Speaker 1the biggest thing that i keep an eye on here and what i'm focused on a little bit is is the job market because i really think that ultimately the job market's either going to pull this economy down further or at least force the fed's hand or it'll re reignite a little bit and grow faster one of the most intriguing aspects of where we're at in this bull market we're just about ready to celebrate its third birthday heading into its fourth year is that we have not used a lot of the normal support systems that are generally used during a bull market there has been an upward bias in valuations going on for 30 years in this country and so we can't use our judgments back historically of judging high or low anymore something else is going on if i go back to 1960 and i divide all the months up into periods where the funds rate went up that month or went down that month the difference in stock annualized stock returns for the s p is 14.6 versus 1.7
Speaker 2jim it's hard to believe it's been already a month but here we are against a ghost pass no kidding so what we're doing is each month we're having you on to talk about the markets the economy what you're seeing under the surface in some of the data that you look at that might be meaningful and important when it comes to thinking about the economy and where we might be headed um and so this conversation today um we'll be working through some of the latest charts that we've pulled from your sub stack paulson's perspectives um to get your take on you know sort of what we're what the data is telling us and where things um may be going and for people that are watching this and are interested in kind of following along with jim in real time you can go to his sub stack which is paulsonperspectives.substack.com and you can sign up and then sort of see what type of material he's putting out both in the free and that in the paid version um if you're interested so um so jim we like to start you know what we will where we always want to i think start these conversations with you is sort of just has anything changed from your perspective from where we were a month ago and what are some of the most important things that investors should be paying to attention to
Speaker 1right now yeah um we'll certainly have i mean we've had um uh enough weak data to get the fed to ease since we last spoke we're kind of in the works towards that as we spoke last time but you know at least they did that now whether they do it again that's of course still up for debate but uh but that's probably the biggest thing that has changed and we'll visit a little more bit more about that but you know i got i got just as much concerns as anyone does right now i guess you know i'm still worried about inflation kicking up from tariffs although i i'm less worried about that i i think it's probably not going to really come through in any meaningful way but that you know it's still in the back of your head if that would happen i'm probably more worried inflation i'm a little more worried about recession and again i don't think that has high probability either at the moment but it still certainly uh could happen and that that's still much more solid inflation in my mind anyway of uh you know watching for other sites that that would uh come out i think that the biggest thing in the short term is i wouldn't be at all shocked you know we get a little i don't know if i call it full-fledged 10 correction but a pullback a pause in here at some point um i don't think we're en route to a bear i don't even know if we'll get a correction but you know we've had a pretty good run off those april lows and um you know some marking some time it does seem like some of the sediment indicators have you know risen up a little bit at some point in time but you know we've had a pretty good run off those april lows and um you know some marking some time it does seem like some of the sediment indicators have you know risen up a little bit it feels a little more complacent you look at the vix and the move index bond and stock market volatility there they're they're both extremely low you know kind of sensing a sense that people are getting a little complacent and feels a little too easy and that thing so i wouldn't be surprised by that i wouldn't i'm not going to do much about it because i don't think it'll last or be that deep but um you certainly could have that but i guess the biggest thing that i keep an eye on here that i'm focused on a little bit is is the job market because i really think that ultimately the job market's either going to pull this economy down further or at least force the fed's hand or it'll re reignite a little bit and grow faster again taking us out of this mode i think that's the key ingredient i just don't see how we can stand pat if job creation which you're on here right now is one percent year to date it's annualized through august now and she analyzed at six tenths of one percent it's just unacceptable growth for the job market i think to persist while our leaders and policy officials stand pat so if that weakens any further you're going to do a couple things bring bring relief but you're also going to raise uh recession fears um you can imagine we're at four or three unemployment if we went to four or five you're going to hear a lot of concern coming out of people's you know uh voices i think um on the other hand if it picks up again or you know there's going to be concern about you know the fed doesn't really need to ease further so to me an important ingredient of where we go from here is going to be what does that job market do in aggregate going forward uh i'll probably be visiting a little bit more about that
Speaker 2particularly in the next month what was your take from the um take away from the fed meeting like one of the things that i thought was interesting and you can correct me if i'm wrong here but what was your take from the um takeaway from the fed meeting like one of the things that i thought was interesting and you can correct me if i'm wrong here i had never really heard of like a rate cut being positioned as like a risk management like rate cut and that was one of the things that pal was saying was that like you know we don't really know if inflation is done here but we're willing to cut um just in the event that we are so maybe they're always risk management rate cuts it's just i've never really heard it freed up that way um i don't know what what what are your what what are your thoughts on that
Speaker 1um obviously i'm not a big one on the you know the fed meetings the press conferences i um i i kind of feel like on the day they finally do them we pretty much knew everything they were going to say before we did it anyway there's not ever too much that comes out of them i mean you could say well they didn't do a half they did a quarter and there was some expectation half so there physically was a difference there but i mean as far as what he said probably about what he said the week before that and the month before that and you know for the most for the most part i i don't think that there was really much that was added there it's cool came up with a nifty new slogan for rate cut you know one that uh kind of more than anything probably highlights the fact that you know this is a rate cut that he really doesn't want to do but kind of needs to do and and how do you how do you justify that well that's a great term for it you know and he's not the first fed chair has done that we you know we've had rational exuberance you know we've had we've had other terms that have been great terms brought brought up by past better reserve chairmen to try to uh get in a mindset that uh gives them a good position if you will all right you know so uh bonus to him for coming up with a creative term i think we'll see if it sticks to to your point but as far as what we found out on that breast coverage from what we knew before i don't think much has changed i think at the end of the day we're sitting here uh even this morning's gdp numbers were revised up for the second quarter to 3.3 and uh in the second quarter and real gp 3.8 i think consumption was revised up by more than percent but the reality is year to date real gdp is up at a one and a half percent annualized pace after these revisions and real personal consumption is also up at a one and a half percent pace and as i mentioned through august employment growth is up six tenths of one percent those are not rate rates of growth that would be normally associated with standing pat particularly you know when inflation rate even though it's 2.9 or whatever has still been basically in the same range now for the last two years so i do think that we're we're still more towards the towards and i think the fed felt that way at the meeting but towards uh more towards the view that the fed's going to be and i think the fed's going to be more towards the view that the fed's going to follow through with some more rate cuts as we as we go ahead here that would be my guess as well i actually think the economy is going to slow down even more here probably for the next six months and i think we're going to get more concerned about recession but that could turn out to be wrong we'll just
