Speaker 1Welcome to the Jim Paulson Show. I'm Jack Forehand, and the co-host with me today is Matt Ziegler, and joined by the man the show's named after, Jim Paulson. Jim, how are you doing today? Very good. Very good. Thanks for having me, guys, as always. Yeah, we always look forward to talking to you, and today we've got a lot of good stuff going on because there's just so much going on in the market. We had a CPI report that I guess was not as good as people expected, but the market's up anyway. We've got a big Fed meeting next week. We've got a lot going on with AI, and you've got, I think, 26 or so charts to help us work through it. So we're excited to get through it. Yeah, I think we had like 34 last time,
Speaker 2so you're actually slacking a little
Speaker 1bit over there, Jim, in terms of your charts. But yeah, we're excited to go through it. For anybody who wants to follow your work or the charts, you can find it at paulsonperspectives.substack.com. We appreciate you sharing all this stuff with our listeners and our viewers. And I. I guess to start, we should probably start with what I just said, which is there's a lot of things going on, and you've always been great at helping us dissect what the most important things to pay attention to are. So what are you looking at as we head into a Fed meeting? We just got a CPI report. What are the most important things you're paying attention to right now?
Speaker 3Well, I know that, you know, the CPI report's sexy and the jobs report and the Fed is always, you know, a major draw. And all that will matter. I know it does. But I. I think we just had a little less attention to that stuff because I think it's just kind of creates volatility for the day and we move on. Now, you know, but I guess what I am. I guess what I'm most focused on is that the. I think that we'll talk a little bit about this, but I think people are looking at an average of the overall data of the economy, and it's really like two completely separate things that average out to be okay. But if you. If you look at the separate components, it's really the story of two tails. And one of the tails is really not that good. And so what I'm most focused on is we continue to bring negative force to the part that's not doing well at all. And that, I think the longer that goes, the worse the possibilities are for, you know, what to. for the economy to grab the attention of everyone by suddenly not doing. not looking so good. And, you know, it's kind of disappointing that in that regard that, you know, we've re-spiked energy prices back up almost to previous highs, and we're now taking the 10-year bond yield to five and the two years running like the Fed's already raised rates. The yield curve is almost back down to its flattest position of the year after coming off a lot from last year. I mean, policy force is very negative and also just the negative lagged force of. higher inflation pressure from energy prices bleeding out into everything, you know, hitting real purchasing power, hitting margins and everything. So the longer that goes on, it just makes me more concerned. And I guess that's what I'm kind of watching. I kind of keep hoping we'd get kind of a dip and people would back away from, well, maybe we should not tighten and maybe we should think a little differently. And then maybe it won't be so bad. But the longer this goes on, the more I get a little more bearish on the whole situation. I guess that's what I'm focused on. That's not any one thing, but the accumulation of monitoring it. And I'm more concerned less about when the reports come out because they're already passed for the most part. I'm more concerned about what policy says about where reports might be headed coming in the future. That's what disturbs me about policies being pretty tight.
Speaker 1I know we all pay too much attention to it. And you just mentioned that before. But heading into the Fed meeting next week, I mean, I think the odds as of yesterday were something like 80 percent they're going to hike. Do you expect that's what we're going to see?
Speaker 3Well, where's my coin here? Flip it. Do you
Speaker 1have a weighted coin or do you just have a 50-50?
Speaker 3I think it's 50-50, but heck if I know. I think they sure sound like they're going to raise it. The markets have priced in a lot of hike, I think, is in there, you know, to some degree. I don't – I really suspect that Warsh doesn't want to, the new Fed chairman, but he feels a little pinned back. Maybe to show some that he's still focused on inflation. And it'll be interesting. They were kind of split last month. So maybe they're split enough again that they pass another meeting. I don't know. At this point, you know, a lot of the damage has already been put in there. I mean, we've got almost a 5 percent 10-year, you know, further inverted curve and panic that's resulted from all that. You know, we took the market down below its June high, the initial AI. S&P high, you know, we breached that, which technically that's not good. So I think the hike might turn out to be anticlimactic, even if they do it. Now, what a lot of people are hoping for is they don't, which means they could get a big rally, at least in the short term. I don't know if either sticks. You know, you get these short rallies, and then over the day, because I think the undertow of this thing is how strong is the economy. That's what we're going to come back to, I think. It's not – on any given day, it could fly around on the news. So to speak, but I think the undertow is that. And I'm not sure it'll be really important what the Fed does, because ultimately, the economy is going to have to dictate that for them. And to the extent, you know, that we're kind of somewhere in the middle there, it's not a layup either way. That's why I say I think it's a coin flip right now, what they might do.
Speaker 2You've been covering the estimates quite closely here. Let's get this first chart up. Tell us what's going on.
