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He Was Overweight Tech for 15 Years. He Just Downgraded the Mag Seven | Ed Yardeni Explains Why
00:49:59
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- [00:01]
Ed
You're about to make a trade which you do you listen to.
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Justin
Is it get optioning those options or.
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Ed
Let'S do a little research.
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Sponsor/Announcer
Learn more@finra.org TradeSmart this episode is brought.
- [00:17]
Sponsor/State Farm Announcer
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Ed
The problem I have is it and communication services have worked out all too well to the point where collectively now they account for 45% of the market cap of the S&P 500. When concentration works for for a long time, at some point you have to say well you know, am I just going to have a portfolio that's composed of two sectors or seven stocks or am I going to diversify? 2026 could finally be the year where it does in fact broaden. And obviously that's consistent with my change on how you should rebalance your your portfolio. The index of Leading Indica Economic indicators should just they need a recall. I mean it's a defective product. It just doesn't work. It's been telling us a recession's coming since late 2021. While everybody's worrying that the Fed will be less independent with a new Fed Chair that's appointed by Trump, I, I think it could actually be more independent. We could have a situation where you know, 2026 is the year of the bond vigilantes.
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Host/Interviewer
Ed, thank you very much for joining us and welcome back to Excess Returns.
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Ed
Thank you.
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Host/Interviewer
The markets, the economy, the investing landscape is evolving in front of us and investors are having to think or rethink about some long held assumptions that have been ingrained in investors minds over the past, let's say decade or so. And so I think today we want to talk about maybe how some of those probabilities have shifted. For example, you recently moved the Mag 7 to underweight, which we'll talk about. But there's a number of other things including the AI driven capital spending boom, the rise of productivity, how those two things fit into the roaring 20s 2020 thesis that you've talked with us about. And you know, just generally what you're thinking about with inflation rates, global markets and, and, and a lot of other things. Today was a, a Fed day. So appreciate you sort of jumping on with us right after the Fed just ended its press conference. I know that, you know, you're constantly putting out research on your identity.com, you have your morning briefs, your quick takes, your webcast, there's a bunch of great charts on there. So that's where you can get and follow along with Ed in real time and get the content and the research that he's putting out to clients. And days like today are sort of, you know, you spend your time thinking about what this means for the market and digesting that for investors. So hopefully people go check out your research on yourdaddy.com thank you. You're welcome. So let's, you know, I think we want to start. We'll get into the. I want to ask you about the, the Mag 7 underway in just a second. But first just spend a minute talking about the way that you think about these forecasting sort of scenarios. Because one thing that you do is you kind of have more of a probability based approach.
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Ed
Sure.
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Host/Interviewer
Rather than a pointed like forecast. So you can use explain like sort of the rationale for why you do it that way.
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Ed
I just want to be balanced. I just want to tell people what I think is the most likely scenario and acknowledge that there are alternatives. And obviously there's a base case and then there's the alternatives. So in the current situation, I've been pushing the idea of a roaring 2000 and twenties decade. Been saying that since 2020, actually late 2020. And even back then it looked delusional. But it's worked out pretty well. And right now I'm assigning it a 60% probability and then a 20% probability that this gets a little bit ahead of my exuberance, becomes irrationally exuberant and we get a melt up, meltdown. So that's 20%. So put it together, you got 80% that it's still a bull market. One where it just continues to go up in a leisurely fashion with some volatility around it and another one where we have a melt up meltdown and you know that's not necessarily going to cause a recession. That's not necessarily going to be the end of the bull market. But it can be a lot more volatile. And then that leaves me with 20% for everything that could possibly go wrong. So I try to discuss the specifics of those three scenarios along the way. And it's just my way of kind of communicating my conviction about things.
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Host/Interviewer
It's sort of hard to believe that it was four or five years ago that you kind of came out with this roaring 2020 sort of idea. And I do remember it seems like time flies, it seems like yesterday, but it was on CNBC I think and it was like, you know, that was clearly the. Not like this extended strong bull market in throughout the 2000s was clearly like non consensus by a long shot.
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Ed
Yeah. And related to that was, you know, for the past three, four years we've had the most widely anticipated recession of all times that didn't happen. It's been the no show recession or the Godot recession. And so I think I was almost alone in arguing that all the shocks that the economy was hit with would be absorbed, the economy would prove to be resilient. I mean Justin, let's, let's just do a quick review here. We had the pandemic. The pandemic led to a two month lockdown that caused the two month recession. Then we had the end of the lockdowns but we still had social distancing restrictions. And then everybody went out and bought goods. So suddenly we had supply side supply chain disruptions led to a spike in inflation, caused the Fed to go from 0 to 5.5% on the Fed funds rate. And now we've, this year we've had tariffs and now we're wondering whether the economy can deal with the funky stuff going on in the labor market. And yet despite all that, real GDP is at an all time record high. Yeah, we had a recession lasted two months back in 2020 but other than that the last recession was 2008. So the economy's been remarkably resilient. And I, I learned from experience, it seems to me that it's a fairly good bet that the economy may very well continue to be resilient for the rest of the decade. So therefore we may not have a recession. So that's kind of the roaring 2020's idea.