Speaker 2have to see and just given the fact that they've kind of at least eased once maybe it's the start of an extended easing cycle we don't know but we thought it'd be a good time to kind of look at this first chart here and sort of look at how the market has reacted or behaved when sort of different support type of activities come into play and so i'll let you kind of talk to what we're looking at here and we we look at this last month but i think it'll be good to kind of rehash this one
Speaker 1of the most intriguing aspects of where we're at in this bull market we're just about ready to celebrate its third birthday heading into its fourth year is that we have not used a lot of the normal support systems that are generally used during a bull market so we're not using a lot of the normal support systems that are generally used during a bull market um usually a bull market begins when the fed is trying to get out of a recession and so it's easing everyone's easy we're trying to leave that recession behind get to a new expansion and that's brings a lot of support for both the economy and the stock market that then is generally pulled back as the recovery and bull market matures. Now, this cycle has been almost the opposite. We started this bull with a Fed that had just started tightening. It started tightening like in April or May of 2022. Inflation peaked in June of 2022, and they just kept tightening, really, with the exception of a couple months last year. This bull market's lived its entire existence under a tightening Federal Reserve, its entire existence under an inverted yield curve, for the most part, entire existence under negative financial liquidity crawl, excess liquidity crawl, all because the Fed has had this chronic tightening position, even from the start of this bull. Well, the result of that, I think, is leaving a lot of support systems that are generally used to really juice up both the economy and the stock market that we have not used. Now, maybe we won't ever use them, but I think we're getting close because the key to them is the Fed easing. If you look at this, if the Fed now drops the funds rate, it isn't just going to set off stimulus from a lower funds rate, which you can see is pretty good. Historically, if I go back to 1960 and I divide all the months up into periods where the funds rate went up that month or went down that month, the difference in annual stock rate is going to be a lot bigger. So, if you look at the returns for the S&P is 14.6 versus 1.7. That's a huge difference. And we've been fighting against the weaker part of that over most of this bull, and we're maybe just entering the other part. But the thing is, if they're dropping the funds rate, it isn't going to stop there. We're going to bring off these other supports as well. By lowering the funds rate, they're going to allow the long-term rate structure, the 10-year yield mortgage rates to come down. We're starting to see a little bit of that already. I mean, they backed up here since the Fed meeting, but they're still for where they were two months ago leading into the Fed meeting because people were already baking in a cut. So, if you now can get the 10-year treasury to come down, look at what that means for what we didn't have until this point. But it'll also be the yield curve steepening for the first time. I don't have that one on here, but that's a pretty positive force as well. Also, money growth. If they're going to ease monetary conditions, monetary growth is going to pick up. And if you look at the S&P, it's going to pick up. And if you look at the S&P, it's going to every month back to 1960 when money growth year-on-year has expanded versus slowed, it's a big difference in performance. So, we've been dealing with that 2.2 sort of low number because monetary growth has been so weak. The annual rate of money supply growth in this country was negative year-on-year for 16 consecutive months during this bull market. It was never negative in 1960 until this bull on a year-on-year basis. And now, we had 16 months of consecutive negative bull. That's the type of tightening we've been facing in this bull that are now going to change. By the way, at the end of the first, second quarter, I should say, money growth finally year-on-year reached the rate of nominal GDP growth for the first time in this bull. So, I suspect it's already starting to surpass it in the second quarter, which means that for the first time, there's going to be positive excess liquidity available to the bull market. And that's going to be the first time available for the financial markets not being all used up to finance economic growth, something we have not had. Okay. The dollar, I think the thing that affects the dollar the most is monetary policy because they control the return that that dollar pays and they control the supply of the dollar. So, when the Fed's been really tight, restricting the money supply and the like, it has been really tight. So, when the Fed's been really tight, restricting the money supply and the like, it's just caused a massively strong U.S. dollar. If you look back since 1960, or in this case, 1970 for the dollar, when it floated, every time, every month that the dollar has gone up, all those months on average, the stock market's only appreciated by 1.7%. But every month it's gone down, it's almost 23% annualized appreciation. A weak dollar is a huge stimulative force for domestic producers, for the economy, for the economy, for the economy, for the economy. And so, I think the dollar has gone up. Okay. And it's also a huge stimulus force for the stock market. The dollar has gone up in real terms by more than 50% in the last decade, and it went up a lot during this bull market until just recently. It peaked late last year and has been coming down this year, and I think we're already seeing the influence of that. Look at what international stocks have finally done, for example. They're doing better because the dollar's weakening. That's something we haven't had. And then, you Finally, I think that if the Fed does start to ease, what it will do is it's finally going to communicate to all investors and to all private economic players, for the first time in this recovery, we are going to go out to support economic growth. We are going to support job creation. We are going to support profit generation. For the first time, our policies and our actions are primarily devoted to that, as opposed to fighting inflation. I think that the reason they've been fighting inflation throughout this bull is one of the reasons that consumer confidence has been so punk, and it's still in the tape. And it's not just consumer. Small business confidence until recently is pretty punk. If you look at CEO confidence, it's been, we've had chronic calls for recession in the entire bull market, in part because we've had the Federal Reserve chronically saying it is fighting economic growth. And if they show what their actions by increasing the money supply, steeping the yield curve, lowering the funds rate, allowing long rates to come down, dropping the value of the dollar, I think confidence on Main Street finally will rise. And as you can see, it's a powerful force for stocks for all the months that index has gone up, about 16% annualized, which is a little over 1% that it goes down. So I do think that this to me, as I said, is the most important thing that's happening. So I'm just like, you know, it's surprising that the market was able, despite all those things
Speaker 2that weren't supportive, the market was still able to do what it's done over the past two years. So do you have any, like, on the one hand, we know it's been a very concentrated market with a handful of companies generating maybe most of the gains and most of the profits, if you will. If you look at something like S&P 500, but I'm just also wondering, do you think like, maybe the market saw is seeing through to the fact that I know you're kind of voicing some concerns about, you know, a slowdown recession, but it seemed like maybe the market like, look through all of that, and it's just sniffing out, like, maybe things aren't, they're gonna get better. I don't know. It's just an interesting, like the, the why and that how the market was able to overcome those things. Normally would have not been supportive. And yet, you know, it's done what it's done. I just find it interestingly trying to get at the reasons why.