Speaker 3Yeah, I think this chart. This chart says a lot. I think I hear analysts all the time say how good earnings are, and accurately, across all parts, they are great. They're not only great, they're unbelievable to some degree of how fast they've soared and gone up. But below that surface, it's really a two-pronged, almost three-pronged story on earnings here. And that's what this chart brings out. What I got here is forward 12-month earnings per share. For the blue line is for the technology and telecommunications sectors, kind of new era, which I call the brainiac earnings. You know, earnings that come out from somebody that really came up with something cool. And they're just going gangbusters, which everyone knows. And then there's another part that doesn't get as much attention but should, and that's the green line. And that is those that are tied to energy commodity prices, basically, or commodity prices in general. And they're not a big part. The blue line. The green line's not quite 50% of the market cap. The green line's only 5%, but it's up unbelievably over this period of time. And it's mainly up, we all know the reason, because oil prices went up so much. Okay? And that's what I call the no-brainer earnings. Because if you're an oil company, you're going to make money, even if you're a terrible manager. They're going to go up like the green line's going up. But there's this red line down there, which is all the rest. It's the remaining seven sectors of the S&P market cap. It's weighted and so forth. And they're barely up this year. If it was just those seven sectors, no one would be saying earnings are great. Because they're up like 6% annualized year-to-date. If you back out inflation to 3.5% to 4%, we're talking about 2.5% real earnings growth. No one would be celebrating that as some kind of overwhelming positive force. But if you look at S&P overall, you average it, hey, we're doing great. And that's what I'm saying. I think we really need. We really need to separate these stories. Because if I'm a policy official and I could do it, I'd be tightening on the blue and I'd be easing like a mangy on the red. Problem is, we've got no policies like that. Not aggregate macro policies. So we have to choose later next week, you know, whether we're going to tighten or ease. And I think there's too much calm, is I guess what I'm getting at. Too much average analysis, which leads people to believe, you know, this calm is pretty good. We got to slow this thing down. I do think this is maybe the kind of the thing driving. It's also driving optimism. It's certainly not the jobs market that's driving optimism or other things. It's this earnings explosion. And I think that that's. So if this changes, and I'm going to come back to this a little later. If this changes, that could really alter a lot of dynamics in the market.
Speaker 2So let's move from those corporate earnings over into the actual economic side, because this, this average is misleading theme shows up in a bunch of different places in your work. Explain what's going on here.
Speaker 3And I got a little more pessimistic view on the overall economy than what most seem to have at the moment. Maybe it's not right. Maybe I'm just too boneheaded to appreciate and embrace the AI story. You know, you better pull that coin out again. This is, first I'll just focus on the job market, because I think that's where the epicenter of weakness is. I, what I've got here in this. This is a household employment and non-farm payroll for households in blue, non-farm payroll appointments are red. And to me, you know, I don't, this idea of even the fed said that the job market looks solid and it looks okay. It looks healthy. I don't know where the non-farm or household job numbers have been falling for almost 18 months, not, not even flat. And payroll has been about flat over that period of time. I don't see how you can look at this chart and say that. The job market is okay. It doesn't need any assistance or any help. Um, but so that's just one example. If you go on. to the next chart here, Matt. I'm also fascinated by how much comfort people get from unemployment claims not going up. And so what I've laid on here, the red line is the annual growth in payroll employment, which is about zero. And the blue line is the level of unemployment claims, which is about 200. And that's shown on an inverted scale, that blue line. So you could see that normally when payroll employment goes up, layoffs go down. And when payroll employment goes down, layoffs go up. Except really for the last, I don't know, almost 10 years or so, they've really parted company a lot longer than people appreciate. And people take a lot of comfort that, okay, I know that there's no job creation, but as long as people don't lay off anybody, unemployment rate doesn't go up. Hey, we're okay. That's okay. I don't really think that's okay in America. I think there's a reason why there's so much pessimism on Main Street, because a lot of people aren't okay with that. Even if they have a job, if there's no new jobs, there's no future for them, no hope, if you will. And I think that's weighing down on the overall strength of growth in the economy here. But one other point I'd like to make about this, most people fall back. If they look at these two charts, they go, well, I'm going to go with claims. That's what they, I don't know why, that's where they're at. I go the other way. And maybe that's not right. But one reason I do is because if you look at the last 10 or 15 years, payroll employment has been leading claims, not the other way around. I think most people think the red line is going to come up soon if claims stay where they are. I would suggest the blue line is probably going to go down to higher claim numbers. Why? Just look at the last 10, we went into the 2010 crisis there. When we came out, you see the red line was leading the blue line there. Shot up, it got back to very strong levels long before the claim numbers came back to better levels. And then it started to ease off. You can see in the last, the years after, or during the post 2010 recovery and claim numbers kept getting better, but eventually they caught up in the pandemic. It was the blue line that caught up with the red, so to speak. And coming out of the pandemic, if you, got to squint here, but if you blow that up, the red line again led the blue line out of the pandemic recession. And then claims started to get better. And now what's happened again is claims have held up while the red lines died. And if you look at what's happened in recent years, which one of these are more likely to adjust? It seems to me claims are, is the eventuality, not the other way around. But I think the majority mindset is that it's payroll employment that's going to pick up. I suspect we are going to get some layoffs eventually, particularly if we stay at job growth of zero or worse. If you go real quick, this is just something I wrote about this last month, which I think is another way to look at this. Why pick one or the other? A lot of people are satisfied that unemployment's staying low, which is on this chart. I think it's lower than like 80, 81% of the time in post-war history are now at 4.1. But if I go to the next chart, the annual growth in payroll employment is lower than like two-thirds of the time since post-World War II. And the only time it's ever been lower is you've been in a recession. We've never had job, annual job growth this low without being in a recession. So which one do you go with? You say, well, I'm okay because unemployment rate's holding. I'm not okay because there's no jobs. I'd say, why, why