Discover what’s shaping the markets in 2025 with Rareview Capital’s Neil Azous. Explore trends, strategies, and risks that could define the year ahead in this insightful discussion.
Summary – IBKR Podcasts Ep. 220
The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.
Andrew Wilkinson
Welcome to another IBKR podcast. I’m your host, Andrew Wilkinson. And today’s guest is Neil Azous from Rareview Capital, where he’s the Chief Investment Officer. Neil, welcome. How are you?
Neil Azous
I’m good. Thank you for having me, Andrew. Great to be here with you guys, and happy New Year to you and your whole audience.
Andrew Wilkinson
And a happy New Year to you. Is it going to be a happy New Year for the market? We’ve got the January FOMC meeting coming up pretty shortly. Since we last spoke in the fall, Neil, the pendulum has swung the other way regarding the path of interest rates towards a pause in the cutting cycle.
So, as we head to that FOMC meeting, what’s the market saying now? How have things changed from your perspective?
Neil Azous
Sure, Andrew. Let’s just break that question into two parts, the near term and the long term, and we’ll try to keep this pretty simple.
In the near term, I believe a consensus is emerging or returning from both the Street and the Federal Reserve that the Fed could resume cutting interest rates at the March meeting. So, they’re not going to cut interest rates at the January meeting coming up, but they could in March.
For example, Andrew, March is currently priced at only a 20% probability of a 25-basis-point, or a quarter-percent, cut. So there’s room for things to move to the middle ground at a 50% probability for the next four meetings, really out to June—so between March and June. So we’ve got a little bit of scope for that based on this new consensus re-emerging.
In the long term, I think it’s just really more of a math equation, and we can probably distill it down to one or two inputs. The terminal rate in the market is priced at 4.5%, which is the current federal funds rate. The Fed currently projects the neutral rate—or, as a reminder, the equilibrium rate where the economy is not running too hot or too cold—around 2.5% to 3.2%, depending on who you speak to or what model you look at.
So, if inflation is closer to 2%, the Fed’s likely to cut interest rates by a meaningful amount. If it’s up at 3% or potentially above that, the Fed’s likely not to cut at all. You know, just keep life pretty simple. So, that’s kind of the outlook for the Fed right now. I don’t believe they’re going to do anything coming up here at the meeting in January, but there’s scope to get to a 50/50 for March as that consensus returns.
Andrew Wilkinson
So, from a top-down perspective, as we begin 2025, what’s the current generic approach or starting point for asset allocation, do you think?
Neil Azous
Interesting question. Let me try to distill that down because some people look at asset allocation in different ways—short-term tactical asset allocation, dynamic asset allocation where the best opportunity is, or strategic allocation. I think for us, if we just try to keep life simple, you need a starting point.
And the starting point for us is just a recognition that the new Trump administration moves at lightning speed. And there could be—not necessarily, but there could be—a lack of continuity. And that makes the investment landscape unclear. So, as stewards of capital and managers who deploy asset allocation, I think it’s our job to try to narrow down the themes that potentially transcend the Oval Office.
So, when I do that, I can probably come up with a list of, I don’t know, three to five of those that we would build our generic asset allocation or use as a starting point for asset allocation.
The first one, I think, is pretty basic. Based on what we just said about the Federal Reserve not cutting the interest rate here coming up in the January meeting, it’s because the U.S. economy is beginning 2025 in a pretty healthy state. So, that’s a big theme to be aware of that has nothing to do with the Oval Office at the moment.
Secondly, we have easier financial conditions by the Federal Reserve. So, even if we’re not cutting interest rates next week or this month, it is likely that we will cut something this year. It’s just the degree of how many cuts or the magnitude of those cuts.
And secondly, for those that follow market plumbing, we’ll probably also get rid of quantitative tightening. So, that will end. So, on a net basis, some incremental interest rate cuts, plus QT ending, is easier financial conditions by the Fed. That transcends the Oval Office and Trump’s administration.
Thirdly, I just think of profit growth remaining strong and still potentially having the opportunity to accelerate based on broad government policies, the structural deficit backdrop, etc. So, profits at corporations transcend the administration.
One area that may not do that is tariffs and de-globalization, but that’s happening regardless of who’s in power right now, and so we have to be mindful of that. And then, finally, I would just highlight deregulation and tax cuts, either extending the individual or reducing corporate tax cuts. As a reminder, back in the first administration by Trump, for every new regulation they brought on, they were able to cut four of them. So, that’s an impactful component to asset allocation.
So, collectively, Andrew, when you add those four or five inputs that I just described, that I believe transcend the short-term noise or potential, you know, speed at which they move, or the lack of organization, the net result of that is simple.
It’s just stronger nominal growth, meaning the arithmetic of real growth plus inflation. So, therefore, any portfolio that benefits from growth, or more inflation, or both, should be your starting point.
So, if you just basically distill that down into some of the asset classes, you know, just make life easy on equities. For the cycle, by definition, is determined by cyclical companies. So, you would want an overweight to something cyclical or cyclical industries. Potential value-oriented companies on a style premium tilt. You would want to think about mid-caps and even small-cap stocks.