Speaker 1I think it's a great question, Justin, you bring up and I have talked a little bit about this. And I don't know the answers either. But here's why. Here's my take on it. As you mentioned, this has been extraordinarily narrow bowl. It might be one of the narrowest among them, at least in postwar history. And it shows up in many different ways, not only performance. If you back out the performance of the information sector, the communication sector, performance of the rest of the world. It releases not much. It releases way below normal bull market standards. And you show this in profitability too, which I've done. If I take the S&P profits, if I take out communications information, there's a chance of a difference. Can't remember the exact number, something like almost 20% gains to like five or something like that for the rest. There hasn't been much profit gain as well. And so there's certainly one way to do it. What's happened is gone on between new era and the rest. The rest really has not participated in this bowl. And if we had that, if we didn't have any new era, we'd really be feeling bad about this thing because it really hasn't done much for over three years. And so why is that is the question which you're getting at. Here's my take. I think that this new era group of companies are really not that dependent on that chart of supports that we just went through. They're just not. They are dependent upon innovative creations and innovative cycles and bringing something to the market that has tremendous growth possibilities for the next few years just because it's brand new and the demand is almost infinite relative to the supply at the moment. They sort of allow themselves to become completely divorced from the normal cyclical things that manage the economy. Interest rates and money growth and deficit spending or lack thereof, liquidity or not, debt or not. They don't really depend on that. If you can have, just take any company, if they can chronically innovate something new all the time, they're like untethered from the economic cycle. And I think that's what's happened here. Last time we spoke, a little bit about how he showed everyone evidence that I think much of the rest of the economy went into recession in 2022, showed up in earnings and sales and employment and much of the other sectors, but the new era sectors did. And part of the reasons that we haven't done anything about it is because these new era companies are so large and mega, and they get so much attention that you kind of look at and say, well, the economy must be fine. The S&P 500's up. Profits are up. These companies are doing great. So what's wrong? Well, nothing, the aggregate. But if you dive down below that, I think there's a reason why there's so much pessimism, so much fear of the future, if you will, so much sort of disappointment, if you will, out there in Main Street, in part because a lot of the players really haven't participated that much, not on Main Street in terms of their businesses, but also in terms of their business. So I think there's a reason why there's so much pessimism. So in terms of Wall Street, and I think it's because we've had this one sector that's become so innovative and so rapidly innovative, they didn't just come up with one new thing and that's it. It's just chronic and constant that they've sort of divorced themselves from the cycle. And it's something new we haven't dealt with. But here's the kicker. I don't necessarily think it means that these companies are suddenly going to collapse. I don't think tomorrow they're going to no longer be innovative. This isn't like dot com when people bought those stocks simply because they had dot com in their name, even though they had basically no sales or earnings yet. I think there are really good fundamentals here. They could continue to do OK, but maybe if we're bringing the support to the rest of the market, we could see a lot of other things finally starting to participate. And you're seeing it, Justin, in the sense that smalls are picking up, doing a little better around this talk of Fed ease and actual ease. You're seeing IPO market, you're seeing IPO market, you're seeing market pick up. You're seeing micro cap stocks doing well. You're seeing high beta stocks finally have taken off in recent months. Overall, some of the things that you would have expected much earlier on in this cycle are starting to kick in. I think it's because they need the support where this new era part doesn't. Now, one last comment and we'll move on. I think that we don't really understand all the things that drive new era because we've never really had to. We've had that going on, but not to the point where it kind of overwhelmed everything. And here's the risk of it. If we don't understand what really drives them, it's not the normal cyclical stuff, I don't think, that we also don't understand what will stop them dead. And I don't think we do yet. In other words, in order to get there, what drives that innovative cycle? I'm not sure we really understand the things involved in that. I might not just be interest rates in the money supplies, what I'm saying. And we don't get it, but if we don't get what drives it, we also don't get what ends it. And so that could happen out of the blue too. I think it's a risk, but I don't think we're giving enough attention to that, that we have two things. One that we have been managing for decades in this country and around the world. One, which I don't think is really being managed by anyone outside of those companies that are operating. And we're going to fight out a lot more about that. And I think that's a risk. I've been thinking a lot about that. I've been thinking a lot about it. I can't find any great indicators yet, or I would have thrown them out here already, that lines up with those tech cycles. So I'm still hunting for those, but I don't think they're the normal stuff that we would associate with the industrial economy or much of the rest of what we're dealing with. So I think we've divided this thing, but the good news is we're bringing up the part that hasn't participated if we start to keep this easing process.
