Speaker 1Jim, welcome back. Thank you very much for joining us again this month. Nice to see you.
Speaker 2You bet, Justin. It's good to be here. I always appreciate you guys every month chatting a little bit. It's early
Speaker 1July and it's pretty hot in most parts of the country weather-wise, maybe not so hot from a market and economic activity standpoint. I think that's what we're going to work through with you today. We have a number of slides you've given to us graciously that you have put out on Pulse and Perspectives, which is your sub stack. We encourage people to go check it out. I think today you're kind of building on where we left off last month and making the case a little bit more strongly that things kind of don't look so great under the surface. We're kind of going to chunk it out in sections here. I think there's five or six, maybe even more, sections that you've isolated that you're paying a lot of attention to. So to start, I'll sort of let you paint maybe a little bit broad picture and then we'll get into some of the charts here.
Speaker 2Okay. That sounds good. Yeah. Yeah. I've been expecting for some time that we'd have a leadership shift that goes on from kind of new era stocks to other areas of the market, which I've been referring to as broad marketplace. And that has occurred here, but I'm now just. I think since the AI surge from the March 30th low to the June 2nd top has kind of put me over the edge a little bit in terms of. I think that thing got frothy and ever since then, it's been a little sucking up all the financial market information in the room. And it's all about AI and it feels a little more like.com to me. And there's several things that have creeped up on the indicators I watch. So I kind of, you know, a week into June or so, so I've kind of gone on record of saying, I think there's going to be a correction here in the next several months. I think we might end up the year about where we have been at its highs. Or maybe we won't make that up till early next year. But I kind of, my guess is, is that we're going to have a correction somewhere between 10% to 20% that'll feel ugly. Well, I don't think it's going to be a bear market, primarily because I don't think we're going to have a recession. But I do think we're going to be worried about growth again, and we're going to be worried about a bear market. And the composition of that, if I had to guess, I'd say, you know, the tech stocks or near-earth stocks, they go down more than 20%. But a lot of the rest of it doesn't go down near as much. Maybe it climbs 10% on average. We have something like a 15% or something. I don't know. You're talking about a 10% or something. I don't know. I don't a 50-50 weight between those two parts now, really. You know, it's interesting. Last night, I looked at S&P 500 technology sector. It's already off 10%. Where's June off? You wouldn't know that because, now I'm not talking about the market, is it? But the S&P tech is. And you wouldn't know that just because of the excitement of AI. You know, it's pulled back off that ferocious high, and it's already at a 10% decline. So that's kind of where I'm at. And I've got some reasons for that. I'm interested in why I've kind of come to that conclusion. Again, I mean, I still think we're in a bull that probably extends into 2030 or a little beyond. And so part of me even questions why I'm messing around with this, because who cares if it comes back? But it's been big enough. If it goes over 10% in my mind, I think it makes a little sense to move a little at the margin. I'm not suggesting anyone sell all their near-earth stocks. I'm not suggesting that at all. I'm not going to, no one else is going to tie me up. I'm not going to tie me up. I'm not anything that great to do that. I am thinking, no, they may want to go to an underweight to its market position on that and to move to an overweight in some of the broader market plays, which we could talk a little bit about a little bit later. So that's kind of where I'm heading.
Speaker 1Yeah. Okay. Okay. Yeah. I think that 10% to 20% pullback, if that's where we land, certainly starts to get people's attention as they open up their monthly statements and see, wait a minute, my account's down that much. So let's step into, I think, the first, general area was, you know, the economic momentum starting to show some signs of slowing down. So let's talk about that.
Speaker 2Yeah. I think on average, you know, we came into this year, there was a lot more concern late last year and really early in this year about the economy and it's slowing a lot. Job growth had slowed to practically zero and there was a lot more concern. Then there was some pickup in the job market, a little pickup in some of the economic reports and people have really calmed down about that. I don't think the slowdown is over. And I think it's going to reintensify again. There's still a lot of stuff that really doesn't look right for people being as calm as we are about the economy. And I thought I'd just run through some of those here in these first charts. This first chart, which is just the annual growth in household employment. And actually it's the average of household and non-farm. So if you put them together, the average, they average out to about 10% of the job growth in the last year. And this is even after, you know, the last couple of months reports where people felt better about the job numbers. I think the payroll numbers are up three-tenths in the last year. The household numbers are down three-tenths in the last year. So they average out at a big goose egg. Nowhere, nowhere in our history that I've been in the business going back to the early eighties was zero job creation over any 12-month period considered something that was okay and people could feel confident about. And I think that's a big thing. And not only that, but confident enough that most people thought the Fed is going to raise rates in the face of it. And yet that's where we are. So it doesn't take a lot. It could maybe, you know, maybe jobs take off. I don't, I don't think so. If I just look at a couple more, like the next one I'm looking at, looking at the unemployment rate in blue and the red line is just the part-time employment level. And, you know, they both kind of tell the same story, but they're both telling the story. And that is, you know, the unemployment rate in blue is just the part-time because they're doing something you just don't do in an economic expansion in the last couple of years. You don't have part-time employment rising and you don't have the unemployment rate rising when you're still in an official economic expansion. It's just not, it just isn't never really been looked at that way at all. Those are things that only occur in the middle of recessions. If you go to the next one, another part