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Host/Interviewer
Well, and I think one of the, one of the possible reasons that the market has held up well, I mean it was, you know, a lot of these large growth technology companies which are massive companies and they're huge businesses and they've become huge businesses. You know those stocks all the way up until this year had been, you know, performing very, very well. The max seven as you. Yeah, so just talk about, I think you recently sort of changed and you were on that, you were on that train and bullish on, on the Mag 7. This year is not a great year for the Mag 7, but if you roll it back for three or four years, it's been a Phenomenal period for those stocks.
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Ed
So.
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Host/Interviewer
But what's, what, what, what's changed with your probability assessment in terms of.
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Ed
Well, you know, the, the probabilities really haven't changed that dramatically, but along the way, you know, I mean, the probabilities sort of drive my sense of the overall market, the S&P 500, the NASDAQ. But then along the way, you've got to also provide folks with some opinion on where you want to be in the market. And I've been recommending overweighting information technology, communication services, financials and industrials, and they've all worked out very well. The problem I have is IT and communication services have worked out all too well to the point where collectively now they account for 45% of the market cap of the S&P 500. And it just dawned on me that if I kept telling people to overweight information technology and communication services, I'm telling them to have more than 45% of the portfolio in just two, two sectors. And it just seemed to me that, you know, at some point you have to kind of declare a mission accomplished and do some rebalancing just to create some diversification, unless you want to just totally concentrate it in, in a portfolio that's 60, 70, 80% in just two sectors. So that, that was the nature of, of the change. Magnificent seven have been hanging in there around 30% of the market cap of the S&P 500. You know, that's, that's, that's easier said than done for most professional money managers and even individual money managers. You know, most people still believe in diversification. And so there is a need to rebalance. If something becomes too big a portion of your portfolio, it's time to think about cashing in some of the chips and moving to other areas where there's maybe not as much risk and more upside. So I've been saying take some of the profits out of IT and communication services and sprinkle it and the other overweights, which is financials and industrials. And then I added healthcare because I think that has been a laggard and has got some upside opportunities. But that's all based on the very simple notion that every company in some way is becoming a technology company. And so you don't really, you know, companies either make technology or they use it. Look what Walmart did just the other day. They, they announced that they're moving into the nasdaq. They want to be known as a technology company. They don't want to be just a plain old Vanilla retailer. And so I think that's what we're seeing here is more and more companies want to demonstrate that they can use technology to increase their profit margin, their profitability, their, their, their usefulness to the, to the consumer. And so, you know, fintech covers a lot of financial companies, financial technologies. Healthcare is definitely prime for productivity improvements using technology. I mean they generated an enormous amount of data. A lot of it's on paper and they're obviously scrambling to try to get these things digitized by Google. And then hospitals are starting to connect with each other. So you know, if you have some of your records in one hospital, another other, your records in another hospital, they're actually going to be able to look at these things instead of having to have them fax you a printout of these things. Industrials, I think benefit from the, the AI boom of data centers that continues. But I think on shoring is another development. I mean the President Trump in his tariff negotiations used tariff as a club to get foreign companies and foreign countries to commit to building manufacturing in the United States. And that's all still ahead of us.
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Host/Interviewer
So, so it's, it sounds like the mag seven colleges to put a bookend on that. It was a position sizing thing. Yeah.
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Ed
Along with.
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Host/Interviewer
You just think there's other relative, probably better opportunities.
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Ed
Yeah, I think just prudent rebalancing and just an indication that diversification still matters. And when, when concentration works for, for a long time, at some point you have to say, well, you know, am I just going to have a portfolio that's composed of two sectors or seven stocks or am I going to diversify? Look, I mean the Magnificent Seven aren't going to succeed unless they have a lot of customers. Right now they're doing a lot of business with themselves in terms of developing data centers and large language models and the like. But at the end of the day, they're bread and butter businesses selling their services to businesses and to consumers. And, and a lot of their technologies are very effective at increasing the productivity of workers and increasing the, I, I guess the improving the recreation life that we have in our personal lives using these technologies.
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Host/Interviewer
Is there anything else that you would look at in terms of knowing when a thesis has had success and when to call it, you know, call it. I mean, I think this is a perfect example. I'm just. Is there anything else that like jumps out at you and your experience in the market?