And I’m hesitant to say this, but the typical or traditional playbook would include emerging markets, excluding China. That would represent that cyclical exposure.
And then, just shifting over very simply to the bond side or fixed income, until that inflation trajectory really turns down again, fixed income volatility should remain elevated. And that simply just suggests that a more tactical approach to the bond markets is required. You should remain shorter your duration bogey than the benchmark.
So, for example, if the aggregate bond index average maturity is around 6.2 years, you probably want to stay in that four-to-six-year range and not go out beyond that. And in terms of longer-term credit spreads, you know, they’re historically narrow, but credit exposure should be at the short end of the yield curve.
So, that’s your basic starting point based on those four or five points that I highlighted that lead to stronger nominal growth and transcend the White House.
Andrew Wilkinson
So sticking with fixed income, what do you see as the biggest potential issue regarding multi-asset or blended stock-bond portfolios?
Neil Azous
Fair question. And it’s been a fair question for several years now. But the largest denial, Andrew, in the industry regarding blended or, as you just said, multi-asset portfolios, continues to be that both stocks and bonds are, quote-unquote, positively correlated.
So, that inverse stock-bond correlation that the industry relied on basically from 1998 to 2022 just remains elusive for the third year running now. And there’s no visibility regarding a return to that prior regime. Most believe that it will return when inflation is at or below the Federal Reserve’s target of 2%. And only then will the hedging-friendly properties of U.S. Treasuries return.
That’s kind of the backdrop for, I guess, the generic pedestrian view. But in our case, we think there’s more to the story. As a reminder, we seek to bring a rare view. Our company is Rareview Capital. So we want to bring a rare view to investment challenges, and we place a lot of value on being able to see across the other asset classes, discover these new opportunities, potentially spot impending danger.
And as you followed us for a long time, you know that we call that perspective “sight beyond sight.” That’s our trademark.
So, here’s some sight beyond sight regarding this stock-bond correlation. We believe, Andrew, that this debate is now more nuanced than just growth versus inflation and how those two economic variables translate into bond yields.
The discussion must now include equities. Why is that? The answer is because of artificial intelligence and fiscal spending. So historically, U.S. earnings growth was strongly correlated to economic growth, meaning you could make an argument that the stock market was the economy and vice versa. And that may have been the case from 1998 to 2018.
But as you know, things have changed. So just to give you a yardstick, the correlation between the annual change in earnings, corporate earnings of the S&P 500, and annual nominal GDP growth was high. It was like around 70–75% for a long time, meaning when economic growth accelerated or declined, so did S&P 500 earnings.
Well, over the last five years, that relationship has been upended, and that correlation is now negative. And so it begs the question, why did this change occur?
Well, we know that overwhelmingly the most significant weight now in the S&P 500 has come from negative-net-debt technology companies, right? They’re increasingly insensitive to the business cycle due to the ingrained nature in the United States for our society. These companies can use their high level of cash flow to buy back stock every year, regardless of revenue changes. And by systematically reducing their share counts every year, earnings per share have steadily risen, right? Or rose.
And historically, the makeup of the index, as you’ll know because you’ve been in the business a long time, Andrew, was much more skewed towards financials and energy or industrial companies—basically all those sectors that are sensitive to the business cycle or the rise and fall of interest rates.
But that is no longer the case. And that’s why this whole exercise just can’t be about the linkage of economic fundamentals to bonds. It must also now include the equity side on that general ledger of stock and bond correlation.
So we don’t see that changing anytime soon. We think it’ll be a continued issue for the industry. We think folks will be in denial for a long time, and it’s certainly making portfolio construction much more complicated, which is why folks will continue to move out the curve into alternative investments, commodities, etc., to augment or replace some version of U.S. Treasuries.
Andrew Wilkinson
Any potential grey swan events for 2025? And if yes, then how are you playing it, Neil?
Neil Azous
Gray swan events. I would just say there’s too much focus, Andrew, geopolitically on China, Taiwan, Russia, Ukraine, the Middle East, etc. I think what we’ve seen since the election, President-elect Trump has told you that he cares a lot more about his neighborhood first, such as Canadian tariffs, the acquisition or some partnership with Greenland, the reacquisition of the Panama Canal, etc.
So, to me, if you focus or look at it through that lens, the sight beyond sight or the number one overlooked issue is what I call, quote-unquote, a soft invasion of Mexico by the United States in the next three months. I mean, I can talk ad nauseam about this, but I think the idea of reducing fentanyl, destroying the cocoa fields or the cartels—similarly to the movies you’ve seen over the years or the TV shows that are on Netflix, you know, over the last five years—there will be some very large exercise where on an overt and a covert basis, including the U.S. military in the Gulf of Mexico, surrounding them of some sort, there will be this soft invasion.
And the idea is that they want to prop up the economy, the lifestyle, and the society of Mexico, very similar to what El Salvador has recently accomplished. And by doing that, mothers will not be afraid of their children joining cartels or gangs. They’re gonna want to stay in that country, and that will make migration less of an issue.