choose either one? Let's go with both. And what I came up with on the next chart is the U.S. Job Market Misery Index. You know, we have the misery index, which is inflation. I just, let's put these two together. If I take the unemployment rate and subtract from that the annual growth in jobs, then I've got both components that make up the jobs. How many are out of work and how much prospect is there in the future in terms of job creation? And right now there's about 4.1% unemployment. There's about zero job growth. So the misery index at 4.1. And by the way, that's higher than about 88% of the time in post-war history. And the only time it's ever been higher, if you look on that chart, is when you've been in either in a recession or the first months of a new recovery when the job, when it's been coming down from recessionary levels. We've never been anything like this before. I think, I think misery is pretty high in job market. And I think a lot of participants will tell you that because it's real it's really gotta be frustrating if you're looking for a job or you don't like your job and you'd like a new job. If you're now going to have the Fed raising rates next week. And I think that's where we're at. And I just think at some point we keep bringing negative force on something that's already this vulnerable. It could be a bad result. If you move a little, before I do that, I just wanted to show, I took all those gray, shaded areas are when the Fed was in an easing mode, dropping interest rates. Okay. And when I laid on top of that here is is the Fed funds rate. I use the treasury bill rate because it's consistent series going back, but it's effectively the Fed funds rate, the three day bill, three month bill. And what I want to show you is you look whenever there's been a shaded area, usually the Fed's been easy, almost there are the shade. I'm sorry. The shaded areas are when I misspoke. The shaded areas are when the misery index is where it's at today or higher in the past. So it's kind of shows where we are now or worse. And most every time the Fed's been easy, historically, not maybe not next week, which I think is a little bit, a little bit odd. And I'm not sure that's appropriate. If we move beyond the job market here, Matt, well, one last thing on jobs, I guess. I recently, you know, the, the, the, I recently, you know, the, the epicenter of growth in the economy right now is everyone knows is business investments. That'd be the only really robust thing we got going, but it's so robust that you're going to average it out and everything looks okay. But I look back historically and looked at the trailing 40 quarter correlation between annual growth in the investment to GDP ratio and annual growth in employment. And as you'd expect, we've had a positive correlation throughout post-war history. A lot of times, most recent history really strongly positive correlation that is investment spending by businesses create jobs. This just stopped a few years ago. We're now it's slightly negative investments. No investment spending no longer as a job grant. Maybe that's okay. I don't know. Maybe that's the new world. Maybe it's the new era. We can all be fine with it. I don't think that's a sustainable situation in this country. And if, if, if investment spending is the only thing we got going, which you could almost argue right now, boy, that's a problem in my, at some point if you look a little beyond just job market, a few other quick things I highlight this one I've talked about before the blue line there is the 10 year treasury yield. And the red line is the U S economic surprise index. And this one's from Bloomberg. I don't know if you're familiar with Bloomberg. And it's just based on hard data only. I could have used the overall, they kind of say the same thing, but if I take out survey data, cause some people have a problem with that and just look at actual reports, like the actual job numbers, the actual retail numbers and so forth that you get the red line there. And clearly we've had a slowdown in economic momentum because reports have increasingly now just in the last month and a half or so started to come in worse than expected. So we're, we're changing that again. We spent the whole year, the early part of this year with that going up. And that's, you know, where reports are coming in better than expected. And that's one of the reasons that the stock market has done well and the like. We're now in opposite mode. And what I want to point out here is everyone's so freaked that the bond 10 year bond yields go into five. Maybe it will, but I got to tell you, this thing says it might break four again before the years. What does it say? If you look back on this chart, this is kind of during this bull market, since the summer of 2022, almost every time the red line is been leading the blue line, you don't find a lot of things that lead the bond market. This is one that has during this bull market. Most of the time you can see red line went down. The blue line eventually did. Red line went down. Blue line eventually did really. That's what we got right now. It's not longer than its normal lag time right now. It's kind of coming into right at that lag time. Well, we'd have to have something kind of break for that to happen, but that wouldn't be out of the question. And I'm more, I don't know if I'll be right, but I'm more of the view. We could see 4% handle on the 10-year again than I am breaking five. We'll see. And that's really a testament to weak economic. If you go to the next one, it's a little different indicator, but we're so concerned about runaway inflation in this country and the like. And what I have here is the blue line is total US consumption as a percent of GDP. And the red line is the US labor participation rate. When we had a runaway inflation in the 1970s, it was caused by excessive aggregate demand. And it was caused by excess consumer demand. primarily. You could see that the size of the consumer grew steadily throughout the post-war period. It followed the trend of labor participation. More and more people participated in the job market. More and more people made income. More and more people drove up aggregate demand. Well, the consumption now has stalled for the better part of the last 20 years in terms of growing bigger and bigger. And I think it's because there's less and less labor market participation. I wonder what this last dip, the most recent one that's just happened this year, or in the last eight months or so, in labor force participation, will that show up in the blue line up there? Or will we have even a bigger dip in consumption forthcoming in relation to overall GDP? And that will take, that will grab some attention if that happens. And it wouldn't be unrealistic because you can see the relationship here in the past. If I look at the next chart, just on retail sales, the red line here is retail sales. And you can see what's happened in the last 20 years. And I think it's because there's less and less labor participation. Retail sales were flat for the better part of the last couple of years until the start of this year, and then they popped up. But they haven't been followed by real disposable income, which is the blue line. There's been no pickup in real disposable income. And how long can that red line keep rising if the blue line doesn't pick up? And that's the question I have. So people are excited that retail's picked up. And actually, you can't see it here unless you look closely. It's actually rolled over in the last two months now, the red line.
Speaker 2How much of that is inflation? Just the aggregated sales data with increased prices?