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Ed
I feel like starting to sing Kenny Rogers, you know, hold it. Hold them or fold them. And that's really the question that investors have to ask them, ask themselves, look at your portfolio and are you comfortable with the mix? Now, of course, taxes kind of matter in this, so it's easy for me to tell people, you know, lighten up on the mag 7. Lighten up on information technology, communication and services. But there are tax implications and, you know, so it's not as easy as said as done in a real world portfolio. But yeah, I think another issue is that kind of, because it's worked so well that it's time to kind of reconsider is we've been recommending overweighting the United States. We call it stay home rather than go global. We've been doing that since 2010. And maybe I'm just lazy and I just haven't, you know, kind of tweaked that idea along the way. But it's worked out really, really well to the point where the U.S. now accounts for 65% of the market capitalization of the MSCI world stock market. So it's 65%. And again, you have to ask yourself, is the U.S. going to get to 75, 80? I mean, it could, and I could be wrong here, but I think it's probably time to diversify a bit by, by going overseas. And emerging markets have a lot of people that are aspirational and want to have a good standard of living. And there are companies over there that are certainly part of that prosperity track that they want to be on. Look at, for example, China, you know, when we all know China's done pretty well this year and everybody thinks it's I T. Well, it is I T. But even better than that has been healthcare, which kind of makes sense, right? I mean, they've got a rapidly aging population, and it turns out there's a lot of companies there that are catering to the needs of the aging population and making a lot of money.
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Justin
We're going to talk a lot more about international as we go through this, but I wanted to finish up on the tech stuff. Is it, am I correct in saying, correct me if I'm wrong about this, that you went Underweight on the Mag 7 but just market weight on tech as a whole?
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Ed
No, I went market weight on both Magnificent Seven and on the IT and communication services. And I said, okay, so we're not overweight though, anymore, because again, it's telling somebody to overweight something that's 45% of the overall market or, or 30% as, as we're looking at the Magnificent Seven. It's, it's kind of not Nonsense advice. It's saying, you know, just keep, keep writing the concentration, forget about diversification. And I just don't think that makes, makes sense. And it's, at some point, look, the, the other, the, I mean, there are some events here that have occurred over the past few weeks that convinced me that maybe IT and communication services aren't going to continue to outperform the overall market, hence market weighted. And that was the market. IT and Magnificent Seven seem to be turning even more competitive. I mean, it has always been very competitive. It's the only industry that literally eats its young in the sense that, you know, a company will create a, a new semiconductor chip or a new program and it's very successful with a very high profit margin. And they're, you know, just, just as they're introducing it, they're already scrambling to create the next version of it that will replace the one they just launched because they know if they don't do it, some other IT company will do it. And look what we've just seen recently. We went from, you know, AI. The epicenter of AI is, is OpenAI, a company that's private and is losing money. But everybody got excited when it's doing deals with Oracle and Nvidia. And that's where all the excitement was. And then all of a sudden Google comes out with Gemini 3 that's better than ChatGPT. And Sam Altman over at Open OpenAI declares, you know, Code Red that they got a problem which, which is competition and if, and, and they got a rise to the occasion very quickly. And so suddenly Google becomes the, the, the, the, the, the, the leading horse in, in the horse race. And just about a day or two after that, remember Deep Seek? Deep Seek came back. Deep Seek is what kind of caused the correction in it at the beginning of the year. And Deep Seq just came out with a large language model which is competitive with Gemini 3, with Google's Gemini 3. So I just see a lot of competition going on. I see that these tech companies suddenly are being forced to spend a lot more money not just on data centers, but they're paying a ton of money for people. I mean, you know, for, for AI experts. I mean, we're not talking about, you know, 100,000 or so where, or hundreds of thousand. We're talking about millions is what they're paying out. So the competitive pressures I think, suggest that the profit margin, which is about 40% in it, I think, you know, high profit margins always bring in competitors. Question is, you know, are there any barriers to Entry. And one of the greatest barriers to entry in technology is access to capital. And there sure seems to be plenty of capital willing to take a bet on just about any cockamamia ID that's out there.
- [19:21]
Justin
Yeah. To your point, watching all this leapfrogging has been a little bit too crazy for a value investor like me. And I was just listening to a podcast with Gavin Baker today before we started this, and his prediction is, because Xai is going to be the first one to launch like a Blackwell trained, you know, data center or a Blackwell trained model that basically they're going to leapfrog everybody in January. So it's like as soon as somebody takes the lead, it's like somebody else is taking the lead. It's just, it's just very hard for. If you're not.
