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Tech Spending Has a Cash Problem | Jim Paulsen on the Two Signals That Could Trigger a Correction
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- [00:00]
Justin
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Jim Paulson
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- [00:59]
Justin
Jobs Tech has been driving the market higher, but how long can a market driven by one sector keep going? In our latest episode of the Jim Paulson show, we take a deep dive into the data to look at what is driving the market and if it is sustainable. 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 using the links in this episode. Description thank you for listening. We hope you enjoy the show.
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Jim Paulson
For technology or innovation to be quote unquote successful, it has to at some point. I think it will here eventually, but it has to at some point be not just benefiting the sector that came up with it. You're also seeing another stripe changing. We're having unprofitable stocks, unprofitable tech stocks in particular, leading the tech world, if you will, overall. So Mag7's not only getting beat by small, little no name companies, it's also getting beat by companies without any profits. Although I think we're going to avoid a bear market this year, I do think we will. I'm getting more and more concerned about a meaningful pullback here in the stock market.
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Justin
Jim, welcome back. Thanks for jumping on with us today.
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Jim Paulson
Oh it's great to be here Justin. Thanks.
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Justin
We always like to do these talks with you monthly where we talk about a whole host of things and relating to the market, the economy, policy sort of and what you're seeing, I think in the markets with a lot of the data sets and things that you're looking at trying to help our Audience and investors sort of get a read as best we can as to where things maybe are headed and some of the more I think interesting things, you know, that you're paying attention to. A lot of these or all of these charts actually are pulled from Paulson Perspectives, your substack newsletter. So we're really grateful and our audience is appreciative that you know, some of the stuff that you're putting out to subscribers, you know, you are sharing with us which is, which is, which is really great. And it's always, you know, very important to get your perspective to help us understand sort of what, what we're looking at when we look at these things. And I'm pretty sure I can say this, we are not going to be talking about SpaceX or AI in this conversation or will we be there maybe
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Jim Paulson
a comment to AI here or there?
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Justin
Yeah, that's basically it seems, you know, it seems like that's what's dominating sort of the, the headlines and the media. But from your perspective, what are your thoughts in terms of where we are with the economy and have there been any changes since we sat down with you last month?
- [03:35]
Jim Paulson
Yeah, I'd say there has been a little bit. I, I still suspect that economic growth is going to weaken here in the summer months into the fall from where people expectations are. But you know, it's been better than we've, than I have thought here of late with some recent reports. We'll see what Friday's payroll brings but there's pretty low hurdle on that as we're heading into that. But I, I think the underlying economy still remains fairly tepid. You know, we're probably growing more 2% at best in real GDP overall and employment is still quite, quite, quite weak. And I think a lot of the good feel from this is taken from what profits are doing, which have been spectacular. But as I'll talk about in a minute, that's really concentrated profit success. It's not really broad based. So I think the key to me continues to be does the economy slow down a little bit and if it does, I think we're going to move quickly from worried about inflation to worry about growth and that those would be very significant aspects of what could prove to be the second half. The other thing I'm just worried about a little bit is although I think we're going to avoid a bear market this year, I do think we will. I'm getting more and more concerned about our meaningful pullback here in the stock market, the US stock market, mainly because the BIFURCATION of this market movement lately has been so extreme between just New Era securities and all the rest. Basically all the rest have done nothing. And you got this one small part that's going to the moon to your point, just it's SpaceX that's literally going to the moon with AI, I guess. But I, I'm a little taken back by how extreme the move has been, how it's really based a lot on emotion around another new technology AI And I just feel like there's enough things that are creeping up that are putting out warning signals for me of getting some pullback, particularly if amongst all that we, we also get a slowdown in economic activity. So I'm nervous about calling for a pullback and I wouldn't necessarily, I don't think we're a bear. I wouldn't pull out of stocks, but I would move up to underweighted positions in New Era and overweighted positions in Old era stocks. That's kind of where I'm at and I'm nervous about it because calling a peak in this market, I've never been good enough from the short term perspective. It could go on for a while. On the upside, I don't know, but I'm seeing enough that's got me a little concerned enough to at least tilt in that direction. At this point. I do expect meaningful pullback, but I also think that by the end of the year we'll be back pretty close to where the highs have been recently again. In other words, I think it's going to be sharp and nasty and then have a good rally maybe in the fourth quarter.
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Justin
What about inflation? I think the may print, if I'm reading this correctly, 3.8 year over year, which was, you know, you know, fairly strong. So is there anything there that you're sort of concerned about paying attention to, particularly with this war that continues to, I guess go on and with the streets being semi closed?
- [06:59]
Jim Paulson
Not, not so much. The, the print's not that surprising. I mean, who among us that hasn't filled their gas tank would know that we're going to get higher inflation here for a few months? And I think I just went over 70 bucks here last time at the pump, which has got to be a high for me for maybe ever, I don't know. But I think that that's not shocking and we're probably going to go a little higher in the next few months. I think what's encouraging on the, on the whole front though is I still see quite a bit of disinflation going on. A lot of the parts of the rest of the marketplace outside of energy and those tied very closely to that and also expect economy to slow down. We'll come back to that. But mostly it's interesting and encouraging to me that even while we're firing today on each other, Iran and the United States oil prices are up two and a half dollars, I think through the low 90s. They're not really much different than they were in March. Gasoline prices are about national gasoline price, pump price is about pretty close to where it was in March as well. So a lot of this surge in energy prices was early on and since then it is calmed down a bit. Even if we still got a conflict going on and if it stays in that range, then eventually those prints are going to go to zero for the month. You could still get a flat month at $94 oil if a month earlier was $94 oil. And so the thrust of this inflationary I think is going to start to calm down. Unless we truly get back in situation where we're going to take oil back to $120 a barrel or something. I don't think that's likely. But who in the heck knows with where this is going to be at? I still think the best case is that this is winding down and will wind down in the balance this year. Inflation probably stays elevated until later this year, but it's not at this point it's, that's not unexpected. A lot of that's kind of embedded already in the financial markets.
