A Tour of the Macroeconomic Landscape with Bob Elliott

[00:00:00] Welcome to Excess Returns where we focus on what works over the long term in the markets. Join us as we talk about the strategies and tactics that can help you become a better long-term investor. Justin Carbonneau and Jack Forehand are principals at the Lydia Capital

[00:00:10] Management. The opinions expressed in this podcast do not necessarily reflect the opinions of Lydia Capital. No information on this podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of clients at the Lydia Capital.

[00:00:19] Hey guys, this is Justin. In this episode of Excess Returns, Jack and I sit down with Bob Elliott of Unlimited Funds to get his insights on all things macro from inflation, and the Fed, and interest rates, the labor market, the overall economy, and much more.

[00:00:30] Bob does a great job of tying these economic concepts together in a common-sense way that investors can easily understand and learn from. We also discussed how to think through the market price targets from a build-up and fundamental perspective,

[00:00:41] how gold fits into a portfolio, and the good and bad things about investing in hedge funds. As always, thank you for listening. Please enjoy this discussion with Bob Elliott of Unlimited Funds. Bob, how are you? Thank you for coming back on Excess Returns. We appreciate it.

[00:00:55] Thanks so much for having me. Always sort of fun to sit down with you and talk about the market, the economy, the Fed, investment strategies, maybe a little bit of gardening if we get there. It's that time of year.

[00:01:11] Trying to grow the things in the garden. I think where we wanted to start with you is I guess start with inflation. Recently, inflation looks like it's coming down and coming in.

[00:01:28] Maybe it's going to be able to get back to the Fed's target, which I think is right around 2%, but just generally can you summarize where we think we are with inflation specifically? Well, we've had a big shift in inflation. Basically, we had the supply chain issues

[00:01:45] with continued elevated nominal spending supported particularly by transfer payments, which created a lot of inflation. Then we had a combination of continued elevated nominal spending increasingly driven by income growth, but many of the supply chain issues were resolved,

[00:02:07] which created a big disinflationary impulse, particularly in a couple of goods categories, but meant that services inflation remained elevated. Now we're at this point where a lot of the hope that we would get to the Fed's target, which really existed at the end of last

[00:02:27] year, that hasn't really played out as many had hoped for in part because services inflation hasn't really come down all that much and that disinflationary dynamic that you got from the resolution of the supply chain issues on the good side of the economy,

[00:02:46] it moderated to some extent, which has stabilized the inflation picture a bit above where the Fed's target is and that is in the sort of re-ish percent range, 2.5%, 3% range, depending on exactly what measure you're picking and excluding X, Y, and Z. That is too high for the Fed's

[00:03:09] mandate. What that means is that they're not going to be aggressively cutting if inflation is at this level and the labor market is mostly fine, which labor market is mostly fine. It's the thing where they'll wait and see before delivering cuts if inflation stays at this level

[00:03:34] all indications are that we're stuck a bit here in the a little bit too high level for the foreseeable future. The other thing I want to ask you is about the subcomponent of inflation. What insights do you

[00:03:49] think that they're giving us today and do you believe, like some do, that the housing component is likely to fall or do you think it's going to remain elevated here as we go throughout the rest of the year and into next year?

[00:04:05] Well, if you're looking at oil prices is a critical place to start and that's because oil affects all prices, particularly all goods and to some extent services prices. Those prices, oil has remained elevated. It looked like we were getting a little bit of decline in oil,

[00:04:26] but that's bounced back up. The big disinflationary impulse that existed last year is not happening. Oil is basically flat. Then you turn to goods prices. Goods prices are now basically back to pre-COVID levels of inflation and a lot of those big disinflationary impulses like things

[00:04:49] like used cars and things like that. The price level has come down to the point where we're now at levels that would be commensurate with the rise in nominal incomes. So the odd that happened over

[00:05:03] the post-COVID period. So the odds that we're going to get a lot more disinflationary impulse from those prices are not very good on a forward looking basis, look month to month who the heck knows what's going to happen. I'm just saying like auto prices, they're not going

[00:05:17] to fall another 25% used auto prices, they're not going to fall another 25% because incomes are up a lot. So you don't want to look at pre-COVID prices as your benchmark because incomes are up 25% on

[00:05:29] a nominal basis. So odds are those good prices are not going to fall nearly as much. Then we turn to housing and really housing it's all about all tenant rents. When you look at it,

[00:05:42] which is very different, a lot of people focus on new tenant rents. That is misleading, that's not what drives OER, that's not what drives actual paid for rent. What drives actual paid for rent is

[00:05:53] all tenant rents and the Fed series which captures those suggests that we're still seeing inflation in the 5% to 6% range on an annualized basis of all rents in part because there's a big

[00:06:09] catch up to the rise of new rents that existed in the post-COVID period, those searched at double digit levels at one point. And if we're at that range, we're going to see house price inflation that remains elevated compared to pre-COVID levels. And so you take services inflation which

[00:06:28] is elevated to pre-COVID levels, housing or shelter costs that's elevated relative to pre-COVID levels, goods prices that are probably going to be a bit above where they were pre-COVID given the disinflationary or the de-globalization dynamics that are occurring and oil prices

[00:06:49] that are flat at best. And you add that all up and things are a little too high across the board. And there's no, the Fed can hope and hope and hope that it's going to come down but that

[00:07:00] combination of dynamics is just not that compelling that the Fed is going to get to 2% quickly. One of the things you've heard on Twitter a lot like during for a long time now is this idea that

[00:07:10] you know the housing is lagging with respect to inflation, it lagged on the way up and it's going to lag in the way down so it's inevitably going to fall. You don't believe that right?

