July 13, 2024 • 35 mins
Is the allure of AI stocks overshadowing the perilous reality of small-cap struggles? Join us in this episode as we dissect the intricate landscape of the current stock market with Peter Berezin from BCA Research. We promise an in-depth analysis of the bifurcated performance between thriving large-cap AI-driven stocks and the underperforming small-cap sector. Learn how key economic factors like the ongoing slowdown, diminishing job openings, and the depletion of pandemic savings are contributing to this divergence.
Discover Peter's insights on the prolonged and variable impacts of monetary policy and how the erosion of prior economic insulation is shaping market dynamics. We'll delve into the predictive power of construction job losses and the decline in multi-family housing starts as early indicators of a potential recession. This episode shines a light on how smaller companies, reliant on bank financing and cyclical businesses, face unique challenges that could amplify their struggles in a looming recession. Plus, we critically examine the potential overvaluation of large language models and AI profitability, and whether they can replicate the success of social networks.
We also tackle broader market concerns and sector strategies, drawing parallels between the UK's fiscal turmoil and the current risks facing the US economy. With a 7% budget deficit and low unemployment, we scrutinize the viability of the US dollar during a recession. Can China's economic recovery or a global manufacturing resurgence mitigate these risks? Peter shares thought-provoking perspectives on fiscal policy in an election year, including potential tax hikes and tariffs. Finally, find out where you can follow Peter's work and insights, and explore the long-standing reputation of BCA Research.
The content in this program is for informational purposes only. You should not construe any information or other material as investment, financial, tax, or other advice. The views expressed by the participants are solely their own. A participant may have taken or recommended any investment position discussed, but may close such position or alter its recommendation at any time without notice. Nothing contained in this program constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in any jurisdiction. Please consult your own investment or financial advisor for advice related to all investment decisions.
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:08):
My name is Michael Guyatt, publisher of the Lead
Layer Report, and joining me forthe roughly 35 minutes now,
given the shortened time frame,is Mr Peter Berezin of BCA
Research.
Peter, you and I did a space awhile ago and I emphasize to you
that I'm a huge fan of BCAResearch.
But for those who don't knowabout you and BCA, quickly
introduce yourself.
Speaker 2 (00:28):
Well, bca has been around since 1949.
So we're the oldest and largestprovider of independent macro
research, and I stress the wordindependent.
We're not affiliated with anyinvestment bank.
We just do one thing and that'sgenerate unbiased research.
And sometimes we're bearish,sometimes we're bullish, but
(00:53):
we're always trying to get afterthe truth.
Speaker 1 (00:59):
And the truth is, the truth changes every day because
the probabilities change everyday.
The truth changes every daybecause the probabilities change
every day.
Let's focus on that point abouttruth, because it seems like
there's two different types oftruths that have happened,
really, since last year.
The first truth is that it's abull market for large cap market
cap weighted stocks right,largely driven by AI not solely,
(01:22):
but largely.
The other truth is that thevast majority of stocks beneath
the surface have not reallyperformed all that well at all,
and when I'm referencing that,I'm referencing small caps,
because there's many more smallcap stocks than large cap stocks
.
From a historical perspective,is it unusual to have two
different messages, like whatwe've seen, where the small cap
(01:44):
side is clearly being held backby higher for longer?
There's no real momentum there.
It does not look like a bullmarket for that segment of the
marketplace, while the truth oflarge cap momentum is in place?
Speaker 2 (01:56):
It's unusual for that to happen, but it's also
understandable why that hashappened.
The economy has been slowing.
You can see that in theeconomic surprise indices, which
measure the extent to whicheconomic data is coming in above
or below expectations.
Most recently, the data hasbeen coming in well below
expectations, and so economistshave been ratcheting down their
(02:18):
growth forecasts for Q2.
And that not surprisingly, q2.
And that not surprisingly haskept the majority of stocks in
the S&P from rising.
But there have been a few thathave managed to go up for
(02:39):
reasons that have very little todo with the economy, and more
for reasons to do with hopeperhaps unfounded, perhaps
founded, we'll see over AI.
Speaker 1 (02:49):
So let's take a very big top-down view on where the
economy is.
I have myself argued that thelags are starting to hit, and
the thing about lags when itcomes to monetary policy is that
there's a pretty big range interms of when the lag starts to
hit and as how far out theycould hit.
What's your view on where theeconomy is headed?
(03:12):
What's your view on whereinflation is headed, especially
given the data that came outtoday?
And maybe combine all that witha thought experiment, if it's
possible.
The Fed actually overdid it,and it may only realize it when
it's too late.
Speaker 2 (03:33):
Yeah, so the lags we'll term as long and variable
lags.
I think this time around thelags have been particularly long
just because there was a lot ofinsulation around the economy a
couple of years ago.
Back then, people were frettingabout a recession, but at the
time, we were one of the fewteams that said listen, a
(03:56):
recession is actually veryunlikely because of all the
insulation around the US economy.
Back in 2022, you had hugenumbers of job openings, so
anyone who lost their job couldjust walk across the street and
find new work.
That kept unemployment fromgoing up.
You had over 2 trillion inpandemic savings, so money that
was just in household balancesheets waiting to be spent.
(04:20):
That supported the economy.
And you also have the fact thata lot of people refinanced
their mortgages during thepandemic, and so they were
insulated from rising rates, andit's true for businesses as
well.
A lot of them refinanced theirloans during the pandemic at
very favorable rates.
Now the problem is fast forward,a couple of years.
Things don't look so good.
(04:41):
The job openings are basicallyback to where they were in 2019.
We're already starting to seethe unemployment rate creep
higher.
Anyone who loses their job isnot going to be able to easily
find new work.
The pandemic savings arecompletely gone.
In fact, if you look at bankdeposits in real terms for the
lowest paid 20% of thepopulation, for the lowest paid
(05:02):
20% of the population, they'rebelow 2019 levels.
And even in terms of thosemortgages and business loans, a
rising share of mortgages noware paying over 6%, shrinking
shares paying less than 3%.
So as more homeowners areforced to buy a home using these
(05:23):
very expensive mortgages, thatmeans that monetary policy is
slowly working its way throughthe economy and I don't think
Fed rate cuts or, for thatmatter, even fiscal policy, is
going to save the day.
Speaker 1 (05:40):
I forget who had mentioned this to me before.
I haven't looked at this so youmay know the answer to it, but
historically, if you're lookingfor a leading indicator of a
recession from a jobs marketperspective, you tend to see
pretty high predictive power interms of construction jobs being
(06:02):
lost first, of constructionjobs being lost first, right
prior to sort of a broad-basedrecession, because of how
important the housing market is,the long tail of construction,
and it seems, from the data thatI've seen, that that is
happening.
Is there something to themakeup of where the unemployment
is starting to pick up that ismore consistent with what you
would see prior to recession?
Speaker 2 (06:23):
is more consistent with what you would see prior to
recession.
Well, we're definitely startingto see weakness in the housing
market, which is worrisomebecause, as Ed Leamer famously
said, housing is the businesscycle.
