Jim Bianco on Sticky Inflation, Federal Reserve Politics, and Market Concentration Risks

Could the Federal Reserve's next moves be politically driven and potentially reignite inflation? Tune in as we explore this provocative question with Jim Bianco, the president and founder of Bianco Research. Jim provides his expert analysis on the transition from a deflationary cycle to what he calls a "sticky inflation cycle," fueled by remote work, deglobalization, and the political manipulation of energy resources. He predicts a sustained inflation rate of 3-4%, significantly higher than pre-2020 levels, and cautions against potential rate cuts by the Fed. 

We also dissect the complexities of quantitative tightening and its impacts on the economy, particularly focusing on interest rates and inflation. Jim highlights the current stock market's concentration in major companies like Nvidia, Microsoft, and Apple, and discusses the implications for traditional diversification. We examine the risks associated with popular ETFs and consider scenarios where diversified portfolios might outperform these concentrated indices. Jim brings a wealth of knowledge, shedding light on the disparity between Main Street and Wall Street and the evolving labor market dynamics post-COVID.

In the latter part of our conversation, we delve into the relationship between the stock market and rising unemployment rates, the demographic impact on investment choices, and the state of the gold market. Jim discusses gold's role as a non-correlated asset and the challenges faced by ETFs in a saturated market. We also touch on strategic bond market positioning and the long-term economic impacts of the 2020 global shutdown. This episode offers a comprehensive analysis of today’s complex financial landscape, providing valuable insights for both seasoned investors and newcomers alike. Join us for this enlightening discussion with Jim Bianco on Lead Lag Live.

The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.

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Transcript

Speaker 1: 0:08

My name is Michael Guyatt, publisher of the Lead Lag Report. Joining me for the rough hour is Mr Jim Bianco, who I know a lot of people are very familiar with. But, jim, for those who are not familiar with you, introduce yourself briefly. Who are you? What have you done throughout your career? And talk about some of your research. Who are you? What have you done throughout?

Speaker 2: 0:23

your career and talk about some of your research. Jim Bianco, president and founder of Bianco Research. And in the last year I'm also the founder of Bianco Advisors, which runs its own index, which there is an ETF, wtbn Wisdom Tree, bianco Nancy. That is a long, only fixed income ETF. We can talk about that a little bit later. I've been in the financial markets now approaching 35 years actually a little bit longer than that now. I was actually employed on Wall Street during the stock market crash in 87. That's how far back I go. Macro research, primarily fixed income, bent kind of eclectically, jump around in all kinds of topics from politics to crypto and everything in between. So that's my, as they like to say, my TLDR.

Speaker 1: 1:07

All right let's start very high level, because you're known for a lot of that macro work, as you noted. As we know, the economy is not the market and it's certainly not five stocks which we'll touch on as well. But where are we on the fight against inflation and the Fed pulling off the soft landing which everybody says they pull off until the hard landing.

Speaker 2: 1:33

Yeah, I'll go even a little bit more cynical on that last part. Wall Street loves to forecast a soft landing because there's no accepted definition of what a soft landing is. So I'll say soft landing and then in a year I'll come back and I'll torture some definition and I'll tell you I was right. But to that end, let me give you the high level where I've gone with the economy. Every time there's a financial crisis or recession and we had both in 2020, the economy changes and I've often argued change is not worse, change is different, and I think that this economy changed and I think a lot of cycles ended in 2020 and new cycles have begun. One of the cycles, I think, that ended in 2020 was the inflation cycle. We are not. We were in a disinflation, maybe deflationary cycle until 2020. That's over. We are now in what I'll call the sticky inflation cycle combination of remote work, which has fundamentally changed the labor market, deglobalization, which was in place before 2020, but it's been accelerating since and maybe using energy more as a political weapon. That's more of a look at Russia. It probably means that we are in a 3% to 4% inflation world, not a sub 2% inflation world. That matters. That matters a lot. That keeps interest rates up. That keeps interest rates high, and so I would argue that that is the environment that we've been in and that we are going to continue to be in as far as the economy goes in, and that we are going to continue to be in as far as the economy goes.

Speaker 2: 3:08

Economists like to talk about a term called potential GDP. What that is is that is, what would the or what should the economy grow at if no one's trying to stimulate it or restrain it? And that's not a measurable number, but it's roughly two, two and a half percent. We grow above it. We grow below it, but we average around 2.5%. The second half of 2023, we had big numbers on the economy grew well above potential. First half of 2024, we're growing below potential. That's the cyclicality of the economy.

Speaker 2: 3:39

I'm not in the soft landing or the recession camp. I am in the we are continuing to grow a trend camp. Well, that sounds great. Where's the problem? Problem is, that means that it's probably going to keep us in that three to four percent inflation world, and while the Fed wants to cut rates and is probably going to cut rates, I'll argue it's a mistake. They shouldn't cut rates, they'll rue the day that they did. It is what my fear is if they wind up cutting rates, because they'll put at risk igniting inflation when it's already at a sticky level. So that's kind of the high level of where I've been with the economy for the last couple of years.

Speaker 1: 4:24

I will say it is odd to me that they want to cut rates with the credit spreads as tight as they are I mean most of the time right when the Fed is acting. They're acting because they're trying to crush default risk, which is being priced into the high yield part of the bond market.

Speaker 2: 4:39

You know you're right, it is, it is, and it's very difficult to get an answer from them. I think it's political. And I think it's political for the following reason March 31st 2022 was the last time Jay Pollitt met with President Biden if he saw any cognitive decline in the president, and he said he hasn't met with him in person since that meeting on March 31st in 2022. So that was his way to punt on the question, but that was an important meeting. That was when he was in the White House with Yellen and with the president, and effectively, I've talked about this for the last couple of years. Joe Biden pointed at Jay Powell and said he's your man. He's your man who's going to get inflation down to 2%. So don't worry, america, he's going to fix it.

