Speaker 1Jim, welcome back. Thanks for joining us today.
Speaker 2Oh, thanks for having me, guys.
Speaker 1We'd like to have you on these monthly discussions to talk about the economy and the data that you're paying attention to and highlighting for your readers at Paulson Perspectives, which is your Substack newsletter. You spent a lot of time looking at a lot of different unique indicators that you've tracked for years. And I think that this discussion, just given the raw number of charts and different things we're going to look at, is going to do a good job of highlighting the things that you're paying attention to. But where we, I think, always like to start with you is just try to get your take on where you think we are generally with the economy. And if anything has kind of changed or you're paying attention to anything specifically is kind of coming to the top of your list from our conversation from last month.
Speaker 2Right. Well, I think, you know, probably the biggest news is just the jobs numbers. And then followed up by today's inflation numbers that are, job numbers were really weak and inflation numbers were real benign. And we put that together and people have done a 180 on their tightening expectations out of the Fed and the bond yields have come off their straight upside cycle. I think that's kind of the biggest change since we spoke last time. I'm still kind of. I guess in the camp that economic growth is going to slow more than people appreciate at the moment. And inflation is not going to be the issue. And it's going to be more of a concern about growth, particularly on the consumer side of the equation. And I think that's going to lead a little bit to a sentiment shift from inflation fear to growth fear or recession fear, quote unquote, something that has just kind of gone AWOL here. This year, well, there's been no concern about that. I think that's going to kind of raise its head again a little bit. You know, I think we've covered up ongoing weakness in general. We certainly had a pickup in the economy a little bit in the first part of this year, no doubt about it across the spectrum. But a big chunk of what makes people feel mostly good about the economy is what's happened with capital spending. And that's tied to AI. And it's really great. But there's just a lot of the rest of it that still, I think, is not nearly. And I think ultimately will kind of lead to reigniting some growth fears. And again, I won't be surprised at all. In fact, I kind of expect the Fed will be easing here before the year's out.
Speaker 1Are you still thinking that, you know, tech might see a little bit of weakness and correction? I think when we talked last month, you know, it was sort of like maybe a 10. And we kind of got that in semis. But what's your general take on sort of the technology sector in here?
Speaker 2Well, you know, the tech sector has already been down like 15% from its highs at one point this year. So it's been really, really volatile. I guess I think we're still going to have another bit of a scare there on the stock market side where some of this AI excitement finally gives way. Not that it's going to go away. I think AI is here to stay. But I think the immediacy and discounting a lot. The future into now is probably a little overdone. And I think we're going to see a full-fledged correction in the S&P 500, which we didn't see earlier this year yet. Something beyond 10%. But I think a lot of that's going to be centered in new era plays and the communications and technology sectors of the marketplace. Maybe they suffer. Collectively, they suffer a full bear market, 20% decline in those stocks. But with the rest of it, it holds up a lot better, I think, even though overall we might have an official correction in the S&P 500. And I just think I'll get into that a little more detail, Justin, as we get along, kind of a sediment shift that I see coming there that might ultimately lead to that kind of situation.
Speaker 1All right. So let's kind of get, I think these first couple of charts are more economic related. So this first one is the U.S. labor force over the last 10 years. So what are we seeing here?
Speaker 2Yeah, I'm just looking. This is part of what I think is, it's developing a sentiment shift that's going on. We've been primarily worried about inflation. And I think the concerns are going to turn toward a growth. And what's going to get us, I think, ultimately is kind of stuff that's tied directly to the consumer is really weakening off. It has been. U.S. labor force here in this chart is clearly rolled over in a big way. You just don't see that type of move in the labor force outside of recessions. It's basically been flat now since 2020. It's been flat since the beginning of the pandemic. And it's been flat since the beginning of the pandemic. And again we're sitting at zero job creation in this country for extended period of time. And there's not too many instances that you can sustain that for very long where that blue line stays where it's at. Now, either maybe jobs are going to come up a lot. I don't see much support for that argument. Or if not, then how long can that type of job growth support that type of consumption growth? And even that growth is great, a little over 2%. It's not exactly through the roof. And then the next chart I just throw out that basically when I look at the consumer today, they don't have any jobs. Their real purchasing power is eroding. They have a pretty lousy attitude about conditions on Main Street. And their personal savings rate's at a record low. So they can attack their stock portfolios, and some of the upper income groups are probably doing that. But boy, that's not a very good story for the great bulk of the American consumer. It really drives the economy. They don't have that option. So, I mean, their options are savings or wage income, and neither one of those are very good, particularly if you're back on inflation. And I just don't know how long we can sustain that. And then lastly, this is the Citigroup's U.S. Economic Surprise Index. It is rolling over. And even since I did this chart just last week, it's now dropped another five points down to 25. It is rolling over pretty rapidly now as we come down. I think it's going to go down quite a bit. Quite a bit more in the next few months. You know, the thing about getting a bad jobs number at the front end of the report, that often sets the stage for the whole month's worth of reports. Not always, but often if you have a weak jobs number, most reports are under expectations for the month from production to everything else. And I think we might start to