Speaker 3There is. You mean the uptick? Absolutely. Well, in this case, this is real retail sales. So it does back out. It backs out inflation in this case. And it's just the amount by which, and you're right, in the last couple of months, a lot of the decline has been we've raised prices really more than real purchases in retail. And so you're seeing that roll over. But I just think consumers are going to be less and less. And I think that's the question I have. When you think about, you know, lack of any job creation, and you think about the savings rate is almost at a record low, and then you come around, there's no real disposable income growth now for the last two and a half years. I think that's going to come home to roost, actually, I think. And that's an issue unrelated to jobs, but just on the spending. And then I got two more charts just looking a little bit at an aggregate measure of economic, real economic momentum. The red line is the annual growth in the U.S. Coincident Economic Index. And this one in particular is this is based on four major items across, you know, production, spending, employment, everything, kind of a good measure. It correlates very closely with real GDP growth, only it's a monthly series rather than not. And what I've laid on top of that in the blue line is the relative performance of S&P 500 cyclical sectors. Basically, the consumer discretionary, financials, materials, and industrials. And they just keep underperforming badly. And in fact, year to date, that last part of the blue line has really fallen off. You can see there's a fairly good correlation here. And the performance of cyclical stocks leads real economic momentum. Again, the blue line's typically leading, the red line in this chart. So again, I think there's just negative force down on the economy. And I don't think it'd take a lot more to bring a lot more attention. If this red line goes down much more, I believe not far payroll gains will go negative. And that's going to be hard to ignore if that happens. Then the last one just brings us back to where we started here. We'll come back to this a little later. But this is just one chart on that, the profit thing going on. I've over, this goes back a little farther into the 60s. The red line is that same annual growth in the coincident economic indicator, the real economic momentum. And the blue line is real corporate profit, both adjusted for inflation. And if you look until this recent surge in profits, they went from zero to 20% in real term annual growth, maybe in the last year. It has not had any pickup in the economy. And historically, they almost always go up and down together. We don't get a big profit boom without the economy doing that, except this year. We've got this massive profit boom, but the economy as a whole is just laid there in the muck. I don't know what to make of that. Maybe that's just new era, and maybe it's sustainable, but I have my doubts. That's kind of what I'm getting at. And I also think how narrow this is. It also makes me wonder about this profit boom. How much double counting there could be going on in this thing. There's just a handful of these companies that are making up this boom in some regard. There's a lot of companies doing well, but a handful are making up a lot of that corporate profit gain. Those companies own each other. A lot of them own each other. And so what you're finding now is part of their profits is coming from how well the other companies have gone up. And then that company owns the other company, and they get to report better profits. There's little items like that that makes you wonder about the quality of the reports that we're getting. But I just think the oddity of it is what stands out to me. And is it sustainable in that regard? So I don't know, Matt. I'm just saying I could see growth becoming more of an issue and maybe overtaking inflation yet in the months ahead.
Speaker 2Well, if we get there, we might see one of these things that we haven't seen in a while. We're going to trot out the R word. We're going to trot out shock and awe and response. Walk us through what you're thinking on those fronts.
Speaker 3Yeah. Yeah, you bring up the R word before I go to that just real quick. I can't even bring myself to do the R word. There's a part of me that says I should. And you can kind of tell close to that, but I just can't. We haven't had a recession in this country for 16 years outside of the pandemic, which was an exogenous event. It's hard to call one. And balance sheets are pretty strong and healthy. So I'm not even going there yet, but it does make me wonder. The reason I, this is a bit of a sideshow, but I think it's kind of interesting. And that's why I'm going there. I think a big part of this bull run that we've had, and maybe in some degree, the post-pandemic run, we had 22 correction or bear, and then this big run we've had now since 2022, I think a lot of it is because of shock and awe. That is, we have created this massive wall of worry. Which there's few foundations better for a stock market than a massive wall of worry. If you've got everyone worried about end of world scenarios, then no one's overexposed. They're all underinvested. They've all got excess liquidity. And they're all waiting for the collapse for the opportunity to buy. And then it's hard for it to come down when so many players are on the other side of the equation. It's just saying, you know, a bull often runs because of fear. And we've had a massive one. This chart is economic policy uncertainty, or how much uncertainty is perceived in the economy. And this one, the reason I ran is it goes all the way back to 1900. Let me load this up and look at it in some detail. I've got recessions listed there as well with the gray bars. But I'm fascinated. You can see the pandemic spike that we had in 20. That was almost understandable because it seemed like a, you know, a healthcare pandemic that could end the world and for a brief period of time. It only lasted a couple months and it kind of came back below that red line where we are today. But then we had the Trump phenomenon, which is just nothing but a wall of worry created. It's maybe his best achievement in some regards of this. He created this massive support under the stock market by chronically creating uncertainty and the like. This index is created from newspaper articles uncertainty or specific changes like tax policy changes or worried about inflation or government policies is where it comes from. I'm amazed by how high it has got and then sustained when you think about the things we went through in the past. Look at World War I. Look at World War II. A conflict. All the things we've been through, nothing's come close to the type of shock and awe we have experienced in here. I think it's helped the stock market a lot. And if I go to the next chart, I'm going to take this chart and shrink it down just since 1985. And they're not exactly the same chart, but they're very close in what they measure. And this is, again, economic policy. Go back to 1985. And I've got the red dotted lines sort of marked the quintiles over this period of time. You can see we've laid entirely in the upper quintile, the whole bull market in this cycle. But we're getting close. This is why I'm bringing it up. We're getting close to falling back into normal. That might be a big loss of support for the stock market that people are not at all focused on. People might finally get comfortable for the first time. They might actually feel, yeah, things are okay. That's not good. I think this wall of worry has been fantastic. fantastic. Now, I think it's currently around 175 in this chart. 150, it would break into the middle two quartiles. If it breaks below 120, it's in the lower two quintiles. And it wouldn't take long. You can see when this thing's come down in the past, it's come down pretty rapidly once it starts. I think what's happening, we're getting a lot of the same news we've had. It's just that we're becoming more immune to it all. Tariff insert is still wild, but it just doesn't have the same impact anymore. You can tell that because it doesn't get the same mention in media as it used to get. The Iran conflict started getting longer, too. It didn't quite have the impact that it has. Now we're going to get into midterms. That could change dynamics, but it could change in a way that makes people more comfortable. I don't know. I'm saying I wouldn't be shocked if this thing falls back into that range. And you can see in the next chart, why it's worth bringing up today. And this chart looks just since 1985 at how stocks have done on a one-month forward basis from where the economic policy uncertainty index is, and then how do stocks do one month forward, and what's their annualized forward one-month returns. Well, from highest quintile, which is our entire bull market, there's an average annualized return of 20% when you're a top quintile, which we have been the whole time. You see it falls off quite a bit when you go to the middle two, or really if you go to the lower two. And even the lowest two quintiles is not that far away. I'm just saying that I could see where shock and awe changes maybe over the next coming couple of years here. And that could maybe change some of the dynamics in the stock market as well.
