Peter Atwater - Global Macro Series - June 15th, 2022

[00:00:00] Peter

I feel like we are approaching a very binary moment. And so I don’t want investors to think that I am incredibly bearish or that I’m incredibly bullish. What I feel today is that whatever direction is next is likely to be dramatic. This is one of those moments where, if what we’re seeing, have seen as the low, brace yourself for a blistering rally, if this was just a pre-taste of what’s to come, brace yourself for blistering decline.

[00:00:47] Intro

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

[00:01:36] Niels

A New World Order is becoming clearer by the day and in our global macro series. I along with my co-host, 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 will look like. We want to explore their perspectives on a host of important issues and hopefully dig out nuances in their work through meaningful conversations.

Our guest today is someone that I wanted to speak to ever since I, a few year ago, heard him talk about how confidence in central banks is linked to the level of interest rates, which I thought was such an elegant and simple way of thinking about it. He has so many fascinating insights into the world of socio-economics, social mood, and human behavior that you’re in for a real treat today. Please enjoy our conversation with Peter Atwater.

Peter, thank you so much for joining Cem and I today, for what I’m sure will be a super interesting and important conversation as part of our global macro series. We started this season of our global macro series with Dr. Ben Hunt, discussing the importance of narratives. And today, we very much look forward to expanding on this and diving into the world of socio-economic, social mood, human behavior and confidence; and how that (in my opinion), is likely to set the agenda for the world, and therefore for the financial markets in the coming years. Now, since this is your first time on our podcast, perhaps I could ask you to set the stage and provide a little bit of context for our conversation. Maybe by just telling us a bit of your background and maybe share a few highlights that shaped your path to where you are today.

[00:03:21] Peter

Okay, thanks very much Niels and Cem for having me. I have had two careers in life. The first looks like the typical corporate finance career. I spent 13 years at J.P. Morgan building their asset backed securities business. I left there to work for one of my clients and did a tour through several banks. At age 45, as I was blowing out the candles, my then six year old son said “Dad, you’re halfway to 90”, and I decided it was time to do something different. My wife insisted that I not sign up to do anything. I ended up in 2006 watching the end of the housing bubble come to fruition. And with my background in securitization, having been a bank treasurer, having worked with the rating agencies and the regulators I kind of knew what was coming.

So I spent the financial crisis advising folks like you on how to work through it. I got tired of the narrative though, at the bottom where there was a lot of blame being laid at different people, different organizations. And at the end of the day, I was like no, everybody was overconfident. The regulator’s borrowers lenders, just everybody. That sent me down this rabbit hole of looking at confidence and along the way, stumbled into work that Bob Proctor had done on socio-economics which really changed the way I looked at things where suddenly mood, as an input, as opposed to an output, began to reframe how I looked at it. Since then I’ve spent the past decade or so really getting deep inside the psychology of confidence and the psychology of decision making, and have a framework now that I use to evaluate the markets, consumer behavior and things like that.

[00:05:31] Niels

Yeah, it’s absolutely fascinating. I can’t wait for us to dig into some of these things. I think that it was Vladimir Lenin who once said, “There are decades where nothing happens and then there are weeks where decades happen.” It certainly feels this way when you look at the world the past couple of months. But I think we need to maybe go back a bit further to fully understand the importance of the changes we’re seeing right now, and we act as we feel. But of course, history shows that we seem to learn very little since we tend to repeat the same mistakes. So perhaps I could ask you to talk about socio-economics (if we can call it that) and why this is so important to pay attention to in order to better understand what’s going on right now in the world. Perhaps maybe share a few examples that help us understand how these events are linked.

[00:06:23] Peter

Sure. So socio-economics looks at the relationship between mood and decision making. And I think people are familiar with what I would call socio-economics light, which would be phenomenon like the hemline index, or the skyscraper index where there is this repetitive cycle. Hemlines go up, because people feel frisky; hemlines go down when people are in a bad mood. Tall buildings go up. And so you see different ways that confidence manifests in decision making.

That’s the field of socio-economics. They’ve looked at everything from economic and financial decision making (so buying things in the market, selling things), to political decision making, to cultural decision making. What you start to see are the parallels in the behaviors. So you see lows in confidence – highly emotional, highly impulsive behavior in finance, in the markets, in politics, in culture. So those trends become useful indicators for investors. Because on the surface, you’d say, “Well, what does these things have to do with the markets?”

We’re not good at compartmentalizing our level of confidence. So I like to see what wealthy people are doing outside of the markets? Where are they vacationing? What are they buying? What are they doing? That gives me clues in terms of what they’re likely to be exhibiting as investors.

[00:08:07] Niels

Yeah, absolutely. Is it correct that there seems to be a bit of a time lag between when we start observing things or changes in sentiment before they show up in the financial markets? So to some extent, you could say that socio-economics could be viewed as a leading indicator at all? Am I off the path here?

[00:08:29] Peter

Well, there’s been some really cool work done looking at sentiment on Twitter. What you find is that mood on Twitter, and they do all sorts of language analysis to come up with this, but basically, how we feel and express ourselves on Twitter rolls into the markets on a 24 to 48 hour lag barring exogenous events. So there’s no question to me that mood is driving what happens in the markets. So you can see the parallels, even in the media. One of the things that I noticed routinely is the media is a great mirror of mood. It’s not leading, it’s not following. If you’re in the business of being a media company, resonance to mood is rule number one. So I read the front page. I watch what’s on television, not because I’m interested in it, per se, but what are the editors of the Financial Times for The Wall Street Journal, The Economist putting on the front cover because that’s intended to resonate?

[00:09:40] Niels

Yeah. Interesting. I’ve got a couple of more small introductory questions, and then Cem, if you would chime in, in a second. But you mentioned the media and this is actually something I wanted to bring up anyway because it plays an important role in all of this. I’m just wondering, when you look at it, how the technological revolution that we’ve seen in the past 20 years (including social media, like Twitter), how that may have changed socio-economics, if you we can call it that, or how it’s evolved with it that influence?

