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It’s Not K-Shaped. It’s No Shaped | Jim Paulsen on What You're Getting Wrong About 2026
00:57:35
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- [00:00]
A
We're excited to announce the launch of a new podcast, the Jim Paulson Show. We have followed Jim's work for most of our careers and have always respected his balanced and data driven take on markets. We are really excited to launch this new monthly show where we'll get Jim's take on the major issues impacting both the economy and markets. We have included this episode in the Excess Returns feed, but if you want to keep receiving new episodes, you can subscribe to the Jim Paulson show on all major podcast platforms or our YouTube channel using the links in this episode. Description thank you for listening. We hope you enjoy the new show.
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B
If we kind of take out this distortion of trade this year. So if we look at third quarter real GDP it was 4.3% but if you take trade out, say it was neutral, then it was only 2.4. If I look at year to date real GDP is 2 1/2 but without trade it's 1.8. A lot of people say it's a K shaped economy, the difference between wealthy and poor. I think it's a no shaped economy, the difference between new era and old era. High valuations without emotional optimism is not nearly as risky as high valuations with emotion, with great emotional optimism. A lot of the character looks more like the bottom of a bear than it does the top of the bull. And therein lies the opportunity.
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C
Jim, it's great to have you back and Happy New Year.
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B
Happy New Year. Do you guys do.
- [01:18]
C
Thanks. We always enjoy these conversations and I know our audience does as well because you have a way of kind of cutting through what is important in the markets, what's important in the economy, how investors should be thinking and you know, just this I think level headed approach to how you think about the markets. And for this conversation we are piggybacking off of a video you did on your substack where you were talking about the outlook for 2026. The things that you're paying attention to and sort of maybe how things are influencing the market and maybe where some things are a little bit cloudy. And specifically you know you talked about this idea and we'll get into all this, this no shaped economy. You were talking about how AI fits into the outlook beyond the mega caps you recently wrote about. This Wasn't in your 2026 outlook but we want to talk to you about it. Sort of some warning signs in technology and just kind of thinking about what this all means for the, you know, markets as we head into the new year. You know it was funny we Were actually just talking before we pressed record here and you know, we were talking about the, the silliness sometimes of these S P500 price targets, but these strategists have to do it still. But, you know, today we're not gonna, we're not gonna pin, trying to pin you down on a price target because we really know you don't believe in that. But I think a lot of these things that we're going to talk about are influencing factors that we think, you know, are important and investors should be paying attention to.
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B
Yeah, well, I, I don't know if I don't believe in it or not, Justin, but I just, if I could do it well, I'd probably put them out there every year. But I, I'm not sure if I could do it well. Well enough.
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C
Yeah.
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B
So pretty random inside 10% probably, you.
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C
Know, especially over that, you know, short of a period of time. But yeah. So anyway, so and for those listening, you can get all of follow along with Jim's research on his substack, which is paulsonperspectives substack.com. so with that, let's just kind of dive in and we'll kind of use your outlook as the outline here.
- [03:22]
B
The.
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C
One of the things we, where we wanted to start with you is, you know, you're sort of suggesting that the economy is maybe more sluggish than sort of these strong. At least the most recent one the GDP headlines suggest. So can you explain sort of what you're thinking on that?
- [03:38]
B
Yeah, I think the economy is weaker than maybe most think right now, including the Fed, but just on Wall street as well. And I think that plays a big role on how this plays out this year. If growth stays that strong, we got a probably different outcome than I'm looking for. I think we're going to be. We're sluggish and I think we're going to stay sluggish at least through the first half. I think we'll avoid a recession and come back and talk about that. But I think growth is pretty sluggish. I, you know, the real GDP reports is what's really turned this thing a lot. You know, we had the fourth, the third quarter real GDP report coming at 4, 3, which, you know, when you kind of go through some of the other data that's out there right now, it just doesn't add up a lot. Doesn't make, doesn't seem to make a lot of sense. And it comes after a very strong second quarter of 3.8. But we also had a first quarter that was, or a second quarter that was first quarter that was down six tenths of a percent over the last three quarters that have been reported. And I think, I think that what we have to take into account is one big volatile aspect of the economy has been trade. Never since Trump did what he did with tariffs and that's just so evident in the GDP data this year. In the first quarter, imports soared as everyone were trying to buy stuff before the tariffs went in. And so a lot of companies were buying supplies and everything else before the tariffs came in. And as a result, the net deficit, trade deficit ballooned and subtracted growth from the domestic economy. And we had a -6/10 of a percent first quarter real GDP number. It wasn't that meaningful. It wasn't like it was truly a recession. It was just a distortion created by Trump. Then in the next quarter after that, in the second quarter we had a surge or a big drop off in imports because everyone had already bought them. And so the trade deficit improved dramatically, adding to growth and we had a 3.8%. They improved a little bit more in the next quarter and that grew 4.3. But just to look at this where things are, if we kind of take out this distortion of trade this year, so if we look at third quarter real GDP, it was 4.3%. But if you take trade out, say it was neutral, then it was only 2.4. If I look at year to date, real GDP is 2 1/2, but without trade it's 1.8. And if I look at the last four quarters, real GDP is 2,3, but without trade it's 1Point8. So if you just look at real GDP alone, to me I think it's much closer to 2 than, than these other estimates. If you just take out the excess volatility and trade, that's likely to calm down. Now I think going forward, trade's never that huge of a, of a factor