Dear Hedgeye Nation,
It's not every day two heavy-hitting Macro investors come together to hash out the current marketplace and economic paradigm. Watch as McCullough and Bianco challenge consensus views in this Macro Masterclass.
Below we have transcribed key excerpts from their conversation.
You can watch the entire hour-long interview here.
* * *
McCullough: Welcome back to another Real Conversation. Jim we had a great conversation this summer, where you caught some people off guard for your bullishness. Awesome call, and I don't think you're known as a perma-bull (maybe one of the furthest things from it). That really was a moment in time when there weren't really a lot of people like you, who have been bearish plenty of times in their career, where you were rip-roaring bullish. Congrats on that.
Bianco: Thanks, yeah everything in 2020 was unusual in terms of how the markets traded, so you did get unusual calls too.
McCullough: Can you walk through that a little bit; there's so many companies out there that are in the business of marketing certain asset classes because they get paid a fee on it. And there's people that're in the business of marketing one-way bearishness or bullishness.
How do you deal with that and think about it? You've been at this a long time.
Bianco: Yeah you do tend to get pigeonholed into a certain type of genre, "Oh you're a perma-bull or a perma-bear."
Everybody thinks that you're opinion is a religion. I like to say that my opinion is a rental.
I can rent it for a week or I can rent it for 10 years; it depends on how I see it. Half of what I do is say which way I think the market is going to go, and the other half is to evangelize on what is going on in the world. But I keep those separate.
Yeah we could be printing too much money or doing things which I consider reckless, which is what I was saying last summer; but we're going to go up, which is also what I was saying.
You don't want to say we're printing too much money and being reckless, so therefore you moralize that the market must go down, and not recognize that this might work for a while. And that's what was behind my bullishness last summer.
McCullough: That's a great word - moralizing. It really is what you have to play against. What is it about this environment that allows you to go both ways, maybe a little bit moreso than you have done in the past over the course of your career.
Bianco: The seat I sit in, as an independent research firm (kind of like you are), I'm not beholden to a trading desk. I don't have to be saying something and then someone tells me I'm talking against anyone's position. We have no investment banking, so I have that freedom. I also have the freedom where I've been doing this long enough that I've been hammered enough with bad calls to know that there's nothing absolute about what you say.
Don't take yourself so seriously. Yes I have an opinion, I think it's going to happen. But I've had opinions in the past that haven't worked out, so I'm not going to get myself that enamored or wrapped up into my opinion that it has to work out, and stammer my feet and say, "Why isn't it working, it has to work!" I did that earlier in my career, many decades ago, and I've learned from it.
McCullough: At the end of the day, it's not our first rodeo, we've screwed up publically many of ways, in fact probably more ways than many people have had the opportunity to. For me at least, I think I learned how to be bullish in a bubble. Because the last times I wasn't doing what I should be doing, which is making money in a bubble.
By the way, one of your recent quotes is one of the best I've seen from anybody in a while, you said, "The great think about a mania is that you make a lot of money fast."
Bianco: You do, you make a lot of money real fast. But it can be a roach motel; the problem with a mania is you have to know when to get out. What last spring taught us, or at least it will teach a lot of people, is "Oh if you lose a third of your money in 6 weeks don't panic, stick with it." And then that becomes permanently half your money is gone and you go, "What the hell just happened? I was on top of the world, and then everything fell apart."
That's what I mean by you can make a lot of money real fast in a mania; but keeping it is the trick, not making it.
Because do you get chased to by a 10% correction like we had in September? Or a 30% correction like we had last March? No, it comes back. So how do you know when to get out? If you don't, you end up with this giant round trip.
That's going to be the hardest part about this; not being bullish on the up, but knowing when to pull the plug gets you paid.
McCullough: Who gets you out? At the end of the day, that's a big question in Risk Management. To me one of the biggest bubbles was the deflation expectation at the interest rate lows; there are lots of different kinds of bubbles, I don't think that's the one that people had been worried about.
This interest rate bubble - do you agree with that or not, that we're in a bubble of deflationary expectations?
Bianco: I do agree that we're in a bubble that interest rates are overvalued because you have a non-price sensitive buyer with a printing press that's been buying these things. That said, that's been the state of affairs for the bond market for 12 years now.
It's not to say that it is a bubble; it has been that way for so long, that we've almost forgot what it's like to not be that way. The real question is when does it go too far, and when do we have a problem in the bond market. I think that's coming a lot quicker than everyone thinks, like maybe later this year. I think what we saw last week is the beginning of a lot more problems in the bond market as we go forward.
For those not in the bond market, I want to quote Jim Carville from 1994, "When I get reincarnated, I don't want to be a .400 hitter, I want to be the bond market. You can intimidate everyone." If the bond market has a problem, everyone in finance has a problem. And that could be something we're looking at in the second half of this year.
McCullough: Agreed, and not all bond problems are the same. Going back chronologically, there were a lot of head fakes. 2013, 2009, 1999, 1994; all of those were not times to sell "End of the World" newspapers because bond yields were going up.
Bianco: This gets back to that moralizing thing as well. Is it wrong for the Fed to be printing money and buying bonds? Yes. But I'll only moralize on it to a point; there's a tidal wave of $100 bills coming at me.
Do I want to surf that, or stand there with my hand up saying "Stop"?
That's the problem that I think people have to realize. The bond market is being driven by the Fed, that is the state of affairs. It's only when we get to the point where inflation is unsustainable, which I think might be coming a lot sooner than people think, does it become a real problem. It's not right now, but we might be starting to see the beginnings of it, especially with what we saw in the bond market last week.
McCullough: My call has been that it's going to happen like all things in the Risk space; it happens slowly, then all at once.
Like all breakouts in Growth or Inflation (in this case we have both, which I call #Quad2), it's mathematically impossible to not have higher levels of inflation, faster, in March, April, and May due to the Base Effects, which are the most deflationary Base Effects.
Even if you don't have sustainable inflation, our view is that you're going to have shockingly high headline inflation, for all the bureaucrats, Fed watchers, and "cover your ass" institutions that are going to be looking at these high inflation prints.
Bianco: You are going to get high inflation numbers in the next 90 days. That's the Base Effect. In March and April of last year, everything was shut down, no one was buying anything, and price plummeted. We're going to roll that off in Spring of this year. The 9 month (since May) annualized rate of Core PCE (the Fed's favorite measure) is 2.5%. So you're probably going to see inflation shoot up from about 1.7% to 2.5% in the next 90 days. Everyone knows it. And I call this the built-in excuse for why any signs of inflation will be dismissed.
Let me make a quick comment about inflation. The highest level in the last 28 years for Core PCE inflation is 2.55%. I'm saying that we're going to go to 2.6%. People say oh that's not inflation - well first of all it's a 28-year high. If you get to that level, and you will in the next 90 days, well everyone expects it'll fall off after that. But I don't think it will. If you stay at that level and interest rates go to positive real yields, you're looking at a 3% 10-year yield. I think that will cause a lot of consternation in the bond market. If you get rates to start to rise to 3%, those losses will hurt. That will cause a lot of problems in the bond market - which means everyone else will have problems.
Yes, I think we're going to see inflation. But I'm not calling for massive inflation, I'm calling for 2.5%.