“We’re In Uncharted Territory” | Warren Pies on Treasury Issuance, Housing Market, Oil, And Recession Risk

Episode Summary

Executive Summary: Warren Pies argued that higher bond yields have become the main macro threat to equities, especially because they hurt market breadth, small caps, and earnings-sensitive stocks. He is now overweight bonds and underweight stocks/commodities, sees bonds as fairly valued, expects recession risk to rise by mid-2024, and thinks energy remains a useful hard-landing hedge despite short-term oil bearishness.

Main Topics: Shift in asset allocation: bonds over commodities and stocks (Priority: 5/5): Pies explains that his team changed positioning mainly because prices moved to more attractive levels. Bonds moved from overvalued to fair value, while commodities, especially oil, rallied near target levels and now look less compelling. Interest rates as the key driver of equity weakness (Priority: 5/5): He argues that rising Treasury yields are the proximate cause of stock-market weakness, reducing equity attractiveness versus risk-free rates and damaging breadth, especially outside the mega-cap tech names. Earnings quality vs. market reaction (Priority: 4/5): Although large-cap tech and the broader market continue to post decent earnings and guidance, stocks are failing to hold post-earnings gains. He views this as bearish news failure, suggesting expectations were already too high. Recession framework centered on housing and construction payrolls (Priority: 5/5): Pies maintains recession risk is rising into mid-2024, led by weakness in residential construction payrolls, housing starts, and multifamily activity. He says the call is not that a recession is already here, but that the probability is increasing. Energy as a hard-landing hedge (Priority: 4/5): He recommends overweight energy within equities because it tends to outperform going into recessions and can diversify portfolios when bonds fail to hedge stocks. He still sees oil as tactically more bearish after the Saudi-short squeeze. Fiscal deficits and Treasury funding mix (Priority: 4/5): The discussion closes on the unusual combination of high deficits, low unemployment, and heavy bill issuance. Pies says this is historically anomalous and could worsen materially if the economy weakens.

Key Arguments: Bonds are now closer to fair value after the 10-year yield rose from roughly 3.8% to around 5%, making them more attractive than they were earlier in the year. The rise in yields has hurt equity breadth and hit small caps harder because many companies outside the mega-cap cohort are more rate-sensitive and rely more on capital markets. The equity market rally has been driven more by multiple expansion and margin optimism than by strong upward revisions in forward earnings. Post-earnings stock reactions are bearish: strong reports are often not being rewarded, which suggests best-case expectations were already embedded in prices. Recession is not here now, but housing is deteriorating and residential construction payrolls are the key leading indicator to watch for a potential mid-2024 downturn. Energy can outperform into hard landings because higher oil prices often coincide with late-cycle stress; it is less attractive in soft-landings where the Fed cuts quickly and energy stays subdued. The U.S. fiscal backdrop is abnormal: large recession-like deficits are occurring while unemployment is still low, and the government is financing a large share with bills rather than coupons. If recession arrives and the bond market does not rally as expected, the Fed may eventually have to re-enter the market with renewed QE.

Data Points: 10-year Treasury yield: ~3.8% to ~5% - Pies says bonds moved from overvalued to fairly valued as yields rose sharply in the second half of the year. 10-year yield target for oil trade: ~$100 per barrel Brent target was reached near $98 - His team expected Saudi supply restraint and short-covering to push crude toward $100. Bonds position change: Overweight bonds as of a 5% 10-year yield - He says they added bond exposure progressively at 4.5%, 4.8%, and 5%. Cash allocation: Largest position in the second half of the year - He describes portfolio positioning before the recent change. Forward 2024 S&P earnings estimates: Small uptick after Q2 earnings season - He says estimates had been flat/down much of the year and only recently ticked higher, mostly on margins. Percentage of stocks sold off after earnings: About 75% - He cites Q2 earnings season as especially weak in terms of price reaction. S&P 500 stocks above 200-day moving average: Declining as yields rose - This breadth measure is used to show the negative relationship between rates and market participation. Russell 2000 level: Below its 2022 lows - Used as evidence that small caps have been hit hardest by higher rates. S&P 500 earnings growth expectations: 12% in 2024, 10% in 2025 - He says the market is still priced for a soft landing. Nominal GDP fair value for 10-year: About 5.1% - His model suggests the 10-year is roughly at fair value versus nominal GDP. Typical 10-year vs. Fed funds spread: About 120 bps - He uses this historical spread to argue fair value for the 10-year is near 4.25% assuming a 3% terminal fed funds rate. Residential construction payroll decline threshold: 8% to 10% - He says this magnitude of decline historically aligns with recession onset. Housing construction payroll peak: January - He says residential construction payrolls peaked in January and have trended lower since. Mortgage rate stress level: Around 8% - He argues this is where builder buy-down economics begin to break. Single-family starts: Down from ~100,000/month to ~70,000/month - He cites this decline as evidence the housing market is not reaccelerating. U.S. deficit: 8.5% of GDP - He highlights this as anomalous with unemployment near full employment. Unemployment rate: ~3.5% to 3.6% - Used to show the deficit is occurring outside a recessionary labor market. Bills as share of total debt: 22% - He says this is high relative to Treasury’s stated 15% to 20% range.

Pivotal Quotes: "There are no bad assets, only bad prices." — Warren Pies: Explaining why he shifted from underweight bonds and overweight commodities toward bonds as valuations changed. "Yields have been the proximate cause of the sell-off." — Warren Pies: His core explanation for the equity market’s weakness and narrowing breadth. "This is a really bearish development." — Warren Pies: Describing strong earnings reports that fail to hold gains, which he views as a bearish news failure.

Implications: Listeners should watch Treasury yields, housing construction data, and earnings reactions more than headlines about recession certainty. Pies’s framework implies bonds may outperform stocks near term, while energy remains a key defensive sleeve if the cycle turns down.