The Next Chapter for Inflation with Cullen Roche

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[00:00:19] Hey guys, this is Justin. In this episode, Jack and I have back one of our favorite guests,

[00:00:23] Cullen Roche, founder and CIO of Discipline Funds over the course of the last 10 years, you know, macro has is just so up in front in our faces all the time that it's something that even if you're not applying it in like a really, you know, daily useful way, it's still something that in a general sense

[00:01:41] I think is important to understand just to help you navigate a lot of the understandings of what's going on.

[00:01:47] Yeah, and I don't know if that's like

[00:02:44] QE was going to cause hyperinflation and you sold all your stocks and bonds and you moved all into whatever, some sort of inflation hedge or whatever it was. That ended up being a pretty

[00:02:51] disastrous mistake for a pretty long time. So it depends. It's all sort of environment

[00:02:56] specific, but understanding this stuff has become more important because the Fed and the

[00:03:01] government has just become so much more involved in the way that we all operate every day.

[00:04:03] empirical evidence about what QE did in Japan. So it's not, part of it is,

[00:04:06] or a big part of it is just that I was lucky

[00:04:08] and not necessarily smart.

[00:04:12] We wanted to spend, I think, a lot of the time,

[00:04:15] they just kind of talking about inflation

[00:04:18] where we're at, ways to measure inflation

[00:04:20] and the different things we're seeing around sort of

[00:04:23] inflation as, I guess, a topic. Yeah, so I think the most important one is the core PC, which is the core personal consumer expenditures inflation index. And that's the most important one because that's the one the Fed cares the most about. So that's the one that I think most impacts policy, which is the thing that ultimately

[00:05:43] impacts portfolios and interest rates and everything on the ground. I'm a big, big advocate of looking at just commodity prices. So I think if people want like the truest, best, real-time indicator of what's going on with inflation and you want something that you know is not really manipulated, that is more sort of market-based, you just go straight to like the Bloomberg Commodity Index and look

[00:07:00] at like the year-over-year rate of change.

[00:07:01] And you can kind of get some confirmation on what's going on. inflation as a whole. And we also know that the way that the Bureau of Labor Statistics measures inflation and shelter in particular has sort of a flaw in it that tries, where the economy is at and where inflation is probably going to be in about six months when you actually see this sort of bleed into the data. So, to answer the question succinctly, I like looking at lots of indicators, especially things outside of the government, even some of the newer ones, like, you know, trueflation

[00:09:43] is an inflation indicator that is really popular on Twitter, that, what do you think? I mean, do you think as wages continue to go higher? And that's just one example. I mean, wages have kind of held in there that, you know, inflation can come down or is there just such a positive correlation between wage growth and inflation that, that, that, you know, inflation can't.

[00:11:00] It's like fighting against, like the tsunami.

[00:12:05] Phillips curve data made it look like back in the especially the 70s and 80s. And the reason for that is that there's just lots of things that cause inflation.

[00:12:08] So you can get, for instance, during COVID, like a lot of people love trying to peg this

[00:12:13] to like one thing.

[00:12:14] They said, oh, it was all fiscal spending or, you know, it was all corporate greed or you

[00:12:20] can pull up all sorts of political narrative that people from various political parties

[00:12:25] would would pin this down to. actually go down during the recession. And that's in large part because, um, behaviorally, people just don't allow it. You won't, you won't stay with a job that, you know, cut your wage by 20% when, you know, you go into a recession or something like that. So there's this weird sort of behavioral stickiness in the way that inflation works where wages can

[00:13:42] create sort of a, I think a floor in inflation over the weak necessarily, but well, I guess that depends on where you look. If you're in commercial real estate, it's been pretty bad. I think prices are down 15% or so. Residential's been really strong, though, and that's, in large part, I think, because the demand came way down, but the supply was just never factor in the way that consumers respond to rate hikes in the sense that rate hikes can put a lot of pressure on corporations, and they're putting a lot of pressure, for instance, right now on commercial real estate. But consumers, the way that they tend to respond to, for instance, rate hikes during a high

[00:16:21] inflation is they borrow more.

[00:16:23] And so a lot of what's been happening in the, in the wrong direction where the Fed stays really tight and consumers end up not borrowing a lot and, you know, tightening their own belts a little bit here to the point where you get a little bit of a giveback from last year.

[00:17:40] Taking into the labor market a little bit, you had some really good tweets recently with

[00:17:43] some charts that I thought were really interesting. And, good news in all of this, I guess, is that A, the credit is available to actually borrow and B, the second jobs are actually there for people to fulfill.

