Fiscal Taking Over (guests: Lyn Alden, Jose Rocha & Felipe Hirai) - Market Huddle Ep.84

Episode Overview

• Lyn Alden presents her core macro thesis comparing the 2020s to the 1940s, highlighting a shift towards massive fiscal spending financed by central banks, which creates an environment of financial repression.
• The discussion analyzes the investment implications of this environment, arguing that assets like precious metals and commodities are poised to outperform due to negative real yields and high starting valuations in equities.
• The conversation shifts to Brazil, examining its handling of the COVID-19 crisis, its rising but manageable debt levels in a low-interest-rate world, and its geopolitical stance between the US and China.
• The episode concludes with technical analysis of the US Dollar, a history lesson on England's "Great Recoinage of 1696," and a humorous take on the idea of the Federal Reserve directly buying equities.

Key Concepts

• Engineering Approach to Macro: Applying principles from control systems analysis, like identifying feedback loops and bottlenecks, to understand complex economic systems from a unique perspective.
• The 1940s Parallel: The core thesis that the 2010s (private debt deleveraging) and 2020s (massive fiscal response) are analogous to the 1930s and 1940s, respectively.
• Fiscal Dominance: The current economic environment is defined by large-scale government transfer payments directly boosting personal income and the broad money supply, overpowering other economic factors.
• Financial Repression: A state where interest rates are held artificially low, resulting in sharply negative real yields for bondholders, a key feature of both the 1940s and today.
• "Wartime MMT": A term used to describe the 1940s policy where the Federal Reserve and Treasury collaborated to cap bond yields, effectively printing money to finance war deficits.
• Market Bottom Dynamics: The principle that markets tend to bottom at the peak rate of change of economic damage, not at the absolute trough of the economy itself.
• Valuation Headwinds: A key difference between the 1940s and the 2020s is that stocks and real estate are already expensive today, lacking the "valuation tailwind" that boosted their returns in the past.
• Brazil's Economic Reality: The country faces unique challenges due to a large informal economy, which makes lockdowns unsustainable, and a high debt-to-GDP ratio that is considered manageable only due to the global "lower-for-longer" interest rate environment.
• Geopolitical Positioning: Brazil is analyzed as a neutral commodity exporter navigating its relationships with both the US and China, with President Bolsonaro's alignment with President Trump being a key factor.
• The "Great Recoinage of 1696": A historical event in England involving Isaac Newton that serves as a lesson on currency debasement, coin clipping, and arbitrage.
• Trader Psychology: The discussion touches on common trading biases, such as a persistent bullish narrative on the dollar, and superstitions like "goochering" or jinxing a trade by talking about it.