of the jobs mark that's really bad is labor force growth. Now that's the blue line in this chart, the annual growth. The annual growth rate in that is negative over the last year on this chart. And I've also put on their full-time employment. So full-time jobs are declining in this expansion and fewer and fewer people are working in labor force. In the last several months or just in the last year, you can see that the decline in the labor force has been pretty spectacular or something that generally doesn't ever happen unless you're in recession. But if you go to the next one, another part of the jobs market, if you didn't have that decline, imagine where this unemployment rate would be right now. We've had zero job growth. If labor force would have grown its normal half to 1%, my gosh, the unemployment rate would be not in the threes, it'd be close to five just over the last year. So to me, I don't know how sustainable this is, is what I'm getting at. It's got me more and more frightened that some of that comes home to roost. If we broaden out a little bit from the jobs market, I guess I got one more question. I'm going to ask you a question. I'm going to ask you one more on the jobs market on the next chart. Just more recently, you know, we had pretty lousy jobs report this month. In terms of the numbers that came out, it came out much more disappointing than what people are looking for. We had downward revisions from the previous months. Well, one of the reasons is because it kind of shows up in this chart. The red line there is unemployment claims on an inverted scale. They've been climbing again. You can see they did go down that red line on an inverted scale. Claims got improved, but now they've been coming back up. And then if I overlay that with the blue line, which is the monthly ADP report on employment, it too has rolled over and now it's been coming down. So yeah, we had a little burst there, you know, at the start of this year in job data, but that's kind of gone away again. And I think sort of fits with a generalized weakness overall. If I look at the next chart here real quick, this is just to broaden out to some other indicators. You know, as housing starts and it's just lousy, and not only is it lousy, it's just gotten lousier here in the last couple of months. It's fallen quite dramatically. You know, it's about as bad as it was in the worst of the housing crisis in 2009. There's just no activity going on there. Does that jive with what we see with, you know, explosive earnings in the economy? No. Does it jive with what I just showed you about how the job market looks? Absolutely. It does. If you go to the next one, this one is not widely publicized, but it's annual growth of real disposable personal income, excluding subsidy or transfer payments made to individuals. It's deeply in the negative territory. It's declining over the last year. Again, you just don't see this historically outside of a recession when you get into this. So there's no jobs, there's no real income being internally by private market players that aren't being propped up by subsidies. And I think that's To me, that's going to come through not only in weak housing spending, but in ultimately weak retail spending and commercial consumption as well. If you go to the next chart, this came from the Atlanta Federal Reserve GDP Now forecast. This just came out, I think, last night or the night before. It is now down for this quarter to 1.25%. I know that the PCE Now forecast for the second quarter just fell below 2% this week. So we're not having robust growth going on here. You can see it was earlier. For a little period of time, all these numbers looked better, but they're all kind of rolled over and kind of rolled down on themselves again. One more comment at the end. I want to make the point that momentum in the economy, I think, has been… …weak and is still kind of weak. Yeah, it had a little period of pickup. The Fed felt a little better about things, enough to quit easing and whatnot. But I don't think a lot has changed there. And I think, as I'll get to the next section here, I think a lot of this is going to get even worse.
Speaker 3Yeah, and as we get to the next section, you made the point here that despite the fact that growth is not great, policy has been somewhat contractionary, right?
Speaker 2Yeah. And I just got a number of different things that I'm looking at on that regard. This one is just a bar chart of kind of showing what has happened here since early this year. All of them have some different dates on them, but they're all tied to really since early this year. A lot of them really just since the war turned or the hostilities with Iran. If you think about it, what the hostilities did was it brought back tightening of economic policies again. It raised yields. It slowed the rate of growth in real money supply. It raised inflation, lowering. The real wages and real growth in monetary aggregates over that period of time. We've had a reinversion or flattening of the yield curve over this period of time. And believe it or not, while we're spending on the war, out of the federal government, the net deficit spending over the last 12 months to GDP ratio has actually contracted by about 2 percentage points from about 7% to 5% over the last maybe 15 months. So we have a contraction of fiscal policy. We've had the 10-year yield go up, I don't know, about 70 basis points from its lows below 4%, almost 460 this morning. We've had the real money supply that was just starting to recover got almost to 3%. It has come down again to about a quarter of a percent year on year, almost going negative again. We had a pretty good flattening in the 10s to 2s yield curve over this. Over this period of time, the U.S. dollar, which I've now mentioned, is up 5% to 6% in nominal terms and a little more than that in real terms since this war broke out. And my thought about this is a lot of the reason the economy picked up a little bit as we entered this year was these things went the other way. Bond yields came down. Money growth was improving. The dollar came down. And so we sort of reversed all that. And with the lag, I think that's going to hit a lot of interest. Economic information can take sort of the thrust out of the economy that everyone's sort of betting. Go to the next chart. This is just an attempt to show that these policies are going to matter. And what I have in here on the red line is a quasi-economic policy measure. And can't see it real well here with the small type, but it basically is made up of 50% weighting on the U.S. Treasury yield, a 30% weighting on the real U.S. dollar index, and a 20% weighting on WTI crude oil prices. And my point is, is if I weight those accordingly, when rates go up, when the dollar goes up, when the oil goes up, those are all negative