Speaker 2: 5:31

And the Fed has been under enormous pressure to get the inflation rate down and they're under enormous pressure to show that the inflation rate is down. That's what I mean by being political. We want to cut rates. They want to cut rates because they want to say see, we're on a glide path, 2%. See, we're the professionals, we know how to do this. See, we fixed this inflation problem, as opposed to being able to look at it objectively and see what they want. They're looking at it politically and saying we have to convince everybody that we fixed this problem. We have to convince everybody that we've fixed this problem.

Speaker 2: 6:04

Now, in fairness to Paul, the inflation rate on March 31st 2022 is 8.6%. That's over your CPI. Today it's 3%. So it is down a lot from that period and they could take if you want to argue, they could take credit that at least while they've been fighting inflation it's gone lower. I just question whether or not it's going to continue to go lower from here. So I think that there's a lot of politics in there. And then the other thing I'll give Paul a little bit of a pass on.

Speaker 2: 6:32

When he does his press conferences, he's standing there and he is describing the consensus among the Fed officials. If you look at the dot chart remember the dot chart is where do they think each one of the 19 Fed officials, where do they think the funds rates can be at the end of 2024, 2025, 2026, and the long term? If you look at that 25, 26 or long, especially the 25, 26 chart those dots are all over the place. And in 2025, there's a member of the Fed that thinks that they will not cut rates one time between now and the end of the year. There's another two members of the Fed that think they will cut rates 10 times 1025 basis point cuts between now and the end of next year and everywhere in between.

Speaker 2: 7:19

So when Powell stands there at the podium and he tries to talk about what the committee is thinking and where the committee is going, there's no agreement among those members in the committee. They are all over the place, and so he's trying to present it as yeah, we all agree on what we're supposed to. No, you don't. You don't agree on what you're supposed to do. So that further complicates his mission right now.

Speaker 1: 7:46

A question off of YouTube. I'll show on the screen here and I'll say it loud for those listening. Can Jim explain how quantitative tightening brings inflation down? All right, so we have this 3% 4% sticky range you think that we're going to be in. How does QT factor into anything?

Speaker 2: 8:00

So quantitative tightening in simple terms. So quantitative tightening in simple terms, quantitative tightening is the size of the Fed's balance sheet. It peaked at about $8.5 trillion. It is down now under $8 trillion. What does that mean with the Fed's balance sheet?

Speaker 2: 8:18

Remember that the central bank we use the vernacular but it's not specific the central bank can create money. Print money is what we call it. They're not actually printing dollar bills, the Bureau of Engraving does that but they can electronically create money. When they electronically create that money, what happens with it? It purchases treasury securities and at its peak I don't know what the number is right now, but at its peak it was nearly 30% of the treasury market was owned by the Fed.

Speaker 2: 8:50

Through quantitative easing, as they do quantitative tightening, they are reducing the amount of money that they've created. They're actually extinguishing it, if you want to use that term. So that means that they're not selling treasury securities. What they wind up doing is remember, bonds mature and as they mature they just buy back less. So the amount of buying power, buying pressure that comes from the Fed to hold interest rates down dissipates and that should help keep interest rates elevated, and it's higher interest rates that is supposed to restrain the economy, and that restraint of the economy then puts downward pressure on inflation. So that's kind of the simple answer of what they're trying to do with quantitative tightening. Now it gets a lot more complicated than that how they're doing it, what their targets are, how successful are they, and the like.

Speaker 1: 10:23

So I remember back in my college days and CFA studying days the narrative that stocks are the hedge to inflation. This has been a strange environment for stocks to be hedged to inflation because of how much concentration there is in the stock market now. So I want to share on the screen something that you put out on X where, if you look at give me a second folks, there we go, and this is a post that Jim put out that went fairly viral around 300,000 views, at least a 60-year extreme. This is looking at the five largest S&P 500 stocks and one day it's the opposite Five stocks are killing the index funds while everything else outperforms.

Speaker 1: 11:07

I myself have called this the concentration bubble, really for like eight, nine months. So you look at the S&P 500, it looks like a bull market. That's clearly been a you can argue a hedge of sorts against inflation, but most stocks, as I keep referencing, are still below their 22-month highs. So it's a very odd hedge in that it's a concentration type of dynamic. Do you find that to be something that, in your view, is actually really bad or is that just the way way in quotes the stock market is?

Speaker 2: 11:42

Yeah, it's kind of the way the stock market is, but we need to understand what's happening with it. As I commented on, this is so 29% of the S&P is five stocks. I've only got data back to 64, and this is the highest in at least 60 years. I don't know if there's ever been a period higher than that. What does it mean? Well, first of all, why do you buy SPY or VOO or IVV?

Speaker 2: 12:10

Those, by the way, are the three largest ETFs in the world and they're all S&P 500 trackers. One is StageStreet, one is BlackRock and the other is Vanguard. Why do you buy those? Because you believe in the concept of diversification. I want to own a broad mix of the stock market. So what does it mean? When the stock market's concentrated, you're getting the least amount of diversification in 60 years. So your portfolio, or anybody's portfolio, is Nvidia, it's Microsoft, it's Apple. Now, maybe it's working. I looked the stock markets up on the early percent today. It's working and it will work until it doesn't. But understand, I'm not bullish on the stock market. I'm bullish on Apple, nvidia, microsoft, amazon, meta, tesla. That's what's bullish on.