[00:19:00] So again, that's not a lot of people, that's the basically the number of people who are quitting on a monthly basis. And that's indicative of really, I think, how much can like negotiating power workers actually have relative to like capital. So like, can you actually change jobs because you want to, because you just want to quit

[00:20:25] and go get a different job? The market seems to expect a lot of cuts this year. That seems to be getting pushed out in the future here a little bit as we get stronger data. How do you think they're thinking through where they are right now? Yeah. I always say this, but being on the FOMC or the Fed board, it's got to be one of the worst jobs in the world. Just because there lined up for open houses with like, you know, 100 or 200 people trying to buy one house that was already overpriced. And there were all these pricing indicators in 2021 that made it, at least in my mind, it looked like the risk of inflation flaring up on the upside was relatively high. And the Fed didn't have the luxury of being able to

[00:23:03] just like make that assumption that this was a big risk. They had to be able to wait and see.

[00:24:06] bleeding into the data, but there's a real chance here that the Fed is still lagging in a way that creates a material risk of them being too tight for too long.

[00:24:11] It looks really good so far.

[00:24:13] So the Fed has, this is sort of almost a weird environment in the sense that the Fed looks

[00:24:18] like they've handled this really not really apples to apples. But at the same time, like you're in an environment where, you know, let's say that, you know, growth is one to two percent by middle of the year and the unemployment rate starts to tick up, you know, you're going to, the Fed's going to find themselves in a situation where they're going to feel like they have to start

[00:25:42] cutting not because they want to, but because percent. And I think in that sort of a scenario, I think a lot of people would look at what the Fed has done and they'd say, you made you were too late raising inflation. And then you waited so long to cut rates that you ended up, you know, causing more unemployment

[00:27:00] than was necessary.

[00:27:01] And now, you know, a million people are out of work for no good reason. You don't get environments like 2022 where the Fed, rather than incrementally raising rates in a sort of nice systematic manner, like the way you're talking about or cutting rates in a nice systematic manner. Back then, they were raising rates by 75 basis points at a time, which is that sort of like hyper-reactive response

[00:28:22] causes problems.

[00:28:22] And people say, oh, the last few years have been all hunky dory,

[00:28:26] but that's not true for regional banks is about as truly independent as it gets. So like, I think Powell has been really independent. I mean, Powell was really, I mean, in a bad way pressured by Trump, you know, back when Trump was president and Powell really like, he stopped

[00:29:41] to his guns for the most part there.

[00:29:43] So, and I, you know, I think the one thing

[00:29:46] that we're gonna see this year is, of the United States again. Well, it's interesting too on Trump. Like we were doing another podcast the other day. And like the first thing we were talking to was like, basically if Trump wins, Paul's gone anyway. Cause I don't think Trump is a fan of him. So like it might be like in, you know, whatever January he's out of here anyway. Yeah, you know, that actually would be,

[00:31:00] I can't remember who I think maybe it was Josh Brown

[00:31:02] who was talking about that,

[00:31:03] that the theory that like the,

[00:31:05] that Powell might actually resign Fed she's very often and so I think pal has been a great fed sheet for the most part. It's it's just It's so easy to beat up on them because the job is an impossible one based on utilizing tools that are Deficient that you know tinkering with interest rates and quantitative easing or extremely blunt instruments that are

[00:32:21] imprecise at best and so you know we think of this guy as like the driver of the vehicle but really he's almost like

[00:33:26] experience has been so crazy. I mean, nobody got nobody got all this stuff like 100% correct. It's just it's been such a crazy ride over the last like three to four years that I mean,

[00:33:32] the fact that they're in the position they're in right now. I mean, it's is sort of incredible.

[00:33:37] I want to ask you about this this thing. I don't understand very well, which is this

[00:33:40] neutral rate of interest idea. And so the idea, I guess, is that there's a rate where

[00:33:44] the Fed is not being restrictive, but they're not being loose either. But it seems like the economy in a way through that interest rate. I've never really found that to be super useful. So like imagine it's almost like a Wall Street analyst who has like a theoretical neutral valuation and the valuation of stocks and bonds that this analyst theorizes is like the perfect

[00:35:01] rate where stocks are neither overvalued or undervalued and could sustainably just grow at this rate Look at your rates, don't necessarily go from exactly in a proportional manner, for instance. Credit card rates don't go in a proportional manner relative to what those interest rates do. And so there's the weird thing with interest rates, especially in the way that all credit is structured in the economy is that there's really, there's like thousands of different

