the magnitude of the deceleration and growth that we’ve observed, the magnitude of the accelerations in inflation we’ve observed. We’re now kind of transitioning to a regime where we’re going to see a little bit less expediency, if you will, on both of those fronts, particularly on the growth front, which may be slightly positive for the markets.

[00:06:37] Niels

Yeah, what a time to be recording this. A day after we saw the first glimmer of hope. For the deflationary camp. Absolutely.

There’s so many things we’re going to talk about today. And it’s kind of hard to decide where to start. For my part, I wouldn’t mind about starting maybe with the bigger picture. Kind of what I think you refer to as your strategic perspective, and kind of the transitioning, maybe, from the world of deflation, as we knew it for two, almost three decades, and maybe to a world where inflation is not just going to be a thing of the last 12 months, but actually a thing of quite a while even though it may come in different shapes and sizes. So what is your kind of view strategically at this point?

[00:07:33] Darius

Yeah, that’s a great question. And I like your emphasis on strategically, because what we just talked about was really the kind of the shorter term cycles that tend to drive the markets from a dispersion perspective. But from a strategic standpoint, I think it’s very important to step back and identify that there has been a regime shift with respect to the direction of travel for the trend inflation rate. We’ve been trending lower, really, since the early 80s, and sort of ultimately made the lowest lows, kind of in the GFC, and kind of retested some of those lows (pick your indicator) in 2020.

It’s very likely, at least according to our models, we’ve built a pretty sophisticated model to project the long run trend in things like core PCE, etc. And that model has had a pretty significant inflection. It’s suggested that we might see core PCE, for instance, trend at a rate that’s around 60 to 110 basis points higher than its trend in the prior decade. Now, that doesn’t sound like a lot. But when you do it in percentage terms, you’re talking about 40% to 70%, more inflation, through the lens of the Fed’s preferred inflation gauge, and oh, by the way, consistently, and persistently trending higher than their target. So that kind of opens up a Pandora’s box of a lot of different scenarios, from asset markets.

On the bullish side of the ledger we’re talking about an economy that likely has higher potential nominal growth; an economy that for a variety of reasons, not at the least of which is deglobalization, is both a bullish and bearish factor in some respects. But we’re also talking about a Federal Reserve that might be acquiescent to that and not push back. It’s very well that history is littered with these sort of inflationary episodes where you go from a regime where there’s less inflation to higher inflation where you’re talking like the 40s, or the 70s and the central banks willingness to acquiesce to that may be a big factor in understanding how that ultimately impacts the economy and asset markets.

If you put a gun to my head, I think the Fed, really, is going to be forced with a very difficult choice in this decade which is, do you save the economy in the stock market by effectively acknowledging that there’s 40% to 70% more inflation in the pipeline that has to come through, or else what? Or else we kind of go into a depression, or do you save the bond market by consistently and persistently pushing back against that pressure and trying to maintain a 2% target? I don’t know the answer to that, but to me, I think that’s the biggest question we investors kind of face from a strategic asset allocation perspective.

[00:10:17] Niels

Yeah, I’m sure we’re gonna talk a lot about that. And of course, I live in a country with tight gun controls, I would never put a gun to your head. On the other hand, Cem lives in Chicago. Take it away, Cem.

[00:10:30] Cem

Wow! Yeah, I’ll put a gun to your head. (laughter)

So we can talk about a slightly higher trending inflation over the long run (I think that’s my views. That’s a pretty safe bet, given structural trends. But the real question, for me, is path. A. How do we get there? We can obviously go to 10%, inflation, and then go to deflation and end up in that average. There are a lot of different paths to get there. And I think, in particular, we’re (like you said) at an inflection point. The problem with the distribution of outcomes, as you and I have talked about in the past, is very leptokurtic, and you can have lots of different potential outcomes. I’d be curious to think what you think the most likely path is. I’d really like to start with three to six months, which is always hard, right? That’s always the hardest; six to twelve months, and then out two to five years, what do you think? And again everybody’s trying to prognosticate these things. It’s not easy. A lot of it depends on reaction functions, etc. But I’d like to hear your thoughts and where your head’s at currently, with inflation, where you think it’s going.

[00:11:51] Darius

Yeah, so let’s start with… Great question, Cem. We’ll start with the medium term. We think about the medium term as three to six months. It’s sort of different than kind of the traditional economists think about it. From that perspective… And if you had asked me this question, by the way, two days ago, my answer would be very different.

We got some very important economic signals out of yesterday’s CPI Obviously, it was a very positive report in the sense that we surprised consensus estimates to the downside by a significant degree on both headline and core. But, to me, that’s kind of the sideshow. The real juice in the report came via the lens of the Cleveland Fed’s median CPI statistic, and the Atlanta Fed’s sticky CPI statistic. The reason that those are two important indicators is because they tend to track core PCE (which is the Fed’s preferred inflation gauge) quite closely.

If you analyze the time series on a month over month annualized basis, we’re talking about significant decelerations that, historically, we have not seen outside of recession. So a median CPI decelerated 250 basis points to 6.3% month over month, annualized, and sticky CPI decelerated 270 basis points to 5.4% month over month, annualized.

I can’t stress enough how unusual it is to see the kind of breakdowns we’re seeing in these types of indicators. The key takeaway here is that if you roll this kind of momentum forward over the next couple of months (and again, I’m not saying you could, or that there’s even a basis to do so), if we did see this kind of sustained breakdown over the next few months we could be talking about observing 2% to 2.5% core PCE on a month over month annualized basis, as early as August or September. To me that’s a very new and a very important piece of new information that we Bayesians have to just humbly accept as part of the new market narrative.

So from an inflation standpoint it’s our model’s view (and again, these kinds of things are almost impossible to model), just from if you try to model the trend in the time series, it’s very likely that we continue to decelerate. It’s unlikely that we will see this kind of pace of breakdown continue. But if it does, and again, I would have argued that it’s unlikely we even saw it in the July report, but we did see it. So we have to acknowledge that there’s something happening in the time series and on the ground that is anomalous, relative to history. And if that anomalous thing relative to history continues, we could be talking about a much different inflation dynamic three to six months from now than the one we’re currently talking about.