And so if you look atsingle-family housing starts,
they're down 2% year-over-year.
Multi-family housing starts aredown 50%.
(06:44):
It's a massive decline inmulti-family starts.
They're down 2% year-over-year.
Multifamily housing starts aredown 50%.
It's a massive decline inmultifamily starts.
And then, outside of theresidential area, things look
even bleaker.
Office starts are at nearhistoric lows, for obvious
reasons.
The vacancy rate for officespace is close to 20% by some
(07:07):
measures.
They're not building anyshopping malls.
Haven't been building anyshopping malls for years.
Even in industrial real estate,we're seeing vacancy rates rise
.
So the construction sector isnot doing well.
Home builders are not doingwell.
They've been going down,whereas the S&P 500 has been
(07:28):
going up.
That is a worrisome indicator.
Speaker 1 (07:32):
You had mentioned, the lags have been taking a lot
longer to hit, which of course,then makes me think about
divergences in markets right,lasting for longer than
something I expected.
When you have divergences fromthe economy, the stock market,
from large caps to small caps,from different sectors against
(07:54):
each other, how do thosedivergences usually resolve?
Meaning, if someone were to say, okay, large caps versus small
caps, that divergence resolvesin one of two ways Either small
caps play catch up or large capsplay catch down, right to get
to the mean, whatever that meanis.
Or you look at economic dataand the pace of growth and
(08:15):
slowing versus monetary policydirection.
That sort of differential Dodivergences tend to resolve
positively or negatively?
I know that's sort of a verylarge kind of generic,
broad-based question, but Ithink that's important for asset
allocators because I thinkeveryone down does notice that
it's a very lumpy not just stockmarket but very lumpy economy
that may be now starting to actmore normal.
Speaker 2 (08:39):
Yeah, I think it really depends on economic
circumstances.
If the economy doesn't start toreaccelerate, if it continues
to decelerate, we're going tohave a recession.
Recessions are toxic forsmaller companies that are often
very reliant on bank financing,that tend to have fairly
(08:59):
cyclical businesses.
So in this case, we're notgoing to see small caps catch up
to large caps.
We're going to see small capsdo badly and large caps also do
badly.
Now, what happens to large capswill also be very much a
function of whether the profitsfrom AI actually materialize.
(09:24):
And my impression, looking at alot of these large language
models, they're all kind of thesame.
You ask ChatGPT a question, youget kind of the same answer
that you would get if you askClaude or Gemini, and so the
presumption that a lot ofinvestors have is that these
large language models willgenerate these incredibly
(09:45):
profitable monopolies, just likesocial networks were able to
generate large monopolies.
People would use Facebookbecause everyone else was using
Facebook, but these models couldturn out to be more like
airlines, where they're veryuseful, but because they're all
kind of the same, there's nocompetitive moat and they don't
make very much money.
We don't know, but my guess isthat investors are going to have
(10:07):
second thoughts about the wholeAI story.
Speaker 1 (10:12):
Yeah and I always reference this point that from a
behavioral finance perspective,there's this concept called the
disposition effect.
So when faced with uncertaintyand volatility, people tend to
not sell their losers first,they sell their winners.
And there aren't that many bigwinners, and we know which ones
they are, so those becomesources of liquidity when that
(10:34):
uncertainty hits.
Now the recession argumentobviously ties into the yield
curve, the inversion being aslong as it has been.
I always joke that the stockmarket doesn't care about the
inversion until the stocks godown right, in which case then
that's when the media talksabout it.
But is there anything from ahistorical perspective that
(10:57):
suggests the length of time of ayield curve inversion is
correlated to the magnitude anddepth of a recession?
Speaker 2 (11:06):
Well, in general, yield curve will invert around
18 months before the start ofrecession.
This time has been longer, andsome people were saying that the
yield curve is no longer avaluable leading indicator.
I don't buy that argument.
I think it's still a valuableleading indicator, but the lags
(11:27):
are just longer at this timethan normally have.
A lot will depend on whetherconsumers continue to spend I
have my doubts there out of pastincome, out of current income
or out of future income byborrowing.
All three sources of consumptionlook a lot more challenging now
(11:49):
.
As I mentioned, the excesssavings are gone, so it's going
to be more difficult to spendout of past income, since that
income is no longer around.
If you look at the savings rate, it's almost half of what it
was in 2019.
So saving out of current incomeis more challenging because
people are already spendingalmost as much as they possibly
(12:10):
can out of current income andthen spending out of future
income.
Look what's happened to creditcard delinquency rates.
They're now at the highestlevel that they have been since
2010.
The unemployment rate was 9% in2010.
We have the same delinquencyrate with the unemployment rate
of 4%.
So if credit card balancesstart to shrink as they already
(12:32):
are.
By the way, that means peopleare going to be spending less
and consumption is 70% of theeconomy.
Speaker 1 (12:41):
You've been quoted as saying stocks could drop 30%,
which doesn't sound surprisingto me.
It should not sound surprisingto anybody because we just went
through that in 2022.
But I'm curious why that number?
Why is there sort of is thatbased on some average historical
behavior that you've looked atwhy roughly a third of market
(13:03):
cap would be raised?
Speaker 2 (13:04):
at why roughly a third of market cap would be
raised.
Well, that would bring stocksdown to our net present value
estimate of where the S&P shouldbe trading.
And to get down to that level,which would be around 3750 on
the S&P 500, you only need tomake two assumptions.
First assumption that you needto make is that forward price
(13:25):
earnings ratio drops to 16.
And the second assumption isthat earnings estimates fall by
10% from current levels.
Neither assumptions are thatchallenging A decline in the PE
ratio to 16 would still leave itslightly above the average
between 2012 and 2019.
The average back then was 15.8%.
(13:46):
Of course, that period didn'teven include a recession.
The 16 PE that I'm predictingis a recession PE and a drop of
earnings estimates of 10%.
That's a lot milder than whathas occurred in the last three
downturns.
So 37.50 would actually be arelatively conservative estimate
.
Speaker 1 (14:05):
Okay.
So let's play that out, becauseif that happens, small caps,
you know they might outperform,they might actually be down less
because it goes back to, Ithink, the source of the selling
role even more on the tech side.
But that becomes reallyinteresting because if that's
the case, I would make theassumption that small caps, for
us to do that as the proxy,would actually break the October
(14:27):
2022 lows, which they did inOctober of 2023 before this
rip-off that happened.
If that happens, that's a verystrange thing historically,
isn't it?
I mean, you have a drawdown inlarge caps that was reset with
the move higher, but you havethe drawdown in the Ross 2000
(14:48):
not reset because you never tookout the 2021 highs, so they
make new lows before making newhighs.
I mean that just seems like avery odd dynamic that I don't
know if we've ever seen before.
Speaker 2 (14:59):
Well, I think actually with small caps one has
to talk about what index do youwant to use.
Like the Russell 2000 hasmassively underperformed the S&P
600 index, which is also asmall cap index, the Russell
2000, especially over recentyears, has become kind of
stuffed with low quality stocks.