- [09:06]
Justin
What do you think? We have the first Fed meeting in mid June with Kevin Warsh at the helm of the Fed, who's taken over for Jerome Powell. Do you think it's going to be more of the same, I guess, or do you have any sense around? I mean, I think he kind of was brought in under the, you know, idea that rates would go, you know, lower. But that seems to be sort of a question mark now, I think with, with, with what's going on in the economy and inflation, everything.
- [09:37]
Jim Paulson
Yeah, I, I think there's going to be drama at this point. Not so much they go lower, but it'll be whether do they hike now or do they. Not the immediate rain. I think once we get beyond this first, you know, action or first meeting where they have to make a decision officially about whether they're going to do. They could hike. I mean you've got a ten year treasury that's gone up to almost four and a half percent here of late. That's certainly Got a quarter or a half point, you know, that could be put into the funds rate, leaving the yield curve where it was when the 10 year treasury was at 4. So there's room for the private market suggesting a Fed hike at this point. I think personally that'd be a mistake if they did that. But I'd probably the minority on that view at the moment. I'm not as worried about, you know, if the real issue, if you're raising rates for inflation, I don't see what a Fed hike right now is going to do any good for bringing the price of crude oil down. I don't think it has anything to do with it, you know, the price of crude oil. We know what's driving that. And it's all about a conflict, geopolitical conflict. And that's not going to be altered by whether the Fed raises the funds rate or not. This is not an excess demand driven inflation problem we have. This is a one off supply restriction inflation problem that's temporary until that ends. And I don't see why tightening policy is going to make any difference. It's not going to quicken that process. But they may tight for a period, I'm hoping, and my guess is they won't. And maybe Warsh will have, you know, some impact of that as being the new chair fit our Fed chair. But you know, he's just one vote on that and we'll see where it goes. I mean this is, this is going to have a lot of stuff pinching on it. You know, Friday's payroll numbers will, will factor big in this decision and how people feel about it as well. So I'm not. Because ultimately the economy is going to dictate this, right? It's either slow down or it's not. That's where it's going to come down to.
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Justin
Is that the market's expectation, do you think that they, they will be hiking? You know.
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Jim Paulson
Yeah, I think it is right now. I, I think that'll be wrong. But that, that's where I think the kind of the average expectation is. And certainly a 1, 1 fed hike out the gate that might even be more probable, you know, but, but saying there won't be cuts, I think that's pretty aggressive. I think there still could be cuts this year before we get done with
- [12:12]
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- [12:59]
Justin
You, you had mentioned the sort of concentration of performance and earnings robustness in sort of the new economy stocks versus old economy. And that bifurcation, I guess that's sort of happening in the market. And that's what this first chart, I think highlights.
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Jim Paulson
Yeah, it starts to get to this and basically what I have in there is the blue line is basically the division going on in the stock market. It looks at the relative price performance of new, what I call new era stocks, which is basically within the S P 500, the stocks that are in the information technology sector and the communication services sectors and they're on a, on a cap weighted basis how they're doing relative to the rest of the stock market, which I called old era stocks. And you can see what the blue line's done. We had that big boom in the dot com era in 1990s and we've had a big boom here in the last several years as well in terms of the performance of new era stocks over older stocks. What you can lay on top of that is what's going on in the economy and it's been very bifurcated as well because this economy divides it down to new era spending versus old era spending. It takes nominal gdp, investment spending on information processing equipment and intellectual property products as a ratio of the rest of GDP or the, or, or the, the rest of GDP, and that only makes up about 13% of total GDP is from New era or excuse me, not, not even 13 on nominal terms, but less than 10% of GDP is made up from, from nominal new era investment spending. And yet you can see it clearly traces out what the stock market's doing. Stock market's just following what's going on in the economy between new era spending and older spending on Main street. It's going right into the stock market. So when you look at this, you know, for me, when I think ahead, how this plays out, you got to ask yourself the question here. If you're worried about what the stock market's going to do. You got to say, where's that red line going in this chart? It's newer investment spending going to continue to climb relative to old on in the economy. Because if it does, that blue line's probably going to follow. And so that's a big question, I think for me. And if I look at the next few charts, Justin, I'm starting to see some things that tell me, you know, the timing's not perfect on any of this stuff, but tell me there's pressures building on that red line, which is now a blue line. In the start, I changed up my color scheme. But the blue line there is new era investment spending as a percent of the rest of the economy. And what the red line is is what I call total policy stimulus. And it's just to look at what is total economic policy been doing. And that red line just combines into one policy variable. Money supply growth, the yield curve, overall fiscal deficit spending as a percent of GDP and the dollar. Those are four very key policy variables. And they're, they're put in a position where they're kind of weighted equally. And I put this on an inverse scale here. So when the red line's going down, that's suggesting policy easing and when the red line's going up, it's policy tightening corporation across all four of our major policy variables on average, you can see it's got a pretty close relationship here, that the tech part of the economy does best when there's tightening going on in the economy. When there's policy tightening, you can see that throughout the 90s bull, you can see it throughout much of the recent years and you