[00:14:34] Cem

So I’m actually gonna dive in before you go into a longer time series and push back a little bit because that just makes for a better conversation. Let’s be polemical here. But if you look at the CPI report, and you dig under the hood (which I know you do, in great detail), the real reason this number came in low was energy, right? That’s the overwhelming reason. There are other factors, to be clear. I’d love to hear your thoughts if you disagree, but that’s what I see.

Energy was, month over month, down 4.6%. Some of the internals like fuel were down 11%. We saw dramatic, dramatic effects in energy and then knock-on effects because of that, as well. We kind of knew that would be a major issue here, but it was decelerating dramatically more than we even thought. And so, as the Fed would say, separating the core from the rest, those things can change quickly. Hard to say, what affects that has if China invades Taiwan tomorrow; that may change things. You can have changes in policy that can change things quickly. So given that, how much credence should we be giving CPI and the deceleration here? What are your thoughts?

[00:16:06] Darius

Great question. Let me be clear, just even before I answer the question, just for the listeners, we are at a very, very interesting time right now in the economy and asset markets. Nothing that we say in this podcast or anyone saying, or anyone talking at this particular juncture should have a lot of certainty. Again, as Cem mentioned, I think the range of outcomes, economically and by extension from the perspective of asset markets, is quite flat right now. It’s a very wide distribution, which is very unlike what we saw at the beginning of the year, when I thought the range of outcomes was actually quite narrow. We were going to slow and slow pretty precipitously, and the markets are going to have a problem with that. It’s a much more two sided bi-directional risk from that perspective now, kind of answering your question.

So yes, energy was a very significant drag on the overall time series and certainly played a role in the decline in things like median CPI. But you can’t deny the improvement we saw on sticky CPI of which energy is gonna have a very low impact on that. And more importantly, we saw a pretty substantial deceleration on core services CPI. We saw that come down 150 basis points on a three month annualized basis to 6.7%. Now, those numbers are more than double the kind of trend rate we’ve observed pre COVID. And so we’re still very much not out of the woods.

I think the number one thing I really want to focus on is the fact that we’re seeing this kind of improvement without seeing the kind of drawdown in aggregate demand you typically need to see in this kind of improvement on inflation. It’s very clear that, to tip the cap to the “teem transitory,” which was very wrong last year, it may be the case that both the transitory camp and the persistent camp are right but just at different intervals. The persistent camp was very right, in calling for the incremental surge in inflation going back to last fall. But it could be the case that if we observe this kind of breakdown in inflation (and again, it’s a broad base breakdown across core goods, core services, median CPI, sticky CPI), if we see this kind of broad base breakdown continue in the ensuing months, then “team transitory” will ultimately be proven right. That’s kind of the nature of markets. It’s not about whether you’re a bull or a bear. It’s about the timing with which you buy and sell securities and exposures. That’s all that matters.

[00:18:33] Niels

I just want to add one thing. I want to let Cem continue down his path, but I just want to say one thing about this inflation and what’s going on right now. It’s only been a couple of months ago, I think, that Powell came out saying that there are two parts of the whole inflation picture: energy and food, that we don’t control. That’s why we look at Core CPI. Oddly enough, exactly after that speech, or whenever he made that comment, those two things have just headed south dramatically. We know that, in particular, oil is being massively manipulated by the (in my opinion) very risky strategy by the White House in terms of releasing so much of the strategic petroleum reserves, because of elections (in my opinion).

Of course, we knew that, especially in energy markets, a million barrels here or there can really make a huge difference because with commodities it’s very, very, “here and now” demand and supply that determines the price. So I also caution this as, yeah, let’s not celebrate too much right now. It’s one number, and we know things have been manipulated in recent months.

I guess from my perspective, and maybe we’ll talk about this more later, I think we’re into this new regime in terms of just inflation. Inflation as a whole, I think we can see much more unpredictable sorts of trends in inflation, which will make it very hard for any economist or commentator to make much sense of this. I also think this will then allow markets to be much more volatile than what we’ve seen in the past.

But anyways, that’s a side note, I want you, Cem, to continue down the path of where you were heading.

[00:20:28] Cem

So now, this is where I really put a gun to your head. Three to six months, again, who knows. As we go further and further out, this is where your conviction, where you see the path of things really kind of shaking out. I think it kind of comes in, let’s talk six months to twelve months. So it’s extended, kind of a little bit further. I know that’s not your primary focus. You’re really talking to people about quick moving, changes, and what that might mean for shifting from one regime segment to another. But really, I’m sure you do think about the big picture quite a bit. I’d love to hear your thoughts about six to twelve and then longer term. and then, why? How do you feel that way and why?

[00:21:18] Darius

Yeah, great question. So, just as an aside, at 42 Macro, most of our sort of risk management investment horizon is focused on the rolling 3 to 6 month time horizon. We definitely have very informed views on the six to twelve month horizon. Generally speaking, in terms of how we’ve orchestrated our backtests, it tends to be the case that the markets are only pricing in things like the rate of change of growth, inflation, inflections in policy on usually no more than three months forward. Things like, is a company going bankrupt or not; those things tend to be much longer lead times in terms of market response.

So anyway, just kind of focusing on the six to twelve month forward view, I don’t think we’re too dissimilar from the consensus which is calling for a pretty significant deceleration in inflation, particularly when you get out six to twelve months. That’s when you really start to see the breakdown in the time series momentum. Now, the one thing I think that is pretty interesting is that if you look at our model on inflation, it’s now starting to call for, let’s call it, a June bottom, a 2023 bottom at a pretty elevated level, just shy of 4%. Now, that’s very path dependent.

