Jim Bianco: Inflation is Dead – Long Live Inflation! How YOU Can Profit NOW
In this episode, we have the pleasure of hosting James A. Bianco, Founder of Bianco Research Advisors. Bianco shares his insights on a wide range of topics, from his macroeconomic framework to the impact of inflation on the global economy. This conversation also delves into the implications of the current political and military climate outside the U.S. and the workings of the Bianco Total Return Index.
- A brief introduction to James A. Bianco’s career trajectory and the establishment of Bianco Research Advisors
- Understanding Bianco’s macroeconomic framework, including his approach to analyzing the macro space and the key indicators he focuses on
- An in-depth discussion on inflation, its current state, and its potential implications on the global economy
- Exploring the role of the Federal Reserve in managing inflation expectations and the potential risks associated with their strategies
- A look at the current political and military landscape outside the U.S., and its potential impact on the global economy
- Discussion on the potential impact of shipping disruptions in the Red Sea on the global supply chain and inflation
- Insights into the bond market, including the potential impact of higher interest rates on the equity market
- An exploration of the Treasury Borrowing Advisory Committee’s role in advising the Treasury on bond and note issuance
- A discussion on the potential signals for a hard economic landing or recession, and what could indicate a stronger economy than anticipated
- An introduction to the Bianco Total Return Index and a discussion on the future of actively managed ETFs in the equity market
This episode is a must-listen for anyone interested in macroeconomics, inflation, and the global economy. Bianco’s insights provide a comprehensive understanding of the current economic landscape and offer valuable strategies for navigating potential future scenarios.
This is “ReSolve Riffs” – published on YouTube every Friday afternoon to debate the most relevant investment topics of the day, hosted by Adam Butler, Mike Philbrick and Rodrigo Gordillo of ReSolve Global* and Richard Laterman of ReSolve Asset Management.
James Bianco, a seasoned Wall Street professional and founder of Bianco Research Advisors, offers a distinct perspective on the macroeconomic landscape, with a focus on the role of the Federal Reserve, inflation, Treasury bonds, and the growing popularity of actively managed stock picking ETFs. Bianco contends that the Federal Reserve’s ability to manage inflation expectations through compelling rhetoric is a key determinant in the stability of the economy. However, he asserts that these expectations, often shaped by immediate experiences such as pandemic-related price hikes, may be more unanchored than realized by the Fed, thus complicating the management of inflation. Understanding the role of Treasury bonds and the Committee that advises on their issuance is another crucial element in understanding the broader fiscal landscape. Bianco criticizes the Treasury Borrowing Auction Committee for primarily serving the interests of bankers and hedge funds rather than taxpayers, though he does acknowledge that some Treasury Department staff members are aware of this bias. Bianco also draws attention to the impact of supply chain disruptions, especially in shipping, on inflation and subsequently, the stock market. These disruptions, he believes, could result in a continuous inflation rate of 3 to 4 percent, challenging Wall Street’s belief that inflation is under control. In terms of investment, Bianco predicts a growth in popularity of actively managed stock picking ETFs as investors seek to capitalize on the right themes. He suggests that higher interest rates may pose a challenge to index funds, but investors who can discern the right themes and trends will still thrive. This is especially important given the competitive environment between stocks and rising interest rates, and the potential impact of the latter on both stocks and bonds. Considering the potential for an economic downturn, Bianco believes that the yield curve, specifically the three-month to ten-year curve, can serve as a reliable indicator of a forthcoming recession. Despite aggressive rate cutting by the Federal Reserve, the yield curve has remained inverted for over a year, signalling the possibility of an economic downturn. In conclusion, the current economic landscape with unanchored inflation expectations, potential supply chain disruptions, and higher interest rates calls for a shift away from traditional investment strategies. Investors must focus on actively managed stock picking ETFs, seeking to align with emerging trends and making informed decisions based on understanding key macroeconomic indicators. Bianco’s insights underline the importance of a broad, yet focused macro lens in navigating complex financial environments and making wise investment decisions.
1. James Bianco’s macro lens and insights
James Bianco is the guest, and is introduced as the founder of Bianco Research Advisors. He has a background in Wall Street and has experience in the 1987 crash. He currently runs a research business and an advisory business. James Bianco’s macro lens starts with a broad perspective and then narrows down. He believes that the Federal Reserve’s ability to manage things is crucial, and their rhetoric plays a significant role in managing inflation expectations. He also mentions the importance of the Treasury Borrowing Auction Committee (TBAC) in advising the Treasury on bond issuance. He argues that the committee, consisting of bankers and hedge funds, represents their best interests rather than the taxpayers’. However, he acknowledges that some Treasury Department staffers are aware of this issue and present the other side of the argument to the Treasury Secretary. Bianco predicts that actively managed stock picking ETFs will become more popular, as investors seek to capture the right themes and outperform the indexes. He believes that higher interest rates will pose a challenge for index funds, but investors who choose the right themes will do well.
2. Importance of Indicators in Analyzing the Macro Space
James Bianco’s macro lens starts with a broad perspective and narrows down from there. He looks at various indicators to understand the macro space. One important indicator he mentions is inflation. He discusses how people’s perception of inflation is influenced by their personal experiences, such as the cost of purchasing goods during the pandemic. Another indicator he focuses on is payrolls, which provides insights into the labor market and economic growth. Additionally, Bianco emphasizes the significance of goods inflation, as it affects consumer purchasing power and overall economic conditions. He believes that understanding these indicators is crucial for analyzing the macro environment and making informed investment decisions.
3. The role of inflation expectations in managing inflation
Inflation expectations play a crucial role in managing inflation. Accurately measuring these expectations is challenging, as people’s beliefs are more unanchored than the Fed realizes. People base their expectations on recent events, such as the pandemic, rather than historical data. This discrepancy between perceived and actual inflation can have significant consequences. For instance, President Biden’s approval rating was negatively affected by people’s pessimism about the economy due to rising prices. The Fed faces the challenge of anchoring expectations and must use rhetoric to lower inflation expectations. However, there is no historical calibration between the Fed’s playbook and reality, making this task more complicated. Despite this, the theoretical connection between the playbook and reality can still have an impact. It is crucial for the Fed to manage expectations effectively, as losing faith in their ability to do so may lead to an accelerating inflation cycle. Overall, inflation expectations are a key factor in the Fed’s fight against inflation, and accurately measuring and managing these expectations is essential.
4. Impact of supply chain disruptions on inflation and the stock market
Supply chain disruptions, particularly in shipping, can have a significant impact on inflation. People are willing to pay extra to get goods quickly, which drives up shipping rates. James Bianco highlights the potential problems in the Red Sea and how it can lead to a slowdown in goods production and higher prices. For example, car manufacturers are facing delays in receiving parts, leading to idle production and increased costs. This can result in a general slowdown and stalling of goods, as seen in 2021 and 2022. The shortage of goods relative to demand can cause prices to rise, as people are willing to pay more to get the available goods. The inflation rate may stay in the 3 to 4 percent range, which is a problem for Wall Street that believes inflation is under control. Additionally, supply chain disruptions can impact the stock market. While a strong economy and demand can lead to earnings growth and opportunities, higher interest rates can be a headwind for stocks. The competition between stocks and higher interest rates can result in a market that appears to be doing well but is not going anywhere. In this environment, actively managed stock picking ETFs may become more popular as investors seek to capture the right themes and outperform the indexes.
5. Implications of higher interest rates on stocks and bonds
Higher interest rates can have implications for both stocks and bonds. If interest rates rise, it can be a headwind for the equity market, according to James Bianco. He suggests that stocks may not perform as well as people expect, and there may be a shift towards actively managed stock picking ETFs. Bianco also discusses the potential impact on bonds and the need for the Treasury to adjust its issuance strategy. He mentions the Treasury Borrowing Auction Committee and the importance of representing the taxpayers’ interests in decision-making. Overall, higher interest rates can create challenges for both stocks and bonds, requiring investors to consider alternative strategies and approaches.
6. Indicators of a hard landing or recession
Indicators of a hard landing or recession can be identified by analyzing the yield curve, specifically the three-month to ten-year curve. If the curve un-inverts, it could signal a potential economic downturn. It is important to define terms like ‘soft landing’ and ‘hard landing’ to avoid ambiguity. An inverted yield curve has historically been a reliable predictor of recessions. The yield curve has been inverted for over a year, and there is no indication that this trend will change. The Federal Reserve is cutting rates aggressively in an attempt to prevent the economy from falling apart. On the other hand, if the economy remains stronger than expected, the yield curve may become more inverted, indicating higher interest rates. In this scenario, actively managed stock picking ETFs may become more popular, as investors seek to capture the right themes and select the right stocks. Higher interest rates could pose a challenge for index funds, as competition increases. Overall, understanding the indicators of a hard landing or recession is crucial for investors to make informed decisions and navigate the market effectively.
