Episode #494: Stephanie Pomboy on the Corporate Credit Crunch

Guest: Stephanie Pomboy is the founder of MacroMavens, a boutique research firm that provides macroeconomic research and commentary to an exclusive swath of the institutional investment community.

Date Recorded: 8/2/2023  |  Run-Time: 53:59

Summary: In today’s episode, Stephanie shares her take on the investment landscape and why she’s very concerned about the corporate credit market. Then she shares her take on the dollar, gold, and where she sees opportunity given her bearish views. In reading some of Stephanie’s recent research to prepare for the episode, I came across some data points that I haven’t seen anyone else talking about, so I promise you’ll love this episode.

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Links from the Episode:

• 0:39 – Sponsor: FutureProof
• 2:17 – Intro
• 3:06 – Welcome to our guest, Stephanie Pomboy
• 3:26 – Stephanie’s market overview
• 5:48 – Fed’s rate hikes impact timing, affecting borrowing costs and revealing tightening effect on economy
• 10:52 – Consumer discretionary sector suffers due to rising costs
• 14:07 – Investment grade and junk spreads show divergence from stock market
• 16:28 – Top 10 companies hold more cash than the rest of the S&P 500
• 20:56 – Massive divergence in consumer sentiment measures
• 25:36 – Wholesale inventory-sales ratio is high
• 29:49 – Earnings manipulation concerns in S&P numbers are at their highest since the 1970s; source
• 32:39 – Stephanie’s view of the dollar & gold
• 38:25 – Distinguishing between asset inflation and wealth creation
• 41:48 – Investing in stocks at all-time highs may lead to reverse wealth effect for everyone
• 43:33 – Embracing stocks at any price reveals a cult-like behavior
• 45:24 – Advisors are holding cash, eyeing TBI over bonds, and watching BRICs
• 48:39 – Stephanie’s most memorable investment
• Learn more about Stephanie: Macro Mavens; Twitter;

 

Transcript:

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Meb:

Welcome my friends. We got a huge episode today. Our guest is Stephanie Pomboy, founder of MacroMavens in one of the top macro minds around. In today’s show, Stephanie shares her take on the investment landscape and why she’s very concerned about the corporate credit market. Then we get to hear what she thinks about the dollar gold and where else she sees opportunity. In reading some of Stephanie’s recent research reports, I came across some data points that I haven’t seen anyone else talking about, so I’ll promise you’ll love this episode.

Before we get to the show, if you don’t already subscribe the Idea Farm Newsletter, go to the ideafarm.com to subscribe for free. In our email after this episode is released, you’ll get a little teaser from one of Stephanie’s recent research reports. Over 90,000 investors subscribe. So join them and subscribe today. Please enjoy this episode, Stephanie Pomboy. Stephanie, welcome to the show.

Stephanie:

Thanks, Meb. Great to be with you.

Meb:

Where do we find you today?

Stephanie:

I am in the Bear Country right where I feel most at home in Colorado.

Meb:

My brother who’s in the foothills around Golden Evergreen, loves to send me neighborhood updates when it’s either a mountain lion or a bear in the neighborhood. We don’t have much of that here in Los Angeles.

Stephanie:

It’s a change from the critters in New York for sure.

Meb:

So You got a remote perch, which you can see the world, which gives you a non-consensus view. So we’re going to start super broad. What’s the world look like to you today? What’s going on out there in the summer of 2023?

Stephanie:

Well, I think this is a fun time to do this podcast because we’ve had this year basically where the Fed is raised rates in the unprecedented fashion on an economy that’s toting record amount of debt. And initially the markets realized, hey, this probably isn’t going to be rarely a lot of fun for us. Let’s see how this plays out and have now concluded that basically those rate hikes were a giant yuan and that the economy’s not going to have a recession and basically the second quarter was the low for profits and we’re going to claw our way back to double digit profit growth next year and the fed will pivot and you’re a schmuck if you’re not getting along with everything. You got my self-appointed job I view as being to identify what’s priced into the market and then pick at where that might be wrong, where the opportunities lie around, where the consensus might be wrong on that.

So when I see everyone who used to be forecasting a recession and just trying to figure out when it was going to happen, taking it off the table and saying, okay, the worst is over, it’s all going to be good. I have a fair amount of skepticism about that and we can go into detail on it, but basically it just seems to me like basic math. At the end of the day, if you take interest rates and you raise them in record speed and magnitude on an economy that has twice as much debt as it did in 2007 and ’08 and a corporate sector that has twice as much debt as it did then, you’re probably not going to have a better outcome than you have then. And obviously you have to weigh things like the fiscal stimulus against it, but that seems to be fading in the rear view mirror in terms of the bulk of it. So I think we’ve got some real headwinds and I’m happy to go through the details of where I think the real issues lie, but that’s my general thesis.