[00:07:18] You don't see this decline in housing that a lot of people, inflation that a lot of people have been talking about coming. I don't in part because I think people are too focused on the

[00:07:30] pace of new rents and new rents are only something like 10 or 15% of the overall market. And what they're not focused enough on is the level of prices in the post-COVID period, particularly looking at all tenant rents on a level basis relative to the level of new

[00:07:50] tenant rents. And what those show is that all tenant rents haven't caught up with new tenant rents and if new tenant rents are really the leading indicator of what's going on,

[00:08:03] you don't want to look at those on a change basis. You want to look at them on a level basis. All the people pointing to the fact that new tenant rents are only maybe you're growing

[00:08:14] at 3% a year or something like that, they don't tell you that they were growing at double digits when inflation was spiking. They neglect to inform you about that. They're like, oh, just look at this here. And rents are a level concept. And you shouldn't necessarily expect

[00:08:33] rents to fall meaningfully because rents are connected to income growth and income and that and I should say more generally when you think about the inflation dynamic is going on here. Income growth is a primary driver of inflationary pressures in an economy over,

[00:08:51] not over a month, there are one data report or over six months, but over sort of a structural basis. And we still have nominal income growth that's growing at 5% or 6%. The most recent PCE report,

[00:09:04] the wages and salary growth was very strong. And if you have that circumstance where you have income growth that's growing at that level, then you're going to have the prices of other

[00:09:15] goods also grow at an elevated level. And so the fact that income growth is growing at one or two points a year on an annualized basis higher than where we were pre-COVID, you would expect

[00:09:27] that inflation should be one or two points above where it was pre-COVID as well since this fundamental productivity in the economy hasn't really changed between pre-COVID and today. So we had you last on in April. I was ready with my exciting YouTube cover. I was going to

[00:09:42] have flames next to you and stuff. You know, when I asked you about what the Fed might do, it turns out you told me the Fed was basically going to do nothing. It sounds like that is still

[00:09:49] your opinion that basically we're going to be in a waiting game here with the Fed. Why should they do anything? It's important to write in a central bank. They move when there's, in particular, when there is a deterioration in economic condition.

[00:10:06] That's when they really get their hustle on. Okay, so where, you know, and not a deterioration in economic conditions where growth is slowing from three to two to one or where the unemployment

[00:10:18] rate is meandering up. They react swiftly when there is an acute crisis dynamic or an acute slowdown going on in the economy. And there's no indication that there's an acute slowdown. In particular, you know, soft prices are at highs. Spreads are at tights, you know, just off tights.

[00:10:43] The unemployment rate is 4%. The total employed percentage of Americans is essentially at multi decade highs and inflation is too high. So you add that up. Like why would they move? And just think about what would have to happen? How much of a

[00:11:01] deterioration would have to happen to get them to move? It's not, you know, just growth being a bit softer than maybe what's expected in the stock market or what we saw, you know, in the second half

[00:11:13] of last year. You'd have to have a meaningful deceleration in growth before the Fed would even start to get meaning, you know, meaningfully concerned about what was going on. And then you'd have to have some period of time where they see that and recognize it

[00:11:27] before they start to do anything. So what the most likely thing the Fed is going to do through the end of the year? The answer is like not much. You know, finally, mostly short range markets have caught up with that. But that's, but you know, what's the urgency?

[00:11:40] That would be my counter that like what is the urgency? What data suggests that they need to move more quickly than essentially doing nothing? No, there doesn't seem to be any. And this isn't referring to this situation because I can definitely understand there's not much of a case

[00:11:55] for easing right now. But is this a flaw in the way the Fed works? Like it seems like always in these cycles, basically what you said happens, which is things go really bad.

[00:12:02] They cut a lot. Like is there any way they could I mean, I guess that's the nature of the backward looking data and how long it takes to come through and stuff. But is there

[00:12:09] any way they could operate in such a way that we ever would have like the like to slowly work the rates down and ease right in their type of cycle? Or is this just kind of the nature

[00:12:16] of the way the game is? Well, for any of these central banks, their slow moving nature and backward looking demeanor, I call it a feature in a bug. It's a

[00:12:32] feature because what it means is if you understand the data that they look at and the way that they make their decision and how they balance things, it's a feature because you can have a much better

[00:12:46] understanding of where they're likely to go. If you could start to think about what's going to happen with the economy, then they know. So that's a feature. The bug is that it means that policy is always delayed and this is how it works with all these central banks.

[00:12:59] Two main reasons. One, they are consensus driven organizations. That's a very important thing to think about, which means that the action only comes when the last person decides that it makes sense to to boo, right? That's the nature of a consensus driven organization.

[00:13:17] And two, they're looking at the actual data. They're not looking at, you know, they're in general not predicting what's going on. They may make predictions, but they're not changing their policy based on predictions, right? They're changing their policy based upon the actual

[00:13:34] data that they see. If you go back and go read what what Powell said in November and December about what was going to happen to the economy. He was the one who was saying that there

[00:13:44] were going to be a bunch of cuts happening. But who cares? His predictions were irrelevant. The only thing that mattered was what actually transpired with the actual data and the actual economy. And that didn't align with cutting, so they didn't cut, right? And so that really

[00:14:01] emphasizes the fact that it's the data that they make the decision on on a backwardly basis and consensus driven, which means slow moving. And so you add those two things up. And like, unless there's an acute crisis, they just don't move that fast in any direction.