Speaker 1: 13:04

That's so well said, because so much of the frustration I see from trolls that are coming at me with my own views on things is defining the market.

Speaker 2: 13:15

Right, exactly. And so those are the stocks that are driving the rally. Now I'm not making any statement about how much longer they're going to drive the rally or when it's going to end or what is the catalyst for it being ended. But understand, that's your bet, is what you've got. And what I also said is I can see a period in the future when you could do the Dave Portnoy thing and randomly pick letters out of a Scrabble bag and you will outperform the S&P 500 because those seven stocks will be dragging it down and dragging it down and any random letter you bought will do better. That's the other side of this equation. Now, when that happens, we can argue, but right now that's really what you're playing on. And what is the theme around all of that? The theme around all of that is AI. So we're all playing the AI theme, whether we like it or we don't. Now, if you've ventured away from that, you bought the equal weight S&P RSP, you bought the mid cap. You bought the Equal Weight S&P RSP. You bought the MidCap, you bought the Russell 2000,. You're mid-single digits on your returns and a money market fund's up 3% for the year. So you're not that far ahead of a money market fund for the rest of the year. So the rest of the market isn't doing a whole lot. These big companies are sucking everything up.

Speaker 2: 14:42

Last thing what's different about this cycle than everyone else? Now you go back to 2000,. You go back to any of the other bubbles. We've had these bubbles before. The difference is these bubbles usually start with very small companies. We called them B2B and internet companies. You know the hours of the world. They were tiny companies in 97 and 98. And they take off and then they swell, and they swell, and they swell. What's different about this one is we're going to start a mania with the largest companies in the United States and make them even larger. I don't know if we've really seen an example of where we started with the largest and made them larger. We usually start with small to medium-sized companies and then they end up as the largest and then the bubble pops. So that's what's a little bit different and that's why the market is so concentrated and that's why I think the next time somebody buys SPY, just say I'm buying NVIDIA, because that's essentially what you're doing. And I'm not saying that's bad. I'm just saying understand the trade that you're making.

Speaker 1: 15:42

Yeah, no, I love that. And you are exactly right. Everybody's in the exact same trade. I've used that analogy we're all on the same side of the boat holding an anvil, whether you realize it or not. Now I guess the question becomes what's the catalyst for that to change, for that bursting of the concentration bubble which, similar to what you just said, I myself have argued we've never seen it in this way before. It seems to me there's two things that can take place. I want to get your thoughts on this. One is and we may be starting to see it now which is that inflation comes in much lower over time, in which case the bets are the Fed starts to cut aggressively. That gives the lifeline to small caps which have been held back from refinancing.

Speaker 1: 16:19

Risk concerns. Small caps are working big time right since last week. The other catalyst, I think, could be just a recession right, because every recession, unemployment picks up. Unemployment picks up. People start having to sell their assets. Their assets are primarily market cap weighted Vanguard type products At the margin. That happens you don't have the automatic flows coming in from 401k buys and that creates that sort of decline, meaning the large caps catch down to everything else. Is there another scenario, another catalyst that could just cause a bigger rotation to break this strangle.

Speaker 2: 16:54

Well, yeah, I mean there is. But let me go through your catalyst. The first catalyst is the Fed declares victory. We're professionals. Do not attempt this at home. We got the inflation rate down to 2% with a soft landing. Everybody hails the new god king, jay Paul.

Speaker 2: 17:11

Problem with that argument, as I see it, is we're already at about 190% of market cap to GDP. The size of the stock market is the largest relative to the economy it's ever been, even above the 2000 peak. Where's this new dollar that's going to go into the stock market? What you might wind up seeing is it will go up marginally but it'll be just kind of a big rotation zero-sum game. If you want everybody to go into small caps, well, we're going to take it out of the mag seven, we're going to sell the mag seven and we're going to go in the small caps. And that could be problematic for the S&P because that small cap rotation out of the mag seven will actually make the S&P decline, even though those small cap stocks are going up. We sort of saw that on Thursday with the beat in the CPI number for one day and then kind of petered out after that. The recession scenario yes, the recession scenario is definitely on the table.

Speaker 2: 18:12

Let me make a quick comment about recession. I've been using this line a lot and I want to keep using it a lot. There was an economist of note Rudy Dornbush was an MIT economist in the 1970s and was very influential at the Fed and he said a very famous line economic expansions do not die of old age, they're murdered. What he meant by that was I hear people talk about will the economy roll over? Will the economy pop? Are we going to go into recession? If you look at every recession for at least the last 50 or 60 years, there's always been a catalyst, a murder. Covid was the last one. Housing was the one before that the tech bubble, the Gulf War, spiking oil prices from $10 to $40. You actually had $145 crude oil in July of 2008. In terms of with the housing bubble too, something has to murder the economy. They don't just roll over. Now you could argue that the economy is more vulnerable to being murdered because of its current state, with the high debt levels and everything, and I'll agree with that. Murdered because of its current state, with the high debt levels and everything, and I'll agree with that. So a recession would do it, but it would most likely come with a murder weapon. Now, to be fair, I thought the murder weapon was 18 months or 15 months ago when Silicon Valley Bank failed. I thought there it is, there's the murder weapon. It turned out not to be, but that doesn't mean that the concept doesn't work. So, yes, we could be very vulnerable to something along those lines.

