What did you make of this week, it was such a dramatic turnaround on Thursday.
Should we believe it? I would not take it with a grain of
salt. What a week it was, the midterm
elections and the inflation report. And let's not forget Veterans Day
without our votes. A big thanks to them.
There wouldn't be peace. The inflation report stole the
limelight, though, for the week. And unarguably, I don't think it should
have. It's just one data point and was very
welcome. That inflation's come down from the
highs. It still seems broad based and
particularly broad based in services which suggest the labor market is still
extremely tight. I'd argue that we see narrow
disinflation goods, apparel, used cars and still broad based service inflation.
So I think inflation still still a risk. And I just remind people that in October
20 21. Inflation was about 6 percent back then.
And so it's still about over 6 percent on a core basis.
Now, that's a lot of inflation over the past two years.
That's a really good point. I mean, we really focus on how much has
come down. It has come down some finally, but it's
still a very high level. And do we have any assurance it's going
to keep coming down at a fairly brisk level?
It goes down to 2 percent or thereabout? Well, look, I think it's all about where
the numbers come in versus expectations. And if you look at street consensus,
they're already baking in pretty significant moderation.
You're kind of heading back to 3 percent next year.
So I think it was not surprising to me to see such a fierce reaction in
markets. Maybe not.
I didn't expect quite as much as what we got.
But I can tell you, David, I've talked to a lot of investors the last few weeks
who have really, you know, kind of quietly arguing it was getting ready to
come down, building their models and have gotten fooled by this, you know,
several times in the past when it didn't happen.
I think there was just tremendous relief that this kind of idea that inflation is
moderating, that we finally got the data to cooperate.
It's moderating for one data point. We've had the chair of the Fed say again
and again and again, I need more than one data point.
I need quite a few data points before I'm really going to leave it.
So do we think there's actually going to change but fed behavior at this point?
Well, you know, unfortunately, I think that the Fed probably didn't like the
reaction that we saw on Thursday. And I wouldn't be surprised to see the
rhetoric, you know, take another kind of hawkish tone to try to clamp down
enthusiasm. I think things are going to stay choppy
for quite some time. You know, let's enjoy the day while it
lasts. It was a nice week.
You know, we've been in need of a nice week in the equity market, but I
wouldn't necessarily expect this to go off in a straight line from here.
David, I wonder, are the markets basically baking in really getting back
down, if not the 2 percent, to sort of two and a half, 3 percent?
Are they a little complacent to the bond markets?
I think the markets are complacent. It's interesting how the bond market
also yields fell upon the inflation report, and maybe that's all that
equities need to know. But yes, investors expect inflation to
come down. But at this stage, we can't keep saying
eventually. It's important that the Fed or other
factors get inflation down quickly because we're looking on the verge of
inflation vs. inflation becoming a multi-year problem.
And if high inflation is a multi-year problem, that might change the entire
inflation risk premium demanded by the bond market.
So I think we're very lucky that the bond market is staying calm about
inflation so far. We shouldn't press our luck.
So clearly, the CPI drove the markets this week.
It drowned out any news about the midterms.
Was that right, David? Did we pay enough attention to the
markets, to the midterms? You know, Laura and I were talking seem
like investors were trying to follow some game plan they had in mind about
how the market would rally post midterm elections or Republican red wave didn't
happen. Hopefully the inflation report wasn't a
surprise, negatively was positively. But I think this has gone too far, too
fast. And I think they did put too much
emphasis on the inflation report, trying to ignore the midterm elections, which
are still uncertain, still uncertain, but looks pretty divided.
It's not clear that Congress is going to do an awful lot.
Is that good news for investors? Bad news?
I think it's good news from the perspective of historically a divided
government. When you have a Democratic president, a
split, a Republican Congress, you're getting 13 to 14 percent average type
returns in the S&P 500. So the history is very favorable.
I think a lot of investors know that history.
And so if nothing else, it gives you a little bit of confidence.
I think the other issue is, you know, in terms of gridlock being good, I think at
the last the last thing investors want right now is more stimulative policy.
So I think there is good news in that. And look, I think this was a win for the
markets. This was a win for democracy this week.