quarter by quarter. And if it does, then I think you're left with the undertow of growth, which is 2ish. And over my history in the business, 2% growth would often be considered the stall speed of the economy. If you hit two would be like, oh boy, falls below two year fall into recession, very sluggish growth rate. But if you go beyond that too, Justin, to look at the rest of the report, real PCE year to date is up 2.2 year to date. Take, take all the quarterly options, real investments up 2%. So real private spending from, from companies and consumers is up 2.15% year to date. Idealized basis overall if you go beyond that and look at the job market, non farm payroll growth year over year is up 0.58%. And year to date through November, 11 months of this year last year I should say it's up 410 of 1%. By any historic definition that's recession. It's a complete stalling of the of the jobs creation market. The unemployment rate in the last few years has now gone from 3.4% in April of 03 to 4.6% in November. That particular rise, actually any rise has never happened in a quote unquote economic expansion ever going back to 1948. Since they've been keeping the unemployment date in this country on a monthly basis, we've never. Once the unemployment rises, you're in recession. We didn't supposedly we're not. I don't really think we are, but it's really weird. The duration of unemployment in this country right now is 23 weeks long. If I look at the duration of unemployment data between 1948 to 2009 before the great financial crisis, it was 13 and a half weeks. So we're sustaining on a regular basis now a duration of unemployment which is twice as long as it used to be over most of post war history in this recovery, so to speak. So not only can you not get a job, but if you lose one, you can't get another job. It just takes forever. And to me we can talk about all these metrics of the economy but at the end of the day for politicians and ultimately policy officials, it's going to come down to jobs. If they're not there, the rest of the worries go out the window. And you can almost see that happening in what's going on at the Fed right now and the urgencies and some of those things. If, if jobs stay punk that these the other concerns inflation or gross GDP or what is going to go out the window. I think just a few more real retail sales were have been down slightly year to date down that is if you back out inflation they've fallen this year through November. Manufacturing and actually they've been flat for almost three years by the way dating back to the point at which the unemployment rate in this country started to rise. Real retail sales has flatlined. You can't find that either in the data going back. It doesn't go back as far but you can't find another period where you're in an expansion for 5 years while real retail sales are flat. Manufacturing, PMI just came out this morning, by the way, is below 50 in all months of this bull market, except for two months and it was below 50 again this morning at 47 something. And below 50 suggests contraction going on in that industry. IP industrial production year to date is growing only 1.6%. The capacity utilization rates falling 3 percentage points during this bull market. That's really weird too. That has happened before during expansions, but it's very weird. Maybe one other time. The service PMI, it's only out since 1997. During recoveries it has averaged almost 56 on average. During this bull market it's averaged 52.3. And the current one is 52.6 again, much lower than normal by any standard. Home Buyer Affordability Index is almost the lower, lowest it's ever been since they've been keeping that data. It's worse right now than it was leading up to the great housing crisis of 09.10, for example, the savings rate has gone from 6.4% in January 2024 to 4% in September of 2025. Now why is that important? Well, that year to date, I said consumption growth, as I mentioned, is up 2.2% in real terms. How much of that is because we've taken our savings rates down from 6.4 to 4. That is to say, people aren't getting jobs, so they're compensating by trying to keep, you know, stuff on the table by taking their savings right down. Well, you can't do that forever either. 4% savings rates are very low rate by historic standards already. And then of course, we know about consumer sentiment. It's. It's been almost the lowest level ever recorded here of late and remains kind of depressed. There's a reason why people feel bad on Main street, you know, there's quite a number of reasons, I think. And we're not suffering from excessive leverage that generally takes us right into a recession or a lack of liquidity that takes us right into recession. When you get into trouble like this without a job creation, if you have too much debt or no liquidity, guess what? It really craters. That's not happening because neither the corporate sector or the household sector is in that position. But outside of that, that thing that could take us into recession, the results here across a broad array of data is pretty weak. And people that are saying it's strengthening or it's going to get stronger. A lot of that comes from basically that GDP report. Maybe it's right, I don't know. It's not. But I suspect that we're going to find out that it's weaker than we think. And then just one last comment on this. A lot of the data from economic policies right now are still pretty weak. I mean yes, the Fed's starting to ease, right? That's good, good. And yes, the yield curve is finally positively sloped but it, it was negative, it was inverted for a record setting amount of time until just recently. The long term bond yields in this country, mortgage rates, 10 year yields have basically been in the same range now for the last three years. They haven't come down yet. You got real money growth. The pace of inflation adjusted M2 in the last year has grown 1 1/2 percent. That can't support runaway real GDP growth just isn't sufficient. The yield curve, its impact has a lagged impact on the economy. So the inversion we had all of last year is going to hit the economy in the coming year, you know, or that money growth has a lag. Fed, Fed easing has a lag. So the dollar is still 6% from all time record highs in real terms. So my point is, is that not only is the economy weak, I think it's going to get a little weaker with this lagged effect of, of policies. I, I did notice that in the latest Fed commentary, I think it was after the, the last cut. They even in their expectations are expecting further weakness in the first quarter at least of the, of this year. And I think it might drag on until summer or after a little bit and then, then I do think it will pick up in part because I think there's going to be more, more easing. To me this is a key thing. If I'm wrong on growth, then this whole environment is going to turn out to be very different in this year. But if I am right on growth and we don't recess in addition to that, then I think we have a good year in the markets primarily because we go from very low expectations and worry about growth eventually to full on policy support rushing through the stock and bond markets.