[00:10:16] Peter

I think that mood moves more quickly. It transcends society faster and broader. But I caution that that’s nothing new. During the financial crisis of 2008 I read a lot of financial crisis porn. Went back and looked at one crisis after another. I remember bookmarking somebody’s comments from the crash of 1857. And you would say why?

It was a comment that unlike prior crashes, it took just days and weeks to play out. It’s like, “Really Hmm, what was it?” Then the author goes on to attribute it to the Telegraph. That prior crashes didn’t have that means of communication. Once you see that, and then you think about radio in the 1920s, you think about television in the 1970s. Suddenly you start to see that all technology does is enable mood to spread wider and faster. It’s one of the things that policymakers, globally, woefully under appreciate today. That when you put trading technology 24/7 in people’s hands, the potential to close markets at a drop of a hat is especially high here.

[00:11:45] Niels

Yeah, absolutely. One other thing I was just curious about in terms of what the impact might have been, I don’t know if there was a specific impact. But it is what happened around COVID; the whole lockdown and working from home and all the changes we went through. Of course there would have been some kind of impact, I’m sure, on social mood here. How do you see that? Because, again, you would think that this is something we haven’t really tried before as a world society. So how does that fit into your picture?

[00:12:19] Peter

So in a couple of ways, what’s been striking to me, has been the disparity of confidence between those at the top and those at the bottom in the last couple of years. I’m the guy behind the K shaped recovery. And it had nothing to do with economics, it had everything to do with confidence. What I saw was that if you were able to work from home to isolate, your confidence rebounded dramatically, because of the ability to be self contained, Today we have this Downton Abbey system of delivery, where food and goods and everything is brought to your door. So isolation has never been easier for those at the top. You saw their confidence skyrocket. At the bottom, if you had to go out into the hospital, to the supermarket to deliver things, all the stuff you just didn’t recover.

But the other piece of it is what we saw among young people during this period of time. We saw a really nihilistic, a very nihilistic response to the pandemic and manifesting in the trading world through all the Reddit stuff that you’ve probably talked too much about. That was a fascinating parallel phenomenon, where you had at the very top of the market (which I put back in the beginning part of 2021) this concurrent bubble of extraordinary confidence among the financial elite, paired with this “Fuck It” mentality among those at the bottom. That sort of swept together in things like Spax and crypto. It’s just a very interesting time where behaviors at the top and the bottom are parallel, but for very different reasons.

[00:14:30] Niels

I’m going to lead Cem, into the world of finance now, because I want to just share with Peter, how I got to learn about his work and why I really have been looking forward to Peter joining us today.

It goes back a few years. This was of course at a time where none of these dark clouds and pandemics and all of that existed. I heard you talk about it and it was actually with one of the guests who’s also been on the Global Macro series, Danielle DiMartino Booth. I heard you talk about that confidence can be really seen (confidence in the Fed and other Central Banks) as really relating to the level of interest rates. I thought at the time when I heard it, “Wow, that’s so simple, but yet so true.” So if you don’t mind, if you could share with our audience what it is you’ve learned about that relationship and then, Cem, will take us into the world of finance, no doubt.

[00:15:30] Peter

Sure. So, there have been lots of comments, particularly over this last decade in terms of, TINA (there’s no alternative), you know, don’t fight the Fed. All of this got me thinking about how you would measure society’s confidence in the Fed? That sent me back to the late 1970s, early 1980s. When did people think that central banks, particularly the Fed, were pathetic, that they had no confidence? If you go and read what was being said about central banks and the policymaker’s in the Eccles building. You’ll see that in the late 1970s, as interest rates were spiking, confidence evaporated, there was absolutely no confidence that the Fed could turn inflation around.

It then became so obvious to me that interest rates are a reasonable proxy for our confidence in the Fed. The higher rates go, the lower prices go of bonds, the less confidence we have. Then it became very easy to see in the cycle, the Greenspan cycle, the extraordinary belief of Bernanke and Yellen, at least lows and confidence that QE could solve all of the problems. Then you say, okay, negative interest rates, wouldn’t that be an expression of overconfidence in central bankers? And so that’s the spectrum that I used. I think it’s been interesting, and then quite confirming to see that since I talked to Danielle, that the confidence in central bankers is waning as interest rates are rising.

[00:17:22] Niels

Absolutely. What’s on your mind this morning, Cem?

[00:17:25] Cem

Well, socio-economics is something that I think is very important to sentiment. It’s something that I’ve talked about on a micro level, with dealer positioning. People position in the markets, particularly in the options and vol space, based on their mood, and based on their fears. Ultimately, that has reflexive effects on the market. We’ve studied this in great detail, we actually have a fund that specifically takes advantage of that. But what we’ve found through that positioning is that it’s not directional as a human race. As broadly thinking about markets, people think up and down. And the way it tends to affect markets is unless you get a bad enough outcome, if people are very bearish let’s say, unless you get a bad enough outcome, it reflexively hems in the move. But if there’s enough dynamism to the mover; if there is enough of a real structural problem, at the end of the day, a nuclear bomb can go off, like something really serious can happen, that affects the world in a meaningful way. If something bad enough happens, it actually instead of having a reflexive effect has a magnifying effect. In our markets, it’s really this kind of gamma effect versus these Vaughn charm effects. People who know me will understand what I’m talking about. I won’t dive into that here. But it’s important to understand that kind of dynamic exists. I think that’s particularly relevant.

Now, when you think about bigger cycles, because we’re talking about populism that’s been building over the last really decade. It’s hard to believe we had the Tea Party and fiscal conservatism just a decade or so ago; that populism has built right as a function of that monetary policy and supply side economics, etc, that we’ve seen and the inequality that’s been driven by the Federal Reserve.