You know, we don't know the results yet, but things did go pretty smoothly.
And Laura is right about the historical data and we've talked about that.
But I think investors are putting just too much weight on that historical
observation. And I'm not sure a divided government is
all that wonderful right this moment. There's likely to be fiscal fights
ahead. Let's see what happens during the lame
duck session. Even if Democrats hold on to the Senate,
they might want to use the lame duck session to push through some more
policies. And I just think the the the poor
showing amongst the Republican Party at a time of such high inflation is not
good for. The supply side and the weakness on the
supply side is part of the structural problems we're seeing with inflation.
Everybody right now wants to draw parallels in history.
It depends on which history you pick, but I know you've done work specifically
about 2002, I believe. Yeah, it's eerie, David.
I mean, we've actually seen there's about a seventy eight percent
correlation between how the S&P 500 is trading this year and how it traded back
in 2002. And there are some similarities.
That was another mid-term year. There was geopolitical angst in the
backdrop from 9/11 and those sort of build up into the Iraq war, similar to
what we've got in Russia, Ukraine these days.
And it was also a period of messy normalization after we'd had a big
crisis, big drop in the market, initial rebound.
And it took basically a year and a half for the market to get back on its feet,
find a bottom. And I think we're doing something
similar right now. Not only 2002, 2013 was a year where
after the midterm election Fed policy and how well taken a pretty hawkish
stance at the December meeting of 2018, saying several more hikes are likely.
Market fell almost 20 percent in December 2018.
That was a mid-term election year. What about geopolitics?
Lori mentioned that briefly. And we still have a war going on in
Ukraine. We've got President Xi meeting with
President Biden next week. Unclear what's going to happen there in
Asia. There are geopolitical issues here.
How much is the market discounting, though?
The market is aware of it, trying to ignore it.
There are certain industries. Where were the tensions growing like in
semiconductors? But it does seem like an even with this
election that tough on China and support of Ukraine, too.
I think that's the policies and sentiment that will continue to prevail.
I won't come back to saying David talked about, which is President Biden said
democracy is on the ballot for Barack Obama said that as well.
It looks like whatever happens here. Most Americans seem they sort of believe
in the election process. They showed up.
They voted. Not a lot of disputes yet, really about
what happened. How good is that for the markets?
Because to some extent, the markets depend upon know regularity to our
processes. I think stability is good.
I think, you know, the fact that the democratic process worked pretty
cleanly, there weren't a lot of fights. It's kind of a boring midterm at the end
of the day, other than having your polling data kind of make a lot of
people disappointed in the end. And I think that's good ultimately for
the investor ability of the U.S. when you're thinking about global
investors and the premium they're going to give U.S.
assets, particularly in the equity market.
You need that political stability. I think a wildcard is the debt ceiling.
David, don't lift it. You're confident that they always have,
but sometimes they put us through some some headaches before it's done.
But it is important to acknowledge that with these interest rates, these
climbing real interest rates, a little bit of a reprieve on this week,
Thursday, Friday, but there's risk, especially if that inflation risk
premium goes higher, that the debt and deficits will be more burdensome.
Look what's already happened. Housing is getting crowded out.
People are getting a lot more demanding on the valuations for innovative
businesses. And stocks were crowding out.
Innovation was certainly crowding out housing.
I wonder, Laurie, a lot of talk about a possible recession next year at some
point, not clear how long, how deep, even whether happens.
But luckily, I think it's quite possible.
Do we have the optionality for a fiscal point of view to deal with a recession
right now, given what's going on with interest rates, gets them on how much we
borrowed and given the deadlock in Congress?
I don't know that we have a lot that we can do at this point in time.
I think that you know, I think that's one of the reasons why investors are so
focused on the equity side and getting the Fed to pull back while there is
still time to push us into something deeper.
And I think that's one of the big takeaways from this week, is that even
if you sort of believe the last round of hawkish Fed rhetoric did that CPI print,
at least for now, put us on a path where we can look for the Fed to take their
foot off the pedal sometime early next year and avoid having this be a late
2023 recession, more of just kind of an early economic hit.
I think for me, that was one of the biggest takeaways on the CPI.