Companies that don't make verymuch money have many cases
(15:23):
somewhat distressed balancesheets.
So I can actually see theRussell 2000 making fresh lows.
Don't forget, the Russell 2000has a lot of regional banks in
it, many of which are not goingto recover because they've had
to dilute their shareholdersalready.
The S&P 600 probably won'tretest its lows.
It's a higher quality index.
(15:44):
So I'm not as bearish on smallcaps as I am on large caps.
Even though during recessionsmall caps normally underperform
, I think this time around it'llbe more like the 2000, 2001
period, which was also arecessionary period.
But when were large capsunderperformed?
(16:04):
Because they were so expensivegoing into that downturn.
Speaker 1 (16:10):
What happens to the dollar in that situation?
I mean, that's been sort of theproblem for anything anyone
trying to invest internationally, it's been the strong dollar.
You've had this sort ofheadwind against unhedged
currency investing in Europe orEast Asia.
Does the dollar weaken there?
(16:31):
Stay status quo, Because we are, I think, unusual in the sense
that we're a little bit late tothe cutting game, whereas
certain countries already haveECB obviously has Canada.
What's your take on thecurrency side?
Speaker 2 (16:47):
Yeah, so there's going to be some cross currents.
There's going to be some crosscurrents.
On the one hand, the Fed hasmore scope to cut rates than
other central banks simply byvirtue of the fact that it
raised rates more than mostother central banks, but on the
other hand, the US dollar is acounter cyclical currency,
meaning it typically does wellin environments where global
(17:11):
growth is weakening, wherethere's this risk-off push.
So my guess is that the dollarwill probably strengthen a
little bit, but again it's goingto be more like the 2001 period
where we had a recession.
The dollar strengthened, butjust a bit.
The reason it only strengtheneda bit was because, a the Fed
(17:32):
was cutting rates dramaticallyat that time and, b it was also
very expensive and right now thedollar is quite overvalued
relative to its purchasing powerparity estimate.
The currency that I like themost in fact, last week was the
first time I ever bought thiscurrency for my personal account
is the yen.
I think the yen is massivelyundervalued and it's going to
(17:54):
have a huge short covering rallylater this year.
Speaker 1 (17:59):
I was hoping you would say that, because I've
been on that train.
My whole thesis for a creditevent which hasn't come yet and
may never come, is that therewill be a spark from Japan,
panicking causing, to your point, a short tweeze in the yen.
All that borrowed yen that'sdeployed in other assets a lot
of them might be AI playssuddenly again get repatriated
back to Japan.
(18:19):
Right, but you need to have asuccessive series of yen
advances against the dollar.
Do you think we could be insomewhat of a looming currency
crisis?
I mean, the way that thingshave acted here, with the yen in
particular, has been prettystunning.
Every single intervention hasfailed, which to me only means
(18:43):
they have to go as hard aspossible to spark a squeeze.
They have no choice, Otherwisethe speculators will keep
pushing it.
Speaker 2 (18:52):
I mean I think it's possible.
I mean, typically currencycrises are more common in
countries where the currency isnot issued by the local central
bank.
So a country like Italy canhave a currency crisis because
there's no central bank in Italyissuing currency.
It's done by the ECB.
(19:14):
In Japan and the US it's lesslikely but not impossible.
If you think about the UK, forexample, the Bank of England
issues its own currency andthere was something that kind of
resembled a currency crisis acouple of years ago when Prime
Minister Liz Truss tried to pusha fairly fiscally irresponsible
(19:35):
budget.
A large deficit and gilt yieldsrose dramatically.
The pound sold off, so we couldget some of that, and certainly
it's a possibility even in theUS that we see that, because
right now we have thisextraordinary situation where
the budget deficit is 7% of GDPand the unemployment rate is
(19:58):
only 4%.
If we get a recession, thenrevenues are going to dry up,
that budget deficit is going toget even larger and we could
have some existentialquestioning around the future
viability of the US dollar as areserve currency.
Speaker 1 (20:14):
Which is probably why gold is also hanging in there
as somewhat of alternative.
Speaker 2 (20:20):
Yes, absolutely, absolutely.
Speaker 1 (20:23):
Let's take the other side of it, things that could
stunt a recession or counter itbefore it's entrenched.
You and I would probably agree.
It's debatable that the Fed canget the lags of them cutting
right just in time for when thelags of the hiking cycle cause
the recession.
What about the argument that,for example, what if China
(20:46):
starts to recelerate?
It's been in its own economichell for some time?
I've heard that argument beforethat, yeah sure, the US might
be weak, but China, from aglobal growth perspective,
because it's not synced in thesame way, could pull things
somewhat higher.
Any chance of that at all?
Speaker 2 (21:05):
I think there's a chance.
I mean, it hasn't happened yet.
Why China hasn't stimulated isa bit of a mystery.
It might just be the case thatin the past, every time they
stimulated they got too muchstimulus.
The housing market would startto surge and then they would
kind of regret how much stimulusthey pumped into the economy.
So maybe they've just been sortof conservative and tried to
(21:26):
calibrate the amount of stimulusnecessary with what the economy
requires and maybe they'll justcontinue to crank up the dial.
We haven't seen it yet.
To be quite honest, a lot ofpeople have been calling for
stimulus.
It hasn't really arrived.
If you look at the creditnumbers, if you look at the
budget spending numbers, they'reall fairly weak, but it's
(21:49):
possible.
It's possible that China willdo more.
Another possibility is thatglobal manufacturing starts to
reaccelerate after close to 18months now fairly weak data.
I've talked about thethree-year manufacturing cycle.
In the past three years up,typically followed by three
(22:09):
years down.
We've had a weak manufacturingsector now for a long time and
maybe that sector will start todo better because people have
finally decided that they needto replenish some of those
electronic pieces of equipmentthat they bought during the
(22:30):
pandemic.
It's a possibility.
We're not really seeing it inthe data, but it's something
that could extend the cycle.
I think we should be at leastcognizant of that.
Speaker 1 (22:41):
As many are probably aware, it's an election year and
that term fiscal dominance hasbeen out there quite a bit, at
least on the social media side.
Independent of who wins, Couldthe fiscal side counter a
(23:04):
recession just in time?
It seems to me that there'slags and everything, but maybe
the lags of fiscal policy areshorter than monetary, so there
can be a much faster reaction toany slowdown order, but the
(23:28):
problem is that they might notbe invoked Right now.
Speaker 2 (23:30):
As I said, the budget deficit is already very big.
Typically, what happens duringrecession is that there's some
fiscal stimulus, the budgetdeficit rises, but then it comes
back down.
Well, we never had that periodof fiscal consolidation.
Debt levels are rising and willcontinue to rise for years to
come.
What I worry about is quite theopposite.
I worry that we're actuallygoing to get tax hikes next year
(23:52):
.