If we don’t get the kind of continued breakdown we see and we currently just observed in the July CPI data on some of the things in the core PCE, we’re going to continue to see a Fed that’s very much actively engaged in removing liquidity from the economy and financial markets. As a function of that, we’re going to see a more significantly negative growth slowdown in the first half of next year which will ultimately lower that entire curve. So again, answering everything today is based on how the world is currently set up today, just from a Bayesian prior standpoint.

So to kind of answer your question, or not to answer your question, but to me, I think the most important dynamic in that whole process is inflation could be bottoming at a level that is very inconsistent with the Feds 2% target, on a year over year rate of change basis. This implies that if we don’t sustain the kind of breakdown in annualized momentum, then we’re talking about a Fed policy setting that’s going to be significantly more tight throughout 2023 than what is currently priced into money markets: Eurodollar, futures, Fed fund futures, etc.

So to me, I think the key takeaway from this discussion is like, hey, look, the distribution of outcomes is extremely wide. It’s a very credible case towards seeing a Fed that is significantly more tight than what consensus is currently pricing in. Also there’s a very credible case in seeing a Fed that is way more dovish, in one or two months, than it was currently priced in. So to me, I think it just makes the game hard, but ultimately you’ve got to make a bet if you want to make money in financial markets.

[00:24:11] Cem

So I think six to twelve months is the toughest, right? I would agree with that 100%. It’s easy to see the deflationary effects that you’d expect from the Fed accelerating off its low here than at any other time. Again, we don’t have a lot of inflationary history in the last 40 years, but if you go back to the 60s and 70s, and prior, when we did have inflationary periods, the Fed does have the ability to slow growth, as we know, by raising rates and they always do. The question is how much can they and how much is structural? Ultimately, at what point does structural inflation meet decline in growth to a point where they have to choose. So, where that structural level of inflation is, is important (like you highlighted).

At the end of the day, if that’s going to be higher and how high is a question? At some point, you start to get (and we’ve seen this in the past) people starting to lose faith in the Feds ability to control inflation. I think that’s what we may start to see six to twelve months out or so. That’s the big question, at least, are we going to bottom at a higher structural level of inflation that people expect or that’s being currently priced? And what does that mean for long term inflation expectations that the Fed can control? Right now they’re able to control those long term inflation expectations. It’s pretty impressive. I think we’re at 8.5% CPI, right? And we’re pricing ten year breakevens, at around 2.5%, right?

We’re basically looking back at the last 40 years and saying, hey, we’re going to be slightly higher than the last 40 years, on average. Again, that’s what I think the base case is for people. But that assumes that the last 40 years is where we live now and not in some other period, if you ask me. So, I do think that’s the toughest time. Given that, let’s start transitioning to a long term. Based on your views, do you think that the Fed controls things here, and then ultimately gets the world back on track in the next year or two to where we have essentially been for the last four years?

[00:26:38] Darius

Yeah, so that’s a loaded question. Loaded question two guns, by the way, we’re counting against my head for those of you keeping score at home.

So, the first thing I will say is that, I very much agree with you (not to make boring TV) that we’re going to bottom at a level of inflation that is unacceptable relative to both the Fed’s mandate, but also to recent trends. It’s very likely, however, that along that path to getting there, the markets are going to eventually price in the full recovery. And at some point, we’re probably going to have to unwind some portion of the market pricing in that full decline back towards 2% inflation.

Fun fact, the Fed is forecasting core PCE, which is currently at 4.8%, year over year, to be, in 2023, at 2.7%, which implies, obviously, a deceleration of 210 basis points. Never in the history of that time series have we seen that kind of decline over that sort of period of time without going through a recession; without having had a recession first. So, it’s interesting, to say the least, if we get that kind of decline in inflation, will we need to see a recession to do it? I was certainly in the camp that we were going to have to get a recession. And part of the reason for that was that it became very clear, listening to the Fed’s statements, particularly Powell’s statements in May, and then again in June, that this is a Fed that is increasingly comfortable with delivering economic downturn or an actual recession, to get inflation under control. Knowing what we know about core PCE, it’s like you’re going to have to have a recession to achieve your inflation objectives.

That may no longer be the case. Certainly the most recent data we got out of this July CPI report would seem to create a new avenue for that debate. So, we certainly have to acknowledge that as market participants. Going back to the longer term inflation dynamic there’s a lot of different things pushing and pulling the stationary mean of inflation higher, not the least of which is globalization, aging. I forget the guest, Niels, you had on the podcast a few weeks ago, who wrote the paper on the structural aging factors. That’s one of the factors in our structural inflation model.

So if you’re talking about inflation, let’s use the high end of that range. It’s somewhere around 2.8% for core PCE. The Fed wants 2% and so what are they going to do about that 80 basis points if we can’t get back down to that 80 basis points? Is the Fed’s policy setting going to be, I don’t know, just way too tight for way too long of a period of time, for most of this decade because they’re kicking and screaming trying to get it back to 2%? I think it is equally as relevant that they opt to sort of acknowledge that and maybe they do it under the guise of a green transition or green inflation or something where they effectively revised their inflation target higher.

I mean, they’ve already done it. They did it back in August of 2020 by effectively saying it’s an average inflation target, and we’re going to stay as easy as possible until we achieve our employment mandate. That was a big code word for we’re gonna let inflation run hot. And so we’ve seen kind of the first step in that direction. So it’s not inconceivable that we see a couple of incremental steps in the direction of acknowledging that there’s just going to be more inflation and we have to deal with it. If that’s the case, then this is a bond market that is egregiously overpriced from that perspective. The reason I say that is that we’re still talking about term premia.

If you look at 10-year term premia somewhere at minus 70 basis points at the highs of the inflation episode in the 70s. And by the way, I’m not saying this is the 70s, I do not think it is the 70s to be very clear, but just kind of giving you some bands of outcomes, you can have term premia as wide as 300, 400 basis points on the 10-year treasury. Now, again, I don’t think we’re going there but you could go from minus 70 to plus 100, and that’s a very different bond market than the one we’ve come out of, and it’s a very different asset mix from the perspective sector and style factor dispersion in the equity credit markets. And so to me, I think that’s a real key question here.

