|
ED HARRISON: We can talk about this year, because we have six months to talk about, but you know that this is going to be a look forward interview, and we are going to be talking about 2021. This is like what do you expect at a 2021 interview? In order to do that, we actually have to go back and say what happened since you and I talked last? Where are we right now?
The last time we talked, you were just pointing this out, Darius, you guys were making the Quad 3 call for the rest of the year, which was spot on. Talk to me about, first of all, what are the quads, and where have we been in 2020?
DARIUS DALE: That is a great question. When we last left off, it was early June, we had just recently made a pivot to what we call Quad 3. In terms of what the quads actually are, it is a framework that allows you to quickly contextualize where the economy is in rate of change turns. Quad 1 is where growth is. Quad 2 is where growth is accelerating, and inflation is accelerating at the same time. That is where you tend to see the preponderance of negative returns in fixed income and duration sensitive assets. Quad 3, as we highlighted, Quad 3 is where growth is decelerating, or at least the market perceives growth to be decelerating, more on that later, and inflation is accelerating. That is where you get paid to be long growth at any price. That is where you also get paid to be long commodities and short the dollar.
Then lastly, Quad 4, we were famous for making some pretty hefty Quad 4 calls. If you go back to 2008, you go back to 2016, you go back to Q4 of 18, and obviously you go back to January, February of this year, that is where growth and inflation are falling at the same time. That is where we tend to see the preponderance of outsized negative excess returns in equities and credit.
ED HARRISON: Last we talked, we were not in this growth deceleration phase, we were in the bull reopening phase. Everyone was talking about the reopening. Everything was good. What happened?
DARIUS DALE: Yes, absolutely. That is good. If you go back to late April, one of the things that became very clear to me and really through the lens of our healthcare policy research, Emily Evans runs that for us, it became very clear to me that reopening was going to equate to a positive shock in the economy. That positive shock actually extended itself well past what anyone could have possibly projected. Moreover, they actually took the GDP up much higher and much faster than anyone could have expected, including us.
The reality is, the market always knew that we would get to this point, i.e. here, in the here and now that we are observing in terms of rising case counts, the potentiality for more lockdowns and a potentiality for a difficult winter from an economic perspective. That is why at that moment, we pivoted to a Quad 3 portfolio because we thought the market would start to discount what we are observing now in the data in terms of Phase 3.
ED HARRISON: This seems like there is light at the end of the tunnel. When we think about 2021, we are thinking, okay, we are in a Quad 3 environment and that is negative, but it seems like the markets already moving beyond that to 2021 with the vaccines and so forth. How are you guys looking at that? What is the macro picture before we start to drill down into individual bits there?
DARIUS DALE: Well, I think the thing that has been most positive for asset markets that has developed in the last few months is the fact that Phase 2-- so Phase 1 is for shut downs, the initial shutdowns in February, March, and April. Phase 2 were the bounce and the reopening activity, the reopening trade, the positive economic shock that was reopening. Then Phase 3, what has happened in the asset markets is the fact that Phase 2 extended itself for much longer than anyone could have possibly projected, including us.
As a function of that, we have gotten this very, very positive handoff all the way into the latter parts of Q4. Which means Q4 is now tracking in what we call Quad 2. I am not sure how close you guys have been following, but we have pivoted to a Quad 2 playbook and expectation from an economic perspective about five or six weeks ago. Then the reason for that is that handoff, that Phase 2 handoff really got us to the point where it is very unlikely we have slowed sharply enough here in Q4 to observe anything that is negative from an asset market perspective, i.e. Quad 4.
More importantly, by the time you get into Q1 of next year, it is very likely that you have stimulus and very, very easy base effects for both growth and inflation to contend with. If you are bearish, you just ran out of time and space to actually price that in, which is why I put out a note this morning, I just said simply at the title of the chart of the day was if we run out of time. Was Phase 3 finally fully priced in in the 9.6% drawdown the SPY in September? You had a 7.5% drawdown in the SPY in October, and was that the market saying, hey, the data is going to peak and slow into the back half of Q4 and into the beginning of Q1? That is it.
|