- [19:45]
Ed
Yeah, well, it's either a horse race or it's a, a frog race. I mean, they, they are, they are, they are kind of leaping over each other. And you have to factor that into the consideration is people who are very comfortable with the Magnificent seven. Another analogy is Game of Thrones, right? It's like we got seven, seven kingdoms. And in the credits of Game of Thrones, you have towers going up and down, signifying that, you know, some kingdoms are rising and other kingdoms are, are declining. But they all, you know, until recently they all had a moat around them and they all, you know, could make a lot of money, but now the moats are no longer as effective as they're realizing that they're actually starting to compete with one another.
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Justin
Is that part of how you at least think about the Mag 7? Because one of the things we talk about a lot on the podcast is this idea of the Capex boom. And you referenced that, the idea that these were, you know, asset light companies and now they're spending massive amounts of money and now they become sort of completely different types of companies.
- [20:44]
Ed
Sure.
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Justin
Is that part of your thought process as you think about like the Mag 7 going forward?
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Ed
That's a part of it. And you know, Michael Berry, you know, is clearly having another field day in terms of his thoughts. And I think there's something to his view that as his view that there's an issue of over what period of time should you depreciate chips? And that just increases the uncertainty about what you're really investing in.
- [21:15]
Justin
When you think about sectors like tech, how much does valuation play into what you're doing? I mean, you didn't mention that as a cause for why you did a downgrade here. But like At a certain point. Does valuation play a role in what you're thinking about when you're analyzing a sector like tech?
- [21:27]
Ed
Well, you know, I certainly have to take that in consideration when you're looking at the stock market. In theory it's pretty simple. It's just PE times E, the valuation multiple times earnings. So I mean anybody can come up with numbers, but getting them right is, is the trick. And there's clearly a valuation question mark or issue. With regards to the magnificent seven, we're talking about a forward PE of about 30. And that has made a lot of sense because they're amazing, they are magnificent companies. They have been able to grow their earnings remarkably well, but the question is whether that growth rate now slows down because they are spending more on capex, they are spending more on high, high priced talent and they're competing more with each other, which may put some limit on how much they can actually make.
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Justin
Do you think it's fair at all to compare them? Like if we look back to 2000 and try to take lessons from 2000, do you think it's fair at all to compare them to the Ciscos of the world? You could argue we're in another tech boom, but you could also argue these companies are not nearly as expensive and it's not nearly as crazy as it was back then. So how do you think about those comparisons?
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Ed
Well, I think it's worthwhile comparing them. I mean it's a useful experience we had back in the late 1990s. There are similarities, but there are already also differences. Back in the late 1990s we had a lot of seller financing. So companies has sold to other companies that they lent money to to buy their product. It's not a very good model and it blew up. We also, they sold a lot of product to dotcoms who had no earnings whatsoever but were burning through the cash that venture capital gave them. And venture capital decided not to give them second round of financing. So an important part of their customer base just kind of imploded. In the current situation. Most of the concerns have been about the so called circular financing where Nvidia is giving OpenAI money in order for them OpenAI to build a data center. So that's, that's a concern. But I, I think, you know, we could have things blow up in the AI world without a kind of creating the same kind of implosion that we had during the tech wreck of, of 2000. Most of these companies are doing very well. They're generating real revenues and incomes. Their earnings are solid. And so I think we're in, in, in a better situation right now.
- [24:22]
Justin
How do you think about AI with respect to the average company? Because right, right now we've maybe seen a lot of the gains in these bigger tech companies, but you would think over time it will broaden down across the economy. Do you think that's part of as you think you're still bullish going forward? So as you think about the outlook for the market in the years going forward, do you think that's a big part of the story? Is AI carrying down to the average company?
- [24:40]
Ed
Well, I started talking about the roaring2020s as I mentioned back in 2020 and I mentioned that a bunch of these technologies, including AI, I didn't pound the table on AI. I mean, who knew that it was going to be November of 2022 that OpenAI would create or introduce ChatGPT? And AI has been sort of a, a huge, you know, rocket ship ever since then. It's all seem, seems like everybody's talking about, I think for the most part everybody is looking at artificial intelligence. They're trying to assess whether it can make a productivity difference to their businesses. And I think a lot of people are finding that the answer is yes, that it can increase productivity. It could take some time, but I think the evidence is that some productivity impacts are occurring pretty rapidly.
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Justin
Do you think this is like an Internet level innovation or maybe something greater than that? Do you think this is something that is one of those game changing things that we'll look back in our careers, one of the biggest innovations we ever saw?