see that a little bit. So I'm concerned that, you know, going into that jobs report on Friday, the sentiment was by and far away that the Fed's going to have to raise rates. That was widely. In fact, people were mad that the Fed was behind the curve at the last meeting. Didn't really give a good explanation, all that stuff. But mainly they were thinking the Fed's got to move around because the bond market's going nuts, right? Went up to 460 on the 10-year, new high to 30. And oh my gosh, it's out of control. Well, that's really changed quite a bit. Now, expectations have come down quite a bit for that. I think it's not only not, are we not going to have to raise rates? It's going to be, we're going to find out that. Even where we're at is going to, the bigger problem is going to be growth rather than inflation going forward in the next few months. And that kind of gets to the next few charts I want to talk about. Kind of this sentiment shift that's occurring. Right now what's happened is people are going, okay, Fed's not going to raise rates maybe right away, but I'm still worried about inflation. And I say that is the case because I still think, I'll come back to it in a minute, that the relationship or correlation between stocks and bonds is such that that's what it suggests is the situation. That people, investors are more worried about inflation than growth. But just to start out this chart, the blue line here is the 10 year treasury yield going back to 2023. And the red line is Bloomberg's hard data, economic surprise index. I'm just backing out the survey data. I wouldn't have had to, but it's a little better relationship. If I back out the survey data, what you find is just hard data reports, actual economic reports. How are they coming in above or below expectations? You could see they've dropped off considerably. And what I find most interesting about this chart is that red line has been leading bond yields rather consistently throughout this bull market, up and down. Study that chart. Red goes up first, then blue. Red goes down first, then blue, all the way across for the most part. And right now it's suggesting that we might, in the not too distant future, see us with a three handle on the 10 year again, not a five handle. That's what people want. We're expecting just a couple of weeks to go. That's just to set the page. Now, if we're going to get something like that, you got to have a sentiment shift. I think people have got to give up the inflation goes to worry a little more about growth if we're going to actually go back down to those levels. So let's look at kind of that where that relationship is at here in the next chart. And I've shown this next chart before. The red line is just the 10 year treasury yield, and the blue line is the correlation on a treasury yield. A trailing one year basis between stock and bond, stock and bond yield movements. And it's on an inverted left hand scale, that blue line. And all this says is right now we have been in during much of this bull market since 2022, we've been in a negative correlations position between stocks and yields. That is, most of the time when yields rise, stocks go down. When yields fall, stocks go up. Why is that? That's a sign that. The investors are mostly worried about inflation, because when yields go up, that suggests inflation is becoming more intense and stocks fall. And when yields go down, that's it, all inflation's cooled a little stocks go up in the last few days since the job report, stocks have gone up every day, yields have gone down. That's kind of what's going on. People are still in the inflation mode, but with that yield, if that correlation starts to go south on that chart goes more positive, that reflects an anticipation. And if you're worried about growth, if you're worried about growth, if yields are falling today, stocks may fall too, because they're both failed about recession. And if, if yields go up, when you're worried about recession, you go, oh boy, that's good economy, strong enough to lift yields. And so there turns from a negative relationship to a positive. Look how close the bond yield corresponds to this one year trail correlation. When, when you're mostly worried about inflation and the correlation, that blue line's high. Yields are high. When you're more worried about recession, yields go get low. I think we're shifting sentiment and the rest of this year from being worried about inflation to worried about growth. We're gonna have that blue line head south towards positive correlation. Yields are gonna go down right now. When they go down, it's pushing stocks up, but if sentiment shifts, we're gonna start finding a week where yields fall. And so do stock prices. And that's kind of what I think we might get into a little bit. Um, let's go to the last chart in this section, just to talk a little bit about what this means for the stock market. Okay. For bonds, bond yields go down. Bonds do okay. If that, if that's correct, I'm laying that correlation again, which in this case is the red line, uh, here over the S and P 500. Uh, and, and, uh, what I wanna show you is that whenever that correlation goes more positive, that is the red line goes down, which means people start worrying more about growth. Uh, and, and, and, uh, what I wanna show you is that whenever that correlation goes more positive, that is the red line goes down, which means people start worrying more about growth. Look what happens to the stock market. It heads south. When you have rising inflation expectations and that thing goes north, people are worried primarily about inflation. Believe it or not, you think that wouldn't be good for stocks. Well, it has been. Okay. Uh, stocks have gone up most of the time when the correlation's rising. In fact, they benefited greatly in the last few months from a big increase in that correlation, if you will, on the red line rising a lot. I think that that correlation is gonna roll over. And if it does, it's gonna put the stock market into some turbulence, as it has in the past, since back here, back to 2000, for example. And that's the, the thing, sentiment shift. Right now, we're looking at lower yields as a good thing. Okay. Because it means inflation's not quite as problematic, but I think we might get in a situation where lower yields start to connote weak growth, which also is gonna feed into this profit story.
Speaker 3Well, on the Fed that you mentioned before, um, I think the odds went from what, like something like 70% of a hike to like 30, um, after this last report for September. I mean, do you, do you think we ultimately probably don't see that hike now?