7. The importance of active management and thematic investing in the current market environment
Active management and thematic investing are crucial in the current market environment, according to James Bianco. He emphasizes the need to move away from index investing and consider actively managed stock picking ETFs. Bianco believes that higher interest rates will pose challenges for the stock market, but there will still be opportunities for investors who choose the right investments. He suggests that capturing the right themes is key to success in this changing landscape. Bianco’s view is supported by the performance of stocks in 2021, which has shown the potential for active management to outperform passive strategies. He predicts that more actively managed stock picking ETFs will come to market as investors seek to capitalize on specific themes. This shift towards active management reflects a growing recognition that the traditional approach of investing in broad market indexes may no longer be sufficient. Instead, investors should focus on identifying and investing in companies that align with emerging trends and themes. By doing so, they can potentially achieve better returns and navigate the challenges posed by higher interest rates. In summary, active management and thematic investing offer a way to adapt to the changing market environment and capitalize on specific investment opportunities.
President, Bianco research
Jim Bianco is President and Macro Strategist at Bianco Research, L.L.C. Since 1990 Jim’s commentaries have offered a unique perspective on the global economy and financial markets. Unencumbered by the biases of traditional Wall Street research, Jim has built a decades long reputation for objective, incisive commentary that challenges consensus thinking. In nearly 20 years at Bianco Research, Jim’s wide ranging commentaries have addressed monetary policy, the intersection of markets and politics, the role of government in the economy, fund flows and positioning in financial markets.
Jim appears regularly on CNBC, Bloomberg and Fox Business, and is often featured in the Wall Street Journal, Bloomberg News, Grants Interest Rate Observer, and MarketWatch. Prior to joining Arbor and Bianco Research, Jim was a Market Strategist in equity and fixed income research at UBS Securities and Equity Technical Analyst at First Boston and Shearson Lehman Brothers. He is a Chartered Market Technician (CMT) and a member of the Market Technicians Association (MTA). Jim has a Bachelor of Science degree in Finance from Marquette University (1984) and an MBA from Fordham University (1989).
[00:00:00]James Bianco: If you believe inflation is not a problem. It’s not a problem. If you believe it’s a problem, it is a problem. I get the theory and the theory is probably right. The problem with the theory is, is that it’s hard to measure it. I, kind of liken it to sentiment in the stock market. When everybody’s bearish, the market peaks when everybody’s, when everybody’s bearish the market bottoms, when everybody’s bullish, the market peaks. It’s a great idea and it works. The problem is, how do you know when everybody’s bearish or when everybody’s bullish?
That’s really hard to figure out.
[00:00:41]Rodrigo Gordillo: All right. Hello everyone, once again, to another episode of ReSolve Riffs. And today we have a very special guest, Mr. Jim Bianco. This is the first time that he’s on our podcast, even though we’ve been thinking about you for a long time here at ReSolve. For those of you who don’t know Jim, he runs Bianco Research Advisors.
You can find him at Biancoresearch.com. And we’re going to be talking about everything macro, you know, where the markets are, inflation, what’s going on on the political front, and the military front outside of the US and maybe a little bit about his Bianco Total Return Index, which I find very interesting.
Welcome Jim. Thank you for coming today. How are you doing?
[00:01:25]James Bianco: I’m doing fine. Thanks for having me. Looking forward to the conversation.
[00:01:28]Adam Butler: We might even touch on a little Bitcoin too. I know Jim’s got some thoughts there as well. So,…
[00:01:34]James Bianco: Yeah, I’ve heard of Bitcoin. Yeah, we can talk about it. Yeah, that’s right.
[00:01:37]Rodrigo Gordillo: And Jim, maybe because our listeners might be new to you, maybe just a quick five minute intro into your past and what you’ve done in your career, and then we can get into the magic.
[00:01:46]James Bianco: Yeah, so I came out of Wall Street in the 1980’s. I worked at Lehman Brothers, when it was Lehman Brothers, and Shearson Lehman, it changed its name to, and I worked at First Boston before it became Credit Suisse.
I was there for the 1987 crash that, you know, so now you can kind of back into how old I am. From there, I moved back to my hometown of Chicago and started working for a brokerage firm called Arbor Research and Trading. And in 1998, I spun myself off within Arbor Research and Trading into Bianco Research. Twenty-six years old right now. We provide macro and fixed income research for institutional investors, mainly, throughout the world, right now, through our, either directly through Bianco Research or through Arbor Research and Trading, our affiliated partner, and earlier, or late last year…
Now I should say we started Bianco Advisors, which is an advisory company that provides the Bianco Total Return Index. And that is an index, where it is our estimate as to changing factors, as to overweighting and underweighting various sectors to outperform. Say, the Bloomberg Aggregate or the J.P. Morgan Broad Investment Grade, and a couple of, about a month ago now, WisdomTree brought up an ETF on it, WTBN for WisdomTreeBianco, N for Nancy, WTBN, and it trades on that as well. Pretty busy. We’ve got two businesses going here and we’ve got a research business, which we’ll spend most of the time talking about, and we’ve got an advisory business and a tracker ETF following our index as well.
[00:03:26]Rodrigo Gordillo: Amazing. Amazing. Lots going on. Well, I want to touch upon that, that how you run that, later on in the podcast, but let’s first start with the, with your macro framework. Just broadly speaking, everybody, every macro player that I know has a wide, different lens by which to look at the macro space. Before we get into your views, how is it that your macro lens works? What, what are you, how do you look at the macro space? And what are the major indicators that you like to look into?
[00:03:56]James Bianco: I like to start off very broad and then I like to narrow it down from there. So, on the very broad aspect of the markets in the place, I like to look at what are the economic trends and what could come about to change the economic trends. And then from there, I try to, you know, focus it down, more narrow, and the best way to explain it is maybe to tell you broadly where I’m at right now.
I think that 2020 was one of the biggest economic events, and that was the shutdown/restart, or as I like to call it, the reboot of the economy, the global economy. When it was rebooted, it didn’t come back quite the same way as it was going into it in 2019. And as I like to always, you know, warn, different is not dystopian, different is not worse, it’s different.
The biggest thing we know about difference is remote work. If you go to YouTube, the television show 60 Minutes last night did a very good episode, probably three years too late, because they should have done it three years ago, about the nature of offices and the nature of cities are going to have to be re-thunk because of remote work.
That is probably the most obvious exit. And then you can throw into that an acceleration of deglobalization using energy as a weapon, and the like, and you’ve got a different cycle. What is that cycle? I think the bull market and bonds that started in 1981 ended in 2020. I think we’re in a multi year bear market in bonds now, within a multi year bear market in bonds, you can have a two or three year rally within that. But I think if you were to ask me in 10 years, 15 years, I think rates will be much higher than they are today. But like I said, there could be a peak and a rally, and a peak and a rally.
And I think what’s changed is the inflation cycles changed, that the low sub 2 percent inflation world has now given way to a more friction world higher inflation, say in the 3 to 4 percent range, has given way to a world of more transactional nature of jobs, which will lead to faster nominal growth, which will lead to higher interest rates.
So within that, I’ve been advocating the idea that interest rates have turned. They’re going much higher. That made me look like a genius ‘til around November 1st. And then they proceeded to rally 120 basis points. And then I don’t look so smart anymore, but I stuck with this, this bearish call and I am still sticking with it. And I think that interest rates are going to go higher. I think within that, we could kind of flesh this out if you want, I think that inflation, everybody on Wall Street talks about inflation is going to the last mile to 2%. Well, if you want to use the sports metaphor there, I think we’ve already hit the finish line on the, on the last mile, somewhere in the high two’s to around 3%.
And that inflation might be, you know, starting to bottom here ish and start back up. I’ve got various reasons to think that goods inflation might be moving higher. I think that housing inflation might be bottoming as well. And I think that services inflation is going to stay stickier than people think, and that’s going to help to bring up interest rates.
So, like I said, I start big picture. I think the cycle turned in 2020. I think that there’s a lot of economic things that are changed since 2020, and then I try to focus it down from there. But really what I think is driving all of this right now is inflation. Prior to 2020, what drove everything was real growth.
You could kind of ignore inflation. Let’s focus on whether the economy is speeding up or slowing down. Let’s focus on employment. Post-2020, it’s all about prices, and what is to a lesser extent important, is about real growth.
And I think Wall Street’s had a very difficult time making that adjustment because they still want to focus on, let’s talk about the economy, let’s talk about real growth, real growth, real growth, and then we’ll get to inflation. And I think the way you should be discussing it post-2020 is inflation, inflation, inflation, and then real growth.
[00:08:06]Rodrigo Gordillo: Well, it’s just one of those things that, who’s asking, right? And it’s the allocators that have had their own personal experience, to be in a period of 40 years where inflation really has been less and less of a problem, up until 2020.
And we always liken it to, most of people’s careers has been about balancing on a barrel, a two dimensional kind of balancing act, whether it’s growth, low growth, and whether you need to inject money in order to increase the economic growth or take it away in order to decrease it. All of a sudden, when you inject a real inflation thrust, then you’re trying to balance on the top of a ball, right?