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C
Yeah, that's, I think, I mean you painted a pretty like picture where it's like we're almost on a tightrope where we could go one way or the other depending. And I know one of the things that we've talked about and you just mentioned is that this is probably one of the most hated bull markets we've seen in a long time. And so you know, that's the feeling towards the markets and yet the markets have continued to sort of march higher here.
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D
Do you give Any.
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C
I'm just. I'm curious.
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B
And this.
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C
I think I would know the answer to this based on what I know about you. But like, a lot of people say, you know, okay, after the market is up, you know, three years in a row at roughly, I mean, let's call 20, 25, effectively close to 20%. So it's been, you know, three years of 20% gains, roughly for the S and P. Is there any credence that some people just say, well, you know, historically the market has performed well after that period, and so therefore we think it should. But I mean, I think if, you know, there's people like you that are digging under the surface and bringing, I think, the real stuff, you know, to the forefront here. So, you know, I don't know, is there anything there with, like, the market's been up three years in a row plus 20, and therefore there's strength and the momentum should continue. I mean, what are your thoughts?
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B
Well, the. It's actually been up 16% in each of the last three years.
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C
Okay.
- [15:47]
B
And if you have to go, you can. You can find one instance of that where it's up three years of that amount in the. Or maybe more than one instance, but they all occurred in the 1950s where you had that. And I don't put a lot of stock near that. I mean, on the flip side of things, if I look back historically, bull markets, the fourth year is generally pretty good. If you make it to the fourth year, it tends to be a good year. That's also, you know, on the other side of the. The coin, suggesting that. I think it's concerning that markets are up as much as they had. You know, that's always kind of a concern. I do feel like that there's a lot of people. They're not. Not too many people are suggesting we're gonna have a bear market this year. Okay. And it'd be wonderful if they did. I mean, that'd be good. You don't generally get a lot of those. Some, but not a lot. But what. What I do see is a lot of people talking about a correction someplace here, which we probably will get a correction, but just the fact that that's a common theme and it has a lot to do just with. I think what you just brought up. A lot of people are saying, well, geez, it just can't go up year after year after year. One thing I'd point out about that is we just had a 20% correction in the last year. 20%, which by almost a bear market in The S P and we had bigger correction in the broader market like Russell and stuff like that. Now you don't generally have a 20% correction quote unquote bear in April last year and then have a bad year after that is typically you have that big of a upset, you, you have a good year. So I don't know if any of that holds a lot of credence with me. It's like you try to fill up the two barrel wheelbarrow body side of the issue and which one gets more and there's stuff that you could put on each side of that. I would say what, what to me, I don't know if it's the most should receive the most attention, but to me what's received the most gravitas here is that this bull has been hugely concentrated in new era activities and new era stocks. And then there's the rest and the rest really haven't had a good bowl at all. And yeah, some parts of them started to move a little bit last year because the, the reason why this bull's been so concentrated is because it's, it used to be a unique bull and it was the only bull in post war history that lived its entire existence under Fed tightening. Now that no longer is that case. But it really, really wasn't until just last year that the Fed has really begun to ease in any meaningful way. And all policies have been tight most of the time throughout this bull. And I think what that has done, and we'll get to this a little later with the division between new era and old era. But we can come back to it but just quick. I, I think that new era pursuits in the economy and in the stock market have done two things. They become really big on as far as size relative to gdp, relative to to market cap and the like, to the point to where their contribution to things can actually cover up a lot of what's going on in the rest of the economy for the first time. So you could have situations they finally become big enough if they're growing at 25 to 30%, they're big enough now that that could cover up the fact that a lot of other things are just laying there in the dead in the water doing nothing. But when you average them out, GDP is a 2 looks okay. Right. And I kind of think that's what's going on here a little bit increasingly so. And the reason this is important is, is why did this divergence happen? And I think it's because these two parts of the economy operate on two different drivers or cycles. The new Era economy has its own drivers, internal innovation. And if I'm, if I'm a company that comes up with a new idea like an iPhone that no one in the world has, I'm going to grow like gangbusters in the next several years. I don't care if the interest rate's 30% or zero. I don't care if the yield curve's inverted. I don't care if fiscal juice is contracting. It doesn't matter to me because I'm going to grow like man. Okay, they, they have divorced themselves from the normal cyclical forces of inventory, consumer spending trends, all this stuff, including policy. They don't need policy support to do okay, but all the rest of the economy does. That's how they operate through time. And so what happened here is this bull began with the Fed fighting inflation, which kept killing off everything else in the economy. But every time they looked up, New Era was doing so great and all the headliner companies were wonderful and going gangbusters. And I, they thought, well, we might as well keep going because the economy looks okay. And I think what's happened is the economy has really been the tale of two stories. One that's really just kind of laid there in the muck and one that's done extraordinarily. And that's why I'm saying this isn't. A lot of people say it's a K shaped economy, the difference between wealthy and poor. I think it's a no shaped economy, the difference between new era and old era. And the catalyst has been policy typing. And the reason that's important this year is because it's finally starting to go to easing. Which means what? You're going to awaken a lot of the parts of the economy and the market which have been dead in the water for so long. There's a whole nother issue. What happens to New Era? I don't think it's impacted by much, but it's kind of got its own drivers. Some of those are changing as well. So I, I think to me that's what is the most important thing this year is do, do we breathe some life into these parts of the economy that have just been doa. And let's face it, as, as portfolio managers, we have all, some of us quickly, some of us slowly, some of us grudgingly have moved away from old era parts of the economy in our stock portfolio. We just get tired of it. How many I've done it too. I mean, how many times I said, well, I think small caps are going to go, jeez, you know, I think and after a while you just kind of give up. You buy, buy some more of that new era stuff, you know. And so I do think we, we kind of got that out there in spades. And the good news is there is a lot of room left over in much of the economy because we haven't used it up. It's, it's even reflected, you know, in the economy now. We got the unemployment rate that's gone up to 4,6 now the Fed even has forecasted that's going to go up a little higher. If that goes up to like, you know, five, I mean that'll be like we had a whole, on a whole labor market recession and now we're at the bottom of this recession and we're going to reduce it. That's bull market stuff. You know, when you have excess labor capacity, excess factory capacity, you got a whole lot of cash on the sidelines, you got unused balance sheets, we got all of that. That's the definition of being at the bottom of the 0809 crisis or the bottom of the 73, sorry, 4 up or the. Take your pick. A lot of the character looks more like the bottom of a bear than it does the top of the bull. And therein lies the opportunity as long as new era doesn't just fall all fall apart entirely.
