Moody's Talks - Inside Economics - Fear Gauge and Frothy Markets

Episode Date: June 25, 2021

Mark Zandi and the Moody's Analytics team discuss what they are watching to gauge the health of the economy and the big topic was froth in asset markets.    Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and I'm joined by my two colleagues, Ryan Sweet. Ryan is director of real-time economics, and we'll be getting to the indicators shortly like we typically do. And also, Chris DeRides, Chris is the deputy chief economist. Do you guys ever want a different title? Are you happy with those titles? Just ask. Yeah, it's better than Crypto King. Crypto King, yeah, right. Much better. Yeah.

And you, Brian? You're handing out new titles? You know, we always have debates about titles. It's kind of fun to think about titles. No big deal. No, I'm good. You're back from the beach, I see. I am.

Back to reality. Yeah, very good. But you never really escaped, right? You made all the podcasts. Oh, well, I'm not going to miss them for anything. but yeah I mean I did a little bit of work here and there but doing work down the there's that old saying like a bad day in the golf course is a good day in the office it's better than a good day in the office but you know that all applies

that sounds like a 1950s slogan to me I never yeah that's yeah back in the day what was I going to say oh we are going to take a break for next week though we're we're not going to have a podcast for next Friday, which is, that would be July 2nd, I guess. So just for the July 4th weekend, we're going to take the week off. Then we're going to come back the week after. And I do have a guest. Wayne Best. Wayne is the chief economist of Visa. And he's, you know, obviously has a lot of cool data based on usage of the visa payment system on consumers. And he'll be talking about that. And we'll talk about the consumer more broadly, obviously key driver of what's going on in the economy.

So we'll look forward to that. This podcast, I thought we devoted to markets. They're asset markets. They're red hot. I mean, as I'm speaking now, I think the stock market, the S&P 500, is at a new record high. And it seems like we've been hitting record highs daily. And of course, we've been talking about the sizzling housing market and house prices. and, of course, crypto, we've had a lot of fun with that. That's backed down, but, you know, it's still parabolic compared to where it was a couple years ago. CRE, commercial real estate values, commodity prices. Pick your asset prices are up.

So I thought the big topic this week would be about asset markets. But before we go there, as we do on insight economics, we go into the data and the statistics. And Ryan, director of real-time economics. What's the real-time statistic that you want to point out for this week? All right. We're going to go with sticking with the big topic, 15.42 as of right now. 15.42, and it has to do with markets. Oh, just went down to 15.41.

This is real time. I'm telling you. I'm staring at it. It is real time. This is a good hint. I know. That's a financial market. Chris,

do you have any idea? What do you saw? It's not related to bonds because nothing is over 2% in bonds. Or maybe increase in the S&P 500? No, it's down a lot over the last five to 10 business studies. It's below his historical average of 19. have. 19.

A half. Oh, boy. Any ideas, Chris? Can you give us another hint that won't give it away? It's in the U.S. Macromed. It's not a commodity, is it? Is it commodity?

No. We forecast it. It's not a commodity. We forecast it. We forecast it. We forecast it. It has to do a financial. And it's a daily.

Stocks, bonds. Oh, is this? I'm just swinging here at the end of, hand softball, or this is more like a hardball overhand pitch. It's not like the VIX index, is it? It's the VIX. Oh, okay. There you go. All right. You're surprised I got that. You thought you were giving up on me. No, I thought you were guys going to get it much sooner. So the VIX, the VIX is a measure of expected fluctuations in the S&P 500 over the next 30 days. It's a useful fear gauge. So when it's going down, there's a lot more optimism in the market than,

when policy uncertainty is going up or there's a lot of fear about the economy, the fix goes up. So you said it's, would you say it was 15.1? 15.42 now. It went back up. It went back. Listening to us, a lot more angst out there, you know, in the marketplace as we prepare to talk about markets. So you're saying 15.4 is actually low compared to it's, average, which is closer to 19. Correct. Right, okay. But, you know, that's not signaling anything of any consequence, right?

I mean, that's pretty kind of... No, I think it just supports the idea there's a lot of optimism in the market, and there's not a lot of fear. You know, even though the Fed turned a little bit more hawkish uncertainty around monetary policies low, uncertainty about fiscal policies coming down. I would argue that, you know, the stock market's going to remain pretty strong going forward. And we forecast the VIX in significant, can you imagine we're forecasting a measure of angst in the financial system. So that takes a lot of hubris. But we do that because it's a key variable that the Federal Reserve provides in the bank stress testing process.

So they give us, I think, 26 variables as part of the CCAR, the so-called C-Car stress test scenario. and that's a gauge of angst in the financial system. And it's a key variable that banks and other financial institutions use for pricing, securities, loans, that kind of thing. And so that's part of the C-CAR process. And therefore, we brought that variable into our models and produced forecasts for that, excuse me, and provide that to our clients. So I don't think we would have done that otherwise.

We wouldn't have modeled and forecast VIX, I don't think, if not for the fact that the Fed is using it in the stress testing process. But that's a good one. That's a really good one. I used the VIX to forecast high-yield corporate bond spreads. Makes sense, right? Yeah, it does. Because that spread, that spread represents concerns about not getting repaid on that bond. So there's, if you're worried about the financial system, the economy,

the probability you won't get paid back on on that bond is higher. And so that spread is higher. So that makes a lot of sense. Yeah. Okay. And, okay, so Chris, what's your statistic this week? Yeah, so one that stuck out to me this week was 7.6%. 7.6%.

7.6. Is it housing related? Nope. Okay. Oh, that's a break from. I'm going off the reservation. Going off the reservation here.

So that, right, because Ryan asked that question, it means he doesn't know right off the bat, which is, that's a bad sign. If Ryan doesn't know it right off the bat, this has got to be a tough one.