It’s a three dimensional game that nobody has any real experience except for veterans like you and historians that have gone back to the 40’s to the 70’s, to the 20’s to really understand what inflation is. So I think there’s a, there’s not a lot of demand from the analysts for, to get insight into what’s going on with inflation.
But I do think it’s going to be the dominant factor going forward. We like, we like to say that it’s not going to be a period of inflation. It’s going to be a period of inflation volatility. These ups and downs, right?
[00:09:11]James Bianco: Yeah, yeah. And Dan Tarullo was a Fed governor from 2009 to 2017. And I like to say that, you know, the best Fed officials to listen to, the ones that recently leave, because then they tell you what they really think.
They’re just not reading the talking points that they were handed. And so after he left in 2017, he went to the Brookings Institute in October of ‘17 and gave a speech, and a paper, and it was basically, the Fed has no theory on inflation. And if I was to summarize it for everybody, why, what do you think moves inflation? Is it money? Is it velocity of money? Is it rational expectations? Is it some other theory? Is it monetary theory? Go ahead and go ahead and back-test it. Your correlation to inflation is going to come up to zero in all of these. And his point was, inflation is extraordinarily difficult to understand.
That’s not a problem, if the Fed would just start with that, but no, the Fed likes to say, we’ve got these levers and these dials that we could turn and push, and you want it to the 3rd, the 4th quarter, we gotcha. We could put it right there, wherever we want. You know, Bernanke’s favorite line, that we could get rid of inflation in 15 minutes. We could just raise interest rates. It doesn’t work that way. It’s a lot more complicated. It’s complicated. Then everybody thinks, and because it’s a lot more complicated, that’s the other impatient here on Wall Street. I think inflation is a problem. Okay, fine. Where’s the model? And I want to know out to the 4th decimal place where it’s going to be at the end of the year.
Oh, you can’t do that. Okay, then forget the inflation thing. Let’s go back to talking about payrolls because we’ve been talking about payrolls for 30 years and we think we understand that. That makes sense.
[00:10:48]Adam Butler: I mean, I think the Fed always has a major challenge, which is to a meaningful extent, they also need to anchor expectations. The Fed comes out and says, we have no model for inflation. We have a variety of dials. We don’t know which way to turn them to manage inflation shocks in one direction or the other, then there’s a much greater potential that the economy becomes unanchored, right? Because, you know, every company is going to interpret their own inflation picture.
They’ll lose faith in the Fed’s ability to manage things, and it may lead to a change, or an accelerating sort of inflation expectations cycle, which, you know, I think that really is the only weapon that the Fed really has to bring to the table to fight inflation, which is rhetoric, right? Just how are they going to jawbone inflation expectations lower, and follow a playbook that is simple enough that everybody can kind of understand. And even though there’s no historical calibration between the playbook and reality, there’s a theoretical. And just the theoretical connection alone can do some of the heavy lifting.
[00:12:05]James Bianco: Yeah, I agree. There’s two things about that, is that May 31st of 2022, so about 18 months ago, 19 months ago, Jay Powell was in the White House with Janet Yellen and President Biden. And that’s when the inflation rate was nearly 9%. It was like 8.7 percent and President Biden, literally in the Oval Office with the cameras rolling, pointed at Jay Powell, and I’m summarizing, he said, America, this is the guy who’s going to make inflation go away. It’s not me, the President. It’s not the Treasury Secretary. Here’s your man. He’s got all the answers and he’s going to make it go away. And of course, Jay has taken that mantle on, and he immediately started by raising rates 75 basis points at a meeting right after that, you know, in order to start to tackle that inflation.
In that the Fed does use this theory about inflation expectations being well anchored. If you believe inflation is not a problem. It’s not a problem. If you believe it’s a problem, it is a problem. I get the theory and the theory is probably right. The problem with the theory is, is that it’s hard to measure it. I kind of liken it to sentiment in the stock market. When everybody’s bearish, the market peaks when everybody’s, uh, when everybody’s bearish the market bottoms, when everybody’s bullish, the market peaks. It’s a great idea and it works. The problem is, how do you know when everybody’s bearish or when everybody’s bullish? That’s really hard to figure out.
Well, what is the sentiment? What is the expectations about inflation? The Fed has used things like the Michigan survey or the TIPS break-evens and they said, it’s well anchored, it’s under control, but then you go look at the political surveys and the President’s approval rating is in the tank. And when you ask people why it’s in the tank, they’re very pessimistic about the economy because prices have risen for the last three years. And what they see is a 20 percent or 25 percent rise in the last three or four years where the Fed is saying, no, no, the year-over-year expectation for inflation is mid two’s. So therefore we’ve got the problem solved.
Again, the theory of inflation expectations is right on. But we could spend the rest of our life trying to figure out how to properly measure it. And I don’t think they’re measuring it properly. I think that those expectations are a little bit more, you know, to use their term, unanchored than they think, because everybody anchored themselves off the last big event in their life, the 2020 shutdown.
And they know now that it cost them $120 to buy something that cost them $100 in the middle of 2020, and that’s what’s driving the mentality. Not that the inflation rate was 9 percent year-over-year in June of 22, and it’s 3.4 percent if you use CPI, you know, at the end of 2023. They don’t think of it that way.
[00:14:52]Rodrigo Gordillo: No, and look, as a Latin American, you know, inflation expectations indeed are what works. It is, what ultimately breaks the back of hyperinflation, when somebody new comes in and creates a new currency and says, we’re not going to do it this time. And that tends to cause in that type of scenario, it tends to cause deflation. Not disinflation, but deflation.
I think a lot of the issues here is people in their minds think, okay, my $100 now only buys $80, right? So in other words. It costs you 120 to buy the same thing. So now I thought inflation was licked. Why is everything costing me $124 this year? But this inflation just means that you’re, the cost of purchasing things is coming in at a lower rate.
It doesn’t give you back what you’ve already lost in terms of purchasing power, especially if you have no ability to increase your own income, right? And so it, that kind of anchoring to expectations works in Latin America when you actually create a little bit of deflation so that people can feel good again. That’s not going to happen here.
And so it just, it’s a complicated thing to deal with in the environment. And I find funny that you said that the, that the President pointed at Powell and said, you’re going to fix inflation. Do you then point at Yellen and say, you’re going to create, you’re going to cause inflation once again in November? Like what, what was he, what was he saying to the Treasury about all of this, right?
[00:16:15]James Bianco: That’s the big, that’s the big question. I was going to say, you’re right about understanding inflation. No less than the President’s staff, and I’m going to say President’s staff because, let’s just assume that every tweet that comes out of the White House, it’s not him, and he doesn’t even know what they’re coming out.
We’re saying that inflation is down, and they would criticize companies for not lowering prices, okay? Tell me you don’t understand what inflation is without telling me you don’t understand what inflation is. Yeah. And so, but again, you set those expectations. Oh, so the inflation rate’s down so prices should be falling and they’re not falling.
So something’s wrong, you know, so yeah, I get that that it’s a complicated thing. It sounds easy on the surface because you see this on social media all the time. You talk about inflation. Oh, just look at money supply. You know that, that’s it done, you know, takes four seconds to figure out what inflation is, but when you start to really dig into it, it’s far, far more complicated than that.
[00:17:13]Rodrigo Gordillo: Velocity of money and all that.
[00:17:15]James Bianco: Well…
[00:17:15]Adam Butler: It’s, yeah, you sadly, in all of these economic terms, are subject to this syntactic ambiguity, right? Like every, per every, even every economist that you talk to, you say inflation, they hear something at least slightly different than what you meant, when you said that word, right?
So it’s not even, you can’t measure it. You, you can’t, we don’t even have a common definition for it, right? I mean, I think we can all sort of, there’s a lot more convergence around a definition of growth, right? For some reason, there’s this massive. mosaic of different ways to interpret this term inflation. Why do you think that is?
[00:17:57]James Bianco: I think it’s because it’s a, you know, first of all, the corollary of that is deflation. And that, if you think inflation is hard to define, trying to define deflation, because I like to joke, if you ask five economists, what is the definition of deflation, you’ll get seven answers, because some people think it’s a fall in financial assets. Others think it’s just a negative CPI. That’s deflation.
As far as inflation goes, I think part of the problem is, is that what economists are trying to do is not just try to tell you what’s been happening lately. Oh, because that could be subject to food prices are up or down or gasoline prices are up or down because they’re, they’re volatile. They’re important. They also have a big psyche on everybody, you know, especially gasoline prices, but they want to try and look at what is the underlying trend of inflation.
That’s why the Cleveland Fed invented the Median CPI, and you’ve got, you know, the Multivariate Model by the Dallas Fed that tries to look at what is the undertone, or the tone or trend of inflation beyond what we see, as far as the last print goes.
And then when you start thinking about it in those terms, and you start asking people, what is the definition of inflation, you start getting a lot of different answers, because one of the pushbacks I get is, I talk about that the economy hits constraints, and then those constraints get met by higher prices. And then I hear people tell me, well, but that’s not inflation. That’s constraints being hit by higher prices. And I’m like, yeah, but the public knows they go to the store and it costs more money. And they’re not thinking, oh, there’s a shipping problem out of Asia, so this is not really inflation.
