Loading summary
Transcript35 lines
- [00:00]
ReliaQuest/IBM Announcer
This podcast is brought to you by relioQuest. Cybercriminals are constantly attacking. They want your data. They want your identity. They want your innovation. RelioQuest fortifies your business with agentic defense AI that detects, contains and eliminates cyber threats in minutes. It helps your security team move faster at the work that matters most to protect the business now and delivers insights to help them predict what's next. ReliaQuest agentic defense for the enterprise. Learn more at reliaquest.com that's R E L I A Q U E-T.com foreign.
- [00:36]
Jack Howe
Don't think of this episode on the K Shaped Economy, originally recorded back in December as a rerun. Think about it as me recharging my batteries so I can come back and dazzle in our next episode together while you hear about this topic that's still very relevant for the economy and the stock market. And if you haven't listened to this episode before, it's an opportunity to fill in that hole that you've felt in your life. Probably an S shaped hole for sad, but not for long. Thanks and see you soon.
- [01:09]
Mike Reed
What we're seeing is a divide in kind of the sentiment, the feeling, the economic prospects. And the divide is between those who are on the upper income end of the spectrum versus those on the lower end of the income spectrum. Has there always been a divide? Yes, but right now that wealth effect is just so pronounced. What we're looking at is this K. You know, going from a lowercase k to an uppercase K. Hello and welcome
- [01:35]
Jack Howe
to the Barren Streetwise Podcast. I'm Jack Howe and the voice you just heard is Mike Reed. He's an economist with the Royal bank of Canada focused on the us. He's going to talk to us about the K shaped economy. There's a little K moving toward a big K. Could be a special K. Have some banana slices ready just in case. Listening in is our audio producer, Alexis Moore. Hi Alexis.
- [02:04]
Alexis Moore
Hi Jack.
- [02:05]
Jack Howe
Could this possibly be? I saw something about the 300th episode. Is this number 300?
- [02:11]
Alexis Moore
This is number 300 on Apple. It will say 301, but we don't count the trailer. That's not a real episode.
- [02:18]
Jack Howe
They're filthy liars is what you're telling me. It feels like we should have some fanfare. Have you prepared? Is there a heavenly choir of angels that's gonna come out from the behind the scenes and sing hallelujahs?
- [02:31]
Alexis Moore
Not quite that.
- [02:33]
Jack Howe
How about a college football band? It doesn't have to be Division 1. I'll take 2 or 3. It's fine.
- [02:39]
Alexis Moore
I think we could do that.
- [02:44]
Jack Howe
Ah, sweet music. Reminds me of the time when I played the. The sax solo to Wham's Careless Whisper at the middle school band concert. Have I told that story before? 11 times. Right. I tell anyone who'll listen. Frankly, I think, Alexis, we have to move beyond alphabetical analogies for financial conditions. I'm excited to talk about the K's coming up. The K's are important right now, but we already have S shaped growth curves and L shaped recessions. V and U shaped recoveries. And there's something with a W shape, I can't remember. And now we're differentiating between upper and lower case. And I'm worried that my penmanship is not good enough to handle all this. I wrote about this recently in Barron's. We just need to think up some new metaphors for these specific conditions that are going on now. I'll give you an example. Mike Reed from rbc, who we'll hear from in a moment. Remember Alexis, when he was talking about this interesting condition, about how the ratio of retirees to leaving the workforce has changed relative to young people entering the workforce? And that's really important right now. And I haven't heard this analysis before, so I feel like it deserves its own metaphor. The ideal metaphor would evoke young people waiting for old people to turn over their spots. Tell me which one you like more. The first one is pickleball hours at the town basketball court effect, right? You're waiting to. You're waiting to play. But the pickleball. All right, that one's a little long. Here's a better one. Restroom at a Rolling Stones concert dilemma. Now, think about it. It's an older crowd, okay? Going to see the Stones. But there's some young people, too, right? It's a big band. I would gather that there's some older folks who are Stones fans. Maybe in the restrooms. Maybe younger folks who are curious about the Stones waiting outside. As I hear myself say this aloud, I don't think I've hit a home run with this one. I'm gonna continue to workshop it. Now, I've got one or two others I feel more confident about. I want to talk to you about small caps. I saw a grabby