Meb:

Well, there’s a lot of alleyways we’re going to go down, but the first being is you had a quote which I liked and I’m not sure what you mean by it, so I like to hear it. But you said even with the pause, you’re talking about the Fed, the fed is still tightening and that is a crucial nugget that the markets are missing. What do you mean by that?

Stephanie:

So every day when the fed raises rates, it doesn’t impact anyone until they have to borrow at higher rates. So one of the problems right now for example is no homeowner wants to sell their home because it entails going from a 3% mortgage rate to a six and a half 7% mortgage rate. No one’s going to do that, which is why everyone’s hunkering down. So these higher rates that the Fed has engineered only really impact people when they have to pay them. I mean, it sounds like such a stupid thing to say, but it affects the timing of when these rate hikes hit.

So for example, the corporate sector, they have an enormous amount of debt that’s been coming due over the course of this year, and they have much more that comes down next year and the year after this year coming into the year, they had somewhere around 650 billion worth of debt that needed to roll over and next year it’s a trillion and then it’s another trillion in the year after that. Companies, this is why I think you’re seeing this record number of corporate bankruptcies is that it was fine until all of a sudden the bonds matured and they had to come out and issue new debt at these higher rates. And a lot of companies just couldn’t do it. We had these zombie companies who couldn’t even cover their interest expense out of cashflow.

So they all presumably said, “All right, I guess we’re not going to be able to borrow. We’re out a business.” And you’ve seen, as they mentioned, the largest number of bankruptcies since 2010, and again, we’re just in the early stages of these interest rate hikes actually starting to hit as the debt comes due and people step into this new environment where suddenly rates are twice in many cases what they were prior. Junk issuers were borrowing at 4% before the Fed started raising rates. And on my Bloomberg here now junk yields are 840. So that’s a pretty substantial increase in interest expense and there are a lot of companies that just aren’t going to be able to make it.

So that was my point about every day that the Fed does nothing, it’s still tightening because every day these higher rates start to hit a new swath of people, plus there’s a second part of it, which is a little bit more macro, and that’s just a law of diminishing marginal returns on debt in general. The US economy has become so addicted to credit that we now require more and more credit fuel to go each GDP mile as it were. And that’s in large part because as we’ve borrowed more and more and more and the debt’s gotten bigger and bigger, we’ve just have to allocate more and more of every marginal dollar towards servicing that debt. So your interest expense keeps going up and up and every new dollar of income you get, you’re portioning rather than 50 cents of it to interest expense 60 cents and then 70 cents and whatever.

So it creates this law of diminishing marginal returns where every dollar increase in credit gets you less GDP growth. So in an environment, for example, where the fed takes rates up and then just holds them there, and let’s say credit growth goes to zero, in theory, I would say it would go down because you’re holding rates at a high level and those rates are resetting, but let’s just assume credit growth is zero. Well, that’s going to have a huge drag on economic activity. So in this context, I think of a new paradigm for Fed policy and that is that there really is neutral is tightening. When they’re not raising rates because we’re in this deep process of diminishing marginal returns on credit, just keeping rates steady is effectively tightening because every day we get less GDP growth out of our credit growth. Raising rates obviously is layering on even more aggressive tightening.

So you have a situation where what people perceived as neutral, no change on the policy is actually an effective tightening. So I don’t want to get too deep in the weeds on that, but I think it’s important that people realize that we are long since past the point of diminishing marginal returns on credit. So that also is something that’s ignored in this idea that we’re not going to have a recession because the fed’s going to pause. Well, all right if they stop raising rates, that just doesn’t compound the damage further, but it doesn’t mean things aren’t going to slow and get a lot weaker.

Meb:

Yeah. Are there any particular areas, so it could be sectors, companies or even the investment grade junk that is particularly concerning to you. Are there areas that look better than others?

Stephanie:

I mean, I guess in terms of sectors, I tend to beat up the most on the consumer discretionary sector because we’ve had this environment where you’ve seen a huge squeeze on household pocketbooks as inflation has just savaged their budgets. Food and energy outlays just went through the roof obviously and housing expenditures. So this and healthcare obviously has always been a major drag. So they’re being squeezed hard on that front. And this is another one where Wall Street celebrates the fact the inflation numbers are coming down, but for the regular Joe who’s going to the grocery store, he just knows that the price of bacon doubled in the last year and now it’s only gone up another 20 cents rather than doubling again. He doesn’t think it’s getting cheaper. So the Fed may declare victory that inflation is coming down toward two, but it doesn’t help the consumer at all.