could certainly see it in the monks of this bull market where we've had mostly tightening going on most times since the 2022 inflation spikes. Now the other thing to pick up here is the red line's leading by six quarters. I pushed the policy variable out six quarters. There's generally a lag between what money supply does today and what the economy does maybe four to six quarters later. And what I'm picking up here is the policy starting to ease now. The Fed's paused that again of late. But on average the dollars come off. Real money supply has gone up. Bond yields until very recently have come down. The yield curve has certainly steepened over this period of time. And I see that easing happening. And we're just about that point six quarters after policy changed from tightening to easing. And you can see what that's suggesting. It's suggesting that that blue line may finally roll over. Whereas the ratio of new to old year spending may finally start to roll. If that happens, you can imagine what that will do to stock trends, stock market trends, and that's what I'm a little worried about. A couple other things that come into play in this thinking, if you go to the next chart, this is another key variable for this blue line, the ratio of real to old Euro spending in the economy. The red line in this thing is total US Corporate cash as a percent of new era investment spending. So if you look at it, it makes sense. If cash among corporations is building up relative to the level of new era spending, guess what? Newer spending is probably going to be strong. And if cash starts to dry up relative to new year spending levels, then in the future new era spending is likely to slow down. You can see what that's suggesting right now. It's been rolling over. It did have a recovery, so did the blue line. Now it's rolled over again. You know, the lags aren't perfect here, give or take, but I, I think again, it's another troubling sign for what may happen here for the trends of spending within the economy. And then finally, I would just point out that I think that generally economic policy has been tightening of late and that's likely to slow the economy down. And one way to look at this is the blue line in this chart is Citigroup's U.S. economic surprise index. And all that does every, every day is it calculates when the economic reports come out. Is that report better than what was expected or worse than what was expected? If it's better, the blue line goes up, worse, it goes down. So it just picks up net net positive surprises, net negative surprises in the economy. Well, really what that is is a momentum measure of economic growth because typically when the economy is accelerating, all of our expectations are behind it. We're kind of catching up to the fact it's accelerating. So our estimates aren't as good as they actually come in. The alternative holds as well. When the economic momentum starts to lose momentum, what happens typically is reports are worse than what was thought. And so it's a great measure of economic momentum. And you could see it's gone straight north here in recent months, Tom, and that's showing up in the data. The data's been better than expected. That's why people are feeling better and whatnot. But what I've done here is taken that 10 year treasury yield, pushed it forward by three months and then inverted it and you could see it's a Pretty darn good relationship when, when bond yields go up today, three months later, economic momentum fades. If bond yields go down today, three months later, economic momentum picks up. We've just been through a period of pickup and economic momentum and guess what? That brought a big surge in bond yields because momentum picked up. But what's likely to happen now, just about at this point three months later is I think economic reports start to disappoint as we go through the summer months. And you know, if you get disappointing reports in the economy brings greater Fed ease, which has not been great for the tech part of the economy. I think there's room for me to believe that not only overall economic growth could be weaker than expected here in the coming months, but also maybe tech spending in general might weaken off as well. And that's what I've got me a little concerned about. Perhaps a, a correction or, or sorts. I don't. Last comment I make, I don't want to ask me, we'll come back to this a little bit later. But also got to think of the other tightening forces that have been applied on the economy here kind of quietly in the background in the last few months, most of which are tied to the geopolitical conflict. Geopolitical conflict gets what have oil goes through the roof. Okay, well now the inflation rate's up as you pointed out earlier, Justin, the inflation rates. Right. Guess what that's doing. The real wage has suffered some of its biggest declines in the last couple months that it's had in the entire bull market. But real wages are been negative of late. Yeah, you've also got because oil went up, inflation, interest rates have gone up, not only 10 year yields but mortgage rates. And across, across the spectrum a tightening force overall. You now got people expecting Fed tightening to come through. You've had the dollar was depreciating, it started to appreciate again or strength a little bit as rates have come up in this country. That's a negative force. In the last 12 months, the net deficit spending from the federal government as a percent of GDP is contracted by 2 percentage points from about 7.2% stimulus to 5.2% stimulus. So you've got tightening and the real, real rate of the money supply has almost turned negative again after being positive for a while. And that's in part because inflation's going up. So you've got monetary tightening, you got rate tightening, you got dollar tightening, you got fiscal tightening. What, what is that going to do? Probably going to slow the economy down and that's what that's Kind of where I'm looking here for the summer months, maybe into the early fall, maybe sell in May and go away this year might not prove out to be too bad, even though it might be more like sell in June or later in go away or whatever. Flattened with Jay, this idea of new
- [23:12]
Jack
era spending against old era benefit, it's been like one I've been thinking about a lot recently because the new era spending is kind of being done in advance. But you'd argue like for this to continue for a long time because that's kind of the big question now. Can it continue? You'd have to argue for it to continue. We have to start seeing benefit to sort of your average company. Right. Because that's what's going to be the revenue that's going to come back to them, that's going to allow them to keep spending. I mean, do I have that right?