Part of the reason why you might see an expansion term premia, for those who are kind of not as into the weeds on bond math. But you’re talking about a higher level of inflation. Higher inflation creates more inflation volatility, creates more economic volatility, and all things being equal on the policy rate, etc., you do need to price in higher risk premia into the asset class. If you price a higher risk premia into the asset class in the treasury market, obviously you’re gonna be talking about pricing in wider risk premia across the curve. Ultimately, I do think that a Fed that acknowledges a higher level of inflation, with easier policy, is likely to be positive for risk assets.

[00:31:38] Cem

I think you’ve touched on a very important point. We can talk about whether the two-year, and this is why I broke up the time period, being correct. But the amount of risk premia that’s where the 10-year is priced, relative to the risks at hand, does seem inefficient or mispriced. I guess mispriced is always a dangerous word.

Let me throw in a little bit of history, and I’m sure you know this, but just for our listeners. The last time we had real secular or structural inflation was obviously in the 60’s and 70’s. I hate to just refer to that period, because, like you said, every period is different, but things rhyme. And if you look at what the Fed did in the 60s and 70s, when William McChesney Martin raised interest rates 7.5%, the Fed funds rate (which people don’t remember, in ‘68 and’ 69), to fight inflation, caused a very mild recession, in ‘68 and ‘69. It was enough to bring rates down over that two year period, from 5.5%, 6%, all the way down to about 3%. It leveled off at 3% and then took off when they stopped and pivoted. It went and took off to 10%. The reasons why they are now relatively well documented are that these are structural effects, some of which, many of which we actually share in common. I think that’s an important thing to note. So we could, and we’re likely to cause recession, if they continue down this path, and they’re not even close to 7.5%.

To be clear, nobody’s expecting them, at this point, to go 7.5%. That’s what he did in order to cause a very mild recession, because the demand push was so strong during that period; on the back of the Great Society program from LBJ, and a lot of fiscal policy, etc; a lot of things that we’re seeing now. At the end of the day, it leveled, they couldn’t get it down to 2% or below. The economy was in recession, so they stopped and pivoted, and that’s when inflation ticked higher and then long term inflation expectations pivoted higher and that’s what started to create this massive decade long problem.

After that, people think Arthur Burns was asleep at the wheel. Arthur Burns raised the Fed funds rate 10.5%. Yeah, we’re talking about 3%, 4%, etc., at 10.5%, people still refer to him as one of the major reasons for why inflation took hold and was alive until Volcker had to step in. That’s not actually true. There was structural, underlying inflation, a lot of which, again, if you just look at the factors (I’m not trying to say this was the same period), the structural causes of that ultimately, a lot of them were the same things that we’re experiencing now.

So again, just a little history lesson which I think is important for people to refer to and think about as to what has the Feds done in the past? What does that mean? Yes, they’re absolutely able to cause a recession and lower rates in the short to medium term; call it a one year, two year, etc, period. The question is, when that recession hits, are they going to continue at that point to be hawkish? History says that they can’t politically and they won’t. If they’re not, the question then becomes what then?

I think that point is what’s important about this 2-year versus 10-year risk premia, that people are kind of not pricing in. Everybody’s talking about inflation in this general sense, but I think about where, when, and the timeline is incredibly important at this point, and particularly as we talk about that kind of duration, 10 years or so, which is actually the lowest spot that we’re seeing out there on the curve.

[00:35:38] Darius

Yeah, a masterclass, by the way, thank you for elucidating us on some of these dynamics in the 70’s. I agree with you, and I, myself, am guilty of this as just labeling Arthur Burns as this guy who let the inflation genie out of the bottle. Obviously, it could be argued, and I will argue that there’s a lot more that he could have done to stamp out inflation. It just wasn’t politically correct and feasible at the time, we obviously had President Carter. President Nixon was, obviously, leaning very, very aggressively against them; against those kinds of policies. So I think he took the road of trying to have the cake, and eat it too, which I fear that this J Powell Fed may ultimately want to opt for, which is you want to get inflation down. But you also don’t want to kill the economy.

Eventually, what you’re going to wind up doing is having stagflation as the only outcome. If you tighten just enough to slow a little bit, but you don’t tighten enough to get rid of inflation, stagflation is really the moto outcome of that policy mix. So this is kind of the issue, kind of longer term for asset markets, is the Fed going to allow the process of returning inflation back to trend, however quickly, it may take? Again, as I mentioned, we could be looking at month to month annualized rates of core PCE at 2.5% to 2% by September, or it could be we don’t get there at any point in time, or we don’t sustain that at any point in time in the next several years.

As I mentioned, the distribution of outcomes is quite wide and each of those scenarios needs to be accounted for in your portfolio construction at the very least. So yeah, I would tend to agree with that. One other thing I would call out is that if you look at 10-year inflation swap rates,which you can look at TIPS, break-evens. Some people don’t like break-evens, because the Fed’s leaning on the tips market. So just go straight to the source, we’re talking about 10-year inflation swap rates at two spot 7%. The upper end of our range for our core PCE model is 2.8%. Historically, there’s been this 50 basis point spread between headline CPI and core PCE. This thing is misprice by 60 basis points today, even at the peak, or just rolling off the peak of a very significant inflation episode. And so to me, if we move into this era of higher inflation, which I would argue we already are in, and it’s persistent, there are a lot of institutional asset allocators that are going to be dragged into this regime, kicking and screaming, unfortunately. And so that just is what it is. It goes back to the question that I think of the decade, which is, does the Fed save the bond market, or does it save the economy and the stock market? I think the worst possible outcome is if it tries to do both.