So I’m curious if people are very bearish right now. It’s pretty obvious. We’re in the fourth percentile now, of mood, of positioning, and sentiment and lots of different metrics. I fear, and a lot of people are fading reflexively and saying, Okay, well, this can’t get worse – we have to bounce back, sometimes that can become reflexive to your earlier point.

The market was rallying there as nihilistic populism was being expressed by crypto. I completely agree with that. What happens when that nihilism gets expressed now to the downside at the same time, things are actually breaking? So do you have a mental model for socionics as it relates to that? Yes, there’s a reflexivity to it. I think that’s people’s initial reaction. How when people get too bearish, to be bullish; or when people get too bullish, to be bearish. But I think there’s more to it than that. Curious to hear your thoughts.

[00:20:09] Peter

Yeah. So I have probably been frustrating to my clients since the last couple of weeks, maybe even months at this point. In my relative indifference between the bull case and the bear case, because to your point, mood is really down. Yet, we haven’t seen any sort of a capitulatory event. What I sense is fatigue. What I sense is sort of the family car ride that’s gone on too long, and the kids in the backseat have had enough and want to get out.

There are some who would say, well, that’s enough to create a low. I could come up with, and did for my clients, the bull case, that there are plenty of indicators would say this is the low. And the analogy I used was October 2011, where you rose out of the financial crisis and then had a setback. People thought it was going to get much worse. The famous economist cover would be afraid with a vortex on it. There were lots of good socio-economic indicators saying this is the low, and we could have just had that.

What we’re experiencing is this setback from the bounce up from COVID. This is the relapse and we land solidly and take off. You can create a really bullish case. Particularly for places like Hong Kong and all of the carnage, he long duration equities, the dream bubble that is has largely popped. The challenge that I have with that is what I think of as stacks of vulnerabilities that people are experiencing today that the hits just keep coming.

If I think about the weight that particularly low end consumers have today; housing, gas, food, we have a war in the Ukraine. We have scarcity, we have school shootings, there’s a burden to that. That burden runs the potential of creating exhaustion. That it collapses on its own mood driven weight. That what today is described as uncertainty and as powerlessness falls into despair and hopelessness. That’s a game changer. That’s a game changer because institutions are highly abstract organizations in a time where “me, here, now” reality is driving decision making. You don’t have the influence, from a societal perspective, on what’s happening in the streets.

[00:23:28] Cem

Yeah, I think there’s a big mean reverting effect in the short term right to sentiment, or even the midterm. There is a momentum effect when you start looking at longer. Let me get to what I mean here.

Populism. I think we both agree, and I think it’s pretty obvious, Trump. Whether you’re looking at Trump or Bernie Sanders in the US, both have gone left. Globally, populism has become a thing. That’s a function of inequality that’s been building. COVID released the hounds and allowed that 12 trillion fiscal policy, which is a populist Revolution by any other name, happened.

If you look at crypto, for example, you’ve had this distrust of government by the labor class, which is the younger generation. You’ve had this belief in technology’s ability to solve all these problems. Which has been driven by unlimited monetary policy and chasing dreams. So crypto has perpetuated the market bull, but as it turns out, it kind of vanishes. It liquidates you’re going to get a bit of the opposite.

Also, populism drives fiscal policy, which drives inflation. Inflation drives populism more. At the end of the day, more populism means more price controls and fiscal policy in some way, which at the end of the day, reduces liquidity. So these are some of the momentum and factors right to sentiment that sometimes are under appreciated.

I think the populism one, in particular, once it gets going, much like get a positive feedback loop to monetary policy and free market economics, you have negative feedback to a rebalancing that happens to equality. So I think that’s an interesting, important point about Socio-economics. It’s incredibly important but at the end of the day, how does it affect supply and demand? And there are multiple different factors which I think are interesting.

Do you think on the crypto side (going back to crypto), that your views are likely to see another leg down. That will cause a lot of anger. Do you feel that if that happens, how do you think that anger really channeled? What do you think it will lead to? Ultimately, I’m curious?

[00:25:57] Peter

Yeah. I think that crypto runs the risk of being an enormous betrayal. It becomes a triggering point, for the eye opening to a cycle of what I call griftazation that has occurred since the banking crisis. What we’ve seen is the financialization of self promotion like never before. It has appealed to the very high end, when you look at folks like Elizabeth Holmes and Theranos. It’s been overwhelming at the low end, politically and financially. There are lots of parallels in the cultish figures and cultish behavior that we see.

I know people will take offense to my use of the word but, it’s true dictionary definition. In terms of blind and eager followership in fantastical promotion. Here it’s a precarious thread that gets pulled, because it’s in so many things. Especially for young people who had nothing to lose, invested it and to lose it, again, is going to be where you see dramatic change. Use and revolution is a common pairing.

This brings in issues of relative wealth, inequality, age, and all sorts of demographics. I think what those on the left and the right are overlooking is that the real battle isn’t political ideology left and right, it’s more up and down. How does that divide become resolve; what happens between those at the top and those of the bottom in power, in money, in all of these different measures that I look at? And that’s what we have yet to see unfold.

Could that on the other hand, Cem, result in an enormous wave of money into cryptocurrency? Absolutely. The question in my mind is, what in that environment does the crowd decide has value? If you look in a prison environment, ramen noodles have an extraordinary value that is underappreciated elsewhere. But we will pick something or some things that we believe matter most to us. That’s where economic value will be moved.

[00:29:03] Cem

Yeah, I think I couldn’t agree with you more, you’re gonna get us a lot. I’m gonna try and disagree with you more. But I think I agree with you on a lot of things there. That inequality is the real issue here. The populism, and we’ve seen these big cycles. This is what drives big cycles. Natural selection and free market economics; inequality is a natural state of things. But we as humans, believe in equality and justice and all these things which are not natural constructs, necessarily, that when exerted upon this natural system, creates big booms and busts. That’s what populism is. That’s what revolution is.