[00:14:16] Do you think I was listening to you on the unusual whales last one they did with with Jem Cresson and he was talking about the idea that he thinks they might not a lot, but he might

[00:14:23] they might cut through the end of the year. And he also thinks that might bring like a meaningful acceleration inflation, like not not 4%, but something like much higher in the future. Like it would be a huge mistake to be cutting right now. Like what do you think about

[00:14:35] that idea? Like if they do cut now, it could cause like a meaningful acceleration inflation. Nothing really moves that fast. I think that's part of the part of the lesson of the last couple

[00:14:50] of years is you know, the real economy just is like not that sensitive to interest rates. And so you're on a tightening side, but also on an easing side, right? Like they're not,

[00:15:00] you know, the Fed moves 2550 basis points in terms of cutting cycle. Like what are the odds that it's going to, you know, who is doing what in response to them that will meaningfully influence economic

[00:15:15] conditions? And I think the answer is like not, you know, there isn't, there aren't a lot of there aren't a lot of folks whose economic conditions are constrained by the by interest rate

[00:15:30] changes that are on the order of 25 or 50 basis points. And the reason why that is, is, you know, mostly what's happening, most of what's driving economic conditions right now is income and income growth. That's basically basically what we see as households earning

[00:15:45] a pretty good income 5 to 6% a year, and they're spending five to 6% a year nominal. And the savings rates basically flat, like that's that's basically what's happening. And businesses are earning, you know, reasonable earnings and to the extent they need to do

[00:15:58] CAPEX, they're financing it out of cash flow and mostly not borrowing. And so an incremental move of interest rates in one direction or another isn't going to make a huge difference in any time frame that the Fed cares about to cause their change of behavior. Now,

[00:16:16] if we entered a significant easing cycle, we're talking about hundreds of basis points of easing, then I think what we would experience is we'd unleashed, you know, incremental borrowing that would supplement the already elevated nominal income growth. And that incremental

[00:16:32] borrowing would mean that overall nominal spending would be elevated in comparison to the productive capacity economy, we're already at, you know, the US is already at the productive capacity, right? I mean, employment, you can't find any more people, right? I mean,

[00:16:48] part of the reason why it's been able to continue to expand is because we've had so much immigration. If you just look at, you know, employment as a percent of the, you know, prime working age population, it's basically at all time high. So like there is no incremental

[00:17:04] supply that can that can come into the market and and meet higher nominal demand. So I agree, like significant a significant easing cycle might cause a reacceleration of nominal spending and lead to inflation. But you know, anything that's in the range of

[00:17:19] anything that's plausible from the Fed, frankly, won't do much whether they do something or don't do something. This is something I really learned from you because I'm used to these debt driven cycles in my career. And you've talked about how this is

[00:17:30] an income driven cycle and you kind of have to flip the way you look at a lot of different things when you look at it from that perspective, it really changes the way you

[00:17:37] view a lot of things when you look at it as an income driven cycle versus a debt driven cycle. Yeah, that's right. And just think about it. If you're if you're a if you're an average household with the average, you know, the median household in America and

[00:17:49] you own your house and you locked in a 3% mortgage and you own your car outright and you are employed and your wages are growing at 4 or 5%. Just just think about that household. What if interest rates were 2% like maybe what

[00:18:10] if interest rates were 3%, how would that influence their behavior? Like wouldn't make much of a difference, right? Like, you know, what if interest rates were 6% wouldn't make much of a difference, right? They continue to, you know, earn their income and they spend out

[00:18:25] of their income and they pay off their more, you know, they pay their mortgage the way that they've been paying it on an ongoing basis and it wouldn't really affect them. The primary place

[00:18:34] where it would affect them would be through asset price, right? So if you had lower interest rates, that would likely increase the level of asset prices just simply from the discount rate dynamic, which would cause them to, you know, feel wealthier and possibly spend more out of their

[00:18:52] income and similarly the opposite directs. But from like a cash flow statement perspective, you know, it doesn't really make much of a difference what exactly the level of interest rates are and it's why, you know, at some level, it doesn't really matter what the

[00:19:07] Fed does from the real economy perspective. They're not going to have a meaningful influence on a time frame that any of us care about in terms of what's going on. Could the long end start to have meaningful influence? Why don't know we're starting

[00:19:20] to see it a little bit here in the last couple of days. It could have a meaningful influence on asset prices, but the Fed's move itself not necessarily significant in that regard. You touched on wage growth earlier and this is another thing I've learned from you,

[00:19:34] which is this idea that if wage growth doesn't come down, inflation is not going to come down. You're not going to have 5% wage growth and 2% inflation. That's not like a sustainable thing. I'm just wondering when you look at the labor market, do you see any signs of

[00:19:45] weakness? Do you see any signs as coming down or is it really just kind of trucking along? Well, the labor market is definitely weakening. And so, you know, I often will talk about how the income driven cycle is very durable to higher interest rates because it's meaningfully in

[00:20:05] contrast to those historic debt-driven cycles. But it doesn't mean that interest rates have no effect on the economy because, you know, there's lots of businesses that are negative cash flowing that need incremental borrowing in order to continue to operate. And the longer the

[00:20:25] interest rates are elevated, the more that they decay essentially and they cause job losses. Plus, we've sort of naturally gotten to a point here where, you know, we basically employed every person in the U.S. that wants to be employed, you know, plus a few million

[00:20:43] immigrants per year. And so, you know, we're sort of reaching our limits in terms of how much more incremental labor force growth we can get or employed labor force growth we can get. And so, we're seeing a cooling that is a function of both of those elements,

[00:20:58] reaching our labor capacity and the sort of ongoing drag of higher interest rate. It's just a super slow movement. Right? We went from, you know, 6% to 7% income growth to, you know, 5% to 6% income growth to 4% to 5% income growth over the course of a few years.