Speaker 3You wrote a great recent post about the furthest right on that chart, which is one of the biggest supports, I think, maybe the second biggest in terms of its historical performance, which is confidence. And we've talked about this a lot in previous podcasts. We have a lot of things that are deviating, a lot of things where confidence usually would follow that it's not following. So we want to dig into some of these charts here and just get your take on what you think about them. The first one here is the misery index. So can you explain what the misery index is and what this
Speaker 1chart's telling us? Yeah, I wanted to use this, Jack, because the blue line is confidence. You can see it's in the tank. And you got to remember, we're in the tank at a time when we're five years into an uninterrupted economic recovery and three years into a bull market going into a four. And it just is very odd. And I laid on top of that the misery index on an inverted scale. So when the misery index gets very high and it's the combination of the unemployment rate plus the inflation rate, you think about those are the two key ingredients in the economy that make us feel either good about the economy or bad about the economy. If inflation is really high and the unemployment rate's high, we feel lousy about it. And if they're both really low, we feel pretty good. And you can see historically that's been the case. When inflation and the combination of inflation and unemployment are very low, that is the red line is high, confidence is typically very high. And when the unemployment and inflation get high, confidence goes into the tank. And until 2022, really, these things really were very closely related. You can see that the pandemic took confidence way down. But you can see that once inflation and unemployment started to improve again, inflation was falling, unemployment came down. And you can see that misery index went from about 13 or so back down to about six. You can see confidence started to really come up. It came up about to 85 on that blue. But then in mid-2022, that's when inflation peaked and the Fed was just starting to tighten. And they've basically been tightening ever since. I think they just drove confidence right back down into the tank. And that's when we separated, that is confidence separated from the performance of the economy in a way that's really never happened in the past. Post-war period. And I don't know for sure, but my high suspect is that we've generally never tightened when the inflation rate's been coming down. And actually, when the unemployment rate's been going up, as it has recently in the last few years. So I think that what I wanted to show with this is you can't explain the lack of confidence or extreme pessimism because the separated from the performance of the economy. So what is it is the question. I mean, do you have
Speaker 3any ideas? I was trying to think of something like we were doing the outline for this. I mean, one thing I was thinking about, and you can tell me if this is relevant or not, but this idea that like, it seems like any kind of economic surveys these days are along party lines. It seems like everybody, you know, on one side is when they're in power, whatever's happy, the other side thinks inflation is a disaster. And I don't know, does that play into this? I mean, the national debt, I mean, I wouldn't think your average person is that concerned about the national debt, but like, do you have any ideas as to
Speaker 1what else it could be? You know, the political divide is certainly a possibility. I've often thought that from time to time, and on both sides of the aisle, we're all disgusted all the time, it seems like with something. And I do think that, you know, you could conceivably do that. The reason I don't think it's the political divide is this thing fell apart since June of 2022. And a big chunk of that was when Biden was still in office. And then it stayed this way. Trump's got an office. So if it's the divide, I don't think that really explains, you know, where this went down was one side of the other and people are just concerned. Now, could it be the overall divide, you know, that's out there that people are worried about? Maybe, maybe, because we haven't had as much conflict for a while, at least, between the aisles of the right and the left as we have, you know, in recent years. Although you could say we had some of that definitely back in the 60s. 70s. And we didn't get a big divide back in that period. So I don't know, of course, but I don't think it is the political divide. Could it be government debt? I mean, possibly. We have gone over 100% government debt to GDP here in the last few years. But I got to tell you, we were over 90% debt to GDP back here at the in 2020, if you will. And you could see the confidence index, at that point, hit pretty close to record highs near 110. And we already had debt to GDP of, you know, over 90%. Today, we're a little over 100%. I just can't believe the 10% more government debt to GDP would cause this whole fiasco that we've now seen the last few years when we were giving it such a high level of confidence, not too long ago. So they could be part of the equation. And probably like many economic issues, it's not just one thing. It's probably a combo package. And I think that's a big part of it. I think that's true. But I have my favorite. And I think it is basically the Fed, which is what we'll maybe get into here right now. They've kind of been creating some of these others.
Speaker 3So this next chart looks at confidence against the probability of a recession calculated by the Fed, I believe, correct?