Quotes

• At 3:50 - "One of the things that really kind of influenced the way I look at at macro is actually some of the the control system analysis research that I've done in my engineering field... you look for bottlenecks and for feedback loops." - Alden describes how her engineering background gives her a unique framework for analyzing macroeconomic systems.
• At 5:16 - "A big comparison I've been making is that in many ways the 2010s and the 2020s mirror what happened in the 1930s and 1940s." - Alden introduces her core thesis comparing the current economic cycle to the period of the Great Depression and World War II.
• At 6:00 - "The last data point came out in April, which was kind of the worst part of the job loss, but personal income went up rather than down... This was because the government reports, this is mainly due to government transfer programs." - Alden explains the shocking anomaly where personal income rose during peak job losses, attributing it directly to massive fiscal stimulus.
• At 11:41 - "The market tends to bottom at the highest rate of change of economic damage, rather than the bottom in economic damage." - Alden explains the market's forward-looking nature, noting that it often bottoms when the negative economic news is at its most intense, not when the economy itself hits its lowest point.
• At 14:12 - "The weird thing was how compressed it was. In addition, it's somewhat weird how shallow the sell-off was compared to the sheer magnitude of the job losses, but the actual timing of it lined up with how previous recessions and bear markets played out, just very compressed." - Alden analyzes the 2020 market bottom.
• At 27:01 - "it was like wartime MMT." - Describing the 1940s partnership between the Federal Reserve and the Treasury to finance war deficits.
• At 27:17 - "Even though you had periods in the 1940s where inflation spiked into the double digits, they still held the Treasury yield at 2.5% or below, artificially." - Highlighting how policy suppressed bond yields despite high inflation.
• At 27:26 - "Treasuries lost on a real basis even though they made money nominally. They underperformed inflation and underperformed many other assets." - Explaining the negative real returns for bondholders during the 1940s.
• At 28:25 - "The deficits look a lot like they looked like in the early 1940s, but instead of spending on a war, they're spending on, you know, the pandemic..." - Comparing the scale of current fiscal deficits to the World War II era.
• At 29:37 - "In the 1940s stocks were cheap, and now they're expensive... they don't have the valuation tailwind that they had last time." - Differentiating the current investment landscape from the 1940s, suggesting equities may not perform as well this time around.
• At 29:48 - "It's more likely in my opinion that we're going to see the 2020s end up being a pretty good period for precious metals and potentially for other commodities as well." - Giving an outlook on which asset classes may benefit in the current decade.
• At 61:01 - "This is essentially going to be the same peak level that you guys had in Canada a few months ago, which is... way better than US and way better than other countries in Europe." - Context on Brazil's COVID-19 death rate peak compared to other developed nations.
• At 62:03 - "The economy is still very informal. People need to go out to make a living. So, people, even though we are kind of in a lockdown, people are already getting out." - Highlighting the economic pressures that are ending the lockdown prematurely.
• At 62:37 - "Brazil's debt to GDP is going to close to 100%... but to us, there's a significant difference if you go to that scenario with interest rates of 15% and it's a totally different ballgame if interest rates are at 2%." - The guest explains that the current low-rate environment fundamentally changes the risk of high government debt.
• At 64:58 - "Our president, Bolsonaro, is very much aligned with President Trump. So from that perspective, Brazil and the U.S. have been pretty, pretty close." - Discussing the political alignment that may influence Brazil's geopolitical and economic decisions, especially concerning China.
• At 94:48 - "I won't lie, I can't... I have a really hard time letting go of my uh, dollar bull narrative. I'm still dollar bullish." - Patrick admits his persistent bullish bias on the US dollar despite recent market movements.
• At 95:09 - "Very wise of you not to mention the Euro. And I'll... I'm going to actually tell you a story about our good friend Cuppy." - Kevin praises Patrick's caution and shares a story about how their friend repeatedly jinxes trades by getting overconfident.
• At 98:35 - "You as a Scotsman yourself, I'm sure that that really butters your shortbread, right?" - Patrick jokes with Kevin, who has Scottish heritage, about the segment on English monetary history.
• At 108:30 - "What would you say you do here?" - A famous line from the movie Office Space, used in the "WTF Clip" to humorously question the economist's suggestion.
• At 108:40 - "What the Fed should start to do would be buy equities... buy a big ETF and support the equity market." - A quote from economist Bill Lee on CNBC, which forms the basis of the "WTF Clip of the Week."

Takeaways

• Use the 1940s as a historical playbook for navigating today's environment of high government debt and fiscal dominance, which points toward financial repression.
• In an era of financial repression, prioritize inflation hedges, as traditional safe-haven assets like government bonds are likely to produce negative real returns.
• Consider overweighting precious metals and other commodities in a portfolio, as they historically perform well in inflationary periods and current equity valuations are high.
• Apply non-traditional frameworks, like systems analysis from engineering, to gain a fresh perspective on complex topics like the macroeconomy.
• Time market entry based on the peak rate of negative news, not the absolute economic bottom, as markets are inherently forward-looking.
• When evaluating a country's debt, context is key; a high debt-to-GDP ratio is far more manageable in a world of near-zero interest rates.
• Acknowledge that emerging market economies face different constraints, such as large informal sectors that make public health policies like lockdowns difficult to sustain.
• Factor geopolitical alignments, such as the relationship between national leaders, into any international investment thesis.
• Be aware of your own persistent biases in trading and investing, such as an unwavering bullish or bearish view on a specific asset.
• Maintain trading discipline and avoid talking a good position to death, as overconfidence can lead to jinxing a trade.
• Study historical monetary crises to understand timeless lessons about currency debasement, arbitrage, and the principles of sound money.
• Monitor unconventional policy proposals, like the Fed buying equities, as they can indicate a major shift in what is considered acceptable central bank intervention.