Speaker 1It's interesting because you were talking about this idea of people worrying about everything. And looking forward, there's probably more and more things to worry about. That doesn't seem to be ending anytime soon with all the upheaval and turmoil we have. But your point about people stop worrying about the things they normally would worry about is really interesting. It's not the actual things to worry about that's going to go down. It's that people don't care anymore about all the things to worry about, which is really interesting.
Speaker 3I think that's true. I think we've become immune to it a little bit. I would argue that sentiment, as I see it in the marketplace today, in the stock market, Main Street's a different animal. I would say it's not necessarily totally exuberant. I don't see that. More exuberance in periods past. But it's certainly not radically pessimistic either, particularly with the AI story and everything. I'd say it's just complacent. I mean, when you keep getting told the world's going to end, and it never does quite, and stocks keep going up, and every buy and the dip you do works, I think that's where we're at. It's more complacency. And that's also why a change in the narrative would be huge. What I'm saying is we have been trying, since the pandemic, to worry about inflation. What if we suddenly, to Matt's point earlier, start worrying about recession? That would be a big flip in the narrative. That would tend to shake, at least in the short run, shake up overall. But I do think a lot of the other information out there has been vetted to some degree. And people have come to grips with that. And it's kind of the same old, same old, rather than something brand new they have to vet. That could change, of course. But my basic point here is we've been helped a lot by shock and awe in this bull.
Speaker 2Abnormally so. And maybe that's coming to an end. So let's get ourselves into some of the warning signs for the stock market itself. Because, to your point, we're baking in these assumptions. If that narrative changes, it catches some people off sides. You've identified some warning signs.
Speaker 3Yeah. And I want to focus on those that I've just kind of thrown out there here in the last month. I mean, I've talked in the past about some of the more high-level ones that people know about. I mean, valuations are high. You know, overall, the Buffett, you know, the Buffett indicator, it gets a lot of press. That's a record high market cap to GDP. You know, you certainly, you can look at put-call ratios. There's other sentiment measures that suggest caution and that kind of stuff. As I mentioned, technically, we just broke yesterday through the old AI rally high in early June. We broke below that in closing. So there's some technical issues. I think participation is slow, those kind of things. But these are some that I've just kind of come across in the last month that I've been focused on that I think are not maybe as widely focused. But it's just on top of all those other things that people know about are also things that are important. And this first one is just the S&P in blue shown with that economic surprise index, which I talked about earlier with bond yields. Well, there's also been a pretty good relationship with the stock market. When economic momentum, when those red line dips down, you can see a kind of a dip in the blue line as well, most of the time. We haven't had that yet on this dip, but it's been a pretty good dip already. I think it might get worse. You wonder if it's going to catch up to that stock market. People certainly went up this year, you know, in some regard, because of the increase in economic momentum. The red line went up dramatically from late last year, to about June. That was during when the stock market rallied as well. And now it's come off quite a bit and people still feel like it's okay. I'm not sure what level that red line gets to before someone goes, oh gosh, maybe it isn't. But I don't think we're that far away from it. This one is just odd. That's why I put this in there. This really looks back, I think from, if I can see those dates. Yeah, I thought it was, if you go back here to the top, top of the market to 2000 in the dot-com market, I got the S&P in blue. And since dot-com, the red line here is the relative performance of large cap growth. Now, since dot-com, you have rarely had a market rally in the S&P 500 that sustains without growth. Almost. The one that might come to mind a little bit is off the bottom of the 2010 crisis for a brief period of time. You can see it on that chart. But otherwise, there's been a pretty good connection between these two. When the S&P goes up, growth is generally outperforming with the red line. So it is very concerning, I think, when you look at that 25, 26-year record, that we've had a heck of a pullback in the relative performance of growth, which have not recovered with this most recent AI rally. And maybe it doesn't matter. I said this is a little bit of an obscure indicator, but it certainly caught my attention. This looks, again, at the S&P 500 in blue. But what I've got here is a measure of what I call household enthusiasm in this case. And this is just a ratio here of the real purchasing by the unemployment rate. So if real income is rising and the unemployment rate is falling, the red line is going up and households feel pretty good about the work. And you can see there's been a pretty good relationship here, really going back to the 1990s, periods of time when household enthusiasm climbing on Main Street, Wall Street does well as well. And when this has rolled over in the past, it's generally brought some turbulence to the stock market. Now, it has popped up of late. You can see the very end of that series. But it's been coming down here for the last several years, really since 2024, 23, 24, without much response from Wall Street. Maybe that's a new phenomenon that's going to continue. I don't know. But it bothers me that Main Street is feeling some pressure, if you will, which is typically a rattled wall, and it hasn't done that right now. I also think that red line won't stay up. The red line went up predominantly because real wages went up after inflation moderated here a few months ago on the backdrop of oil prices peaking. But now we know what oil prices have done again most recently. So in the next few months, what's going to happen? Red line's going to come down again as real wages start to come off again.