Speaker 1Right. The blue line here is the confidence index again. And then what I've laid on top of that is the New York Fed's probability of recession for the coming 12 months. And that's on an inverse scale. So when the probability is going up, the red line is coming down. And you can see a really close relationship here. It makes sense. If the probability of recession is skyrocketing, confidence generally is going to plummet. And it's been a fairly consistent relationship throughout and still is now. What's important to realize is this particular probability estimate is based primarily upon the yield curve. So the flatter the curve, the more inverted the curve, the more negative or the more greater, higher probability of recession historically. And it's important to know that the current data point, like it's like a 62% probability of recession right now, that's based on where the yield curve was 12 months ago. So this probability is leading confidence by about 12 months. We'll come back to that in just a minute. But it stands to reason when the probability of recession goes up, people lose faith in the future. And that's been fairly consistent, not perfect every time, but fairly consistent. And who controls the yield curve for the most part? Not entirely. But certainly Fed policy plays a huge role in it. And I think the yield curve wouldn't have stayed inverted for as long as it has or been inverted for as long as it has if the Fed wasn't so stubborn in continuing to fight inflation rather than pursuing other goals. And they've, you know, as a result, created an hysteria with recession. Throughout this bowl, which started in October of 2022. There's been a rather high level of persistent recession fear evident just in the media. You know, people like CEO Jamie Dimon has regularly warned of an impending calamity. He's not the only CEO that's done that. A lot of commentators have a reason for that because there's a lot of indicators like this in this chart that a recession was supposed to come. Now, it has never happened. And while the yield curve this time didn't lead to a recession, the yield curve inversion again led to a significant. Slowdown nonetheless. And so the the reduction in confidence isn't isn't all that out of place, if you will, particularly when you are earlier comments that a big chunk of the economy really hasn't done that well. And so maybe it was accurately reflecting more than we know, if you will, particularly it might have caused it might have correctly forecasted a recession in the big part of the economy, just not the aggregate economy as we talked about earlier. Now, why is this important today? Because if we go to the next chart, this one is the same chart I'm just showing the next twelve months, which is based the last point now says today's yield curve position says there's only about a twenty eight percent chance of a recession one year from now because there's a one year lag. And so the yield curve is done a little better. And I think this is in part because the Fed started easing last year for a few months. And then they just started easing again. And the result is they've lowered the probability based on this methodology of a recession one year forward, in other words, a year from now. And what's important here is how close is the relationship here between that red line leading by one year and the blue line, which is confidence? And this says that for the first time, the yield curve saying the probability of recession is coming down. Well, the next year we should see confidence come up. And. And as I said, that could run right through not only the stock market, but also the economy. If people start feeling more confident about the future, we may see for the first time some animal spirits emerge where people actually risk taking goes up. People make commitments to hire more, to build more, to buy more, to whatever, particularly if they become more confident in that that bullishness on Main Street will also feed right through Wall Street is what I'm thinking.
Speaker 3This next chart is interesting because this is back to what we talked about at the beginning. And when you're giving that answer about the FAANG stocks not being subject to these market supports, one of one of the things I was thinking about is maybe a lot of these supports now are really broadening supports rather than their market supports. And this kind of gets at that in this chart with respect to confidence, which is when confidence gets better, it seems to be much better for the smaller stocks.
Speaker 1It is it is, I think, Jack, that, you know, one of the narrow market without confidence, without those supports, I think the S&P did really well. I think the S&P did really well. we're headed. And this isn't the only chart that shows they're kind of out of whack, at least where they've been historically. And there's some catch-up to the current inflation environment, let alone where it may go from here. Here's another one that just overlays the 10-year yield, which is the blue line in this chart with the annual rate of nominal GDP growth. Nominal GDP growth has slowed from basically, I think, 14% to 15% down to under 5%. And over that period of time, the 10-year yield has gone up from 2% to 4%. And again, it just doesn't normally happen that way. We are back with a nominal GDP growth rate that's every bit the same as it was from 2010 to 2020. And yet the bond yield is twice as high as it was then at various times. Again, I'm not sure we'll get back to that. I'm not sure we'll get back to that. I'm not sure we'll get back to two, but could it fall back to three? Yeah, I think so. And I think the delivering factors, the Fed is holding up that short end, not allowing long yields to come down.
Speaker 3Can you explain this one? Because I actually wasn't totally familiar with the resource unemployment rate. So can you explain what this is?
Speaker 1Yeah, this is a little bit different way to look at the bonds being out of whack, Jack, than just these single indicators. What I got going on here, the blue line in this chart is the 10-year bond yield again. And the red line in this chart is what I call the total resource unemployment rate. And I'm combining the unemployment rate of labor with the unemployment rate of capital. And the unemployment rate of capital is just 100 less the capacity utilization rate. So if the capacity utilization rate is 80%, there's 20% unemployed capital, so to speak. And what I'm taking now is the capital unemployment rate plus the labor unemployment rate dividing by two to get their average. And it's on the inverted, right-side scale there. So you could see that the total resource unemployment rate now is about 14, excuse me, about 13.5% are in that ballpark. And it was closer to 11% here just a couple years ago. It's come down, actually worsened by about two percentage points. Some of that's due to labor, about a percent of it. Some of it's due to the factory utilization rate. But when I look back historically, you can see whenever that total unemployment rate on this chart goes down, meaning unemployment is going up in the economy, bond yields come down with it. It's happened almost every time in this chart, except for this time. We've had a pretty big loosening in both the factory unemployment rate and the labor unemployment rate, and yet bond yields haven't budged. In fact, they've gone up. And again, just another way to look at how out of bounds or out of whack things are. And so I'm just building the case for, I do think there's more room for bonds than you think. Now, if you think about it, if the bond yield comes down from four-ish to three-ish, I think stocks will actually do a lot better than bonds unless we have a recession. If we stay out of recession, then stocks are going to do better. But I think bonds will finally get some decent returns and really the best returns perhaps that we've had in this entire bull market.
Speaker 3This next one is interesting because it shows maybe the biggest decoupling of all of them, which is the copper to gold ratio relative to yields.
Speaker 1Yeah, this is a. Long-time favorite of financial people in the financial markets for quite a while, the copper-gold ratio. A lot of people think copper's, you know, got a PhD in economics and Dr. Copper, they call her. And basically what the red line is, that ratio of copper-gold, you know, copper is driven more by real economic strength, if you will, or weakness in the economy, by industrial activity, by spending, by strengthening the economy. So if there's a lot of goes down. Gold, on the other hand, is driven more by fear and pessimism. So if there's pessimism, gold goes up. And if there's optimism breaks out, gold comes down. So the ratio is kind of an interesting ratio of economic growth to coffins is what you really got going on there. And how does it come down? Well, it could be some combination of the economy weakening, showing up with weaker copper prices, while gold, spikes on the fear of weaker growth or fear of conditions in the future. And you can see that here in the last several years, really since 2022, when the Fed really started tightening, is copper-gold has just collapsed. And there's generally a very close relationship to bond yields. It's totally been divorced. Again, you know, this thing's been divorced for a long time. I thought yields would have come down long before now. And they didn't, primarily, I think, because the Fed didn't ease. I thought the Fed would ease. Long before now, they just didn't. And so if they're finally going to start to ease, I do think there's a chance that we not only will come down as the Fed eases, but maybe the bond yield will come down more just catching up to the reality that's on the ground on Main Street. And we'll see if that proves out to be the case.