Speaker 2: 19:42

Let me throw in another scenario for you. I don't know if a lot of people recognize this. About NVIDIA, I said you know, if you bought the S&P, you buy NVIDIA. Did you know I'm saying this rhetorically that five customers are 50% of NVIDIA's revenues? Five customers it's Microsoft, it's Tesla, tesla's bought over a billion dollars of NVIDIA chips so far. It's Supermicro, it's OpenAI, it's Microsoft, and that their cost of goods sold 20% of their cost of goods sold is from TSMC, taiwan Semiconductor. It's a very close circle. I mean, you know, the funny thing about NVIDIA is yeah, do you own any NVIDIA chips? Do I own any NVIDIA chips, michael, do you own any NVIDIA chips? Nope, none of us do.

Speaker 2: 20:30

It's a specialized product for specialized customers. Now they run two vulnerabilities customers. Now they run two vulnerabilities. Vulnerability one is Intel and Matt Fico devices and even Taiwan semi are looking going. Man, they're worth $3 trillion. Maybe we should try and create a better product than them, or the same product that at a lower price, and undercut them, and we only have to make five phone calls to basically sell this product.

Speaker 2: 20:55

And the second one is kind of a story that's kind of coming into the fray. You know what's AI doing for us, where is it going? What is the great hope for AI? Now, in 25 years, the great hope for AI might be everything we say, just like in 1999, the great hope for the internet was realized by 2024, 25 years later. But in March of 2000, the NASDAQ peaked and it took 16 years to make a new high after that peak. So maybe a realization that we're buying forward the AI scheme, but it's got to happen in one or two or three years.

Speaker 2: 21:41

If it's more of a long tail 10, 15 year type of story that we eventually get there, we're too far ahead of ourselves with these prices. That's the other thing you've got to be careful of as well too. Like I said, I believe the AI story. I believe AI is going to be everything it's going to be. It's got to be that in a year. It's got to be that in two years, it cannot be 10 years. You've already bought, you've already discounted it now for the next 10 years, and therein lies the problem. And that's exactly what we did with the internet in 99 and 2000. It eventually realized all of those hypes and dreams. It just took 20 years. It did not take 20 months like everybody was hoping. It was going to be in 99 or 2000.

Speaker 1: 22:28

Another comment from a listener on YouTube. Jim Hockaday was saying recession is the only way to get inflation back 2%, but the market is never high enough for the billionaires. Main Street versus Wall Street, billionaires, main Street versus Wall Street. Is there anything that could get us back to 2%? That would prove that thesis wrong? On three to four, where it would not involve some degree of pain or economic hardship.

Speaker 2: 22:54

Yeah.

Speaker 2: 22:54

So you're right. A recession would get us back to 2% or maybe lower, and we would stay there as long as we're in recession and then when we come out of recession, then we go back up. The story that gets us back to 2% or lower is what most mainstream economists believe that the cycle did not turn in 2020, that this is a continuation of the pre-COVID cycle and that this is just a bunch of temporary long tail, one-off supply chain problems, post-covid adjustments, too much stimulus, excess savings getting run off, and when all of that goes run off, we go back to that 2% inflation world. That is always a possibility that it isn't a different cycle like I'm arguing it is. It's back to the pre-2020 cycle is what it would be, if I'm right, and this is a new cycle of three-ish percent. How long will this last? To the next recession? When you have a recession or a financial crisis, it shocks the system and it changes. When you have a recession or a financial crisis, it shocks the system and it changes, and maybe we shock the system and we change it in a way that would alleviate the chronic supply problems that we would kind of rectify.

Speaker 2: 24:15

I think remote work is the biggest one. I think that, just to go off on a quick tangent, I think that most people are not fully appreciating how much the labor market has changed and that it is a very, very different labor market. And, to put it in this perspective, labor workers have more power over demanding wages than management anytime maybe in the last generation, if not longer and that is keeping wages up. And, as I like to say, if you're getting a 4% or 5% raise every year, you could pay 3% to 4% inflation. You could pay 3% to 4% inflation. So that's part of why I think the inflation is up. But if the mainstream argument, the Fed's argument, that we're on the last mile to 2%, meaning nothing changed in 2020, it was just a big one-off. We shut down the global economy, we restarted it and then everything went back to the way it was Well, the labor market didn't because of remote work Then, yes, we could go right back to 2%. Finally, if I could make a Hockaday's comment about the rich and the billionaires, this is a K-shaped economy, more so than ever, and the reason it's K-shaped the letter K, one going down, one leg going up, and you could argue isn't it always a K-shaped economy? Yes, the haves do better than the have-nots, sort of. But what's changed? This one is inflation.

Speaker 2: 25:41

2010 to 2020, the inflation rate was under 2%. The average wage increase was a slightly over 2%. To use a tennis metaphor, 2010 to 2020, if you're in the lower half of income you held serve. You got 2% more at your job every year and everything costs 2% more. So when you go to the store you can buy the same things that you bought a year ago. Didn't get worse. You held serve Rich. Money got richer because the stock market kept going up and home prices kept going up or something like that. Sure, they didn't get worse. But since 2020, cumulatively, the bottom half has gotten worse because wages have not kept up with the cumulative inflation. That's why everybody's so angry about inflation right now.

Speaker 2: 26:26

Top end, you could argue the rich. Maybe their wage increases haven't kept up with inflation, but they have portfolios. They own real estate, their home, if nothing else, and that they've benefited from those recovering as well. Bottom end bottom end doesn't have a home. They rent. They don't have a stock portfolio. Bottom end doesn't have a home. They rent. They don't have a stock portfolio. They're not debating whether or not their SPY holding is NVIDIA. They don't own any stocks, so that's why they're so angry.