Speaker 2And you see a disconnect between that and, say, when people talk about the wealth effect, this is a different way to frame the way some of that gets lumped in, I think.
Speaker 3It is. I think that there's a wealth effect from housing, real estate, and stocks, and bonds. But the reality of that is, that I've looked at historically, is that's really coming from the upper quartile, or maybe not even that much, of the income distribution. And because of that, and because it could be overcome, what is spent by what is spent by the lower, lower income groups, and maybe not even all that lower, maybe some mostly middle and lower income groups. That's what I've come to find. That's why I do pay attention to these. This does not have the direct wealth in it, though. To your point, Matt, this just has real income and unemployment. This is really obscure, guys, but I drew my attention. This is the IACIP services, monthly reports, going back to 1999, because that's when they started coming out, and what you have here is the red line is employment, and the blue line is new orders. Now, the reason this caught my attention is that new orders is what's driving this economy right now in a big way, because new orders is basically capital spending is what it is. It's investment spending. So what you find is a lot of the time, most of the time, when new orders go up, so does employment, which makes sense. And that's also true, as I said, of investment generally creates jobs, and they kind of move together a little bit. If companies are bullish enough to expand their capital spending programs, they're probably bullish enough to hire people, too. But there are some times that poke out on this chart, two other previous times that are very interesting. One of them was the top of the dot-com market. When that blue line shot up, and you know, employment went nowhere over that period. And we know what happened to the stock market after that. Then again, if you look at 2021 and that bull, at the end of that 2021 period, new orders had shot through the roof, but employment, I assume, services went down. And we know what happened in 2022. We had a 20% plus bear market. We've got the same pattern going on today, where new orders are shot up, and there's been no increase in ISM employment from services. And I don't know if that's telling us something again, or if it's not. A lot of the other times they've moved together and everything was okay, but those specific times kind of brought it out. We've got that same pattern going on today. This is kind of getting increasingly out there, but I'm relating the stock market here, S&P 500, to CAA credit spreads. And this is getting increasingly tied to the AI story, where tech spending used to be financed almost entirely out of cash flows. Now they're using credit and other means to do it. And you can see that these credit spreads, deep junk, are definitely widening out. And so are CDS spreads. Now, some of the bank spreads haven't done much, but you're starting to see some pickup in these. And you can see historically that when we've had any kind of pickup in that CAA spread, we've had turbulence in stocks. Most recently, it's been particularly close. I've just got those last three dotted lines come out in this bull market, where you had a pickup in credit spreads, and you had a definite pullback in the stock market. Now, we've had as big or bigger pickup in credit spreads again, just this year. And as yet, we've had no reaction from the S&P 500. So again, just another thing that kind of gives you a pause. Tie that idea back with the
Speaker 2credit spreads in particular to if we see a Fed hike, because I think this is one of the other concerns. We see spreads widen on a hike if we lessen liquidity in the system.
Speaker 3Yes. I think there'll be some of that. But I think it's been less sensitive than it has historically to, let's say, Moody's BAA or CSA Bark junk spreads. Because of the fact that balance sheets for the household and for the corporate sector accurately are fairly strong and have been really since the great financial crisis in 2008-9. You know, debt to income ratios have come down, are still coming down for the household sector. Corporate ratios have come off, and cash levels have been pretty good. So it's made it less and less sensitive that we haven't seen the spreads widen out, even as the economy has slowed a lot in the broader part. But I think this is how it relates a little bit, Matt, to this day's situation is the one part of the economy that's driving all the data in a good fashion is the one part that's using debt now in a big way. I mean, consumers still aren't in a big way. Most economy companies aren't. But the new era part that's going gangbusters with growth is using debt now for the first time. And they didn't ever used to be that way. So they've kind of transformed themselves into cash on the barrel head. We don't involve ourselves in cap spending to one that's old-style industrial cap spending type of risk. And it's starting to show up in some of these spreads. And I think that's sort of. That sort of is concerning, given that that's the one part of the economy that's really doing well and really tugging all the rest of it along, and that it's really changed its stripes from what it's ever been historically. You know, the last part of tech that ever felt that way to me was when Bell Operating Companies, leading up to fiber optics, they all laid the same fiber optic cable down the railroad beds all across this country. And most of them went, after that, no one made any money on it. So they changed their stripes. So anyway, it's a good question. This chart is just looking at another way to look at how overdone this rally is relative to other asset classes. And this one just compares the relative performance, total return performance of the S&P stock