Speaker 2I'm just curious, Jim, do you find there's a place for gold in investors' portfolios? Or is it sort of like there's two camps, right? There's kind of an inflation hedge, or it's going to protect you when things get dicey, kind of like the point you're sort of making that gold should do. Or there are some people that say there's no cash flows generating, and it's just a commodity. And so it doesn't deserve a place in one's portfolio. And sort of what's interesting is we did a podcast just earlier today. And even though we kind of picked this point in time, which wasn't a great point in time to pick for stocks, if you look at the stock market in 2000, actually gold has outperformed the S&P, starting at a really bad time to get into stocks, because stocks were so overvalued. But I was surprised at that, that gold actually outperformed stocks when you started at that point in time. So I'm just wondering what your general take is on investing in gold, if you don't mind sharing.
Speaker 1Yeah, gold outperformed stocks over that last basically 25 years or whatever you want to put at it. But really, it outperformed stocks for about five years. And then it's miserably underperformed ever since, really. That's kind of what's happened. In other words, if you pick, you know, at that point, one of the worst, one of the best times to buy gold and the worst time to buy stocks simultaneously, it would be 2000 at the dot-com top. Because no one was scared about the future. Everyone was bullish to the wall, and they'd been through 10 years of wonderful nirvana. And the last thing they're going to hold is stodgy old gold. At the same time, everyone was all into stocks and, you know, and so they'd bid those up to ridiculous values. And so gold did outperform dramatically and for a good five years or more, and then has really underperformed since. But over the 25, because of how overvalued stocks were and undervalued gold was at that point, that's why it occurred. Is that a regular curse through history? I doubt it. I highly doubt it. Now, is gold not worthy ever of owning? No, I don't think that. I think gold has got its merits. I'm not a super big gold bug, but, you know, I've also lived my entire professional existence. It started right after the peak of inflation in 1980 under chronic disinflation. And I didn't start in the 1960s and think gold was the best thing ever invented, you know, in my first 20 years of existence. So, you know, I don't think that's a good thing. I don't think that's a good thing. So, I think that plays a role. I've often kidded that gold, to me, gold is whatever worry you have. If it's inflation, if it's recession, if it's depression, if it's government debt, if it's political divide, if it's war, the answer is gold. It's the answer for everything that keeps you up at night. Anything you can ever come up with, the answer is gold. And it's often sold that way. I think it's a bit, what bothers me about gold is it tends to be like other things. It's sort of a hot button sort of issue for people emotionally, unlike almost any other investment. There's a lot of emotion surrounding gold ownership. It's kind of like I'm going to grab it and go to my bunker, you know, and we'll be the ones that are still alive after the smoke clears. And that bothers me a little bit because I think there's always a bit of a premium in there because of all that. There's a lot of emotion around it. But there's times I don't have any problem with people owning some, just like owning a little cash. What I would say, though, today is I just see, which is really odd when the market's up where it's at, but I see a lot of the fear assets, the primary fear assets really up. Gold is really up. Cash holdings are pretty pronounced today. You know, retail money market funds to disposable purse Lincoln were almost at record high. Crypto is another asset favored for what ails you. And, you know, a lot of these fear assets have been really elevated and makes me a little suspicious of them, I guess, as far as timing is concerned. But as far as a buy and hold small gold position, I think they do a great job. They've got, you know, inverse correlations a lot of the time with your stock and bond holdings. And they can hold portfolios together like cash and maybe even better than cash because gold actually will appreciate if, you know, you're not going to be able to sell it. And so, you know, I think that's a big part of the, particularly don't like gold right now. I think it's overvalued. There's a bit of a mania there. And I'm seeing commercials on television about selling your jewelry at night and things like that. I think that gold's a little stretched and it's likely to have a bad period here in the next several years. To your
Speaker 2point about money market funds too, before we move on to this next chart, I did see just the other day that there's like $7.7 trillion in money market funds. And I was thinking the chart was at an all-time high. And I don't know what the total market cap of US stocks are. You might know it off the top of your head. But it was just surprising to me that, to your point, that investors are stockpiling cash. I mean, maybe they're getting better yields on that cash than they were. So they're happy with getting 3%, 4%, whatever they can get, especially some of these online banks that are yielding higher results or whatever. But yeah. I think it is interesting.
Speaker 1I think that, to me, the elevation of gold and money market funds and crypto tie in really well with confidence on mainstream being in the tank. It dovetails perfectly with that. That's just what you'd anticipate to be the case. And I'd also, quite frankly, you could argue, at least, that another defensive asset has done really well in this period, extraordinarily well. And some have considered it a defensive asset in recent years. And that's called technology. It's a defensive asset because, guess what? It doesn't go down with the cycle, right? It just goes right through it. So it's interesting to me if you include that and you say, "Look, gold's through the roof. Money fund's through the roof. Crypto's through the roof. Tech stocks are through the roof." And confidence is in the tank. That tells you that there's a massive run for fear-based assets. And I do wonder if optimism breaks out. That's kind of what we've talked about here. Those, I think, are all at somewhat of risk. I'd say tech is the least because there's some real business there. But I do think even underperforming, I think there's a risk. And it's tied, to your point, I think, tied a little bit to confidence if it revives. I mean, I get pushback on putting tech stocks in that bucket, but I do think in recent years, people have kind of started to consider those. Steady Eddie. Well, no, I think you're
Speaker 2right because I think like what the way that they, it's almost like, I remember maybe it was, I forget the last time that it was like not, it wasn't this year. It was maybe a year or two ago and we had this air pocket in the markets and tech stocks held up well, and you were hearing things like people would rather pay for their iPhones than like kind of put food on the table, you know, it's like they'd become like kind of a staple. So even though these companies have, like you said, they're, they're innovating, they're growing, but they've also become so intertwined into our fabric of society that people aren't willing to live without them really. And they're willing to give up other things in tight times versus like, you know, normally they, other things they would cut.