- [23:34]
Jim Paulson
Yeah, I think so. And that's, that's the other thing that bothers me, Jack, is this even much more so than the dot com boom in the 1990s? I'm seeing much greater bifurcation of success in this economy and in the stock market than we ever saw in the 1990s. In the 1990s, we, we were growing, you know, GDP was growing 3 to 4% rather regularly. Productivity was very explosive. It was close to 2 to 3% as well over the vast majority of that era. Job creation was very healthy. Throughout the 1990s, optimism was everywhere. It wasn't just on Wall street, it was throughout, all across Main Street. Small, large companies, consumers. That was a very different world than what we have today. What we have today is we've got a world that's just phenomenal results from the innovations that we have in place, much like we had in the 1990s to some extent, but it seems like it's much more limited to that sector or all on the stories of what might come for the human race in the future. Kind of one of those two things because we've got this bull run which is really spectacular, but it's very, very concentrated among a small cadre of technology stocks and profit. Success is also highly bifurcated in those areas. And meanwhile much of the rest of the economy and much of the rest of the market hasn't really participated. And I question you can do that for a while, but can you do that forever? Can you really have a situation where tech is booming while the job creation is zero and the unemployment rate sort of grudgingly but slowly is rising a little bit and Everyone on Main street says this is the worst economy I've ever seen in the history of America with their sentiment reports. I don't know, I don't know the answer to that, but I kind of question it's, it's, it's sustainability. And that's kind of what these next charts get into a little bit. Jack, it makes me a little leery of this whole situation where we're into here. This first chart just looks at this bull market since October 12, 2022 and says, you know, a lot of people, particularly investors, are very optimistic about the stock market because profits are so good. And it's true, profits angrily are up 10 or 11% in the last year. Very, very solid profit growth and they continue to show signs of growing very rapidly in the quarter we're in. But when you look under the hood, if you will, it's all centered on new era pursuits. All the rest of the economy is not really participating in that at all. The blue line in this chart just looks at the trailing twelve month earnings per share of what I call new era. Parts of the S and P, information technology and communication services. And the rest of the red line is the other nine sectors, their market cap, earnings, results, tech. New era is just exploding. It's as strong or stronger than it ever was in the 1990s, no doubt about it. But the other rest of the stock market, those nine sectors, their earnings are actually down today from where they were at the start of this bull. And they, they haven't done much for almost a year. They've been flat while new era earnings have been explosive. Old era earnings have just sort of laid there. And this goes a long way of explaining sort of the kind of the dichotomies that we see out there, you know, why people are complaining about how bad things are when we're looking at a stock market going gangbusters, why there's so few jobs being created at the moment when stock market's going gangbusters, I think it's because of the fact that it's so concentrated and it's getting more and more concentrated into this new era sectors. That's the only place there's success to Jack's Point. For technology or innovation to be quote, unquote successful, it has to at some point. I think it will here eventually, but it has to at some point be not just benefiting the sector that came up with it, it has to start benefiting the other parts of the economy or it will not be a success. And indeed in and itself will probably fall in on itself with. With. It doesn't correct that. I still think AI and everything else will create benefits. But I think it's taken a lot longer than it has in the past and. And we're living off a very bifurcated situation in the interim. I'm just shocked when I look at no earnings. Zootopia 2 has come home to Disney Plus. Let's go get ready for a new case.
- [28:36]
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- [28:40]
Jim Paulson
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Jim Paulson
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Justin
You're clearly barking at.
- [28:56]
Jim Paulson
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- [29:02]
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- [29:28]
Jim Paulson
Shop now@palmolive.com Advancement for 9 of the 11 sectors in the S&P 500. I bet if I looked at small caps we'd stocks where you know those we'd see similar results overall. So it's really been a limited thing. If you look at the next chart, just looks at price action and people are more aware of this one. This just divides the Stock S&P 500 into new era and old era. Now it hasn't been quite as bad. Old era stocks have gone up, you know, not, not terribly. It's just that new air stocks have just gone up so much more. Just unbelievable. And it's kind of getting worse. I mean if you look at what's happened year to date, year to date. Right now older stocks are. Are up just slightly year to date. I don't know in the low percentage points. But new air stocks have just gone through the. Through the roof year today. And most of this has occurred just since the March 30th low there on the blue chart. The March 30th low, they've just skyrocketed it. This chart looks very much like the chart of an AI stock, you know. But it's. It's the just the new year stocks within The S&P 500 and the red Line looks like it. It's in a foreign, foreign world. It's. It's living on Mars while the blue line's living here in the United States. It's. There's not any participation. I just question how much longer can that go on before something kind of has to take a pause and even it out a little bit. If we go to the next page, I will say that some semblance of this has happened at different times. What this chart shows is that, you know these big moves when, when the New era stocks start to outperform dramatically faster than old air stocks, that is when the blue line starts really ramping up higher than the, the red line does when that's happened. I've laid out four other times in the past during this bull market with that curve where you can see with the arrows going up. And in each one of those previous times, once you had a significant differential in returns over a very short period of time, it was followed by a pretty significant correction going on primarily among New era stocks. You could see the last four times that's occurred. And I. This, this one we've had since March 30th is easily as big as any of those before that. And again, doesn't mean it has to happen again, but it sure looks like we might be due for another one of those pauses. Again, doesn't mean we have a bear market, but it could feel pretty nasty for a while and there could be a lot of pullback in where there's the greatest emotional excitement, and that is in New era securities.
- [32:23]
Jack
Going back to your idea about like, these benefits going down, like, it's interesting because I see like a dichotomy. I mean, you talked about they probably will, and I kind of think that they will too. Like, I see when I use AI in my life and I talk to other people who are running like small businesses like you do, you do feel like the benefits of AI are going to spread down everybody? Like, I had to redo the. Our website for excess returns wasn't great. And like, we did like a new professional website. I did it with Claude in like three hours, like the whole thing from like, end to end, like, to being like a live website in like three hours. And it's. But I can't, like, quantify that in terms of thinking about, like, what that actually means for the economy. But I have to assume as the technology diffuses down, people are going to realize that they can, you know, create a lot of efficiency or create revenue or whatever with this technology.