Even if Trump wins Now, he'snot going to raise income taxes,
he's not going to raisecorporate taxes, but he's going
to raise tariffs, and thereality is that tariff is a tax
on consumers, especially low-endconsumers, those companies that
are producing goods in China.
They're not Chinese companies,they're US companies with
(24:13):
manufacturing facilities inChina that are producing things
there, bringing them to the US.
They're going to charge ahigher price if they have to pay
higher tariffs on those goods,and so that could actually be a
situation where taxes rise inthe midst of recession, which
(24:33):
wouldn't be good at all.
Speaker 1 (24:37):
I wonder if that explains the weakness in the
transportation part of the stockmarket, the transports which
have been very diverged againstlarge caps, even though they're
still large cap.
I mean, maybe there's someanticipation that's coming and
if investors are forward-lookingthey're starting to discount
that.
Speaker 2 (24:57):
Yeah, I think we're kind of moving from a period
where bad news about the economywas good news for stocks
because it meant the Fed couldease policy, to one where bad
news about the economy is badnews for stocks because it means
lower corporate earnings.
We're kind of actually seeingthat today right.
(25:19):
That today right the marketrallied when the soft CPI print
was released and then it'sselling off because I think a
lot of investors are starting tosay to themselves maybe profit
margins are going to go down ifprices go down.
Profit margins soared duringthe pandemic because companies
(25:41):
could just jack up their prices,but if they can't do that
anymore, we're going to getsofter profit margins.
That's bad news for stocks.
So I really do think that we'reat a tipping point.
I was bullish on stocks lastyear, but then in the end of
(26:02):
June just a couple of weeks ago,now less than a couple of weeks
we turned bearish, because I dothink that we're in a unique
situation where the economy isvery, very vulnerable and
valuations are very stretched.
That's a bad combination forequities.
Speaker 1 (26:18):
So it's always a question of length and magnitude
, right.
The difference between acorrection and a crash is time,
right.
I mean 20% decline that happensin a week is very different
than 20% decline that happensover a year, so it's really just
about the compression of time.
Any thoughts on the risk of atail event?
(26:40):
And I say that some people willsay I'm a permit bearer for
framing it in this way, but itseems to me when I look at some
of the positioning data, thereis a lot.
I've used this line beforeeveryone's on the same side of
the boat holding an anvil.
You look at leveragepositioning, speculative
activity.
There isn't so much of acounter position.
(27:00):
So is there a chance that thisplays out aggressively, quickly,
different than how 2022 bearmarket played out?
Speaker 2 (27:11):
Yeah, I think that's the big unknown and we're seeing
some really weird stuff.
Just this morning, right, theNasdaq.
Haven't checked the latestnumbers, but last time it
checked it was down nearly 2%.
The Russell 2000 is up 3%.
When's the last time that'shappened?
I haven't checked the latestnumbers, but last time I checked
it was down nearly 2%.
Speaker 1 (27:30):
The Russell 2000 is up 3%.
When's the last time that'shappened?
I don't remember a single time,not in the last 20 years.
Speaker 2 (27:34):
The whole world is rotating out of NVIDIA into the
Russell 2000.
That's right, but you know whatthat means.
You know that a lot of peoplehad long QQQ, short IWM trades
on and are now oh crap, I needto close those.
So the positioning coulddefinitely amplify any move down
in stocks.
(27:55):
There's been all sorts of voltrades that people have been
putting on.
Those could go sour very, veryquickly.
So I don't expect the nextrecession to be like a balance
sheet recession of the way the2008-2009 recession was.
I don't think we're going toget a financial crisis.
(28:16):
It's possible, but I don'tthink so.
I think this will be more of anincome statement recession.
But nevertheless, the fact thatstocks are so overextended, the
fact that positioning may bevery one-sided now, does raise
the risk of stocks going down.
And, by the way, you don't needa deep recession for stocks to
fall.
The 2001 recession was a verymild recession.
(28:38):
We didn't even have twoconsecutive quarters of negative
growth and yet the S&P stillfell 49% peak to trough.
Speaker 1 (28:50):
Stock sector positioning.
That's the case.
So typically the recessionsectors are the sectors that
provide good services that youneed utilities.
Consumer staples need Utilities, consumer staples.
Healthcare Utilities areactually having, as we were
speaking, a massive relativemove against the S&P, almost
(29:11):
like small caps, but with a lowbeta bond-like sector Utilities
are strong from February upuntil April-ish outperforming.
The narrative was it's becauseof AI.
Everyone realized that suddenlyyou have to use electricity for
all these GPUs, then weakenedbut now showing some very sudden
strength.
If you were thinking from anequity strategist perspective,
(29:36):
do you want to tilt and try toplay that momentum relative-wise
in utilities?
Do you want to consider stapleshealthcare, how would you think
through sort of the sector mix?
Speaker 2 (29:47):
Yeah.
So we've been recommendingoverweighting utilities,
healthcare and consumer staples.
I would say of the three, Ilike healthcare the most, partly
because that's one of the fewareas in the CBI where prices
are still rising.
Healthcare prices tend to besubject to long-term contracts,
so a lot of healthcare providerscouldn't raise prices as fast
(30:10):
as other prices were risingduring the pandemic.
But now they're playingcatch-up, which is going to be
good news for healthcare profitmargins and, of course, from a
structural perspective,populations are aging.
Ai will actually be very, veryhelpful for drug discovery.
So there's some political risksaround healthcare, depending on
(30:32):
what happens in November.
But I do like that sector goinginto year end.
Outside of the classicdefensives, you might want to
use a bit of a barbell strategy.
Perhaps own a few materials,because material stocks
typically are late cycle stocks.
If the recession happens alittle bit later than I'm
(30:54):
expecting, we could get a rallyin materials.
By the way, materials were agreat performing sector in the
first half of 2008.
The recession started inDecember 2007.
We didn't know about it untilthe end of 2008.
So if you want to hedge yourrisks against a recession
(31:18):
happening as soon as I'm callingfor one, maybe owning some
materials gold miners, forexample makes a bit of sense,
but in general, I would bemoving into a more defensive
stance when it comes to equitysector allocation.
Speaker 1 (31:31):
The big question, and those that have followed me for
a while know why I'm askingthis question.
The question is how wouldlong-duration treasuries behave?
There is, to your point, thedeficits keep rising, the debt
keeps rising.
I do think personally, thatgold has been a beneficiary of
the concerns around governmentdebt, which is why you've seen
some defensive posturing thereas opposed to long duration
(31:52):
treasuries.
But do we get back to a placewhere treasuries on the long end
acts like that pristinerisk-off asset?
Speaker 2 (32:01):
I think we do.
Actually, now, the question ofdebt is an important question
and it's not entirely actuallyobvious whether high debt levels
are bad for bonds or good forbonds, certainly if high debt
leads to the same outcome thatbefell Italy and befell Canada
(32:28):
in the early 1990s, where youjust have to go through this
very extended period of fiscalausterity and that's not
inevitable, certainly not in theUS and certainly not given the
political dynamics, but it couldhappen.