Speaker 2I don't, I, I think, I think, um, placing down for the count, we could go talk a little bit more about that too. But, and I guess I will a little bit later, but, um, you know, what's, what's happening here, uh, is even though we still got this Iran conflict going on and oil prices are going up and down oil price right now is the same place it was in March, which means that almost by definition. You're going to feed 0% energy inflation into the CPI numbers here going forward. Could have been one of the reasons we had a soft one here, just the last day or two, but I think going forward, even if we just oscillate where we are, inflation pressures are going to ease again, uh, both on core and, and on, on overall. So the, it's not just the growth story that's starting to deteriorate again. I think it's inflation story that's starting to lose its oomph, if you will. So I think, and quite frankly, I, I didn't. Didn't even know what that probabilities were. I guess I don't watch that real closely. I, I find it to be a, a random indicator of sentiment more than anything else that I do about anything, what the fed may actually do. Um, you know, because that thing just changes wildly over time. It can change very quickly. So, um, I, uh, but I, I, I know right now people still think it'd be hiking, but, uh, it, you know, wasn't that long ago they thought they might hike last, last, uh, meeting, um, and they certainly we're going to do it at the Jackson Hole and whatever else. I think we're not going. I think we're going to be cutting rates before the year's out. Maybe I'll be really wrong. Won't be the first time, but that's where I'm at right now.
Speaker 1See, Jim, that's Jack is knee-deep in the prediction markets. He's betting daily on the Fed.
Speaker 3I am. I'm going to lose all my money very quickly because I learned nothing about that.
Speaker 2I'll lose my money fast enough on the lotto tickets. I don't need to get into it.
Speaker 3So this next set of charts comes from your article, Policy Pain, which you and I also covered on our last call episode last month. But this gets at the idea, and you mentioned oil before, that a lot of people don't know a lot of these sort of tightenings we've seen, there's a lagged effect, and we maybe haven't seen that effect yet, right?
Speaker 2Right. And that's kind of what I'm getting at here. This just shows the stock market, S&P 500, the growth rate of that annual growth rate going back, I think, to 2023, if I can see that correctly. And the red line there is just an economic policy indicator based on a few different economic indicators, mostly weighted a little bit towards oil change in oil prices, changes in the bond yields, changes in the U.S. dollar, and how they've changed. And then in this case, that red line's leading a blue line by 13 weeks or about three months. That is to say, to your point, Jack, generally, when oil prices rise or bond yields rise or the dollar goes up, those are all tightening forces on the economy and on the markets. But it generally takes about three months before they really start to show up and impacting the stock market. And that's kind of what this shows. And right now, if you look ahead, with the increase in the last three months we've had in oil, in bond yields, and in the dollar, you're looking at a somewhat significant downdraft, perhaps, in the S&P 500 on its six-month growth rate over the coming three months. And it's not a washout. It's not a bear market. But it'd be a very significant drop off in the S&P. And it would be policy-induced. The impact of these things, like I said this before in earlier talks, the real impact of oil prices is not when they're rising. That's when people get mad about it. And they get mad about what they see at the pump, and they get mad about, you know. But the pain occurs later after you've been having to consume under those conditions for a period of time. That's when it really starts to change economic and market behaviors. And typically, the worst negative fallout from energy prices peaks is once they peak. Once they peak and everyone goes, oh, boy, good. We made it through that. That's when the real damage starts to show up. And I think we're just getting to that point where that's coming about. This is just one example where maybe some of the pain from that is still yet to come overall. One more chart, the next chart, just shows, Jack, we talked about this last time a little bit too, but this just shows that it's economically, those same forces, the economic policy indicators, this one's a little different one for the economy. And I'm just lining this up against the average of the ISM services and manufacturing ISM PMI reports on the blue line. And here are those economic policies lead by about 12 months. So it makes sense. The stock market leads the economy by X number of months, and policy leads not by as much, it leads the economy by more. And it shows here again that by the end of this year, you're going to see much more pressure downside on the economy. And if the economy starts really moving off, let's say in the last quarter or later, then the stock market's going to react to that before then, if you will, because it's a leading animal as well. So I really think that when I look at this, it's policy ultimately that's going to shut us down. And it's sort of ironic a little bit because we've been so, you know, obsessed and focused with one problem economically for most of the time, and that's been inflation. And even though the economy, when we first started worrying about inflation, real GDP was growing double digits after the pandemic. And now it's growing, you know, like less than 2%. And job creation was way up there too close to that. And now it's flatline. We're still myopically focused on fighting inflation. And I think we're going to find out that we overstayed that fight. And we probably pushed downward on growth a little too much. I do think we avoid recession. That's only because we haven't had one for 15 years. And I just don't know what causes them anymore. But that's not a very good reason. Also, because balance sheets are still pretty clean. But outside of that, I'd say we're going to have something that at least scares us about a recession. That's kind of what we're looking for.
Speaker 3This next section of charts is very timely because this idea has been out there with AI that we're either, in a productivity boom or we're about to be in a productivity boom. And I think the point you were making is that these are very rare occurrences in history.