Can you want to go to say, he's using back into things here. Yeah. Yeah, he needs to rev up here. Get his game back. So, so you want to give us a hint? Sure, it's top line headline. It's perhaps the biggest statistic in the U.S. economy.

What? What's he talking? Are we looking at the same economy? Yeah, we look at what? Are you talking about Singapore or what are you talking about? 7.6. This isn't GDP. GDP? GDP was 6-4.

They're close. They're very close. Oh, it's not GDP. Gross domestic income? I don't know. Yes, there you go. Oh, geez. Mark is on fire.

There you go. Wow. Gee Louise. Oh, no. Are we going to get in the debate GDI versus GDP? No, not a debate. You brought it up. You've got to explain it to people.

You know, what is GDI, gross domestic income? And why is that important relative to GDP? So it's a, so GDI is an alternative measure of the, the, the, value of output in the economy, right? So GDP is an expenditure approach, right? We sum up consumption, investment, government spending, and other exports, right? Everyone's familiar with that, and that was 6.4% growth in the first quarter. So that grabs the headline. That's the one everyone focuses on. GDI is an alternative measure, which is basically looking at the income, right, summing up the incomes. And in theory, those two, right, someone's expenditure should be someone

else is income. So under GDI, we sum up wages, profits, taxes, all the other income categories. Right. So again, in theory, they sum up to each other over long horizons. You see that they match each other quite well. But right now, there's a bit of a disparity, right? 7.6 versus 6.4. I like to use the average of the two to get a sense of the true underlying output. And so that suggests that the economy is growing even stronger than the GDP statistic might indicate. So it's a positive, certainly indicating strength in the economy. Yeah, it makes sense. Does GDI include transfer payments?

I think it does. GDP, yeah, and there's a correction, I believe that's made to adjust for that. To adjust for that. Okay. Yeah, GD, the reason why I think people don't, don't really focus on GDI gross domestic income is that it's a bit lagged

relative to GDP. So GDP comes out the end of the month following the previous quarter for that quarter and I don't think GDI comes out for another month after that, right? Or maybe it's the month after because they need profits, a corporate profits

to calculate GDI. And that's just a little bit, that comes from tax returns and it just takes a little bit of time to get all that data together. It's lagged a little bit. But I think you're right. There was a fair amount of research around this in the Obama administration. I think the Council of Economic Advisers came to the conclusion that a better measure of the health of the economy was exactly what you're doing, a equal weighted average of GDP and GDI.

That worked better at, I think it's actually predicting the next quarter of GDP than looking at GD. but certainly a good statistic. That's a good one. That's a really good one, yeah. Well, I'm just going to, I'm not going to quiz you. Maybe I'll come up with a quiz in a second, but I do want to point out. I'm going to go to my go-to-indicator. That's the back-to-normal index.

That rose again, 93.7 last week. 93.7 means we're 93.7 percent of the level of economic. activity that prevailed right before the pandemic. So we're still, you know, six, seven percent percentage points below where we weren't. And just as a refresher, that back to normal index is a compilation of a lot of statistics. Government provided statistics, including our GDP tracker, but also a lot of third-party data. And I think we now have a half a dozen states that are back to normal by that index. You know, Florida being the largest, it's completely recovered, you know, what it lost

during the pandemic and then some. And the states that continue to lag are New York. Not surprisingly, that got hit really hard by the pandemic in Illinois. And I think they're now at 82, 83%. So still a ways to go here, but clearly making a lot of progress. So good news on that front. Is there a major driver in the index? It's been driving that up.

I haven't looked at this past. I don't know what drove it up this past week. I haven't a chance to dig into it. But pretty much everything is kind of pointing up. I think recently the amount of people going through TSA checkpoints has really picked up quite a bit. That's an indicator that we include in that back to normal index. We're still, TSA checkpoints, people going through TSA checkpoints still isn't back to pre-pend them in levels. but it's getting there pretty fast.

I think seated diners, you know, we get the data from open table, and that measures the number of people are making reservations to go to restaurants. That's come back quite a bit in the last, well, a couple, three months as we've reopened, and I think that's adding to it. In our own business confidence index, we have a survey that we conduct every week. that's been slowly but steadily improving. And it's now at a place that's consistent with an economy that's a global economy that's expanding. I think that's also been a contributor to getting back to normal. So that's all good. You know, this is an easy one. I'm sure you're

going to get it right away, but I'm just going to say, because this is an important one, 2.35%. Inflation expectations. Yeah, exactly. 2.35. percent. That's the, that's our inflation expectations pulse index, which is a combination of a bunch of different measures of inflation expectations. And that's for the consumer expenditure deflator. And at 2.35% that's just, you know, that's above the Fed's target of 2% long run through the cycle target of 2%. And that's probably about where they would want to see it peak out. I don't think they'd want to see that go much higher than that. But it feels like it's starting to peek out.

If you look, peak, it feels like it's kind of rolling over here a little bit as survey-based expectations start to come in a little bit with more stable oil prices. So that's good news. Michigan was down too, right? What's that? Inflation expectations from the year of Michigan survey. I believe those were lower as well.

Yeah, that's right. That survey came out today, I think, didn't it? yesterday. Yeah, today this morning. Yeah. Hey, while we're on inflation, Ryan, this is something you were going to investigate. I'm not sure if you've gotten around to it. And it's relevant to today's PCE deflator data, which came out.

You know, that's the measure of inflation. The Fed uses to peg monetary policy. Did you notice that PCE deflator inflation is now above on a year-over-year basis? CPI inflation? And that's incredibly unusual. It's happened in times past, but very rarely. Do you have a sense as to, you said you were going to look into that? And I just wondered if you had a chance to look into that, why that's going on.