So I don't have a strong viewon the long-term outlook for
bonds, but in the near term, ifI'm right about the recession
(32:50):
call, if I'm right about howCapEx and consumer spending is
going to slow, that'sfundamentally the good story for
ETFs like the TLT, which I'vebeen buying personally.
Speaker 1 (33:05):
Peter, for those who want to track more of your
thoughts, more of your work,where would you point them to?
Speaker 2 (33:10):
Well, I've got a Twitter presence, linkedin as
well, and, of course, visitbcaresearchcom and check out
some of our research.
Speaker 1 (33:20):
Appreciate those that joined this live stream.
I will have this as a podcastin a couple of days here, and
please make sure you check outBCA Research.
I am sincere, I'm a big fan oftheir work for many, many years.
That's a little bit of a familylegacy, as my father was too.
Thank you, peter, appreciate it.
Speaker 2 (33:36):
My pleasure.
Speaker 1 (33:37):
Cheers everybody.
My name is Michael Guyatt, publisher of the Lead
Layer Report, and joining me forthe roughly 35 minutes now,
given the shortened time frame,is Mr Peter Berezin of BCA
Research.
Peter, you and I did a space awhile ago and I emphasize to you
that I'm a huge fan of BCAResearch.
But for those who don't knowabout you and BCA, quickly
introduce yourself.
Speaker 2 (00:28):
Well, bca has been around since 1949.
So we're the oldest and largestprovider of independent macro
research, and I stress the wordindependent.
We're not affiliated with anyinvestment bank.
We just do one thing and that'sgenerate unbiased research.
And sometimes we're bearish,sometimes we're bullish, but
(00:53):
we're always trying to get afterthe truth.
Speaker 1 (00:59):
And the truth is, the truth changes every day because
the probabilities change everyday.
The truth changes every daybecause the probabilities change
every day.
Let's focus on that point abouttruth, because it seems like
there's two different types oftruths that have happened,
really, since last year.
The first truth is that it's abull market for large cap market
cap weighted stocks right,largely driven by AI not solely,
(01:22):
but largely.
The other truth is that thevast majority of stocks beneath
the surface have not reallyperformed all that well at all,
and when I'm referencing that,I'm referencing small caps,
because there's many more smallcap stocks than large cap stocks
.
From a historical perspective,is it unusual to have two
different messages, like whatwe've seen, where the small cap
(01:44):
side is clearly being held backby higher for longer?
There's no real momentum there.
It does not look like a bullmarket for that segment of the
marketplace, while the truth oflarge cap momentum is in place?
Speaker 2 (01:56):
It's unusual for that to happen, but it's also
understandable why that hashappened.
The economy has been slowing.
You can see that in theeconomic surprise indices, which
measure the extent to whicheconomic data is coming in above
or below expectations.
Most recently, the data hasbeen coming in well below
expectations, and so economistshave been ratcheting down their
(02:18):
growth forecasts for Q2.
And that not surprisingly, q2.
And that not surprisingly haskept the majority of stocks in
the S&P from rising.
But there have been a few thathave managed to go up for
(02:39):
reasons that have very little todo with the economy, and more
for reasons to do with hopeperhaps unfounded, perhaps
founded, we'll see over AI.
Speaker 1 (02:49):
So let's take a very big top-down view on where the
economy is.
I have myself argued that thelags are starting to hit, and
the thing about lags when itcomes to monetary policy is that
there's a pretty big range interms of when the lag starts to
hit and as how far out theycould hit.
What's your view on where theeconomy is headed?
(03:12):
What's your view on whereinflation is headed, especially
given the data that came outtoday?
And maybe combine all that witha thought experiment, if it's
possible.
The Fed actually overdid it,and it may only realize it when
it's too late.
Speaker 2 (03:33):
Yeah, so the lags we'll term as long and variable
lags.
I think this time around thelags have been particularly long
just because there was a lot ofinsulation around the economy a
couple of years ago.
Back then, people were frettingabout a recession, but at the
time, we were one of the fewteams that said listen, a
(03:56):
recession is actually veryunlikely because of all the
insulation around the US economy.
Back in 2022, you had hugenumbers of job openings, so
anyone who lost their job couldjust walk across the street and
find new work.
That kept unemployment fromgoing up.
You had over 2 trillion inpandemic savings, so money that
was just in household balancesheets waiting to be spent.
(04:20):
That supported the economy.
And you also have the fact thata lot of people refinanced
their mortgages during thepandemic, and so they were
insulated from rising rates, andit's true for businesses as
well.
A lot of them refinanced theirloans during the pandemic at
very favorable rates.
Now the problem is fast forward,a couple of years.
Things don't look so good.
(04:41):
The job openings are basicallyback to where they were in 2019.
We're already starting to seethe unemployment rate creep
higher.
Anyone who loses their job isnot going to be able to easily
find new work.
The pandemic savings arecompletely gone.
In fact, if you look at bankdeposits in real terms for the
lowest paid 20% of thepopulation, for the lowest paid
(05:02):
20% of the population, they'rebelow 2019 levels.
And even in terms of thosemortgages and business loans, a
rising share of mortgages noware paying over 6%, shrinking
shares paying less than 3%.
So as more homeowners areforced to buy a home using these
(05:23):
very expensive mortgages, thatmeans that monetary policy is
slowly working its way throughthe economy and I don't think
Fed rate cuts or, for thatmatter, even fiscal policy, is
going to save the day.
Speaker 1 (05:40):
I forget who had mentioned this to me before.
I haven't looked at this so youmay know the answer to it, but
historically, if you're lookingfor a leading indicator of a
recession from a jobs marketperspective, you tend to see
pretty high predictive power interms of construction jobs being
(06:02):
lost first, of constructionjobs being lost first, right
prior to sort of a broad-basedrecession, because of how
important the housing market is,the long tail of construction,
and it seems, from the data thatI've seen, that that is
happening.
Is there something to themakeup of where the unemployment
is starting to pick up that ismore consistent with what you
would see prior to recession?
Speaker 2 (06:23):
is more consistent with what you would see prior to
recession.
Well, we're definitely startingto see weakness in the housing
market, which is worrisomebecause, as Ed Leamer famously
said, housing is the businesscycle.
And so if you look atsingle-family housing starts,
they're down 2% year-over-year.
Multi-family housing starts aredown 50%.
(06:44):
It's a massive decline inmulti-family starts.
They're down 2% year-over-year.
Multifamily housing starts aredown 50%.
It's a massive decline inmultifamily starts.
And then, outside of theresidential area, things look
even bleaker.
Office starts are at nearhistoric lows, for obvious
reasons.
The vacancy rate for officespace is close to 20% by some
(07:07):
measures.
They're not building anyshopping malls.
Haven't been building anyshopping malls for years.
Even in industrial real estate,we're seeing vacancy rates rise
.
So the construction sector isnot doing well.
Home builders are not doingwell.
They've been going down,whereas the S&P 500 has been
(07:28):
going up.
That is a worrisome indicator.
