#1218 Darius Dale | Wall Street Insider Reveals When Recession Will Hit

Darius Dale is the founder & CEO of 42Macro. In this conversation, we talk about global liquidity and its relationship to various asset markets, such as stocks, real estate, & bitcoin. Darius also speaks on the historic relationship between inflation and recessions. ======================= Pomp writes a daily letter to over 250,000+ investors about business, technology, and finance. He breaks down complex topics into easy-to-understand language while sharing opinions on various aspects of each industry. You can subscribe at https://pomp.substack.com/

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:02Anthony Pompliano?

  What's up everyone? This is Anthony Pompliano. Many of you know me as Pomp. You're listening to the Pomp Podcast, which is my effort to find the most interesting people in the world and sit with them for hours while I ask questions in an effort to learn. So it would mean the world to me if you would subscribe to the show on your favorite audio platform, watch episodes on YouTube, and tell your friends and family about the podcast. My goal is to help millions learn from the world's most interesting people. So let's get into today's episode. Darius Dale is the founder and CEO of 42 Macro. In this conversation, we talk about global liquidity and its relationship to various asset markets, including stocks, real estate, and Bitcoin. I always enjoy talking to Darius, and this conversation is no different. He's

• 0:45Anthony Pompliano?

  incredibly intelligent, and I learn something every single time. So here's my conversation with Darius Dale.

• 0:54Speaker 01

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• 1:21Speaker 02

  Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his personal opinion. This podcast is for informational purposes only.

• 1:45Anthony Pompliano?

  All right, guys. Bang, bang. I've got Darius here with me. Darius, a great place for us to start is liquidity and asset markets. It is the heartbeat of the financial system. What's going on with liquidity in relationship to these asset markets?

• 1:57Speaker 03

  Yeah, absolutely, man. It's great to be back. So I'll start by saying, you know, I feel like we've been talking about liquidity, you know, pretty much ad nauseam for the past few months, specifically with respect to the fact that we've seen and are currently observing this negative inflection in global liquidity. Recall that, you know, our liquidity proxy globally accounts for the global central bank balance sheets, global broad money supply and global FX reserves minus gold, and that number has been trending lower, albeit modestly in recent months. And so what we wanted to do is to sort of add some analysis to, you know, our view that, hey, we might see a correction this summer in asset markets as a function of that inflection in liquidity. And the reality is, once we perform that work, it really doesn't suggest that we should see a correction.

• 2:39Speaker 03

  So I'll start with the first chart where we show the relationship between the S and P 500 and our global liquidity proxy as measured by those indicators. And what you can see is that the correlation is very tight when you regress it on a levels basis. In fact, liquidity explains 97% of the level of the S and P 500 when you look at the R squared on that. But we go to the second chart and we regress it on a percentage change basis. So how does liquidity explain the rate of change of the S and P in any given interval? And we see that it only explains about 12% of the rate of change in that second chart. We performed that same analysis for Bitcoin as well, looking at a trailing 10-year study. So that S and P study was since the start of 2009.

• 3:18Speaker 03

  Looking at the Bitcoin study on slide three here, we see that liquidity explains 77% of the level of Bitcoin. But when we regress Bitcoin against the, you know, sort of the rate of change of the two indicators, we see that it explains about 0% of the change in Bitcoin. And so the summary of these four charts is to suggest that, hey, look, you might have informed views about liquidity, but on a short to intermediate term timeframe, you can't necessarily take those views and extrapolate it to asset markets in sort of the linear way that I think we've all been conditioned to in recent years.

• 3:51Anthony Pompliano?

  So when you go ahead and you look at that liquidity, a big thing is it could lead to inflation or it could lead to disinflation. You all have continued to point out the disinflation that's showing up in things like the PCE report. Describe what you saw in the May numbers.