So we haven't banked all the data yet from this morning's release, all the really granular data. So I will have it for you next week. I'm going to write it up on the site. And then we can talk about it next week. Yeah. I'm just, I was just pretty big difference, actually. So it's a little surprising. So that would be good.

Before we move on to markets and the big topic, we have the statistics that we've been calling out on a regular basis. And Chris, yours is the unemployment insurance numbers. So what do they say last week? Yeah, claims for last week came in at $411,000. The week before was revised up to $418,000. So looking at those two weeks, it's an important. improvement, dramatic improvement. And certainly there is some statistical noise in here just based on the revisions itself.

So it's good, but I wouldn't get overly excited about it. It's not really showing dramatic improvement or deterioration at this point. So I still think we'll continue to move in this positive direction, but things won't really accelerate until later as we get to August, September, schools up and up. UI benefits expire. We'll get a ramp up in activity then. Claims were still down

between the reference weeks. So the BLS Employment Report, that's the week that includes the 12th. They're still down. So job growth should be stronger for June than it was in May. What was it in May? It was like six, seven,

I can't remember, six, seven hundred hundred five. Five, 59? Right around there. So you think, it's going to come in stronger. than that, do you think, based on the claims data. Right. And a few other mobility data, home-based data, all kind of points to an acceleration in job growth.

And then there's a number. What's your number? I have 750, $750,000. That's a good number. Okay. That's pretty healthy. That's a total. Yeah, total.

Yeah, of course you'll refine that as we get closer and we get more. Well, is it coming out next? Is it going to come out next Friday? Yeah, next Friday. Oh, yeah. Right. Okay. Yeah,

so I'll fine tune it once we get ADP. We get one of the ISM surveys. So I'll let you know if it changes. Right. And just to remind everyone, a UI claims that is consistent with a great economy, a good economy is? 250,000. Yeah, okay.

250,000. So we're still not quite there yet. Are we, is it useful to watch UI claims for, for some of these southern states that have ended the, supplemental UI. Do you think that's going to affect the number of people who are filing for claims? I certainly should. I haven't looked at that. I don't know, Ryan, if you may have, but yeah, we should certainly start following that. Yeah. Yeah. But I also think it will affect the number of people that are receiving pandemic unemployment insurance benefits. Maybe more people drop off continuing claims

faster. But that's something that we should definitely be keeping close. Tracking. Yeah. Yeah, let's watch. Go ahead. No, I was just going to say a couple weeks from now when we reconvene, let's talk. Maybe you can take a look at that. So we can be very curious what's going on there. Based on Google trends that you can look for a job search intensity by states using a few keywords. Yeah.

In the states that ended it, you see a little bit of an improvement compared to states that are still paying the expanded UI benefits, but not this huge, you know, gap that which suggests that UI was a huge issue. That is interesting. Can you send that data to me? Yeah. Can you send that? Yeah. Yeah, that's kind of interesting.

So what do you do? Index it to 100 at some point in time and to see how it moves. So the states where you've ended it and states where you haven't ended the supplemental UI? I could do it that way. The way I always do it is just taking a simple average. across the states that had ended it, and then the states that had not ended UI benefits, looking at them and smoothing it, you know, to take out some of the volatility.

Yeah, yeah. Let's take a look at that. That's interesting, very interesting. And Ryan, your statistic, I always forget it. What was it? It's the 10-year Treasury. Oh, the 10-year. Well, how can I forget that?

I mean, why didn't you hold on to that? Because we're going to come back to markets in a second. And we might as well just start with that because that is kind of the rosetta stone for understanding to a large degree what's going on in markets, I think. And my statistic was copper prices, is copper prices. And I just looked before we started the podcast, $4.30, maybe a little shy of that per pound. And that's up a little bit from last week, but still below the peak, which we achieved back in early May, $4.70. And just for context, if you're over $4 a pound, that's consistent with an economy that's a global economy that's doing well. And there are significant inflationary pressures.

Anything around three, that's kind of typical. Anything below two that's consistent with the economy that's really struggling. So we're still seeing a lot of inflationary pressures out there related to the restarting of the economy, the global economy, economy from the pandemic. So keep watching that one. Okay, so anything else on the statistics that you want to bring up before we move on to the big topic and markets? Just anything out there, you want to call out? I was a little surprised that you picked inflation expectations. As my indicator?

Yeah, I thought you were going to go of minus 20%. Ah. Minus 20%. That statistic really did stand out this week. I think it was last five. I had not one, but two clients. bring up minus 20% to me this week. What are you guys talking about?

Chris? Oh, look at him. Look at him. Oh, I see. Oh, I don't know. Are we, hold on. Wait, second. Are we talking about my interview that was on CNBC regarding the possibility of a correction,

a stock market correction? Is that what you're talking about? I believe the headline was Zandi says, beginning of a correction is underway. See, that's just, that's just rolling. He was in there. It was pretty certain. You know, there's this old, I guess adage is the right word, but sound piece of advice, never forecast something in the date at the same time.

And I did not do that. I did not violate that principle, but I guess they took license. And I said, I don't know when the correction is going to occur, tomorrow, or whether it's already started next week, next quarter, but this market is getting highly valued and is very vulnerable to a significant correction. And we will come back to that because, you know, as the market keeps going higher, the more I believe that, the more, the stronger my confidence in that perspective. But thank you for calling that out. That was very kind of you. I really appreciate that. Anytime. When did that interview occur? Was it after you left the Sixers game? Oh,

Oh, wait. That could have fed into your pessimism. Was that last Friday? When was the Sixers game? I can't remember. You were there. It might have been. It might have been last Friday.

Yeah. I think it was last Friday. Yeah, yeah. That was game seven. That was a bad day, actually. Sixers lost game seven to, who did they lose to? Oh, Atlanta. Yeah.