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Ed
Well, I want to put it in perspective. I don't want to get into the hype of AI. And so if I, if we put it in perspective, it kind of makes kind of a more logical sense and you don't get as hyped up about it, you just see it as an evolutionary development. The idea is that we've been in a digital revolution since 1965. Started with the IBM mainframe, as a matter of fact, in the late 70s I did a dissertation, an econometric dissertation, statistical dissertation. And I remember sitting at a punch machine. This is where you punch the data and the instructions on a card and one card after the other and you have a stack like that of the data and the instructions and you give this to the mainframe operator and the mainframe operator said, come back next tomorrow and we'll have a printout for you. And sure enough, big stack of paper with printout and you'd look at it and Say, I got to run it again. I want to change this, that. And that was the digital revolution. Where are we now in the digital revolution? Well, we went to Digital equipment, introduced the computer, the minicomputers in the late 1980s, and then we had the PCs and the Microsoft operating system, Microsoft Excel and Word. If you think about it, Microsoft Excel and Word, those were the only apps that really mattered back then. It was only two apps, and once everybody that could use them, used them, that increased productivity for a few users. But it wasn't really applicable to a lot of businesses then. I think another big evolution in the revolution was the cloud. About 2011, 2012, Amazon started to rent out its servers, and here we are with AI. AI to me, is just a super duper app where, you know, basically it's a tool that all of us can design our own apps, use it for our own applications, and it's applicable across all sorts of business models, much more so than Word and Excel ever were. So I think this is all evolutionary and, you know, next thing we'll have quantum computers. The next thing we'll have alternative ways of training computers. You know, I'm very much involved in this area and so I gotta get a lot of feedback. And I've had one neighbor actually tell me that, you know, he's aware of my macro view of AI, but he said he's actually investing in a company that may come up with a way to kind of slice and dice the way large language models do their work, and it could be a lot faster and require cheaper chips that are much cooler. So all of a sudden, you know, the whole technology could change. I mean, right now everybody's getting concerned about all the power needs that AI has and say, well, there's no way we can move on this because it's going to take forever to get the electricity that we need for it. And, you know, technology solves problems. That's a problem. And guess what? There's already entrepreneurs that are amply being financed by private capital that are looking into the, into the issue, and undoubtedly somebody will come up with solutions to these things. So that'll be the next evolution.
- [29:26]
Justin
It's interesting, like, whenever we think you hit a wall with this, then there's some innovation that none of us saw coming and we get through it. Like, for instance, in that same podcast I was talking about before, they were, and I don't know if this is possible or not, but he was talking about the idea that within three years they could have data centers in space because you have Power in space. That would obviously be a game changer if that actually comes to reality. And someone like me sitting here as a value investor would never see that come.
- [29:48]
Ed
Well, that's the solution. That's one of the solutions for the power shortage. You put them out in space and, you know, you don't have any clouds, you're directly facing the, the sun. And so you can apparently power these things. But, you know, it's all science fiction, but it's, it's happening.
- [30:05]
Justin
I want to think about this at an economic level because I know you're a con, an economist, and like, you look at things like productivity, how do you think, like at an overall economic level, when you look at something like AI, how do you think about it would impact those overall economic numbers?
- [30:17]
Ed
Well, it's back to the roaring 2020 idea that in 2020, I said, Look, I think we're facing some labor shortages. And I didn't know what was going to happen with restricting migration at the border. You know, first it was wide open, then it's closed. I didn't know what was going to happen with deportations. But I did know that my friends are retiring, the baby boomers are retiring, and that's really slowed down the labor force. And the only solution for that problem is productivity. And I think AI is just one of the things that's helping do that.
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Justin
Do you think about the impact on jobs here? Thinking about the other side of it, if this does replace the jobs, I mean, we've looked in other innovative cycles and those jobs have eventually been replaced, better jobs. But do you worry about that short term, if this does replace jobs, what it might mean?
- [31:03]
Ed
I do, but I think over time people will adapt and realize that, you know, some, some jobs just aren't there anymore and, and others are being created. I have one account of mine is actually a professor at Harvard Business School, and she told me that she teaches introductory finance at Harvard Business School. And she told me just a few months ago that her students are very depressed because there's, you know, they're not getting the kind of job offers because everybody's kind of trying to assess AI. But she said she reckons that about 25% of them are looking into doing their own thing, starting their own businesses. And so people adapt. But there's definitely going to be problems in labor market and we're seeing it already.
- [31:54]
Justin
When we think about inflation, do you think AI is a significant, if we think about longer term, do you think it's a significant deflationary force over time?
- [32:01]
Ed
I Think so. I think technology is itself deflationary. Technology always gets cheaper and cheaper, and as it gets cheaper, the companies try to maintain their profit margin by introducing new technologies. So it's very competitive and it's very dynamic. Yeah, and I think it's inherently deflationary. And I think to the extent that we are seeing a country like China, for example, use automation, robotics and software, including probably AI, to manufacture just about anything you can imagine and dumping it in the global economy, that's clearly deflationary. So I think that's the case. You start to think about all sorts of radical changes in the world economy. I mean, science fiction people have been talking about a basic universal income for a while saying, you know, when science fiction becomes science fact, you know, we're not going to need a lot of people to produce things. Elon Musk has been saying those kind of things.