[00:38:30] Cem

I think the last thing I’d say about this before we kind of move on is credibility. The Fed has credibility, at least with the market from the last 40 years, and they’re pushing the market around as they tend to do. What happened in the 60’s and 70’s is the market lost credibility in the Fed. And that was partially primarily, I would argue, because of structural factors that they could not control. And so the question is, is that the case? If we get there again in the next year or so, or two, and we start to see the market and realize that the Fed may not be able to control this, that’s when things get (in my opinion) very interesting, and can lead to major regime change and decade long effects. As we know, if you get that direction right, as people who have in the last four years, you’re going to make a lot of money. It’s a hard thing to get right. It is, I think as you mentioned, mispriced,

The last question for you as related to this, what’s the trade? How would you envision, and that’s always the case, where does the rubber meet the road? Do you have any trades in particular that you like, given that?

[00:39:47] Darius

Yes Let me start by saying I fancy myself a macro risk manager, and the number one goal of a macro risk manager is to not lose money. It’s to help investors compound returns and avoid drawdowns while doing it. In a raging bull market of 1999, or 2021, you’re probably not going to outperform listening to folks like myself, but over time, what your goal is, is compound returns, and have a higher adjusted net value some years in the future as a function of not having to suffer that kind of geometric return decay that you tend to see. I think volatility drag is the appropriate term for that. (Go look it up for those who are not aware of that.)

Anyway, so kind of what’s the trade from my perspective? I think there are, as I mentioned, three core scenarios that I think need to be reasonably allocated to, across an investment portfolio. There’s this sort of best case scenario, where growth is likely to continue to slow as a function of the lagged impact of the accumulated tightening we’ve seen to date, and it’s likely that inflation slows, but perhaps not at the same pace that we saw and observed in this breakdown in July CPI.

That trade says you can be long risk, but you certainly want to be favoring defensive sectors, style factors within the equity and credit markets. You probably don’t want to be too far out on the risk spectrum, as it relates to digital assets, because that is an inherently more unstable environment than an environment in which growth is accelerating and the Fed is kind of adding to the liquidity function in the economy; the Fed and Treasury combined. So that’s sort of the base case scenario; kind of long risk, defensive oriented style risks.

The bull case scenario, which we talked about, is a scenario in which the market is significantly breaking down… or not the market, but inflation rather, inflation pressure is significantly breaking down on a month over month, annualized basis. If that continues, we’re talking about a Fed that, by November 2, is very much done with rate hikes and talking about maybe revising its balance sheet; the pace of its balance sheet withdrawal. And more importantly, I think it has less to do with quantitative tightening, as it relates to net liquidity.

In that environment, if we did see that, you’re talking about $2 trillion of excess liquidity sitting in the reverse repo facility, that would become de facto QE if that applied to asset markets if given the green light by the Federal Reserve. And so it could very much overwhelm the Fed’s quantitative tightening program if we achieve some of these sort of more, I would say, best case scenario outcomes with respect to inflation. And so that obviously needs to be allocated because, again, it’s no longer this kind of distant possibility. The data is telling you, this is legitimate potentiality. And so that obviously favors being even longer of risk.

Again, as long as growth is continuing to slow, you’re generally going to want to favor defensive sectors and style factors. But the one caveat to that is, and this is I think the hardest part of getting the trade right today, if inflation does continue to slow at that pace, which again, is a massive if. There’s not a lot of time series, as history has suggested, it should and could. If it does, you might actually start to see a re-acceleration in growth because, again, what it ultimately implies is that maybe the Fed’s policy setting was not as restrictive as we all thought it was, after all. And that this economy still has a ton of potential to continue growing gangbusters.

You’ve talked about on the program, Cem, that there’s still a lot of sort of pent up fiscal in the pipeline already that is waiting to be spent and allocated to the economy. So that’s something that could potentially cause growth to inflect as well. And again, that’s not our best case scenario. But I’m just sort of outlining all the core tenets of the bull case scenario, why, and why I think markets have recovered so aggressively off the June lows. Now, again, if we had all these data points in hand, we would have obviously done a better job positioning for them, but it is what it is. We just have to focus on the next play.

Then the last scenario, which I think is just as credible as the other two, which is this breakdown in inflation momentum that we just saw is not persistent and we really struggled to get well below high threes, low fours, from the perspective of annualized core inflation momentum. And that, to me, is really scary, because it probably means that this is a Fed that, at least at face value just taking their word for it, can and will tighten this into what must be a significant slowdown, just given the structural up shift in the inflation.

Again, they’re going to try to beat us back to 2% inflation in that scenario. But clearly, the dynamics and underlying inflation momentum are preventing that outcome from happening. So ultimately, they just have to do a little bit more tightening, or not a little bit, a lot more tightening than what is currently priced in. So, as I mentioned, again, that distribution is very flat and very wide. And so I think, from a portfolio construction perspective, I don’t think it really favors leaning too far into the wind on one of those scenarios right now because I don’t know that we have enough data, and enough ability to forecast which is the path of least resistance and ultimately the most high value path to take.

[00:45:11] Niels

I just want to pick up on something that Cem referred to, and this is this political correctness of central banks. And I just wonder, at the moment, when I look at things, is that there are a lot of things happening in the world right now, both from the war in Europe, but also in terms of the still the fallout of COVID. I wonder if the Federal Reserve, to some extent, even though they probably wanted really low interest rates (ultra low interest rates), we also know that as soon as they do that they lose one of their main tools in the toolbox. But now at the moment, they actually have an excuse for hiking rates significantly to get that tool back. So I think that’s one thing that we need to bear in mind.

Then the other things that I think are very important. I mean, I’m going to definitely dumb down the conversation compared to you two. But when I look at it, with my simple view, I’m hearing people always talk about oh, we have to get back to the 2% inflation target. By the way, I mean, this was probably picked out of thin air at some point, right? Where does the 2% come from? But in any event, it is a target that’s been there, during a period of globalization, where we know that all the forces helped us to have low inflation, and low interest rates. Now, I think the three of us agree, and certainly some of the guests we’ve had on this series, agree that the world is changing. And we’re probably already in a de-globalized world. We have a massive demographic shift, including in the US, that, to me, seems very inflationary. And, of course, we talk about this as if inflation is the only thing that the Fed worries about, and it’s not. We have unemployment as well.