This is something different. No, to them, it’s all inflation. And, you know, or you could say that core inflation is doing X, but gasoline prices are up or down. They think that inflation is up or down because of what gasoline prices are doing. So that’s where it gets to be really complicated because we can’t really settle on what is the underlying trend or what is the underlying cause.
Going back to Dan Tarullo, right, there’s no underlying theory. If there was an accepted theory of how inflation interacts with the economy, and that’s it, write it in the textbooks, we don’t even have to entertain other ideas, then we could then get to an accepted definition. But since we can’t have an accepted theory, we have several theories about inflation, we have several ways to measure it and several ways to argue about it.
[00:20:25]Adam Butler: Well, I mean, it’s the, the answer is it’s complicated, right? It’s like trying to measure, am I healthy? Or, you know, in defining intelligence,
[00:20:34]James Bianco: You know, I’ve used the analogy of weather, you know, is, you know, is, is the weather good or bad? Well, you know, we were talking off camera. I’m in Chicago. It’s six below zero. It’s January. It’s the middle of January. That’s not unusual. You know, you guys are in the Caymans. It’s, 80 degrees. That’s not unusual.
Is my weather unusual? It would be for the Caymans, but it’s not necessarily unusual for Chicago in January. So it’s all a relative scale is really what boils down to.
[00:21:02]Rodrigo Gordillo: So I guess the question then is, from your perspective, you’re coming up with certain beliefs with regard to inflation that were plateaued, maybe going up. How, how do you measure inflation? How have you gotten to that conclusion and what can we expect going forward?
[00:21:17]James Bianco: Yeah, so the first conclusion I start with, I’ll start with housing inflation, because that’s the big one, the most interest sensitive sector that there is. And the assumption that everybody makes is that we’ve got these punishingly high interest rates that are really hurting the economy.
You’ve heard Jonathan Gray, he’s the CEO of Blackstone say this, when he reported disappointing numbers in October, he said interest rates are too high. They’re punishing. Bill Ackman has said something similar to that. He thinks that the Fed is going to have to start cutting rates in March because interest rates are punishing, and that gets a big reception on Wall Street because there’s an old adage on Wall Street that the Fed keeps raising rates until something breaks.
And over the last two years, we’ve had a 25 percent decline in the stock market. We’ve had, at a total return basis, one of the worst sell-offs we’ve seen in the bond market, because we went from like 1 percent to 5 percent on interest rates, and the math shows you that if you held like the 30 year bond through that, you lost almost half your money. We’re down about 50 percent at the lows as well. And we had a banking crisis about a year ago in March of last year, with a bunch of banks, headlined by Silicon Valley Bank, failing. So surely something broke, right? Those are three things that yes, but they didn’t necessarily break the economy.
So I push back on this idea that we’ve raised rates to the level that we’ve broken something economy-wide. Sure, some banks had some problems. Sure, the stock market had some indigestion in ‘22 over it, recovered in ‘23. We haven’t broken anything. So I start with the idea that when you look at the housing market, it’s holding up a lot better than people think it would have. If you would have asked anybody in the abstract, a year and a half ago, what happens if mortgage rates go to eight percent? The answer would have been a hell of a lot worse than what we’ve actually seen. And so it’s actually held up okay.
Now part of that might be because the average mortgage rate, even though the current mortgage rate in the US is 7 percent, down from 8 two months ago, the average mortgage in the United States is still three and three quarters, because so many people still own the same mortgage that they had from three and four and five years ago. So I don’t think that we’ve seen that pain really come into the housing market.
And if you look at some of the real-time measures like Zillow, Redfin, these are the online sites that do some algorithms. There’s really some evidence that home prices are bottoming and that there’s some evidence to that rents are starting to move higher.
Now home sales are down a lot, but the way that I interpret that is most people are not stressed. I have a home. I call a broker. I list my house. I want X for my house. My broker tells me yes, but mortgage rates are up and the average monthly payment for your house is higher. Fine. I still want my X. I don’t want to lower my price.
So if nobody shows up to look at it, I’m fine with that. But I’m not selling it for less than what I want. So home prices are starting to hold up. And so I think what you’re seeing in the data is some signs that you might be seeing more of a bottom in home prices. Then you are seeing, you know, further declines.
Now, add to that, that 30% of the inflation report is owner’s equivalent rent. That’s the way that they impute rental inflation in the CPI index. Now, everybody’s on this idea that that has to come down a lot and they look at the year-over-year numbers. But again, just like we were talking about with the public’s attitude about inflation, look at the cumulative numbers.
Most of the real-time measures of home prices and rentals since 2020 are up 30 or 40 percent. The owner’s equivalent rent is up around 23 to 25%. It has not risen as much as the real-time measures of the housing market. I think it has to rise more to converge with that gap. So that doesn’t mean that rental inflation or OER has to go up.
I just think it’s going to be sticky. It’s going to be slow to going down and it did rise in the last couple of, or outperform by going up five-tenths of a percent in the last couple of CPI reports, and Wall Street’s pointing at that going, oh, that’s wrong. It’s got to come down. It’s got to come down.
I keep saying, no, it has under-counted the amount of housing inflation we’ve had to date. And it’s going to go up. Another one that I’ve been looking at is services. Services are largely service inflation, that is, about 60 percent of what we spend is in services. That’s largely driven by paychecks.
And there’s been an attitude change in the public, you know, remote work, as I mentioned before, about paychecks. Jobs are more transactional. If you look at the JOLTS Report, job opening labor turnover report. If you’re old enough, like I am, you remember the old newspaper want-ads reports, newspaper ads, for jobs.
They used to measure that, but we don’t use those anymore. So they invented Help Wanted Index or whatever. The Help Wanted, that’s what I was thinking of. Yes, the Help Wanted Index. That went away with the dinosaurs. So the JOLTS Report replaced it. And if you look at the, also what they added in their report is the number of people that turn over their jobs. It’s really high.
Now, Wall Street likes to talk about the number of jobs that have turned over has come down from the previous month, the previous month. But if you look at where we are, like something like 2 percent or 2.5 percent of jobs a month turnover, that’s higher than anything we saw pre-pandemic.
Sure, it’s lower than it was a year ago or 18 months ago, but it’s still much higher. And if you look at, we’ve invented words like quiet quitting, and labor hoarding, and we’ve seen big wage gains. We’ve seen the biggest amount of strike activity in at least 20 years, headlined by the UAW and the Hollywood strike.
Those are the two most headline strikes that everybody’s familiar with. Workers feel comfortable. I have a job. I get a paycheck. I will spend money. What if I lose my job? Eh, I’ll find another job. We’ll go to the Caymans for a weekend vacation. And then when I get back, I’ll find another job. I am not concerned about my job status.
That’s what you’re seeing, I think, in the labor market. So, I think Wall Street’s got this backwards, that they keep focused on this idea of how much pandemic savings is left. I think it’s really comfort about the labor market that’s got people spending because that’s one of the big surprises of 2023, was the consumer spending just kept going and going and they kept trying to force it into all this excess pandemic savings, which there, that is true.
And that’s there. But I think it’s about jobs. And then finally, goods inflation is around zero. It has really decelerated in the last couple of years. But what did we find from 2020 that really drove goods inflation was shortages, and shortages relative to demand. Could we be seeing that again? I think that we’re really underestimating what’s happening in the Red Sea now.
I’m not talking about Israel/Gaza, I’m talking about in the Red Sea, with what the Houthis are doing. Oh, they’re a ragtag bunch that are firing off homemade rockets into the Gulf of, you know, into the Gulf of Aden or into the Red Sea around the Bab al-Mandab. That’s the 16 miles of water between Djibouti, Djibouti and Yemen where they’re attacking all the shipping. From the Houthi standpoint, it’s been enormously successful because hundreds of billions of dollars of shipping goods has been diverted around Africa on the Cape of Good Hope. That adds 10 days or so, one way, 20 days round trip back to Asia.
We work in a just-in-time world. I need my stuff scheduled to show up on time. What they’re doing by shutting down the Red Sea’s commercial shipping is they’re putting all of the just-in-time behind schedule. Volvo and Tesla have already announced that they’re going to idle their plants at the end of this month, because they’re looking at their inventory schedules, and they’re saying the parts we need at the end of January and early February are not going to arrive on time. And we’re not going to be able to finish making cars because we’re going to be missing parts. So we’re just going to idle. And the longer this goes on and the longer we have to send ships around Africa and add time and add friction and more cost, the more that we’re going to see that we’re going to have a problem in a just-in-time inventory world.