• 4:04Speaker 03

  Yeah, absolutely. So with respect to inflation, I did want to talk about inflation specifically out of that PC report that we got on Friday, because to me, I think the return of inflation as a topic is what's going to cause the markets to go down, and we're not quite there yet. So I think it's safe to say that we're comfortable punting on that view that we would see a correction in asset markets, at least until we get to August and not September, because that's when I think that we might start to see firmer inflation data, certainly relative to consensus expectations, which are calling for a recession to begin in Q3, which we obviously disagree with. We've long disagreed with that view. We've been of the view that a recession would commence in late 2023 or early 2024 since fall of 2022. So that hasn't changed on our side. So just getting

• 4:45Speaker 03

  into the PC report, on slide five, we show core PCE inflation and supercore PCE inflation, the bottom panel, which is core services, PCE, ex housing. And so what we saw on the PC report is we saw a little bit of a downtick in core PCE, which is the Fed's preferred inflation measure. That's the top panel there, that decelerated modestly on a year-over-year basis to 4.6%, decelerated modestly on a three-month annualized basis to 4.1%, which is the lowest print we've seen since December in that time series. The second, if you look at the second indicator, the second panel, rather, we saw a much bigger deceleration in supercore PCE inflation to 4.5% year-over-year, but a much bigger deceleration three-month annualized to 3.8%, and that's the lowest print in that time series that we've seen since November. So we are

• 5:30Speaker 03

  continuing to see these very positive outcomes on the inflation front. And that's been one thing that's been supportive of asset markets is these negative, persistent negative inflation surprises. We've also had persistently positive economic surprises as well. So if you look at that from a double whammy perspective, we have growth surprising to the upside, inflation surprising to the downside, and obviously, both of those dynamics have been very positive for asset markets in the first half of the year. We expect they're likely to continue to be positive, at least through July, potentially into August. But then after that, we might start to see some inflation data firm up.

• 6:02Anthony Pompliano?

  And so when we think of the business cycle, inflation is one of these weird things because I keep coming back to this idea of inflation is driving prices higher. But now what we have is we have business owners that are guessing what is going to happen. In some way, it's like playing a pin the tail on the donkey, but the donkey's moving. And so you're trying to figure out like, hey, what should I actually charge for this thing? And if I change all my prices, I gotta go print my menus. And now all of a sudden in two, three, four months, if the prices are supposed to change again, am I going to go print my menus all over again? Or, you know, whatever the thing is for your specific type of business. How do you think about that inflation in the business cycle? I'm like, what are business owners actually doing on the ground in response to these kind of inflationary movements?

• 6:46Speaker 03

  Yeah, you have a great, that's a great way to pose the question because in reality is inflation is a process. It's not just, you know, we receive inflation as financial market participants as, you know, this number that gets reported by, you know, various agencies or if you, you know, things look at other indicators, you know, that may or may not be government related. But the reality is there is a, there's a systematic process of inquiring information, acquiring information from the economy, business owners, and ultimately having to decide whether or not they're going to be able to, you know, pass those costs on to their ultimate customers. And what we see here in this chart here on slide six, you know, what we're showing in this analysis is various cycles within the economy. And we're trying to see how they sort of behave in and around recession.

• 7:26Speaker 03

  So the chart on the left shows the median trailing 10-year delta adjusted Z score for various indicators that represent each of these cycles. So there's a basket of indicators that represent the housing cycle. That basket of indicators on a median basis tends to break down below trend right around 18 months prior to recession. That's the X's on these, on these plots here. The orders, the basket of indicators that represents the order cycle breaks down ahead of a below trend. So right around kind of eight months ahead of a recession. The production and profits indicators tend to break down on a median basis right around, you know, kind of six months ahead of a recession. And the employment indicators tend to break down on a median basis right around the start of recession or zero months.

• 8:06Speaker 03

  And what we see is the light blue line there in the chart on the left, the X marks the spot on the light blue line is six to eight months after the recession starts. And so that's a long way of saying we should not expect inflation to break down materially below trend until we're well into the recession process, which again, we believe starts in late 2023, early 2024, the earliest. And so that's our, that's kind of a long way of saying. We've gotten a lot of disinflation. We've gotten a lot of immaculate disinflation. And ultimately, as investors, we've got to start to prepare our minds and ultimately our portfolios for the possibility that inflation really starts to get sticky in the second half of the year, leading up to recession, because history suggests that it's very unlikely that we're going to continue to see this immaculate disinflation.

• 8:50Anthony Pompliano?

  So we basically, you're saying that there's a high probability or a probability that we're going to get disinflation. Once that kind of culminates and, you know, ends, then we get this reinflation that starts to occur, but it's a reinflation into a recession, which may not be kind of the way that people intuitively think of the relationship between inflation and a recession.