piece of analysis from Jill Carey Hall. We've had her on the podcast before. She oversees U.S. small company research for B of A securities. And Jill points out that earnings growth underlying the S and P small cap 600 index is expected to jump from 6% this year. To to 17% next year, a near tripling. And if that happens, small companies would go from being growth laggards to growth leaders. And historically, when that has happened, small cap stocks have outperformed Large cap stocks 75% of the time by an average of 9 percentage points a year. That's a big deal. Those numbers to me, are too tempting to ignore. Yet the big small cap rally is too long awaited to quite trust. Over the past 15 years, the large cap S&P 500 index has returned 640%. In total, it has trounced its small cap sibling by more than 280 points. That's left small caps cheaper, about 30% cheaper than large caps relative to this year's projected earnings. There's a lot of drama here about whether those small caps are going to have a big comeback next year, like Jill is predicting. This is the kind of thing that needs a metaphor. And the ideal one will call to mind something that's small and poised to go fast. But it's not nearly assured of success. I'm calling it the Chihuahua on an E Bike setup. Now hear me out. Those E bikes are fast. You've seen them, right? The way they go by in the city. I mean, they're dangerously fast. And a Chihuahua on one of those things is going to go fast with it. But let's be honest, their little paws can't reach the handlebars. So anything could happen.
- [06:32]
Alexis Moore
I think that's your best yet. It's pretty good.
- [06:35]
Jack Howe
Moving in the right direction. All right, give me one more. Have you ever heard of a fat cannibal stare down?
- [06:41]
Alexis Moore
Not at all.
- [06:42]
Jack Howe
Because it's new. It hasn't had a chance to catch on yet, but give it time. That's where stock market behemoths who've been feasting on smaller competitors for decades, they begin to hungrily eye each other's total addressable markets. Think about all the cases of that. Right now, Alphabet, that is the number three company by stock market value. It has developed its own zippy artificial intelligence chips with help from number six, Broadcom. And it's suddenly seen as a threat to number one, Nvidia. Nvidia says that its chips are set apart by their software, which gets me thinking about Microsoft, which is busy battling for cloud AI work with Amazon. And Amazon is now selling AI chips of its own. One's called Trainium. I can't remember what the other one's called. I want to say Inferencium, but that could be what Wolverine is made from. In the X Men, now Tesla, that's actually fallen just outside of the top seven. Tesla says it's now all about robo taxis. But to my eye, Alphabet's Waymo is the early leader there. And Alphabet's YouTube is giving streamers like Netflix and Amazon pause. But Amazon's rapid rise in advertising, that's gotta be a menace to Alphabet and meta platforms. And that's a fat cannibal stare down. And it's always a volatile situation, especially when you combine it with a muffin top market. Right now, technology, media and telecom stocks combined for 45% of the S&P 500. If we're lucky, all this emerging AI wizardry will help more than it hurts. A report this past week from Deutsche bank says that AI next year will either weaken a fragile job market in the US or boost productivity by more than half a point. Could be comforting or painful. That's a classic family reunion. Bear hug from a cousin you like, but who talks way too much about crypto conundrum. Frankly, I have mixed feelings. Mike Reed is senior US Economist for Royal bank of Canada. He says the economy is hitting a capital K phase. Subtle distinction there between a little K and a big K. I don't think it matters so much if you're writing in cursive with the K, but I can't quite remember. K is one of those letters where the cursive resembles the regular. And I know it's not the case with all of them. I still think capital G might have been an elaborate practical joke. Anyhow, here's Mike.
- [09:19]
Mike Reed
What we're seeing is a divide in kind of the sentiment, the feeling, the economic prospects. And the divide is between those who are on the upper income end of the spectrum versus those on the lower end of the income spectrum. Has there always been a divide? Yes, but right now that wealth effect is just so pronounced. What we're looking at is this K, you know, going from a lowercase K to an uppercase K. I don't think
- [09:45]
Jack Howe
I excelled in handwriting as a kid. When you talk about going from lowercase to uppercase, is it that the, the part that points up on the K points more upward on the uppercase K. Is that, Is that what's happening?
