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- [00:00]
A
Today's Animal Spirits Talk youk Book is brought to you by State street. Go to statestreet.com im to learn more about the original OG ETF spy. Also check out Uncommon Sense for all the research insights. That's statestreet.com Im to learn more welcome
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B
to Animal Spirits, a show about markets, life and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.
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A
Welcome to Animal Spirits with Michael and Ben returning guest Michael Aroni, Chief Investment Strategist at State Street Investment Management. I think we could just wind him up and let him go, but we talked about everything going on in the market today. Winners, losers, AI. It's funny, we didn't get into geopolitics till 60% of the way through our conversation, I feel like, which is kind of surprising. These days that's all anyone cares about except for maybe the market. I think the most interesting thing is the fact that earnings estimates just keep going up and want nothing to do with what's going on in the Middle East. Don't care. I guess as long as companies keep making money, the market won't care.
- [01:25]
C
We had our earnings from Goldman this morning and David Solomon said we're only a couple of weeks into the quarter, but the quarter started with very significant engagement across all aspects of the business. The quarter started in a positive way. We'll say the level of certainty is higher, but at the moment the engagement's pretty high and we're seeing that. I mean, it's early, but you heard that from Delta. And of course they're wildly exposed to higher jet fuel and the market is looking forward past it, corporations are looking past it and the market's been right so far.
- [01:55]
A
Yeah. So we had to throw a bunch of questions to Michael about like what are the risks? Give us the actual risks that could derail this thing because nothing seems to be able to derail.
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C
Nail the top, please.
- [02:04]
A
Yeah, so we got into all that and more. A little history on the ETF game. Here's our talk with Michael Aroni from State Street.
- [02:15]
C
Michael, as always, great to see you.
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D
Good to see you, Michael. Good to see you, Ben.
- [02:18]
C
I saw a tweet from Balciunas this morning. ETFs as a group set a quarterly record with 22 trillion worth of shares traded in Q1. March was also the biggest volume month ever. Volume is on pace to beat last year's record by 50%. Really is an incredible moment for the ETF industry. Spy. Spy needs no introduction. Was there from the beginning. I think it was the first ETF launched in 1993, if my. Correct me if I'm wrong. Do you remember where you were? When? When, like what, what, what do you think about what, the early days of the ETF industry, when this thing was launched or. You were probably in high school, actually. Forgive me.
- [03:00]
D
No, no, I was, I, I graduated high school. I was in college actually. So I was, I was probably a sophomore at Bentley College, it's now Bentley University, back in 1993. So I probably wasn't thinking too much about the ETF industry and spy at that point. But certainly from our perspective, again, way back then, if you wanted to own the s and P500, you had to buy all 500 stocks or a mutual fund. And neither were particularly convenient or accessible from that perspective. And so of course, since that timeframe, as you're highlighting, the ETF industry has grown to more than 13 trillion in the US, more than 20 trillion globally. And Michael, you were mentioning those stats. This is the quickest point. We've reached up to 500 billion in new flows, the fastest in a new year ever. That's coming off of records in 2024 and 2025. And that's for the industry. Let me be clear, that's not just for SPY or for spy, but this is the fastest. The industry has gotten to half a trillion dollars in just a few first few months of the year. Adoption continues to be incredible.
- [04:06]
A
If you had to try to narrow it down. How much of this is just cannibalization of current funds, like money's coming over from mutual funds or individual stocks or whatever, as people, you know, go to advisors or just go on their own and try to allocate, make allocations easier versus new money. Do you have any sense of that? How much is new money versus how much is just money that's already been invested in different vehicles?
- [04:25]
D
You know, it's hard to quantify, but I do think it's clear that the mutual fund industry itself, in terms of the assets have been falling. That's no secret from that perspective. And investors have voted with their feet and they voted to take to the ETF in terms of its low cost, its liquidity, its transparency, accessibility, its tradability, all Those types of things. But in terms of kind of new money, I think there's kind of an intersection of a few things. Certainly as we move from a more commission based wealth management platform to one that's more goals based financial planning, the wealth management community, the RIA community, the broker dealer community has adopted ETFs enthusiastically. And ultimately you're seeing, I think that is where a lot of the new money continues to come from. And Ben, when we look at the breakdown in terms of where is new money coming from in terms of assets generally, whether we look at like US wealth or institutional defined benefit, defined contribution, these types of things, retail investor, the US wealth community continues to be the fastest growing pool of assets and they are the biggest adopters of the etf. So I think it's fair to say it is a balance. But I think that given the incredible kind of creation of wealth and the growth in the wealth management, US wealth management industry, a lot of this is coming from new money.