It generally, to your point, feeds into the young because the young are the labor class during the boom and they don’t have the assets, they don’t benefit on the way up. They’re also young and emotional, and they have the energy to fight. So that tends to be the case and I agree that we’re seeing crypto as a clue.

Crypto was that Zeitgeist embodied in markets. That was a desire to catch up. It was also for this generation believing in technology’s ability to solve all the problems because that’s what came and makes tons of sense. And I fear you’re right that when crypto does, or if it does, ultimately have a wash out, it will only feed into that lack of hope that is left.

I’m curious where that channels? That revolutionary impulse seems to be,if you think about crypto, focused on money, on monetary. I don’t think it’s a coincidence that the Fed, under the shade of darkness, built barbed wire fences around itself in the last month and a half. It hasn’t been publicized. But I think there’s this fear of credibility at the Fed. I don’t think enough people talk about what that might mean, ultimately, for America. And broadly, overall. So I’ll shut up for a second. I’m curious to hear your thoughts.

[00:31:01] Niels

I want to add to that discussion a little bit because I think one of the things that has changed to some degree is, we can get upset if we lose money as prices go down. I think what’s changed for me, to some extent, is what we saw with Luna, because suddenly it brought out some real anger. If you look at some of the Twitter feeds from people. I think we all know who are on all these platforms, and so on and so forth. Who has been encouraging the crypto world. Some of course, had been outright pumping it, I’m sure. Others have just been very much focused on it, the anger towards the kind of rock stars, it’s really interesting to see how the tone has changed.

I also wonder, if there is an (I think you’ve talked about this at some point, Peter), that there might also actually be a risk to the people at the top. So we think about the people at the bottom struggling through all of this, but what about the people at the top who may have borrowed money against assets that may not be worth what they were? I’d like to bring that into the this crypto segment if we can.

[00:32:19] Peter

Sure. One of the unseen bubbles to me in all of this is the level of borrowing those at the top have undertaken since 2009. I’ve said this before, if a bank like J.P. Morgan has more outstanding in its private bank than it does in its entire credit card portfolio. And that was just a staggering acceleration of one, while the other remained largely flat.

Behind the scenes of all of this, we’ve seen a growth of leverage to those who have been presumed to be invulnerable. They have felt that way, the entire entourage, the luxury goods industry. I look at the dedication of resources in the past 12 years to catering to the very high end and all of its many wants, is just absolutely mind boggling to me.

Those at the top are vulnerable to experiencing a bubble burst that they and their entourage are woefully unprepared for, and there will be no sympathy. This is not going to be 2008. The crowd will be celebrating the failure of those at the top. So that’s part of this closing of the gap.

One of the things that I would encourage you to think about is, we talked about confidence but the opposite of confidence is vulnerability. With confidence, I have certainty and control, when I’m vulnerable I have uncertainty and powerlessness. What this huge divide has highlighted is that others have a good – these two feelings of certainty and control, that I at the bottom do not have. When we talk about closing these divides, what we’re really talking about is those at the bottom want to regain certainty and control in their lives and will take pleasure in contributing to the powerlessness and uncertainty of those who have had such extreme certainty and control in their lives.

[00:34:54] Cem

This is a good tie into your K shaped recovery. I think we’ve had K shaped recoveries for quite some time where people are diverging. I know you called for one in 2020. To a great extent early on, we had one. Obviously, the fiscal response has an argument, an X recovery. I’m going the other direction. I think we’ve had so many K shaped recoveries over the years, because the Fed has been the only game in town. Because of monetary policy, by definition, it is sending money to those who can borrow, which is the top.

So to the extent that fiscal policy or responses to people, is the new mode of dealing with inequality, essentially, are we going to see X type recoveries going forward? Every time the market or the economy crashes do we start to see pushes towards addressing inequality?

[00:35:57] Peter

So I’ve joked many times that the significance of the K shaped recovery was the resonance of the term. I think it speaks to your point that we’ve had one after another after another. That it’s such a clear phenomenon this time that maybe it’s one too many.

I think many are overestimating the ability to counter what could be ahead with additional fiscal stimulus. That the advent of modern monetary policy, as a theory, as a concept, was itself a consequence of zero negative interest rates. It’s something that’s only believable in an environment where money is free.

I say that not as a criticism of the individuals, but just let’s talk about it. Why was it resonanting? And resonance is only enabled because people believed in that environment that money was free. As money goes up in cost, responding with fiscal stimulus becomes more difficult. Now it becomes a question of choice.

One of the obvious choices would be greater taxation as a means to help fund whatever economic malaise we’re experiencing. I wouldn’t count on government’s as being in a position to solve this. With either monetary or fiscal stimulus. We’ve seen the peak of the ability to do those behind us. I would also say that, given the inflation that we’re experiencing today, policymakers will be far more reticent to over respond to the next crisis. They are going to be naturally more timid.

[00:37:54] Niels

You mentioned the word inflation, Peter. Today, at our time of recording, it’s only been an hour or so since the latest inflation data came out. I’m looking at a headline saying that U.S. inflation quickens to a 40 year high. So I kind of want to talk about that a little bit. I want to talk about inflation in a slightly different way. Because sometimes I think we just talked about the word inflation.

Really, there are probably two kinds of inflation. There is this kind of expected inflation, something we can build on. Something we can rely on, something we can plan after. And then there’s this unexpected inflation, which is probably what we see now, because nobody was really expecting this level of inflation. Unexpected inflation means that it can also go down a lot from time to time, and then goes back up again. So it’s probably more than kind of the 70s type inflation. I was curious to know, because I think the unexpected inflation is much worse than the expected inflation. I’m really curious to know whether this is something you’ve thought about, the difference in inflation. Not a lot of people talk about these differences between these two types of inflation, and how that ties into the whole thing about confidence, I imagined as well.