But, yeah, my son and I went. We had great seats. We had very good seats. Yeah. But we had a lot of fun. fun. And I hadn't been to a ball game in, I don't know, at least a year and a half, a long time. So it really felt good to be with lots of people screaming and yelling and having a lot of fun. But disappointing ending. I know you weren't upset by that, though, right?

No, as a Celtics fan, I was very happy with the result. Really? I mean, I kind of, that's weird because I kind of root for Boston when the, when the Sixers because we're our rivals and I always like to see but you have a very different attitude it's kind of anyone who's not Boston you have a problem with no no anyone I root for anyone that plays the Yankees uh no I don't I'm not anti-phaladelphia sports I think Boston and Philadelphia fans just don't see eye to eye on things that's true I'm that's definitely true I rooted for the Phillies when they're in the world series if the Sixers made it to the championship i would root for them to win yeah well you know as chris doesn't even enter into

this conversation because all he cares about is that bocce ball thing you know i got the euros going on oh that's true they are i haven't watched any i know ben's a big fan of that ben ben's our sound guy yeah but uh chris are you a mLS fan no not really never really got into it yeah still time though my son is young he'll play okay let's talk about the markets and let's go right to the bond market so you know the the the the kind of the frame here is markets are hot when i say markets i mean asset markets and asset markets that includes the bond market we'll start there the stock market real estate markets both housing and commercial real estate commodity markets crypto market you know anything you can anything that you can turn into cold hard cash, we'll call an asset in an asset market.

You can use it to pay down any debt. That's an asset. So let's start with the bond market and the kind of the benchmark, and that's the 10-year treasury bond, the treasury yield. And that's still sitting at one point, well, I don't know. Is it 1.5 percent? I think it is, right? It's been up and down a little bit, but I think we're still.

Yeah, so it's up for basis points to 1.53%. Right. 1.5.3%. Okay. So, you know, we've been down this path a few times in this podcast. Any thoughts on to what's going on there and, you know, why we're kind of, how long we've been at 1.5 now or roughly 1.5? It's been at least several months. It's like all year, right?

Yeah. Is it pretty much all year? Yeah. Yeah, since the beginning of a very tight range. the tenure has been treating him. You know, this is, when I talk about this, this is how I talk about. I'm curious what you guys think about this frame. So I say to understand where interest rates are headed, take the 10-year treasury yield,

decompose it into inflation expectations, and then the real yield. The real yield is simply 10-year treasury yields, the nominal tenure-t treasury yield, less inflation expectations. And inflation expectations, well, as we discussed earlier, they've normalized, they've risen. Based on CPI inflation expectations, we're now sitting somewhere just south of 2.5%, which is kind of at the high end of the range that the Fed would probably feel comfortable with, consistent with that PCE inflation expectations numbers of 2.35% we were just talking about. So that seems like that is roughly where you'd expect it.

I probably wouldn't argue that that would go much higher. If it did, then something's going off the rails. But that leaves the real yield, the nominal at 1.5 inflation expectations at 2.5. That means the real yield is like negative 1%. And that doesn't seem to make any sense in the context of the economy that we're seeing, this very strong growth with lots of jobs, unemployment coming in. in everyone's general view that we're going back to full employment soon by the end of 2022, certainly no later than the start of 2023.

So you would expect real yields to go from being really negative to less negative and then ultimately positive. I mean, you would think in a well-functioning economy, they should be somewhere around one to one-and-a-half percent because one-to-one-half percent plus two, two-and-half that gets you kind of in the long one where you expect a nominal 10-year treasure yields to be, somewhere around 3.5 to 4%. Does that kind of way of thinking about it makes sense to you? Is that how you think about it or are you thinking about it in a different way? I agree, Chris, that your framework makes a lot of sense. The one thing I add is when I look at

the tenure, the term premium. So the extra compensation that investors need to hold long-term rates versus short term. And that is one reason that, you know, real rates are still, you know, firmly negative. So the term premiums negative because of QE and things like that. Yeah, but Ryan, you can, as you're suggesting, you can decompose that real yield that minus one percent. Oh yeah, right. Into the into the term, into real short term interest rate expectations, plus, which I think is, Or at least I thought it will, my, my thought is that that's the market's thinking around monetary policy and the direction. That's correct.

And then the term premium, the term premium is the compensation investors get for investing in a long-term bond compared to a short-term bond because presumably there's, you know, more uncertainty, more risk, and therefore you should get some compensation for that. And if you look at that, the term premium has actually gone from BORN, being very negative back in the teeth of the pandemic to close to zero. So that's actually improved. But the real short-term interest rate has continued to decline and become even more negative. That's what I can't get my mind around.

You know, why would that be the case? I mean, what's going on that would cause that? That's just, because of anything, you know, the Fed, everyone seems, the Fed seems to be moving towards increasing short-term rates sooner than they had previously said and, you know, what they're thinking. So why is that, why is it, do you have any sense of why that's happening? Why are real short-term interest rates declining like that? Why they've gotten even more negative? No, I mean, it's, it's puzzling to me as well. Yeah, it's puzzling. Yeah. Chris, we got you back. Yeah, can you hear me now?

Yeah, yeah, you're sounding great. Yeah. Yeah, you're sounding very good. So we were just talking about, I think this is where you went, you know, trying to understand why real yields are as low as they are. But I'll just throw it back at you. Is there anything about the frame that you want to call out or you think is missing? How are you thinking about this? Yeah, I think you're right. It's a bit of a puzzle.