[00:21:19] Right? Over the course of a few year time frames. That's slow moving and it creates a slowing... There's definitely a slowing of, you know, there's some slowing of demand, there's some slowing of income growth. You know, we're seeing that get picked up in things like

[00:21:36] retail sales, the GDP report, stuff like that. So, we are seeing some moderation. It's just, it's not moving, it just is glacial. Okay? If you don't have a debt crisis, this stuff just doesn't move that fast. Right? It takes years and years to slowly have higher interest rates

[00:21:53] decay the economy and the expansion. It's like, you know, a tanker ship and you throw it an anchor and then you throw out another anchor and you throw out another anchor. And like, yeah,

[00:22:04] eventually it'll work but it's going to take a long time to slow that tanker chip and the US economy is that tanker ship. Yeah, it's tough for making predictions on Twitter and stuff when

[00:22:13] you got this slow moving tanker that's not too much exciting stuff going on the day basis. Well, that's right. Yeah, I mean like, you know, I feel like what I should write on Twitter

[00:22:23] every day is like the economy is no different today than it was yesterday. You know, like that probably wouldn't give me many clicks. Although I do write that, you know, the US labor

[00:22:32] market remains securely tight. I write that every single week and you'd be amazed two years ago how many people were like, yes, but what's that stupid Hemingway thing? Slowly but then suddenly. Okay, where is the suddenly? Like tell me the suddenly. It's not to say that suddenly

[00:22:50] can't happen. And so I don't want to say that that's an impossibility because you do eventually get to a point where you get a self reinforcing downturn. But we're not there yet. And there's no, there are no indications that we're having a meaningful self reinforcing downturn.

[00:23:07] Typically, those self reinforcing downturns come in a credit dynamic because you reach a credit limit, then credit gets cut off, then your nominal spending growth falls sharply, and that creates the second and third consequences. But if we're just having an income driven cycle

[00:23:25] affected by higher interest rates, it can take years and years to play out, go look at them at the mid 60s expansion. That's four or five years where we were kind of bouncing around at,

[00:23:36] you know, low unemployment rate that was slowly but surely decaying. There's no reason why we can't have that occur. That doesn't mean that we're having a boom, to be clear, which

[00:23:46] is priced into the equity market. But it doesn't mean that we're just because we're not having a boom doesn't also mean that we're having immediate recession. So as the idea with these debt driven

[00:23:58] cycles, we were we were prone to these kind of blow off type situation where things eventually blew up. Is it the idea we're less likely to have that in an income driven cycle than we

[00:24:05] were in a debt driven cycle? Yeah, that's exactly right. And this isn't this isn't this isn't by chance. Like what happened was we had the GFC. And basically, everyone in the regulatory framework was like no more GFC type dynamics. Right? We're going to totally restructure

[00:24:24] the the banks have been restructured to have lots more capital. You know, it's hard, it's hard to hard to remember. But you know, in 2006, 50% of us mortgages were floaters. You know, today, it's essentially zero. Right? That's a that's a huge restructuring of the way in which

[00:24:42] debts are serviced in the economy. You know, 1520 years ago, lots of companies borrowed through CNI or, you know, other loan arrangements, they were borrowing on floaters today, you know, big companies basically term out long term fixed debt, you know, at low yields. And so

[00:25:00] we went through this whole process of household businesses financial intermediaries, we want to make sure that they are, they are, they can withstand a rise in interest rates. So we don't have another crisis type dynamic that we saw in 2008, which was, you know, a terrible outcome for,

[00:25:18] you know, millions of Americans. And we have been very, very effective at doing that. But the consequence of that means that the Fed's power to slow the economy is much weaker today than it was back then. And the likelihood that we get a cascading self reinforcing negative

[00:25:38] dynamic is a lot lower today than it was back then. And so, you know, it's not it's not a random outcome. We sort of purposefully said let's restructure our economy to have it look a lot

[00:25:49] more like the 50s and the 60s than to look like, you know, the the pre GFC type economy. And just one question on that. Is there is there any risk that the debt has moved from the public over to the government side?

[00:26:09] And thinking where there might be like levels of debt that could be problematic, I don't know what you're, you know, what you think about that with the level of sort of debt in this country. I mean, businesses are in good shape, consumers are in pretty good shape.