- [05:53]
C
So obviously a combination of money coming, rolling out of the 401k into the IRA, getting out of the funds, the mutual funds are going to the ETFs as part of it, there's a lot of new money still coming to the market. I'm flabbergasted every time we hear these numbers. I'm like, because of the acceleration. It's not just the staggering amounts, it's the acceleration. But getting to spy and the market generally, there has been a lot of concern, anxiety, consternation, whatever you want to, however you want to describe it, about the concentration in the market and the lack of participation from the 493. And there was a lot of people over the last couple of years saying if the engine of the Mag 7 slows down or stalls or heaven forbid, goes in reverse, watch out below. It just did not come to pass. In fact, the opposite is true. Yeah, the Max 7 had a terrible quarter. They were down 16% year to date at the lows in April, they've rebounded since, but they're down 7% on the year and the S and P is flat. Obviously the 493 is up. Can you talk about the dynamic of the incredible rotation that we're seeing seemingly on a day to day basis? Like we're recording on Monday, April 13th and software is having an incredible day now. It had an incredibly bad three, three day stretch. Like in particular, there was a puke last week. But alternative asset managers, nobody wants to own and they're bouncing bigly today along with software and it, it's it just seems like it's happening every day. There's a new leadership group and of course if you zoom out like you know there's things that have worked over a longer period of time outside the intraday stuff. But the rotation inside of the index is really incredible.
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D
It's been phenomenal and it actually started Michael, back in November of last year I think is really when the AI bubble fears, the fears around whether all this hyperscaler capital expenditures were going to achieve the return on investment would businesses and consumers, what is the rate of adoption for AI, what use cases are we going to use? All that began to come under question. Of course we would have seen it reflected through kind of examples like Oracle increasing its CapEx and then ultimately rather than funding it from operating cash flow, having to go back to the debt markets to do it, meta increasing its capex and really disappointing investors. To me it was a critical churning point. But what you're describing, the good news is is that really from that period on up until the US Iran war broke out, you saw a significant shift in leadership and the markets actually performed well. In January and February, small and mid cap outperformed, industrials outperformed, international and emerging markets outperformed last year and in the early stages of this year and you saw a tremendous amount of rotation. For me, I think what's driving that is there's been a clear kind of shift in the underlying market dynamics. And what I mean by that is really if the kind of environment has been driven by globalization, by efficiency, by global trade, free trade, by this notion of global cooperation, peacetime dividend, low rates, benign inflation, if all of that I think is kind of slowly churning under the kind of the system here and now we're moving to a more de globalized framework where it's kind of, we're remaking the global trading system. Of course there's been more geopolitical risk, higher rates, stickier inflation. So we're moving from efficiency to resiliency. And through that transition you're seeing a rotation in leadership and you're seeing kind of real assets in gold and industrials, energy, materials.
- [09:51]
C
It's exciting.
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D
These are the leadership and I think ultimately that structural underpinning is what's changing now and really leading to kind of this dynamic. And it's I think a lot of times investors lose sight of that. Like we focus on what's happening day to day and we're kind of losing sight of the fact and I don't care Michael, if you go back to whether it's 2016 and it was Trump and Brexit. Whether it was the pandemic in terms of its expo, kind of exposing what global supply chains look like, or if it's kind of the trade war, all of these things have led to a real shift in the underlying investment environment. And I think as a result, you're seeing some real differentiation amongst winners and losers and a real rotation now that's got some legs to it.
- [10:39]
A
I think the loser piece is the most interesting to me because typically when there's a new innovation like this, all investors want to do is find out that what's the big winner going to be? Right? And it seems like this cycle for AI has been who are the losers going to be? So Michael mentioned software. That's the one everyone's focusing on. I looking at even today, like consulting firms Booz Allen and Accenture and Gartner, they're down like 50, 60, 70%. And it's, I just think, I don't remember a time like this when there was such a fast rerating for the losers. I've seen it for the winners before, but the, the separation among people trying to figure out what is AI going to disrupt in terms of making losers. That to me, seems like a new part of this kind of cycle.
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D
But I think it's an incredibly healthy part of the cycle, Ben, and I think it's an important part of the cycle.
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C
Not if you own those stocks.
