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Hedgeye CEO Keith McCullough had an epic conversation with Real Vision CEO Raoul Pal to explore what happens when a biological crisis turns into a financial crisis.

The two macro titans explain why they both think this liquidity crisis is far from over and that as the deleveraging continues, the dollar will continue to reign supreme. They also examine whether shorting equities is worth the risk, how much juice is left in the bond trade, and if it’s too early to go into gold. 

Below is a brief transcript from the interview. Click below to watch the entire interview on Real Vision

McCullough on Real Vision: "This Might Be The Deepest Quad 4 In History" - 3 31 2020 1 16 55 PM

RAOUL PAL: Good to speak to you. These are ridiculous times. The last time I spoke to you I think we started with, so what the fuck is going on? I think now, we're really into something quite extraordinary. Neither of us have lived through anything like this before. It's amazing. What is your sense here now?

KEITH MCCULLOUGH: I guess you have the senseless at this point. You have a lot of people that are getting whipped around in a lot of different ways. I think a lot of different belief systems, if you will, particularly on the liquidity front, have been dismembered. You have more of a disbelief that what you thought could fix it or that it could go down, but it would be fixed. There's so many different things that I think people were just generally unaware that this could actually happen. Now with all the fixes, even though you didn't think it could happen, the things that you thought that could fix the damn thing aren't working either. I think it's a total clusterfuck.

RAOUL PAL: Yeah, it seems that we're completely-- we don't have any ability to respond to this because the monetary mechanisms just don't work.

KEITH MCCULLOUGH: Again, what is going to work? If you look back historically, and I think you and I had the similar view on this, it's the cycle stupid. If you knew the cycle was slowing, quite similar, actually, and no cycle of course is the same, but it's quite similar to 9/11, where you have a tipping point. You have an economy that was already slowing from its bubble peak back in 2000. You get a shock. It makes it slow at a faster rate.

That part of this rhymes cyclically obviously, we had the US economy peaked at the end of the third quarter of 2018 for God's sakes, the global economy peaked a year before that. You end up in a place where, yeah, the virus made it slow, faster, and no, you don't really know where it stops too slow. I could tell you one thing, it's certainly not some magical valuation that's going to make the stock market from stop going down or credit for that matter.

RAOUL PAL: No, I think you and I both, last time we chatted, we were both looking for the cycle to slow. I was a little bit more than the cycle would slow. Then you changed from your Quad 3 to Quad 4 pretty early on, as you saw the changes. I think that 9/11 thing is very right, because I remember that well. The economy was just starting to roll over again after 2001 and things were weakening and then the event happens and then everything turns to chaos. What do your model starts to say about how severe this is? Do you get any sense of that?

KEITH MCCULLOUGH: Yeah, we're getting some of the gnarliest probabilities is what I call it. Anything's possible, Raoul. You end up in a place where now, a lot of theme-based folk are going to start to talk about, like, what's possible, what could possibly make it stop, but what's probable is quite different. What's probable is that we're going to see what we call some of the deepest Quad 4 readings in US economic history, and I mean that quite literally and mathematically. Quad 4 as you know is when both growth and inflation are slowing at the same time. When I say it's going to slow to the deepest point in the Quad map, what that means is you're going to see some of the worst rate of change slowdowns ever.

McCullough on Real Vision: "This Might Be The Deepest Quad 4 In History" - 3 31 2020 2 25 22 PM

The biggest problem with this, of course, is that we came from just like the last two cycle peaks, the 2000 peak going into '01, the 9/11 made it happen faster or the '07 going into '08, '08 banking system made it happen faster. You're coming from full employment cycle peaks and that's there's only three times in the last 20 years where we've come from there, so when I say deep Quad 4, it not only includes slowing from an industrial perspective, which we're already in a recession, in a profit perspective where S&P profits were already at 0% growth, what could possibly go wrong?

Consumption starts to slow at a faster rate now, because jobless claims start to rise at the fastest pace, again, that it would have to go back unless we're wrong on this and I think that there's more of a consensus concern about how right we could be as opposed to being wrong at this point, but jobless claims are going to rip, and the Fed can't control that, a fiscal plan to give you checks, $1000 checks isn't going to stop that. When you lose your job, you can't even apply for a mortgage. This is the most dire part of a cycle is of course, when employment turns and that's when you're officially in a recession and you don't know quite how deep.

RAOUL PAL: Yeah, I get the sense that the rate of change of unemployment is going to be of an order of magnitude that none of us have ever dealt with. The only parallel I can now draw is 1929 in terms of how this plays out, because this is a full debt deflation underway. As you say, I don't know what monetary policy can stop this.

KEITH MCCULLOUGH: Well, again, I don't know, what the capacity is of the Federal Reserve and what the scope is from a legal perspective. Let's just start there. Can the Federal Reserve like the Bank of Japan start buying stocks, or start buying junk bonds for that matter? The answer is no. You're going to have to, into an election, don't forget, that's the other thing. It's the thing about cycles as you very well know. It gets the most amount of people in the wrong place at precisely the wrong time. That's where we're at.

You're also ahead of an election, are you allowed to have a massive social faculty socialist bailout program of stocks and junk bonds? I think absolutely not. Those are the things that I guess as I'm still short junk bonds, short bank loans, levered loans, small cap, leveraged stocks, you give me any flavor of what tried to express the end of the cycle, which is you short leverage high beta illiquid instruments or investment vehicles, private equity, I'm short that. Unless you're going to tell me how the Federal Reserve is going to bail that out ahead of an election, I think that that's just going to end the way that all those cycles do which they end in distress.