Speaker 2: 26:54

Last thing, two things to keep in mind about this too, is about 75% of all consumer spending is the top 50% of income. So if the top 50% of income see their homes go up, see their portfolios go up and they feel better and they start spending, the economy stays strong. And the other thing is remember one person, one vote. Jeff Bezos might get a million votes or 10 million votes when it comes to the economy because of his net worth, or Elon Musk, but they get one vote at the ballot box. And so does somebody Musk, but they get one vote at the ballot box. And so does somebody on his public assistance get one vote at the ballot box.

Speaker 2: 27:29

That's why the president's approval rating slowed down so much and that's why people say that the economy is terrible. It is terrible for a big segment of the population, the lower half. It isn't for the upper half, but the upper half do all the spending so that the economic statistics look okay, but the broad population, the K-shaped economy, it isn't for them in the bottom half, and that's the stress point that we're seeing with this economy right now where he says I have a question If 5.5% Fed fund rate is restrictive, which it is for the bottom 90%, what would happen if next time they try to raise rates and 3.5% becomes too restrictive and the bond market says no?

Speaker 1: 28:13

I guess the implication there is we just keep leveraging higher and higher, so now you're going to have a lower high because it's just too much of a choking point.

Speaker 2: 28:21

Right. So let me answer the question a little bit generically. Is five and a half restrictive? Yes, and this is, by the way, when I talked about earlier the Fed dot chart that they're all over the lot. Some members think they're going to have 10 rate cuts by the end of next year. One member thinks that they're going to have none and they're all in between.

Speaker 2: 28:40

It really comes down to a very simple question what is the neutral funds rate? The neutral funds rate is what is the rate that neither stimulates or restrains the economy. According to the Fed, because that's their long-term shot, it's 2.75%. It's under 3%. This is why they keep talking about wanting to cut rates, because they say look, we're at 5. Half. We got to get to 275. That's 10 rate cuts. That's the 10 rate cuts. Right there. We got to get going here. We got a lot of work to do. We got to do 10 of these.

Speaker 2: 29:12

But if you look at the market, there are various metrics that measure it in the market. Back in my timeline from about three weeks ago I did this. I'll try and update it again this week. The marketplace thinks that the neutral funds rate is closer to four, meaning five rate cuts, maybe four rate cuts is all you need to get back to neutral. That explains why has it been that we've been at five and a quarter five and a half for a year. Stock market's going up the economy, we're debating whether or not there's a soft landing after all those rate hikes and holding for five and a quarter, five and a half a year. There's no recession at this point because maybe that's, I'll agree, restrictive, but not that restrictive. It's not 200 basis points or 250 basis points of restrictiveness, it's maybe 125 to 100 basis points of restrictiveness. Why does that matter? Because if the Fed is intent on cutting rates sooner rather than later, because the Fed thinks they got 10 rate cuts to go and they do chop the three and a half and that turns out to be stimulative and that turns out to reignite inflation, we could have a real problem in our hands. Watch the bond market. Watch the bond market on this one.

Speaker 2: 30:28

In July 26th, one year ago of 2023, was the last rate hike. Excuse me, last rate hike was one year ago, july 26th last year. Where was the 10-year yield? It was at 380. And everybody said that's it. The Fed's done 100% right. The Fed was done. This is it. The Fed's done. 100% right, the Fed was done. This is it. Everything's going to turn and it's going to go better.

Speaker 2: 30:48

What happened in the next three months? Stock market fell 10% and bond yields went to five. Why? Because the bond market was saying, oh, you're not going to stay restrictive anymore. Well then you're going to risk inflation. I don't want to own your bonds. And the next move in the bond market was straight up in yield and that actually put a lot of pressure on the stock market and the stock market wound up going down.

Speaker 2: 31:15

If the Fed starts cutting rates, do not assume that the bond market will rally. You could wind up producing much higher interest rates, because it would be a rejection of the Fed's policy. Because the bond market would say look, we're still not sold on this idea that we've gotten past this inflation problem. And now you're going to start feeding sugar to this thing and hype it up even more. Maybe I don't want to own your bonds anymore.

Speaker 2: 31:40

Rates go up and that could put pressure on the stock market. I might add, in the last 18 months we had a 10% correction. As I mentioned, july to October last year, march, april this year. We had a 6% correction in the S&P. What was the consistent theme between both of those Was? The 10-year yield was over 4.5%. So higher rates could definitely be something that could really pressure the stock market, because it has. Now we're 420. Right now we're not at 450.

Speaker 2: 32:11

But if you wind up making more noise about cutting rates, cutting rates, cutting rates and everybody says it's the most bullish thing ever leverage yourself up and get in the stock market and rates go up. Because the bond market has decided that if you're not serious about the inflation rate I'm not serious about owning your bonds it winds up driving rates up and the stock market doesn't like that and it winds up going down. They make it worse. So you have to be careful.

Speaker 2: 32:34

So what I'm arguing here is there's this saw, and cutting rates is always good. Raising rates is always bad. That's not always the case. Cutting rates is good when the market is convinced there is no inflation problem. Raising rates is bad when the market is worried that there is no inflation problem because you're getting too restrictive. So you got to put that into the context. I happen to think that cutting rates would be a mistake. I said that before because I don't think we cutting rates would be a mistake. I said that before because I don't think we've finished with the inflation fight. Let's see how the market responds to it as we get closer and closer to that potential September rate cut.

Speaker 1: 33:45

And presumably a big part of that is going to be how the market interprets what happens next to unemployment. Elias from LinkedIn put a question here. What are your thoughts about the nonlinear relationship between job openings and the unemployment level? So job openings have obviously been dropping, they're inverse, unemployment rate rises and typically I think when you get past this stage is when it's hard to turn around. From the research I've seen, is there a chance that the stock market, oddly enough, may like a rising unemployment rate because it means the Fed is getting that lagged response in just in time, the bond market does not revolt and everything you just said gets countered.