- [11:27]
D
Well, yeah, I hear you. Well, what can I tell you? I do think that this is a critical transition point in the CapEx cycle that I believe began back in November and is continuing to unwind. And I think naively, back in the early stages of the AI phenomenon, markets kind of believed that everyone was going to be a winner. And that's not how capitalism works. We know that. So of course, out on the horizon there's these exceptional returns and all of this CapEx is chasing that potential. I think where we are now in the cycle is investors have come to realize that some of that, dare I say most of that will be spent wastefully and only a small portion of it will be spent productively. And now I think we're trying to determine those winners and losers. The one I've been kind of using as an example, Ben, is that back in the TMT bubble days, right? It's our most recent corollary, you have the four horsemen and I think you could probably add a fifth, right? It was Cisco, it was Dell, Microsoft, intel, and you could probably add Nortel Networks. Now, Michael if we think about that list, only one of those companies has really reinvented itself and added value to shareholders. Four of them continue to struggle to this day to recoup those highs. I think we're in the part of the cycle for AI now where that is happening and I think it's a healthy transition. We can't all be winners. There will be winners and losers and I think the market is trying to find that out. And given where valuations were, I think ultimately they're kind of selling first and asking questions later. But I think they're laying the groundwork for kind of ultimately who will be the next winners and we'll see. This is creating a great deal of opportunity in my opinion, for those that could get this right.
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C
Over the last couple of years we've played this game from time to time, like which Mag 7 stock would you least want to own? And sometimes you could throw out Apple. Like I just think, you know, whatever, why are they so expensive? Or you could throw out Meta, whatever. And I had always been on the side of I know what history says, I know that the names at the top 10 do not persist from decade to decade. But we've been having this conversation about these hyperscalers for so long they've continued to reinvent themselves because they are, there's no precedent in history to these names. They're not AT and T, they're not General Electric, I understand those are big companies, but these are monopolies, they're conglomerates. They just buy all their competition. Like they just seem impenetrable. And of course I couldn't see, and the story is still being written, but I couldn't, I couldn't see the, the thing coming and the transition from asset light to asset heavy. I saw a chart this morning from bank of America showing that a lot of these companies are projected to spend 90% of their operating cash flow on CapEx. Of course that's a moving target, but let's just say it's directionally correct. Investors don't like that. And you're seeing that, you're seeing the rotation away from these names.
- [14:41]
D
Yeah, absolutely. And so we were joking around up front about spy, where I was, you know, you were teasing me, saying I was in high school. You go back to 1993 and we look every five or 10 years and we look at the top 10 names in Spy just over that 30 plus year period. You're certainly seeing the shifts from the Cisco's, the General Electrics, the General Motors, the ExxonMobils. There's been a number of dramatic shifts. And Michael, I think in every one of those periods people would say, boy, these companies will never be displaced. They have a comparative advantage, a capital advantage, a structural advantage to everybody else. And yet it happens every single time. And so, you know, I kind of joke around this notion around. If you think about what happened in the TMT bubble again, it's the most recent corollary in terms of all that spending that, that went on. I've been using kind of Netflix as a little bit of the example here where that massive amount of spending on broadband capacity ultimately laid the foundation for the new companies, the new winners. Netflix, I don't know. Ben, you and I were receiving the CDs in our mail when Netflix started. It was only the laying of all that broadband capacity and all of that bubble investing that allowed them to become the streaming giant that they are today. So all these hyperscalers are laying the foundation through all of this investment and the data, the data center infrastructure build out for someone to come along and get that excess capacity and take it in a different direction. Now, hey, I work for an ETF provider, so I'm not exactly sure who that winner and losers will be, but ultimately I'm confident that that's kind of where this cycle is heading. And in this mag 7 there's a few Nortels, Intels, Dell computers and Cisco's and there's probably only one or so Microsoft's, as if we're going to use that example of kind of moving forward in terms of creating value. And I think that that will happen yet here again. And I think the market has started and investors have started to realize that and they're kind of looking towards areas of adjacency that will benefit, like in industrials with the kind of modernization of the power grid and the investment that's being made there for a time.
- [17:06]
C
It sounds like you don't think, with the caveat that of course we're all just guessing the best we can. It sounds like you don't think that the Mag 7 will get to like 50% of the index.