- [09:57]
Mike Reed
Yeah, absolutely right. It's your upper income households who are directionally kind of accelerating. They're consuming a lot more, they're seeing income gains that are outpacing those at the lower end of the income spectrum. One thing I do want to clarify, however, and I think this is an interesting finding from our report. It's really the middle income folks. So I would say the 20th to the 80th percentile, those are the folks who are being pinched the most. When you look at credit card delinquencies, auto loan delinquencies, those have been on the rise. They were down during kind of that post Covid era where we had that injection of pandemic relief. You also had a pause on student loans. So that tended to benefit kind of those new entrants to the workforce, those who were burdened by large student loan debt. It allowed a lot of folks who had student loans to start paying those down more meaningfully. But now in a situation where that assistance has gone away, these folks are now needing to pay back their debts. The interest is now accruing. So you have a growing debt burden. And one way we can kind of look at that is within the national accounts, the data from the Bureau of Economic Analysis. One measure I look at is the non mortgage personal interest payments as a percent of disposable personal income that peaked in this cycle around 2.7, 2.8%. And even though the Fed has been cutting that interest burden is still quite high, it's leveled off around 2.5%. That is again kind of a picture for the macro economy, when in reality that interest burden is likely falling on a specific segment of this consumer group. So that is to say there are likely a disproportionate share of consumers in that middle lower income spectrum that are reliant on debt to help fuel their lives. Whether it's auto loans, using their credit cards to make everyday purchases, again those student loans, so they're exposed to this higher interest rate environment.
- [11:59]
Jack Howe
So this sounds bad to me, right? And not just from the standpoint of we don't want so many people struggling out there, but also if we're thinking about the investment implications here, it just seems like how is it that we've got a stock market near all time highs and people have made great money with their investment assets, but so many participants in the economy are not being pulled along. So it makes me wonder which is the case right now. Is it that A, we've got some kind of, you know, miracle economy and stock market that can continue to do well even without the participation of these folks, or B, we're in this Wile E. Coyote moment, if you, if you know what I mean, from the, from the old cartoons where the, where we've run off the cliff, but we haven't yet fallen because we, the effects haven't caught up to us yet. Is either of those accurate or is there something different going on?
- [12:54]
Mike Reed
Yeah, I think we're somewhere probably closer to the former. I wouldn't say we're in a Wile E. Coyote moment wherein, you know, the coyotes kind of run off the cliff and looks down and he's about to fall. We don't think we're there.
- [13:06]
Jack Howe
He's got the rocket roller skates on. He's, he's hanging there in the air. But yeah, okay.
- [13:11]
Mike Reed
And to your point, you know, a large part of that is being driven by this wealth effect. The stock market housing prices are another good example. When you think about, again, some of the folks who have been homeowners, those folks who are able to lock in favorable mortgage rates sub 3% in 2021, they're still benefiting in many ways from that. So there's still a large cohort that is well positioned to continue to spend and they will continue to propel this economy. In fact, in our report, we pick on the top 10% as being a near majority driver of consumption in the U.S. now, the problem there is that if there's a pullback, say in the stock market, and that's something we flagged as a risk, then you have to start to worry about the knock on effects. And by that we mean, you know, the jobs that are reliant on their spending. So what we're focused on right now are those kinds of non discretionary buckets that the upper income households tend to spend disproportionately on and the trajectory there. So things like leisure and hospitality, dining out, travel, hotel spending, restaurants and so on. So that's where we've been really focused on kind of looking at that upper income cohort and how they're feeling about their prospects. And the idea is as long as they keep spending, they'll help support jobs in the economy. But if they start to pull back and we do see kind of margin compression and consumption slow in that top 10%, that is where we're a bit more concerned about those knock on effects again for the labor market.
- [14:47]
Jack Howe
Thank you, Mike. Let's take a quick break and we'll be back with more on the state of the US Economy.
- [14:57]
ReliaQuest/IBM Announcer
This episode is brought to you by MassMutual. When people count on financial guidance, they want a company known for strength, stability and trust with the solutions to fit their needs. Financial professionals can help people move forward with confidence, backed by MassMutual's 175 year legacy. Learn more at MassMutual.com MassMutual.com.
