Episode Summary
Executive Summary: The episode analyzes why stocks, especially tech and growth names, sold off sharply after the Fed’s 50bp hike and why markets reacted more the next day than immediately. Guests Luke Kawa and Neil Dutta argue the macro backdrop remains solid, but rising rates, tighter financial conditions, China risks, Russia/Ukraine, and shifting post-COVID growth patterns are driving a major style rotation away from long-duration growth toward cyclicals, commodities, and select defensives.
Main Topics: Fed tightening and the delayed market reaction (Priority: 5/5): The hosts and guests discuss the Fed’s 50bp rate hike, why it was well-telegraphed, and why markets initially rallied before reversing sharply the next day. The discussion centers on tightening financial conditions and the market’s eventual acceptance that the Fed is serious about slowing demand. Tech/growth selloff and the rate sensitivity of equities (Priority: 5/5): Luke explains that higher rates and rate volatility punish growth stocks because markets increasingly favor current cash flow and stable businesses over long-duration speculative growth. Neil adds that the pandemic-era narrowing of growth winners is unwinding. Macro outlook: slowing but not recessionary U.S. economy (Priority: 4/5): Neil argues the economy remains healthy, with strong aggregate hours worked and solid nominal growth, and that consensus already expects moderation. He sees no major recession signal in current data or labor market trends. China, supply chains, and global demand (Priority: 4/5): The guests debate whether China is a temporary drag or a more durable risk. Neil expects improvement from current lockdowns and supply disruptions; Luke is more cautious, arguing repeated disappointments raise the bar for calling a turnaround. Portfolio implications: bonds, commodities, and correlation shifts (Priority: 5/5): With both stocks and bonds down, portfolio construction is changing. Luke argues for commodities as a structural hedge and defensive ballast, while Neil suggests using rallies in defensives to add cyclical exposure. Housing, mortgage rates, and the real economy (Priority: 3/5): The discussion explores how higher mortgage rates affect housing activity. Neil argues residential investment can still grow because construction and renovations matter more than sales commissions; Luke says higher rates clearly worsen the first-time homebuyer outlook. Global central bank tightening and term premium (Priority: 4/5): Both guests note that unlike prior easing cycles, major central banks are tightening simultaneously, which is pushing global term premium higher and contributing to bond market volatility.
Key Arguments: The U.S. economy is still fine: Neil argues aggregate hours worked imply roughly 4% to 4.5% underlying growth, so the macro backdrop does not justify recession fears. Market volatility is being driven more by rates, liquidity, and global risks than by day-to-day economic data. The Fed welcomes some equity weakness because looser financial conditions would worsen inflation pressures. Tech and growth stocks were over-owned beneficiaries of the pandemic and are now being repriced as growth normalizes and rates rise. Commodities look attractive because structural inflation, energy transition needs, and underinvestment make a return to 2% inflation difficult. Housing is slowed by higher mortgage rates, but residential investment may still contribute positively because construction and renovation activity continue. China is a major risk, but both guests think the next 6-12 months are more likely to be better than worse, even if timing is uncertain. A synchronized global tightening cycle is easier for the U.S. than a lone Fed tightening while others ease, though it still pressures bonds and risk assets.