contractionary forces, if you will, over the span. So what we've done with this war is we re-evaluated. We re-tightened policy. Now, how does it affect the economy? The blue line there is the Citigroup U.S. Economic Surprise Index. Okay? And the surprise index, when it rises, it's saying that economic reports are coming out better than expected by most people. When does that happen? It happens when the economy is picking up. It's starting to accelerate. And when it does that, most economic reports are better than people thought. They have to revise them up because things are getting better. But it does the same thing on the downside. When that index falls, it says that reports start coming in less than expected. And what that, to me, that's a measure of momentum in the economy, is what surprise indices are. Now, what I did was take that policy variable, the red line, I pushed it forward by three months, and I turned it over, inverted it. And this is the result you see. Three months later, when that policy variable improves, that is, arrives. Three months later, the economy picks up. And when it gets worse, when it tightens, three months later, the economy slowed down. And you can see what we're looking for in the coming three months overall is a pretty good slowdown in economic momentum. I think some of that's starting to show up, but more of it will as we move on. Other things, I referenced this a little bit in the past, but there's this sense that, you know, we're past the peak in oil prices. Now, we'll see. We're back at the time of this talk. We're back firing missiles again. But I think we have seen the peak in oil. And there's this sense that, you know, we brought this thing to some sort of resolution, and if we get beyond it, we're going to be okay. But the reality is, when I look back at every major oil spike that we've had since 1907, the damage for the economy and the stock market generally doesn't show up until oil peaks. And then the damage starts to show up. And I just show this on the S&P 500. This is a chart of the S&P 500. I put the dates on there of every major crude oil price spike since 1970, major ones. And in every case, you had additional damage in the stock market. Either it went nowhere or, more frequently, it went down a fair amount once oil prices peaked. Oftentimes, while they were rising, market did fine. And so does the economy. It's once they reach a peak. With a lag time, they start to bite. And you think about it, when oil first goes up, it goes up fast and dramatically. It takes a while before prices at the pump goes up. Then it takes a while before people start to do anything about it and change their behaviors. It takes a while for that energy price spike to go into other prices, other farm prices for lack of other things. And those prices go up and those behaviors change. And so, oftentimes, the greatest damage from oil price spikes. It doesn't occur when everyone's focused on it. It occurs after they forget about it. And I think that's what's coming now down the pipe. Another thing I'm concerned about, this chart looks at the annual growth in forward 12-month earnings for the S&P 500, the blue line. You can see there's strong momentum here going on. Or actually, there's this estimated forward 12-month earnings. But what I've laid on top of there. And it's leading by 12 months, is the 10s to 2s yield curve. And you can see that there's some impotence for why we're having a little better economy, a little better earnings. Because the yield curve was deeply inverted not that long ago. And then it has steepened back into positive territory here recently. But what it's done now is it's rolled over really since the end of last year. I think that's going to, with a lag of about 12 months or so, it's going to start to impact earnings. We're getting pretty close to that window of 12 months later. And I do think that policy type, this is just one example, just the yield curve. I could show you similar relationships like this with the real money supply, with bond yields as a whole, with fiscal juice, with the dollar. That is, they all have that impact. And I just showed you that oil prices tend to have a lagged impact negative as well. And people are really liking earnings momentum. But I'm saying it and the economy as a whole could be starting to go. We can again, as we go through the balance this year.
Speaker 3This next set of charts gets something you've talked about a lot in the podcast, which is this idea that the bifurcation between old era and new era has gotten very extreme.
Speaker 2Right, right. These are just the things, you know, I'm concerned about weak economy. I'm concerned about tightening policy. And I'm also concerned about the bifurcation that's going on in this. And we've talked about this past, so I won't spend a lot of time on it. But this is just the taking the S&P 500 and taking the two sectors which make up new era stocks. That's the information technology sector and the communication services sector. And look at their cap-weighted earnings, forward 12-month earnings here. They got 4 to 12. This is estimated 12-month forward earnings. And you can see that the spike that's occurred here of late, a lot of that recently has been AI, but it's just been explosive. But the rest of the S&P, the other nine sectors, their market cap forward earnings is the red line. Are they up? Yeah. they're up a little bit, but boy, lately it's been pretty flat out there. I mean, they're not going down, let's say that, but they're not exactly going up anywhere close to what people focus on when they look at the S&P earnings going through the roof. It's mostly all the blue line. And my point about this, how long can this big of a fundamental divergence or bifurcation sustain itself out there in the economy? How can one third be on fire and most of the rest of it is barely moving? I mean, earnings on that red line are not much higher than they were, what, two years ago, three years ago? It's a bifurcation where we're leaving a lot of damage in the wake of just this one small segment. Maybe it's sustainable. I suspect it. Another way to look at this bifurcation is not only through earnings, if you go to the next slide, but just in real economy itself. I divided up real GDP into two components, that comprised by real. New era spending, which I just defined as the investment, real investment spending on information processing equipment and on intellectual property products. That makes up 13% of real GDP. That's the red line. It has risen by an 8% annualized pace almost in the last six quarters. The other 87% of real GDP, the old era parts, has risen by a little over 1% in the last six quarters. Again, how long can we do that without something breaking, which then feeds into the stock market as well? So I'm a little worried about that aspect as well.