Speaker 2Yeah. I think, you know, a big part of this AI story, no doubt about it, is for it to be successful, it's got to raise productivity. Otherwise, it's not going to be successful. And the problem is, you know, it's really hard to measure productivity. And it's getting harder and harder in the new era age. And particularly harder to measure, like, services productivity. You know, we've had that problem for some time. But we still only have the one measure of productivity, the annual productivity index. And that's shown in this chart, the annual growth rate going back to 1948. And the first thing I want to point out is that we currently have productivity that's like two and a half percent. And people already are going, hey, man, we're already experiencing a productivity boom. And I don't think we are. I think that a lot of what's going on today is kind of a false productivity signal. And we have a lot of them. If you look closely on this chart, you'll see that there's a lot of them. And I think that's a lot of them. And I think that's a lot of I put recessions on there. And the best productivity periods we've ever had are when we're in recession. Look at those spikes. You get one maybe not right during the recession, but it starts in the recession and then goes up for a quarter or two after the recession. And every time that happens, we spike upward. I would suggest that a lot of our current productivity improvement has been because the growth's been so sluggish, not because it's been booming, if you will. And I think that's a lot of what's going on. And that's kind of what I want to get into just a little bit more is that actual productivity booms in World War II history, I think we've only had really two that qualify for that. The rest of the time, we see kind of false bubbles. You look, the highest productivity on that entire chart was in the middle of the 2020 pandemic recession when the economy collapsed. Why is that? Because when you get into recession, companies start to downsize operations, in order to survive the recession. And when they downsize operations, they cut their staffs, they lower marketing costs, and then sales haven't completely died yet. So measured productivity goes way up, even though sustainable productivity hasn't. And I think that's kind of what we got going on here. If we look at the next chart, this is just a real quick calculation. Back in 1948, I looked at all the quarters in the chart before where we were either in a recession or in a growth recession with growth, or I should say real close to a recession, a couple quarters after. I think I went from one quarter after recession started to two quarters after it ended. And look at our productivity during that period of time was 3.3%. Then all the rest of the time during expansions, we only had 2% productivity growth. Our measured productivity is mainly about how weak is the economy, that it is about how really sustainably productive is it? And I think we're misinterpreting that even as we speak. The next chart gets at what I think is a true productivity boom and why it may be difficult for us to do that. I got three things on this chart. The blue line is real GDP. The red line is non-farm payroll employment. And the green line is productivity. But the key here is they're all detrended. And so what that means is that the green line is productivity. And so what that means is I took their average growth rates since 1948. And if they're growing faster than their trend line average, then they will be rising. And if they're growing below average, they're falling. So it just gives you a sense of how are GDP, employment, and productivity doing relative to average. And you can see that in recent years, really for almost much of the time during the last 20 years almost, all three of them have been growing slower than average. Employment has been growing slower than average. GDP has been growing slower than average. So has productivity. You could see a little uplift in the green there here just in the last year or so. You see the green line has been going up while the blue and the red lines are going down. That is productivity has grown above average slightly while employment and real GDP has grown below average. Is that a real productivity boom? Is that something we should celebrate? That because companies are growing so slowly that they're cutting operations, that we're going to cheer about the productivity that results from that in measured terms? I don't think so. But yet, you hear that story today. There are two clear periods that stand out on this chart, and I got them circled in black dotted lines. The first was in the 1960s, and the second was in the latter part of the 1990s. The first was when IBM announced its first mainframe computer that set off a technology boom, and the second was the dot-com boom in the late '90s. During these two periods to almost all other periods, you had not only a solid rise in employment, a solid rise in real GDP, but despite using more and more labor above average rates, you had rising productivity on a rising labor force out there. That's a productivity boom. The word boom is important. You don't get productivity during bust growth and employment and real GDP growth. To have a boom, you need all three to go up. We've only had that happen two times for sustained periods in post-war history. I don't think we got it in us to do it right now. If you think about how we're going to grow our labor force at above average rates and employment, we got low birth rates in this country. We got delayed marriage and family formation. We got aging baby boomers population. We got no net immigration. I don't know how we're going to grow the population fast enough to sustain rising employment at above average pace to qualify as a boom overall. And we do have, I think, that issue. The last chart I'll show you on this is I expanded that first chart. This is just productivity growth again to include all the shaded areas or all the recessions and all the growths which are any periods of time when real GDP growth was less than 2.2%. And you can see again, there's two periods that stand out there, 1960s, 1990s. All the rest of them don't stand out. And ours clearly looks nothing unique about it. Nothing you can write home and yell and scream about a boom. I think the major productivity we have today is because there's a big gray bar over it. It's because conditions are so weak that a lot of companies are cutting operations and maintaining staffs at very low levels to keep measured productivity high even though it's not a sustainable boom productivity. So I don't know. I'm a little suspect about the story of a boom, but we'll see how it plays out. That's for sure. Even if you have sustained productivity, just one last point. You know, let's say AI just creates a situation where job growth is perfect. It's permanently negative, okay? And I guess it's real productivity because you're creating more output with less and less labor. But are we going to call that a boom in this country? Is that going to feel the same as the 60s or 90s booms? I don't think so. It might be on paper, the same productivity growth might be recorded. I don't know. Maybe it's even sustainable, but I don't think it's going to feel the same as the booms that we had in the 60s and 90s when everyone, had massive job opportunities. Companies were growing very rapidly and expanding operations. That, that'll be a very different sort of productivity environment.
Speaker 1Well, the other thing that you kind of hear about with like these companies that are really using AI is the cost of it. So, right? So it's like you get, maybe you get this productivity gain, but like, what is the cost? Like these IT directors and, you know, heads are, you know, spending whatever it is, triple on, you know, AI and the cost of it. And stuff. So I wonder how that would sort of counterbalance the productivity. It might not show up, productivity might go up, but then there's, there's the cost side of it too. I don't know. It's just interesting to think about.