[00:39:17] Peter

Yeah, so I don’t think of inflation as an economic phenomenon as much as a psychological one. There it ties to feelings of scarcity. So, what inflation creates for me, particularly as a low end consumer, is enormous feelings of vulnerability, because things are now scarce. I can’t afford them. So I have to start to make choices and those choices, cognitively, are difficult.

In my classes, we talk a lot about poverty, not as an economic condition, but as a psychological one. That’s what we’re seeing., the stress cognitively emotionally that goes along with these issues. To your point, the wildly swinging inflation destroys predictability. Certainty is one of two legs that I need to stand on to be confident. We don’t like environments of control, but no certainty. It feels like Las Vegas to us. So we need to have a better sense of certainty.

Now, having said that, what’s so interesting about today’s phenomenon is, we have this huge connection between market’s economic inputs: gas, food, and the economy. I call it that we live in a market-to-market economy, where investors can now speculate in all of the things that you and I need to live on in our real lives.

What I think that that creates, is an environment of huge spikes up and down, which have the potential (particularly right now), to create a complete miss where everybody is expecting prices to remain high, and we see them violently collapse unexpectedly. There’s a headline quote from Janet Yellen this morning, “Gas prices are going to be high forever” (something like that). The way she said it caught my attention, because it’s just an extrapolation.

I think what we’re likely to see is sort of the lumber phenomenon, moving through product after product after product. That Zeitgeist moves it too fast in one direction, only to move it too fast in the other. I’d be curious, Cem, you’re nodding up in your head up and down, so I want to get your thoughts on that.

[00:42:10] Cem

I think this is incredibly important. It is the cost of money. And the cost of money feeds directly into supply and demand. I think socio-economics and psychology are all critical to understanding a part of supply and demand. But I’m very mathematical in nature and I think about derivatives. I’m always measuring, we’re actually measuring, real time, supply and demand, and factors that relate to that. So there is a real structural supply and demand factor to interest rates going up just in terms of money in the system and money in pockets.

I will take exception (this is somewhat polemical, but I think it’s important) with the idea that volatility and expectations of interest rates are bad. I actually would say that, right now, with the Fed once least of all, and the most dangerous thing for this market is expectations of higher inflation that more people have more confidence in. I think that long term inflation expectations are the worst possible thing for the system right now. The Fed knows it. By the way, ow could they think this was transitory? I didn’t think it was transitory. They were simply trying to tell the world, please believe it’s transitory. Because if you believe it, at least long term interest rates will come down.

The reality is (and we know this, broadly) that long term inflation expectations beget more inflation, because of two reasons: One, people bring investment forward. They start building inventories, they start buying things now, because the cost will be higher and later, A.

B, if inflation is 6%; expectations are that there’ll be 6% for the next two, three years. Interest rates are 3%. What’s everybody gonna do? Everybody’s gonna go borrow at 3%? Anything that’s pinned down, leverage it four to one and buy more of it, which pushes inflation higher. So the whole system has this momentum factor if long term expectations for inflation go higher. The whole thing begets more and more and more inflation.

So I think the Fed is actually trying to create volatility and expectations for interest rates. I think any confidence that inflation is going to be here is quite possibly the worst thing that can happen to the system. So I’m just gonna push back on a little bit and curious to hear your thoughts.

[00:44:41] Peter

No, I agree with you. I think the Fed is determined to push the markets into a corner. If they just have to keep raising the Fed funds rate to do that, they will do that. I agree with you. The job market gives them latitude; more latitude than I think people appreciate. But, I think we need to recognize that they’re going to push it and keep pushing it and keep pushing it. The breaking point on the other side of it is, to your point, Cem, about de-leveraging all of those inflation expectations.

[00:45:24] Cem

And at the end of the day how do they do that with the tool that they have? They don’t have the right tools, really. They have to take money out from corporations and much like monetary policy was actually deflationary for all these years, we somehow believe that by pulling away from monetary policy, we can also create a deflationary environment. Which they can eventually if they just take all the money away, drop a bomb on the whole economy. But it’s really the wrong tool for the job. So I think that’s the existential problem that we’re facing right now.

[00:46:01] Niels

Speaking of equity markets I don’t know whether this is something actually that you do agree with or follow, but I heard you earlier talk about Bob Proctor. And of course, a lot of people will know him as the longest running publication on Elliott Wave. As you referenced, he has spent a lot of time on socio-economics, for sure. I don’t know whether you see any links in what you see in terms of the social mood and changes to social mood. What they’re expecting in terms of markets where they have been (because I will say that I’ve been following for a while), that they don’t always get it right. But they are looking at this.

The largest cycle top that you can have within Elliott Wave terms of (I think they call it a grand supercycle high or turning point), it is a high turning point this time. Then essentially something that could (in their view) end up being a bear market in equities, like we saw in 1929. So I’m just curious whether you, in your work, actually also look at these things and try to tie them together in terms of where markets might go because clearly, if they’re right, this will have a major effect on the world economy.

[00:47:19] Peter

So you know, I do read Bob’s work and the work of his team and have a huge amount of respect for it. I am not an Elliotticians, and so I don’t spend a lot of time focused on wave counts and the like. What I’m looking for in my work is indicators of extremes in sentiment. Here, I would say that we saw an extraordinary extreme a year ago, January. Whether you look at stocks or crypto, what you saw was a bubble in abstraction. Things that were fantastical. With enormous time horizons and valuations to go along with it. I think the term “long duration equity” understates the magnitude of the abstraction. Then the valuation we put on those abstractions.

The challenge, as we speak today, is if you look at a lot of those abstractions, they’ve been beaten with a stick. They have been absolutely pummeled, at a time when the bigger, stronger, major indices have gone into a bear market, maybe ish. But behind the curtain, there’s a lot of carnage. The question for me is, is that carnage likely to rebound? Could it rebound? Could you see not that this past January was the top, but now some sort of a hyperbolic price ascent?