And we’re also finding out that the world is relatively inelastic. Shipping rates. We all look at these container prices, and that’s become kind of a new parlor game on Wall Street, that container rates are going up. What does that mean? 70 percent of shipping is on a contract. I have a big container ship. It’s contracted for the year. It goes back and forth between Asia and Europe. It may be six times a year because it takes, you know, so many, it’s an 8,000 mile trip if you go through the Suez Canal, and then it has to go back. But now that you’re sending my ship around Africa, it might only be able to do four or five trips a year.
Well, that extra one or two trips it’s missing, I will contract out excess in, excess shipping in the spot market. Those prices are up 80 percent in two weeks. So what the shippers are telling you is people want their stuff now, whether they’re Tesla or Volvo or consumers, and they will pay extra to get it now.
So pay up, get those ships online, fill them with containers and start sending them around Africa in order to get them where they were. So if there’s going to be a general slowdown and a stalling of goods because of what’s happening in the Red Sea, the first thing people are going to say is what’s available, and how much is it going to cost me to get it, and I will pay that to get it.
That’s what we saw in 2021 and into 2022. Goods prices, when CPI was up 9%, CPI goods was up nearly 16 percent, year-over-year. So I think all of these are suggesting for listening, that the inflation rate, like I said, the last mile might be here right now, and that I’m not saying we’re going to get anywhere near 9 percent because it’s not nearly as bad as that, but we can stay in a 3 to 4 percent world is what we can wind up staying in.
And yes, that’s a big problem for a Wall Street that thinks inflation’s licked, we’re going to 2%, the Fed’s going to cut rates six or seven times this year. Not if we stay in a 3-4 percent inflation world. That reality won’t happen.
[00:32:05]Rodrigo Gordillo: Yeah, it looks like, I mean, the inelasticity of it is very interesting because like you said, you have a tight job market, you continue to have demand, you know, housing is sticky, as you mentioned, but also, I mean, the, well, there’s a discussion to be made of whether inflation is going to be much worse for Europe, United States, just because most of the shipping that’s being disrupted is in the European, is for European delivery. But of course that raises rates everywhere, as you mentioned, because just, there’s just less capacity to do less trips. The interesting thing is that what needs to happen for that to calm down is not kind of a, less rockets being thrown at these ships. It has to calm down completely because you just can’t get your shipment insured. It’s the insurers that simply will not insure your, or if they will insure it, the costs are so astronomical that you’re better off going around. So it has to, it has to end completely for it to go back to normal.
[00:33:03]James Bianco: Yeah. So a couple of things about that.
You know, there’s big ports in the Eastern half of the United States. Savannah, Charleston, Norfolk, New York, New Jersey, just to name a couple of them. About 30 to 40 percent of the goods that come to those ports come through Europe. So the Asian manufacturers put it on a boat through the Suez. It stops at Rotterdam or Felixstowe, which is the largest port in the UK, and then it gets put on another ship and it’s sent to New York or it’s sent to, you know, Savannah or Charleston. And the reason that is, is because another technical thing is the Panama Canal, which would be another way that they could send it. The water levels on the lake and the Panama Canal are so low that it’s running at around two thirds capacity and there’s a big backlog to get through the Panama Canal. So they’ve been actually sending stuff through Europe. So the shortage of stuff will show up on the East coast of the United States.
Now, maybe we can mitigate that by increasing shipments to the West coast and putting them on rails. But again, in a just in time inventory, I’m sitting here in Detroit and I am making a car and on February 17th, I need these 20 parts to show up so I can finish this car. You’re telling me I’ll get those parts. It’s just some time after February 17th. What am I going to do with this half built car, is what’s going to happen at that point. That’s the problem. And I remind everybody that in 2020, in September of 2020, this is five months after the recession ended, car production in the United States was 200,000 units a month, all car production and truck production in the United States. By the fourth quarter of 2021, it had fallen to 84,000 units a month. That was not because demand was down, because demand was increasing during that period, because we were already past the lockdowns and we were restarting the economy.
It was just-in-time inventories couldn’t finish making the cars. Chips, you know, silicon chips out of Asia and everything, was a big problem. And that’s why by 2021 90% of people were buying cars over sticker price. Yeah, they’re inelastic. I want a car, I want a deal, except when there is no deal and I need a car. What do I have to write down on this check in order to get this car?
And that’s what people wound up doing and that’s what could wind up happening this time, is sure, everything you’ve ordered you will get, but you need it at the time you expected. Otherwise it creates all kinds of problems that produces goods inflation because of the inelasticity.
I want, what is available and what do I have to pay to get it? And prices go up.
[00:35:41]Adam Butler: Reinforcing this de-globalization theme that was talked about a lot in 2022, re-emerged with this, with the Ukraine conflict. You know, every time there’s conflict and some, the supply of some major good is threatened to be disrupted in, in the Ukraine situation, obviously it was commodities and in the Houthi situation, it’s now, you know, …
[00:36:12]James Bianco: Shipping goods, industrial goods,
[00:36:14]Adam Butler: Then there’s this major potential for an uptick in inflation. The interesting thing about logistics, and like you say, the sort of just-in-time world, is that it’s subject to queuing theory, right, where, you’ve got this idea where, and there’s great models on this, where you’ve got a lineup for the bank, and there’s a certain number of tellers. Well, you take away one teller, and it’s not just that it slows down by one third, it slows down by, like, you know, 80 percent because the line keeps getting bigger and bigger and bigger, right?
And, you know, we saw that play out. That’s a big reason why we did get to that 9 percent inflation, right? It’s not just that, oh, it slows down for a while, and then once it stops slowing down, everything catches up. It doesn’t catch up. It takes a very long time to get back to that equilibrium again. And in the meantime, everybody’s got to live with too much money chasing too few goods, which leads to inflation, right?
And so, you know, I totally still, one of the things we haven’t really covered is the demand side. You know, there’s a lot going on, on the fiscal side that I think also may contribute substantially to a higher than expected growth rate and a higher expected rate of in-demand coupled with potential supply constraints. You’re back to sort of the same cocktail we were looking at in 2022.
[00:37:44]James Bianco: Yeah, you’re right on the demand side. What you’ve got happening right now is you’ve got enormous, you’ve got an enormous $2 trillion, 6 percent of GDP deficit in the United States. I saw a statistic and I believe it to be correct, that whenever the deficit has been this big, we’ve never had a recession. And the reason is, is that what deficit spending is … first of all, let me back up. What borrowing to spend is, is pulling forward future consumption to the current.
The great example I like to use is a mortgage. When I’m in, when I’m 30 years old and I’m freshly married and going to start a family, I need a house then. Now I can afford the house when I’m 60, after I’ve saved for 30 years. It’s too late then for me to buy the house, so I pull that consumption forward to right now by borrowing the money in the form of a mortgage and paying it off slowly over time.
And so what deficit spending is, is that we have all of this spending in the economy that is going on by the government, and that is creating demand and it’s creating, economic activity on top of everything else that’s been going on, and that demand makes prices a little bit more inelastic. People want to buy it. They want to pay up for it. They want to get it right now. What would slow the economy a lot would be if we were to stop the government spending as much, as that we’ve seen.
But the problem with that is, is then, if you were to slow the economy, we would risk recession. If you keep the government spending going, we could be risking the idea of inflation, right now, and I think really what is, it comes back to when it comes to demand, it comes back to an attitude change, right?
Because people would say prior to 2020, you didn’t have maybe the massive government deficits that we had then, but you had massive wealth creation through financial markets. Why didn’t that wealth creation through financial markets create inflation? I think it was the legacy of the financial crisis of 2008.
When I looked at my brokerage statement, keep the example simple, when I looked at my brokerage statement at the end of the month, or the end of the quarter, and I saw that my portfolio went up in value and I went on Zillow and I saw that my home price went up in value, I said, okay, good. I’ve got extra savings.
I feel comfortable. I feel a little bit more secure. But that’s all. I just wanted to feel more secure about it. I’m happy. I have extra savings. That’s why I didn’t see inflation. Today, and we saw this in 2021, when I get extra money, either the government mails it to me, or meme stocks boom, or Bitcoin booms, or the government spends it, and I see that I have extra wealth in my pocket, checking account or my brokerage account. I book a trip to the Caymans. I spend it. I buy a new car or something like that. That attitude changed. We saw that in 2021, when we saw that the government was mailing people money. They didn’t put it in the bank and say, good, the rainy day fund is there. We could exhale and relax.
We know, we spent it. We spent it. We paid over-sticker for cars. You know, we invented the word YOLO – You Only Live Once. Let’s go for it. And you know, we speculated in the markets with it. So that’s been the big attitude change coming out of 2020 with the attitude change.
Coming out of 2009 was a lot more conservative. I want to make sure that my savings is higher. Now the attitude changes. I want to live a little bit more and maybe it’s a PTSD from what happened in 2020, but I’m willing to spend and that will fuel demand. And that will fuel more inflation and ultimately higher interest rates.
[00:41:40]Rodrigo Gordillo: Sorry to interrupt, but I did want to take a quick second to remind listeners that while we do absolutely love providing our audience with world class guests and weekly investment insights, we wanted to remind you that we actually do our best work outside of this podcast, and we try to do this by providing cutting edge, globally diversified, and systematic investment strategies that are designed to be broadly non-correlated to traditional equity and bond portfolios.