- [15:30]
Jack Howe
Welcome back. We're learning about the US Economy from our friends from up north, the Royal bank of Canada and its senior U.S. economist, Mike Reed. Let's listen to more of that conversation. Now. It's a strange situation because the stock market should reflect the economy and how well things are going and company profits. But at the same time, the stock market can also drive the economy if these upper income or if these wealthy people are feeling flush right now. I mean, everybody's like checking out their investment accounts online and saying, oh, I've really, you know, and they're checking it four times a day now. You know, if the market tanks, they won't check it for months. But right now they're checking it and they're liking what they're seeing. It's got them confident and they're out there spending. Is there any way to tell, as an economist, are we more geared or less geared or about the same to needing the stock market to stay this high so that the economy stays okay? In other words, are we in a precarious situation where, boy, we better get that next leg up in the s and P500 or economic growth could grind to a halt?
- [16:36]
Mike Reed
Yeah, we think so. To your point about kind of that wealth effect in spending, it's hard to look back and really pick out a point in time where there was a notable stock market correction and then there was a pullback in consumption. There's probably a few, but, you know, it's hard to really quantify that. But I think more importantly right now, to your point, you do have a lot of folks watching their retirement portfolios. They're probably a bit more sensitive if they're in that retirement phase of life on a fixed budget, so to speak. Although it's quite large. In fact, baby boomers are sitting on about $85 trillion of wealth. the same time, if they do feel a little bit of a uncertain outlook for their portfolios, they could certainly cut back. And you know, that has again, the knock on effects for consumption and the labor market, the jobs associated with the spending. But the other cohort that we're really focused on right now is the, you know, call them about to retire workforce. We're really hitting this peak baby boomer retirement wave right now, and we're on a record pace. We're approaching about 2 million workers retiring this year. And if that continues, what that does for the labor market is it creates replacement demand. Now, replacement demand is kind of in this interesting concept. What's happening is you have this large baby boomer population that is entering, you know, this phase of life called retirement. And when they leave, you know, essentially you have to hire folks to backfill. So that puts downward pressure on the unemployment rate. And especially right now, that's notable because the generation that's newly entering the workforce is relatively smaller. We're at a ratio of about two and a half retirees for every new entrant who is looking for a job. So we're in this kind of unique dynamic where you don't need this strong job growth to support a stable unemployment rate. But if you have a situation where folks who are about to retire are checking their portfolios and thinking, maybe I'll retire next month or the month after, all of a sudden, you know, there's a correction. You know, we're kind of worried about a 10% or greater correction. They may say, oh, that, that's really kind of changing the math in my head. I may delay my retirement another few months, maybe a year, and that starts to reduce that replacement demand and could put additional upward pressure on the unemployment rate.
- [18:55]
Jack Howe
I have not heard that piece of analysis before, and I'm a man who lives in a non stop meteor shower of Wall street analysis. I haven't heard that point before that with all these baby boomers retiring, that's favorable for young people who are looking for work. There's lots of spots to fill. But if the stock market tanks, then those baby boomers are going to say, hang on a second, I better work more and earn more because I have to make up for this lower value in my portfolio. Then the job openings go away, and then those younger folks looking for work are in a more difficult position. So, you know, we're like triply exposed now to the potential of a stock market decline. I mean, it's, it's always kind of bad. Right now it's driving a lot of the consumption, and also it's really keeping the job market healthier. When you talk with the investment strategist at your firm, how does that inform how people ought to invest right now? I mean, when you put all this stuff together, do we still have reason to be reasonably optimistic? Should we be more cautious than usual right now? Should we be making changes to the way we invest?
- [19:59]
Mike Reed
So I think that the changes that we're trying to communicate are changes to the way in which you're thinking about economic data. So does that change the way you invest? I mean, I think the way you invest always changes. But one thing we're stressing is you have to react to some of the Economic releases a bit differently than you have before, notably the payroll number, but also in thinking about the consumer, and when we say the consumer, typically we've meant the overall consumer. But increasingly what we're talking about is you have to think about consumer segments. So where are consumers going to spend? Who has the most spending power and what companies are kind of meeting their needs. So going back to kind of this K shaped, one thing we've seen is sometimes you have this, this trade down effect. So if you have folks who are kind of in that middle income cohort, they can always trade down. And so the companies and businesses that serve that area where folks are trading down to might not feel the pain. But when you think about the business segments that are serving those kind of, you know, call it the 40th or 20th percentile, the folks who maybe aren't able to trade down but have to trade out, they have to make cuts from their budget. It's those businesses that face a risk if things start to turn for the worse. At the same time, if you were to draw a Venn diagram of folks who are, you know, at peak earning potential of their career, who have the greatest wealth and age, the biggest overlap is within that baby boomer generation. So you think about that. What are their needs, what do they tend to consume? And I mentioned earlier the leisure and hospitality sector. But you know, also another one we flag is healthcare services.