I think the frame is a good one. One question I have more than an answer is whether we should actually be thinking. about the Treasury market on a global scale, right? Is it given the dominance of the dollar and global investors needing to allocate capital to the U.S. as well, should we be thinking, should we be using a global inflation expectation or a global type of framework? So same framework, but maybe the parameters are not U.S.centric. Perhaps it's a broader picture. Yeah, yeah, maybe that makes it make more sense. So then you're saying, so inflation expectations globally comes to question

to how you would measure that. Yeah, yeah. Abstracting from that for a second, they have not moved up nearly as much as U.S. inflation expectations. Therefore, real yields haven't fallen as much as we think they have, at least when we use U.S. inflation expectations. That's right. That's one way to square the circle.

Right. You're kind of saying, it sounds like you're saying that that's a theory. I'm not sure I believe it, but maybe. Yeah. I do believe that foreign investors certainly do have a significant impact, right? And it's not only the absolute, but the relative options that are available for capital allocation that matter, right? And you've made this point before about the, the German investor, right? What are my preference? What are my options here between a German bund or a, a U.S. Treasury, right? Even with that negative return, it might be a less negative return in the U.S. than my other best option. So you still have that demand coming in. Yeah.

Chris, one thing, or excuse me, Ryan, one thing you mentioned last week or the week before when we were talking about this, just because it's such a puzzle, we keep coming back to it. It's kind of a mind-numbing kind of discussion. And it has so many implications. for everything. And we'll get to the asset prices in just a second. By the way, this is an asset price,

right? This is the price of a bond, right? So we are already talking about asset prices, and they're high. When bond prices are high, interest rates are low. So we're talking about an asset market where prices are high, very high, record high, right? I mean, because interest rates are not a record lows at the moment, but they're pretty damn close to record lows. Ryan, you mentioned the coming at the fact that the that issuance is way down, Treasury issuance is way down. We have these large budget deficits. The Treasury has been issuing a lot of debt, but that that issuance is down.

And that's because they've been drawing down an account at the Treasury's been drawing down one of its accounts at the Fed. and using that to finance activities as opposed to issuing more debt or bonds. So did I get that right? Did I explain that? Yeah, you got to look at Treasury issuance. I think it's coming in weaker than what people are expecting, and that's having implications for the tenure.

But again, it's back to your point that the Treasury is drawing down this account. So do you think that could be playing a role here as well? I do. Right. Because if there's less issuance, you know, that means less supply so prices don't know when supply goes down prices are going to go up and put down with pressure on interest rates right okay all right and when we decompose the real yield into real short-term interest rates and the term premium what's the residual there what's the is it is it

the term premium that we back out it's the we calculate the term premium we calculate the term premium right and then what it's the real short-term interest rate that's the residual that Correct. That's the difference between all the stuff we know and what's left over. Okay. Right. And I tried it both ways when we did it. And then we settled on using the methodology from the Federal Reserve on estimating

the term premium. And it seemed like the residual for the expected path of the real Fed funds rate made much more sense under that, using that as a residual than trying to estimate it. Okay. I know we're getting really into the weeds and some of the, we've probably lost some of the listeners. so we'll move on, but that's an interesting point. Okay, so when I think about asset prices more broadly, do you hear that echo now?

No? There are technical issues going on. I'll keep going and hopefully it goes away. Interest rates are a key factor driving the prices for all assets, right? because kind of the way I think about asset prices, the value in asset is equal to the stream of returns on that asset. You know, if it's a stock, it's corporate earnings, if it's a home, it's rent payments. If it's commercial real estate, it's rent payments. It's that future stream of returns on a present value basis.

So what's that stream of future returns equal to today? And, of course, that present value, what's worth today is dependent on the interest rate. So if the interest rate is, if the general interest rate is lower, that in all else being equal, that drives up the price of all assets. The value of corporate earnings in the future are worth a lot more if interest rates are very low. the value of that a future stream of rents is worth a lot more if interest rates are low. So if you have low interest rates, that causes prices to move higher across the board. And in the case of the housing market, as we discussed, you know, if interest rates are very, very low, that also juices up demand for, in the case, housing.

and that bumps up against fixed supply or relatively fixed supply and you get this significant increase in prices. So there's lots of different ways low interest rates help to support asset prices. And to some degree, and Ryan, maybe you can explain this. That's by kind of by design, right? I mean, that's one reason why the Fed lowers interest rates in a tough time. It's an effort to get asset prices higher. Is that correct? Yeah, that's one of the monetary policy transmission mechanisms. So how the Fed can try to either speed up the economy or slow it down is through asset prices. And their primary lever to affect asset prices used to be.

And it still is the Fed fund rate. But now they have quantitative easing or the purchase of mortgage back securities, long-term treasury bonds. And that can influence the price of assets. Right. And it also generates a whole kind of whole range of debate and controversy around who benefits from monetary policy, right? I mean, because high income, high net worth households own all the assets. Then when the Fed lowers interest rates, they, and it juices up asset prices, they benefit high income, high net worth households benefit, low income households that don't own a home or certainly don't on any stock. They don't benefit. They don't benefit. from it. But that's a tough one, right? Because it's not like anyone's getting hurt, you know, directly from the lower interest rates. It's just that the people are benefiting or people are already in a pretty good spot financially. But at the end of the day, that's kind of sort of needs to happen to help, at least partially to help support the economy and get it back up and running so that

everyone can get back to work and even lower middle income households can benefit. But it's a pretty tough one. Yeah, I mean, the Fed funds are it's a blunt tool and they try not to use it to, you know, prick asset bubbles. And I know with all the attention on the income and wealth inequality, in the U.S. they're, you know, the Fed's paying, you know, trying to address that, but they can't use the Fed Funds rate. I mean, the best way for them to address the income or wealth disparity is to run the economy hot and get unemployment rates across all demographic cohorts as as low as possible. Yeah, right.

So let's get down to brass tax. And stock prices, they seem to be hitting record highs every single day. I mean, we're sitting here on a Friday. I don't looked in the last, you know, 40 minutes, but it looks like we're going to hit another record high on the S&P 500. Does that make sense to you? What do you think about that? Chris, are you a buyer of stocks?