- [23:26]
C
I think it's so weird for me.
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D
Because to your point, we have these like these, we have these catalysts that you'd expect to have potentially reversing themselves at the bottom of the bear market. And we've got them after the markets had a massive run. And like, I don't even know how to make sense of that because I don't think I've ever seen that in my career before. It's just, it's hard to like figure out what to do with that.
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B
Yeah, I think it is but, and to me I'd say you move more and more to old era. You know, I wouldn't exit new because I, I think, I don't necessarily think new's going to collapse. I just think it's going to trail and we can come back to the wise on that a little bit. But, but, but the, I think where the possibility is and it will be bizarre, Jack, I think it be bizarre if it does happen for me to some extent. But, but to have essentially a feel in a part of the stock market and in the economy that feels just like you're coming off the low of a recession or A bear is, is going to be kind of weird with the S P, you know, at, at, at, at all time record highs, you know, but there is some weird stuff. I mean, like just give you a couple examples of. We are at an all time record high right now, okay. In the stock market. Real close. In fact, I think we are at record high technology stocks. We'll come back to that. The S&P 500 technology have been market performers now for 18 months. We're at a record high. How, what happened there? We're going to record highs without tech really being the lead. Okay, that's a little weird. We are at a record high in the stock market while the unemployment rate's gone up percent 1.2% tech snack at a record high in the stock market. With money market cash levels still at 7 to 8 trillion dollars, corporate cash is still very high as well as a percent of GDP. It's rolling over a little bit, but it's very, very high. You know that, that's kind of where we got, we got this new high in the stock market. At the same time we have an unbelievable bull market in the greatest fear asset ever known to man. Go, what is that? How does that jive with a financial market bull? You can't find another instance of that. Okay, so there's a, there's a lot of weird things going on. So why couldn't the weird thing I just described a bit earlier happen? I guess that's what I'm coming down to. I, if I pick some numbers or something, you know, I say that S P tech probably does, you know, high single digits, but some of the broad market plays might do 20 this year. Now we might also have a correction during the year at some point. And that'd be kind of how I look at it. And in some ways that wouldn't be much different than what happened on the flip side in the last couple years. Last three years, it's mainly been text on that and everything else kind of not so much.
- [26:20]
D
Yeah, crazy statistics I saw, which you're probably familiar with. The permanent portfolio, you know, a quarter gold, a quarter long term bonds, a quarter cash or short term bonds and a quarter stocks. That was up 20% last year, which is, which is.
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B
I wasn't aware of that. That's interesting.
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D
I think that's the highest that's ever been up. Like usually one of those things is at least having a terrible year because that's the whole point of the portfolio. You know, you want something for each environment. So just to see that do it. It just talks about how weird this environment is.
- [26:44]
B
Yeah. I just wrote a piece not too long ago, within the last month, too, that looked at consumer confidence and S. PPE multiples. And every time you go back historically, even going back almost to the 50s or the, it was 1960s, but every time when PES got up towards the high end of the mark, consumer confidence would be right up there with it. You know, this is the only time when we got massive valuations and the most pessimistic attitudes on Main street ever. I, I think that I, my conclusion from that study a little bit was that I think high valuations without emotional optimism is not nearly as risky as high valuations with emotion, with great emotional optimism. And again, that's another weird thing no one knows what to do with. But it's, it's certainly worth thinking about all these things that are different and certainly probably it is different this time in the sense something different will happen. Whether we could figure that out, I don't know. But it certainly isn't odd if we do have a surprising fourth year where a lot of this other stuff finally comes to life. And the catalyst to me is, will we be easing finally? I just see the policy mindset finally shifting for the first time in this bull from fighting inflation as number one, number uno, to supporting economic growth, restarting the job market. And I do think that's happening. And you know, you got the, the President's got to pick a new Fed chair. That's coming up as well. I'm thinking maybe, maybe I'm more hoping that he's not going to be as vigilant on tariffs. I think that might fade away a little bit this year and then maybe other stimulus kind of overcomes it. From a fiscal standpoint, it's surprising. The fiscal deficit during FERC last year actually went from 7% a year ago to 5% roughly now. And that's a 2% reduction in fiscal juice to GDP. And it doesn't feel like it's been that, but it's actually been a pretty big tightening. And I think that could change as well. And I, you know, we used to always say, don't bet against the Fed. And what that really meant was don't be selling when they're easing. Right. Well, we might get them all easy. Dollar coming down the yield curve, steeping the money supply, growth going up, fiscal juice expanding, you know, all at the same time. That's like the start of a new bull.