Speaker 1 (07:32):
You had mentioned, the lags have been taking a lot
longer to hit, which of course,then makes me think about
divergences in markets right,lasting for longer than
something I expected.
When you have divergences fromthe economy, the stock market,
from large caps to small caps,from different sectors against
(07:54):
each other, how do thosedivergences usually resolve?
Meaning, if someone were to say, okay, large caps versus small
caps, that divergence resolvesin one of two ways Either small
caps play catch up or large capsplay catch down, right to get
to the mean, whatever that meanis.
Or you look at economic dataand the pace of growth and
(08:15):
slowing versus monetary policydirection.
That sort of differential Dodivergences tend to resolve
positively or negatively?
I know that's sort of a verylarge kind of generic,
broad-based question, but Ithink that's important for asset
allocators because I thinkeveryone down does notice that
it's a very lumpy not just stockmarket but very lumpy economy
that may be now starting to actmore normal.
Speaker 2 (08:39):
Yeah, I think it really depends on economic
circumstances.
If the economy doesn't start toreaccelerate, if it continues
to decelerate, we're going tohave a recession.
Recessions are toxic forsmaller companies that are often
very reliant on bank financing,that tend to have fairly
(08:59):
cyclical businesses.
So in this case, we're notgoing to see small caps catch up
to large caps.
We're going to see small capsdo badly and large caps also do
badly.
Now, what happens to large capswill also be very much a
function of whether the profitsfrom AI actually materialize.
(09:24):
And my impression, looking at alot of these large language
models, they're all kind of thesame.
You ask ChatGPT a question, youget kind of the same answer
that you would get if you askClaude or Gemini, and so the
presumption that a lot ofinvestors have is that these
large language models willgenerate these incredibly
(09:45):
profitable monopolies, just likesocial networks were able to
generate large monopolies.
People would use Facebookbecause everyone else was using
Facebook, but these models couldturn out to be more like
airlines, where they're veryuseful, but because they're all
kind of the same, there's nocompetitive moat and they don't
make very much money.
We don't know, but my guess isthat investors are going to have
(10:07):
second thoughts about the wholeAI story.
Speaker 1 (10:12):
Yeah and I always reference this point that from a
behavioral finance perspective,there's this concept called the
disposition effect.
So when faced with uncertaintyand volatility, people tend to
not sell their losers first,they sell their winners.
And there aren't that many bigwinners, and we know which ones
they are, so those becomesources of liquidity when that
(10:34):
uncertainty hits.
Now the recession argumentobviously ties into the yield
curve, the inversion being aslong as it has been.
I always joke that the stockmarket doesn't care about the
inversion until the stocks godown right, in which case then
that's when the media talksabout it.
But is there anything from ahistorical perspective that
(10:57):
suggests the length of time of ayield curve inversion is
correlated to the magnitude anddepth of a recession?
Speaker 2 (11:06):
Well, in general, yield curve will invert around
18 months before the start ofrecession.
This time has been longer, andsome people were saying that the
yield curve is no longer avaluable leading indicator.
I don't buy that argument.
I think it's still a valuableleading indicator, but the lags
(11:27):
are just longer at this timethan normally have.
A lot will depend on whetherconsumers continue to spend I
have my doubts there out of pastincome, out of current income
or out of future income byborrowing.
All three sources of consumptionlook a lot more challenging now
(11:49):
.
As I mentioned, the excesssavings are gone, so it's going
to be more difficult to spendout of past income, since that
income is no longer around.
If you look at the savings rate, it's almost half of what it
was in 2019.
So saving out of current incomeis more challenging because
people are already spendingalmost as much as they possibly
(12:10):
can out of current income andthen spending out of future
income.
Look what's happened to creditcard delinquency rates.
They're now at the highestlevel that they have been since
2010.
The unemployment rate was 9% in2010.
We have the same delinquencyrate with the unemployment rate
of 4%.
So if credit card balancesstart to shrink as they already
(12:32):
are.
By the way, that means peopleare going to be spending less
and consumption is 70% of theeconomy.
Speaker 1 (12:41):
You've been quoted as saying stocks could drop 30%,
which doesn't sound surprisingto me.
It should not sound surprisingto anybody because we just went
through that in 2022.
But I'm curious why that number?
Why is there sort of is thatbased on some average historical
behavior that you've looked atwhy roughly a third of market
(13:03):
cap would be raised?
Speaker 2 (13:04):
at why roughly a third of market cap would be
raised.
Well, that would bring stocksdown to our net present value
estimate of where the S&P shouldbe trading.
And to get down to that level,which would be around 3750 on
the S&P 500, you only need tomake two assumptions.
First assumption that you needto make is that forward price
(13:25):
earnings ratio drops to 16.
And the second assumption isthat earnings estimates fall by
10% from current levels.
Neither assumptions are thatchallenging A decline in the PE
ratio to 16 would still leave itslightly above the average
between 2012 and 2019.
The average back then was 15.8%.
(13:46):
Of course, that period didn'teven include a recession.
The 16 PE that I'm predictingis a recession PE and a drop of
earnings estimates of 10%.
That's a lot milder than whathas occurred in the last three
downturns.
So 37.50 would actually be arelatively conservative estimate
.
Speaker 1 (14:05):
Okay.
So let's play that out, becauseif that happens, small caps,
you know they might outperform,they might actually be down less
because it goes back to, Ithink, the source of the selling
role even more on the tech side.
But that becomes reallyinteresting because if that's
the case, I would make theassumption that small caps, for
us to do that as the proxy,would actually break the October
(14:27):
2022 lows, which they did inOctober of 2023 before this
rip-off that happened.
If that happens, that's a verystrange thing historically,
isn't it?
I mean, you have a drawdown inlarge caps that was reset with
the move higher, but you havethe drawdown in the Ross 2000
(14:48):
not reset because you never tookout the 2021 highs, so they
make new lows before making newhighs.
I mean that just seems like avery odd dynamic that I don't
know if we've ever seen before.
Speaker 2 (14:59):
Well, I think actually with small caps one has
to talk about what index do youwant to use.
Like the Russell 2000 hasmassively underperformed the S&P
600 index, which is also asmall cap index, the Russell
2000, especially over recentyears, has become kind of
stuffed with low quality stocks.
Companies that don't make verymuch money have many cases
(15:23):
somewhat distressed balancesheets.
So I can actually see theRussell 2000 making fresh lows.
Don't forget, the Russell 2000has a lot of regional banks in
it, many of which are not goingto recover because they've had
to dilute their shareholdersalready.
The S&P 600 probably won'tretest its lows.
It's a higher quality index.
(15:44):
So I'm not as bearish on smallcaps as I am on large caps.
Even though during recessionsmall caps normally underperform
, I think this time around it'llbe more like the 2000, 2001
period, which was also arecessionary period.
But when were large capsunderperformed?
(16:04):
Because they were so expensivegoing into that downturn.
Speaker 1 (16:10):
What happens to the dollar in that situation?
I mean, that's been sort of theproblem for anything anyone
trying to invest internationally, it's been the strong dollar.