- [33:12]
Justin
So when we think about the, the overall market, we're doing this at the end of 2025 and obviously people will be asking you about 2026. You've talked about how your roaring 2020's thesis is still in place. But so are you pretty much as we look into 2006, pretty optimistic about the market in general?
- [33:25]
Ed
Well, I've got the S and P getting up to 10,000 by the end of the decade. By the end of 2029. I think right now S&P 500 earnings should be something like $300 a share next year. I think by the end of the decade, by 2029, the market could be discounting $500 a share as a reasonable earnings number for 2030. So at the end of 2029, if the market's looking forward and looking at $500 a share, put a 20 multiple on that, which I think is reasonable. Maybe a little bit on the high side, but it's reasonable. Gets the market up to 10,000. Next year, I see the market going up to 7,700. Look, I've been pointing out that the economy is resilient for the past four or five years. And I'm going to stick with that story. I've been arguing that, you know, for those who are saying, well, you can't have the economy grow like this all the time without a recession. I've been saying, well, we're kind of having rolling recessions affecting different industries at different times. We don't have to have economy wide recessions. Economy wide recessions in the past are usually caused by credit crunches. So, yeah, I mean, things could go badly. I mean, that's why I do the scenarios. You know, the 20% things going wrong includes something like private credit blowing up, includes some for some reason, the stock market takes a huge dive, creates a huge negative wealth effect, consumers really retrench and that causes a recession. The debt crisis is always good for a scare. You know, we could have a situation where, you know, 2026 is the year of the bond vigilantes. It already feels kind of like that in Japan and the United Kingdom. And even here the Fed's been lowering interest rates and yet the bond yield hasn't really budged much from just north of 4%.
- [35:23]
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- [36:24]
Justin
Do you have any thoughts on why this whole idea of the recessions and a lot of people are calling for recessions and you all the standard indicators, the yield curve, the SOM rule trigger. Do you have. Do you have any thoughts on why those were wrong this time and why the economy was so resilient despite many of the indicators and many of the people saying it shouldn't be?
- [36:41]
Ed
Yeah, I mean the. The index of leading indica economic indicators should just. They need a recall. I mean, it's a defective product. It just doesn't work. It's been telling us a recession's coming since late 2021. I think it was. And it's just been wrong. We haven't had a recession. The inverted yield curve has a good history of predicting recessions. It didn't do it this time. And whether an inverted yield curve really does, it tells you that investors believe that if the Fed continues to raise interest rates, something will break in the financial system. And if something breaks in the financial system very quickly it could become an economy wide credit crunch if it involves the banks because the bank's capital gets depleted by the losses and they have to stop lending to even good borrowers. In the current situation. I've been arguing that since 2008 the banks have been regulated, supervised, they're much stronger. I've been arguing that the capital markets have been doing more of the financing and if something blows up in a private credit deal, it's like a haircut on our rate of return on a portfolio. I mean people who are managing portfolios with private credit, they know what they're, they know the risks they're taking and they must be accounting for some losses here and there. And when it happens, it just reduces the rate of return. It doesn't create a credit crunch. So there's no credit crunch this time. I also argue that the Fed has learned how to play whack a mole as they did in 2008 and again with the great financial crisis and again with the great virus crisis. What I mean by that is when something, when, when there's a problem in the credit markets, when there's a crisis, they respond immediately with the liquidity facility. So yeah, the mold kind of sticks its head up and they, they whack it down. So that's what happened in 2023, that there was a, a banking crisis that lasted like what, a weekend? Because on a Sunday they came up with a liquidity facility that calmed the whole thing down. And we didn't have a credit crunch. So I think that was a good part of it. The other part of it is, you know, the pessimist said, look, there's no way you don't have a recession when the Fed goes from zero to five and a half percent. And I said, well yeah, it is tightening, but it's also normalizing. Zero is the abnormality, not five and a half percent. And maybe we'll be surprised the extent to which the economy can actually deal with that kind of rate hike. And I think that's been demonstrated to be the case. But you know, I mean, certainly some sectors, some sectors did have a rolling recession like housing and office buildings and so on.
- [39:37]
Justin
That's interesting to me too, to think like, will we have in the future here, will we have more of that type of situation where you see recessions in small pockets, but it's much harder to trigger the entire economy into a recession than it has been in the past?