- [29:14]
D
I want to ask you about the easing because that, that was one of the things we want to cover. And we, we did this episode recently, my colleague Matt and I, where we went through all the market forecasts we could find. I think we found like 22 of them and we put them all together and we said like what is the, it's a good way to figure out what the consensus sort of is going into this year. And one of the things they did say is like they all, it was pretty common to say less Fed cuts that are priced in. It was pretty common for people to say know maybe we won't get as much easing. And I know the Fed is very, very difficult to predict what they're going to do, but you feel like we might get maybe more or at least what's priced in. Right. In terms of the number of cuts. Can you talk about that?
- [29:46]
B
I do, I do. And it comes down to, I think it's weaker than people perceive right now. And I think the lagged impact of these contractionary policies we've had in place last year, that's a lag 12, some of them 18 months. And that's going to weigh on things as we go forward into this year. So I also think that, I think jobs rule and that's what I come back to a little bit. What if job growth actually goes negative? I could year on year roll over. That would, that would be a shock. You know, what if unemployment rate does get very close to 5%? That's going to be a shock. And it's, it's some of those things I think that could radically change how people look at the policy environment very quickly. And let's face it guys, I mean the policy expectations by Wall street, including myself or anybody else, we, we change overnight all the time on that. We get, you know, eight cuts, four cuts go back and forth. So I'm not sure it means much to have, have it be one way or the other, but I would to your point, Jack, I think that's exactly what people are, we're at, they're thinking the easing cycle is about over. I think we're just getting warmed up. I mean I know one of us will be wrong. I hope it's not me, but I, I, I think we're going to continue to ease pretty aggressively. I, I would even suspect, I guess that I think the 10 year treasury is, is going to get closer to 3% by the end of this year. I, and I think an equilibrium level for the funds rate, to me that makes a lot of sense given the downshift in growth we've had. Since 0809 in economy I think is more like 2% with inflation maybe settling in, in the twos or something. So I think there's quite a bit of room there. But you know, I, I don't know for sure. Just like, like anybody else and I think it's just hard for people to, you look at the S and P as a whole and it's 25 and a half times earnings betrayal and what, 22 on future and you know, it's just really high and how can it do well and that kind of stuff. And I think that there's also this thought that when the tech thing ends it has to crash, you know, but it doesn't. It could just languish, you know, still kind of there and maybe people slowly kind of move away from it a little bit, but it doesn't crash out of bed. If that doesn't happen, then there is a lot of room for other parts to do better. That's kind of what I'm looking for this year.
- [32:20]
D
I'm wondering also, we're going to talk about that tech new era stuff in a second here. I'm wondering also like the changes at the Fed or the potential changes, like how much this, that plays into it. When we did our forecast episode, we were talking about, because I'm not a great Fed historian, I'm what you would call a macro tourist, I guess in terms of I, I have some knowledge about these things, but I don't have a ton. But we were debating the idea like I had asked ChatGPT, has there ever been a dissent from a Fed chairman? And the answer was no, not in the modern era. But I'm thinking about like someone's going to come in with a bias towards easing. You've got these other people. It seems like it's going to be an interesting dynamic on the Fed this year between the push and pull of of all these different camps.
- [32:55]
B
To me it's not hard to believe that could happen. Jack, just, I mean, just look at, look what's going on in politics in general. I mean, everything that we've been subjected to, a lot of that is like, you got to be kidding me. Look at that. That's first ever. I mean, he said what? Because, I mean, we're, we're doing a lot of things that we never did before. I mean, you know, with the birth of executive orders from the White House with Obama. I mean, it's gotten the point now where we just ignore the legislative branches and just do executive orders or I guess we can declare war too, without, you know, I mean, look at all the stuff we're doing. So a dissent by the Fed would be way down the list of oddities, I think at this point by the Fed chair even. And it could happen because you're going to put in a guy that probably has a easing bent and you still got guys on that board that think otherwise. I just think even for the people that don't want to cut further, I just think the data is going to force. You know, I always said it's not that important to pay attention to the Fed. It's more, much more important to pay attention to the Fed's boss. And that's the economy. That's, that's what, that's where they take their marching orders from. And to me, you know, inflation, if it re accelerates big, that's one thing. If it lays here while unemployment rate goes to five, I don't think there's going to be much debate that's working.
- [34:20]
D
And to your point earlier, if anybody was unsure about if they're going to focus on the labor market, if they're going to focus on inflation, it seems like they're answering the question. They're, if they, you know, they're going to focus on the labor market first before they worry about inflation, I think.
- [34:30]
B
That'S where we're at because inflation's no longer at 9% or whatever, you know, or 8. It's, it's in striking distance of being, getting to be more of a. Quite frankly, it's, it's already at and has been last three years, areas that we've been at for last 30 years that we thought was okay until we came up with this 2% rule. But I just think more importantly, you just can't have a job market that's completely flatlined and not respond and be tightening. You know, I think that's a hard thing. Maybe I'm wrong. You know, like there's a lot of first for everything, but I kind of think that's going to be hard to do.
- [35:06]
D
So you wrote a great article. You referenced earlier a few cautionary tech tales that people can find in your substack. But I wanted to ask you about it because there's a lot of sort of common narratives about what has to happen with tech, why it has to happen. And you found some stuff maybe a little bit outside the box you were thinking about here. So could you just talk about what you were finding in that article?