Speaker 2I think it's true, Justin, that, you know, I think also there's a lot of buying going right, right now because there's a lot of freebies out there, you know, kind of, which is kind of what happens when you ever do something new, right? But once the price starts coming up, then some of that demand go away in a hurry. And we may run into that for the too distant future.
Speaker 3And what this, this, this next set of charts gets to something where I think we talk about in almost every episode is here. We tend to talk about AI CapEx all the time and what it means for the stock market. And you wrote this article, capital spending in the stock market, where you got, it got into some of this stuff.
Speaker 2Yeah. And you're right. It's a popular theme and you can see why, because this first chart sort of lays out why the blue line there back to the nineties is S&P 500 on a large scale. And the red line is capital good orders, core capital good orders, non-defense XR, core capital. Good orders over the same time period, man. That's a close relationship. There's no doubt about it. When the stock market's going out, generally cap spending, core cap spending is going up as well. And it's been no exception in the current bull market. And certainly AI has played a big role in that. So the question is now for the stock market is, you know, does, does the red line ever roll over? And if it does, that's going to be trouble for stocks. If I look at the next chart, just real quick, this is not a pretty one. The red line here is just the relative performance of AI stocks in the stock market. And the blue line, uh, is core capital, good orders again. And my, my point is, you know, one of the things that could be going on already, AI stocks have been underperforming of late. And, uh, that could be, they could, they're kind of a leading animal. They could be suggesting the core capital of spending is going to slow, uh, just as one signal of that is maybe showing up right there. Uh, cause it's not the other way around typically as stocks lead the fundamental and the stocks are now suggesting the fundamental may weaken off. Um, if that does, if you go to the next chart, um, again, I come back to, uh, policy stimulus here. And in this chart, I'm looking at the blue line being the annual growth and core capital, good orders. Uh, and the red line is just an, uh, economic policy indicator, which is leading core capital, good orders by 12 months. Um, and you can see a pretty close relationship here, historically. And again, it's policies like oil prices and money supply and the dollar and fiscal juice, um, leading overall economic growth, leading capital spending and, and policies matter and they've been tightening. And when they tighten with a lag, guess what? It also hits capital spending. And I think that that might well occur here, particularly as we get closer to, uh, the end of this year into next year. Um, you know, if we, if, if you get, start getting reports of, of weakening capital spending, that that's going to send a lot of fear through the stock market, at least for a period of time, uh, it'll be a little, little fear over that. So we'll, we'll see if that comes to play.
Speaker 3Yeah. I would think given the magnitude of this AI CapEx, like if, if, if we start to see signs that that's rolling over, I mean, I guess people could interpret it both ways, but I would expect that to be somewhat of a negative, um, in terms of what's going on. And it's your point that the market's going to sniff that out, right? I mean, the market's going to probably anticipate that ahead of it when it comes.
Speaker 2Yeah, I think so. It's interesting. You know, we've talked a lot about, I've had a lot of people comment to me lately that Jim, we've already had the bear market in tech. It was the semis and the big drop that occurred, you know, we've already had that it's over. Maybe that's right. I don't know that it's not, but I'm, I'm still, you know, the S and P even right now is 150 point, not even that 150, a little over a hundred points away from being back in the same range that it's been at since the March high, uh, or the June high. And, uh, if I look at the relative performance of tech or comms, they're both still in a downward trend off that AI top in June. And I don't know, I don't know if, um, if we really did a lot here with the big move up that we, we had to new highs, um, it wouldn't take much to put that back in that same trading range we've been in since June. So something like this on top of what's already going on in the jobs market and consumer market, I think that would combine again, to scare more about potential recession and the fed and others kind of overstaying the tightening.
Speaker 3And, and even though we just saw the correction in semis, you'd expect to have a volatile period like this with a transformative technology, we're probably going to see an above average number of corrections, um, just because as the news changes, it has so many long-term implications. Yeah. And I think you might expect that, right?
Speaker 2I, you know, I, I always think, I always think of, uh, the terms bull and bear only really apply to broad market index because, and, and yet we, we apply them to everything. I hear it all the time. You know, uh, Nvidia is now officially in a bear market or, you know, well, to me, that's kind of meaningless because if you got a high beta stocks. Anytime the S and P coughs by 5%, the high beta stock's going to go off and have a bear. Uh, it doesn't have the same connotation and, and tech's kind of in that role too. Um, it could have multiple bear markets within the context of an ongoing bull. Now it's a little interesting that we had as big a pullback in tech that we did with the overall market really during that period of time going up. The rest of the S and P actually went up over that same period of time. That was, that was a little odd, that big disconnect. And to your point, we've got great volatility in that new era sector. And now it's many times larger relative to the overall S and P than it used to be, let's say, even back in the 1990s. So it's wagging a much bigger volatile dog than it used to.
Speaker 3So for your next article here, we invoked a little Michael J. Fox, um, and your articles back to the future with bonds. And I think you were arguing there's some mispricing in the bond market.