You've had this sort ofheadwind against unhedged
currency investing in Europe orEast Asia.
Does the dollar weaken there?
(16:31):
Stay status quo, Because we are, I think, unusual in the sense
that we're a little bit late tothe cutting game, whereas
certain countries already haveECB obviously has Canada.
What's your take on thecurrency side?
Speaker 2 (16:47):
Yeah, so there's going to be some cross currents.
There's going to be some crosscurrents.
On the one hand, the Fed hasmore scope to cut rates than
other central banks simply byvirtue of the fact that it
raised rates more than mostother central banks, but on the
other hand, the US dollar is acounter cyclical currency,
meaning it typically does wellin environments where global
(17:11):
growth is weakening, wherethere's this risk-off push.
So my guess is that the dollarwill probably strengthen a
little bit, but again it's goingto be more like the 2001 period
where we had a recession.
The dollar strengthened, butjust a bit.
The reason it only strengtheneda bit was because, a the Fed
(17:32):
was cutting rates dramaticallyat that time and, b it was also
very expensive and right now thedollar is quite overvalued
relative to its purchasing powerparity estimate.
The currency that I like themost in fact, last week was the
first time I ever bought thiscurrency for my personal account
is the yen.
I think the yen is massivelyundervalued and it's going to
(17:54):
have a huge short covering rallylater this year.
Speaker 1 (17:59):
I was hoping you would say that, because I've
been on that train.
My whole thesis for a creditevent which hasn't come yet and
may never come, is that therewill be a spark from Japan,
panicking causing, to your point, a short tweeze in the yen.
All that borrowed yen that'sdeployed in other assets a lot
of them might be AI playssuddenly again get repatriated
back to Japan.
(18:19):
Right, but you need to have asuccessive series of yen
advances against the dollar.
Do you think we could be insomewhat of a looming currency
crisis?
I mean, the way that thingshave acted here, with the yen in
particular, has been prettystunning.
Every single intervention hasfailed, which to me only means
(18:43):
they have to go as hard aspossible to spark a squeeze.
They have no choice, Otherwisethe speculators will keep
pushing it.
Speaker 2 (18:52):
I mean I think it's possible.
I mean, typically currencycrises are more common in
countries where the currency isnot issued by the local central
bank.
So a country like Italy canhave a currency crisis because
there's no central bank in Italyissuing currency.
It's done by the ECB.
(19:14):
In Japan and the US it's lesslikely but not impossible.
If you think about the UK, forexample, the Bank of England
issues its own currency andthere was something that kind of
resembled a currency crisis acouple of years ago when Prime
Minister Liz Truss tried to pusha fairly fiscally irresponsible
(19:35):
budget.
A large deficit and gilt yieldsrose dramatically.
The pound sold off, so we couldget some of that, and certainly
it's a possibility even in theUS that we see that, because
right now we have thisextraordinary situation where
the budget deficit is 7% of GDPand the unemployment rate is
(19:58):
only 4%.
If we get a recession, thenrevenues are going to dry up,
that budget deficit is going toget even larger and we could
have some existentialquestioning around the future
viability of the US dollar as areserve currency.
Speaker 1 (20:14):
Which is probably why gold is also hanging in there
as somewhat of alternative.
Speaker 2 (20:20):
Yes, absolutely, absolutely.
Speaker 1 (20:23):
Let's take the other side of it, things that could
stunt a recession or counter itbefore it's entrenched.
You and I would probably agree.
It's debatable that the Fed canget the lags of them cutting
right just in time for when thelags of the hiking cycle cause
the recession.
What about the argument that,for example, what if China
(20:46):
starts to recelerate?
It's been in its own economichell for some time?
I've heard that argument beforethat, yeah sure, the US might
be weak, but China, from aglobal growth perspective,
because it's not synced in thesame way, could pull things
somewhat higher.
Any chance of that at all?
Speaker 2 (21:05):
I think there's a chance.
I mean, it hasn't happened yet.
Why China hasn't stimulated isa bit of a mystery.
It might just be the case thatin the past, every time they
stimulated they got too muchstimulus.
The housing market would startto surge and then they would
kind of regret how much stimulusthey pumped into the economy.
So maybe they've just been sortof conservative and tried to
(21:26):
calibrate the amount of stimulusnecessary with what the economy
requires and maybe they'll justcontinue to crank up the dial.
We haven't seen it yet.
To be quite honest, a lot ofpeople have been calling for
stimulus.
It hasn't really arrived.
If you look at the creditnumbers, if you look at the
budget spending numbers, they'reall fairly weak, but it's
(21:49):
possible.
It's possible that China willdo more.
Another possibility is thatglobal manufacturing starts to
reaccelerate after close to 18months now fairly weak data.
I've talked about thethree-year manufacturing cycle.
In the past three years up,typically followed by three
(22:09):
years down.
We've had a weak manufacturingsector now for a long time and
maybe that sector will start todo better because people have
finally decided that they needto replenish some of those
electronic pieces of equipmentthat they bought during the
(22:30):
pandemic.
It's a possibility.
We're not really seeing it inthe data, but it's something
that could extend the cycle.
I think we should be at leastcognizant of that.
Speaker 1 (22:41):
As many are probably aware, it's an election year and
that term fiscal dominance hasbeen out there quite a bit, at
least on the social media side.
Independent of who wins, Couldthe fiscal side counter a
(23:04):
recession just in time?
It seems to me that there'slags and everything, but maybe
the lags of fiscal policy areshorter than monetary, so there
can be a much faster reaction toany slowdown order, but the
(23:28):
problem is that they might notbe invoked Right now.
Speaker 2 (23:30):
As I said, the budget deficit is already very big.
Typically, what happens duringrecession is that there's some
fiscal stimulus, the budgetdeficit rises, but then it comes
back down.
Well, we never had that periodof fiscal consolidation.
Debt levels are rising and willcontinue to rise for years to
come.
What I worry about is quite theopposite.
I worry that we're actuallygoing to get tax hikes next year
(23:52):
.
Even if Trump wins Now, he'snot going to raise income taxes,
he's not going to raisecorporate taxes, but he's going
to raise tariffs, and thereality is that tariff is a tax
on consumers, especially low-endconsumers, those companies that
are producing goods in China.
They're not Chinese companies,they're US companies with
(24:13):
manufacturing facilities inChina that are producing things
there, bringing them to the US.
They're going to charge ahigher price if they have to pay
higher tariffs on those goods,and so that could actually be a
situation where taxes rise inthe midst of recession, which
(24:33):
wouldn't be good at all.
Speaker 1 (24:37):
I wonder if that explains the weakness in the
transportation part of the stockmarket, the transports which
have been very diverged againstlarge caps, even though they're
still large cap.
I mean, maybe there's someanticipation that's coming and
if investors are forward-lookingthey're starting to discount
that.
Speaker 2 (24:57):
Yeah, I think we're kind of moving from a period
where bad news about the economywas good news for stocks
because it meant the Fed couldease policy, to one where bad
news about the economy is badnews for stocks because it means
lower corporate earnings.