Data Points: Fed rate hike: 50 basis points - The Fed raised rates by half a percentage point, which had already been widely expected by markets. Aggregate hours worked growth: 3% to 3.5% - Neil used this as evidence the economy is still growing solidly. Underlying economic growth estimate: 4% to 4.5% - Neil inferred this from aggregate hours worked plus conservative productivity growth assumptions. Consensus U.S. GDP growth estimate: 2.3% - Neil referenced the Blue Chip consensus forecast for the year. Fed GDP forecast: 2.8% - Neil cited the Fed’s forecast as stronger than consensus. NASDAQ move: Up about 3% on Wednesday - Luke and Tracy described the post-Fed market bounce before the Thursday selloff. Rates already higher: More than 100 basis points higher - Luke noted that equity markets had already compressed while rates had risen materially. Residential investment composition: Sales are about one-fifth; construction and renovations make up the rest - Neil explained why housing activity can still support GDP despite higher mortgage rates. Excess savings: Over $2 trillion - Neil cited household savings as a cushion supporting spending and rates resilience. Terminal/equilibrium funds rate: Higher than before; previously estimated around 4.25% - Neil argued the neutral rate is likely higher in the current nominal growth environment. Nominal growth environment in 2018: About 4.5% - Neil used the 2018 comparison to argue today’s equilibrium rate should be higher. Estimated current nominal growth environment: North of 6% - Neil estimated inflation around 3% to 3.5% plus real growth around 3%. Policy size/sequence: 50bp moves with possible further hikes after neutral - Neil said the Fed has given clearer forward guidance than earlier in the cycle.
Pivotal Quotes: "“Flows before pros, but P-R-O-S-E.”" — Luke Kawa: Luke used the phrase to describe how market flows and positioning have overwhelmed traditional fundamental analysis. "“The Fed welcomes the tightening.”" — Neil Dutta: Neil argued that weaker financial conditions help the Fed’s inflation fight rather than hurt it. "“It’s stocks down and bonds down because of the rate increases.”" — Tracy Alloway: Tracy summarized the unusual 2022 portfolio environment where traditional stock-bond diversification broke down.
Implications: Investors should expect continued regime change: less support for long-duration growth, more value in cyclicals, commodities, and selective defensives. The macro risk is not an imminent U.S. recession, but persistent volatility from global tightening, China, and inflation.
From the Transcript
Flows before pros, but P-R-O-S-E. There's no story we can use that is going to adequately explain why risk appetite changed on such a dime between Wednesday afternoon and Thursday morning. There's nothing that does it. So, what we have to do as asset allocators, we have to take a step back and say, well, you know, there's really three big risks we see on the table. One is kind of Fed tightening, which is going to be, you know, possibly, if it's too much, it's bad for growth. Bad for risk assets. If it's too little, it's probably just bad for risk assets, financial assets generally. There's the Russia's invasion, which is just creating kind of persistent supply issues and threatening to exacerbate kind of some of the negative supply commodity price issues we've seen way on forward consumption. And then there's China, which is both the, you know, a supply and demand issue. And I think that's one thing that did spook people a little when the Chinese yuan depreciated a bit there because it's like,
It as enough to really weigh on the unemployment rate. At best, the unemployment rate probably flattens out in response to this tightening of financial conditions over the back half of the year. But I think, in my mind, the Fed welcomes the tightening. And given the kind of inflationary environment that we're in, this sort of idea that there's this put out there that the Fed will have your back, I mean, And the strike price on that put is a lot lower than it used to be. And that's, again, it goes back to this idea that, you know, in previous episodes when the equity markets were faltering, the growth outlook was faltering quite substantially as well. I don't think that that's as compelling this time around. And in an environment where inflation is still high, I think it's really a no-brainer. As Powell mentioned this week, their goals aren't intention. Right. So, Luke, I want to bring you in on this point because.
Of people's portfolios is also down. What used to across the last several years performed as this nice hedge: stocks go down, bonds go up, is not working. It's stocks down and bonds down because of the rate increases. What does that do, Luke? How does that change the thinking of portfolio management when the sort of these asset allocation models that worked extremely well, one part goes down while the other part goes up, are no longer working? First off, if you're in an environment where more things aren't working, it's gross down. It's not being, it's not taking large tilts in any one direction. It's kind of, it gets back to more of a risk control and prioritizing relative value environment. That's step one. Step two, though, is expanding the kind of range of possibilities. And one reason, obviously, why bonds have been doing so poorly is because commodity prices.
About Odd Lots
Bloomberg's Joe Weisenthal and Tracy Alloway analyze the weird patterns, the complex issues and the newest market crazes. Join the conversation every Tuesday and Thursday for interviews with the most interesting minds in finance, economics and markets.