JAKE MERL: Welcome to Trade Ideas.
I’m Jake Merl, sitting down Michael Gayed, portfolio
manager at Pension Partners
and author of the Lead-Lag Report. Michael, great to have
you back on the show.
MICHAEL GAYED: Always a pleasure.
JAKE MERL: So, you’ve been here several different times
over the past few months talking about
the probabilities of a spring crash for stocks.
Now, that thesis didn’t quite play out as the Fed stepped
in with this dovish pivot.
And you were just here a few weeks ago talking about how
emerging markets should outperform the S&P
in this easy money environment as the dollar weakens. So,
what exactly are you looking at now?
MICHAEL GAYED: Yeah, so look, it’s clear that central bank
paranoia is in full swing.
It’s not just happening with the Fed, it really was
sparked by the ECB last week.
And it seems like there’s this very serious worry that the
direction of inflation expectations
has to be reversed. And a lot of the argument I was making
around a potential spring crash or big collapse
really related to a potential liquidity scare, which it
seems the central banks now are trying to get ahead of.
They’re obviously seeing something, something clearly was
to the fact that they are now reversing course so
Now, this is a debate about inflation and deflation. And
in terms of timeframe, whether you’re able to get
inflation expectation to pick up near term versus very
long term. Couple things to think through here.
One is the Fed likely is going to do something, likely
they’re going to cut rates,
likely the ECB is going to take on further action, because
at this point, they’re going to have to.
The argument is that that’s a form of insurance just in
case things get worse in the trade war from of course,
is that at least historically, when the Fed has cut two
times in a row, that’s precedes a recession.
Doesn’t have to be the case. I believe historically, the
odds are not good for the economy
if that’s the sort of messaging the Fed wants to put out
there. The issue for the Fed is nothing they’ve done
clearly has caused inflation expectations to sustainably
pick up or sustainably rise in any way.
I think a lot of that has to do with oil.
Historically, oil tends to be the best correlated
commodity to inflation expectations.
As market participants look at oil day to day, they view
that as a source of cost push inflation,
that should cause inflation expectations to rise,
which should then prevent the Fed having to lower rates to
try to spark inflation.
And that is consistent with emerging markets rallying,
with commodities in general rallying.
I think for the Fed to ultimately get this right and the
ECB to get it right,
they need commodities to help them push through an
expectation of rising prices,
which should cause an increase in the cost of money, which
also ultimately increases inflation.
That has a lot of implications on various sectors of the
stock market. The main one really being financials.
A lot of people talk about the disconnect between the
value and growth style,
that you’ve had this incredible outperformance of growth
as a style versus value,
not really taking into consideration that the reason that
value has underperformed so much
is because the largest sector of most value indices is
Financials have had a very hard time largely because they
can’t really make money when the yield curve is doing
what it’s doing. In terms of lending long and borrowing
If you’re going to bet that the Fed commodities at
reflation is coming from a sector basis,
financials make a lot of sense.
If you’re betting on a global basis, emerging markets,
commodities make a lot of sense.
But all this is short term, I still maintain that long
deflation is probably more likely than none in our future.
JAKE MERL: So, isn’t the Fed cutting rates almost a
MICHAEL GAYED: Yeah, so this is an interesting thing to
If central banks are getting market participants used to
the idea that they’re always going to save the system
with lower rates, and market participants always believed
the system always needs to be saved,
then you never really have the urgency to borrow.
Because rates will always be lower at some point in the
next year, two years, three years.
So, if everyone believes that, how can you possibly have a
pickup in the increase of transactions to
pick up in the velocity of money?
So perversely, I think if the Fed continues on this path
of trying to save the economy,
save the markets by always lowering rates rather than just
you may actually have the opposite effect.
They may actually be the reason why inflation expectations
continue to go lower.
Because the idea is that they’ll just keep on lowering no
JAKE MERL: And so historically, when you look back, when
the Fed initially cuts rates,
the stock market initially rises.
But that marks the top of the market, and then we get the
recession and the bear market.
Do you think that will play out the same this time?
MICHAEL GAYED: I still think that with hindsight,
I think we had a global bear market start end of January
2018. I think we actually have been in a bear market.
And that’s the thing about bear markets, you don’t know
you’re in one until long after it’s probably over.
And remember, you can have bear markets without
recessions. This is so many people forget in a
A lot of global equities peaks in late January of 2018,
small caps have not made new highs.
In the US, we’ve got a lag quite a bit as well. A lot of
commodities have not really come back.
So, it could really be that this has already been in play
for some time. We haven’t seen a capitulation move
and you haven’t seen it in the S&P, which still is the
only place to be as it has been for several years now.
The thing is, if you’re going to say there’s going to be a
bear market here,
you’re inherently then saying something really, really is
off because you’ve had-
if you’re going to have a global bear market starting
right now and then the S&P starts correcting,
emerging markets still have been crushed already. The
commodities have already been crushed.
A lot of things have already low prices. So yeah, they can
go lower. But at some point,
you’ve got to probably bet that maybe there already is an
overreaction in that disinflation trade near term.
JAKE MERL: So, before you mentioned financials,
how exactly would you go about playing the current
MICHAEL GAYED: So, I think from a sector basis, energy
financials probably make the most sense.
I know people still love tech and tech still has momentum.