You know that the danger in calling the tops of the bubbles is they have this wild way of coming back from the dead. Having talked about Tesla in 2019 and spelt the sentiment then; look, everybody expects him to go bankrupt. Be careful what you’re wishing for.

We’ve seen the resurrection of what happens when you have carnage and dreams come back to life. So, I think you can make a case, albeit I think it’s a hyperinflationary asset bubble case, that you could have another wild and crazy upward cycle. So here, the question is, is this 2006 going into 2007 where what we’ve seen is the LIFO unwinding of a bubble, that the last In wild and craziest stuff is unwound first? Eventually what you get to are the too big to fail enterprises, aka big tech.

So, this is one of those where if we start to see big tech drag, and become vulnerable, then this is a repeat of what we’ve just seen in a broader collapse of technological dreams that does incorporate and pick up the biggest of the big. That has enormous ramifications to the passive investor because they are so overweighted in big tech.

[00:50:46] Niels

Yeah, absolutely. And to your point, actually, Peter, when we spoke with your friend Grant Williams a couple of weeks ago, we actually talked about the fact that one of his other friends who actually lives in Zug, Felix Zulauf, had exactly forecasted what you refer to there, that we would see like a 30% correction this year. But that it would end up being a time where you actually would see a doubling of equity markets into 2024 and then everything falls apart.

So, he sees exactly what you described there. I have no idea what’s going to happen. It is interesting that we can’t be sure exactly how this is going to play out, which makes it very interesting but it’s certainly also a very difficult time to be an investor.

Another thing I wanted to ask you about is also related to one of our previous guests, Peter Zion. He talks very clearly about this trend towards deglobalization that we’re heading into. I’m curious, now we’ve had 50 or even 70 years of globalization, what describes that, or is it stability and peace and all of those things? If he’s right, that’s a major shift, if we’re going towards deglobalization. So if he’s right, how do you see that impact the whole thing about confidence? It could be in different countries, it could be in different currencies. Everything seems to be up for grabs, if we’re heading into a deglobalized world.

[00:52:23] Peter

I look at globalization as a consequence of rising confidence. In parallel, it’s a concept I called horizon preference. When we are under threat, the bear is outside of the tent, the only thing that matters is me, here, now, myself, this immediate time horizon, this immediate physical horizon. Those are the only things that I care about.

As my confidence rises, all three of those broaden. At the extreme, we embrace something that I call “us everywhere forever.” We’re collegial. We’re consensus building, we’re peaceful. We are the world embracing things that are abstract and different. Not just the people but the places, the geography, it’s that this huge accordion opens in terms of relationships, in terms of time horizons and geographic horizons.

I think you can make a case that we’re somewhere near the top of it. You’ve got people exploring Mars. You’ve got all sorts of interconnectivity. You could say that Tom Friedman called the top with his book “The World is Flat”. So the consequence of that is that, to me, deglobalization will be a consequence of falling mood. We naturally balkanize, we naturally divide. We move from way outside in this abstract circle to the middle of the circle being all about me. That, again, has huge implications for the World Health Organization, the UN and NATO. These Supra International bodies become too abstract and irrelevant, because the crisis I feel is right here. I think we got a bit of a preview of that with COVID, if confidence falls.

[00:54:29] Niels

Right. So that’s quite interesting, because I want to try and really understand that because what you’re saying is that deglobalization is a consequence of changing social mood. So what I’m curious to understand is if everything is going great, what is it that starts to change the social mood that leads to the deglobalization? Now, I can understand a pandemic can do that, for sure. But is there anything else that you’ve seen that causes the change in mood before we head towards all the other consequences? That I want to understand a bit better.

[00:55:05] Peter

Yeah, so the biggest cause of all of this, I always say, is the overconfidence that precedes it. We have a hard time identifying what is the tipping point? What’s the thing that sets it in motion? If I go back and I look at the confidence charts around the collapse of the banking system, what you’ll see is that economic confidence bottomed the weekend, Lehman Brothers collapsed. So to say that Lehman caused confidence to then rise is just a very uncomfortable statement. But if you’re looking for causation, that is true. I would say that what Lehman marked was the hopelessness and despair that goes along with bottoms. So the question to try and answer yours is, at peaks there’s rarely a single moment where you can say, this was where we were most overconfident. I feel that with the markets, maybe I can put that around January 2021. But the unwind will begin on its own. Look at what just happened kind of thing. It’s a very subtle deterioration in mood.

[00:56:20] Cem

I’m going to jump in here, I couldn’t agree with you more. It’s a deviation from equilibrium, right? The further you get away from some equilibrium, (and this is why cycles happen), the more fragility there is. Doesn’t mean that moment things are going to break. In this cycle it’s been inequality. It’s been monetary policy driving. I would argue your globalization question, Niels. We got globalization massively for 40 years, because corporations were given more and more money. What is a corporation intended to do? To increase profits. And in order to increase profits, they have to lower costs, right? And so there’s this massive push that’s been happening. It’s a cooperation game at the top. We’ve been in this massive cooperation game where everything works. But inequality was the result of all of that.

The populism that came, because we got away from this equilibrium, is ultimately what has pricked that bubble. It’s what brought Trump left and brought fiscal policy and now is in the process of going the other way. Populism is correlated with nationalism. It’s correlated with competition over commodities and scarce resources, because the prices are going up. That also ties into the geopolitical stuff with Russia and China. Russia, Ukraine, and China support; all of this is connected, but essentially at its core, to Peter’s point, is a move away from an equilibrium too far to the point where fragility kind of presents itself. I think that’s the important point. I couldn’t agree with you more here.

[00:57:58] Peter

Yeah, we’re naturally xenophobic, when confidence is low.

[00:58:01] Cem

Absolutely. Absolutely.