Speaker 1So maybe that's the case. To tell you the truth to, to your point, Justin, if I, as long as I got my darn iPhone, I can get somebody to bring the food to my table. Exactly. So, all right.
Speaker 2So as we kind of get towards the end here, just let's walk, walk us through these last, I'll let you kind of talk to these last sort of few slides as we work through them and just kind of what we should be thinking about when we're seeing this on, on the, in the presentation here.
Speaker 1Yeah. I, the only thing, the only thing I, I wanted to make a point on inflation because there's still concern out there. Certainly the Fed has it about tariffs coming through. Tariff rates are still going up. I do a couple of points. One is tariff rate now is probably 11%, uh, maybe even pushing 12. I, I doubt it's going to get much higher at 15 at the max. So we've had a big chunk of this come through. And, and so far there's been very little show coming through the inflation but one of the other problems that inflation is going to have, if you think inflation is going to take off is we've now slowed the growth rate down in the economy. And I mean, in real growth. And I think slower, real growth. Um, I think really puts a check on inflation pressures. And as I mentioned, you know, year to date real GDP and personal consumption of one and a half percent employment at six tenths of 1% annualized. Those are rates of growth that are just too slow to sustain an inflationary episode. And this chart kind of gets to that a little bit. These next couple, I just, uh, CPI here is the red line, uh, or excuse me, it's the blue line. Overall, and it's running at just shy of 3% right now. But what I laid on top of that was the, uh, annual growth in real disposable personal income. You could see that, you know, really going back to the early nineties, there has been a, uh, kind of an anchor provided by the pace of real growth for inflation. It just can't move too far away for what real growth is doing. It's just hard to sustain a inflationary burst when real growth is at a certain level. And you can see there was a burst of real disposable personal income during the pandemic that led to a burst in inflation. But then since then it's come back down. And ever since then, inflation has been moderating. Now, if you can see real disposable personal income did pick up in 2023 or 2024 to early 2020, uh, or late 2024, you know, it picked all the way up to about 6% growth. And that might've led to a pause in the decline in CPI inflation, but little more than that. And since then it's now moderated again from about 6% to 2%. And I think at 2% real disposable personal income growth, you go back in that chart, you just can't find episodes of much inflation with that. So one of the problems that we're not, we're going to have with this inflation story is not only are tariffs hitting maybe 20% of the products in the economy, because services aren't really directly hit, but with real economic growth slowing, it's just going to make it really difficult for those to be put through the economy. For example, with, with wages, you know, slowing down or cost inflation with the labor market now only up six tenths of 1% year to date, how are we going to have wage costs push inflation out of that? If, if real GDP is running one and a half, how, how can companies pass on higher prices in that low growth environment? And I think that's what these charts say. I got another one behind that. It looks at personal consumption expenditures on the next one, similar story. Again, a very close relationship historically, where inflation rate is sort of bounded by the pace of real activity. And in this case, real personal consumption growth, you could see that also picked up in the last year or so, and maybe stalled out the decline in the inflation rate, but now it's also been weakening wrong. So I do think one of the things I don't hear a lot of talk about is when you're growing the economy at 2% or less, it's awful hard to pass on higher prices. Yeah, I mean, ultimately, these tariffs, they're either going to be passed
Speaker 2through, but you're to your point, I mean, probably they can't be because it's like, we don't have any, like, wage growth, but, and if not, then the companies have to absorb these. So for some companies, there would be more pressure sort of on the margin on their margins, if they are forced to absorb the tariffs, right?
Speaker 1Yep. And that is happening, Justin. If you look at this morning's data release, and this is Thursday morning, you know, they came out with the revisions on GDP this morning. But one of them, they also came out with a revision of profits, and they revised down profits in the second quarter. Profits actually went down in the quarter, even more than they nearly expected. So year to date now, profits have come down over the last first six months of this year. And margins have also gone down. Well, come on. Now, margins are still very high. GDP, profits to GDP in the economy are still running 13%, you know, way above historic norms. There's quite a bit of room there left, but they are coming off. And I think that could, in part, reflect them eating some of the tariff hikes showing up in some of that data. But here's the deal. If you're looking at this chart right here, and, you know, personal consumption is growing at two, employment at half percent. And like, even if you have cost coming at you, how are you going to raise prices in that environment? I mean, it's just too sluggish for companies to do it. They may take a hit in their margins, but guess what? If they try to raise prices, imagine what that's going to do to their overall business. And that's what I'm thinking. I just think that the inflationary pressure tariffs might just get extinguished by a lack of real growth. And you're right, that'll hit profits.
Speaker 2And I'm no, you know, I'm no expert, but it's like you had, you know, this big increase in prices of a lot of things. And while the rate of that growth might have slowed from like peak inflation, it's not like things went back to pre inflation. So things got expensive and then they stayed expensive. And then they haven't been growing as, you know, prices haven't been increasing as much. But so to your point, I just think it's like stuff's just expensive is the bottom line.