- [35:23]
B
Right. You know, I think every year of this bowl most, because, because tech Made a big run in the last bull too. In 2021. It didn't outperform as much, but it made a big run. And it just feels like every year this bowl there's been concern about tech. You know, New Era has gotten. Because we all reference the2000.com and feel that way, feel it and valuations are high and, and now it's, it's to the point where, yeah, everyone owns a lot of New Era, let's face it. We just do. We're all probably overweighted too much and it's very high value. And I think that scares people. This would be this year I've heard myself. I don't know if you agree, Jeff, but I've heard less about those two concerns surrounding tech than I have in recent years. There's so much chatter about AI and this new biting edge and chat GP and all this stuff that it's almost like we've gone away from those two things that you could just any strategist come out and say, well, geez, the values are ridiculous and they're all. Everyone owns them. I be cautious. Those things are still there. And I, I agree that they're meaningful, but I think they've been proved not to be as meaningful as we all felt for quite a number of years. And I think there's some other things though that are starting to happen and I'll just throw those out that I talked about in this piece. One of them is, is I monitored going back to 1990, how tech is done and its stock price relative to New Era spending in the economy. So if you. It's not a broadest definition, but if I just take New Era spending to include information processing equipment spending and, and information intellectual property product spending, add those two together in a nominal terms, then I take a ratio of the S&P 500 tech sector to that and look at it through time. Normally during the bull runs of tech, tech is. Stocks are going up more than New Era spending is in some sense the price earnings multiple of tech to tech spending is rising. Okay. But there have been times where it started to roll over and tech spending actually was going up more than tech. When that has happened in the past, tech stocks have been. That's been a warning sign of weakness coming up in the relative performance of tech stocks. Well, it's been happening the last six months where again, tech stocks are starting to trail or move only in line with overall tech spending. Not widely talked about, but it's there and it has some meaningful impact at least as Historically, I think a bigger one for me is if I go back and look at the relative performance of the technology sector back to 1990, and you overlay the ratio of total corporate cash holdings, that is cash and cash equivalents as a percent of gdp. They look like the same chart most of the time or they go up and down really closely together. And last year, kind of maybe the third quarter into the fourth, corporate caps, GDP rolled over, hasn't just died and come off a lot, but it has rolled over for one of the first times in this bull market. Again, not a good sign typically historically for the relative performance of tech stock. Tech seems to run on excess cash. They've had it in every one of the most recent bull markets over the last 35 years. And when that cash starts to dry up, it tends to hurt the technology sector more than most. I don't know if tech's all that sensitive to a lot of other policy variables, but in terms of liquidity holdings it has been historically and this thing has been liquidity plus in recent years. And maybe that's starting to. It doesn't help that we're now dropping interest rates, which is the return on cash. However, look at a whole lot of cash if they're getting some returns on it. But if you start to bring those rates down, guess what? They're going to start using those cash into the pursuits and suddenly the cash GDP ratio is going to fall. And that tends to constrain. Maybe it's the innovation and the capital spending that they have to do to do that with cash. I don't know. Another one that is maybe not widely filed is R&D's contribution research and development spending in the economy. That contribution to overall gdp, it goes up and down generally as a leading indicator of the relative performance of technology. And that thing has been coming down now since 2023 and more aggressively here in the last four to six quarters. R D spending to GDP is really coming down and it's very low now. Again, another sort of warning sign in an industry that might be the poster child for R and D. Right. Overall, I think two other things. One is, I've already mentioned that in the last 18 months now the relative performance of technology, relative price is unchanged with the S&P 500. Now admittedly know they did really well in the summer, then came down, they rallied hard, back up. But 18 months, if you have held tech, you haven't gone anywhere relative to the market. And one of the things, the attractiveness of tech has just been its constant outperformance it is a winner. What if it comes down at all here? Let's say it underperforms this quarter by, you know, somewhat significant amount. Suddenly it could become a loser for almost two years. And if you think about that, it wouldn't be a meaningful loser but it would be a psychological, cultural mindset loser that would really get people start question, should I have this much weight in tech stocks? And they really haven't had to do that very often because tech might underperform for a little while. Noise comes back, maybe it will again but if it doesn't, it's going to bring people sort of re examining where they're at them. And that dovetails with my last kind of point and that is that I, I think that in every new era cycle that leads big like this, the reason they lead is because their own fundamentals are outperforming and there's no doubt about that. And tech, tech and communications has done that in this cycle. Their, their fundamental performances have been just phenomenal, you know, just no almost out of this world. But I think what's also helped drive these stocks hunt is not just their own fundamental performances, but it's the lack of any other fundamental performances anywhere else in the, in the stock market to be had. It's, it's rarity that, that we're pricing into tech stocks. It's not just their fundamental story, it's that wow, they're doing this in a world where no one's doing anything. And I think that's been a huge driver and it's probably getting to be a bigger and bigger driver because every year people are disappointed with every international stock, every small cap, every mid cap, every value stock that you've ever bought when I could have owned, you know, the new era that it may be coming to an end because not only is tech doing not as well, but other parts are starting to pick up with Fed easing a little bit. And if, if that continues to grow, I would argue that nearly every portfolio out there is going to at least decide to, well, maybe I should reduce my exposure just a little bit. And if everyone does that, that's going to be a pretty heavy pull down on technology and new era in general. So you know, some of those might be known by people but I certainly aren't mainstream thoughts right now why people might be concerned about technology but I think they're meaningful thoughts that that might, might matter here.