Speaker 2: 34:26

Sure, I mean the stock market could be looking at the unemployment rate and creeping up to 4.1% and saying, good, this will keep the Fed on cutting rates, keeping rates down, and we like it when rates go down. By the way, why is the stock market, I've argued? Why is the stock market like rates going down? Other than the obvious case that it lowers the cost of capital. That's a big one. Cost of money gets cheaper and that helps company profitability and the like, but it's also a competition thing too.

Speaker 2: 35:00

Real quick, dr Jeremy Siegel wrote an update to his famous book Stocks for the Long Run last year. In it he said what is the long-term potential for the stock market? In other words, given everything we understand about the stock market, what should you expect it to do every year? About an 8% return. In other words, it might be 16% one year, zero the next year, but over a long period of time it averages eight. That sounds about right. Well, in 2019, when money market rates were zero and bond rates were two, we would scream Tina, there is no alternative. What are you sitting around with no yield? Why don't you get into riskier things like stocks, and at least get a return? And that worked until 2020. Well, in 2024, money market rates are 5.3%. The bond index the investment grade bond indexes are 5%. So a lot of people are looking around going.

Speaker 2: 35:55

So I'll use the money market example. That's 70% of what I should expect out of the stock market and it gives me a $1 NAV every day. So, no risk. Okay, I'll take 70% for no risk. Sure, it doesn't look like a good trade now. Look like a great trade in 2022. We don't know what that's going to be going in the future. So when rates go up, a lot of people will conclude I'll just take those bond yields, thank you very much, as opposed to risking the stock market.

Speaker 2: 36:27

And why is that? Because most of the money is owned by older people Now, typically as a cohort, as a demographic group. The richest a demographic group will be is the day before they retire and then they start drawing down on their money. So most of the money is owned by boomers, and I've often liked to describe a bear market as time. Could the stock market have a bear market? Yes, could it go down 50%? Sure, just to use an example, okay, great, but doesn't it always come back? Yes, that's historically been the case.

Speaker 2: 37:04

But if you're 65 years old and you buy all the way into SPY and it starts a bear market that might last five, six, eight years. You're thinking that's half my expected life expectancy. I don't want to spend half of what I got left waiting to get back to my high watermark. I'll take bond yields. Thank you very much. If you're 35 years old, wave them in all the way down, because if it's 45 or 47, they get back to the old high. You got a good 20-year run to make a lot of money before retirement then at that point. But the problem is the 35-year-olds don't have the money. It's the 65-year-olds that have the money. So that's why bond yields that they also matter as well too as well.

Speaker 1: 37:52

too Curious to get your thoughts on gold. I'd argue that I think this move is really more driven on anticipation of negative real rates to come, because that's the kind of environment that gold tends to do well in. But this time it's actually trying to anticipate it as opposed to react to that. Any thoughts on gold and why it's been doing as well? Is it the negative real estate? Is it some positioning to alternative, non-correlated defensiveness? Because people are skeptical about treasuries? There's not that many long-running options.

Speaker 2: 38:23

What do you describe it to. Gold has been a very, very frustrating asset. But I would argue your second argument people are in search of a. Everybody right now is in search of an uncorrelated asset that what they want is they want to own something so that, at the end of the day, if they say, or like right now, or something like that stock market's up 1%, Okay, then I kind of know what all the other assets are doing. If you tell me that that stock market's up 1%, Okay, then I kind of know what all the other assets are doing. If you tell me that the S&P is up 1%, I'd like to own an asset. That if you told me the S&P is up 1%, I don't know what the other assets are going to do. And, by the way, crypto may not be that case either. It's got a correlation to the ups and downs of the stock market A little less so recently, but it's still holding. It's having a good day today, like the stock market's having a good day. So the hope is that people are buying gold because they think it's going to be an uncorrelated asset.

Speaker 2: 39:24

Now there's been stories around it the end of the dollar's hegemony that the dollar's going to stop being a reserve currency, I'll ask. The only problem with that argument is replace it with what? As soon as you give me a viable alternative to the dollar, it's gone in three seconds as the reserve currency. And don't make me laugh by telling me it's crypto. Crypto can be it in about 10 years, when the ecosystem not the price of the coin, the ecosystem is like 100x larger than it is right now. It could be it. It could be the euro, it could be the yuan. They don't have the rule of law. The Saudis aren't going to trade oil in the Saudi dinar because it's too small a currency. It would just so distort their currency. What you need is you need a currency that trades trillions of dollars a day, a currency that has established rule of law and a currency that has a legacy. Of all that, there's only one. There's only one, and that's why, like it or hate it, the dollar is going to remain the reserve currency and it's going to remain its status until an alternative is created. So all this talk about that. The Saudis ended the 50-year agreement about petrodollars. Fine, it's just a piece of paper. They've got no other choice but to leave the system the way it is. So instead of telling me what's wrong with the dollar, you need to tell me what's going to replace it.

Speaker 2: 40:55

Now that I've kind of went off on that tangent, let me come back to gold. I think that gold is benefiting from a lot of those kinds of stories the perception that we're going to have a weak dollar, the search for an uncorrelated asset. The other thing about what gold is benefiting from is its relative size Stock market's $47 trillion in the United States. If you add in world stock markets it's about 80 trillion, over half of it's in the United States. The bond market's well over $100 trillion. Gold's like two. So if you're going to put that in that asset class with stocks and bonds, a tiny movement out of stocks and bonds will have enormous implications for gold. But let me come back to my original comment, single most frustrating asset that I've ever followed over the last several years. What's your opinion about gold, Michael?