Speaker 1I get that. But here's the reality of the situation. Throughout time, really, post-war, prices always go up. and they never come back down. I'm not talking about money prices, but I'm talking about consumer prices. Rarely for any extended period do they come down. If you get a great impression, okay. But otherwise they go up. But what does happen, and what's happened here, okay, is prices went up, and then they went up, continue to go up, but they're going up less. But through that period, real wages have recovered and gone on to new highs. So wages and compensation also goes up, and that's one of the reasons we haven't totally fallen into recession is because real purchasing power has actually advanced from the labor market because their wages now have gone up more than consumer prices. And that's kind of the way it works itself out through time is that prices never come back down, but compensation comes ahead. And I think that's playing out the same way here. And I think on the street, people always say, well, you know, the price of whatever is still a lot higher. That's right. And it's going to stay that way, man. It's not coming back down to where it was pre-pandemic. But your compensation over time hopefully will go up. That's kind of how that works out, at least has.
Speaker 2Okay, so the last chart here, we'll end on Jack and I's favorite conversation with people is about valuations, I guess, and sort of where the S&P is. I think this chart is showing it, the current multiple versus where we may have been in 50th, 75th, and 25th percentiles over time. So I'll let you kind of just explain what we're looking at and also maybe what the takeaway is if there is one.
Speaker 1Yeah, this chart goes back to 1870. It's monthly data, and it comes from the S&P 500 or Dow Jones if you go back far enough. But it comes from Kenneth R. French data. And I think that. I think what all I'm showing is the trailing 12-month PE multiple on the U.S. stock work going back over time. And currently, you know, that level is about 24 times, 23-something, I think, at the current moment. And what I wanted to point out, people are worried about valuations right now. And I get it. I get it. I mean, they're very high. And I started this business, I mentioned, at the start of the 1980s, and I think I've said this before, but I didn't ever, my rule of thumb I developed, quickly, was I never looked at any stock that didn't trade at a single-digit mold because I thought anything trading double digits was too expensive. Now, obviously, that approach didn't last very long, but it worked in the early 80s, I can tell you that. And so it seems extraordinarily high today. But what I want to point out is that we need to understand that there has been an upward bias in valuations going on for 30 years in this country. And so we can't. use our judgments back historically of judging high or low anymore. Something else is going on, and that's a whole other topic. I've written a lot about it, of why this is occurring. But it's definitely occurring. And what I got in here, the red line on that chart, is the average P.E. multiple over the previous 30 years. Now, from 1900, which averaged the 1870 to 1900 multiples, all the way, really, till the early 90s, when I got that 14 times written down, the multiple stayed at a very, very narrow range. The average multiple traded, you know, probably around that 13 to 15 times level, rather regularly, over any 30-year period you want to look at. It was a stable valuation range, if you will. But in the last 30 years, it's been anything but stable. There's been a clear upward trend in valuations in the United States stock market. So the 30-year average mobile right now is 19 and a half times earnings over the past 30 years. That's up from 14, 30 years ago. That's a pretty radical shift in people's investors' mindsets when it comes to valuation of having to adjust your center force by that amount over that short period of time, particularly for us old codgers that have been around a while. And I just want to point out that a couple of things about valuation, Dave. It's high, but I don't think it's just obscene. If I got a. A 19 and a half multiple day, let's say we're at 20, I don't know what the exact multiple is, but let's say it's like 23 and a half or something a day compared to an average of 19 and a half, that's a 20% premium to average today. Now let's go back where I have 14 listed on that chart there, early 90s or any other time prior to that, if I take 20% times 14, you end up with about a 16.8 multiple right now, 16.9. Now, someone said we're trading at 16.9. You'd say that's above average, but it's not ridiculously out of this world. That's what you'd say. And I think that's kind of where we are today. I mean, where we sit today on multiples, you got to remember that we were, we were just here in the pandemic. We traded almost 30 times. We did that at the top of the.com. We're something quite a bit less than that. We might be at the 75th percentile in valuation today, or maybe a little higher, but we're not at the 90th or anything like that. And this is the S&P 500. If we now go and step out of that into these other areas of the market that haven't participated, if we had data for the last 150 years on utilities and staples and industrials and high beta and all that stuff, I bet you'd find even cheaper history going on right now for those, not on a relative, but just on an absolute basis that if you consider the trend and overall valuations, they haven't done much at all, small caps. Those kinds of things. So is the market highly valued S&P? Yes, I think it is. Is it absurd today? I don't know. I don't know if you can make that case. The other thing to think about is who's to know when this upward trend in the red line is going to stop, where that going to be 10 years from now, 15 years from now. Will it be normal to have an average to have 25 multiple on the stock market, you know, 10 or 15 years from now? I don't know. So I do. I do think you've got to be careful if you're, and I think a lot of people do, you know, if it's overvalued, I'm going to stay away. I get that impulse. I was born in a value shop, but I, um, I think you gotta be careful when the valuation range is no longer a stable animal and no one really understands all the forces
Speaker 2driving. Yeah, I think that the, that's a great point. And I think that maybe in a future episode, we could kind of talk through some of the reasons why this might be, um, I think that'd be. Yeah, you got lots of thoughts and, um, we may even have some things to ask you about that too. So, um, all right, uh, Jim, thank you very much for spending the time doing this with us as always. Um, the, you know, these months go by very quickly, but there's always lots of interesting things to talk about and, you know, getting your perspective, Paulson's perspective on all of this is always, is always great. And I know everyone learns a lot. So. So, uh,
Speaker 1opportunity, uh, Jack and Justin bull to, to be able to put some of that out there. And I appreciate everyone that listens in, uh, I really do. And, um, whether you agree or disagree, I just hope to give you something to think about just like I am every day. So I appreciate it very much. Thanks, Jim. You bet.
Speaker 4Thank you for tuning into 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 excess returns pod.com. If you have any feedback or questions, you can contact us at excess returns, pot 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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