Aahan Menon from Prometheus Investment Research discusses their macro framework, liquidity, and the resilience of the bond market. They talk about the economic slowdown, delay in recession, and factors contributing to the economy's resilience. They also dive into misunderstandings about government debt, trends in the bond market, and the outlook on stocks and bonds. The podcast covers systematic macro investing and the potential impact of AI on the investment process.
The economy is experiencing a resilient slowdown, with no immediate recession in sight due to various structural and cyclical factors.
Policy tightening, including higher interest rates, is crucial for managing inflation and economic growth, even though the market expects rate cuts.
Liquidity dynamics play a critical role in market conditions, with incoming treasury bond issuance potentially reducing liquidity and impacting both stocks and bonds.
Inflation is predicted to remain above 2% throughout the year, primarily driven by housing and transportation prices, potentially surprising the market with higher inflation outcomes.
Deep dives
Prometheus Research: A Systematic Macro Research Firm
Prometheus Research is a systematic macro research firm dedicated to the democratization of finance. They specialize in developing a comprehensive understanding of macroeconomic conditions and transforming that understanding into proprietary investment strategies. Their research ranges from short training signals to in-depth discussions on the macro economy. With a focus on managing the balance between comprehensiveness and granularity, Prometheus aims to cover the broad needs of investors.
The Slowdown in Economic Growth
Prometheus Research believes that the economy is currently experiencing a slowdown. While the slowdown has been resilient and has not yet transitioned into a recession, Prometheus anticipates a protracted path towards a recession. They identify four major reasons for this extended slowdown, highlighting both structural and cyclical factors. These factors include changes in private sector balance sheets, the shift from manufacturing to services, semiconductor and automobile shortages, and the resilience of the economy to interest rate hikes. Prometheus emphasizes the importance of understanding that a slowdown does not automatically imply a contraction, and it requires significant impacts on investment and consumption to reach recessionary territory.
The Role of Financial Conditions in Policy Tightening
Prometheus Research posits that policy tightening is crucial for managing the balance between inflation and economic growth. They argue that the Federal Reserve will need to keep interest rates higher than the market expects in order to achieve the desired tightening of financial conditions. While short-term interest rate markets have priced in multiple cuts over the next 18 months, Prometheus anticipates a need for an extended period of higher interest rates to impact debt service costs and have a meaningful effect on economic conditions. They suggest that the market's expectation of rate cuts is incongruent with the economic realities and the resilience of the economy to tightening measures.
Liquidity Dynamics and the Impact on Markets
Prometheus Research focuses on liquidity dynamics as a critical factor influencing market conditions. They emphasize the comprehensive understanding of liquidity, considering it as the flow of cash and cash-like assets in both the real economy and financial markets. Prometheus predicts that incoming treasury bond issuance will inject risk and potentially reduce liquidity, impacting both stocks and bonds. They note that while liquidity tightening will negatively affect asset prices, it occurs because of the resilience of nominal GDP, which supports stocks comparatively better than bonds. Prometheus suggests that despite the overall impact on assets, stocks appear more favorable than bonds in the current period, albeit with reservations about standalone performance.
Outlook on Inflation and Market Expectations
Prometheus Research expects inflation to remain above 2% throughout the year, and potentially climb higher due to various factors. Their analysis highlights housing as the primary driver of inflation, with transportation prices also contributing to sustained levels. While acknowledging potential economic slowdowns and cyclical impacts on demand, Prometheus anticipates a net support for new car demand and prices due to depleted automobile inventories. They stress the importance of understanding inflation in terms of both macroeconomic factors and drivers specific to individual sectors. In contrast to market expectations, Prometheus envisions inflation levels ending the year higher than what is currently priced in the market, suggesting a potential surprise in inflation outcomes.
Stocks vs. Bonds: A Challenging Environment
Prometheus Research acknowledges the challenging environment for both stocks and bonds, yet states that stocks may outperform bonds. They highlight that policy tightening will impact all assets, but the driving force behind the tightening is resilient nominal GDP, supporting stocks relative to bonds. While Prometheus does not view either stocks or bonds as particularly attractive in isolation, they believe that stocks relative to bonds may present a more favorable investment option, considering the anticipated changes in discount rates and the duration supply dynamics. They caution that both stocks and bonds will be affected by the tightening of liquidity, but stocks may have a relatively better performance outlook amid prevailing economic conditions.
Question for the Next Guest
If you are an investment professional, has AI already changed your investment process? And if so, how? Additionally, do you expect AI to have a greater impact on investment processes in the future?
This week, Aahan Menon, Co-Founder of Prometheus Investment Research joins us for in depth discussion about their macro framework, liquidity and that the bond market may still have some gas left in the tank.