Speaker 1: 41:43

I tend to think of it much more as that point about the non-correlated demand. I think the breakout which occurred and I said that repeatedly on X I said gold was sending a warning. As you know, jim, I like to be a little bit bombastic in some of the ways that.

Speaker 1: 41:55

I've read things and that was before some of the dynamics of the intervention from Japan with the end, and also, obviously, iran and Israel, which everyone forgot about. World War VII, I think is the number we were at at that point, but it does seem like it's like Super Bowls at this point. Yeah, exactly, it's like, but it does seem like that. That is the case. I wonder if that's, if that's smart money or not in quotes or institutional money which you can consider smart money. I say that because I'm going to show a comment from Mike Gannon on LinkedIn here. I think central banks have been buying the gold, not retail. There's a lot of evidence around that, not in play yet, but if, when it comes, the miners might catch up. Speaking about frustrating gold is frustrating, but miners can be especially frustrating.

Speaker 2: 42:38

Oh yeah, because sometimes their correlation to the price is zero. Buy the junior miners because gold's going to leverage and it does, and the junior miners don't do anything and stuff like that. That happens to a lot in those markets.

Speaker 1: 42:52

So is there anything in that space that gets you excited? We're going to talk about your index shortly, but beyond that, and what you're doing alongside your own personal investing, do you play with the gold miners at all? Do you play with gold itself?

Speaker 2: 43:04

In and out. I've played with gold forever and a day. I'm old enough to go all the way back to Central Fund of Canada that I used to own that thing for forever and a day. Ian McCavity's a closed end fund that traded in Toronto. Boy, there's some old names right there as well. So currently I'm not in gold and it's not because I don't like it, it's just, you know, maybe it's neglect. I just been looking at other places and other things and, as you mentioned, tied up with my own fund and stuff like that, that I haven't really ventured off into gold. But I just don't have a good feel for what should be the next move in gold and that's probably the biggest reason why I'm not playing it so, uh, you have an index, you have an etf that seeks to track that index.

Speaker 1: 43:57

Yep, uh, you are getting a taste of the challenge of raising assets, you know, and getting people to be aware of a product in a very saturated world. I always go back to I think what people don't understand about the fund world is um, in order to compete, you have to do something different, because you're not going to compete against the vanguards of the world, so you've got to have something that's unique which, hopefully, when it works, it works really well. When it doesn't work, it doesn't get crushed, depending upon the cycle you're in. Talk about the index on the share my screen just to show it, jim's got it on his pinned post here as well as his Q2 letter. Etf WTBN index has done quite well. I get the sense that people still don't want bonds in general. So you're maybe hitting up against some asset class demand issues, but talk about the index and talk about where you see demand maybe shifting, because if the Fed is going to be cutting rates, it seems like they're going to.

Speaker 1: 44:50

I'd bond you and do well going to be cutting rates.

Speaker 2: 44:54

It seems like they're going to I'd bunch and do. Well, let me talk about structure and then I'll talk about what I do and exactly about the. So structure I technically am not an ETF manager. What I am is I'm an index manager. We have the Bianco Research Total Return Index.

Speaker 2: 45:08

Biancoadvisorscom explains the index. It's a discretionarily managed fixed income index. We're always long the bond market. We change our weightings, whether duration, whether we want a position for yield curve, flattening or steepening, whether or not we want to position overweight or underweight, corporates overweight or underweight, structure or mortgages, some other index bets like high yield, the dollar tip, securities emerging and the like. So we manage the index. I'll tell you where it is.

Speaker 2: 45:39

In a second Wisdom Tree is our partner. They brought up a tracker ETF to our index. If you want an example, the S&P index committee manages the S&P 500 and SPY just tracks the S&P 500. We're set up the same way. I'm the head of the Bianco Research Index Committee and WTBN tracks us. So what you see up on the screen is the orange line is the Bloomberg US aggregate index. It's like the S&P 500 at the bond market and the blue line is our index and the black line shows that we've outperformed the Bloomberg aggregate index by almost 100 basis points 98 to be exact, through the end of the second quarter. So, yeah, we're off to a good start, relatively speaking. You're right, it's a challenge to get people to notice you when there's 5,000 other these funds as well too, but we've been getting a little bit more noticed and a little bit more inflows recently, so that's been encouraging for us. And you're right, we are offering you have to offer something a little bit different.

Speaker 2: 46:49

What we're trying to argue, and what we've argued on our website and stuff is no one can beat an index is what everybody says. Well, that's true in equities. The equity data shows that it's very, very difficult to beat an index. But in fixed income, it's very different. About half the active managers, if not more, can beat an index, and we're beating an index as well too. Now, why is that? I'll give you one simple answer.

Speaker 2: 47:16

In equity land, your biggest weightings, your mag seven, are your all-stars. If you are a stock picker, you better pick seven stocks or five of those seven stocks, otherwise you have no chance to outperform an index. But in fixed income land, your biggest weightings are your problem children. It's your countries that have borrowed too much debt, it's your over-levered companies, it's your bad structures and mortgages. You can see those and you can avoid those or go towards the ones that have better structures and set up to outperform an index. An index can't change even if the structure is bad. That's why we've argued that in fixed incomes, you should be looking for an active manager and in equities, you should be looking for a passive manager, and that's what we're holding ourselves out.