Their prices reset at a much higher level and they just stopped going up as fast. So I think that they’re having this real squeeze on their budgets, plus they’re also facing this higher interest expense because a lot of them went from paying down credit card balances during COVID with all the stimulus money they were getting from the government to once that was depleted, running up those credit card balances in record fashion and they’ve really added a tremendous amount of credit card debt in the last year at 20% interest rates. I mean no one’s doing that because they enjoy borrowing at 20% interest rates. They are doing it because they have no choice but to do that. So I think the consumer’s really under real stress and obviously that’s at the lower end of the consumer chain and it gets masked by what’s happening at the high end where people tend to be fairly bulletproof and you go out to restaurants in New York City or LA and everything’s full and everyone’s buying fancy bottles of wine and it doesn’t seem like there’s any recession.

But when you come into the middle of the country and you talk to people who don’t live in those bubble communities, it’s clear that there are real issues and you’re seeing it in rising delinquency rates as well across the auto loan delinquency rate, for example, clearly an issue credit cards as well. So that’s an area where I tend to focus on that as a weak spot and it’s one where I get a lot of pushback. I mean if you look at the forecast for consumer discretionary earnings, it’s like these people earned fantasy land. We’re talking well into the double digits and I’m just not sure where consumers are going to get the money to absorb the price increases that companies are going to have to keep passing along to generate those margins, especially if the employment picture is slowing and we’ll find that out shortly.

Meb:

So where do the investment grade in junk spread sit? Is this something that is already been seen in the spreads? Are they blowing out versus T-Bills or is it not so much?

Stephanie:

Well, what’s interesting is obviously you had, when we had the risk off on the Fed tightening last year, you saw a real increase in credit spreads alongside the decline in the stock market. And since then, like the risk on in stocks, you’ve seen a rally in the investment grade and the high yield space. However, it has not in no way kept up with the stock market. The two are sending different signals now. So year to date, I think the S&P is up 18% or somewhere in that magnitude. The investment grade bond yield is exactly unchanged. So it hasn’t rallied at all in that stretch. And the JNK, the junk ETF is down 2% on the year. So the credit market hasn’t sold off further, but it’s not giving you the signal that the stock market it is that all is clear.

And within that junk space and the delinquencies we have seen, for example, the high yield or speculated grade default rate is forecast to go to 5% over the next 12 months by Moody’s. They just raised that for the third time and however long from three to four to four to five, and that’s their base case scenario. Their pessimistic scenario is 13%, which is actually higher than we saw during the global financial crisis.

So finally, someone is doing the math that I outlined earlier, that if you have a corporate sector with more debt and you raise rates faster in shorter fashion, you’re probably going to get an outcome that’s equal to or worse than that scenario. So Moody’s is holding that out as a possibility, but getting to the sectors within the area where you’ve seen the delinquencies, it has been concentrated in those consumer discretionary companies. So of the bankruptcy filings we’ve seen this year, 24% were consumer discretionary companies, which is the single largest sector of any of the other sectors for those bankruptcies.

Meb:

The media seems very obsessed with the big fantastic seven, I don’t know what they call them, the giant market cap companies, but you had a quote where you’re actually talking about cash on the balance sheet where you said the top 10 companies in the S&P hold more cash than the bottom 400. It’s not for nothing that more than half of investment grade companies are now rated B2B or lower. Is this something where we’ve seen this small cap valuations blow out relative to large cap up there with some of the biggest valuation spreads on average? Is it something that’s for a reason and maybe small caps are more exposed and lower quality or how do you see some of these companies and this debt reset where they’re sitting?

Stephanie:

Well, so I think about the corporate space very much like the consumer sector where you have the haves and the have nots and the averages that everyone focuses on really tell you nothing about what’s going on. As you said, the average company isn’t doing what the top seven companies are and the small caps obviously in a totally different universe. So I think it’s an error to look at those averages and that’s why I highlighted that cash on the S&P balance sheets because everyone says, “Well, don’t worry about debt service. There’s 2.2 trillion in cash on corporate balance sheets, corporate balance sheets are strong.” Well, no, the top 10 companies are strong. Everyone else is loaded up with debt and has no cash. So that’s a problem. And bear in mind that these are the top 500 companies. If you broaden the lens out to include all of the companies in the United States, I mean the top 500 is a very small portion of… It’s the top triangle of the pyramid of companies. You get a very different picture.

And that’s I think something that people miss as relates specifically to the small caps. I generally think of them as having two major issues in an environment like this. One is that they’re more reliant on debt and not debt that comes from the capital markets. They have to generally get debt from the bank initially, super small caps obviously as you move up to the mid-caps, et cetera, they can actually raise funds in the capital markets. But generally when you’re going into the bank, you’re not getting as good a rate as you would of the capital markets then. So in an environment like this, they’re stressed for access to credit.

And the second thing is they lack the economies of scale to handle increases in input prices like we’ve seen the way like a Walmart, for example, can manage those margin pressures because they can negotiate with their economies to scale. They can really go in and negotiate better terms for their input costs and the smaller businesses can’t do that. So those are the two issues I see confronting smaller cap companies. And right now I don’t think there’s any reason to believe that those pressures are going to recede. Of course, the market believes that the fed’s going to pivot and rates will immediately come down and inflation is vanquished and everything’s good as we’ve talked about. I have a high degree of skepticism about that.