Speaker 3So these next charts get into this idea that we've certainly seen some optimism in the stock market. And I think you would argue even some degree of complacency, right?
Speaker 2Yeah. I don't know whether you call this optimism or complacency. I'm more confident that we're complacent. It's debatable how. Optimistic we are. There's certainly some sentiment reads that are still sort of middling or some. Recently, I saw where the CNN fear and greed was like deep fear. So some of those standard measures would not suggest it was a sheer optimism. But I do think there's a minimum complacency. We've just gotten so used to this thing. It just keeps going up and tech stocks always work. Yeah. So we're going to keep going up and tech stocks always work. We're going to keep going up and tech stocks always work. And by the dips and those mentalities are all real strong. And then we're really strong now because earnings momentum is so good. And what I'm starting to see though, if I get away from some of those sentiment reads and just look at behavioral sentiment indicators, behavioral sentiment, and this is one right here. The blue line here is the S&P 500 index. And the red line is still summary, but basically what it measures is the exposure that individual investors have to the stock market. Yeah. This looks at their exposure to stocks, less their exposure of cash. And that ratio of how much in stocks, less cash is at one of its highest ratios here over this chart. It's really only been higher at the top of the dot com. And that was only by a little bit. We're not, we're not at a real conservative asset allocation, you know, among players. This looks more like optimistic players than not. Another thing I'm looking at is the morning consult survey. Every morning, a group of investors, consumers are interviewed and, you know, how they're feeling about things. And a lot of this is tied directly to the stock market. And what I'm doing is comparing that morning consult survey, which is the red line to the S&P 500 there, which is the blue line just since this bull market began. And you can see up until really this AI search in March 30th, at least directionally, these things moved at the hip right together. Up and down, pretty much throughout this bull market. But since March 30th, stock market went super higher. Morning consult's gone south. And again, I don't know which one's right or which one's going to win out, but it gives me pause where before it was always having the support of at least those underlying investor attitudes. That is another bifurcation that disturbs me a little. If I go to this next chart, this is one that's bothered me for a while and continues to here at the S&P 500 in blue to the red line records the total level of corporate and household cash in the United States as a percent of GDP, nominal GDP. And you can see really the last 30 years or so, back to 1990 at least, the stock market's been hugely tied to liquidity in the economy. When there's lots of it, it goes well. When it dries up, it tends to go bad. And that really was directly the case until the start of this bull. And it's really parted company quite a bit since that period of time where liquidity continues to dry up relative GDP. I think that's going to be important, particularly now that even tech cash is starting to diminish as people get into using leverage as opposed to cash. In the new era sectors, you've got another chart I didn't throw in here today, but if I look at the ratio of cash holdings to new era spending, that ratio has been rising steadily throughout this bull until recently, where now cash relative to tech spending, new era components of it, is starting to roll over. And again, it's just something else. It's a warning sign and to add on the pile of concern.
Speaker 3James, but that Main Street sentiment thing from the previous chart is really interesting to me from the perspective of like, if we think back to like 1999, I would assume this would have looked very different, right? I mean, because we've got like bubble-like behavior in the markets now. We had bubble-like behavior in the markets then, but I would assume sentiment would have been much better than it is now. And I just wonder if you have any thoughts on that and what that means.
Speaker 2The answer is we don't know because this doesn't go back that far. This is like, doesn't go back. I think it's something like maybe 2019. I don't remember exactly the date when they started this, but it's been very good since I brought it out. And so I don't know what it was back in dot-com, but I suspect there was greater optimism there, accurately, at least on Main Street, I think there was. Because at that time, what's really different between these two cycles to me is there was not this bifurcation like we see today. Yeah, there was a bifurcation in the stock market, but over that bull, a lot of ex-tech stocks also went up nicely. They just didn't go up as much. We've literally had where most of the market hadn't done hardly anything. And we have this one sector that's going through the roof. Same thing in the economy. And throughout the 1990s, we had 3% job creation a lot of the time, 2.5%, 3% job creation. We had 2.5%, 3% productivity at times over that period of time, measured productivity. So we truly had a booming economy. It was broad-based and all participatory. That has not been the case here. So I do think there's divergence. And I think it's very telling, Jack, when you look at that's really come about just since that AI surge. This AI surge to me has a lot of different ways that kind of looks like it's really like a one-off where nothing else really participated. It's this one small part that lit fire and nothing else really did. And it kind of shows up on this survey as well. They don't see anything close to the kind of excitement that shows up in that AI move. And if you back out the AI move from the S&P 500, that blue chart looks far different, far different without AI stocks in there boosting that thing up. So I don't know exactly what it was, but I suspect there was a lot more out. Now, in some sense, that's a good thing. And I think that's one of the reasons I don't expect this thing to end today in a dot-com result right now. I don't. Because in part, so much of the market, so much of the economy has not participated like it did in the 90s and is in great need of liquidation. What we have is a small part that's probably been even more aggressive than it was in dot-com in my view and does need liquidation. But it's going to happen against a lot of the rest stuff that is in pretty decent shape. That's kind of why I'm thinking we might have a 20-plus in new era and a 10% or less in the rest, not an all-out collapse across the board. This chart just looks at how defensiveness has left the marketplace in a big way. And this is, this did happen also in 2000. This looks at the market cap weighting of the S&P 500 defensive sectors as a percent of total market capitalization within the S&P 500. Basically, I just included the utilities, consumer staples, the healthcare REITs in that measure. And we're right back down to