I’m sitting over here in Europe. And despite all of these crises, there’s no people to be found, in terms of getting people back to work. Everybody’s saying, oh, we need people and so on and so forth. I think that seems very inflationary as well. And it’s going to keep unemployment rates at a level that probably makes central banks very uncomfortable in general. So I just struggle in general to see how we should even be talking about getting back to what it used to be because I think the world has changed.

If we believe, certainly I do, that there is something called the 40-year interest rate cycle, well, we have a long way to go and we shouldn’t even worry about getting back to really ultra low rates for now. And actually, we just released yesterday, I think it was, an episode which I really encourage people to go and listen to, with Edward Chancellor who just released his new book, “The Price of Time”. And he’s probably one of the leading financial historians, especially when it comes to interest. And he doesn’t see a bright future for those who are hoping for low interest rates.

So I just think it’s interesting. I’d love to hear how you, maybe, in your work, factor in things like demographics, factor in things like maybe unemployment and some of the structural changes that I think we all agree that they’re out there.

[00:48:37] Darius

Yeah, so that’s a great question. I think it’s extremely important to factor in, not just these longer term trends, but understand exactly how to use them and weaponize those longer term trends into your asset allocation. So, we have this thing, what we call our four horsemen of economic risk at 42 Macro. There’s politics, leverage, balance of payments, and demographics. And demographics is very much one of them. We’d look at demographics through the lens of the working age population growth, relative to the old age dependency ratio.

One thing that is pretty clear is that we have a little bit more working age population growth than the rest of the developed world, certainly relative to places like China, etc, on a 5 to 10 year forward basis, but our old age dependency ratio is really starting to rise. That’s consistent across much of the developed world, including in China, where we had a significant amount of globalization and tapping into their underutilized labor resource. All that is sort of changing in the sense that this structural decline we’ve seen, looking at the US statistics in isolation, this structural decline we’ve seen in the employment to population ratio, labor force participation rate, which by the way didn’t start with COVID. It’s been trending lower since 2000. It’s only going to continue to decline. And so companies are going to increasingly find it difficult to meet production targets, etc, etc. in this world where people are aging and leaving the workforce. You can make the case for political reasons, maybe not joining the workforce with the same kind of fervor that might have happened in recent decades.

So I think, going back to the question on interest rates, I mean, it all boils down to the fact that some people believe that inflation is purely a monetary phenomenon. I think just living through the pandemic and seeing what happened with inflation, it’s not just a monetary phenomenon, it’s a fiscal phenomenon, it’s a resource scarcity phenomenon. It’s a bunch of different phenomenon, which is why our secular inflation model has 16 different variables; 16 different key variables to help guide the output of that model. Again, I don’t think the model is the letter of the law.

If we’re having this conversation eight, nine years from now that we actually nailed it to the decimal place, but I do believe directionally, it has proven directionally accurate. And I think it’s likely to continue to prove directionally accurate, in terms of the kind of the change and all those different variables. So ultimately, we’re talking about a time series that instead of making lower highs and lower lows on inflation, and by extension interest rates, we’re going to be making higher highs and higher lows.

It’s still going to cycle. We’re still going to have a Federal Reserve that rates respond to inflation being too high or too low, or employment being too tight or too loose at various stages of that process. But ultimately, the direction of travel was higher. I think the starting point of this 60/40 allocation, which is very popular across not just the institutional investor community, but obviously the retail investment community, that’s probably wrong. We probably need to make space for something that looks more like a 60/30/10, whereby the 10 is physical and digital commodities.

Now, I’m certainly not going to get on the podcast and tell everybody to go buy 10% Bitcoin allocation. But I do believe that things like Bitcoin, things like gold, things like physical commodity baskets, will have a pretty important place in investor portfolios in this coming decade. Again, this is a decade we’re exiting that looks a lot like the kind of 90’s where everyone’s long US stocks and tech stocks and bonds and things, and all that stuff is working, but we’re just in a different era. And I think it’s gonna get increasingly proven once we get to the other side of this Fed tightening cycle and economic cycle, and the dollar starts to decline.

[00:52:31] Niels

I thought you’re gonna say the 10% was going to be trend following and volatility investment. strategies.

[00:52:36] Darius

No, no, I very much agree. I very much agree that alternative asset allocations and alternative investment managers are part of that bucket. Again, I agree with that, and I always mispronounce his name, so forgive me, Mr. Antti Ilmanen, it’s a really difficult name.

[00:52:56] Niels

Ilmanen, yeah.

[00:52:56] Darius

I very much agree with him that the starting point of valuations renders this concept of beta more or less dead. This is an alpha generators market, and will be an alpha generators market for an extended period of time. And I think one by one, we’re going to be convincing large institutions and large swaths of retail investors that is the case. What we experienced in 2001, and obviously, throughout the 2010’s decade, is going to increasingly be proven to be something that we’re not getting back to.

[00:53:35] Cem

I want to dive in here, because I think you’ve really highlighted a point that I think we all talked about from different vantage points. And I think that’s this idea of factor correlation, and the idea that we tend to get clustering of things in a similar direction when things happen. If you listen to the media, or even most wealth advisors out there, people and even the Fed, you segment every factor on its own. People seem like they talk about the war and Ukraine is, as you know, an idiosyncratic factor; something that kind of came out of nowhere. And there are lots of other things; slowing growth versus value, and what that means in terms of money supply, protectionism, deglobalization, fiscal policy, these are all (to most commentators) separate things. But we’ve seen in other periods, these things clustering as well.

I think I’d like to highlight the military conflict and increasing likelihood of that. For example, which people think is completely unrelated to some of these other things going on, on the money supply side and inequality side. I’d love to hear your thoughts about how you look at correlation and factors and how they cluster.