Meb:

Yeah. I was looking at some of the Cleveland now and I think was it Cleveland now saying that next month going to, they expect it to tick up on the next CPI rating. I think just on the year over year math, it looks like it’s bottom. I feel like the people that don’t pay attention to that, that might catch them by the surprise when they see the headlines and inflation going back up.

Stephanie:

Yeah, no. Honestly, I think that’s why the Fed did that thing where it said, “We’re going to take a break this meeting, but we’re not going to take hikes off the table because they know the math. They know last July CPI was zero. So the odds of us having a challenging comp this year we’re pretty high.” So I think that’s why they did that little sachet or whatever you want to call it at the last meeting.

Meb:

I love your charts MacroMavens. I’m a chart guy, so you speak to me when you have these giant chart books and you also have great titles too. So in a recent piece, it’s getting hot in here, which was that Nelly?

Stephanie:

Yes. I was going to say her, but I didn’t think a lot of my clients would get that.

Meb:

So we got some Nelly. And what’s interesting, I love tracking sentiment and following it. Sometimes it’s not super useful. Other times it’s I think incredibly useful, but a chart that really stood out to me. I always pause and take notice when I see big divergences, particularly if there’s a series that goes back decades. So you had the Michigan consumer sentiment versus consumer confidence and you see this massive divergence, which has really never really existed in the last 60 years. Talk to me about where sentiment is today. What do you see? What are these divergences and what’s going on?

Stephanie:

Yeah, it’s interesting. Well, both measures have ticked up in the last month, so I guess it’s important to acknowledge that sentiment has improved. But as you said, the conference board measure, which is called consumer confidence, is really close to its all-time highs. It’s at a level that’s been associated with prior peaks while the University of Michigan survey, even though it did pop up in the latest month, is still mired, not even just at a low level. But at the lows that we’ve seen at the absolute bottom of prior recessions, the weakest sentiment readings you would see at the bottom of 2000 and 2009. That’s where we are for the University of Michigan survey. So the two of them are telling you totally different things, and of course everyone gloms onto the conference board measure when in doubt. But the reality is, as I highlighted on that chart, we have seen divergences not of the magnitude we’re seeing right now, but we have seen divergences in the past between these two surveys.

And in each case it’s interesting. They seem to occur right on the eve of a recession. And what happens is the conference board number continues to move higher or flat lines while the University of Michigan survey is rolling over. And then eventually the confidence survey catches it on the downside, but it’s always that pattern and it’s always just on the eve of a recession. So I thought it was worth flagging just because we’ve seen this a few times before, not to this degree, but there’s something going on there to have two such starkly different readings on sentiment. And then so I dug in deeper to try to figure out what was driving, for example, the recent increase, and it’s not too hard to figure out what it is.

Obviously when you go through all the detail, you find out that what people felt best about was that their finances relative to inflation were improving. They thought that the odds that inflation outstripped their income, which had been a major concern actually were starting to dissipate. So the lower inflation readings, the cooler inflation, especially I would assume at the gas pump was making them feel better. And then of course the stock market coming roaring back. So you have to believe that those two things are going to continue to sustain or even accelerate from here to anticipate that this gap is going to close by the University of Michigan survey for the first time actually rising to meet the conference board.

And when you look over in oil well until today was back over $80 a barrel and nothing geopolitically or based on our domestic energy policy makes me think that that’s necessarily going to go lower anytime soon. This idea that light easing of pressures when you go to fill up your gas tank is going to persist, seems unlikely. In fact, gasoline prices have already moved up pretty sharply in the last month or so.

Meb:

Yeah. The trader in me hates that the White House didn’t book their W take the profit on their SPR refill. It seems like a very obvious policy win to say, you know what? We made this amazing trade. We sold it when it was high, we bought it when it was low. It seems like a really foolish move to leave it up to free markets to hope that oil is going to continue down as a policy mistake. What do you think about that?

Stephanie:

Yeah. Especially I mean, are they thinking that their diplomacy is going to persuade everyone to pump a ton of oil for us so we can consume it cheaply? I don’t know. I mean, don’t get me started on the energy policy because I have nothing constructive or good to say about it.

Meb:

One of the things I like about reading your work is you always have some wonky for many economic charts that many will not have heard of. And I love talking to particularly my macro friends when they get all excited about a chart or a topic, that’s not something that’s in my quiver. So there was some where you were talking about wholesale inventory sales ratio, it’s a mouthful and inventory cycle. What do those mean to you and why are they interesting or useful?