where we were at the dot-com top. Now, what I think is most telling is you think about when you enter the stock market today in the S&P 500, you have the defensive parts comprising 16%, 17%. At the start of the 1990s, at the bottom of the '09 market, you had a defensive weighting that was twice as great as double what it is today. That says not only is there not much downside protection, but you're also involving yourself in a market which now is going to have a lot more volatility than it used to have when defensiveness played a bigger role in. And we have both things that we're dealing with today. The chance of not much safety jacket until the weighting of these parts get bigger. And secondly, just daily volatility is going to be much more pronounced because of the lack of defensiveness. If you look at the next chart, this is another way to look at that defensiveness thing, but it's quite striking when you look at these dates. And it's another way to look at defensiveness. I got back to 1962 here. I used the Kenneth R. French database. I looked at the lowest price beta quintile stocks to the highest price beta quintile stocks, their relative total return performances. And if you think about it, in aggressive markets where people are optimistic, they're going to bid up high priced beta stocks the most relative to the low beta. And when they're defensive and worried, they're going to bid up low price beta stocks relative to high. So when this ratio is very high, it says people are being very defensive. And you can look at the dates at the peaks here. '63 was the missile crisis. You know, the bottom of the missile crisis market. You got 1274, the bottom of the nifty 50. You got 1090, the commercial real estate crisis on the coast before the bull started the 90s. You got '02, which is the dotcom bottom. You got 1108, which was close to the bottom of the great financial crisis. You got 2000 in March, which is the bottom of the pandemic market. You got 1222, which was right close to the bottom of the 2022 bear market or the start of the current bull market. That's where this thing peaks. Massive defensiveness. We're at the opposite end of that extreme. All those days correspond to big market tops. And we're sitting at one of the lowest ratios there that we've ever had, going all the way back to the 1960s. Again, just disturbing to me a little bit. Tells you something that people are piling into and what they're not involving themselves into. This also just shows up. There's a lot of excitement here about earnings momentum. And let me tell you, we're in the middle of a crisis. And it's legitimately so. This is the S&P 500 forward 12-month consensus EPS on a log scale. And you can see earnings are doing just fine by estimates. Now, two points. One is that while rising earnings momentum is a wonderful thing, and it is, it is until it isn't. That's to say, if you're going to say earnings momentum is great today, so I don't have to be worried about anything, that's an incorrect statement. If you're saying earnings momentum is great today, so that's good for stocks, that's a correct statement. As you can see, all throughout the 90s, it was really good, did fine. Okay, a lot of these other periods. But when the market does roll over, which is where those arrows are pointed, usually it rolls over when earnings momentum is fantastic. So having fantastic earnings momentum does not mean a bear market is a long ways away. Okay? Because almost all of them happen from peak earnings momentum. Doesn't mean, there's a lot of times when it doesn't happen from peak earnings momentum, buff. A lot of them start from that situation. Not like it has to roll over before you get in trouble, and that's the point I'll make. Now, what this also says, and we'll get to that maybe in a couple of other charts, there's a lot of optimism here. Because unlike trailing earnings, estimated earnings are a sentiment measure, as much as they are an earnings measure. I mean, if you're looking, these are brought by analysts, and if your stocks are doing well today, and you just keep raising your target prices, particularly because you got to be able to recommend them for another year. And so there's a bit of a sentiment read that what we have going on here, telling us about a fundament. And I think that's always been a prop. A couple more things on earnings momentum here on the next couple of charts. This chart just looks at that estimated forward 12-month EPS in relation to the trailing 10-year, 120-month level of earnings in the past. And just to show you how aggressive this 12-month earnings number is relative to past estimates in relation to kind of the average of the last 10 years, we're at a record high in that measure. That's a pretty steep slope to achieve, where not only are earnings great, but they're really great in relation to what we've produced over the last 10 years, saying something about sentiment. I think I have one more in here, too, I'm just looking at this last chart, comparing the dot-com situation, which was the red line in this chart, the last five years of the dot-com compared to, well, actually, the last three years of the dot-com compared to the three years of this bull market, and the blue line being this bull market. And you can see that at the end of the dot-com, you had this surge in momentum winning. Momentum stocks took over the marketplace, right at the end of that bull market. Well, they've done that again here in a big way in the last few months. Again, none of this to me is definitive. It doesn't tell me that this is over, has to happen. I'm just piling up stuff in my mind that is guiding me more concerned about being a little more cautious. The last thing is valuation, Jack, which I've looked at. You can look at it a number of different ways. But this has kind of been my favorite way to look at it. I have a lot of problem with valuation measures anyway, this one included, I suppose. But all I'm doing here is looking at the level of the S&P 500 every month compared to its trend line average over since that period, since 1950. And you can see it sort of trades regularly around the zero marker. It goes above and below its trend line over time, which you'd expect. And you can all suspect that when it's really below trend line, it's a better value than it is really above trend line. What going above it is talking about momentum and all that. But I wasn't too concerned. Just a few months ago in late 2025, this thing was a little over 23% to its trend line. High, yes. But it was in that same range that you saw in the '60s. And that persisted for a long time, traded 20% of the premium to trend line. It was a bull market that lasts a long time. I was even okay with that. You know, we could persist there. But what it's done just in the last six months or so is it's gone from that kind of premium to a 60% premium now above its trend line, just in a matter of six months. And now the only thing that's ever been higher than that was.com. It was still quite a bit higher. But nonetheless, nothing else is like that. And again, that gives me a little pause that this thing maybe is getting a bit extreme.