Speaker 2Yeah. What I, I, I haven't been right on bonds at all. I mean, in some sense you could say, I could say I haven't been wrong. They haven't really gone. Uh, the bond yields haven't gone up a lot either, but I thought they'd come down by now by a long time ago. So you got to take this with a grain of salt again, but I, I still think the downsides of the bigger place for these bond yields to go. And this is just one example of they just feel mispriced to me on this chart. I've got the, the green line is annual real GDP growth. The red line is annual CPI inflation, which is all by the way, is even lower. Now it's back within that black. Dotted circle. And the blue line is the 10 year treasury yield. Now, what I find interesting is that the averages on growth and inflation, particularly on growth, uh, over the last few years of this bull are basically at the same place they were prior to the pandemic, more or less. And yet bond yields are significantly higher than where they were. Why? If, if we, if we were fine with that kind of relationship, why are we suddenly not when the growth inflation environment is just about the same as it was then. Yeah, inflation is a little elevated since the Iran conflict, but look at right before the conflict. There's virtually no difference between what real GDP growth was doing, what inflation was doing in the three years, four years, over the last three or four years, than there was in that period I circled earlier prior to the pandemic. They just feel like they went up when inflation went up, and they've stayed up ever since inflation and growth have come down with no change. And I just wonder if, you know, you think about, well, if we go back to the future, we start looking at, really, we can only sustain 2% growth with virtually no net labor force growth in this country. Without massive sustained real productivity, we're not going to be able to sustain any better than 2% growth at max, in which case we're back to where we were after the 2010 crisis when we had similar problems and we just couldn't grow. And I don't. You know, everything's kind of back there except for yields. If you go to, just real quick, run through a couple of these just to show you different aspects of both real growth and inflation and how it doesn't differ from where it used to be pre-pandemic. Here you got real GDP growth or real personal consumption growth in blue and real payroll employment growth. They're both weaker right now than they were prior to the pandemic. Why are yields higher? If you go to the next chart, this is. Real annual growth in non-residential investment and residential investment. Now, non-residential investment is certainly doing better, but it's really not that much different than it was pre-pandemic. And the red line is far worse in terms of residential investment. So, why are yields so high when real consumption, real employment, real investment, no different? If you go to the next chart, you're looking at some. Inflation components here. I've got two of them here. The annual core CPI inflation rates in blue. I just went down again here since I published that. And then there's a true inflation measure, which is more debatable whether you use it or not, but it's a daily measure of inflation pressure. It's updated with real-time data, unlike CPI, which uses estimates and only comes out once a month. It has a pretty close relationship with general movements. Neither one of those are any different today and haven't really been now for the last couple of years. So, it's a pretty close relationship. Now, for the last few years than they were prior to the pandemic. One thing's different. The Fed has the funds rate a lot higher, and the 10-year bond yield is a lot higher. If I look at wages in the next chart, I look at average hourly earnings in blue, which also just moderated again in the report, and the Atlanta Fed's growth tracker. Again, these are now. They haven't been as low, but they're now back to where they were pretty much for several years leading up to the pandemic. And still, we've got a pretty good premium overall. And then finally, if I just look at commodity prices, and they've been up and down, no doubt about it. We had a big spike here with the Iranian conflict, but even they kind of have come back down within the same zip code of what they used to be prior to the pandemic. So, if the last chart, Jack, I'll just show where bond yields are relative to commodity prices overall. Bond yields are blue, and the commodity prices are in red. And again, you just. I don't know if you've seen the last chart, Jack, but if you look at this, even the commodity world essentially looks pretty similar with a little blip for Iran to what it was 2015 to 2020. Bond yields are just so much higher. And I really think as I look forward that we're more likely to go back to that future than we are going a lot higher in bonds and yield. It would seem like this
Speaker 3is a tough period to figure out inflation just because you kind of have to separate that oil thing out, right? Because that's. That's so volatile and so responsive to different changes in policy, and you kind of have to get to what's going on in the core here to really understand it and sort of take out the oil, right?
Speaker 2True. And the core's moderated off again, too. I mean, they're all impacted. When you increase oil that much, it's going to impact everything from core to bifurcated measures all the way through. But core had a little uptick, and now it's coming back down as well. And I think, you know, on top of that, you got inflation or growth in general slowing down again a little bit. So I think the inflation story is going to run out. It sort of started to run out last year. And then we had a pickup in some data earlier this year. And the Fed, at least the old Fed, was so heavily tied to the most recent report in the rearview mirror. You know, they put the brakes on everything. I think that we're going to take the brakes off and start easy again. Now, you could throw this out the window if there's a major escalation in the war and we take crude oil to $150, $200 or something. That's out the window. I get that. But if you just stay flat with crude oil, even at these elevated levels, people will still be complaining. But the reality is inflation is going to continue to moderate again.