market to the U.S. bond market. And in the last 76 months, the stock market has outperformed bonds by more than it ever has over the previous 100 years. Now, I picked a specific time period to get that result. I agree with that. But if you use 10 years, it's very similar. My basic point here is just that we've had very extreme levels of performance of this one asset class showing up to a lot of different ones, but particularly to the bond market as a whole. By the way, the bond market suffered negative returns over this last period of time. And it's only done that two times in 76-month periods. And this one, its negative return is twice as large as it was the other time it did it briefly. So not only are stocks really out of bounds increasingly just on how they've done, but bonds are increasingly out of bounds on how poorly they've done. And if you look at these dates, if you want to study that more, closely at a minimum, those red dates at the top were good times, not to sell out of stocks, but were good times to move your allocation more towards bonds and away from stocks because they tend to, they ultimately, when that went down, stocks underperformed bonds. And I could very easily say, maybe we don't even have a collapse in the stock market, but we start to underperform bonds. 5%, 10 years might prove to be pretty good for a period of time. That was some price of yield plus appreciation. They could be very competitive with a stock market. And then these last couple I want to bring up, I want to focus in here on the importance of investment, which is kind of the epicenter of this thing, and the stock market. The blue line again is the stock market here, and the red line here is gross, private, domestic investment. And these are just levels on log scale. But boy, you can see how closely related they are going. We're back quite a ways here, where when investment rolls over in real terms, business spending rolls over, you get some meaningful pullbacks in the stock market here. And I'm kind of surprised how flattish overall real investment has been here over the last few years. New era has continued to soar, but when I average it in with other old era investment, it hasn't been nearly as dramatic. And it's already kind of shaking. We're kind of showing a sign where the stock market is getting ahead of that investment equation. And it's not a huge sign, but it's a little bit concerning. In the past when that red line started to peak out, stock market eventually had some issues. And we're kind of there now over the last couple of years with investment as a whole.
Speaker 2Do we lose anything on this? Explain the per job part. That was one with this one that I wanted to understand, why it's good to divide it per job in this case, or is it useful?
Speaker 3Yeah. Well, I'm going to show you that in an uptick. I'm going to show you that in an upcoming chart here. Investment as a whole, it's kind of how much additional capital are they willing to apply to the labor force is what I'm kind of getting at. And it's really, it isn't just investment. And I should have made that one clearer. I'm glad you brought it up. It's really how much labor deepening are they applying, if you will. And that's what correlates. If I just put investment up there, it wouldn't be this close at all. It's not the level of real investment. It's the level of labor deepening, if you will, that really shows the strong correlation. That's starting to change. And it's kind of amazing when you think about the fact that labor has virtually flatlined and yet old and new investment combined have not continued to rise relative to the labor force. So thanks for bringing that up. And maybe this will make it a little clearer that this is a little closer period just since 1990, but I'm looking at the stock market and I'm looking at S&P real profit per job. No, not investment, but profit. At the end of the day, you invest for profits. And this is the thing really driving things right now, is you can see that there's, I would say there's profit productivity is obvious in this economy. Regular productivity is not obvious to me. We are not seeing, I think, the output per hour going up, I think, in any meaningful way yet. But we certainly have seen profit productivity, where real profit per job has exploded. And you can see that that's really the biggest thing driving the most recent stock market over recent years. And the concern I have with this is if anything happens to this red line, I think most would be worried. Most would be worried. And so let's look at the next chart, where I'm going to take this profit per job, the annual growth of it, which is the blue line in this chart, and I'm going to overlay the yield curve, the 10s to 2s yield curve with that. Now, the yield curve, the red line here is leading by four quarters. So it is historically not a perfect relationship, but historically, when that red line rolls over, what you get is pressure on the profit cycle, particularly profit per job cycle in the United States. And today, as we said, we're heading back almost to another new low in the 10s to 2s yield curve. We've got two-year yields going up a lot faster now than the 10-year yield on the idea of Fed tightening coming and the like. But my point here is that we're not going to see a lot of profit per job. We're not going to see a lot of profit per job. But my point here is we're getting to that lag time now, where that peak of that red line here most recently, we're just entering that period here as we enter towards the end of this year. And so I have some concerns about it. And I think more than anything, this would change a narrative if profit per job starts to roll, particularly in the new era.
Speaker 1Can you explain the difference between profit productivity and regular productivity and why you're paying attention to profit productivity?