• 9:12Speaker 01

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• 9:40Speaker 03

  Yeah, no, totally. I mean, typically, you tend to see things like core PCE or wage inflation peak during or even slightly after recessions conclude. You know, history shows that it's very rare, actually, you know, going back to that Chart 5, where we show the deceleration in core PCE, the deceleration we're observing in supercore PCE. It's very rare that we actually see those outcomes ahead of a recession. In fact, if you look at the core PC time series throughout all the recessions that we have, I think it started in the 1950s, there's only one observation of deceleration leading up to recession. That's the 1981-82 recession. All other observations, core PC was either flat or accelerating into the start of a recession. So in our view, we are going to start to see more sticky inflation outcomes

• 10:23Speaker 03

  in the second half of the year. And part of the reason for that is base effects, right? If you look at June data that we were going to get, I believe, on July 12th, in a couple of weeks, the base effects for June are actually really tough. I.e. So we should see another month of really, you know, sharp disinflation in the month of June for the June inflation data. When we get past June, the base effects curve really starts to level off. So it's very likely that we start to see year-over-year measures of inflation kind of bottom out wherever they are, you know, after the June data point. So that's something that I need to put on, we want to put on investors' radars. Because again, we see a very modest negative inflection liquidity. I don't think that modest negative inflection liquidity is enough in and of its own right to cause a correction in cross asset markets. That's what the data that we just highlighted on the correlation studies suggest.

• 11:08Speaker 03

  However, I think what will cause a correction in asset markets is the realization that, hey, inflation is going to be sticky, the Fed's going to have to do more, the ECB is going to have to do more. All these other central banks are going to have to do more, just like we saw with the Bank of Canada and the Reserve Bank of Australia recently.

• 11:24Anthony Pompliano?

  Talk about home prices. I know you've got a chart here that that shows that those are re-accelerating.

• 11:29Speaker 03

  Yeah, absolutely. So that's, I mean, talk about sticky inflation, right? So we got data this week from FIFA and S and P CoreLogic Case Shiller in terms of the national home prices. And what we see is on a three-month annualized basis here in chart eight, the top two panels, FIFA home prices, which are the single month, I think the data is through through the month of May, is accelerating at plus 8.7% on a three-month annualized basis. It's sort of bottomed in the first half of this year and it's now really starting to accelerate. The CoreLogic Case Shiller data, which is a three-month moving average of the month. So it includes May, April, or sorry, May, April and March. That data is up 4.4%, but it's eventually going to catch up to the FIFA data.

• 12:10Speaker 03

  And that's an issue because when you look at the bottom two panels, we show the CPI Shelter Component of CPI that's compounding at 6.2% through my annualized, PCE index on housing is compounding at 6.2% through my annualized. What this bottoming in the top two panels suggests is we're probably going to bottom in housing inflation, let's call it two, three quarters from now, at levels that are extremely inconsistent with the Fed's 2% inflation mandate. And that's concerning in the context of everything we're talking about in terms of the Fed, you know, ultimately having to do a lot more to really kind of offset, you know, the, you know, the impulse to inflation that we continue to see, one, out of the housing market and two, out of the fiscal authority. Don't forget, we're running it. Record non-war, non-recession budget deficit here in the US economy.

• 12:53Speaker 03

  It's $2 trillion, about 8% of GDP. And that number, you know, it's going to come down a little bit over the next 12 months or so as a function of the debt ceiling. But it wasn't really, it took big haircuts to that number. So we're going to continue to see a lot of inflationary pressures in the economy. And that's an issue in the context of Slide 7 here. Where we show the ISM manufacturing, the supplier delivery times index. We show the ISM services in the red line. The supplier delivery times index there in the black line is global freight rates. And what we see from these indicators is that they're pretty much back at levels that are consistent with 2% inflation. Right? Like, we're not going to get any more immaculate disinflation from the transitory elements of inflation that were caused by either the pandemic or the fiscal response to the pandemic.

• 13:37Speaker 03

  You know, so that's a long way, went away of saying, I think we're getting close to the end of the good part of the inflation battle. And then the real work is going to begin, you know, kind of in the second half of this year, really into the early part of next year, in terms of the Fed reaction function. And really, it's not just the Fed, it's the ECB, it's the Bank of England, it's a lot of central banks globally.