- [33:05]
Jim Paulson
I think you're right. I, I don't know. I'm not an expert on AI. I think that, I think some of it to me, for me it's, it's just like Google on steroids. You know, I Google something and it could come back much more organized than it used to, but I could have done that before. I really want to look up stuff, you know, Google something and figure it out. It's more than that. It's far more than that, of course. And I think the issues will be the power usage going to take to continue to do this if the demand ramps up for it, and what ultimately they can charge for it. I think about many of our past technological innovations, Jack, and there's a lot of this, the stuff that we all use that we really don't pay for. I mean, even coming out of the dot com era, a number of things that are done or changed that none of us really pay for and we use it. And then there's a lot of that we use just for fun too, you know, looking up information on other things that probably detracting us from what we should be working on, if you will. So I don't know, I don't know where it'll go, all of it. I think though the odds strongly favor when you have some technological major breakthrough, ultimately it tends to create greater productivity, at least in some measure. But I'm not, you know, I'm not sure we can keep doing what we're doing on this chart for that much longer. When something breaks in the, in the short run, if you will, even might take five years before what we're talking about really gets disseminated. This situation or its speed of departure I think has got to gotta change.
- [34:48]
Jack
We did an episode with Andy Constant recently and one of the points he was making, and I'm not sure exactly what it means, but I think it's interesting is he made this point that like if you, you referenced the 90s before, like when you looked at the 90s tech bull market, one of the interesting things was tech started out as a very, very small part of the market and then kind of groomed throughout it. Like with this bull market, tech has been a huge part from the beginning. I'm just wondering, do you think there's like any implications of that? Do you, do you think about what that means?
- [35:12]
Jim Paulson
Well, in this bull market, I think we have a chart of that coming up. The market cap. It's a good, it's a good, good question. I do think that, I think there is something not as Stable and something that is growing so rapidly and impacting so much of the growth rate of the economy much more than it used to past innovations. I think that I don't know what the data is exactly like when the railroads are first spread out for the Industrial Revolution, but I suspect that the. You know, that as far as sustainability, that it's hard that those things ever got to the size of dictating almost the entire gain of the stock market, entire gains of growth in the economy that we're kind of verging on today. It didn't get that big in the 1990s, like you said. It got pretty big by the end, but it wasn't nearly that big throughout where this one kind of was big. And now it's gotten even bigger and taken out the 1990s. I think it gives a certain sense of greater instability in that world than it was in earlier innovation periods when there was more that was still sort of propping up economic growth. Overall. We're becoming almost too dependent on innovation for growth rather than having it be born and sort of come out and disseminated in a world where there's greater support going on in general. And then that diffuses how fast it has to come out, so to speak, and how fast it has to start showing benefits. We. We need to see them. This is actually that chart. In another way, this thing just goes back to the start of this bull. But this looks at the ratio of market capitalization of New Era sectors to the total S&P 500 capitalization. We started this bull where New Era accounted for about 33% of market cap, and now it's about 50%. In fact, what kills me on this chart. And we have. We have gone since March 30th. Think about this. From March 30th, a little over two months, we've gone from about 42% of market cap, or even a little less than that 41 something, to almost 50% of market cap. 7, 8 percentage points in two months. You want to project that out? We'll. We'll be, you know, before the end of the year, we'll be over two thirds of the economy comprised by New Era stocks. It's not going to keep going at this pace. It just can't. But even today we're sitting, you think about it. It's been a little over three and a half years where New Era accounted for a third of the economic or a third of the stock market. Now it accounts for half of it, basically. That's. That's unbelievable. And where will we be if this is 2/3? I, I think particularly when you think about new era companies are probably the least job creation force there is among all the industries out there, at least in the short run as far as direct, direct employment. So I'm just concerned about some of this. I'm not saying it's going to die or go away, but I think it's got to slow down.
- [38:37]
Jack
Yeah, and I think your point agrees with Andy's which is his idea was there's only so much GDP pie like tech can't be everything. Like tech can't take over the entire economy. There's a certain point where it just, it just doesn't, it can't grow anymore.
- [38:48]
Jim Paulson
Well, you know, Jersey blow Jack, I used to say, I think this just came out of the 1990s when we were doing the dot com run. I used to say, well you know, we're going to have to redefine our s and P10 sectors, which it was 10 sectors back then. We can't. It seems stupid to have a sector called technology because everything's going to be technology. That was my argument. Everything's going to be technology. The only, only thing going will be technology eventually. So we'll have to, you know, maybe we'll call it the innovation sector or something but you can't call it tech because everyone's going to be using tech and doing. But in reality what, what's wrong about this cycle to some degree is not everyone is. It's basically this innovation sector's creating all this stuff. It's creating most of gdp, but no, it's not getting out and affecting others in a positive fashion. And that's, that's a problem now maybe it probably will still do that but it's almost innovating itself too quickly to be absorbed. And that's a problem because it becomes too big a part of existing activity.
- [39:57]
Justin
And it seems too like every time the rally starts to broaden out and you kind of see it in this chart like you know, the beginning of this year it was really great for value stocks and a lot of these other sort of non new era stocks stocks and. But then like it turned on a dime like in, you know, in whatever it is, April or something like that. And it's weird that like it's almost like investors, they're so conditioned to these large cap growth names sort of working in. They take these pauses. They seem like. But then it's back to the old playbook. So I don't know, it's just an Interesting observation that there's these, we have gotten these fits and starts. You know, you, you can comment on, on, on this, Jim, but you know, but it's the same old playbook when I don't know that things go back to the, the large cap tech.