Speaker 3Well, I think that. I think that in some regard, real productivity, I've written a lot about this too, Jack, that there hasn't been a lot of evidence that's picked up yet. That's. People will say this too, that we're still. The jury's still out whether it's AI and all this is creating productivity in the economy. The old style output per hour by workers is rising. And yeah, it's up a little, but I've shown that that's basically because the economy is growing so weakly. Whenever we have recession. Or weak growth, productivity goes up. Measured productivity goes up. Because if you get into a weak period, companies cut jobs and yet sales don't right away fall. And so you get same sales with less jobs, measured productivity is up. It's not a sustainable productivity. And what we have had in the 90s was sustainable productivity with dot com. We had rising output with rising jobs going on. And still had rising output per job. So we had like 2% or 3% job growth and we had 2% or 3% productivity growth all at the same time. That's not what we got here. We got maybe 2% productivity, but that's with jobs going to zero, essentially. So I don't think we've seen the old style productivity. But what we have had, and almost uniquely so in this cycle, is one of the best surges in profit productivity, which is not. This is the official term you're going to see in the economic 101 textbooks, but I've used this and it's really exploded since the 1990s and has continued to explode in this cycle. Prior to the 1990s, profit productivity, as measured here, was pretty flat from World War II up until the 90s. I've used the profit productivity past overlay with PE modals and the like. It's one of the reasons we have record setting new valuation range since the 90s from what we had from. Let's say prior to that for the previous 100 years, I think this profit productivity is out of bounds as well. It's been a key things that has come about. So in some sense, we're no longer making workers more productive, but we are squeezing more to the bottom line in real terms per work. And there's a reason why more profit margins are record highs at the same times that labor compensation and GDP are record lows. That's because profit productivity is making up the difference. It's a big way. Is it sustainable? That's debatable. But I am a little worried about what might happen just because of the policy pressure now on profit productivity and on the basis of a pretty close relationship story. This is the chart we started with, with those earnings broken out in those three categories. The blue line makes up a little less than 50%. Really the blue and the green make up about 50%, pretty close to 48, I think, and the red line makes up the difference. If you look at each component separate, let's start with the red line. Do we expect that that's going to get better in the next 12 months? I don't know why. The bond yield has been going up, the yield current has been getting flatter, real money growth is around 1.5% to 2% in the last year, which is pathetically low. There's not enough room even to grow GDP much more than 2%. Okay. If anything. The red line, you could expect with higher oil prices, retarding purchasing power and policy tightening for monetary and fiscal concern, why would the red line get any better? In my view, I think it's going to get worse. If you look at the green line, is that going to get better? Well right now, you'd say it might with oil prices back up close to highs, but really even though oil prices have gone back up to their previous highs in March, that means they're flat over the last 12 months. And guess what? Those flat numbers are going to bring that green line down in the next quarter or two. That is, oil prices may still be high, but they're no longer rising on a growth basis, and that's what matters for profitability. It's not the level because costs catch up, it's they got to keep going up. They've stopped going up. Even though they're back up to highs, they stopped going up since March, which means that's going to catch up to that green line. It's going to come off. We've got two components, I think, going down. Then it's down to what does the blue line do? And that's the wild card, no doubt about it. Can this thing keep up at the pace it's been going? I think it's doubtful, even if nothing bad happens in this arena. Just it was so unbelievable from the base it started at this year. And what I'm looking at, too, is based on expectations here. This is forward 12-month earnings estimates. I got to believe there's a healthy dose of emotion in those numbers. And maybe even getting more so now as we're going forward as people are catching up to this. But I'm also looking at things like corporate cash flow to new era investment spending. That ratio has come down just the last two quarters quite a bit. That was a really good driving force for this whole cycle, and just tech in general was when new era spending was financed. Now it's not. And it's really, in the past when that's happened, that's sort of ended a lot of these tech cycles. I think it could impact AI side overall. But I just think that when I look ahead at the driving force of today's year, this year, the driving force has been that blue line and that sharp. And if it even goes sideways up here or just slows its ascent while green and red go south, suddenly the S&P 500 goes south. The S&P earnings growth rate starts to erode. And that also is a new narrative that hasn't been part of this so far this year. I think those are some of the concerns. All that said, I'm not forecasting a bear market for the S&P. I think there's a bear market in tech coming, 20% plus decline in tech and telecom, the blue line companies. But I think the rest of it, you know, they haven't done that much to tell you the honest and true. Those stocks, seven sectors, they haven't done much at all. I think they go down somewhat with it. But I think a lot of them hold up pretty well. So maybe you get a 10% to 15% overall correction that's made up of 20 plus for new era and the rest of it goes down some and puts you in that range of a full-fledged correction over time. I also think a gut check here would be good. It would also bring policy easing and some of the things I think. The broader economy needs here for this thing to continue, if you will. If we carry this on too long, I think we do create a situation where the divergence between profitability and jobs in this country becomes so extreme, it caves in on itself, at least for a period.
Speaker 2And that could be from a slowing of the rate of growth or a change in the rate of change, which can not.
Speaker 3Which is always what matters for stock investors. It's not necessarily the level. And the rate of change, the change in the rate of change is that second derivative that drives stock prices at the margin. And that, I think, is probably on steroids when you're dealing with this blue line and its concentrated impact on the overall stock market this year. If everything was doing that, that'd be one thing. But now we got a real bifurcated situation, which I think increases the beta on that situation even more. Well, Jim, this has been great.
Speaker 1We'll forgive you for your time. We'll forgive you for less than 30 charts this time, but I'll
Speaker 3expect 30 next time. Well, you know, it's just public.
Speaker 1I did shortchange you, though. You have 27 charts, and I only gave you credit for 26 in the beginning. So I do have to correct myself.
Speaker 2Take 27. All right, Jim, people want to find you on the Internet. Where else? Remind them where we should send them.
Speaker 3You can go to Paulson Perspectives, all one words, with Paulson at en.substack.com. And I live here in Minnesota where everyone's spelled with an O-N, but I'm an import, so I'm an en. Very good. They can look at all this stuff that I put out about two pieces a week generally. I'm too old to do more than that, guys.
Speaker 2Hey, two pieces a week and 27 charts per hour. You're doing pretty good, Jim Paulson. This is Excess Returns. Check us out on the Substack, too. We'll have the transcript, all sorts of links to Jim's work there. Like, comment, subscribe, wherever you're watching, and we're out.
Speaker 4Thank you for tuning in to this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the Excess Returns Network at excessreturnspod.com. If you have any feedback or questions, you can contact us at excessreturnspod at gmail.com. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the hosts or their clients.
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