Speaker 3So this last set of charts comes from your article observations. And you were looking at a bunch of different things you're seeing, particularly in relation to this new era versus
Speaker 2old era, which we've talked about a lot on the I always found a little bit interesting. This chart is just looking year to date at what the S&P 500 new era stocks are doing to old era. And again, new era to me, I just separated out the tech and communication sectors. And then the other nine sectors make up the blue line, all cap weighted on both indices. And what I found most interesting of late is that since that June the stock market, after we had the AI surge, you had this big, like I say, a bear market, semis and new era stocks had a 15% correction from the top to the low. And over that period of time on the blue line, the rest of the stock market was actually going up. Now, that's hard to find. If I go back and look even at the 90s, at least the weighting between these two camps. Now, I know they're different. Communications today wasn't what communications was back in the 90s, but I can't find a lot of periods where you had as big a severe move in new era stocks as we did while the rest of the stock market was rising. That's a kind of a new thing. And I think it's underappreciated what happened there because I don't see a lot about it. And what does that mean? I think a couple of things. That's one reason I think we could have a full on bear market in half of the stock market in the S&P, in new era, and still have maybe not even a correction in the overall S&P. That's one reason I think we could have a full on bear market in half of the stock market. And that is not what happened in the 1990s. I mean, when it started to crack, you know, it took it all down. This is a very different animal. We're having things like small caps and value stocks and, you know, actually do pretty well, even while you're having this massive sell off in the stars of the bull. And so I still think you could, that's why I still think you could suffer a big correction in what is popular and maybe not have that much damage happen in the rest of the stock market. And you could have a bear in half of it and still come out without an overall correction. I don't know if that'll happen. I just think it's kind of an interesting thing to think about. At a minimum, to me, it kind of tells you that you might want to think about your allocation between new and old a little bit, not sell it all, but to lighten up. This chart just looks at the correlation between those two charts I just showed you there. It looks at the correlation on a rolling six-month basis. Of daily changes in new era and old era stocks. And it has almost gone off to a record low right now. It's just barely above where it was at the top of the dot-com marketplace. Now, I've got to tell you, by the way, when you're bottom quintile on this chart, which is shown by the red dotted line, I think, there's a huge difference. The average annualized forward, I think that's three month S&P 500% change from, you know, the previous year. So, I think that's a huge difference. The average annualized forward from the highest quintile correlation readings is about 17.2% above. If you're above the green line, this is a very good signal that it's a good time to buy the stock market. When you're below the red line, it's a bad signal because returns are only 4% compared to 17% the rest of the time. So, when you get this low of a correlation between those two markets, as I said, one's actually going up while the other's going down, that typically is a bad sign for the overall stock market. Some of these are just market indicators, I think, are interesting. This one looks at the S&P 500, which is the blue line, and compares it to a FedSpeak sentiment index. I mean, people come up with all sorts of things. This is wonderful. This is Bloomberg's creation, and they, somebody does a lot of work going through all the notes of the Federal Reserve and all the speeches and everything they do, and puts a numeric calculations on whether they're hawking or not, and they're hawkish or dovish. And putting that together, you get the red line, and when that red line rises, there's more hawkish FedSpeak, and when it goes down, there's more dovish FedSpeak. And what I want to point out is just about every time that thing has had any significant rise at all towards hawkishness, the stock market has a hiccup. There's a little indigestion for a period. Not necessarily a bear market, but at least a little indigestion. And we've just had, you know, one of the larger hawkish pickups over this entire period. The only one that's one that was bigger, was during the pandemic inflation. Outside of that, this one we've just been through in recent last couple months is one of the biggest hawkish Fed upticks we've seen. And I think, again, just another sign of pressure on the stock market. These next couple charts, I just want to reiterate, we just had another GDP reward come out for the second quarter. And I updated these charts for what I've run earlier. I've separated the U.S. economy GDP report into new era GDP growth, which is the blue line, and old era GDP, not growth, just their levels. And I sent them both at one there, I think that's about six quarters ago. And in the last six quarter, what I put in new era growth is just investment spending, real investment spending on information processing equipment and on intellectual property products. And those two comprise a relatively small portion of overall real GDP, but they're accounting for the vast majority of its growth rate. They have experienced explosive growth. You can see here over the last eight quarters, they're up over 10% per annum pace. The rest of the economy, which is maybe 90% of the economy, is up 1.3% over that same time period, or six quarters. That's a huge divide that just continues to persist. It got worse again in the current quarter. Last quarter, new era growth's up eight, seven, and the rest of the economy is up 0.9 tenths of 1% annualized. So this is not something we had to this degree in the 1990s dot com world. When 1990s, we had certainly technology doing much better than the rest of the economy and the rest of the stock. But nothing this extreme, nothing like this just almost utter divide. I can show you that in the next chart, what kind of this same thing looked like of new era to old era GDP growth in the last four or five years leading up to the dot com top. Yes, tech, tech, economic activities were much stronger than the rest of the economy's activities. But the rest of the economy's activities were also very strong leading up to the top of the dot com top. But the rest of the economy's activities were also very strong leading up to the top of the dot com market. We're not growing at 4% in the rest of the economy. We're barely subsisting at one. And I think that's what makes this very different and somewhat more vulnerable here than even more so than the dot com era. This last couple here, this one just is sort of a not sure what to make of it. This is the relative performance of Russell 1000 