We're kind of actually seeingthat today right.
(25:19):
That today right the marketrallied when the soft CPI print
was released and then it'sselling off because I think a
lot of investors are starting tosay to themselves maybe profit
margins are going to go down ifprices go down.
Profit margins soared duringthe pandemic because companies
(25:41):
could just jack up their prices,but if they can't do that
anymore, we're going to getsofter profit margins.
That's bad news for stocks.
So I really do think that we'reat a tipping point.
I was bullish on stocks lastyear, but then in the end of
(26:02):
June just a couple of weeks ago,now less than a couple of weeks
we turned bearish, because I dothink that we're in a unique
situation where the economy isvery, very vulnerable and
valuations are very stretched.
That's a bad combination forequities.
Speaker 1 (26:18):
So it's always a question of length and magnitude
, right.
The difference between acorrection and a crash is time,
right.
I mean 20% decline that happensin a week is very different
than 20% decline that happensover a year, so it's really just
about the compression of time.
Any thoughts on the risk of atail event?
(26:40):
And I say that some people willsay I'm a permit bearer for
framing it in this way, but itseems to me when I look at some
of the positioning data, thereis a lot.
I've used this line beforeeveryone's on the same side of
the boat holding an anvil.
You look at leveragepositioning, speculative
activity.
There isn't so much of acounter position.
(27:00):
So is there a chance that thisplays out aggressively, quickly,
different than how 2022 bearmarket played out?
Speaker 2 (27:11):
Yeah, I think that's the big unknown and we're seeing
some really weird stuff.
Just this morning, right, theNasdaq.
Haven't checked the latestnumbers, but last time it
checked it was down nearly 2%.
The Russell 2000 is up 3%.
When's the last time that'shappened?
I haven't checked the latestnumbers, but last time I checked
it was down nearly 2%.
Speaker 1 (27:30):
The Russell 2000 is up 3%.
When's the last time that'shappened?
I don't remember a single time,not in the last 20 years.
Speaker 2 (27:34):
The whole world is rotating out of NVIDIA into the
Russell 2000.
That's right, but you know whatthat means.
You know that a lot of peoplehad long QQQ, short IWM trades
on and are now oh crap, I needto close those.
So the positioning coulddefinitely amplify any move down
in stocks.
(27:55):
There's been all sorts of voltrades that people have been
putting on.
Those could go sour very, veryquickly.
So I don't expect the nextrecession to be like a balance
sheet recession of the way the2008-2009 recession was.
I don't think we're going toget a financial crisis.
(28:16):
It's possible, but I don'tthink so.
I think this will be more of anincome statement recession.
But nevertheless, the fact thatstocks are so overextended, the
fact that positioning may bevery one-sided now, does raise
the risk of stocks going down.
And, by the way, you don't needa deep recession for stocks to
fall.
The 2001 recession was a verymild recession.
(28:38):
We didn't even have twoconsecutive quarters of negative
growth and yet the S&P stillfell 49% peak to trough.
Speaker 1 (28:50):
Stock sector positioning.
That's the case.
So typically the recessionsectors are the sectors that
provide good services that youneed utilities.
Consumer staples need Utilities, consumer staples.
Healthcare Utilities areactually having, as we were
speaking, a massive relativemove against the S&P, almost
(29:11):
like small caps, but with a lowbeta bond-like sector Utilities
are strong from February upuntil April-ish outperforming.
The narrative was it's becauseof AI.
Everyone realized that suddenlyyou have to use electricity for
all these GPUs, then weakenedbut now showing some very sudden
strength.
If you were thinking from anequity strategist perspective,
(29:36):
do you want to tilt and try toplay that momentum relative-wise
in utilities?
Do you want to consider stapleshealthcare, how would you think
through sort of the sector mix?
Speaker 2 (29:47):
Yeah.
So we've been recommendingoverweighting utilities,
healthcare and consumer staples.
I would say of the three, Ilike healthcare the most, partly
because that's one of the fewareas in the CBI where prices
are still rising.
Healthcare prices tend to besubject to long-term contracts,
so a lot of healthcare providerscouldn't raise prices as fast
(30:10):
as other prices were risingduring the pandemic.
But now they're playingcatch-up, which is going to be
good news for healthcare profitmargins and, of course, from a
structural perspective,populations are aging.
Ai will actually be very, veryhelpful for drug discovery.
So there's some political risksaround healthcare, depending on
(30:32):
what happens in November.
But I do like that sector goinginto year end.
Outside of the classicdefensives, you might want to
use a bit of a barbell strategy.
Perhaps own a few materials,because material stocks
typically are late cycle stocks.
If the recession happens alittle bit later than I'm
(30:54):
expecting, we could get a rallyin materials.
By the way, materials were agreat performing sector in the
first half of 2008.
The recession started inDecember 2007.
We didn't know about it untilthe end of 2008.
So if you want to hedge yourrisks against a recession
(31:18):
happening as soon as I'm callingfor one, maybe owning some
materials gold miners, forexample makes a bit of sense,
but in general, I would bemoving into a more defensive
stance when it comes to equitysector allocation.
Speaker 1 (31:31):
The big question, and those that have followed me for
a while know why I'm askingthis question.
The question is how wouldlong-duration treasuries behave?
There is, to your point, thedeficits keep rising, the debt
keeps rising.
I do think personally, thatgold has been a beneficiary of
the concerns around governmentdebt, which is why you've seen
some defensive posturing thereas opposed to long duration
(31:52):
treasuries.
But do we get back to a placewhere treasuries on the long end
acts like that pristinerisk-off asset?
Speaker 2 (32:01):
I think we do.
Actually, now, the question ofdebt is an important question
and it's not entirely actuallyobvious whether high debt levels
are bad for bonds or good forbonds, certainly if high debt
leads to the same outcome thatbefell Italy and befell Canada
(32:28):
in the early 1990s, where youjust have to go through this
very extended period of fiscalausterity and that's not
inevitable, certainly not in theUS and certainly not given the
political dynamics, but it couldhappen.
So I don't have a strong viewon the long-term outlook for
bonds, but in the near term, ifI'm right about the recession
(32:50):
call, if I'm right about howCapEx and consumer spending is
going to slow, that'sfundamentally the good story for
ETFs like the TLT, which I'vebeen buying personally.
Speaker 1 (33:05):
Peter, for those who want to track more of your
thoughts, more of your work,where would you point them to?
Speaker 2 (33:10):
Well, I've got a Twitter presence, linkedin as
well, and, of course, visitbcaresearchcom and check out
some of our research.
Speaker 1 (33:20):
Appreciate those that joined this live stream.
I will have this as a podcastin a couple of days here, and
please make sure you check outBCA Research.
I am sincere, I'm a big fan oftheir work for many, many years.
That's a little bit of a familylegacy, as my father was too.
Thank you, peter, appreciate it.
Speaker 2 (33:36):
My pleasure.
Speaker 1 (33:37):
Cheers everybody.
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