[00:26:23] But what about the like the US government? Well, the US government's got a lot of debt. And I think the US government's indebtedness is and any governments indebtedness is a little a little different in terms of how to think about it than private sector. And the primary

[00:26:43] reason why that is is that the central bank has the ability to essentially write off existing debt stock if the level of debt is too high, or if the price that is required

[00:26:58] by the market to finance it is too high. And so I don't think that like the current the current level of debt or even a higher level that is not that interesting like, oh,

[00:27:08] look at Japan, Japan has tons of that, right? And what do they do? They just printed money and basically retire the debt, right? And, and you know, they have the lowest interest rates in the developed world. So it's not it's not like just because you have high debt,

[00:27:24] you have an interest rate problem, right? The question is basically, you know, what is the appropriate level of interest rates for an economy, given its macroeconomic conditions, and what needs to happen for the central bank to respond

[00:27:42] to basically ease the debt burden that might exist. And so in the US case, you know, if you if you look at the overall picture, if anything, it's probably that the current interest rate level is too low, not too high, right? And so maybe the debt burdens,

[00:28:03] you know, are we going to probably pay off all the debt, you know, dollar for dollar the way it's currently issued, like probably not. Okay, that's a that's a 20 or 30 year timeframe

[00:28:14] story, like, you know, as a as a someone who thinks about in sort of a three to six month timeframe, like who cares? Like, you know, yep, the US debt will not be paid back

[00:28:25] dollar for dollar, where you're probably not going to get the same, you know, real return that you might expect as a function, either you historically gotten. Okay, so what? What does that mean today? No, if anything, you'll need to rise not fall today, given the

[00:28:42] strength of the economy. And so the path and this is I think people, people like skip a few steps here. Like, what needs to happen in order for the debt burdens to be unacceptable is first

[00:28:57] you'll have to rise and yields and the yield have to be true steep relative to the underlying fundamental conditions. And then the central bank will come in and will ease through the purchase of securities if necessary, right? First central bank will lower the short term

[00:29:14] interest rate. And then if the long term interest rate doesn't doesn't play along the way it needs to, then they'll buy a long term bonds in order to bring the interest rate down. But we're we're the beginning of that path, not at the end of that path. So

[00:29:27] the way I describe it is there has to be a lot more pain in the bond market before we get the types of interventions that are that would align with the fact that you know, would align with, you know, the central bank basically paying buying out

[00:29:40] the existing debt stock and reducing the debt burden. So we try to steer clear politics, but I did want to ask you about the election from the perspective of like the economy and markets because you have a probabilistic

[00:29:52] framework, which I really like about how you look at everything. And I'm just wondering, like, do you think about things like elections in terms of how they might impact the market?

[00:29:59] Do you kind of just discard them? I don't know who's going to win. You know, I don't know what's going to happen. Like how do you think about that in your framework? I think in general, when you're thinking about particularly fiscal policies,

[00:30:10] and of course fiscal policies connect to elections, right? Because, you know, the elected officials are the ones implementing the fiscal policies. You want to, you don't have to necessarily meaningfully speculate on this stuff to get ahead of it.

[00:30:30] Like, you're much better off through time if you just look through time, you're much better off, like wait till they pass the legislation, understand what the macroeconomic consequence of the legislation is, pencil that out, bet on those macroeconomic consequences.

[00:30:44] Like in general, you're much better off doing that. And you could get totally caught up and tie yourself into knots trying to bet on, you know, whether or not the political wins will blow this way or blow that way. And the reason why that is is like,

[00:31:02] I sort of say like, things that determine political outcomes are not the question is whether you have edge. Do you have edge in determining the political outcome? I'll say this very bluntly, I do not have edge in determining what the political outcome will be.

[00:31:20] What's the likelihood that we'll have a new administration? Like, I don't know, whatever predict it says, better, you know, it's as good as anything I could come up with, right? Or, you know, various forecasts and models, I mean, maybe you don't want to

[00:31:33] focus on just one one forecast or model, but like, you're saying like there's probabilistic models, am I better than a probabilistic model? Like no, I'm not better than a probabilistic model. That's not my area of expertise. What I can understand is,

[00:31:47] what are the likely policies that are going to be implemented by both paths, right? If the 60% that we go this way or the 40% that we go that way, given the probabilistic model and what are the macroeconomic consequences of that. But even there, what I'd say is, there's still

[00:32:03] a lot of uncertainty. Like, tell me what a new administration's set of policies are going to be like who the heck knows it depends on do they get elected? Do they have the house? Do they have the

[00:32:13] Senate? How much does it get watered down? You know, like who knows, right? And so, well, you get lost in all of those things. And the reality is, like, you're probably going to be fine just waiting to see when the legislation passes, I mean, or is very close

[00:32:28] to passing and then reflect the macroeconomic consequences of those policies as they come. Yeah, that made me think about Andy Constan. We talked to him about like the quarterly Treasury funding announcement. Like he sees all these people are trying to predict the quarterly

[00:32:42] funding, try funding announcement, he just waits until it comes out and then says, all right, what are the implications? I already know what it is. It seems like a similar type of framework. Yeah, I think, I mean, if anything, there is probably more clarity around the

[00:32:59] decision, the primary decision rules that are related to that, then there are to like fiscal policy in a whole like, I'm like literally okay, so new administration comes in, like, is the 10% tariffs on every on everyone? Is that rhetoric? Or is that policy? Is it 60%

[00:33:20] tariff on China? Is that rhetoric? Is that policy? Will Congress, Congress accept that? Will they not accept that? Like, will they water it down? Will there be the constituency to do that? What sort of, you know, exceptions are they going to make? Like, all of those questions

[00:33:36] are super pertinent to understanding whether or not it will have a meaningful macroeconomic consequence. And I'm going to be blunt about this, no one has any answers to those questions, because the answers to those questions will be determined by the electorate, which no one has

[00:33:52] predictive ability to determine what they're going to do. And number two, in the head of the people who get elected, which like who the heck know? And so, you know, like, what are

[00:34:04] you doing? If someone's going to, it's a person who comes in and says, I know for certain that there's going to be larger deficits, certain tariffs policy in this direction, policy in that direction. Like, they're totally overconfident. Right. And so you're much better off putting