At some point, that will change.
The thing with momentum, a lot of interest stays on the
momentum factor, momentum works but when it turns,
it’s like a multi-standard deviation event on the
downside. So, I think that makes a lot more sense now.
The defensive sectors I think are likely to sell off
Utilities, which had been abnormally strong
look like they’re probably on the verge of really
weakening quite a bit.
They’re also overvalued from a fundamental basis.
Healthcare might buck that trend only because they’ve
already taken it on the chin quite a bit.
Energy financials, again, make the most sense.
Commodities, we’ve seen quite a move in gold.
And I think that’s probably likely to continue.
I’ve had this long standing argument that the last great
bubble is faith in central banks
to solve all problems, that the feed system ultimately
leads to tremendous debt over the long term.
Democracies ultimately lead to tremendous debt because
politicians have to always promise new
and better things and that means taking on more money,
borrowing more money.
At some point, you’d get to some saturation debt levels,
and maybe then the market says,
well, there’s something to gold standard, maybe there’s
something to discipline that comes
with the yellow metal, and maybe that we’re starting to
see some of that reasoning play out.
Same thing maybe with Bitcoin. That’s probably one of the
same thesis here.
So, I think broadly speaking, commodities make a lot of
And again, I go back to a lot of what I think is happening
here really does relate to the dollar.
The dollar has sold off the last couple of weeks. I expect
that to continue.
I think at the end of the day, that matters more than
The dollar weakens, dollar’s going to make an asset trail,
inflation expectations rise,
Fed won’t need to cut and that probably does give more
credence to the idea of a reflation trade to come.
JAKE MERL: So, as this reflation trade unfolds and the
you’re also looking at emerging markets as well. Is that
MICHAEL GAYED: Yeah, look, I know there’s still a lot of
talk around China
and whether something’s going to happen or not.
I suspect that Trump’s reelection matters more than a
And what I mean by that is, if a lot of the reason why he
might get reelected is because of the economy
and the stock market, he’s got every incentive to keep
pushing that higher.
And in some ways, it’s the best timing because if you’re
going to do it, you want to do it towards the tail end
of a pre-election year, so that you have something to hang
on, you hang your hat on during the election.
So, I suspect that that’s going to get done fairly
And that may be why China itself is starting to rally too.
JAKE MERL: So, China is a huge part of that EEM, ETF. Does
that worry you at all?
MICHAEL GAYED: No, I like it. Look, this is where all the
bearishness has been.
And, look, there’s a lot of politics, a lot of theater
when it comes to this stuff.
We saw the theater with Mexico. And that was the same week
that you had that poor jobs report, as I recall.
And it only took five days or whatever it was for Trump to
say, oh, we made a deal.
Nobody really knows what the deal was. But all those
concerns around Mexico very quickly went away
because it was concerned about how it impacts the markets.
This is a higher stakes game with China. But I think
you’re going to come to some agreement
and whatever the agreement is, whether it’s good or bad
for the US or for China, it won’t matter.
It’ll catch a lot of people offsides if it does happen,
and potentially cause a rush to Chinese stocks.
JAKE MERL: So how much upside do you actually see for
emerging markets, commodities and financials?
MICHAEL GAYED: Yeah, so look, I think I mentioned before
in the few weeks ago that emerging markets,
when they run, they run 2000, 3000 basis points over the
S&P pretty quickly.
You can have this convergence trade. I think that’s still
obviously very much in play.
I think financials have substantial performance potential
if the reflation trade plays out.
But again, all this is short term, I want to reemphasize
this, I think very long term,
there’s still some very serious problems. The yields have
not really risen just yet. So,
all this is pursuant to the idea that yields actually
react the way they should in a reflationary environment.
If they don’t, that to me is a much bigger problem.
And again, I go back to you don’t really know which
scenario plays out.
Are the bond markets right or it’s going to be wrong
because the central bank’s going to force it to be wrong?
If that’s the case, substantial outperformance and
everything outside of the S&P.
The S&P to me is the last general that you don’t want to
bet on. It’s old, it’s tired.
It’s worked phenomenally.
But if you’re a believer in buy low, sell high, I don’t
know why you would want to touch large caps here.
JAKE MERL: So, Michael, when you say short term for this
reflation trade, what do you mean exactly by that?
MICHAEL GAYED: So, I think you’re talking the next three
or six months that you’re going to have
some reflation trade, or at least let’s call oversold
I’m saying that because if the yield curve inversion ends
up being correct that the recession is coming,
it’s hard to see a recession with inflationary pressures,
given the way things have played out.
So, you really only talked about maybe three to six months
If the yield curve was wrong, it could be much longer than
If the yield curve is rights and you have a recession in
during the election year, then a lot of those oversold
bounces start resuming downward.
JAKE MERL: Well, Michael, that was great. We’ll see how it
plays out in the months to come.
Thanks so much for joining us.
MICHAEL GAYED: Sure, Jake.
JAKE MERL: So, Michael is bullish on emerging markets.
Specifically, he likes buying the iShares MSCI emerging
ticker symbol EEM to S&P 500 ratio at current levels.
He sees 20 to 30% upside potential over the next three to
He also likes buying financials and commodities as a way
to play the reflation trade.
That was Michael Gayed of Pension Partners and for Real
Vision, I’m Jake Merl.