- [40:53]
Jim Paulson
I think that one of that, one of the major things behind that Justin, is in this bull market. It's one of the few in history that has lived almost its entire existence under economic policy type. Okay. And as I showed earlier in that chart, that much of the old economy needs policy support to grow. That's how it grows over time. It gets liquidity growth through monetary stimulus, lower rate environment that really matters for much of our old era pursuits. It gets a positively sloped yield curve. That helps. It gets fiscal juice. That helps. It generally has the dollar helping with a weaker dollar which makes us more competitive to, to foreign producers and the like. This one's been opposite of that. We've been pounding older pursuits with higher rates, inverted yield curves, negative money growth, slower fiscal juice, one of the strongest dollars in our history. And it's just killed off earlier pursuits. And the only game left in town is the game that doesn't need policy. It creates its own growth by itself and doesn't need any assistance from anybody. If I come up with an idea like the iPhone, I don't care what the economy out there is doing. I know I'm going to grow because no one has this new toy. Everyone's going to want it. And so they got their own internal growth rate that's invariant to everything else. And I think that's why we've seen such a dichotomy. I would step back. We wouldn't have had this had we not had this persistent fear of inflation in this cycle most of the time. By the way, inflation has averaged around 3% in this cycle. Big deal. We've averaged 3% inflation over many past cycles. No one cared though. And they eased appropriately. And whatever had we eased during much of this, I think we'd have much better employment growth, much better confidence in this country, much better optimism with more profits for more old bureau percent. But we didn't. And we've left the only game in town and now it's collected. All the capital that's out there is running to this one sector because it's the only thing working. That's why I say in that chart up there. And the reason that as you mentioned, we did start to see older pursuits pick up was because that's when the, we were easing. That was Some of the brief windows from late 04 to late 05 when we actually eased for a period of time and guess what happened? Things broadened out and then we quit this year with the, with the geopolitical conflict and it all went back to the same, same place again. And I think that's what I'm saying. We still could have a pretty big shift back away from new era pursuits to old era. If we have to end up for forced to ease if you will. If our mindset goes from war inflation to we gotta save growth, that would help I think correct some of this imbalance. And that's kind of what I'm sort of betting on on average over the course of this year.
- [44:04]
Jack
But I just one quick thing on, on the iPhone. I was thinking about that when you were saying that and I'm like if I had to think in my life, like if I came on hard economic times, the things that I would cut before the iPhone, like there's like I'd probably turn off the air conditioning before I would get rid of the iPhone. Like it's pretty amazing. Like if you think about where that is in the order of things you would get rid of and in hard economic times it's like at the top of things you're not going to get rid of.
- [44:24]
Jim Paulson
Yeah. I really think though Jack, that it's. They've become not just innovators but they've become sort of invariant economic subjects to the old economic cycle forces. Inventory cycles and policy tightening cycles, even inflation. And I, I think that they're kind of on their own cycle. That's a whole nother subject. I brought this up. I don't think we study enough nor understand enough what drives these innovation cycles. Because it's not policy officials, it's not war. Should the Fed and fiscal authorities and watch they got their own cycle going on and I think that'll be the next big thing over the next few decades. Here is we're going to come to find out there's a whole cycle involved in innovation that's going to be mightily important for an economy which now bases so much of its existence on that part of the part of the world. And we'll see where that goes. I don't think we understand every starting
- [45:24]
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- [46:18]
Jim Paulson
Well, yeah, a couple other things that makes me I as I say, this cycle is becoming much more concentrated, much more bifurcated, much more extreme. And now it's being driven by more risky parts of the market for the first time. So this is just one, this is the Russell 2000 small cap tech relative to the old Mag 7. I mean Mag has killed it. Those big venerable Mag 7. You know, no one would not own those things and they've been run over by small cap technology companies. Well I think that maybe that's fine. There's nothing wrong about it per se. But certainly there's more risk involved when small cap tech companies are leading the tech as opposed to having big old mag sevens with profits and everything else leading. This is a change in stripes we haven't seen yet in this bull. If I go to the, to the next one, you're also seeing another stripe changing. We're having unprofitable stocks, unprofitable tech stocks in particular leading the tech world if you will overall. So mag7 is not only getting beat by small little no name companies, it's also getting beat by companies without any profits. And that's. That changes the feel of this thing. You know one of the great things about this tech run, it wasn't just dot com names without any earnings. It was these well known finance big old cap names. That's changing here under the surface. This tech rally is suddenly becoming riskier in that sense. Looks a little like the end of the 1990s in that sense. One I didn't have in there is if I put a chart up on AI, the Goldman Sachs AI index.
- [48:05]
Justin
But that's parabolic.
- [48:07]
Jim Paulson
Parabolic. And it's, it's multiple. Justin, to your point, it's multiple. Since March 30th on trailing twelve month earnings for the Goldman. I think it's the Goldman Sachs Goldman Sachs AI beneficiaries index has gone from like 35 times earnings to over 70 times or just since the end of March. So that's as high bolic as any of the rest of that. That's it. So we got different drivers here in this rally than we did last year or the year before that in this bull market. And I'm not sure that's wholly registered. Yeah, we'll see.
- [48:41]
Jack
So this, this next chart is oil. And obviously this has been, this has been a big part of the story here on what's going on with oil. And this was actually in your piece where you're talking about this idea that we did a correction may be coming. So we're. What were you getting on this chart?