[00:34:23] yourself in a position to say, look, I don't really know what's gonna exactly transpire, particularly in a, you know, in a bimodal, highly uncertain outcome where the actual policy implementation isn't clear. Like, put yourself in a position so that you're not overweight any

[00:34:41] particular outcome, because you don't really know what particular outcome will happen. And that you don't have any implicit or explicit bets on the politics or the policy, and wait to see the politics and the policy as they come in. So it's a risk management

[00:34:56] exercise. Politics in general, particularly elections, I should say, are risk management exercises much more than they are opportunities for alpha. Yeah, I think that's right. And you know, it's interesting too, because like the candidates are really using before the election, they're

[00:35:11] really using the, will this get me reelected framework? Not is this the good policy framework on both sides? So a lot of times you hear all these proposals and then they end up just disappearing into the oblivion. Right. And like one proposal being discussed is to

[00:35:24] deport every unauthorized immigrant in the United States. Like, you know, is that going to happen? You know, who know? But I certainly, I would neither bet for sure that it absolutely is going to happen as described in the political rhetoric, nor necessarily bet that it won't,

[00:35:47] you know, some flavor of it won't happen. And so like, and then like, if that happens, what are the macroeconomic consequences? And if they're like, oh my gosh, you're just like, there's just so many,

[00:35:58] you know, and then when will it happen? You know, like, I guess I would, I would just impress there's so much uncertainty. This is not like, I mean, we don't even have certainty

[00:36:11] about exactly whether the tax cuts are going to get extended, and how they're going to get paid for it, right? Like, and that's like a super concrete thing. We don't know what the view is from

[00:36:23] either administration on that point, whether they'll get extended, and what the pay force will be for their extension, and whether those pay force will exist. And that is like the most concrete thing that we could be talking about. And that has like a couple percent impact on

[00:36:39] the stock market if it goes one direction or another, if you knew for sure. Like, in the scope of all the different uncertainties, like, you know, holy macro, there's a lot of

[00:36:48] uncertainty just like don't get over your skis trying to predict all the things that are going on. Have a little humility that you don't you have no idea what will be US fiscal policy

[00:36:57] you're from now I have no idea. We may not even have certainty around with the president for Kennedy. So how are you going to make sure that you had it certainly about anything right now?

[00:37:07] I wanted to one more before I hand it back to Justin, I want to ask you about, you know, Tom Lee had come out with this 15,000 S&P 500 target by the end of the decade. And

[00:37:14] I don't really want to talk as much about the target because there's targets all over the place. And you know, those are very hard to do and they most of them end up not working out. But I thought

[00:37:20] what was really cool is the framework you tweeted out on Twitter about how you would analyze something like that, you know, using probability. And so I'll read your tweet and put it up on the screen and then I want to just ask you to explain it. So

[00:37:30] you said pricing out future equity price outcomes in many ways pretty straightforward. Price equals earnings times multiple earnings equals revenues times margin, revenues equals NGDP times company share and margins can only rise if reduced spending is

[00:37:42] offset by dissaving elsewhere, borrowing or asset sales. So I just wanted you to talk about how you would analyze a price target like that using this framework. I think markets are not divorced from macroeconomic reality. That's, you know, of course any price could be

[00:38:01] could be divergent for macroeconomic reality for, you know, for periods of time. We've certainly seen plenty of that in our in our careers. But part of what ends up happening, what ends up eventually driving asset prices is the macroeconomic reality. For instance, let's not

[00:38:23] forget, you know, there was like seven cuts priced in for the US for 2024, you know, only six and a half months ago, right? But what policy actually transpired ended up being, you know, isn't divorced from the macroeconomic reality that occur, right? That that's, you know,

[00:38:41] that's the corollary. And so the same is the same is true for companies and and stock prices. Of course, there's bubbles, there's busts, there can be diversions. But ultimately, you know, companies are stock markets are made up companies, companies generate cash flows,

[00:38:59] you know, they generate earnings, those earnings are purchased on certain multiples. And so you can start to think about what are the ranges, the pl, and sorry, and those earnings are a function of sales, those function of sales is a function of economic

[00:39:15] expansion and whether they can pick up market share in the economy. And so you can start to think about, you know, what are reasonable expectations in terms of what you'd expect. So

[00:39:26] take a very simple example, you know, leave the 15,000 aside, it's like five and a half years from now, like, you know, who knows. But just take for a simple example, like today, S&P 500 earnings

[00:39:40] are expected to be 17% year over year by the end of the fourth quarter. Okay, so very simply, how do you get to, you know, how do you get to 17% year over year earnings growth in the S&P 500?

[00:39:54] Well, you have to have some combination of margins and revenues that get you to 17% growth. If you think of the S&P 500 companies as being a broadly diversified basket of companies that are reflective of, you know, the broad economy. Well, if nominal growth in the US economy is,

[00:40:17] let's say, five to 6%, just to be, you know, that that's, that would be pretty good actually, five to 6% over the course of 2024. If that's the case that that's what nominal growth looks like,

[00:40:29] sorry for the lighting thing, then if that's the case, then the way you get to 17% is you have to have, you know, margin expansion, right? Margin's are already expected, you know, are already at secular highs. How do you get even more margin expansion from where we are today,

[00:40:45] right, to make up for the, you know, to get another 12% earnings growth? Well, you have to have margins go up, you know, a point point and a half. Okay, well, what are margins? Margins are just the difference between sales and what your what the sales cost you. And

[00:41:04] what's the biggest cost labor? Okay, but there's an intersection between those two points, which is a very important point, which is if you pay labor less, then they spend less, right, those two things are linked to each other that people often forget this. This comes up a lot,

[00:41:21] like with the AI story, they're like AI is going to create a productivity boom, and companies are going to be able to fire a lot of people. Okay, if you fire people, then they have less money to spend, right, those two things are related to each other.