Obviously historically, if you look at periods of higher inflation, we have geopolitical stress. We also have much higher volatility effects, which creates a dollar denominated debt crisis and also issues there. We also tend to see periods of deglobalization and protectionism. All of this, in my view (and I think others would agree with this) tend to be driven by the fact that during times of populism, and solving inequality within countries, we begin to look competitively at the world and say, we go from a cooperation game to a competition game.

That simple change, which seems very overly simplistic, but it’s incredibly important; this idea that we’re trying to make do with the best we can, because we can’t all work together, right? That idea does, historically, lead to global conflict. We’re seeing it now. It’s not just Russia and Ukraine. It’s China and everything that’s going on there. And it’s also every single piece within a country. We’re seeing the greater kind of internal strife in the US, and a lot of other countries as well. So, again, people think of that as a separate factor, using that as one example.

So we get a lot of these clustering of factors that all tend to lead to the same direction when they happen. That’s why we get 40-year trends. This is why we get big, longer cycles. How do you look at that? And what type of things do you put into the portfolio or suggest to deal with these changes in correlation and clustering among factors? I’d love to hear your thoughts.

[00:56:46] Darius

Oh, if that’s not a loaded question, then there’s never been one before. So I’ll start by saying I’m in 100% agreement that inflation tends to be the underlying driver of a lot of political dissension, discord, both within societies and across societies. You know, Peter Turchin, has a great book, Ages of Discord, kind of on this topic, and how inflation episodes have historically contributed to toppling regimes and breaking up societies etc.

So, I tend to lean on works like that to support what I’m about to say, which is when you have a scenario where, if you look at the US, for instance, our Gini Coefficient would seem to suggest that we have a significantly, much, much more wealth inequality and income inequality in our society, relative to kind of Western democratic societies. Then you look at something like our employment to population ratio for prime working age individuals (these are two factors we use as in our politics risk in terms of economic risk), you look at those two factors and you marry them together, it’s very clear that the US is on its own with respect to the kind of political risk, the populism risk that we’ve seen. This has been the case, obviously, since the middle of the last decade, which is part of the reason we saw a populist take power. I wouldn’t necessarily say Biden was a populist, but he certainly leaned in that direction during the campaign season. So now we’re two for two since getting to this place where the inequalities in the system, and ultimately the kind of the decline in the economy that produced that outcome from an employment to population standpoint, are really contributing to this populism.

I think it really boils down, you mentioned something about the mood shifting from collectivism, to competition. I think that really boils down to a scarcity of resources. And that’s kind of what inflation ultimately is boiled down to. It can be a scarcity of resources relative to the total amount of money that was printed, or it could be a scarcity of resources relative to we don’t have enough stuff in the ground to feed ourselves or prepare in large, etc, etc, etc. So we don’t have enough workers and bodies; an able supply of labor to create enough goods and services. So, at the end of the day there are many things that cause inflation. The problem, when you get to these inflation episodes, is that those many things tend to boil up all at the same time: you have an energy shock, you have a labor shortage etc, etc, and all these things tend to boil together.

I think I would be very much in the camp that as long as we stay in this regime, we’re going to be dealing with higher degrees of political volatility, higher degrees of economic volatility as a result of that, and it doesn’t all have to be bad. We got political volatility and fiscal policy volatility in 2020 and ‘21 that was extremely positive. That’s kind of the nature of populism is that people tend to get what they want when they’re in democratic societies. You should all expect a fiscal policy sort of reaction function in this higher inflation decade to be higher. And don’t forget one thing we haven’t talked about as a finance, talking head consortium, if you will, is the concept of the fourth turning, which by the way, hasn’t gone anywhere.

We’re getting deeper and deeper into the fourth turning, and shout out to my former colleague, Neil Howe, who was sort of seminal in helping create that work. We’re getting deeper and deeper into the fourth turning, whereby we’re going to start to see the revolutions of this kind of political volatility swinging back and forth, until we ultimately turn into one side, whether it be the far right or the far left, kind of gets to take power, and ultimately kind of gets the will and the entire power of the government. So, that’s going to be fun to live through. I wish I had a better, more positive message.

I guess the positive messages, this isn’t the first fourth turning and it won’t be the last. This isn’t the first decade where the stationary mean of inflation rises, instead of falls and it won’t be the last. It won’t be the first decade where the Fed might look like it has no idea what it’s doing on monetary policy, it won’t be the last.

So, at the end of the day, we’re all going to be fine as long as we understand that there’s different cycles, from an intermediate term perspective, that we can take advantage of to sort of extract the beta that is there and available to be extracted from financial markets. We can definitely do that along the way. And then when there’s no beta to be extracted, or you’re in these more difficult volatile parts of the market, there are guys like you, Cem and Niels, to take advantage of from the perspective of alpha generators. It doesn’t all have to be bad, we just have to accept the fact that the distribution of outcomes is changed both cyclically and structurally.

[01:01:46] Niels

Yeah, I mean, speaking of that, and I hope you’re right, that we’re all going to be fine at the end of this fourth turning. I do find it interesting that so many people managing so much money, many of them have never done so through an inflationary time. So, I really do worry about some of these portfolios. And speaking about folio, I do want to touch before we start to wind down, I do want to touch a little bit about portfolio construction. Here’s another thing that I wonder, in my kind of dumbed down way of looking at things, and that is that a lot of these models that we still refer to were created 50, 70 years ago, in a very different environment, in a very different world economy. And I wonder if we can still rely on them as much as we do. Whether that’s something you think about, whether that’s something you take into account.

I mean, I’d love to hear about how you think about portfolio construction, but also, because you mentioned this, kind of the role of risk management? Can we still rely on what we thought of as safe assets as being safe? I mean, we have very prominent people out there talking about sovereign debt crises, etc. etc. So I just want to sort of jump in that direction before we have to jump so to speak.

[01:03:10] Darius

Yes. So I really appreciate that question because that’s something that I’m very passionate about. Certainly, we spend a lot of our energy and efforts, at 42 Macro, in trying to help investors be more thoughtful about portfolio construction which I find to be like the Wild West still, if you will. It’s kind of one of the least studied and agreed upon kind of things that we do in our industry in terms of institutional finance.