I mean, I've never, I mean, I've probably done for a question. I probably shouldn't ask. You can answer it any way you want, but would you buy, would you buy stocks at this price? What are you doing right now? Are you, are you a buyer, a seller? Are you holding? How do you think about this? Okay.

So we had the episode where we disclosed our politics and now this is the episode where we discused. But, you know, I'm not. By the time this podcast is over, you know, five years from now, there'll be nothing left about us. Yeah, that's right. That's right. So I'm not, I'm not, I'm not.

particularly a stock invest, right? I became an economist, right? Because I'm not preferably adept at managing portfolios or picking stocks. So my approach has always been, certainly based on my current stage of life, just to continue investing a fixed amount every month through thick and thin, don't really pay attention on autopilot. So, yes, I am a buyer in that sense today, but I was buyer through the pandemic as well. But I'm not reallocate. I'm not putting every, you know, I'm not seeing opportunity and say, oh, really, I should sell or go into debt to go into the stock market at this point.

It's just there is some uncertainty around that. I agree with you that stocks certainly do seem richly valued. But, you know, I would, I said the same thing when the Dow was at 30,000 or 25th, or even 20,000, right? So for that reason, I kind of take this more disciplined approach because I can't trust myself to make the right decisions at the right time. Well, let me ask it this way. If you were an investment manager, I suppose you decide, okay, I'm not going to be an

economist, going to be an investment manager. And I'm thinking broadly about the stock market. And I'm a manager. I can put my money anywhere on the planet in anything I can invest in anything. Would you be investing in stocks? I mean, let me put it this way. I also added one more piece of information because I think it's important. And your horizon, your investment horizon is over the next, let's say, next year or two.

Not next 10 years, not next month, but something kind of a year or two down the road. Yeah, that makes all the difference. Your bonus is going to be judged on how well you do here in terms of your investment decision. Yeah, even there, I would say it's a, I would take a balanced approach. I wouldn't say, I wouldn't put zero on stocks. If you give me the option to be more selective, right? I would tend to be more contrarian, might look at sectors that are underperforming, an expectation that will have some mean reversion.

But I certainly wouldn't be all in. I would look for a more balanced approach. And I would have some money and bonds, right? Internationally, I would still look to diversify. So the way I would characterize what you just said is, correct me if I'm wrong, But if on average through time 60% of my portfolio would be in stocks, at this point in time, it might be 40% or 50%. Yeah. Something like that.

That's fair. That's fair. Yeah. That's how you kind of do it. Okay. And if you were on CNBC and they were asking you about the stock market and a possibility of a correction, how would you have answered that question? Well, a correction is always a possibility, but historically, right, stock values tend to go up. I don't expect a, I don't see an immediate trigger for a crash, but it's very hard to determine what a

Well, no, no, no, that's crash is a strong word. Well, 20%. No, I didn't say 20. The correction is 10. I did not say 20%. I said 10 to 20%. And they actually asked me, if they said, no, wait. I said it would not be over, certainly not over 20, because.

that would signal probably a recession. And no one, I'm not thinking that. I'm not thinking it's an overvalued market, not a, not a signal of some kind of, of some kind of a problem in the economy. Yeah. Okay. So, okay. All right. What about you, Ryan, that given that conversation, how, how do you, how would, are you investing in stocks? And if you don't want to answer that question, if you were a hypothetical investment manager, would you be an investing in stock? Or would you take the same path, the same milk toast kind of, you know. No, no, I'm similar to Chris, the way in my thinking. Oh, I knew it.

Because, I mean, yeah, remember, I got three little kids. I'm worried about college 15 years from now. So I got, I got time to write it out. That makes perfect sense. That makes perfect sense. No, you're right. What about you, Mark? So I'm older than you guys, right?

And I think I know something, which is always dangerous. I have reduced my exposure to the equity market. And in part, in large part, because I think it is overvalued. I think it is frothy. I mean, just think about, meme stocks, you know, game, game stop. You know, meme stocks are a bunch of guys or girls or get on social media. It's like a flash mob for stocks.

They decide collectively, I'm going to buy this stock and drive up the price. And by the way, I could care less if it's a company that's doing well or not or anything. In fact, I might even go for stocks that aren't doing well because they're being shorted by institutional investors. This is the GameStop kerfuffle. And I don't like institutional investors. I'm an individual investor and I'm collectively going to make life difficult for these, you know, these fat cats, you know, that are out there investing as institutional investors. And they're driving up, you know, stocks of, you know, AMC and, you know, all kinds of companies that, you know, really, that doesn't feel like a healthy market to me. That feels like a market that,

is infected to some degree by fraud. Or, it's a dot-com bubble, right? The SPACs, the SPACs are these, these vehicles that are essentially set up so that you can go out and acquire companies, you know, that kind of thing. Or the Archiegos, I'm not going to go into any detail here, but, you know, the Archiegos scandal. These are symptomatic of a market that isn't. functioning, you know, tip-top, a healthy, healthy market. And it's not just stocks, you know, it's pretty much across the board. You know, we talked about housing numerous times now, and there's

signs of, you know, of things getting overdone there. We've talked about crypto. We've talked about, you know, the credit, we just were talking about credit spreads in the bond market. You know, pick your asset, you know, so it just feels. like markets are frothy. Now, that doesn't mean they can't go higher. In fact, odds are pretty high. They're going to go higher because when you're in that kind of frothy market, that means that sentiment is taken over and sentiment can run for a while, either on the upside or the downside. Right now, we're on the upside and that can carry markets a lot higher. And that's why I said, I kind of said earlier, and I'll repeat it, you know, every day the market goes up from here,

the more confident I get in my statement that there's going to be a correction. Because the further it's getting away from kind of the underlying fundamentals, the present value of future corporate earnings. We're moving away from that. So it becomes more vulnerable. And you ask, well, what's the catalyst for that change? I'll tell you what the catalyst, rising interest rates. Interest rates are going to rise. They're just going to rise, you know, one way or the other, because this economy is strong and it's going back to full employment.