Stephanie:

Well, this really is wonky and it’s also very old fashioned. So I’m revealing myself to be both a nerd and a fuddy-duddy. But time was, and it’s actually I think me before you and I were really actively involved in what’s going on in the world when economic cycles were a function of inventories. You’d have an inventory swing where you’d overcorrect in one direction and then go back the other way. So they’d overproduce and right at the peak in demand and then they’d get stuck with a ton of inventory and they’d slash prices and slam the brakes on production and lay off people and you’d have a recession and then they’d realize, we cut production too much. We’ve got to ramp back up and hire more people, and then you’d have an expansion. And that was the tail wagging the dog of the economy these days.

The tail wagging the dog of the US economy seems to be the stock market, but it’s a topic for another day. But the reason I was focusing on inventories is it feeds a lot, obviously into the corporate profit story for companies that are in the goods business. And this is obviously a good window into the strength of the consumer as well. So what we had was obviously during COVID, the supply chain issues and no one could get anything. And then the companies were so burned by that that they went out and they ordered five times as much as they normally would to make sure they had a ton of inventory they could satisfy everyone’s built up consumption that they couldn’t make use of because the goods weren’t there, plus. And what happened was it turns out they way overestimated the demand that was going to arise after the pandemic ended.

So they got stuck with all this inventory and they started slashing prices and trying to move this inventory. And there’s this idea that they’ve all managed their inventory so well, but when you look at this wholesale inventory to sales ratio, what you find out is far from it at the wholesale level, which generally leads into the retail level at some point, the wholesale inventory to sales ratio has only been this high twice before, and both of those were big recessions on the backside, but for sure you would expect to see a profits recession as that inventory gets liquidated. And in fact, I don’t know if it was in that piece that I had that chart, but went back and looked at what an inventory cycle generally means for corporate profits and found that from the peak in the inventory cycle, corporate profits declined 22 percentage points on average the growth rate of corporate profits.

So if we were growing, I think at the peak of the inventory cycle this time, corporate profits are growing 6% year on year. That would imply that corporate profits will be minus 16% if you assume it’s a 22 percentage point swing by the time this inventory finally gets liquidated. That’s on nobody’s radar right now. It was a year ago, but now everyone has taken that off and we’re onto good things. So I think it’s important because everyone’s assumed that the worst is over, as I mentioned in the second quarter, and that inventories aren’t an issue, but that chart clearly suggests that they’re very much with us still.

Meb:

You mentioned profits, I saw somewhere else you’re talking about earnings. What do you think for the second half year and into next year, I think I saw at some point talking about earnings manipulation. What are you thinking about in this picture?

Stephanie:

Well, I don’t try to forecast S&P earnings, so I’ll throw out that caveat, but again, revealing myself to be a nerd, I like to look at the government’s accounting of corporate profits because S&P earnings not only only reflect the top 500 companies in the country, which as I mentioned earlier, is just a small sliver of what’s going on in the entire nation. But the S&P earnings, it’s not any state secret, are heavily influenced by share buybacks. And we’ve had this torrent of share buybacks over the last several years, less so now that the era of cheap money has come to an end. But we were doing a trillion dollar plus a year in buybacks, and that was really flattering the S&P earnings numbers. And you saw it when you looked at the difference between the profit figures that government was reporting every quarter and the profit figures that S&P was reporting every quarter.

And that gap has widened out again where the government data are showing a much bleak picture of what’s happening with corporate profits than S&P. In fact, I think by the government’s accounting, we’ve been in a profits recession for three quarters, whereas S&P sees it as only two quarters in, and the magnitude is very different. But then there was, I think it’s Indiana University developed this, I don’t think they call it a fraud score, but it’s a manipulation score for corporate earnings. And they go through and they look at things like the footnotes and what they’re taking gap versus non-gap and all of that. And basically their score is now the highest it’s been since the 1970s. They’re warning about earnings manipulation in the S&P numbers. So they’re waving the flag saying don’t believe the hype pretty much, which comports with what I see on the government profit side.

Meb:

Yeah. We’re going to dig that up and put in the show notes. I definitely want to check that out. We’ve talked a lot about the weird thing companies do. Stock-based compensation has certainly been one that’s been particularly feels egregious this cycle in the tech sector, but a very big transfer of wealth from owners of the stock to the executives for sure. Kudos to the executives. You somehow got this through.

Stephanie:

One of my pet peeves was when you’d see that they would announce a buyback just as the insiders were selling. It’s like talk about greasing the exits for these. I mean there’s a lot.

Meb:

Yeah. There’s been a lot of weird stuff going on. There’s a couple other areas that we haven’t really focused on that I know crosses your plate and we’re going to let you pick and choose here. So we could go with FX and the dollar and what do you think happening there? Or we could go to the shiny metal with gold or we could do both eventually, but which you want to pick first?