[00:36:20] interest rates across but you didn't really impact the supply side of the equation all that much. Just go back to the election for a second. You know, there was an article just today in Bloomberg, I earlier this morning, and the title was investing for Trump 2.0 is trickier than you think, and it was say they were able to get more control over Congress and you got a replacement of the Fed cheap to somebody who was much more sympathetic to Trump or whatever, yeah, I think, other lesson from maybe the Trump presidency is that things, you know, a lot of people, there was a lot of hyperbole about Trump's sort of, you know, dominance over policy in general. And I think the interesting thing from his presidency is that, you know, our system, the way it's designed with checks and balances actually proved that it works fairly well,

[00:40:24] because there were a lot of checks on President Trump I mean, the, so for people who don't know, like the, I mean, the story goes that the inflation targeting came basically from like, I think it was like a New Zealand central banker who in an interview talked about an inflation target of like two to three percent or something.

[00:41:40] And this then sort of became a thing that was more and more common in developed market

[00:41:44] central banks. Does it really matter whether the Fed is targeting 3% versus 2%? I guess it makes a difference for their policy overall. But in general, I think as long as we have a generally low rate of inflation, I think that's consistent with policy and economic growth in general that is good.

[00:43:01] And I think that that's one of the things that I think a lot of people tend to get wrong

[00:43:04] is that they think any inflation is you know, that's fine.

[00:44:22] But in on the whole, the economy grows or worse off in that environment than you were when your wage was higher and prices were higher? We obviously, all the three of us were kind of early in our careers during the Internet

[00:45:42] sort of boom and bust. and hear about things like artificial intelligence, which is all the talk and the rage now. And I do think, I don't know, I'm interested in your opinion, it's what you think on it, but when you think about it and the influence of something that has the potential to be that big on the economy and on inflation, like just do you have any thoughts on that?

[00:47:00] And what are you thinking?

[00:47:04] Well, I think in terms-term tendency is for inflation to be a moderately low rate, similar to sort of the post financial crisis period

[00:48:22] or even the pre financial crisis period to some degree

[00:48:25] where you had 20 years of basically

[00:48:27] a moderating rate of inflation. us all to be unemployed. I think people generally, what we're doing over time is technology allows us to sort of use our time in just other ways where we can refocus on other things like, you know, washing machines didn't, you know, put all of the, you know, the people out of work who, you know, used washboards, you know, they, those people that used to use washboards now, you know,

[00:49:43] they put their, they put their clothes in a weird sort of way, I think a lot of middle class think, working base case over the course of the last few years has basically been that you had this big, you had the big bust initially

[00:52:22] in COVID. You had the course of that, the economy

[00:54:46] I wouldn't say it's like a high probability outcome, but they're still looking historically. Every time the Fed raises rates at the trajectory that they have and you have real interest

[00:54:52] rates as tight as they are right now, you tend to get credit markets that are just really

[00:54:57] tight and that causes weird things, whether it's a big seizure in consumer borrowing at

[00:55:03] some point or the commercial real estate thing ends up flaring up to the gate and everybody gets off. That's not how it works. The economy is something that basically is always flying. And I think the way to think about this, that's kind of useful for me at least, is that the Fed was flying the plane, they were flying it too fast in 2021. They had the lift and nose, raise interest rates.

[00:56:20] So that brought the plane down.

[00:56:21] We're trying to kind of navigate through this turbulence now,

[00:56:24] and the turbulence has moderated,

[00:56:26] but it's still with us. But at the same time, I think that 5% overnight interest rates has created, especially in the housing market, just really like an unsustainable situation where you're not increasing the demand with that interest rate and you're not increasing the supply with that interest

[00:57:41] rate, which is almost like it made the situation where I think that the Fed, the Fed knows that and they know that, they know 40 to 50, 60 million people have been priced out of the housing market, you know, at the cost of basically trying to beat this inflation fight. And I think once they beat the inflation fight

[00:59:01] and they sort of know that it's been defeated

[00:59:03] and that inflation's back to like 2%,

[00:59:06] they wanna ease things back and bring things more and economic knowledge with us. And you've always been kind with your time. And so really appreciate it. If people want to learn more about discipline funds and what you're up to, where can they go? Yeah, so the best place probably is we operate like a corporate blog, I guess it is, on disciplinefunds.com.

[01:00:20] It's under the tab called discipline alerts.

[01:00:22] So we talk about a lot of stuff.

[01:00:24] I talk about some mundane economics,

[01:00:26] a lot of like portfolio management concepts