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D
I don't believe so. I think that again, ultimately what will happen is that. And you're already seeing this happen a little bit early on. To your point, they were funding a lot of this investment for from operating cash flow. Those dynamics are shifting and we're seeing that kind of free cash flow margins, they were getting squeezed and ultimately that was putting some pressure on the companies. It was the notable shift. They can't grow at these rates in perpetuity and others will seek to kind of displace them.
- [17:48]
C
I agree, but they have, it's so crazy that they have. We've had this conversation forever and yes, of course, at some point, like the numbers get so big that they will just collapse on the way to themselves. And not literally, but, but man, it's just been like a persistent conversation like this. But one of the great things about an index is that you don't have to obviously selecting the winners and timing it is exceptionally difficult. But at 35% of the weighting or whatever it is, you're going to need industries and sectors to reinvent themselves. You're going to need financials, which are a huge weighting, to pick up the slack, like energy, which I think is still less than 4%. I mean, it's, you know, it's had an incredible run, but you're going to need other areas of the market to see some of the benefit of the efficiencies that we're hoping are generated by, by this AI stuff.
- [18:37]
D
Yeah, and you were asking me about that rotation. So for us, we were probably a bit premature and suggesting that investors begin to think about diversifying away from that concentration. Right. And I think that in many ways that confrontation with concentration was underway since November. It really took up speed in January and February, certainly with the outbreak of the US Iran war at the end of February and throughout the month of March here, now entering its seventh week, it has disrupted some things. But our view was that ultimately when we looked at the 493 or we looked at small caps or even looked at emerging markets, what was now beginning to happen was that their earnings growth rates were closing the gap with technology in the Mag 7. Now, Michael, I do think, right as we're chatting, you mentioned you marked it April 13th. We're on the cusp of earnings season and to your point, we're still not there yet. Technology companies are expected to deliver 45% earnings growth year over year this quarter on revenue growth of 27%. And they trade barely above a market multiple, given some of the things this rotation that we've chatted about. And yet in some ways they're insulated from inflation and higher rates and geopolitical risk. Not completely. And so at a time when growth is slowing, boy, technology is starting to look a little bit more attractive. And interestingly enough, we just upgraded in our sector work. So despite my concerns long term, like any good strategist, Michael and Ben, I could talk out of both sides of my mouth some of my concerns about the Mag 7, I certainly think at least today, in an environment with sticky inflation, geopolitical risk slowing economic growth, getting that kind of assured growth rate on the earnings growth side and the revenue growth side and paying roughly a market multiple for it, that doesn't seem like a too bad of a trade off, at least in the here and now.
- [20:39]
A
So do you think that the earnings story is in AI is the reason that investors haven't really freaked out about the geopolitical situation? Because we had a minor correction. But I've been telling Michael for a while that it seems like most investors would have assumed if you would have given them the setup, a war in the Middle east, oil supply and demand dynamics totally messed up and oil shooting up 60% in a couple months or whatever, that would have had a much bigger impact on the markets. And the market has kind of looked past it. Is it just like, hey, until we see this hit earnings, the market's not going to care as much as it would have in the past?
- [21:14]
D
I think that's part of it. Ben. I do think that so far when we aggregate the economic data, it doesn't paint a strong picture, but it certainly doesn't paint a picture of recession. And so I think that when we look at the earnings growth where it's forecasted to be and likely to come in, combined with the continued business fixed investment and by the way, AI Capex spending is carrying the heavy load on that. It's rare for us to get an economic contraction under those two conditions. And so I think the market has largely shrugged it off from that perspective. I think also the other thing that the market has convinced itself, and this may pose the bigger risk or the biggest risk, is that this war will be measured in weeks, maybe a couple months and not in quarters in years. So the market is convinced that there will be kind of a negotiated resolution without mass casualties and a short duration war. And I think ultimately even today it's oddly again, you guys are brought up today. I'll bring up today right. Over the weekend we've had a failure to reach agreement between the US And Iran. The Trump administration has started a blockade on the straight, and yet markets have kind of shrugged it off and are moving a bit higher today. And Ben, to your point, I think it's largely the fact that earnings are forecasted to grow at about 13% year over year. When all said and done, that number will come in close to 19% year over year on revenue growth of close to 10%. Net operating profit margins have Rarely been higher. And I think that that is, I don't know about masking, but overshadowing a lot of the geopolitical risks, a lot of the inflation concerns and a lot of the concerns around kind of monetary policy and other kind of things that could weigh private credit concerns that are weighing on the markets is the earnings have been just so good.