Stephanie:

Well, I mean I think they’re both related. One’s the flip side of the other basically. Yeah. With regard to the dollar, my view is that I think for a variety of reasons, the Fed probably isn’t going to disappoint people on this expectation that they’re going to pivot forth with among the variety of reasons. One would be what we talked about earlier, and that is that the math on the inflation numbers gets a little more challenging such that you could actually see them start to move back up. And for sure, I would think given what we’ve seen in terms of the recent firming of commodities in general and oil prices in particular, you’re going to see input prices go up and that’s going to have the Fed a little gun shy about reversing course prematurely.

So I think that’s one reason why this… In theory, that should be bullish for the dollar, but I think it could end up being a negative because it might feed risk off when people start to realize hey, the hope we had that the Fed was going to save us isn’t really coming and every day rates reset and another company files for bankruptcy and things aren’t looking so good out here. And that could lead to a real sell off that would then be obviously negative for the dollar.

But it’s an ugly contest. This is why I always like talking about the dollar alongside gold because it’s not really a question of how bad’s the dollar because the dollar sucks, but then look at our deficits and we just got downgraded and blah, blah, blah. But then look at Europe and look at Japan and it’s not like there’s someone else out there is a beacon of fiscal and monetary integrity that we can point to. So we’re pretty egregious, but we’re not alone. And that’s why I always end up coming back to gold. And if you want to get really dark, ultimately I think that the Fed will ultimately have to pivot because we’ll have a real market correction and that will force them as they always do to come rushing in with the fire hoses. But so will Europe and UK and Japan. So they’ll all run back to the printing presses.

And at some point, and we’re seeing it already with this brick plus consortium that’s really, I guess they’re meeting next month and they’re going to talk about a joint currency. They’re really saying we’re over it. We don’t want to be tied to these world currencies where their central banks are constantly printing money and silently defaulting on the debts that we’re basically financing. So that’s my longer term view and that’s why I own gold and I sleep well at night.

Meb:

I’ve been surprised a bit. I’m always surprised about markets, but I’m surprised gold and the miners both entered some of our momentum based screens over the past year but has had trouble breaking out over its all-time high levels and gold more than anything, I always think about sentiment and the younger crowd and what gets people interested in that versus globally and China and India. I don’t know, but I always thought it would might’ve made its move. But then again, I have a lot of Canadian Australian friends too, so maybe I’m biased. I chat with them too much. Any thoughts there? Is this a good time? By the way, most investors don’t have anything in gold. When we talk to them, real assets in general are pretty low, but gold tends to be almost nothing if anything.

Stephanie:

Absolutely. And I think in recent years, rather than making gold a portion of their portfolios, people have been more inclined to buy the cryptocurrencies and view that as a hedge against any debasement of the currency. So I guess that’s a topic for another day because I still don’t get into the whole crypto thing at all, but I too, I share your surprise that gold looked like it was breaking out and then cut smack back down. And it’s very frustrating and it’s hard to understand why, but I will say last year, as much as gold didn’t do very well relative to what the Fed did last year, I think it was phenomenal as a performance.

I mean, if you had told me going in to January, 2022 that the Fed would raise rates faster and more dramatically than Paul Volcker did in 1970, which they did on a rate of change basis, they blew Volcker away. I would’ve been happy if gold had been down 15% and thought well, that was heroic. So I think gold actually performed really well in the face of the Fed tightening, and maybe it’s a reflection of the same thing we’re seeing in this stock market that no one believes they’ll maintain the tightening. Everyone’s convinced that well, they’ll tighten until they break something and then they’re going to rush back in and we’re going to get so much more stimulus than we had before. So maybe that’s the thought process, but it’s not evident right now. It’s frustrating. I’ll confess.

Meb:

Yeah. We like to talk about ideas and concepts that are non-consensus, and you’ve already mentioned a handful, but if you look around at your peers in this world, a view that you particularly hold that the vast majority of your peers would disagree with, or that’s just largely non-consensus and you’ve probably got a lot, but anything in particular that comes to mind? Either it could be something right now or maybe it’s a tactic you say, look, I love this certain indicator or this way of thinking that no one else likes. Anything come to mind?

Stephanie:

I mean, I don’t know if it’s that I hold ideas, but maybe I focus on things that other people don’t think are important. That whole thing, which I probably went to off the deep end, but the whole thing about diminishing marginal returns, to me that’s really crucial and it frames a lot of my outlook for the economy. You need a certain amount of credit to generate a certain amount of growth, and if you don’t get that amount of credit, you’re just not going to get the growth. So when people come up with these immaculate recovery forecasts, my first question is, where’s it going to come from? This diminishing marginal returns thing is real and it’s empirical. You can quantify it, so how come you ignore it every time you develop a forecast? So that would be one thing.