Speaker 3Paul: Yeah. So we've talked about this idea that tech has dominated for a long time. One of the things in this next section you're showing, though, is tech maybe relinquishing that leadership to some degree, right? Yeah.
Speaker 2I do think that there are some signs that tech is losing its mojo a bit here. It's starting to show up. And what is interesting is it's kind of doing it despite the fact that we had the AI surge, the AI new excitement wave, if you will. That you can see here from March 30th to the June 2nd high. This is the relative price of the S&P 500 technology index just since year end. And what I want to point out, or not since year end, going back to 2025, what I want to point out here is that tech stocks have already had a pretty good pullback relative to the S&P 500 here since the June 2nd high. In fact, if I update this chart, it would go on to lower levels than shown here. But what really gets me is tech stocks now have been a market performer relative to the S&P 500 going back to a tope of last year. They're not just that always outperforming animal anymore, if you will. They're also getting extremely volatile. I mean, look at the volatility we've had now in the last. I could take this back to '04 and actually, we're not that far away from summer of '04 where it hasn't been that much more of an outperformer. But it certainly has been an underperformer since October of 2025. And in the interim, the relative volatility is pretty spectacular. So, one of the reasons people latched on to tech stocks was not only their phenomenal year-in, year-out returns, but also, you know, they were pretty steady, steady-eddy kind of returns. They didn't have a lot of volatility to them. They're starting to get lack of bull, not great as relative returns. And they're starting to get more volatile. But it's not just the S&P 500 tech. If you go to the next chart, look at some aspects of it. You know, this is the other sector in the S&P, which is part of the new era, the communication services sector. It's just really rolled over and died. It did have that AI excitement, but it not only gave that back, it went far beyond that. You could see that these stocks now have been market performers going back to the start of 2025 over that period of time. This idea of buying old tech because it's always going to win is going to start to wear on people's portfolio statements, I think, is what I'm If I look at the third one, this is the venerable MAG-7 index relative to the S&P 500, and it has really fallen on hard times. It really didn't get any pop from AI at all, and it's just fallen off the chart. I mean, how many portfolios owned this or companies in it for so long here during this bull market? And they probably might still be owning them, but it's starting to get long in the tooth now, and that's not what people were used to when they bought technology. And even AI in the last chart of these, Jack, that's also, you know, it's still up a lot from its March relative move, but it's starting to give back some of this as well, some of the excitement's coming out of that as well. I'm just amazed that when you have something as ferocious as this AI, you know. Obsession, if you will, waif through the markets, that it really didn't do much good for new era stocks that have been dominating this throughout the period of time. So I'm kind of thinking we've got new leadership sort of sneakily coming up on people, and it's starting to get a little more noticed, but it's still not greatly noticed. I think most people still think I'm going to stick with tech because that's always a win over time. I don't even disagree with that necessarily. I think. You know, five, 10 years, probably it'll be a winner, but that doesn't mean we couldn't have some difficult periods of time. And right now, every portfolio pretty much probably is overweighted new era securities. Hey, you just can't help yourself. I mean, I'm probably as guilty of that, you know, even if I haven't bought any for a while, I probably haven't sold any of, because you know, they just, they keep doing okay. And the reality of that is when you, you don't sell any of those, you don't buy anything else because they're not doing that well. Suddenly your portfolio. Gets way overweighted in this one area and with damage, like, which is starting to occur in this sector, more and more people are going to go, well, gee, Wes, maybe, maybe I should lighten up a little bit. And if everyone does that, that's where you can get a 20% correction in new era security. So let's look at leadership. Just what's happened here. I would argue, and I just did in a piece that you could say already, and no, one's done this that I'm aware of, but you could say this bull market has been. Driven. By two distinct leaders already in this bull market, not one, two different leaders. This one from shows the performance of new era securities in blue on a relative basis to the S and P five from 10, 12, 2022, when the bull started up until, uh, last October, uh, which was the last high tech, uh, or that period of time. And over that period of time, tech stocks outperformed. It underperformed by 50% or new era stocks. And while the rest of the S and P 500, uh, the other nine sectors of the S and P 500, it underperformed by 20%. Okay. That was a definite new era led bull market really warped. No doubt about it, but look, what's happened since last October and the next chart, if I start both of these again at one index of a one, their relative price performances, you now have gone from October. Uh, so you're, you're talking what eight months, nine months, whatever it is, um, where the, this S and P 500 had now been led by a broad marketplace or the rest of the old era securities within the S and P 500, the green line in that, uh, the nine sectors. If you bought the nine sectors market cap weighted them, you would be beating the two sectors of new era securities over that period, over that period of time. I just looked last night. I put out a tweet this morning that I now can go back a full year. As of last night, July 7th, you can go back a full year where old, the old era parts of the S and P 500 have beat the new era parts for that's the first one year period by a wide margin that's happened during this bull market. So something different's definitely occurring. Um, I've got a piece that will be coming out tomorrow. If I get off this call and finish it, just one part of it will show, uh, look at the relative performance of broad market plays in the S and P 500 or broad market plays in the stock market. I take it back to 1999 and from 99, uh, up till 2010 or 11, that was dominated by broad market plays soundly beating new era securities by the last 15 years has been almost the other way around. Yeah. There's been a little whatever, maybe like we're seeing now, but, but as far as the trend line, if I draw a trend line for 2011 down to today, it just never surpassed this one first time in 15 years.