[00:58:03] Niels

One other thing that puzzles me a little bit is and I’d love your thoughts on Peter. That is, we talked about technology earlier, and how that has had an impact on the media side. But it’s also had an impact on how we spend money. We don’t buy things anymore, we subscribe to things, we lease things. Completely changed and I imagine that you know, especially with inflation coming in, that changes things for the consumer. Now they have to decide on other things, so to speak. What subscription don’t I need any more, whatever it is? How does that play into your work? That kind of change in our behavior? I guess it is.

[00:58:46] Peter

So I would put subscriptions in a broader bucket of the me, here, now phenomenon in the economy. So whether it’s the iPhone, Keurig, Tick Tock, or Twitter everything has been oriented around me, here, now – satisfying our me, here, now need. So subscriptions are just another wave of it.

Here I think it’s worth highlighting for older listeners. Polaroid capitalized on the same phenomenon in the 1970s. This is the first time we’ve seen this sort of me, here, now monetization. You see it in Airbnb and Uber and all of this me, here, now utilization of assets. The challenge is that for the consumer, they have the ability to throw everything overboard this afternoon. I can cancel it all. So you have a time horizon mismatch between consumer preferences and the support system that provides it because you’ve got long-term capital and long-term debt and long-term commitments that are enabling all of us to live this me, here, now elective lifestyle.

It feels, oddly, like the mismatch I’ve lived through as a bank treasurer between short-term and long-term rates; the mismatch that you’ve seen in the commodity markets between long-term take or pay contracts and volatile markets. I don’t think that this mismatch ends easily. Inflation will put more pressure in terms of what we just throw overboard. Interestingly enough (and I don’t need to belabor my point), you’re seeing organizations like Netflix in response trying to be more rigorous in their passwords. That’s only going to piss people off more. You enabled me to do it for free and now we’ve got to pay full price at a time when I’m already frustrated and angry. Yeah, I’m out of here. Screw you.

[01:01:01] Niels

Very interesting. Speaking of themes like that. I’m curious, have you studied… From an investment point of view we all know that certain strategies have worked really well in the past decade or two, like, private equity and stuff like that where you could set your own valuation when you feel like it. But have you studied in terms of what themes and investment themes might actually work well when social mood changes to the downside, because many of us have never really experienced that?

[01:01:34] Peter

So if you think of bear markets as being a retreat from abstraction, the two things that immediately come to mind are cash and commodities, because we refer to them as real assets. We know that at the very lows in markets people want physical cash stuffed in their mattresses. At the lows in 2009 people were advertising mattresses with built in safes. So if you think about it, as far as a retreat from abstraction, you go from long duration equities to value. It’s sort of the pilgrimage to owning stuff that’s real. Then the question becomes, what do we ascribe value to in those moments?

Here, reality becomes based on physical goods; grains,energy inputs. That has not just massive geopolitical implications globally, but staggering implications for the United States, because the entire supply of both of those is largely concentrated in the center of the country and you have more than half the population on the coasts.

[01:02:55] Cem

I think that’s an incredibly important point. I actually had that as something I wanted to ask you about. I think that’s very insightful. A lot of people haven’t thought about that.

Peter Zion, who was on here earlier, made the point that America is an incredible place of strength. It Is troublesome to see that this crisis that’s coming might end up being the best thing that happened to America because it is the place… To reinforce his points we have commodities; all the commodities we need, and then some, both in terms of energy and food supplies. We are an island that has the biggest military in the world, and the intellectual capital, etc.

So our threats are not likely to come from abroad. They’re likely to come from within. To your point, I think this is a thing that people are missing that the strength of commodities is actually going to support a part of America. They are going to elevate its strengths at a time of already increasing tumult. It’s really going to drive the strength of cities down a bit relative to maybe the internal part of America.

This is something I hadn’t really thought about. I’m wondering if you think that somehow creates more existential risks to the political system here in the US? I’d love to hear your thoughts.

[01:04:15] Peter

So it’s a matter of degree, the analogy I’ve used a lot is we may be the best house in a bad neighborhood. But Mom and Dad are getting divorced. And so you have to look inside the house as well as outside the house. So, I think that there is a time period where, absolutely, the United States, the dollar, there are lots of things that we we benefit from. If if survivorship becomes the issue, then what’s happening inside the house begins to really matter.

There you have some interesting, broader implications in terms of how does this ultimately resolve in terms of the internal workings of the United States? The one thing I remind people of is, please don’t forget that the highest organization in the United States, in terms of institutional confidence, today is the U.S. military. Again, if the left and right are fighting with each other, and you’re trying to run a national military, that’s a real problem. People have over simplified the divide in the United States. And what we know in environments of balkanization is that the alignments don’t necessarily end up with where people thought they started.

[01:05:52] Niels

Speaking of divide, and I don’t want to put you too much on the spot here, Peter. But I can’t resist because I’m the only… Well, I guess, Cem, you have some European blood in you. But since I’m the only one located in Europe, I’m curious whether you’ve thought about, after all of these decades of increasing confidence, and all of these institutions that we have seen rise as a consequence, not least the EU and the Euro, do you think that we might actually hit a confidence crisis that is big enough to break up that union and even the currency?

[01:06:34] Peter

Yeah. So, again, the question would be, was what we saw in the Greek crisis, the prior crisis? Was that a low or was that an indicator of what is ahead? Was that a warning of potential vulnerability? I thought it was interesting that the term fragmentation suddenly was all over my Twitter feed this morning, which is not a term we’ve heard a lot. So people are paying attention.

In that regard. I’d watch Turkey. Turkey, to me, is the oversized canary in the coal mine of a national crisis. It has been waning for some time. What happens there has real relevance, not only for Europe, but for NATO more broadly.

Here, this is where national self interest, particularly as it relates to food and energy is likely to become a populous topic, as Cem throws out, that it has nations competing with each other in terms of supply. What we know is that the more confidence falls, the further we come apart.