• 13:55Anthony Pompliano?

  Darius, we are not in an official war, but an unofficial proxy war is being waged. I'll leave it at that. In terms of the NASDAQ, up 32% to start the year, fastest start since 1983. Bitcoin's up 85% though to start the year, which is almost triple what the NASDAQ is doing. When you think of inflation, I think everyone always thinks about the inflation of the consumer goods. But also, obviously, there's inflationary pressures in asset prices. If you take it to the extreme, the Zimbabwe stock market is the best-performing stock market of the year so far, 800%. And I think of this as like Zimbabwe is just a magnification and kind of the extreme of what's actually happening in the US as well. Is that true?

• 14:39Anthony Pompliano?

  Or is there some other kind of nuance there that's important for people to wrap their heads around?

• 14:43Speaker 03

  No, no, I think that's safe to say, right? Like, don't forget, like- We are the world's sovereign currency, so we can't allow ever allow ourselves to be Zimbabwe that will cause so much, you know, economic hardship for many, many billions of people in the world. So I don't think we're headed to that ultimate end game, but we are some version of that, right? You have, again, we're running a record non-war, non-budget deficit, budget deficit of minus eight percent of GDP, and we're not in a recession, right? What's that number going to when we get into recession and the tax receipts start to fall? And, and, and, you know, mandatory spending starts to rise. And so, you know, we are on this sort of path towards populism, right? Like Donald Trump figured this out, you know, you can make the case that Joe Biden kind of piggybacked on that. And whoever's going to be president after that, they're going to piggyback on it more because we're in

• 15:27Speaker 03

  this fourth turning era where the response to economic hardship is just throw money at the, the, the population. It's not austerity, you know, when I started in this business, you know, maybe 15 years ago, it was all about austerity and then cutting budget deficits. Now it's like, you get to the debt ceiling and then you barely even shave off the top of the, you know, shave off crumbs from the budget deficit. So I think that is where we're headed. And this is why central banks have become such active participants in government's global sovereign debt markets, and they're going to continue to be such active participants over the long period of time. That doesn't necessarily mean they're going to be linearly supplying liquidity at every interval going forward, because obviously, as we talked about, the global liquidity has inflected lower in recent months, but it doesn't necessarily mean that they're, you know, they're, they're going to be part of this game for a really

• 16:09Speaker 03

  long period of time. So one thing that really concerns me about the bond market, but is actually very bullish for things like Bitcoin, very bullish for things like the NASDAQ and stocks, is the fact that the bond market is currently starting at a, at a very, you know, kind of perfect price. If you look at term premium in the bond market, they're deeply negative. If you look at where inflation expectations are in the bond market, they're all anchored around 2%, whether you look at break evens or inflation swap curves. And so the reality is, I think the bond market's got this wrong. And I think the fund flow stories out of bonds into stocks into the digital assets like Bitcoin, I think that's going to be something that's had a very long tail to it as a context of the, the political response to, you know, populism and things of that nature.

• 16:50Anthony Pompliano?

  I tend to agree and it feels like with Bitcoin specifically, there is this intersection of different interests, right? You have obviously the undisciplined monetary policy, you have all the geopolitical nonsense, you have censorship, you have seizures happening all over the world, but also you have this feeling of people saying, hey, I need an alternative and it could be an alternative currency, it could be an alternative store of value, it could be an alternative viewpoint. And I think one of the most interesting things is it's kind of something different to all these other people, right? So like what Bitcoin means to me may be different than you or than somebody sitting in another country or in another situation. And so if that is true, let's just take all of those assumptions

• 17:34Anthony Pompliano?

  as true, what else fits into that bucket? And what I find interesting is it's not just Bitcoin. There are plenty of stocks that people look at that, again, they may not look at them as a currency or as a store of value type thing, but there's a stock that may be different things to different people, right? So obviously those start to benefit as well. And then if you go and you look at things like commodities, right? There's a lot of people right now, in my opinion, who are looking at various commodities and one person's buying it for reason A and another person's buying it for reason B. But at the end of the day, if the underlying currency that it is denominated in is devalued, somebody needs to spend more dollars to buy that asset in the future than they do today. And the longer the time period, the more the dollar gets devalued. And so I'm always

• 18:18Anthony Pompliano?

  fascinated by the studies that show the US stock market, if you basically take out the change in the money supply, how it's kind of like flat.