Speaker 2: 48:09

As for anybody who's looking for active money, why did I pick fixed income? Because, as my friend, jim Grant liked to say, who writes the newsletter, grants interest rate observer. It's nice to have an interest rate, to observe again that, now that we've got a four or five 5.3% yield on cash, there's things to do and there's opportunities again in the bond market In 2019, 2018,. When you were sitting there with a 2% yield and zero on money market funds, it was collect very small coupons and wait for the bond market to explode. Well, it did, and a lot of people have said well, isn't the last three years been like the worst total return in the bond market in the last 100 years? Yes, we started a fund in December because we said, okay, we needed to get from zero to 5%. That was an excruciating process for the bond market to get there, but it's there now. That's why we decided to start this fund late last year, or the index and then the tracker fund to be more exact year, or the index and then the tracker fund to be more exact, because then we wanted to try to take advantage of it. So anybody who's looking for a 40-legged and a 60-40 portfolio or a fixed income alternative, that's who we're holding ourselves out for. So yeah, thanks for letting me explain it.

Speaker 2: 49:28

Now, where are we? If you go back to that website that you had up or the tweet you had up a little bit ago on the right-hand side, my buddy, eric Hale, sent me that little graph with the roller coaster on the right and I said we had been short duration, thinking that rates were going to rise. We had gone to neutral duration at the end of April at 4.7%. We had a bet on rising inflation break-evens, which worked out well for us. Currently we're kind of neutral across the board, with a small bet long the dollar through some currency swaps. So I said you know, okay, we're an active manager, but we're pretty much positioned like the index.

Speaker 2: 50:21

Everything's neutral and I used the analogy. We're kind of like at the top of the roller coaster, where we want up to the top and now there's a whole bunch of tracks up here that the roller coaster can pick as to which direction it wants to go. And that's why I decided that I wanted to move to neutral and I'm waiting to see. Is the Fed going to cut rates? Is the economy going to really decelerate? Are we going to go to 2% or are we going to go more towards my thinking that we're going to hold 3% on inflation and that it's just a cyclical downturn and the economy stays strong and that even if the Fed cuts rates, that that might be a mistake.

Speaker 2: 50:57

That's my belief. I'm not ready to go there yet. I was waiting for a little bit more evidence. So we're kind of neutral, but I suspect by Labor Day we won't be neutral. I'm just throwing that out. Conceptually. I don't plan on staying here at this neutral position for a long time, but that's kind of how we really look at investing in the bond market. Again, you can look at our website and you can look at our fund. If you've got any questions you can ask me. I'll answer any questions that anybody has about it.

Speaker 1: 51:27

Jim, as we wrap up, where can people find some of your work and some of your research? Where can people find some of your work and some of your research? And maybe the thing which, to close off, that you think most people need to pay more attention to, that's not getting a lot of media hype that you are starting to focus on.

Speaker 2: 51:45

So, to answer the first part of your question, I told you about Bianco Advisors and WTBN. Biancoresearchcom is my website. I've been in the research providing business for 30 years. I also am very active on social media in three places Biancoresearch at Biancoresearch on X at Biancoresearch on YouTube and under my name, jim Bianco, on LinkedIn. So I tried to post some stuff and I got some ideas. I'm going to post the next day or two up there as well so you can request a free trial for our research. You can follow me on social media.

Speaker 2: 52:20

The thing that I would argue that people are not focused the most on is that thing I talked about at the beginning. When Jay Powell gives his speech, at the beginning of every one of his press conferences he says well, the economy is broadly returning to pre-pandemic levels and you know you hear a lot of economists going we're reverting back to normal. Their argument is there wasn't a cycle change, there wasn't a huge shock to the system. You shut down the global economy and you had some of the most wild financial markets in history in 2020. That didn't leave a legacy effect. I think the legacy effect is it ended the inflation cycle and some others. Now maybe I'm wrong, but what I'd like you to do, jay, is tell me why that event in 2020 didn't matter, that everything that was will be. Even though one third of the people have not returned back to the office Doesn't matter. Everything that was will be, that the cycle that we had before 2020 will continue.

Speaker 2: 53:23

I think that's the thing that people have to start thinking about. Are we in a different cycle? Now I'll point out one other quick thing. 1981 was the end of a cycle, the inflation cycle Old enough to be around back then. But as late as 1985, the smartest and best people were telling you we're going back to 15% inflation one more time. That inflation cycle did not end in 1981. It took them four or five years to finally realize that that cycle changed. Right now, you hear everybody talking about deflation going back down. We're going to see microscopically low interest rates. That cycle is over is what I believe.

Speaker 2: 54:04

Now, if I'm wrong on that, make the case that the cycle is not over. Make the case that what was in 2019 will continue as we go forward from here. People just assume that, and I think that that's where, well, if you're just going to assume we're in the same cycle. When we're not, then everything's going to go haywire. Now I'm hoping the idea that maybe I'm wrong, that the cycle didn't change, but make the case, make the case. They don't even want to make the case. That's why they broadly pre-pandemic levels. Returning to normal as if everything has happened since 2020 is not a new cycle. It's abnormal for the cycle that we all understand that we should be in. That's what I think people have got to start thinking about. What changed about 2020? It was from an economic standpoint. It was as momentous of an economic event the complete shutdown of the global economy and restart of the global economies anything we've seen in economic history and I'm making my case it will and is having a legacy impact on the way that things work.

Speaker 1: 55:11

Avery, please make sure you check out Jim, as well as his index and index tracking fund ETF, and hopefully I will see you all on the next episode of Lead Lag. Live, jim. Always a pleasure, thank you, sir, enjoyed it. Cheers everybody, thank you.