large cap growth index over to the overall S&P 500. And we've got a pretty strong significant underperformance going on and large cap growth. And at a time when most people are the most excited they are is about the most growthy stocks you could imagine AI technology stocks. And here we have what almost looks like only shows up in bear markets in the past showed up in the 2022 bear market showed up in the 19 in the 2000 bear market. And here we got growth, which has been a favorite for some time is having a significant underperforming period here of late. I don't know what to make of this. If the rest of growth outside of very limited number of tech stocks are doing really poorly, you are seeing equal pickup in large cap value going on. So it is sort of, I guess more just I don't know what to make of it. Interesting as opposed to I know what this implies. I wish I did. This is for the gold buffs. And I've always, it's always fun to write about gold because whenever you do, you know, you're going to just get your, you're going to get a lot of attention because there's always the gold buffs out there a little bit that are all in all the time. And whenever you got something bad to write about it, you're going to hear about it. This one I just thought was interesting. I'm just indexing the price of gold in blue. To the level of the global money supply in red. And just what I'm noting here is both were indexed at 1.0 there at the start of this. And what I've noticed is gold tends to leave the global money supply, but then it's come back to it. So, you know, it, it did this briefly back here and 08, then it came back to it again. And then it went up again, far above it. Then it came back down after 2012. Back to the U.S. money supply. Then it went up again into 2020, 21. Then it came back down again, 22. And now it's gone way above it. And maybe it's making its path back to the global money supply. Well, if that's the case, the global money supply where it's at today suggests $2,000 gold is what that's saying. If it's got to go all the way back there, there's still quite a bit of room. Gold's off 25% from its highs, but there could be a lot more downside if it's, if it's going to reconnect with the global money supply. Maybe it won't. But if it's, if that's still somewhat of a legitimate, even getting in the ballpark, you know, even if it gets to $3,000 gold, I don't know, but there's still a fair amount of downside risk there. Maybe because of the excessive optimism that emerged in this gold ball market for a period.
Speaker 1So we got through, I think we broke a record today for the number of charts we got through. But, you know, Jim, I want, just in closing here, I think like all of this is kind of like a mosaic and you're painting a picture of these concerns. Possibly weaker growth in the future and the things that you're sort of highlighting or everything that we discussed. But I'm just wondering, would, would, would it be fair to sort of in closing here and thinking about like the one, and I know you don't, you don't think like this, but, and I'm not trying to pin you down, but like the one thing to me that might be sort of like actionable, I mean, it's all actionable, right? Depending on how you want to act on it. But the one thing is that stock bond correlation that you kind of described at the beginning, where if yields start to fall and stocks start to fall, it sort of tells you that the narrative or the mindset has shifted from concerns of inflation to concerns of growth. Would that be something that could be maybe a little bit elevated from your perspective in terms of what investors might be paying attention to? Again, it's all important. I'm just trying to get out. Like the, the one or two things that you think really would stand out. If you saw a change, you would be like, okay, this is starting to be, you know, concerning.
Speaker 2Well, I, um, I hear what you're saying. I, I've never been a big one for just one indicator. Right. The one thing, it's just, it's not the way, um, I've been burned too much by that, frankly, over the years. And I, I'm kind of the weight of evidence person, um, where I look at a lot of different things, a lot of different indicators. I don't. Too excited or down on any single one per se, but I kind of build piles and when the weight's heavy on one side, I kind of lean that direction. And that's kind of, kind of how I go about it, whether it's right or wrong. I don't know in terms of doing it that way. But, uh, you know, I think the correlation is more a symptom of other things in some regard, Justin. It's sort of is, uh, monitoring or picking up what is being driven by. Right. Probably policies, the late impact of policies actually affecting stuff. It starts to affect growth. It starts to affect inflation. And then people alter their attitudes about things. And, and so I, I, I guess the takeaways for me from what I'm at is, uh, I still think there's a good shot that we're not going to get an all, all out bear market here in the S&P 500. And if we don't, we get through this period, we probably go into the 2030s before we have a bear market. We get through this period. Um, and so I don't think you want to cash out of this stock market. Okay. Well, what I think is ask more or could be thought about doing is attaining some of your allocation. You may want to up your bond a little bit, go to the stocks in general. Um, you may want to move out a little out of the new era stocks, maybe with some of your favorites, maybe some of those that have done the best and move towards a broader rate of news from old era stocks, some of which haven't been done. They haven't been doing all that bad and they have some positive momentum themselves of late, uh, going on. Um, you know, and, and, and just move allocations a little bit in that direction to try to get through this period. Um, or you might just want to ignore it and stay put, you know, and say, I can hold my nose and, uh, get through this to the other side. If, if, if we aren't going to have a, you know, a 30% plus bear market or something. Um, that's, that's kind of up to you. I, I think making some allocations towards more defensive posture or just towards old era or a little bit to bonds, a little bit out of the new era, uh, makes some sense for a period. If nothing happens, we get through this, policies change and that looks and maybe one moves back. But, uh, uh, I think in the interim that that's what I would say. I feel like it could be actionable for investors. Not necessarily any one indicator tells me that, but kind of the whole, the whole weight of the story kind of leads me there.
Speaker 1We're better. Good stuff, Jim. Good stuff. I like that. So, all right. Thank you very much. We will see you, um, next month. Always appreciate your time.
Speaker 2All right. Thanks you guys as always. Appreciate it very much.
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 excessreturnspod.com. If you have any feedback or questions, you can contact us at excessreturnspod at gmail.com. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the hosts or their clients.
PodcastTranscript AI