• 18:24Speaker 03

  Yeah, yeah, totally. If you just regress the, go back to those regression charts, if you just rebased the stock market in global liquidity, it hasn't done anything. It's like 97% level, that means it hasn't done anything.

• 18:38Anthony Pompliano?

  And it's kind of this weird thing where you can go back pretty far and it still hasn't done anything. And so in some weird way, you know, we have assets that go up because we have a central bank that obviously helps on the global liquidity front. But if we didn't have that, how much real value is getting created in the world?

• 18:59Speaker 03

  That's a good question, man. I mean, that's a, that's a very deep, long, you know, longer term, kind of like deep thought topic, but the reality is, think about, think about the era we just left, right? They kept interest rates at zero for a really long period of time. They were constantly expanding their balance sheet and taking risk out of the global financial sector, forcing investors like us further and further out on the risk spectrum to, you know, find replacement assets. And the reality is, that's how you got, you know, the Ubers and the Netflix and all these sort of formerly unprofitable companies now that are extremely profitable because they were able to, you know, grow their, the size of their business and, and take a ton of market share. So, you know, that, that was an outcrop of monetary policy, you know, creating all that supply, particularly out of the tech, you know, kind of tech oriented type, um, type, type world. And so,

• 19:40Speaker 03

  you know, I think we've left that world, you know, certainly from an interest rate perspective, I, I, I really struggle to see how the Fed is going to ever be able to take interest rates back towards, you know, where they were in that, in that previous regime and the reality, because there's so much latent inflation pressure in this system, you know, we run a, um, you know, we, we call a secular inflation model, it's got 20 different features that are highly correlated or highly correlated to the under the unit root of, um, of inflation. And the reality is that, that model suggests we're probably going to see, you know, persistently like, you know, three percentish core PCE inflation over the next decade, uh, in terms of the, the, the, the mean of the, of the time series. And so if we have three percent core PC inflation over the next decade, it presents the Fed with a very interesting choice. Do they revise their inflation target to, from two percent to three percent?

• 20:25Speaker 03

  Or do they just constantly fight against what is likely to happen in the economy and constantly be fighting against, you know, the, the latent inflation pressure in the economy, trying to get to two percent? I happen to think they're eventually going to pivot to three percent. They're not going to pivot to three percent anytime soon because Jay Powell and his, you know, he's 70 years old. He wants his legacy to be that he didn't, you know, let the inflation genie out of the bottle, but reality is he might not have a choice because if the unemployment rate right now, it's at 3.7%. At 5.7% unemployment rate or, you know, heaven forbid, it's 6.7%, which would be a very, you know, low unemployment rate to low level for the unemployment rate to get to in a recession. I think the median is around seven and a half percent in recessions in terms of the peak unemployment rate. If it gets to 6.7%, 300 basis points higher than where it is today.

• 21:07Speaker 03

  You're hearing all this tough talk on the dot plot and all that stuff, that nonsense. These guys, I mean, they panicked already with inflation running at four or 5% core PCE in terms of bailing out the banks this this year. You know, financial stability and economic stability will very much dominate their thought process as we move forward in time. And so ultimately, we know that liquidity is coming, it just might not come, you know, very, very soon.

• 21:28Anthony Pompliano?

  Darius, where can we send people to find you on the internet? Either on Twitter or find out more about 42 Macro.

• 21:34Speaker 03

  Yeah, I appreciate you, man. So yeah, definitely come check us out. I got Twitter at 42 Macro Weather. That's our public Twitter. Also have our private Twitter as well for our 42 Macro subscribers, 42 Macro Aware. And then come definitely check us out 42macro.com. You can get to get all this research as often as you want.

• 21:49Anthony Pompliano?

  Given my dry voice and not having any water here, this is my prime opportunity to say as an investor in liquid death, I should have had some liquid death water sitting here.

• 22:00Speaker 03

  You put me on, by the way. You definitely put me on. I like it. I like it.

• 22:03Anthony Pompliano?

  I appreciate you coming on and we'll definitely do it again in the future.

• 22:06Speaker 03

  I appreciate you, brother, man. You be good.