- [48:53]
Jim Paulson
Well, I'm just laying out oil back to 1970 here and just, just kind of dating the previous major peaks in oil. And what I come away with here is that every one of these peaks, with this last one being the exception so far every one of these peaks has been associated with a meaningful sell off in the stock market. But the key is after it peaked, not, not necessarily during its rise. In fact, during the rise of some of these, stock market did pretty well. Now there were some where the stock market started to crumble before it peaked, but then it crumbled even more after it peaked. What my point about this is is that most of the negative pressure on the stock market and indeed on the economy too doesn't come when oil is rising. It comes once it peaks. It's the aftermath of the peak where the most intense downside pressure on the stock market and the economy generally shows up. If you go to the next chart, Jack, it's going to label those same dates on the S&P 500 since 1970. And you can see, for example, in 1974 the market peaked, or excuse me, 1972 the market peaked. But when oil peaked in January 74, look what happened after repeat. Most of the time these red dots occur right at the top of market peaks. That is generally the market peaks about the time or shortly after oil prices peak. So it's kind of this sense. The piece I put this in, I entitled it, you know, buy on the cannons and sell on the trumpets. And what I meant by that was I think it's this sense that oh my gosh, maybe we're going to make it through this. Oil went up to 100, 100, $120 and we have this geopolitical conflict and now it looks like it's winding down. I guess we're going to be okay. It's okay to stay in stocks. And that's kind of what March 30 was about, right? March 30 was the first time when Trump and Iran both blinked together a little bit and said that we were winding this thing down and guess what? The stock market went straight north. But my point is historically some real pain generally occurs after oil peaks, not Wallops peak. And I'm not sure that's well appreciated. I put this out recently because I think it's speaks volumes about what's going on with the bond market primarily. And all this is, is the trailing one year correlation between daily movements from the S P 500 and the 10 year treasury yield. And what you look back historically is, is this, this speaks volumes to what the mindset on Wall street is among investors. Typically when correlations are positive, as they were most of the time after the great financial crisis in 2010 and even after the dot com decline, when they're positive, that suggests that people the primary concern among most investors is growth, weak economic growth, that's their major concern. Why? Because if bond yields go up and stocks go up, it says that the equity investors are looking at that rise in yields as a positive commentary on the economy's healthy enough to support higher yields because it's worried about, it's really weak. So if stocks and bond yields go up together, it suggests that people are primarily worried about economic growth. If yields go down, that just says oh, economy's weakening, stocks fall with it. Okay, but it gets very different in a negative correlation. Well, when you're negative, it's primarily worried about inflation in that situation. If bond yields rise, stocks generally fall because they're not looking at it as it means the economy's healthy. They're looking at it as that means more inflation. And if yields fall, stocks often go up because stock market's looking at it as if yields go down, it must be inflation is weak and deal indeed. Initially, when we got, you know, this 40th started out, you had a bit of a drop in yields and stocks took off. We've still kind of been in this negative correlation at least until very recently. And the real question is, if you go to the next chart, why this matters so much for the bond market. The, the red line Here is the 10 year treasury and the blue line is that same chart I just showed you inverted. So when correlations are negative like they were in the early 90s, bond yields are at the highest corn. When correlations very positive, bond yields are at their lowest because all it's really saying is people are mainly worried about inflation or they're mainly worried about growth. We've been more worried about inflation of late. That's why bond yields have been higher. But I think if we end this war, I think inflation's going to come down. If you couple that at a time when the economy is also slowing, I think we're going to quickly go from inflation to growth as being a primary worry. And, and this blue correlation is going to fall down in there to positive territory allowing I think bond yields to fall firmer. The problem is to go from lower rates mean higher inflation to lower rates mean weaker growth is a big change in the mindset. So for a period of time we could see here between now and let's say at the end of this year, we could see where the war ends and rates go down. Bond markets taking out some inflation. But the stock market goes down with rates as they start to worry about weak growth. That's how they could reconnect again. But we could actually eventually when people decide that lower rates we're not going to recess, then we might get back to a situation where lower rates are or lower or lower rates or rates stop falling. Then the stock market can take off again, if you will. But I, I do think it's important to look at how, how do we get from where we are today to it to a situation where we could get rates back to in the threes again. And I think part of that is going through a process or a mindset of focused on inflation is your biggest fear to growth. And that's kind of where I think we might do yet before this year's old last few here, I just got a couple one offs that I think are interesting worth mentioning that I'll just throw out. You know this chart overlays the s and P500 which is the blue line there on a log scale with a ratio of core capital good orders per
- [55:39]
Justin
job,
- [55:42]
Jim Paulson
the red line. And in some ways it's kind of rather remarkable. You know, you can say what's driving the stock market. What has been driving stock market. You know this chart, you could argue that really since 1990 at least the stock market's really just been about capital investment per job in this how much are we investing in our labor force that that's all that's mattered. Once we invest less in our labor force, guess what stock where it goes south. And once we once capital investment to per job goes up, stocks do great. It's really rather remarkably close relationship. And the reason I Bring it up right now is we are just peaked out at an all time record high of more capital good orders to per job and it rolled over pretty big in April. Well, we'll see where it goes. But I do think it's going to be problematic to some extent if for no other reason than at least real capital good orders are going to be under pressure from higher inflation overall. And if the job market does start to pick up, you know, you could see where this ratio of capital good per job starts to, starts to fall on a regular basis and that could bring some pressure on stock. People aren't really focused.
- [56:54]
Justin
Are those capital goods? Would that be. Would that be including things like, you know, what's going on with like the AI build like that type of stuff, like data centers.
- [57:02]
Jim Paulson
It's in there. Yeah, it's in there.
- [57:03]
Justin
So that could be.