- [39:47]
Ed
Yeah, I think so. I think that's, that's, that's kind of the way I see things is that there's, there's a very huge liquid capital market in America. Some of it is in the public domain, some of it is private credit, private equity. And there are a lot of, there's a lot of money involved in kind of shock absorbers. You know, during the Great Depression there was no such thing as a, as distressed asset funds. They would, had a, they would have a great time back then. Right now these distressed asset funds attract trillions of dollars. They're a good diversifier of a portfolio. If something goes wrong, it sure would be nice to make money on that. And so if, if you give money to a distressed asset fund, they will turn around and buy stuff at 25 cents on the dollar and then invest some money to restructure it and then suddenly it's worth a lot more. And so that's, to be able to clear markets quickly is an important development.
- [40:49]
Justin
And I wonder too if the better private debt situation is also playing a role here. I mean, you could argue the public debt situation is not as good, but if you think right now the private debt situation for consumers and businesses seems to be pretty solid. And I wonder if all those people calling for a crash are sort of thinking about different times when the death situation was maybe very different.
- [41:05]
Ed
Well, it is a little bit unnerving because the problem in private credit, it's by definition kind of not transparent. It's opaque. So there may be things going on there that we are only going to find out about it after the fact. And I think that kind of what happened in 2007, 2008, nobody really understood these credit derivatives. Even the people that created them didn't understand how they interact, might interact. And certainly the treasury didn't understand how important it was not to let Lehman fail. But they let Lehman fail and bail that Goldman Sachs and Morgan Stanley like the very next day. So they could have bailed it out, in which case we probably would have had just the garden variety recession and garden variety bear market. But no, it's, it was worse. So it's, it's, you know, I put it in that 20% bucket and I'm watching, you know, there are ETFs that invest in private credit, private equity. And I'm kind of watching to see if there's any signals that they're going to throw off to tell, tell me that there's something really wrong in this, in this sector.
- [42:18]
Justin
Just one more for you before I hand it back to Justin. How are you thinking about the potential for a market Grudge, you know, people like me who are owning the average stock. I mean, the equal weight S&P's underperform the S and P for a long time. Things like value stocks have struggled for a long time. How are you thinking about as we move forward, the potential for broadening and maybe these largest stocks not to lead the market as much as they have?
- [42:35]
Ed
Well, 2026 could finally be the year where it does in fact broaden. And obviously that's consistent with my change on how you should rebalance your portfolio. Financials and industrials have been recommendations of overweight. So I'm just saying overweight the more. But healthcare was not an overweight for me and now it is an overweight. I really think we've seen these mid caps, the small caps and the mid cap sectors do better, which may continue to be the case. Lower interest rates do help the smaller companies refinance their debts. So that's a big positive. And then I think we could see diversification more on a global basis. I mean, this year already saw a lot of that. The rest of the world outperformed the US in local currencies. Of course, the dollar was weak, so that made the foreign investing even better.
- [43:43]
Host/Interviewer
Was there anything in the Fed statement or in the press conference today that you found surprising, interesting. Is there anything that really jumped out at you that investors should be paying attention to?
- [43:55]
Ed
Not really. It seems as though the market got a boost from the notion that the Fed was going to be doing quantitative easing again by buying treasury bills. But that's a very technical development. It's all aimed at kind of calming down the reserve market, the bank reserve market. So I don't view that. And Fed Chair Powell went out of his way to say that there's nothing, there's nothing fundamental about what they're doing. It's just a technical adjustment to make sure they don't have a Repeat of the 2009 crisis that lasted a few days that they had to fix by injecting reserves into the system. So I think the market got a little bit ahead of itself on that one. Other than that it was an expected rate cut with a, you know, with no promise that there'll be more to come anytime soon.
- [44:51]
Host/Interviewer
Right. That was the thing. It seemed like they signaled that, like after this one they're going to pause and let things sort of settle out and see what happens here.
- [44:59]
Ed
That's great. Yeah.
- [45:01]
Host/Interviewer
What do you. Do you have any thoughts? I just saw Trump was just on basically being critical of them and saying that they should have went 50 basis points. Which, the guy that, I don't know his name, Marin. Is it Marin or Marin? He was one of the guys that, that descended to go.
- [45:15]
Ed
He won.
- [45:17]
Host/Interviewer
And then there was two other dissents that said they, they shouldn't be cutting at all. But I guess on that, on that point they shouldn't be cutting at all. I mean, where, where do you fall on that?