Another thing, and this will sound really silly, but I draw a distinction between asset inflation and wealth creation. I think those are two very distinct things. And we get into these environments where people conflate asset inflation with wealth creation, and they assume, for example, that a bubble is actually like we saw with the housing market in 2005 and ’06, perfect example. We had rampant asset inflation. It was a bubble, it wasn’t wealth. And we learned that the hard way when it evaporated. So I think it’s important to draw that distinction. And I guess it’s across that I bear because I am often painted as a permabear, and my retort to that is I’m not a permabear. I’ll be bullish the day the fed stops manipulating with the markets. That’s when I’ll be bullish. When it’s a real market, when it’s a fundamentally driven rally, not some sugar high that’s based on the fed continuing to pump money into it. You may call that a bull market. I call it a bubble. To me that’s a distinction.

So I get beaten up for that, but I just don’t find that to be a compelling investment backdrop. I’d rather own gold. And in fact, since 2007, gold and the S&P have performed exactly the same so they can call me a permabear, but in real terms, I’m doing just as well as they are. Maybe it’s a nuance for looking at the markets and it may be a road to poverty, but I can’t get out of my head that there’s a difference. I want to buy into a market that has strong fundamentals, not that is reliant on Jay Powell coming to the rescue every time it stubs its toe.

Meb:

What you mentioned a little bit when we think of very long-term measures of sentiment and the way people behave was you have a chart, and as one of my favorites is stocks is a percentage of household assets. And it looks a lot like the S&P price because as it goes up, they own more as it goes down, they own less, but it has an incredibly high correlation to future returns, obviously in the inverse when people are most allocated. But in part of that’s just simply valuation. When stocks get really expensive, 2000 COVID peak, your future returns are probably lower because buying an infinite stream of cash flows. And that chart to me is near or at all-time highs relative to history and higher than 2000.

Stephanie:

Absolutely. And I don’t think a lot of people appreciate that. People will argue, “Well, that’s just the top 20% of households that have all the equity assets.” But it’s not really true because the average Joe has a pension and those pensions are loaded up with stocks and junk bonds I might add, and increasingly private debt and leveraged loans and all the stuff that’s opaque and likely toxic. So they are too, they’re chasing those returns at exactly the point where they’re about to flip back the other way. So everyone’s going to get hit by the reverse wealth effect, not just the people at the high end.

Meb:

We did a tweet today that was a retweet poll of one three years ago, and I’m always asking these to just gauge sentiment and see what people are thinking, and sometimes they’re historical quizzes, but one today was I said, do you own US stocks? So far the result was 95%, and these results are the same as three years ago by the way. Would you continue to own US stocks if they hit a 10 year PE ratio of 50, which is higher than they’ve ever been in history in the US? They got up to like 45, I think in ’99 and three quarters of people say yes. And then I said, would you continue to hold them if they had 100?

So double the internet bubble higher than Japan in the eighties and half the people still say yes. So there’s definitely a cult of buy at any price, hold at any price valuation be damned, which to me is a little odd. By the way, goes against what Bogle would say. A lot of people think that Bogle was only a buy and holder, but that’s actually not true. So I think part of that, if we do that during a 50% drawdown, it’s probably going to be a different response in the opposite, which is more detrimental. You should probably be more interested at that point, but I think it’s a good description of the times of this cult of stocks at any price.

Stephanie:

Yeah, absolutely. Well, and it’s contagious. The FOMO, it’s very hard not to get swept up in it. And then in times like this, if you’re not swept up in it, not only do you feel like you’re missing out, but you feel like a moron. When everyone’s out there saying, “No, obviously we’re not going to have a recession. This is going to be fine.” And suddenly everyone left the room and you’re still standing there like, “Wait, guys, what did I miss?” It’s challenging, but I don’t know. It’s classic as well.

Meb:

As we’ve done a tour of the world. Any thoughts generally on positioning? We’ve touched on just about everything. Should we just T-Bill and chill?

Stephanie:

That’s a great one.

Meb:

A lot of advisors I was talking to in the spring were just like hey, I’m just hanging out in cash. Can see what’s going on. Any other things that we haven’t talked about maybe that you want to touch on or any implications that you think are particularly important?

Stephanie:

Well, the T-Bill thing I think is worth underscoring because especially right now, there’s so much uncertainty. We don’t know what the Fed’s going to do. We don’t really know if we’re going to have a recession or not. There’s so much. The election next year, blah, blah, blah. You can get five and a half percent in a six month T-Bill. On an investment grade bond, you get 574. I’m looking at my screen. So you’re chasing risk for 25 basis points. And to me, that just is so ridiculous. You couldn’t pay me to buy an investment grade bond. I’m so happy sitting in cash and waiting for evidence one direction or the other. I don’t need to be a hero. Just give me some time to sit on the sidelines and gather more information. You’re getting paid to wait.

But other than T-Bills, which I like, I think one area that could be interesting, and it does relate back to the whole topic of the dollar in gold, et cetera, is the bricks and this August 22nd brick plus meeting that they’re having where they’ve been rumored to announce a currency that will reference gold. And they have apparently been spending not just the last few months, but years over a decade working together to develop an infrastructure, financial, economic, geopolitical. They’re coordinating on all of these things.