- [23:08]
A
You mentioned recession. If you had told me, coming out of the great financial crisis, hey, in the next 16, 17 years, there's not going to be another credit cycle. We're going to have a few industries that go through their own minor recessions on their own. There's going to be ups and downs, but we're not going to have a recession except for we turn the economy off for a month, we turn it back on. That's essentially a fake recession because so much money was sent out. We haven't really had an economic event or a credit cycle in nearly 20 years. We're getting to that point now. Would you have believed it back then? Because in a million years I wouldn't have believed that the cycle would have lasted this long. And I know we've had different parts of the cycle and it's changed, but we haven't really had a cycle.
- [23:47]
D
I would struggle to believe it. But now, with the kind of benefit of hindsight and me, you and Michael have chatted about this before and we always get a chuckle. You guys always get a chuckle out of it. So every time there's a threat of a recession and market volatility, the plunge protection team comes in and saves the day. So I think, Ben, what we've had in its place of that cycle is incredibly strong and responsive fiscal and monetary policy stimulus at every turn. Whether it was the TMT bubble bursting, whether it was the global financial crisis, whether it was the pandemic, at every turn, governments and central banks have stepped in to try to prevent the worst case from happening. And I think markets have been a little bit, I don't know about lulled to sleep, but kind of recognize this pattern. And it's contributed to this idea that kind of volatility has been muted despite kind of headline risks that are galore. And I think that that kind of continues to this day that investors believe that if a recession were on the horizon, the Fed's going to slower rates, expand the balance sheet, and the government is going to pursue massive fiscal stimulus. What concerns me is that the wiggle room has shrunk considerably. We're in a different rate regime and a different inflation regime doesn't Mean they won't try it. It just I wonder if, if kind of the pursuit of it will continue to kind of cause the potential for the risk to build and not shrink. But boy, every time there's a problem, you can rest assure that the government and the central banks are here to save the day.
- [25:29]
C
You're right. Everybody is incentivized for the system to not break. Thank God. Everybody wants to get in power, stay in power and prevent a catastrophe on their watch. But and also anytime this sort of conversation happens, it's framed as investors naively buying the dip or being lulled to sleep and not understanding the environment or the risk or blah, blah, blah. But let's be clear that if earnings weren't growing at the rate that they are, then the stock market would be doing much differently than it has. It's hitting all time highs because the earnings that these businesses continue to deliver are also hitting all time highs.
- [26:11]
D
Yeah, you think about this. In this century, essentially the profitability for US companies has almost doubled. Doubled. Now you need to think about what is driving that. And some, from my perspective, there's a few things. Lower interest rates, which lowered interest expense and the cost of capital. Lower taxes. So the corporate tax rate has come down pretty dramatically in this. It may not always feel like it, but it's come down pretty dramatically from where it was kind of in this century. And it may even come down a little bit lower. You had globalization. So this is a second kind of structural trend that we've been chatting about. So if globalization is all about efficiency, then de globalization is all about kind of resiliency. And I think that that is one of those structural changes that's unfolding here. And then finally, Michael, you've mentioned it a few times and we've chatted about it a lot is around the technology front. So the dominance of US technology companies where the, the incredible amounts of return on invested capital, return on equity has just been phenomenal when I look at those figures to your point. So again, let's, let's talk some more about spy. That's what I'm here for. I look at the top 10 contributors to the largest contributors to SPY's performance over the last decade. Their return on invested capital and return on equity are both above 30%. That is your U.S. exceptionalism.
- [27:39]
C
Damn right.
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D
It doesn't exist anywhere else now. But here's the thing. Me, you, Ben and our listeners need to determine going forward the sustainability of that. When I look at those metrics, we are really, really, really relying heavily on our Ability through productivity gains, through the AI phenomenon to keep the sustainability of those profit margins moving forward. Meaning I think that 2008-2022 was an unusual period for interest rates where they were kept near zero. And at one point we had $18 trillion in negative yielding debt. I had to pay Germany for the privilege of holding onto. My money exists in no textbook that we ever read. We're beyond that. The second thing is, given where we are fiscally at some point, whether you're Democrat, Republican, Socialist, libertarian, Communist, taxes are probably going to have to go up to help us address deficits in the future. And of course we're moving from kind of a globalization period to one that's a more de. Globalized period. So when I look at the four things that drove that doubling in profit margins, boy, we are really banking on AI productivity gains to help us kind of sustain them or continue that growth rate. Now I'm not saying it won't happen, Michael. Like you said, we don't know. I don't know. My crystal ball is as murky as everyone else's, but boy, that really has to continue for that sustainability could happen. One of my favorite books is the Rational Optimist by Matt Ridley. And so look, policy could change to allow for those things to continue. But it's been quite a good run and some of the tailwinds are turning a little bit. Not into headwinds, but maybe into a little bit of a strong, strong breeze.