Inflation is already at the top end of the target for the Fed. they're going to rise. And by the way, if long-term interest rates don't rise, that means short-term interest rates got to rise a lot more, right? I mean, ergo, right? Because the economy is hot and growing very strongly. And long-term rates are depressed because of foreign buying because things are bad overseas. Well, well, what's going to cause the economy to slow down? I mean, what are we, you know, what's the mechanism for that to happen? the answer is the Fed's got to put his foot on the break a lot sooner and faster and press a lot hard.

Short-term injury is going to rise. And that's even a worse scenario than if long rates kind of drifted higher in a normal, typical way. And by the way, that's the fodder for an overheating economy and a recession, right? That's get inverted yield curves. And I'm sure we're going to be talking about that at some point in the future, no, the not too distant future. So I will.

Right. Yeah. So you get my point. You get my point. So you're asking me, I have reduced my exposure to the equity market. And you say, well, I'll stop there. I've been ranting. I could go on.

We're giving you a hard time. We're giving you a hard time about your CNBC interview, but I think you're going to be right. Not 20. I think that was, it went a little too far out of the line there. I didn't say 20. I started. Let's talk about the crypto king. I want to go back to the crypto king.

We're going to get a 10% correction. Do you still think they're going to raise the capital gains tax next year? Yeah. I think that's in our baseline. Yeah. I mean, you know, that's a, that's a close one. But I, yeah, we, they need to raise some tax revenue if they're going to get that. There's the Biden social programs through.

I mean, they got the infrastructure package. They paid nominally paid for that. You saw that this week. But that's, they're using everything in the kitchen sink to do that, right? I mean, I mean, they're piecing that the revenues of that together without any taxes, which is, you know, they're using everything they got for that one. So if they want to get, if they want to pay for any of the. social program that they're going to put forward, they need some kind of tax increase.

And it's got to come from corporations and that's got to come from high income households. And that's got to be capital gains. Yeah. Or if we get that. If we get that, that's going to trigger a correction in the fourth quarter. If not that, you have a debt ceiling fight that's coming up. That's going to be nasty. And you also have the Fed that's going to announce their tapering plans.

So all that stuff kind of argues for a quick 10%. 5, 10% decline in the stock market. So what's the alternative? Oh, okay. See that? So Ryan, I'm at 10 to 20. And let's say before the end of the year, because again, I can't, I don't know if it's next week, next month, next quarter, but by the end of the year. Because by the end of the year, I think that's when it's going to become clear interest rates are headed higher.

So by the end of the year, I would say, and this is what I said on CNBC, 10 to 20% decline. And Ryan is now saying, I'm not putting a word of your. mouth, you're saying 5 to 10? 10 to 12. Oh, 10 to 12. Okay. 10 to 12. Okay. 10 to 12. And then Chris is saying, Chris is saying, what are you saying, Chris? I would say five to 10. You would. Down? Down. Yeah. Oh, okay. Okay. All right. Very good. If we're getting a tax hike, right, then certainly it's going to have, it has to have some effect, right? Well, yeah. Yeah, I mean, you're taxing some probability to a tax on. I mean, we don't know for sure, but some probability.

Yeah. So you're saying there's a better than even odds that, so this is what we're saying. I'm saying there's better than even odds by the before the end of the year. We get a 10 to 20% correction in the S&P 500. Ryan is saying 10 to 12.15678%. And Chris is saying, 5 to 10. you're taking the under okay which means stocks will be up 15 to 20 percent since we're all going no I know I know but that that that just means that there's a higher probability that in the next six

months it's going to fall and it's going to fall even more yep don't fall even more kind of like the housing market okay so let's uh reallocated to that market see that wasn't that was the question you needed to ask and I was going to go there but I was ranting I felt like I was going on too long Doge coin? Huh? Was that Crypto King? What's that new thing? Like the dog coin, whatever that?

Do you heard about this? I think it's, yeah, it's Doge. Yeah. Doggy coin. Yeah. So where do I put the money? I put it into two places. One is just straight up cash.

Some, you know, my cash position continues to rise. I'm not definitely not putting it into bonds. You know, we're just giving the discussion. We just, we just, just gives them with my rant. and in rental real estate into, you know, investing in investment in single family properties in urban centers, you know, properties that have been vacant for, you know, probably since soon after World War II in Philadelphia,

renovating those properties and then renting those properties. Because, you know, this goes to all our discussions about the rental market in the housing market, how undersupplied it is, and how the housing stock is, we need more housing stock. And so, you know, consistent with that perspective and that view. So that's what I've been doing.

Yeah. Now, one thing that, you know, the listener may be wondering about, he goes, well, why are you guys talking about asset prices anyway? You know, you're not investment managers. So why do you have a view on this? I've got my opinion.