- [21:36]
Jack Howe
You're saying in the Venn diagram, you're saying folks that are old and folks that are well off. And the overlap is a lot of this baby boomer generation.
- [21:44]
Mike Reed
Okay, exactly. And those are the folks that need a disproportionate share of healthcare services, various medications, financial services, legal services. So a big shift away from, I would say your consumption of goods and a greater share of services relative to those other cohorts. And where we're seeing signs of strength in the economy kind of reflects that. When you think about the healthcare sector, that's been one of the main drivers of payroll growth, that's adding net new jobs. That's the sector that we think continues to add jobs. And there's likely some areas of opportunity, again within kind of the pharmaceutical sector, where you'll see strong demand due to the aging of the population as well as those other kinds of services. Now, conversely, one thing that we noticed in our report was you have the millennial generation who has benefited from this wealth effect, but a lot of their wealth is more concentrated in housing, less liquid, and a lot of the spending associated with that phase of life tends to be one off. So when you think about when you buy a home, you start to fill it out with new appliances and furniture, and those aren't things you're buying on a weekly or monthly basis. So those are sectors where we do expect to see a more pronounced slowdown. And when you layer on top some of the effects of tariffs that are now impacting the prices for a lot of those goods, you know, that just means it's going to be that much harder for anyone who's newly entering the the housing market to maybe spend as much as they want. That's an area where we would be a bit more cautious. And the housing sector overall is one that we think is in a deep freeze here.
- [23:19]
Jack Howe
There's so many people who are invested in the s and P500 just because it's beat everything else in sight for a long time. Maybe you don't have an opinion on this, but do you feel like that's a good fit for the moment? I mean, given the type of economy that we have and where money is being spent, is that arrangement of stocks and that sort of flow of company profits, is that a manner in which investors should be positioned right now, or you think that people should be looking for ways to do things differently going forward?
- [23:50]
Mike Reed
Well, it's certainly not my area of expertise. Our head of equity strategy, Larry Calvasina, has a more modest view of kind of the S and P over the next 12 months. She's expecting continued rise, but certainly there are risks to that. And when you think about the concentration of the growth in the S and P really being in that Mag 7, it's really become this AI story. And the way we're thinking about it is, is the AI dividend going to pay out here? You know, the real ROI is not the growth that we're seeing now. The growth in the economy that we're seeing now as a result of AI investment is really that infrastructure being put in place. And that got a huge tailwind. You know, back in 2022 when you had the Chips act that injected about $53 billion into the US economy. And, you know, now we're seeing this big shift towards AI, and the payoff really needs to be an increase in productivity. So it's still, in our view, still very early days, but we're seeing early signs of it. And by that I mean, you know, there's going to be certain sectors that start utilizing AI that are putting the right people in place to take advantage of that technology, but it's not a widespread phenomena just yet.
- [25:05]
Jack Howe
Thank you Mike and thank you all for listening. I want to apologize if any of the comments I made earlier in the episode offended pickleballers, Rolling Stones fans, Chihuahua owners or cannibals, but not cousins who talk too much about crypto. You know who you are. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify or wherever you listen to. If you listen on Apple, please write us a review. See you next week.
- [25:37]
IBM Announcer
The thing about AI for business? It may not automatically fit the way your business works. At IBM, we've seen this firsthand. But by embedding AI across hr, IT and procurement processes, we've reduced cost by millions, slash repetitive tasks, and freed thousands of hours for strategic work. Now we're helping companies get smarter by putting AI where it actually pays off, deep in the work that moves the business. Let's create smarter business IBM.