- [29:26]
A
Is it too glasses half full to think that AI could just solve a lot of our problems? Because you do have, because of the government debt loads and the deficits and the geopolitics that would seem to be inflationary to me. Could, could AI be the offset? Is that two rose colored thinking, rose colored glasses or whatever that, that AI could just solve some of these problems for us. We have an aging population that's going to need to be helped and our fertility rate is declining. Is AI just going to be the solution?
- [29:52]
D
It possibly could be. And I have some great news for you, Ben. So the census department estimates that only about 20% of U.S. companies on a labor weighted basis have started any meaningful investments in AI. So a little bit to Michael's point, despite this notion that it's a bubble and it's saturated and everything's AI there's commercials now on tv. I just saw, maybe you guys were seeing this. There's a commercial where it's like AI, AI, AI. And like they try to decipher the kind of the noise from the AI we're just scratching the surface. And in many ways I do think AI through productivity gains will be an important and critical solution to solve some of these challenges. I believe it'll be disinflationary. I believe it will help solve some of the challenges in terms of the labor force dynamics that are out there, in terms of the fact that both the demand for labor and the supply of of labor are falling at the same time due to demographics, due to AI, due to immigration reform. So AI plays a critically important role here. And I think what's also important is for all those folks that bought into the AI bubble talk, what's interesting is that the 90s capex cycle was much larger and much bigger than where we are today. When I think about that 90s AI cap cycle lasted seven to eight years depending on when you want to start the AI cap cycle. I only think we're in year three. And the other thing is, is that capex spending during the TMT bubble was upwards of 5% of GDP. We're not at those levels yet as it relates to AI. So given all these stats, Ben, I think that this has a long way to go. But like we talked about earlier, I'm not sure that today's winners will be tomorrow's winners. I think that there will be a significant amount of differentiation now going forward, kind of trying to determine who will the winners and losers will be based on a kind of number of the things that we've discussed already.
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C
Your answers are too good, Michael. I got nothing. Got no follow up.
- [31:56]
D
What, what am I. I'm leaving you two guys speechless. Come on, there's no way.
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A
I'm curious what you could see beyond the geopolitics like actually derailing this cycle. Because it's. We, like I said, we've had these certain segments of the, you know, tech went through a recession essentially a couple years ago. The housing market has essentially been frozen. None of this stuff that we've been throwing at the economy has really mattered. So what'll it be, you know? Cause there's the old thing like you can't kill yourself jumping out of a 6 inch high window, right?
- [32:24]
D
Yeah.
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A
People worried about consumer debt and like none of this stuff has mattered. So like what is it that finally throws us off course?
- [32:32]
D
So Ben, I think, and again, you're not asking it this way, right? So we know black swans and unknown unknowns by definition, I don't know what those are. They're lurking, they're out there. The Hundred Year Storm happens more than every hundred years, right? TMT bubble bursting, GFC pandemic all happened in a condense. So this idea that we're somehow markets sit in normal distribution, I'm not saying that you say that they don't. The tail risks are bigger than anyone can imagine. So they're out there. So if we acknowledge that, let's acknowledge it, let's put it aside and let's come up with in my view a logical answer. And that logical answer is, is the arbiter of whether this bull market and this economic expansion or non recessionary environment continue or were to continue. Really the arbiter is is long term interest rates. And I think that clearly when we see long term interest rates rise to a certain level, you begin to see the cracks begin to form. We just haven't got there. We Talked about the QE period 2008 to 2022. This whole century has been highly unusual. We've had some flirtations with higher interest rates, but we just really haven't had anything meaningful. People during the fact of when the Fed the rate hiking cycle that the Fed underwent, they were saying, boy, where's this maturity wall? Businesses and consumers, they had already locked in at incredibly low rates. There was no maturity wall. But the next time around there could be. And so I do think that higher rates are potentially a challenge. We all remember the kind of August 2023 to October 2023 period and that ultimately the Fed concluded its rate hiking cycle in July. We didn't know that then, but we know it now. And then you'll remember that then Treasury Secretary Yellen started at the for the first time in years began to extend maturities on treasury debt. Issuance hadn't happened in a while, so she started to do that. And ultimately rates rose from August and they surpassed 5% for the first time since 2007 in October of 2023 and peaked at the end of that month. And then like we talked about earlier, the plunge protection team came in. The Fed started talking about lowering rates. Treasury started to use T bills to refinance at shorter levels. Sure enough, interest rates backed off of that level and started to cool. From that perspective, we haven't tested it again. Should we test it again? I think that that becomes problematic for markets. And it's based on this idea that the value of any stock, bond, real estate or anything, it's the present value of the future cash flows discount on the discount rate for using 10 years or interest rates as a proxy for that discount rate, they're higher. Everything's going to be a little Bit lower or re rated lower. That was our 2022 problem. We addressed it and we moved forward. I guess for me, should it reveal its ugly self again? And look, the Trump administration, or any administration, any government and central bank has far less control over longer term interest rates than they think they do. So so far they've been contained for a whole host of reasons. Global cooperation, we are all in this together with the dollar as the world's reserve currency. But should they get away from us? I do think that that could be the arbiter whether this rally and economic expansion continues.