[00:41:33] Right, this is why you can't have a stock market revenues are not disconnected from wage growth, because people need money to spend. And so if you think about that interplay, how do you get the margins? Well, the only way you get margin expansion

[00:41:47] is if there's dissavings, because it's only through the process of dissavings that one can spend more than their income. And so that's how that interplay works. So let's get to that 17% number. Well, if you take five to 6% nominal growth, 5% nominal growth, let's just say because

[00:42:04] the economy slowing, then I still need 12% to happen with margin expansion. Okay, who our house was going to borrow more, our business is going to do more cap X and borrow more is the

[00:42:16] government deficit going to widen considerably like who is going to do what to lead to that expansion. It's not disconnected from reality has to exist in the context of the macro economy. So I

[00:42:28] think that's people like, that's such an important thing. And it's the thing if you went through the 2000 cycle and you heard all sorts of stories new economy, companies are disconnected. Nope, the 2000 cycle worked exactly the same way, which is that, you know, ultimately, earnings

[00:42:47] were not disconnected from the real economy and the real economy has limitations. That's kind of the interplay between all of those different pieces. And you could think about that on a one year

[00:42:57] timeframe, or on a five and a half year time. What do you think of the way this year has played out just in terms of like a return perspective? And then what I mean by that is, you know,

[00:43:08] the S&T is up, I think over over 15% through the end of the second quarter, the Russell's basically flat. Yeah, the returns have been driven mostly by a handful of technology names that have, you

[00:43:21] know, been delivering I think for the most part. And so wait, but when you see like that type of diversion underneath sort of in the market sort of, you know, underneath the surface,

[00:43:33] does that give you like pause? Is it just how it is and these companies have large cap tech has delivered and smaller companies are maybe more susceptible to higher rate? How do you

[00:43:43] think about that? Yeah, in general, I don't, you know, I look at the world from a macro perspective. And so I think a lot of, a lot of folks will say, Hey, look, because NVIDIA and a couple of large

[00:43:59] cap tech stocks did well, that's what's driving the market. First of all, to be clear, like the Mag7 only describes something like, you know, somewhere between 40% and 50% of that return, which means that the aggregate market has delivered the rest of the companies have

[00:44:12] delivered plenty of return. Right? And so when I look at it, when I look at what's driven the market return over the course of the year, it's actually been like a very traditional growth surprising to the upside became into the year growth expectations in December last year

[00:44:29] for us growth in 2024 were something like, you know, below 1%. And now, you know, expectations are, you know, consensus expectations are for the US economy to grow at something like 3% for the final three quarters of the year.

[00:44:46] That shift, that's a big shift in growth expectation. And macro markets have largely played out consistent with that, which is that stocks of rally bonds have sold off, and short rates have underperformed or cuts have been priced out. We've also seen,

[00:45:04] you know, commodity prices rise consistent with elevated growth dynamics as well. Like that's a very coherent macroeconomic story as it connects between expectation, shifting expectations, they were too low, now they're higher. And the pricing in the market,

[00:45:23] which is mostly reflective, reflected by higher PEs over the course of the year. And so I think a lot of folks will go down the level below and they'll say, oh, well,

[00:45:36] it's this tech stock and the SAP tech stock, and this is other tech stock. But like, look, if US growth expectations had stayed at below 1% over the course of the first half of the year, well, you know, maybe those tech stocks would have been performing well,

[00:45:48] but other things would have been performing poorly. And we wouldn't have gotten any rally in the overall indices. And so that's, that's where when I, when I say it's connected to when, when I say that the equity market is connected to the macroeconomic realities,

[00:46:02] that's a perfect example of where that connection occurs. I love the way that you can kind of articulate that and make that connection kind of bring around full circle. I think that's excellent. I wanted to kind of just shift here at the end

[00:46:15] to a couple of tweets that you had. Well, one is actually, I think it was an article that you had on limited funds, where you were talking about gold as a being included in

[00:46:31] a portfolio. And just generally, can you just kind of set it up before I maybe get into the tweet? Can you just, how do you think investors should think about gold? Well, you know, gold is, is a contra currency. And it, and it's also not yielding in general.

[00:46:51] And so when you think about what drives the performance of gold, it really is, it's the sort of asset that sort of during benign times, typically outperforms when yields are falling and underperforms when yields are rising because it's not interest bearing. But it is particularly

[00:47:10] valuable as a hedge against tailed outcomes, either high inflation or uncertain environments, or people often forget or low inflation environments as well, where the central bank needs to devalue the price of money relative to debts in order to get the economy out of a deflationary trap.

[00:47:31] And so, you know, I think what we're seeing on a global basis is that there's real concerns about, you know, gold is also a global asset, which is very important to recognize as well. On a global basis, I think there's a lot of concern about whether

[00:47:48] in certain places, there needs to be a continued devaluation of paper money to achieve acceptable economic outcomes. So for instance, in China, which is in a deflationary trap, it's not surprising that we're seeing a huge amount of demand for gold, partially because

[00:48:04] other financial assets are doing poorly there, like houses, stocks, wealth management products. I mean, basically, like if you're in China, what are you going to invest? What asset? You can't move your money offshore. You can't use Bitcoin.