- [57:04]
Jim Paulson
It's not just that it's old and new, it's all of it. Yeah, but it's definitely in there. Yep. But it's kind of interesting. It rolled over in April too. Yeah, I think. Well, which we'll see. And it also depends on what, what the denominator is doing. To your point, Justin, the job. Job growth changing too a little bit. This chart I just put out, I guess earlier this week and I, I just thought it was kind of interesting. I'm not sure what to make of it. There's a busy chart. But I, I call this a bull market of booms. And it's interesting, I just find interesting. I, I'm still kind of thinking about this, but I got several different things in this chart but I would last to read it. But the, the two that started this bowl really were the Mag 7 and Bitcoin, which is basically the blue line and the purple line in there, they really started and they, they didn't just start, they, they boomed. They really boomed. At least really for quite a while. In the early part of this bull we're talking about starting 22 and maybe it was early 2024 where they kind of stopped booming finally. And summer of 2024 they, they kind of both peaked out. And if you look at that, bitcoin's gone down a lot or almost two years now. And Mag7 has been a market performer at best over that time and it's still below its all time relative high that had occurred last year. So bitcoin just absolutely in mag 7 relative to the S and P has really lost its luster if you will. No matter, big deal. Because as soon as Bitcoin and Mag7 kind of topped out. Guess what? Gold took over the gold. Gold took off for the, for the races. Another market boom. Okay. And then it kind of peaked out, you know last year a little bit has really come down hard relative to the commodity prices. There is shown no big deal because as soon as it, because oil took off, oil took off. Went from gold to oil, the black line to the bottom there. And then you know, oil is now starting to peak out. But no big deal because a couple months ago the red line took off. That's AI And I just, I don't know quite what to make of it except it's kind of odd that we've had a three and a half year bull market and it's really been made up of major booms in all these different assets over that period of time. And you gotta wonder if AI rolls over, what's gonna, what's left to go. Maybe that's old era stocks. I don't know. I can't imagine they're gonna swing as hard as these guys. But it's really. I, I don't have a big conclusion on this. I just find it fascinating how many market booms we have experienced in this bull market compared to others I can think about. One thing I'll be coming out with is I'm comparing the risk return frontier of the current bull market. Comparing the risk return frontier doesn't go from 100% stocks to 100% bonds. It goes from 100% new era to 100% old era. And what, what you'll find out when I look at what happened in the 90s to what happened today is that as you go from new era to old era, the, the risk goes up substantially in this bull market. Whereas in the 90s it was almost a straight line of nothing but excess returns with not any additional risk. So it's a very different risk reward potential in this market compared to the 90s. That kind of came from after I did this chart of looking at what's really moving and what isn't. And then the last chart I just throw out or just kind of fun and a question mark too. The blue line here is the relative performance of technology stocks in the S P500. And the red line is Bloomberg US Billionaires Investment Select Relative Total Return Index. And it basically that index is set up by Bloomberg captures the 50 largest holdings of US billionaires in the stock market. And this index captures how it does on a relative basis, the total return basis. And what I want to point out, look how close this has been basically, billionaires have been all over tech stocks throughout this bull. But then Suddenly at the March 30 lows.
- [61:31]
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- [61:58]
Jim Paulson
Let's go.
- [62:00]
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- [62:31]
Jim Paulson
Tech took off and billionaires just kept going down. So I don't know either billionaires got scared out of the tech market before it took off on March 30 after it was pulling back, or billionaires know something the rest of us normal people don't. I, I don't know which it is, but it's kind of fascinating that they're either being left in the dust and maybe they'll decide they were wrong and they're going to start coming in on AI now or maybe, maybe they've been out for reasons that they understand that we don't really know.
- [63:04]
Justin
Yeah, I don't know for sure obviously, because, you know, we don't know what's in the date. But what's interesting about the technology sector is and to your point about the Mag 7, there's been a lot of these names like Micron, you know, Oracle, IBM, these like, I would say second level tech companies have kind of ripped here like over the last month or so. And so, you know, I don't know if that's, I mean obviously Oracle, Larry Ellison, billionaire, whatever, but it's just like it seems like there was like a shift in sort of some of the more speculative or let's say the, a, the, the tech companies that were just, I'm calling them second level. That may not be the right word or not. That's just a hypothesis. I have no idea. That's just an observation, you know, to,
- [63:49]
Jim Paulson
I think it's a Good observation. Who knows? I, you know, I think it's a good observation. What I talked about a little bit earlier too, just would support that, you know, kind of being made up with unprofitable tech companies now and small caps tech companies. That could be part of that. Maybe the billionaires were owning the Mag 7s and really made no change in. And Mag 7's done a little bit better than they have over that period, but not a lot. So that could explain what. What's kind of gone on. It's become a more speculative tech market and maybe the, the billionaires have been sitting in some of the more stable large companies. I hadn't thought about that. It's a good point.
- [64:24]
Jack
I do hope, Jim, though at some point I can be with the billionaires, you know, so maybe I could. Maybe I can find out what they're doing wherever their secret meetings are. I hope I get invited.
- [64:32]
Jim Paulson
Be with you. Me with you on that one. We both be going to the Knicks game here on soon if we.
- [64:37]
Jack
Yeah, that's right. You almost have to be a billionaire to go to the next game right now or something to justify that expense. And I think a lot of the billionaires probably wouldn't spend what it was costing.
- [64:45]
Jim Paulson
Probably wouldn't either. That's all they made a billion.
- [64:47]
Jack
Yeah, that's exactly right by not doing that. But just as briefly as we wrap up, like, are there any main takeaways you want people to have here as we head forward into next month?
- [64:57]
Jim Paulson
Well, you know, I guess for me I'm nervous about it where we're going because it's got such a head of steam in the upside. It feels like death weren't over. Suggest any kind of correction when you got this much momentum and it could go on for a while, but I just trying to keep myself thinking ahead a year from now or whatever rather than tomorrow or next week or next month. I've always kind of invested for a year out and I just think we're going to get a better opportunity here to look at this investment world. Not necessarily from disastrous levels or anything, but from better levels than what tech stocks are selling at currently. Maybe I'll be really wrong and one of these episodes I'll say culp and we'll move on. But that's where I sit right now. I'll be looking for information that suggests there's more of a struggle coming.
- [65:49]
Justin
All right, thank you very much, Jim. We'll see you in about a month or so.
- [65:53]
Jim Paulson
All right, thanks for having me, guys. As always, take care.
- [65:55]
Justin
Thank you for tuning in to 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
- [66:14]
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