So I think that meeting, even if they don’t announce a currency that references gold or anything really substantive like that, I think it may start to draw attention to how much work these guys have done in building a cohesive unit. And the degree to which the west has really ignored this to their own detriment. We have this hubris that these are just snotty upstart countries who never will have any chance of competing with us. Well, as it is now, the number of existing brick countries and the ones that are applying for membership control 54% of GDP on a purchasing power parity basis. They’re already larger than the G7 economies that think that they’re in control of everything.

So it’s a huge deal, and it’ll be interesting to see what comes out of the meeting and what the market reaction is to it, because I think that global investors have really underestimated the potential from this group, especially relative to what’s going on the west. You talk about how everyone’s got allocations to stocks, look at what share of global investors are allocated to G7 stock markets, EFA markets versus the emerging markets. And it’s a joke and it never changes. It’s not like it’s suddenly becomes meaningful even for a blip. It’s just static.

Meb:

Maybe back in 2007. We do a lot of tweeting about that, and I feel like it’s just yelling into the void about the US used to be a little upstart country not too long ago and was not anywhere near the largest stock market beginning of the 20th century. And we do a lot of tweets on do you own emerging markets? And I think the average Goldman says 3% of the stock allocation versus a market cap of let’s call it 12. And as you mentioned, one of my favorite polls is how much of the world is emerging market GDP? And everyone’s like 10%, 20%. A little higher. But historically, GDP weighting equity markets has not been a bad strategy either. Versus market cap weighting, which tends to get you exposed to these little big bubbles every once in a while. Stephanie, we love to ask our guests, what’s been your most memorable investment, good, bad, in between?

Stephanie:

Okay. Well, I sublimate all the bad ones, so we’ll just go right to the good ones. I guess my most memorable investment would be my first apartment purchase in New York. And I bought an apartment with anyone as familiar with New York on Gramercy Park, which is the only private park in the city and had a key to the park and whatever. So in terms of location, location, location, I did well on that and I bought it in 2002 just as the housing bubble was starting to inflate. And I remember about a year into it realizing this really isn’t going to be where I’m going to live forever, because it was a lot of young families with kids and they were in the park and you weren’t allowed to eat in the park or have dogs in the park or basically it was like, why am I living on this park with a bunch of families and I don’t have a family and I can’t go in there with my dog and have lunch?

So I started thinking about selling it, and then the guy in the apartment right below me listed his for 50% more than I had paid just one year earlier. And I thought, “That’s insanity. This is crazy. You got to take this profit all day.” So I listed my apartment and sold it for about that much more than I paid for it and went on to rent and schmuck that I am rented for the next 18 years.

Meb:

Hey. Ramit Sadie, one of our personal finance gurus would love to hear that. He is always talking about the rent versus buy. There’s a lot of romance when it comes to real estate ownership. It is my version of an absolute nightmare to be managing other properties. I can barely deal with our own stuff, but the real estate crowd, my God. God bless you. You cannot force me to get into that world.

Stephanie:

Yeah, no. I am so with you, Meb. I said if I won the lottery tomorrow, I wouldn’t buy anything. I wouldn’t buy a house. I would stay at nice hotels everywhere I went or rent a place or whatever. I don’t want to own anything. I would fly private absolutely everywhere.

Meb:

Yeah. Well, the Mega Millions is up to 1.2 billion, so maybe there’s a chance for us both. Stephanie, this has been a whirlwind tour. You’ve been awesome.

Stephanie:

Thank you.

Meb:

Can release you into the Colorado afternoon to go hiking. What are you going to do? You got any plans?

Stephanie:

I was going to hike, but as we started talking, it’s raining now. So we got those monsoon rains rolling in now. Summer is so short, it’s August 1st or whatever it is, and it’s already cold.

Meb:

I saw the hailstorm from Red Rocks made national news, so that’s like right down the road from my mom. Tell us a little bit where people go to find out more about you. Read your work, watch what you’re talking about, sign up, where do they go?

Stephanie:

Cool, thank you. Well, they can go to macromavens.com and learn all about my background and read some reports and subscribe. And in terms of following me, I’m on Twitter, although I’m not the most aggressive tweeter. Actually, what do we call it now, Xing?

Meb:

Xer.

Stephanie:

I’m an Xer. God.

Meb:

Something like that.

Stephanie:

But it’s @spomboy and then just look for me on wonderful things like this. Thank you for giving me the opportunity to chat with you, Meb.

Meb:

Yeah. And you’re well-behaved. English bulldog didn’t even make a peep, who also makes an appearance on your Twitter. Hopefully we get to hang out in the real world soon. Last time I saw you I think was in Sonoma Napa drinking some wine and wine country. Who knows where it’ll be next time. But thanks so much for joining us today.

Stephanie:

Sounds good. Thank you, Meb. It’s been a pleasure.

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