Overview of Odd Lots — "Citi's Dirk Willer on How You Know When the Bubble Is Over"
This episode of Bloomberg's Odd Lots features Dirk Willer, Citi’s Head of Global Macro Strategy. The conversation centers on whether current market moves—especially the AI/tech-driven rally—constitute a bubble, how Citi defines and detects bubbles, what would signal a top, and practical ways investors can hedge or position themselves amid uncertain Fed policy, stretched leadership concentration, and elevated retail-driven trades (gold, private markets, etc.).
Key takeaways
- Citi labels the current U.S. equity run as a bubble by their rule-based definition, but it lacks some extreme sentiment features seen in past blow-offs. That means the rally can continue, but downside risk remains large.
- A bubble is best defined and traded with rules, not just narrative comparisons to 2000; Citi uses a quantitative, repeatable framework to identify and manage bubble risk.
- Important near-term macro driver: whether the Fed cuts in December is ~50/50; employment prints (NFP) are pivotal for that call.
- Practical hedges include credit exposure and structured currency/S&P combos; simple put spreads can fail in a continuing blow-off.
- EM trading experience provides useful frameworks for thinking about U.S. market fragility (e.g., whether government bonds act as safe havens during risk-off).
Dirk Willer — role and perspective
- Job: Global Head of Macro Strategy at Citi; leads a quant-heavy team that backtests signals and issues trade ideas to hedge funds, real money, and corporates.
- Background: Began in EM and macro hedge funds; traded the 1999–2000 dot-com run and decline—learned the difficulty of trading bear markets and the value of being long fixed income during collapses.
- Emphasis: prefer precise, testable rules to describe bubbles and trigger defensive actions.
How Citi defines a bubble (their quantitative rule)
- Bubble definition: asset returns exceed 2 standard deviations above the long-term trend in real terms (rolling windows, deflated for inflation).
- Clock resets after a large sell-off (sentiment reset), so repeated bursts can produce multiple bubble episodes.
- Historical behavior: once in bubble territory, markets often continue higher; but most in-bubble gains are eventually given back (on a 10-year horizon returns are typically below average).
Signals Citi watches for to spot the top
- “Generals” (leadership narrowness): focus on the top ~7 leaders in a market.
- Warning trigger: if 3 of the top 7 leaders break below their 200-day moving average → high risk of broader market trouble.
- Rationale: bubbles tend to be narrow; leadership deterioration is a reliable technical warning.
- Sentiment & positioning: Citi’s “pulse” indicator (positioning + surveys of large allocators) has not reached extreme bullish territory this cycle.
- Volatility composite: Citi uses a max Z‑score across vol indicators (MOVE, VIX, EM vol, high-yield spreads) to detect regime shifts — watching for one leg of volatility to spike first.
- Fundamentals lag: in past bubbles (e.g., 2000) fundamentals can appear fine for months after market peaks due to lagged CAPEX and activity, so technical signals matter more for timing.
Fed, employment and the December cut odds
- Background: Odds of a December cut moved from ~66% to closer to 50/50 recently; Fed rhetoric is mixed.
- Employment thresholds (per Dallas Fed/Citi discussion):
- If monthly NFP < ~30k → likely cut.
- If monthly NFP > ~60k → likely no cut.
- Between 30k–60k → ambiguous, “fight it out.”
- Problem: government data gaps and distortions (shutdowns, buyouts) make real-time assessment harder—alternative data help but aren’t definitive.
Gold — structure and recent behavior
- Structural story: central bank accumulation (notably PBOC) is a long-term bullish anchor for gold.
- 2024 dynamics: recent rally had two legs — rate-cut/dollar weakness trade, followed by retail-driven “debasement fear” (meme-like buying and physical runs).
- Citi’s stance: they exited gold earlier, cautious near-term because the retail-driven move already ran far; central-bank-driven buys could reaccelerate gold on pullbacks.
Hedging and positioning advice
- Simple put spreads on the S&P can be expensive/worthless if the bubble continues (strikes get farther OTM).
- Better/alternative hedges:
- Credit exposure (long IG/short riskier credit structures) — protects if the real economy or labor market deteriorates.
- Currency-linked hedges: a bursting equity bubble may go hand-in-hand with a weaker dollar; structures that profit from S&P down + dollar weak can be cheaper.
- Use volatility triggers (max Z-score) as a tactical entry/exit for vol buys.
- Crowded trades to watch: EM carry, dispersion trades and retail gold positions; crowdedness raises the risk of sharp unwinds.
Emerging Markets lessons applied to the U.S.
- Trading definition of EM: whether local bonds rally in risk-off determines “EM-like” status (i.e., are bonds safe havens or credits).
- U.S. has more policy tools (Fed/Treasury interventions, market operations) than EM nations, so rules for EM distress aren’t perfectly transferable — but patterns (leadership narrowness, political risk) can still be informative.
- Political risk and elections matter disproportionately in EM; similar political/ fiscal dynamics in the U.S. (e.g., fiscal policy, bond issuance) can still change correlations between risk assets and Treasuries.
Practical checklist (what to monitor this week / month)
- Pulse indicator / Citi positioning surveys (extent of allocator bullishness).
- Employment prints (NFP) and alternative labor data; compare to 30k / 60k thresholds.
- Top-7 leaders vs their 200-day moving averages — watch for 3-breach trigger.
- Max-volatility Z-score across MOVE/VIX/EM vol/high-yield spreads.
- Credit spreads widening and credit market behaviour.
- Dollar direction and any signs of retail panic in gold or physical demand.
- Private market valuations (large private/late-stage rounds) for signs of “bubbly” activity outside public markets.
Notable quotes
- “Whenever the bubble bursts, the dollar weakens, the Fed rates will go to zero, or maybe not quite to zero, but you get aggressive. So everything, that's what you have to focus on.”
- “If you buy it when you enter a bubble, you will give it back eventually — most of it. Most of the in-bubble gains will be given back.”
- “The narrowness is a feature of the bubble. It’s not an exception… if the leaders start to break down, it's a real warning sign.”
Bottom line
Citi’s framework treats the current AI/tech-led rally as bubble territory by quantitative standards, but it’s not screamingly extreme on sentiment yet — which implies the rally can continue, and timing a top is tricky. Dirk Willer emphasizes rule-based signals (leadership breakdowns, volatility composites, employment thresholds) to manage risk rather than relying on narratives. For many investors, the pragmatic approach is to define objective triggers for de-risking, consider credit and currency-structured hedges, and watch employment data and leadership technicals closely.