So we actually manage private and public funds, as well as bespoke separately managed accounts for investors that seek the potential to smooth out portfolio returns in the long run. So if you do want to see that theory that we’ve been talking about put into practice, please do go ahead and check us out at www.investresolvecom. Now back to the podcast.
[00:42:22]Rodrigo Gordillo: So, let’s talk about the rubber meeting the road here. So clearly there, if this is all correct, there’s a mispricing between where inflation is and where it’s going and the belief that there’s going to be a bunch of rate cuts going to happen next year, right? It’s, it’s not…
[00:42:42]James Bianco: Yeah, let me just say, right, but the first part of your question, a mispricing between what the market expects and what actually happens is not unusual. That’s almost kind of standard fare, that we see this happen all the time, that the market prices in a rally. If you go back two years ago I mean, I can remember the, when everybody, I’m talking about February of ‘22, when everybody’s jaw hit the floor, because Wall Street was saying that the Fed would raise rates three, maybe four times.
Now, three rate hikes, that’s 25 basis points, so three would be, they’ll raise rates 75 to a hundred basis points in 2022. Three or four rate hikes. Jamie Dimon came out and said, I could see them doing six. Six? Man, what’s this guy smoking that he thinks they’re going to do six rate hikes? They wound up doing 21, is what they wind up doing in 2022. Deutsche Bank has pointed out, they got a piece they put out about a month ago, that we’re all talking about the Fed pivoting to cutting rates. This is the seventh time in the last two years that the market has now priced in a Fed pivot. The first six times it never happened.
Maybe the seventh time is a change. My point is, yes, the rubber meets the road. There is a mispricing, but that’s always the way it is on Wall Street. So the first part is that’s not unusual, that you get the market pricing in a rally that may not come to pass. The second part of the impact…
[00:44:10]Rodrigo Gordillo: Then, so you totally agree. What’s the impact to? Assets, bonds, equities given your framework in the next three to six months?
[00:44:21]James Bianco: Well, if I’m right in that interest rates go up, of course, there’s two things to keep in mind about bonds is, as we sit here now in January of 2024, there’s a yield again, or as my friend, Jim Grant, he runs the newsletter, Grant’s Interest Rate Observer, says, it’s nice to have an interest rate to observe again, you know, because we’ve got a 4.7 percent yield on the investment grade index, as opposed to something under 1. So there is a yield again. And if prices go down, you are cushioned by the yield, and that needs to be managed. So the bond market will struggle, but not nearly like it did in ‘21 or ‘22. Because what happened then was you had massive rises in rates of hundreds of basis points with no yield to cushion you. Now you’d probably see I’ve been vocal about the idea that we can go to five and a half percent in 2024. We hit five percent in late October, so that’s 50 basis points above the old peak, but that’s only about 150 basis points away from here, not 400 like we did from ‘21 to ‘23, and there’s a yield.
So, stocks on the other hand, is kind of an interesting game because what I’m arguing is, you know, the economy stays a little bit stronger than people think. Demand stays up. That means earnings come back. That at the face of it sounds like that should be okay for stocks. Stocks should be doing well in that.
You’re talking about earnings. You’re talking about growth. You’re talking about opportunity. Yes, all of the above. But what have we learned about stocks in the last two years? They trade on their competition. Their competition is interest rates. When interest rates go up, the alternative is to just park it in a money market fund. And when interest rates go down, stocks look relatively more attractive. Dr. Jeremy Siegel, who wrote the book Stocks for the Long Run, put out a new edition of it this year and I’ll summarize it real quick. The long term potential of the stock market from here forward is 8 percent a year. So like he said, if you do the Buffett thing, buy SPY.
Don’t even value it for five years. Expect that it’ll give you about an 8 percent return, okay? That sounds about right. Well, 2019, if you were going to get an 8 percent return, your alternative was to keep it simple. A money market fund is zero. That’s why we coined the term TINA. There is no alternative.
You can’t sit in a money market fund at zero. You got to put your money in something that’s going to give you a return like the stock market and flows one into the stock market. Well, in January 2024, the money market fund is yielding five, maybe 5.3, depending on the money market fund you’re in. It’s giving you roughly two thirds of the gain you would get in a stock market without any market risk.
Money market funds don’t have any market risk. There are any of these, always one, there is an alternative. It’s interest rates. So if you were to look at the way the market traded last year, you could give the market hundreds of good earnings reports, decent economic reports, and anecdotes that everything’s okay, or you can give it falling interest rates.
And the market said to you, you can keep your earnings reports and good economic reports and anecdotes. I want falling interest rates. That’s why the market, the stock market struggled all the way through the end of October. The S&P was only up 7 percent at the end of October, finished up 26 percent for the year.
And if you took out the Magnificent Seven stocks, it was still down on the year at the end of October, as was mid-cap, as was small-cap stocks. Everything but seven stocks was down in the year, at the end of October, and in the 10 year yield was at 5%. Then at the end of the year, the 10 year yield went to 380 and all those stocks took off 15 to 20 percent in the next two months.
So you can spend your time looking at earnings reports and figuring out what the economy is going to do and talking to management and understanding what they are going to do. Or you can just pine for lower interest rates and it’s lower interest rates that’s going to drive it. But if I’m right and interest rates are going to go up, then the competition stays with stocks.
I’m not suggesting like some terrible bear market, suggesting more of what we saw in ‘23. Looks good, looks okay, but why is the stock market going anywhere? Because a trillion and a half dollars went into money market funds. And it’s getting most of what you should expect out of the stock market. I know people are trying to say, well, cash is trash again, cause stocks were up 26 percent last year.
Are they going to go up 26 percent every year? Well then yeah, then I’ll be in the stock market, but they’re not going to go up 26 percent every year. All last year was an offset to ‘22. The, actually the two year gain in the stock market is zero right now. And so I think really the problem with, if you want to go back to cash is trash, you have to get the Fed to pretty much halve the funds rate to take those money market funds down to two and a half. The only way they’re going to do that is if we have a recession and then you’re back to earning, bad earnings reports. So if we see higher interest rates, I think that’s going to be a powerful headwind for the equity market., and I’m using that word carefully, headwind, not a disaster.
[00:49:48]Rodrigo Gordillo: Well, look, you still have an inverted yield curve, right? So, it’s bad for equities. It’s also bad for bonds. And you know, at some point we’re probably having a very … yield curve because people are waiting for the Fed to reduce rates and if it does happen…
[00:50:01]Adam Butler: Let’s also not forget about Janet Yellen’s role and what’s going on, right? I mean, she, to what extent are you paying attention to the supply dynamics out of the Treasury? She obviously came out and surprised everybody with much fewer or much, much lower coupon issuance than the market expected in Q4.
And you know, to what extent do you think that played a role in bolstering equities, and how do you expect her to react given that, already we’re way out of our historical balance between bonds and bills, given their issuance over the last couple of years. Do you think she’s going to try and make up some lost ground, bring that back into balance, or is she happy to sustain a new paradigm of that mix, do you think?
[00:50:53]James Bianco: Yeah, no, you’re right. The quarterly refunding announcement on November 1st, next one will be February, on February 1st, so in a couple of weeks, really turned the whole bond market around, because what the market was worried about was she was going to issue a lot more bonds and notes, more supply on the back end of the curve.
And what she wound up doing was she wound up issuing less supply, but more Treasury bills on the front end of the curve, and it sparked a rally. Now I wasn’t surprised by the rally. I was surprised by the extent of the rally. I don’t know what way, further than I thought it should have, or needed to go.
Now that we come into ‘24, where we are now moving forward, there’s a $2 trillion deficit, and that has to be financed. And that has ,the bonds have to, you know, Treasury, let me say this, Treasury securities have to be issued to finance that $2 trillion deficit. Now the Treasury can continue, she could continue to try and issue short term bonds, but she’s putting the taxpayer at an enormous disadvantage. That’s the highest point of the yield curve. That is the most interest expense that they’d have to pay is to, but is to be buying into those short-term bonds right now. I, the history of the Treasury is, they can be counted on to do the wrong thing at the wrong time from 2010 to 2020.
When interest rates were at 200 year lows, I used to joke that if I was the Treasury Secretary, the yield curve would be 30 year, 50 year, 100 year in perpetual bonds, and I should just be jamming them down everybody’s throat, and then I turn to you in 2024 when the funds rates at 5 percent and go, aren’t you glad you got another 98 years of one and a half percent. And only Argentina did it, right? And, but you can be counted on to do the, the Treasury can be counted on to do the wrong thing at the wrong time. But I ultimately think that as we go throughout 2024, with this deficit that we have, that the number of notes and bonds are going to have to be increased.
She cannot just continue to just jam Treasury bills down everybody’s throat because she puts the Treasury at an enormous invest, in an enormous reinvestment risk. If the inflation rate does stay sticky, if the funds rate doesn’t come down, this is going to cost many, many, many billions of dollars of extra interest expense by issuing at the highest point in the yield curve.