- [43:05]
D
Yeah, and that cash one is so interesting to me because you know what we had with these mag 7 type companies is we had asset light companies with tons of cash. Now we basically have asset heavy companies that don't have the cash anymore. And so the question is, I don't even know the answer but the question for all of us to think through is like how does that change this whole situation? Because a lot of what made those companies great is sort of not there anymore.
- [43:25]
B
Yeah, they, they're becoming more, you know, like say levered they could and at least they could become more lever cap spending companies. That, which are old style industrial companies have always been so to speak in some regard during big capital spending cycles they lever up and capacitize out and, and it like say in tech, if they capacitize out and it's all cash in the barrel head, that's one thing. But if you capacitize out with, with new funds from other investors and so forth, that's another thing that, that changes their stripes a little bit. I don't know if we're fully there yet, but I would, I would too question a little bit. I, I'm no expert in AI stuff's gone way beyond me a long time ago. But you know, I, I have been around new fads, new things come out, they're always exciting and compelling and, and they're real and there's no doubt and AI will certainly be that way too. But you do wonder if it's going to be less impactful than everyone suggests and all the big wise men say and all of that or even if it is, it takes long, much longer than, than what's expected. That could come and play a role too. Some of the immediate excitement of, of AI could, could pale a little bit or start to, to change in terms of how people perceive it, look at it. But I'm more concerned about more of these fundamental forces I just brought up. Particularly when you already have very over owned portfolios that are very highly priced.
- [44:57]
D
The other thing with AI and it kind of relates to your broadening thing you brought up before is like where will the benefits accrue? Like if you look at some of the people that built out the Internet infrastructure, those companies didn't do that well, but a lot of companies downstream of them did really, really well. So I mean maybe AI will end up being, it'll be the weirdest thing in the world, but maybe AI will be the thing that finally for us value investors like gives us some fuel. Even though you wouldn't associate value with AI.
- [45:17]
B
Yeah, well, you know, there has been techno jobs in the technology sector have been rolled, have Rolled over and been coming down. And in some sense they're showing a little bit of being a victim of their own success. You know, already to some degree, if there is rising, you know, big rise in productivity, some of those things could very much be in their industry. I mean, you think about coding, jobs, programming, I mean, that, that seems like something that AI could do or Google chat. I mean, because the rules for that are all out there. It's like, give, give them the textbook, they'll do it. You don't really need creativity, you just need the textbook and the rules and boom. And I think there are things like that that could happen. But again, I just, just a way, I think some of this stuff takes longer than what people think in the excitement of it all to play out. We tend to get a little over the top on some of the possibilities. But who's to say we might be surprised this time? You know, I, I've been watching robots dancing on, on music stages of late and wondering, you know, how long it'll be before I show up. You know, we have that, we have this podcast. It'll just be a robot here you're talking back. Maybe that's all it's going to take. I don't know. So I, I, maybe where the death of, death of mine isn't premature at all. We'll see.
- [46:44]
C
Where I wanted to go with you here, Jim, as we get to toward the end here, is if you were given a blank slate, you know, think about in terms of like an investment strategist and investment allocation. You know, you have to start 2026 with, you know, you're building a balanced portfolio. You're given a blank slate of money. You know, so there's no allocation. Currently you're thinking of allocating between, you know, stocks, bonds, US International, large cap, small cap, and then just generally commodities and alternatives. Like, I kind of think I know how you might answer this, just given the conversations we've had over the past few months, but just sort of walk through how you would go about allocating a bucket of money and spreading that across the various different options that you would have as an investor in the portfolio. Of course, none of these are recommendations, but I just want, I think that's a good question for you because the people listening, you know, are probably going to be, look very different just given like the points you brought up, how much tech has run, how concentrated the.
- [47:51]
A
Market is and stuff like that.
- [47:52]
C
So just kind of walk us through how you would think about doing that.
- [47:57]
B
Yeah, that's a good Question. I, I can't say what specific allocation.
- [48:01]
C
Oh yeah, okay.