Do you guys have a view on this? why we're talking about this? Why are we focused on asset prices? I mean, why do we care about asset prices? Certainly. Didn't we learn? Yeah, go ahead, Chris. I was going to say, it does affect the real economy, right? The households, certainly high net worth households in particular have a lot of exposure. And if their NASDAGs are hit, they're spending and investing behavior is going to change. So it's certainly is important. And don't you think the great recession in the financial crisis taught us that, you know, our standard macro models pre-crisis didn't really do a good job of incorporating financial

market conditions and inter, and its interaction with the real economy. Yeah. So I think we pay a lot more attention now than we did in 2005, 2006. Yeah, exactly. And, of course, you know, the Federal Reserve has asset prices in its reaction function, right? They, you want to say reaction function, these are the variables they look at when trying to decide monetary policy. Number one, you know, the job market, are we back to full employment? Number two, inflation, inflation expectations. Number three, what they call financial conditions. And that's a

euphemism for asset prices, you know, what's going on in asset markets. Just to round it out, they also talk about global conditions as well. So asset prices matter to the setting of monetary policy determines the wealth of the, of consumers, and therefore their willingness and ability to out and spend, it affects the financial system and financial institutions because they invest in bonds and stocks and everything else. And depending on what those prices are, that determines, you know, their financial condition and their ability to extend out credit. And so we spent a lot time actually modeling it. Now, we generally, I generally do not talk about asset prices, except when I feel like they're out, you know, they're not consistent with kind of underlying

fundamentals and therefore pose a risk, you know, to the economy. Right now, prices are high relative to the fundamentals and therefore there's a risk that we get a correction and that could change the contours of our forecast. Then there are times, you know, when asset prices are low, you know, relative to fundamentals. And I talk about that. I'll talk about asset prices then because they, that means that prices will rise more quickly and that could help be a positive support to economic growth. So I, you know, generally my philosophy is not to talk as an economist about asset prices, stock values, bond values, real estate values, unless they're out of whack, you know, unless they're not consistent with underlying fundamentals. And they're not. And in our

modeling, that's exactly how we model it, right? So we have, here's what the price of this asset should be, stocks, bonds, real estate, given fundamentals, given corporate earnings, given rents, given and the stream of future returns and interest rate expectations. And here's the actual price relative to the fundamentals. And our models will take the actual price back to those fundamental values to so-called equilibrium over some period of time. And that's built into our forecast as well. So it's a very important element of our modeling and of our economic forecasting. So if we did, oh, sorry, last question.

No, go ahead. So if we did get a 20% correction, are you anticipating that we would be in recession as a result? No, you know, obviously 10, 20%, I picked those for a reason because it's kind of a rule of thumb. 10% is typically thought of as a garden variety correction in the stock market. We've had many of those, and they don't necessarily mean anything for the economy, right? It's just a correction. Markets have gone high very fast and they're just coming back in. 20% that's consistent with a so-called bare market.

You know, although we've had a number of times recently where we've gone down 20 and we come right back. So it doesn't feel much like a bare market per se. But anything more than 20, though, that to me is the market is signaling that something is wrong with the fundamentals. You know, the economy is weakening. It's going to go into recession. Corporate earnings are going to suffer. The economy is weakening. It's going into recession. That's going to hurt, you know, rents and CRA commercial real estate values or housing values. So if it's over 20, you know, that would be more consistent with the idea that the market is signaling, you know, a problem dead ahead, you know, for the economy. And I just don't, I, it's that, that seems like a stretch to me, you know, at this point, given all the things that are going on in the economy. So I don't, I don't expect that. I don't expect that. All right.

We've been going, I mean, we're already, you know, probably at time here. We've gone for about an hour. Anything else on markets you want to, but we didn't really talk about crypto. I mean, that's, that's obviously symptomatic of the froth, the speculation. We're going to have our, I think we should have one podcast just devoted to crypto. So we'll come back to that. I mean, we want to do one on the corporate bond market. Because if you look at high yield bond issuance and credit spreads, they're very, very tight.

And issuance is strong. And in the last 10 days, leverage loan issuance has really, really picked up. Is that right? And the catalyst was the hawkish shift in the Fed's dot plots. So a lot of the new issuance is repriced or a lot of the issuance is repricings, basically refinancings, in expecting and expectations of higher rates coming sooner. Oh, interesting. So yeah, let's do that as well.

We'll have a podcast on the corporate, what's going on in the corporate bond market as well. Anything else on markets? What's that? Commercial real estate is an interesting one, right? Because they're even flat is up at the moment. Yeah, I mean, I've been pretty wrong about that, right? I mean, back in the start of the pandemic,

we thought commercial estate values would weaken, and they, I don't think they have to any appreciable to a degree. It depends on the property stuff. I guess hotels, maybe hotel prices, but not broadly. they've held up very much. Another sign of the strength. What's that, Chris? There weren't a lot of transactions during the pandemic either because of all the support.

So the shadow prices might have gone down, but nobody actually had to transfer. A few people had to actually transact those levels. Right. Yeah, you know, this, you make fun of me, but go ahead, make fun, make fun of me. But this reminds me, I've been through a number of cycles now. asset price cycles. You know, there was the Y2K bubble in the equity market in the late 90s around 2000. And then there was obviously the housing bubble.

That was kind of the mid-2000s. And, you know, those, those, I remember coming out and saying these markets are overvalued. They're ready for a correction. And I started saying that maybe two to three years before they actually seem corrected in a significant way. because what happens, that's the definition of a bubble, right? I mean, when people kind of just let loose and keep on buying regardless of whether it's close to fundamentals. And then you hear arguments as to, you know, why try and true measures of valuations don't work anymore,

why this market is different, why these companies that were, that the stock prices up for are different than the companies that, you know, for back in the Y2K bubble, you know, all these kinds of, you know, rationalizations for why, you know, no other way to put it, this time is different. And so this can go on for a while. And that could be wrong for a good long while. But at the end of the day, at this point, if markets don't correct between now and the end of the year and they keep on rising, I assure you we're going to be back here and I'm going to be screaming even more loudly that it's, that we're going to see a major correct. that the market's even more vulnerable and more likely to suffer that correction and suffer bigger declines. Okay. With that, we're going to call it a podcast. And as I said, we're going to take next week off, but we'll be back in a couple of weeks. And we'll have a lot to talk about then. So thank you very much. Talk to you soon.