I think they’re better off shifting out, and smoothing things out. But, you know, that’s what I think. She thinks something different. We’ll find out in two weeks what they are.
[00:53:38]Adam Butler: I agree. I mean, everything, that all makes a ton of sense. I mean, the reality is, as we, as we both know that, you know, the Treasury is responding to what the primary dealers are saying is in demand, right? So, you know, they’re doing it, sending out a survey. The primary dealers are saying, yeah, we want more bills than coupons. And so the Treasury responds. It’s kind of not surprising that if the Treasury is going to do the bidding of the primary dealers, that they’re always going to be offside on what would be best for the taxpayers, right? There’s, there’s clearly a…
[00:54:12]Rodrigo Gordillo: That’s interesting.
[00:54:17]James Bianco: I’ll go you one step further. There is this thing called the Treasury Borrowing Auction Advisory Committee, the TBAC, and this is a bunch of Wall Street hedge funds and bankers that get together with the Treasury once a quarter to advise them on the most efficient way to issue bonds and notes. It’s all bankers and hedge funds that are on that Committee. As I’ve often argued, who is the representative for the taxpayer on that committee? The bankers and the hedge funds will tell you what’s in their best interest. I’ve argued throughout 2010 to 2020, was enormously critical of that Committee, because I said, who on that Committee is arguing for 100 year bonds when interest rates were under 2%? We should have been issuing them as much as humanly possible, but nobody was on that Committee arguing for 100 year bonds.
The bankers didn’t want them because they’re long duration. It’s a new market. They have to take them on their inventory. They have to be subject to taking losses. They didn’t want them, but there should have been somebody saying, I don’t care what JP Morgan wants or what Goldman Sachs wants. I’m here to tell you what the taxpayer wants, and if you want to remain a primary dealer, you’re going to do this. You know, we had it the other way around, so you’re right.
They’re never advised as to what’s in the best interest of the taxpayer. They’re only advised as to what is in the best interest of Wall Street. I don’t blame Wall Street. That’s what they should do. They should tell you what’s in their best interest. The Treasury should have other voices on that Committee.
[00:55:47]Rodrigo Gordillo: What’s funny is that I’ve always, the way that Committee has been described to me, is a Committee of academics and technocrats that weigh things very critically in order to provide their guidance. This is the first time I’ve heard that it’s filled with the Wall Street interests that obviously don’t align with the taxpayer.
[00:56:05]James Bianco: Oh, until last year, Beth Hammack, who is the treasurer of Goldman Sachs, was the head of the Committee, you know, for many, many years. I mean, so, you know, you had a Goldman Sachs managing director running the Committee, and it’s got PIMCO and it’s got a couple of hedge funds, JP Morgan, Bank of America, all the usual suspects are on that Committee as well.
But you’re right, they’re backed up in research by the academics over at the Treasury Department that work in domestic finance that help them with making their decisions.
[00:56:36]Rodrigo Gordillo: Because up until this very second, I had no idea, and I didn’t look into it too much, but I had no idea why Yellen would do such a thing. Now it makes a lot more sense.
[00:56:43]Rodrigo Gordillo: Sorry to interrupt, but I did want to take a quick second to remind our listeners that the team works really hard on these podcasts. We spend a lot of hours trying to get the right guests and we do a lot of prep work to make sure that we’re asking the right questions. So if you do have a second, just do hit that Subscribe button, hit that Like button, and Share with friends if you find what we’re doing useful.
Thanks again. Now back to the podcast.
So I guess. Is there any way that one can get a line on what that Committee is leaning towards? Or is it one of those things that once a quarter it’s, you know, dark period, send it to Yellen and then she makes a decision based on that. Like, what do we know about that committee and how they’re thinking that we could replicate?
[00:57:23]James Bianco: Well, we could read the minutes of the Committee and you could surmise what is in the best interest of Wall Street. I will say this in fairness to the Treasury Department. Under the Treasury Secretary, there are some staffers that work in the Treasury Department, and what I argued, that no one is representing the taxpayer, gets a very sympathetic ear by a lot of the staffers at the Treasury.
They’re fully aware of the problems with this Committee, and they are fully aware that there is another side to the equation, and they do present that to the Treasury Secretary. So it’s not that she never ever hears that side of the argument. In theory, she should, or he should, if we have a different Treasury Secretary, it’s in theory, what is it that they want to do?
Now, the problem is, if you go back the last seven years, we’ve had Janet Yellen as the Treasury Secretary for three years in a rising rate environment, that wants to mitigate the impact of interest rates on the economy for her boss, the President. And before her, we had a hedge fund manager and Steve Mnuchin for four years as the Treasury Secretary.
And so, there, there’s always been a very sympathetic ear to what Wall Street wants on that, at the Treasury Secretary level for many years now. Maybe the next Treasury Secretary, that could change. I doubt if, I kind of doubted that it will because if Trump becomes President, you know, Trump. So Trump is an over-levered real estate guy. He thinks that zero on interest rates is too high. He thought the greatest invention known since fire was negative interest rates as an over-levered real estate guy. What a great idea are negative interest rates, and why didn’t we have them here in the United States for commercial real estate in Manhattan, is really what he was basically thinking about.
[00:59:13]Rodrigo Gordillo: It’s just, how much of this is politically motivated? You know, we’re coming into an election.
[00:59:17]James Bianco: A lot of it. A lot of it is. Absolutely a lot of it is. Yes, just like the Fed, you know, Wall Street, I’ve made the argument too that Wall Street is basically looking like they’re not going to move interest rates on January 31st. That’s the next FOMC meeting. There’s eight meetings a year. That means there’s seven meetings left this year. How many rate hikes or rate cuts, excuse me, do the markets have priced in, seven? How many more meetings are there? Seven. So they’re going to cut rates at every single meeting, in an election year, have they done that before?
Yes, they’ve done that in 2020. They did that in 2008, but usually they cut rates in an election year because there’s a crisis that forces them to do it. They usually don’t voluntarily say, let’s cut rates every single meeting, in an election year. This year they are, and you just have to wonder, why is it that they’re wanting to be so zealous in cutting rates in an election year?
Could Jay Powell remember when he was the Fed Chairman under Trump and all the mean tweets that he got? He doesn’t want him coming back. I’ll just throw that idea out as one possible reason as to why they want to be uber accommodating for the economy. The problem with that argument though, is you could cut rates, and you could help Biden, but if you wind up having inflation, it could backfire. It could backfire in a big way.
[01:00:40]Rodrigo Gordillo: Like you need to have, you need to manufacture that destruction demand. That’s the next step. That needs to happen one way or another. And if you inflate…
[01:00:50]James Bianco: You don’t want to do that in an election year, though.
[01:00:51]Rodrigo Gordillo: If you stimulate the economy, you’re done, right? Getting that genie back in the bottle would be much, much harder. I think there was an IMF paper that went back to 1926 and looked at the different types of inflation regimes that they were, what different governments did, and the clear winners were the ones that actually hit inflation hard and their growth trajectory from point to point was much higher if you got the job done.
But most governments didn’t get the job done, right? They vacillated in order for political reasons, and those that didn’t do it correctly the first or second time, had much longer inflation regimes and had much lower growth. So, you know, hopefully somebody there is doing, is thinking about it that way for this coming year.
[01:01:36]Adam Butler: Otherwise, I think Jay Powell, McChesney Martin is going to deliver for Biden and team this year, and he’s going to look like he delivered a smooth landing. But 2025 is going to show the error of that, of that pivot. But to Jim’s point, we may see inflation begin to pick up in advance of that, which would confound that trajectory.
So it really is a really interesting macro environment. I mean, clearly equities and bonds are still indicating a very substantial amount of confidence and optimism in a soft landing. So, you know, what are you looking for from markets to signal a shift in sentiment?
[01:02:30]James Bianco: Well, there’s a couple of ways you can look at the markets to shift sentiment. Let’s talk about on the downside, if things were to go south on the economy, and maybe get something worse than a soft landing, into like a hard landing or recession. By the way, real quick about a soft landing. I always joke too, soft landing does not have a definition. Is it below trend growth? Is it a mild recession? Is it somewhere in between?
Hard landing is a recession. That’s a, that’s kind of a harder definition. And in no landing, to keep with the airplane metaphor, it’s just the economy keeps growing a trend or higher, which is about two and a half percent or more, which is what it’s done over the last year. And I like to joke, Wall Street loves to forecast a soft landing since it has no definition.
I will give you the definition in a year and tell you why I was right. It’s the way that they, it’s the way, you know, it’s the way that they like to work that one. But what would signal to us that we are going to go into a hard landing and into a recession? A lot of people have noted that the yield curve is 8 for 8 in predicting recessions, except maybe this time it’s been inverted now for well over a year, and there’s no real indication that we might be having a recession. I’ve argued, as others have argued, actually, actually it hasn’t been the yield curve inversion that signaled a recession. It was the un-inversion that signaled the recession.