Speaker 3If we showed this chart to like a lot of people, I think many people would be surprised by this. I don't think many people would realize like the behind the scenes leadership. I mean, we're hearing about tech and AI and stuff in the news all the time. I think a lot of people are, would be surprised that this relative rotation we're seeing behind the scenes.
Speaker 2I agree. I think it's starting to get a little more play, but, uh. Um, I, I think, I think you're right. I think most people, you know, I, I, I know just in discussions with people, I talk with it, you know, a lot of different people I respect and manage money. You know, it's like you have to make a call in here. Are you going to sit with the AI story? You're going to accept it. Are you going to go with its win over time, uh, or not? And I'm not sure you have to make it that black and white. I, as I say, I wouldn't. Totally dismiss that AI wins over time, but it doesn't mean you have to be overweighted the whole time. Uh, you could go, you could still own some, be underweighted, and there could be a goodly period of time where a broader marketplace continue to win. And I think, I think we might be in one of those periods and going forward in their balance this year. I still think that's going to continue to be the case. And not only that, I think there's going to be some damage that's going to be noticeable on those that just sit, uh, with, you know, too much of an overweight in that area. And I, to your point, Jack, I think you are right. And, uh, that's one of the reasons why we maybe haven't seen as much damage yet as we may is that people start to recognize that. Then people will start to make portfolio moves, at least at the margin. And here we don't need wholesale selling or buying of anything. If we get everyone to do marginal moves, and I know everyone's going to have to move in the same direction, then that could be a pretty big move that's that's giving, pulling down new era and giving thrust to broader market or old era plays.
Speaker 3So in this last set of charts, we're going to take a look at some of the economic data behind the scenes. And the first one here, we're looking at yields and inflation.
Speaker 2Yeah, I, I just a couple of comments on bond yields, I guess, overall, there's this view that there's a strong view out there that still exists today, that we hit our all time low in bond yields right before the pandemic. And that, you know, that we now have turned the corner and just like the last time we turned. The corner, we're now heading higher in bond yields. And that, you know, there's a lot of disastrous scenarios out there about, you know, with government debt piling up and with inflation being a problem that we're, we could go a lot higher in bond yields. I think just the opposite of it. I think, I think bond yields are going to return pretty close to where they were. I don't know if they'll get all the way back 10 year to 2%, but I think we're going to see, you know, sub two, sub three, maybe or something in the next few years. And this is just one example. I got a better one coming after it. But if I look at the bond. Market here, the, the 10 year bond yield is the blue line. The red line is just, this is amazingly simple. That's why it's, uh, I just took a weighted moving average of CPI inflation rates over the previous 10 year period. Okay. And if I do that, I get the red line that you wait the current year at 10, two years ago at nine, eight, seven, six, five, four, three, two, one, a long-term moving average of inflation. Look how close that lines up with where bond yields go. Over time since what, 1870 or whatever it is there that that's a heck of a heck of a pretty good record of I've just answered the question. Do you think rates are headed higher or headed lower? This thing's done a darn good job. Now, what I looked at with this, uh, yellow, blue, purple, green line going forward is just say estimating what the inflation rate is going to run in the coming five years. And I got it going from 4% on the. Yeah. Yellow to 3% on the turquoise, 2% in the purple, 1% of the green. Um, if we get back to 2% and hold that for five years, you, you've got, you can see on the right, you got a bond yield that's under 3% on average, based on this historic relationship, you'd have to get a lot higher. You'd have to get in sustained inflation rates, probably at 5% or more year in year out before you're really going to take the bond market a lot higher than it already is in terms of yield. At least according to this construct. Now, the real reason is in these last few charts that, that I'm really concerned about where the economy might be going now in the next five years. Um, and what these get to is what's going on with, I would, I titled this piece was the demographic to dungeon. The U S is getting sent back to, if you will, demographics in the United States have worsened considerably. In recent years, and that is a huge, huge force on economic economy. productivity on inflation, on yields, on prices in the economy, is the degree of growth in the labor force or the degree of demographic power our economy has. We don't have it. And right now, it's going to get worse than it's been. And I'm just going to relate in all these charts. The first one is being real GDP, the trailing five-year average analyzed real GDP growth rate in blue. And what I've laid on top of that is the trailing five-year average analyzed growth rate in the labor force. Now, again, not perfect here. This is the worst one, by the way. The next get better. But pretty good simulation that when labor force growth is doing well, so is economic growth. When labor force growth stalls, so does economic growth. Look what's happened since 2010. We just died out down here in the demographic dungeon. Why is that? I mean, we can't get growth above much above 2%. It takes, the only time we can do it right here in blue, right here in 2025, was when we had a pandemic and we juiced it with like, you know, 30% money supply growth and 20% deficit spending and zero interest rates. You know, we get a good growth. Otherwise, we can't get it above 2%. Why is that? Because our demographic growth is under 1% and getting worse. It's more like a half a percent. If you can't