- [48:02]
B
Every individual is going to be different. I mean they're all going to, you know, and institutions like. But you can certainly talk about over underweights, whatever their parameters are. Right. Of positioning themselves. And I, you know, I, I would, I'd be overweight stocks this year, but I would, I would have some bond exposure and I'd probably be higher now than I've been in that because I do think we're finally going to get a rate move. That's one of my things. I kind of think whether that happens or not, I don't know. But on the flip side of that, I could be wrong. But I don't see where inflation is going to take off again and cause rates to go a lot higher. And I think there is downside on bond yields. So I think bonds have a decent year overall. I think stocks do a lot better in part because bonds do what they do. But in a year like that where bond yields come down and bond prices go up, I think it makes some sense to have more bonds than you maybe have had in the last couple years. It isn't even so much. I, I think it's time to diversify away from the risk of equities as it is. If bonds are going to give me greater returns, then it makes sense to have some more of those than I normally would have. And I think you could, you know, I don't think you necessarily have to go down the quality spectrum for that because a lot of this had become, I think more price appreciation than it would be adding more yield spread, if you will, overall. So I think you could stay fairly high quality and, and just lift a little bit of your, your bond exposure. I'd still be underweight though my parameters because I still think you want to be overweight in, in the equity market. I would be underweight commodities and I would certainly be underweight gold. And I think gold is a massive emotional blow off. And to me the factor that's driven it is just fear. And I think one of the things, I think I'm doing more work on this right now. But you know what has driven Main street confidence to lows And I'm looking into that and I can tell you this already, it's not inflation, even though that's a common theme that does not line up with it. I think it's more the job market and the, the problems that the weakness that's been existing there. And so my point about that is if we finally change to Promoting economic growth, particularly jobs. I think we'll finally get a lift in confidence in, in this country. Now I don't know if we'll go all the way back up to highs but I think we're going to finally get a lift of confidence. And if we do that will be an enemy of gold and the silver. I think overall and if, if economy is weaker in the first part of this year then I think commodity prices might also just surprise in general that they're not that far. Right now aggregate S and P Goldman Sachs US Commodity Price Index is very close to breaking out of that three to four year range it's been in ever since the pandemic. If it breaks into new low territory like crude oil's already done, but if it does overall that could get a lot of attention at least from technicians that could drive that quite a bit lower. I, I'd stay away from those at least right now. Now that said, we are reinflating the economy. If I'm right, we're bringing policy juice and stuff to reinflate. So if the economy picks up in the second half they could. Commodities could have a bounce. But I would, I'd prefer having underweight commodities going into the this year. First part of this year, maybe in the second half you might want to consider lifting some of those if stocks do have a nice run for a period. But I would, I wouldn't do gold. I think that's on a planet by itself and some of those precious metals. I just have a bad, bad year. Then if you get into the stock market I would, I would look to underweight my new era positions. I wouldn't go to zero. It's too big of a risk. This is dynamic stuff these companies do and somebody always comes up with something new and you don't want to be completely out of this. It is a leading edge, not just of the stock market. It's the leading edge of the world economy. And I don't think you want to be out to, to make a bet like that. But to be under, under the 30, what 30 some percent weighting probably 35%, maybe even closer to 40 if you include tech and comms in the s and P500. I think it could be, you know, somewhat significantly below that. And to, to put some in. You could call it old era areas. I just call it broad market areas. You know, I guess I still like smalls, small caps. They have started to do a little better. Micros are even doing better than smalls. You could I think do a spattering of some of those. I really think international markets, they've started to really take off this year. That's because of the dollar. But I think the dollar goes down more this year. Again the real value of the dollar is off 6 to 7% from its high in January. That, that high was within about 1% of its all time high. If it went down to the, you know, 5 to 10% this year that it'd still be high by a story standard. So I think the dollar could go down and I really think the better policy to make America great again, you know, isn't to tear up everyone else to try to make them buy American. It's just to lower the value of the dollar. And if you do that, people buy American because it gets cheaper to everybody. And so I think that's what we're doing and we'll do more of that this next year and I think you'll, you'll have international stocks beating the United states S and P500. I like emerging better than I do developed and I, in my emerging bet I, I do a little frontier too because I, I think that it's sort of a mixed bag. I, I see happening between frontier and emerging market that what's going on since the pandemic is everyone in the world is revisiting, you know, diversifying their supply chains away from China. So China I think is going to continue to be a loser. I, I, I still would be underweight China and I would go into emerging in frontier markets. I think I'd still have more weight in emerging than frontier. But I take some frontiers because I think what we're going to see in the next decade or so, some of those frontiers are going to become emerging. They're, they're going to be some of the winners among the new China supply chain diversifiers and I would do that. But I do think policy juice and dollar weakness really favors international companies this year and then that within the United States domestic sectors I, I think I'd look at some of the cyclical sectors. I think just consumer discretionary, it's a good one. It's really has not done that well of late. I said retail, real retail sales have been flat. If they finally get some policy juice I think that'll help overall I think industrials have done better but could still do well. And I, I'd be looking a little bit of the financials too. I'm less inclined on materials but I might be more interested in that in the second half, second half of the year. I'm, I'M not that inclined on energy either. Maybe later in the year, possibly I'd still, I know they haven't done well, but I, I would be underweighted some of the defensive stuff, yet I'd still be underweighted like things like low vol investing or, or, you know, consumer staples, REITs or, you know, healthcare. Some of those areas of the marketplace. I'd rather go to there in a bigger way when I really thought the market had a bear market risk than I would this year. But we're getting pretty far removed now. And you know, that's, I always say people in my business, you know, it isn't just the market, you know, advice and bets we make. It's. We make a ton of bets every day of our existence. If you think about it, we're talking about range, we're talking about the dollar, we're talking about oil, we're talking about. And the fact of it is, when you diversify, put, you know, go into a lot of those things, I, I really believe you get away from the, the overall market, so to speak. Probably the decisions get worse and worse. You're putting less and less time into the marginal tilts than you are the big tilt. And I think that's true. It's been true in my experience, historically as well.
- [56:43]
C
Anyway, I hope that, yeah, that's, honestly, that was excellent because I think it's good to kind of button up, like the more strategic stuff with, with how, you know, you might look at like allocating or tilting into a portfolio. Again, everyone's different. We know that, but I think that that's a good way to sort of wrap up, you know, today's discussion. So thank you very much, Jim. We really appreciate it. We will see you in a few weeks.
- [57:07]
B
Okay, thanks you guys so much.
- [57:08]
C
Thank you for tuning into this episode. If you found this discussion interesting and.
- [57:12]
A
Valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcast in the Excess Returns network at excessreturnspod. Com.
- [57:21]
C
If you have any feedback or questions, you can contact us at excessreturnspod at gmail.
- [57:26]
B
Com.
- [57:27]
A
No information on this podcast should be.
- [57:29]
D
Construed as investment advice. Securities discussed in the podcast may be.
- [57:33]
A
Holdings of the firms of the hosts or their clients.