The thing about the past was the time between the inversion and the un-inversion was a couple of months. So whichever, you could pick either one, and it looked like it was a good leading indicator. But like in the seventies, when the yield curve inversion and un-inversion could have been up to two years in difference, we were inverted for two years.
You’ve got to designate that maybe it is the un-inversion that signals the end of the recession. And to be clear, I’m talking about the three month Treasury bill to the 10 year note, that’s where all the, so, and that one is still very inverted nearly a hundred, minus a hundred basis points.
So what typically happens is, the yield curve un-inverts last. The last time it did that was 2020 with the Fed cutting rates. So short rates, which are higher than long rates, fall more, fall below long rates. That un-inverts the curve. But what is causing that to happen is the Fed is aggressive in cutting rates.
So I’m going to use a technical term here for you. The Fed is shitting its pants that the economy is falling apart and they’re cutting rates aggressively to try and stop it. So it would be the un-inversion of the curve that would signal to us something’s going on. And again, it’s the three month/10 year curve that I’d be looking at. Not necessarily, I know the 2/30’s curve un-inverted the week before we’re talking, but that’s far different from the three month/ten year curve right now. That would be the signal to me that, you know, something’s going bad on the south side of the equation.
On the north side of the equation, what if the economy is staying much stronger than people think? I think the curve gets more inverted, because what happens then is we get the bear flattener, the bear more un-inverted, if you want to think bear meaning higher interest rates, that the 10 year yield starts marching again towards 5%, maybe even more, because it’s starting to worry that there is an inflation problem at that point again. If the, as I like to say, if the Fed is not going to be vigilant about fighting inflation, then I don’t want to own your bonds.
So if the, if the market believes there’s an inflation problem and the market believes that the Fed is not sufficiently on the case, then it’s going to sell off the long end of the curve. And the long end of the curve is going to go up and up and up in yield. So that’s kind of the leading indicators that I look at.
My bias, of course, is that the economy stays stronger, the deficits stay large. That’s more spending. Demand pushes prices up. Move on through the idea that you’ve got a bottom in potentially housing prices, maybe in wages, and possibly in goods and that you get that sticky inflation and that those interest rates go up, but don’t be afraid of the bond market now because there’s a yield in the bond market.
And that yield can be managed to still get a positive return. This is not ‘21 or 2020 when you’re talking about higher rates with no yield, and you were talking about hundreds and hundreds of basis points, where rates were going to go up. We’re talking about a hundred to 150 with a 4.7 percent coupon. So that’s a very different world for the bond market. But yet I do think that those are the leading indicators that I would be looking at is to what the yield curve winds up doing.
[01:07:24]Adam Butler: So the base case for you is, bear steepener in bonds and kind of a wide range choppy equity market. Would you buy US?
[01:07:37]James Bianco: Yes, I would say that and as far as equities go, I mean, I could go back to the early 2000s and just so people know where I was, and I was used to advocate to the chagrin of a lot of my clients at the time in the early 2000s, that stock picking was a dead art form, just buy SPY, buy IWM, which is the Russell 2000 ETF, you know, you can’t beat it.
Stock picking cannot add enough alpha in order to do that, and I held that position until about two years ago. And I think now what’s happening with the change in the economy is ultimately, I believe that we’re going back to a stock picking world and that it isn’t so much is the stock market going to go up or down? It’s do you have the right themes and the right stocks?
Last year, you needed to own seven stocks. That’s really all you needed to do, and maybe just avoid some REITs, and you would have, you’d be getting paid like Bill Ackman. If you wind up doing those two things, it’s easier said than done.
I understand that, but I also don’t think that this is going to be the world of Just Buy SPY or Sell SPY. People come back to me and say, well, you don’t know what you’re talking about. SPY is up 26% last year. I should have owned SPY. Yeah, okay, you should have, but then don’t come crying to me if in another year, maybe this year, maybe next year or the year after that, the Magnificent Seven are down a ton.
And that you could have done the Dave Portnoy thing where you picked the letters out of a Scrabble bag and you would outperform the S&P because everything, you know, all those other 493 stocks were up and these big seven stocks are just dragging the whole index down. So you could see the inverse of that coming.
So I do think it’s going to be more of a stock picking world. Ultimately, I think what you’re going to see, if I was to just go into the financial business a little bit more is, you’re starting to see a lot more active fixed income ETFs show up. BlackRock’s got some, Vanguard’s bringing some, PIMCO even rolled out one as well too. Heck, I am to some extent with my Index.
[01:09:50]Rodrigo Gordillo: I imagine that’s the motivation for the Bianco Total Return Index that you feel like you have an edge after 20 years of, you know…
[01:09:56]James Bianco: I think you’re going to see the same thing in equities. I think you’re going to see more actively managed stock picking ETFs come to market.
Don’t buy the index, buy the manager or buy the concept that you can, you know, pick the right stocks. That’s where I think we’re going to go. So that’s why when I say that, you know, higher interest rates are going to be competition for the Indexes and the Indexes are going to struggle, and I still believe that to be the case.
Within that, there is going to be themes that if you capture the right theme, that you will do fine. I used to, and I’m saying, you know, everybody says that, but I used to not say that until about two years ago, right. But now I think that that is the type of world we’re in. You said, with the restructuring of the economy, with remote work, with the restructuring of the office, with the re-imagining of cities, because if you don’t have to physically be located in an office, you could live anywhere you want. Look at this interview. You’re in, you’re in a foreign country compared to me that we’re doing this interview. As well, it changes a lot of things that may not be captured by just buy the index or sell the index. And that a manager that understands those trends can really have a leg up.
Whereas from about 2000 to 2020, it was really, really difficult to beat the index. I think from going forward, and I’m talking about from here over the next several years, I think you’re going to see the percentage of active managers that beat, on the stock market side, is going to go up. Now, currently it’s about 5 to 10 percent on a long-term basis, can beat.
I think that number is going to go up by the way, in fixed income land, and it’s always been the case, and I think it’s always going to be the case. The index itself falls around the 50th percentile among active managers. If you didn’t study it, you would have thought, well, the index should be somewhere around the middle.
It isn’t fixed income. It isn’t necessarily in equities, but I think it’s going to be moving more towards that in equities. Because if you go back and look in the seventies and eighties among active managers, then the index was closer to the middle. It was still like in the 66th percentile of the 60th percentile, meaning the majority of managers underperformed the index, but it wasn’t in a 95th percentile, like we’ve seen recently. I think it’s going to shift back. So stock picking is going to become a big deal, I think, as we go forward.
[01:12:29]Rodrigo Gordillo: So just to put it, put this all in a bow, so we’re looking at curve steepeners. We’re looking at a volatile equity market, possibly down. Commodities, you’ve already mentioned a lot about inflation. I imagine commodities are likely to be strong in this next cycle.
[01:12:46]James Bianco: Especially commodities that are associated with inflation, like industrials, that, you know, that would be a big one. Energy, I know energy isn’t working right now, but I still think that energy would be another good one, as well to take a look at.
Precious metals is kind of a funky kind of thing, because I think that their competition is cryptocurrency and that’s why they’re losing a … at demand. Even though I understand gold is at an all-time high, boy, it took forever to get back to that all-time high. And then you’ve got other commodities like softs and grains, oil seeds. They’re going to go with the weather cycle and a lot of other different things as well too that may not be just driven by the inflation cycle. But I think the industrial commodities and energy will probably be the two better ones that will be driven more by the inflation cycle within industrials. I also include lumber in there, too, as well.
[01:13:43]Rodrigo Gordillo: Amazing. Okay. Well, that’s a good macro picture Jim. Thank you so much for taking the time again. Everybody here should go visit Jim’s website. It is biancoresearch.com, is that correct?
[01:13:57]James Bianco: Yes, I actually have two. There’s biancoresearch.com, which is my traditional research site, and biancoadvisors. com, which is the Index that explains our ETF. So we’ve got two of them. WTBN is the ETF that tracks our Index. I’m active on Twitter, biancoresearch@biancoresearch. I’d like to give this warning. You guys will appreciate it. There’s a lot of scammers out there.
I have about 375, 000 followers. And the reason I mentioned that is that if you’re going to follow me, make sure it’s the one with the blue check mark, but 375, 000 followers, not somebody with 14 followers. I’m also available at LinkedIn at my name, Jim Bianco. And also we have a YouTube page, uh, at Bianco Research.
[01:14:44]Rodrigo Gordillo: Amazing, love it. Well, thank you, Jim.
[01:14:44]Adam Butler: As usual, Jim, a tour de force on the economic front. Really appreciate you sharing your time and wisdom with us today.
[01:14:52]James Bianco: Thank you, guys.
*ReSolve Global refers to ReSolve Asset Management SEZC (Cayman) which is registered with the Commodity Futures Trading Commission as a commodity trading advisor and commodity pool operator. This registration is administered through the National Futures Association (“NFA”). Further, ReSolve Global is a registered person with the Cayman Islands Monetary Authority.