So, that will go hand-in-hand with a war on drugs, hopefully a diminution of deportations, etc. And I believe that’s the S.W.A.N. event or the G.R.A.Y. S.W.A.N. event you just asked about that’s probably not priced into the market.
Regarding how I would play that, I would have to show you guys an illustration of this, but I would just highlight that Mexican peso volatility is not high enough for that. So, if you’re an institutional investor or somebody who knows how to trade options very well, long volatility on the Mexican peso is one way to do that. If you’re an institution, I would look into a forward volatility agreement about that because I do think that’s the sleeper of the next three months.
Andrew Wilkinson
I can’t imagine the Mexican government welcoming that initiative.
Neil Azous
I think that’s a fair question, and certainly based on the history of the last Trump administration, it could be, you know, it’s a fair question to ask if that would be contentious. I think we should go into it with an open mind that there’s a new Prime Minister in there that has already spoken highly of President-elect Trump.
They seem like they might want to work together. And at the end of the day, it might be an option for the Mexican government—that’s a non-corrupt side—to rely on the U.S. to potentially take out some of their dirty laundry.
So, there might be a little bit more leniency in the process, which is why we label this away from our conventional thinking as, quote-unquote, a Grey Swan Event.
Andrew Wilkinson
Okay, something to listen out for. My last question: every year you give us a great idea. What’s your favorite idea, or what ideas do you have for 2025 now?
Neil Azous
Sure, Andrew. Well, this year one in each major asset class, but I’m going to be brief on each one. And I know your audience trades or invests in stocks and bonds, currency and commodities. And I also know they use futures and options and technical analysis.
So, in your question, let’s try to feed the beast today, Andrew.
And before I tell you what they are, I just want to highlight two things. First, these are 3- to 13-month views. Please do not measure us in a swing trading window of the next 72 hours or the entry point. Do a lot more work. Also, one important reminder: the risk of loss in trading commodity interest can be substantial. So, please carefully consider whether such trading is suitable in light of your financial condition.
The number one idea, Andrew, that I like is long Brazilian equities. It’s a compelling argument that the absolute and relative poor performance from Brazilian assets is really on an extreme. If you look at all sorts of metrics, I’ll just give you one. If you look at a 14-week relative strength, it has fallen down to around 24, and historically when it turns up from where it is, whether you look at it on a three-, six-, or 12-month view, the returns are very handsome—17%, 24%, 40%—when you look at the statistical analysis of that. So, we like taking advantage of having a long thematic view on Brazil via monetizing the dimension of time and buying six- or nine-month call options on it.
The second one, Andrew, is what I call fixed income convergence trades. So, this is this—you know, if you think of the 10-year government yield in different countries, can they diverge or converge on a relative value view? So, over in Europe, we think of Italy versus France.
And then when we think of it on a regional basis, we think of Germany versus Japan. In the case of Italy and France, Italy has improved its fiscal trajectory, whereas conversely, France has been hurt by political turmoil and concerns over excess borrowing and spending. So, we think those two yields are going to converge.
Regarding Germany versus Japan, over in Europe, inflation has been largely extinguished at the moment, but in Japan, it’s continuing to trend higher. So, if Germany continues to have growth issues, meaning low exports because of China and Russia, whereas the Bank of Japan is going to hike interest rates further, we’re pretty open-minded that the European Central Bank will be forced to cut the interest rate more quickly and potentially below their perceived neutral interest rate. So, we like those two convergence trades.
Over in the currency market, we’ll stick around in Europe. We like short euro-sterling, or euro-pound, whatever terminology you like to use. And the key question is whether euro-sterling can mean-revert and continue its eight-year trading pattern of sitting in a big range, or will that pair finally break into a new higher trading range? That’s the key question. And I believe there are a myriad of bearish euro and bullish sterling drivers that will allow that to happen. And you add in a very long list of powerful technical observations, and there’s a compelling argument that the euro-pound is going to break its long-term trading range this year.
And then finally, you know, in the theme of feeding the beast, the commodity asset class, we like long wheat via futures outright. I know many in your audience use technical analysis; so do we. Currently, the dominant pattern in wheat is using the continuation future. The dominant pattern is called a compound fulcrum bottom.
It’s an extremely rare pattern, Andrew. If a chartist attempts to diagnose that pattern more than once every few years, it’s probably being overdiagnosed. And the compound fulcrum pattern is always a bottom pattern, never a top. And it occurs when the market forms another pattern—a complex head-and-shoulders pattern—after a very prolonged downtrend. And so that’s being formed right now, and we think if it breaks out of the upside of that, that it’ll be a key reversal in that commodity market. And so we like that.
That’s all I have for you, Andrew.
Andrew Wilkinson
Brilliant. My guest today has been Neil Azous, CIO and Founder at Rareview Capital. A huge thanks for joining me, Neil.
And folks, if you enjoyed today’s edition, don’t forget to subscribe from wherever you download your podcast.
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Interesting and bold prediction about use of the US military in Mexico. Although, your reference to the leader of Mexico as its “Prime Minister” does instill much confidence in your insight.