So can Europe come apart? Absolutely. But it will be a function of what happens to mood between now and then. It’s not preordained. None of this is preordained. It’s how low the mood will go.

[01:08:11] Cem

I think your point about Turkey is very interesting. Obviously, I’m Turkish, so I have a little bit of interest there. Turkey has always been the border between East and West. Not just geographically but culturally in lots of ways. It’s really been tied to the West in recent history. In times of geopolitical stress, it tends to become unmoored. That’s because if you think about it, it has a benefit to be unmoored because it can play both sides and it can become in the middle. I think that’s what we’re seeing. I think we’ve seen it for about 10 to 15 years slowly happening. And I think it’s accelerating. Turkey is no longer… I mean yes, it’s part of NATO. Yes, for a while it was trying to be a part of the EU, it was trying to be completely internalized, and then that is not happening now. I think it is really, really going to play this middle ground, which creates more drama between East and West because it no longer has this Western block. It’s very important in that regard. It is in any critical place to watch in terms of the shifting tides of power and risks in the market.

[01:09:21] Peter

Can I add one other sort of related point, and this has to do with Russia? One of the things that is so interesting about Mr. Putin, is that normally, when confidence rises, we become generous, we become kind, more peaceful. There is a personality type that becomes more vindictive, that uses those feelings of invincibility to seek revenge.

One of the things we know, looking at Russia over long periods of time, is that one of the best measures of sentiment for Russian leadership is the price of oil. We need to watch oil. The higher oil prices go, the more aggressive I think we’re likely to see Russia become, in many aspects. I don’t think it’s insignificant that we had a lot of Peter The Great references in this past couple of weeks. The further oil prices rise, the more empowered Mr. Putin is likely to feel.

[01:10:35] Cem

I think it’s not necessarily a personality type. I think Russia and China are both hemmed in and have existential fears in the context of aspirations of greatness. That’s a human trait when you feel at risk and you feel like there’s no way out, you lash out.

There’s a demographic problem in both countries, that they look forward and see themselves hemmed in at this point of extreme strength in the west over all this time. They look forward and they see great risks. So their windows are closing, in a sense, and they have to act. But I agree with you in the context of that bigger picture, having the strength to keep swinging, or getting the strength that will only make it worse.

[01:11:25] Niels

I was just going to comment on the oil price. Given the fact that we have a pretty good idea that OPEC+ is pretty much at capacity in terms of pumping more oil. I fear that Putin seems to be getting stronger, not weaker with the oil prices.

I only have a couple of questions left. Peter, we’ve taken a lot of your time and we really appreciate that. Obviously, a lot of our listeners are investors themselves. It’s kind of interesting, even though I heard you earlier, Cem, say that it feels like a bear market, ect., ect. Actually, to me, it doesn’t feel so much of a bear market compared to two other periods so far. Obviously I shouldn’t wander into the world of the VIX at all in this company, but it will also say that the VIX seems to be not necessarily spiking as much as you would think.

What I was going to ask you, Peter, is there any ideas or suggestions you can share with our audience as to how you can implement more confidence driven decision making? This isn’t for day trading, or anything like that, but just more how you think about investing from your perspective.

[01:12:44] Peter

So if I look at decision making that’s made in an environment of control, but no certainty. Which is what investing decision making is. What happens is that most investors buy or sell based on the outcome that they imagine. I deliberately use the word imagine, because anytime we’re talking about the future, we are imagining.

I think it offends a lot of people. If you’re talking about the future, rule number one is, remember that you’re imagining. The second aspect of that is, remember too that your imagination is a function of your own level of confidence. So if I’m confident, the future that I imagine, is likely to be much brighter than the future that I imagined, when I’m not confident.

So, the degree to which you are certain of the outcome is expressing not the probabilities of that outcome, but your own level of confidence. If I’m capitulating and selling at the lows, what you’re doing is expressing that you believe nothing can go right. That the outcome is only going to be disastrous from here. And conversely, you’re buying at the top; you’re buying short-dated call options at the top because you believe the outcome is only going to make me money.

I encourage investors to be far more ambivalent about the outcome they imagine. That before you trade, before you buy, consider the absolute opposite scenario. You do this to appreciate that the less you can consider it, the less you’re willing to believe it can happen, the more likely it is to happen, because your belief system is too strong in a world of imagined outcomes.

[01:14:50] Niels

Interesting. Peter, there were so many things we could have asked you about. You cover such a broad spectrum of very, very interesting and topical areas. So I just wanted to ask at the very end here, what did we miss? Is there anything you want to bring in towards the end here that we forgot to bring up in our conversation?

[01:15:11] Peter

Yeah, I would just say, Niels and Cem, that we’re talking here today on June 10. I want to be clear to your audience that I feel like we are approaching a very binary moment. So, I don’t want investors to think that I am incredibly bearish or that I’m incredibly bullish. What I feel today is that whatever direction is next, is likely to be dramatic. This is one of those moments where, if what we’re seeing have seen is the low, brace yourself for a blistering rally. If this was just a pre-taste of what’s to come, brace yourself for a blistering decline. It’s one of those times (and I go through this with my clients from time to time) where the setup is too unclear to take a stake, because the price of taking a stake and being wrong is going to be dramatic. It’s going to be jaw dropping of, “Man, I wished I didn’t do that!”

[01:16:21] Niels

Well, it’s a great place to end our conversation today, because I think it opens up, for us, to have you back later in the year or next year to talk about whether we did get a massive, dramatic move up or down for sure. Peter, thank you so much for spending time with us today. We really do appreciate it, as I’m sure all our listeners do.

By the way, make sure you get a copy of Peter’s book and follow Peter’s Twitter feed, which by the way is fantastic. You can find links in the show notes of course, because as you can tell from today’s conversation, we are living in a truly 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. 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.

[01:17:13] Ending

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