- [35:49]
A
That makes sense to me. I've always been of the opinion that our economy is not built to withstand higher rates. And that's why I never thought the Fed would jack rates up as high as they did because of that, because we have so much debt, because we're paying so much interest. So yeah, it seems like politicians would be motivated to keep those rates lower if they can. But to your point, they don't have a lot of control over the long
- [36:09]
D
end, but they're doing everything they can. Right. So of course the Fed resumed its rate cutting cycle, has cut 175 basis points in this rate cutting cycle. We expect them to cut at least another couple of times by the end of this year, particularly if we can get a resolution to the U.S. iran War and move forward. Of course Treasury Secretary Bessant was very critical of Yellen when she was Treasury Secretary for always using T bills to finance to use short term financing. And of course, what did he do? He picked up the practice. And when we talk about what the Trump administration, one of its economic goals is to keep long term interest rates low for exactly some of the reasons you cited in terms of the fact that now we know that debt interest expense is kind of on par and potentially exceeding the cost of defense, for example. And so some of those wiggle room has shifted. Now look, you know, we were again, I like to bring back, we were joking about 1993 and where was I? And I was in college. You know, just prior to that there was these things kind of like unicorns and the Loch Ness monster and Bigfoot called bond vigilantes. They haven't existed in a while either. And so do they come back if we get to a situation where the debt loads are just kind of unserviceable? I don't think so. But you know, if you're asking me what is the risk, I think that might be the risk. Even if it's a low probability one.
- [37:35]
A
All right, Michael, where do we send people to learn more about your research?
- [37:37]
D
A couple things. Go to the State Street's website on there I publish a piece pretty regularly called Uncommon Sense. For those that know Matt Bartolini. You'll find the chart pack there, the flash flows there, and a lot of what we've been talking about today. I'm excited to kind of suggest that we we're going to publish this in our annual ETF Impact Report and that's coming out this quarter. Ben and Michael and we're excited to kind of have another year of that ETF Impact Report where we're highlighting a lot of different things in terms of how the ETF industry has evolved. A lot of where we started our our conversation in that spy was the first US Listed etf. It's now spawned an industry that's kind of kind of taken on a life of its own. And in this ETF Impact Report that will be published this quarter on our website in a variety of places, we kind of unpack it all in terms of where we're headed next and the incredible growth and adoption that we've seen in the ETF industry.
- [38:35]
A
Awesome. Can't wait to check it out. Thanks Michael.
- [38:38]
D
Thanks Michael. Thanks Ben.
- [38:42]
A
Thanks to Michael. Remember, check out his newsletter Uncommon sense. Go to stage eightstreet.com im to learn more, email us animalspiritscompoundnews.com important risk information
- [38:52]
E
Investing involves risk, including the risk of loss of principal ETFs trade like stocks are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETF's net asset value. Brokerage commissions and ETF expenses are will reduce returns. The views expressed in this material are the views of Michael Aroney as of the recording date of this publication and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Before investing, consider the fund's investment objectives, risks, charges and expenses. To obtain a prospectus which contains this and other information, call 1-866-787-2257 or visit www.ssga.com. read it carefully Alps Distributors Incorporated Fund Distributor State Street Global Advisors Funds Distributors LLC Marketing Agent.