So, I think let’s start with what I think are the basic building blocks, and again, none of this is academic at this point yet. I think, from the perspective of trying to create or construct portfolios, you need to sort of diversify across not just investment horizons, but also investment catalysts. I think that’s kind of the first mistake a lot of investors make is, A, I think all this is going to happen at one particular point of time, therefore I’m betting on this one thing or series of things happening at this one particular point in time. I think you need to be a lot more thoughtful about using the various investment horizons, to your advantage.

I think we also need to acknowledge that there’s always a range of probable outcomes to take advantage of. It’s not just one outcome; your base case scenario. You need to be knowledgeable, fluid and flexible enough, and data driven enough (in my opinion) to acknowledge that and position for various tenets of the bear case and the bull case scenarios that are on the sides adjacent to your central thesis. And then lastly, I think it needs to be quantitatively driven. So we think about the world through the lens of annualized expected returns from the perspective of our backtests, percent positive ratios, volatility and covariance, the latter two as being the building blocks of understanding risk, and the former to being the building blocks of understanding reward.

When you put all those different factors together, that diversification across times and catalysts; the acknowledgement and positioning for the full range of probable outcomes, not just your base case scenario, and ultimately doing that with different understandings of how things have historically traded and traded with each other: asset classes and factors with each other across history is very important.

Niels, I think you bring up a very good question about sampling, which is, you know, we’ve lived in this very disinflationary era, and a lot of the indices we would use to construct backtests and understand some of these quantitative dynamics, don’t go much further back to allow us to understand how different factors would have correlated, or the volatilities of different factors in various regimes. So, it makes that aspect of it challenging. And then there’s also other data sets that go back 100 years. One of my favorite people, from my time in New Haven, was obviously Professor Shiller and you download his data set, and you had interest rates, stocks, everything you wanted, back all the way to the1870s.

So the reality is, another problem with sampling (and I’m going on a tangent), but you go too far back in the data and it stops making sense. And so where do you draw the line? I mean, that’s kind of something we all, as folks who have programmed models before, understand that that’s one of the many challenges of programming models on both an in and out of sample basis. Just kind of getting to the meat of it all, I think from a top down, strategic asset allocation portfolio construction perspective, we need to understand that, again, we’re moving into a world that is a lot less monolithic from the perspective of the range of probable outcomes.

We’ve been in this very disinflationary world where the Fed has been incrementally easier at every slowdown in growth relative to the prior slowdown in growth, and this is probably not going to be the case in this decade. There are still going to be tightening and easing cycles. There are going to be inflationary upturns and downturns, and growth cycle upturns and downturns. But we have to acknowledge that it’s not going to be that the direction of travel for all those indicators, it’s just not going to be straight down or straight up in terms of the Fed balance sheet, etc, etc.

So that, from a portfolio construction perspective, requires investors to acknowledge that and start to you have a lot more balance than they’ve probably had in recent years and decades, I mean, quite frankly, if you own five stocks, and nothing else in the last five years, you’re probably not even listening to us. This is probably not a very interesting conversation. But the reality is, that’s probably going to be one of the worst positions you could possibly have, certainly on a relative basis to a lot of other outcomes from the portfolio construction perspective, in the coming five years.

Again, I want to stress to the listeners that we use a lot of big words and processes, but the reality is that I don’t think we know. I don’t think we have the right answers. I think the most important thing we can do is be humble and Bayesian about this entire process, and understand that, hey, we’re probably going through regime change. Some of the things that we’re used to doing are probably going to continue to work, some of the things that we’re used to doing are probably going to stop working. But it’s very important for us to be very present and open and honest about that process, in real time, so that we can do less of what’s going to stop working and do more of what’s going to continue to work. So, if I have one key takeaway from this discussion it’s definitely that from a longer term perspective.

[01:08:21] Niels

Now, if I didn’t know better, I would say it sounds like trend following but there we are Darius.

[01:08:26] Cem

I just heard long vol, it’s weird.

[01:08:31] Niels

It’s funny. So anyways, I want Cem, you, final question, final thought before we start to wind down because I know we have a hard stop today. And we definitely want Darius to come back later on in the year to tackle some of the things we didn’t get to and where we’re heading. But anything you want to sort of add?

[01:08:52] Cem

Yeah, less of a question and more of just a general comment in the pull on what he was just saying. I think prediction is very difficult when we think of it as predicting a certain outcome. I would agree with that. But I think where prediction is incredibly powerful, and this is relatively well documented, is understanding the distribution and what kind of distribution you may be in or may not be in. That’s a very different type of prediction.

I think most people’s brains, when I say prediction, say what’s going to happen? Are we going up? Are we going down? When are we going up or when are we going down? Being able to predict, more leptokurtic distribution (using that word again), fatter tails, or something that’s narrower, or a period of calm, or wider distribution that may be right leaning left leaning. Those things are actually quite a bit easier to predict from a probabilistic perspective. I think, not that anything’s easy in life, but that’s what tends to be the case.

So I think that’s probably what you’re saying is that if you take that approach over the long run, you should have some edge and you should do better. And I think things like volatility (which is not directional), things like trend following, things like your approach which is really very probabilistic really tend to have an extra layer of edge. I really think, especially in this type of period where things are less linear and more nonlinear, I think that these types of processes become much more powerful and important.

[01:10:28] Niels

Absolutely. Darius, this has really been an awesome conversation with so much knowledge that you shared with us. So thank you very much for doing this today. Of course, everyone listening today should go and follow Darius and subscribe to the great work they do at 42 Macro, where he’s very generous when it comes to sharing content. You can, of course, find the links in the show notes for today’s episode, because as you can tell from our conversation today, we are living in a true global macro driven world and it is perhaps more important than ever before to stay well informed.

From Cem and me, thanks so much for listening, and we look forward to being back with you as we continue our global macro series. In the meantime, take care of yourself and take care of each other.

[01:11:17] Ending

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