get growth, back to where it was back here in the 60s and 70s, we're stuck in the demographic dungeon of growth. I sometimes chuckle when I hear people worried about overheated growth. And we haven't got to raise rates because inflation's getting out of control. We're growing at such a slow rate of new labor inputs. I don't think there's any way we have overheated growth capability. Now, if I put higher productivity on that, maybe we stretch out a little more growth, but we certainly won't have inflation. If that's the case. Let's look at the next two. That's a forecast for GDP. Oh, I'm sorry, go back to there real quick, Jack, to the GDP chart. The green dotted line here is based on where this red five-year trailing growth in labor force will go over the next five years if it grows at the forecasted rate, I believe about 0.5% a year, which is what the consensus is, right? Not mine, but just pick the. off the consensus out there. And you can see that we're going to be down here with a 0.5% labor force growth and maybe be doing well to get 1.5% to 2% GDP growth over the next five years because of the depressing effect that lack of labor force does to growth in the economy. The next chart, it looks at what it does to inflation. This lays that same chart in red, the five-year trailing labor force growth rate on top of the annual, not five-year, but just the annual year-in, year-out growth rate. And it's going to be down here with 0.5% labor force growth out growth rate in the inflation rate, the blue line, CPI inflation rate. We had a good surge in labor force growth right here in 2023 and 2024. Why? Because we killed it off for a while after the pandemic. We took demographics down so badly that then for a few years, we actually had good growth in demographics again as people came back to labor force. But now we're stuck with our kind of trendline growth, which again is going to be 5%. And that's what we're going to see in the next five years. So we're going to see a lot of growth. We're going to see a lot of growth. I think we don't have to do much to get there. I don't think the Fed, I mean, this idea that we need to raise rates right now, what good is that going to do? Is that going to bring, open up the straighter home use? Is it going to bring peace to the Middle East, which will stop the rise in oil prices? No, I don't think it'll do any of that. What we have is a supply-side-based inflation problem, and raising rates is not going to improve the supply. It will hurt demand, but we already have relatively weak demand overall. And if demographics keep playing out, it's going to get worse. And so finally, I'll relate this to bond yields, and this is the closest one. This has got an amazingly close correlation. I'm talking about taking the trailing five-year growth of the U.S. labor force and laying it on the day-in, day-out bond yield, which is what you have in blue there. Correlation, I can't remember from something like 0.8 over this period of time. It's remarkable how well the last five years does in picking up the ups and downs of bond yields over much of this history. And you can see what the green bar is now suggesting, the green dotted line for the pressures on bond yield. So I think, I think if anything, we have a lack of inflation, a weak growth problem coming in the next five years. Now, productivity could, again, help that. But again, if we do get productivity, that probably leads to even further downward pressure on inflation and yields rather than upward pressure. And if you don't get productivity, you just got a good old sluggish growing economy. Now, ultimately, we need immigration in this country, or we need a higher cultural birth rate if we want to grow faster than 2 percent stall speed for the rest of our lives. But this kind of lays out that the importance of demographics and what they imply about where we might be headed in the next five years. So there's a lot of talk about a productivity boom in a wonderful environment. I don't know. This tells a very different story. Not that it's curmudgeonly terrible, but it's very different than what I'm hearing, I guess.
Speaker 1As we wrap this up, I just want to make sort of one, I think, overarching comment here. And that is, what our audience is seeing is someone with decades of experience in looking at the markets and economy that has, in my opinion, been right about way more things than he's been wrong and presenting a very compelling case for what he's seeing and, importantly, what you're looking at. And, you know, markets and economies are complex. And I think this has been an extremely valuable discussion. I think it's been a very valuable discussion. I think it's been a very valuable discussion around someone with your level of knowledge and expertise and the things that you look at day to day and over the long term, Jim. So I know this is, our audience is going to get a tremendous amount of value in this one, for sure.
Speaker 2Well, I appreciate that. I would say, though, that I have certainly been wrong and I will certainly be wrong again. I'll miss some things and take it into consideration. But I try my damnedest to do as best I can. And I try to react to things where I get convinced that there's something to react to and a little bit. And I don't see the world ending or anything along those lines. I think our biggest problem in this country, I think, is a lack of growth. And I think it's tied a lot to demographics and low birth rates. And we're going the same way that Europe and China has before us. And I think we still have a lot of opportunities. And I think productivity could help. And technology is exciting. It's better we have than anyone else. But I do think we still face that very serious challenge.
Speaker 1You know, I had invited Neil Kashkari on the podcast. He said no. He actually got back to me. But I think I might send him this episode just to see what he says.
Speaker 2Yeah, I'd be interested in what Neil had to say on that. Well, you guys have me on every time. Absolutely, Jim. Class act.
Speaker 1All right. Thank you very much. We'll see you next month.
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 pod 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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