- [45:28]
Ed
I've been in don't cut. And I been on that since last year. And I've been wrong on it because they just won't listen to me. What can I tell you? And last year I said, you know, if the Fed does go ahead and cut rates and they wind up cutting rates by 100 basis points for the federal funds rate between September and December, and I warned them that my friends, the bond vigilantes might dissent. And sure enough, bond yields went up by 100 basis points. So did they really ease when they went lowered by 100 basis points and the mortgage rates went up by 100 basis points and the same thing. We'll see how this plays out. But we've seen The Fed cut 75 basis points so far this year and the bond yield hasn't come down like that. It still remains above 4%.
- [46:16]
Host/Interviewer
We've asked a couple of other guests about any concerns about the Fed independence just because, you know, Trump does tend to be so vocal when sort of he has an issue with someone. I mean, is that. But, you know, and a lot of responses, I don't know what your response is going to be, but a lot of the responses we've gotten from other guests are like, hey, listen, like, you know, maybe it wasn't as public, but the President has always kind of maybe leaned on the Federal Reserve in one way or another. So just, do you have any thoughts on that?
- [46:43]
Ed
Yeah, I think while everybody's worrying that the Fed will be less independent with a new Fed chair that's appointed by Trump, I think it could actually be more independent because the Fed has this long tradition of the Fed chair kind of establishing a consensus with very rare dissenters. And if there were dissenters, it was maybe one, maybe two, but that was kind of it and didn't last very long this time around. I think I call them the Federal Open Mouth Committee. You know, when they go around talking all the time, you can see you'll probably see much more dissent and they might actually vote that that way. And so there could actually be more independence on the Federal Open Market Committee itself. And that that would be a good thing in My opinion, but there's no way that whoever Trump picks as a loyalist to run the Fed can just jam whatever rate, you know, lower rates the President would like to see happen. And if, and if the, and if they were successful at that, which I don't think is possible because I think that would just bring kind of more resistance from the other members. But if by some miracle of the Fed lowered interest rates in line with what Trump wants. Beware of what you wish for, my friends with bond vigilantes would go the exact other way. I mean, next year we've got a lot of stimulus still coming at us. The Big Beautiful Bill act is retroactive to the beginning of this year. And that means a lot of people are going to get tax refunds in 2026. It's going to be very stimulative in the spring. In addition, the Fed now has cut the Fed funds rate by 175 basis points since September of 2024. And that's going to be stimulative. So, you know, we may find out with the benefit of hindsight that the Fed really didn't have to do what they've done. And the bond market reacts badly to it because the bond market's concerned that inflation is still kind of sticky. And this concern that even once the tariff effect diminishes, that inflation might still be stuck around 3% rather than 2%. And on top of all that, the deficit just widens some more because of the stimulus that's locked in through the big beautiful bill.
- [49:14]
Host/Interviewer
Yeah, so that is, I guess one potential risk is that this inflation sort of stays 3% or starts to edge higher and then, you know, we're back at that sort of inflation worry. Possibly just in wrapping it up here, you had mentioned sort of, you know, diversifying out of, you know, diversifying from the Mag 7, but also with international stocks. So specifically, is there anything there with developed or emerging that you sort of look at or favor a little bit more, or is it just kind of.
- [49:43]
Ed
Like a general, really don't cover individual countries. They, they, they, they tend to have a lot of moving parts just like, like our country does. I, I would say just having some exposure to emerging markets through an etf, maybe even a managed ETF would, would, would be a good idea. Managed by somebody that really knows the, the countries that they're investing in. I think, you know, I think investing in Europe with all of its troubles, that's worked out pretty well this year. But you had to know which country to pick. Spain was among the best performers and Poland was among the best performers. So I think just, you know, opening yourself up to some exposure to the global economy makes makes sense. And you can do that with ETFs and you know, talk with your financial advisor to kind of pick and choose whether you want a a passive ETF that just, you know, manages a bunch of these countries in a passive way, or whether you hire a buy into an ETF that is is carefully managed by somebody with a decent track record.
- [51:05]
Host/Interviewer
Ed, thank you very much for spending so much time with us. I know our audience will certainly appreciate it and yeah, come back again soon. And Happy holidays. Thank you.
- [51:14]
Ed
My pleasure. Happy holidays to you guys. All the best.
- [51:17]
Host/Interviewer
Thank you for tuning into this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the Excess Returns network@excessreturnspod.com if you have any feedback or questions, you can contact us@excess returnspodmail.com no information on this.
- [51:36]
Sponsor/Announcer
Podcast should be construed as investment advice. Securities discussed in the podcast may be holdings of the firms of the hosts.
- [51:46]
Ed
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- [52:02]
Justin
Is that guy with the binoculars watching us?
- [52:04]
Ed
Cut the camera. They see us. Only pay for what you need@libertymutual.com Liberty Liberty Liberty Liberty Savings Very unwritten by Liberty Mutual Insurance Co. Affiliates excludes Massachusetts for their clients.