[00:48:22] You can't invest in houses. You can't... The stock market is in terrible shape. Like, what else... Literally, what else is there to invest in and the economy is in terrible shape and there's pressures on the currency? That's a perfect example of why

[00:48:37] gold would be demanded, right? It's a deflationary trap in the Chinese context. And so when you think about that, that's the role that gold plays from a macroeconomic fundamentals perspective. A global asset affected that is particularly valuable in terms of tail risk.

[00:49:00] The thing I'd sort of... Transfist into saying, like you could get hung up on all those fundamental factors or you just look at it empirically, gold outperforms bonds about half the time the stocks are down. Everyone holds bonds, no one holds gold. It doesn't make any sense.

[00:49:16] It just like fails the empirics test. Like, and you know, the last five years have been a great example, like bonds have sucked, gold has not. Imperials when stocks have been down, gold has outperformed bonds. Like why wouldn't you hold gold in your portfolio?

[00:49:31] Just purely from an empirical perspective. It doesn't make any sense. Well, and I think your tweet kind of went even beyond and you wrote... We'll put this low cost gold commodity and diversified alpha offer the best opportunity for most investors to

[00:49:44] improve the consistency of their portfolio. And yet everyone wants to talk about venture capital, private equity and private credit, which hasn't really seen a lost cycle to your point yet.

[00:49:57] So, and then you'll... I'll let you talk to the chart, but I think it shows, if you take a 6040 and you reallocate and add some of those other asset like this gold commodity than diversified alpha,

[00:50:08] you know, helps to risk adjusted returns. Exactly. I mean, I think, you know, there's so much talk about alternatives that are just alternatives to equity. You know, private equity is just levered equity. That's illiquid. Venture capital is just very, very risky equity.

[00:50:29] Right? There's all of these things and everyone spend, you know, asset managers just spend so much time talking about just various forms of equity or private credit, which is really just a, you know, it's just different credits for that product. Right?

[00:50:43] If you want access to what private credit is offering, you can just go buy, you know, high yield spread, you know, high yield bond ETF, you know, you get it for like tens of basis

[00:50:59] points instead of paying two and 20. Right? So it's all of these things that are like package, you know, so many, so many advisors and allocators are super focused on these assets that are basically the same assets. They're just higher fee. Yeah, no wonder the managers want to sell

[00:51:14] them these assets, they're way higher fee and more illiquid. Right? So it makes sense. Managers produce this all day long and sell it to allocators and advisors. But the reality is it doesn't do anything for your portfolio. If you're trying to build a portfolio, you need to

[00:51:31] find uncorrelated or lowly correlated assets, private equity venture capital from a common sense fundamental perspective are not uncorrelated. And if you look at the actual outcomes and you match things like accounting timeframes and illiquidity timeframes,

[00:51:51] liquidity timeframes, they're also they're super correlated to the other things that you can get essentially for free in your portfolio. And so that's why if you're really looking for diversifiers, golds, commodities, alpha, those are the things that can really benefit a portfolio.

[00:52:07] You also threw up on Twitter that hedge fund net attribution chart, which it's kind of like a chart showing where the returns are coming from in the hedge fund universe, but then also what the tracks from the return. So at,

[00:52:20] you know, at a high level, what's the big takeaway here for investors? Well, you know, hedge fund strategies are pretty good. They generate hundreds of basis points of alpha. The problem is that the fees are too high. And the taxes are too high, right? The

[00:52:32] problem isn't the strategies, the strategies are pretty good. You know, over the last 20 years, hedge funds have stock like returns with half the monthly volatility and a third of the drawdowns. That's a great strategy to have in your portfolio. The problem is as they're

[00:52:48] constructed right now, you know, everyone's getting paid except for the person putting their money on the line. And that's what you know, that's what this chart shows is that, you know, if you take the management fees plus the platform fees plus Uncle Sam's got to get

[00:53:04] paid, plus your advisor's getting paid, you know, you add that all up and it's like everyone is getting paid except for the investor who is allocating to these things.

[00:53:14] And so it's a big reason why sort of in my day job, I'm really focused on how do you get access to these strategies in a way that basically makes the tax problem, you know, makes it more efficient.

[00:53:27] Or ETFs, you know, in a lot of ways are just a tax loophole where you can take capital gains instead of ordinary income and do it at just a lower fee structure. If you can, you know,

[00:53:39] bring the fees down considerably relative to what you'd pay in an LP structure, that's a lot better off for the investor. It's great. Thank you very much, Bob. We really appreciate you joining us. It's always a pleasure to have you

[00:53:51] on to talk macro, to talk common sense macro investing, the ETF business. Next time we have you, we'll talk more about the ETFs. Alrighty. Thanks so much for having me. It's things are getting interesting. This is Justin again. Thanks so much for tuning into this episode

[00:54:06] of XS Returns. You can follow Jack on Twitter at at practicalquant and follow me on Twitter at JJ Carbonell. If you found this discussion interesting and valuable, please subscribe in either iTunes or on YouTube or leave a review or a comment. We appreciate

[00:54:21] it. Justin Carbonell and Jack Forehand are principals at Bolivia Capital Management. The opinions expressed in this podcast do not necessarily reflect the opinions of Bolivia Capital. No information on this podcast should be construed as investment advice.

[00:54:32] Securities discussed in the podcast may be holdings of clients of Bolivia Capital.