Full Transcript: Jim Paulsen on Markets, New Era Stocks, and Oil

The Economy, the Fed, and a Concentrated Bull Market

Justin: Jim, welcome back. Thanks for jumping on with us today.

Jim: Oh, it’s great to be here, Justin. Thanks.

Justin: We always like to do these talks with you monthly, where we talk about a whole host of things relating to the market, the economy, policy, sort of, and what you’re seeing 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 interesting things that you’re paying attention to. A lot of these, or all of these charts actually, are pulled from Paulsen Perspectives, your Substack newsletter.

So we’re really grateful, and our audience is appreciative that some of the stuff that you’re putting out to subscribers you are sharing with us, which is really great. And it’s always, you know, very important to get your perspective to help us understand sort of what we’re looking at when we look at these things.

And I’m pretty sure I can say this — we are not gonna be talking about SpaceX or AI in this conversation. Or will we be?

Jim: There may be a comment on AI here or there. But not SpaceX. Yeah.

Justin: Well, it seems like that’s what’s dominating sort of 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?

Jim: Yeah, I’d say there has been a little bit. I still suspect that economic growth’s gonna weaken here in the summer months into the fall from where people’s expectations are. But it’s been better 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. I think the underlying economy still remains fairly tepid. We’re probably growing more at 2% at best in real GDP overall, and employment is still 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, you know, does the economy slow down a little bit? And if it does, I think we’re gonna move quickly from worried about inflation to worried about growth, and those would be very significant aspects of what could prove to be the second half.

The other thing I’m just getting worried about a little bit is — although I think we’re gonna 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, 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. And to your point, Justin, if it’s SpaceX, that’s literally going to the moon, with AI, I guess. But 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 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 in a bear. I wouldn’t pull out of stocks, but I would move to underweighted positions in new era and overweighted positions in old era stocks.

That’s kinda where I’m at. And I’m nervous about it, because calling a peak in this market, I’ve never been good at that 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 a 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 gonna be sharp and nasty, and then have a good rally maybe in the fourth quarter.

Justin: What about inflation? I think the May print, if I’m reading this correctly, 3.8 year over year, which was fairly strong. So is there anything there that you’re sort of concerned about, paying attention to, particularly with this war that continues to go on, and with the straits being semi-closed?

Jim: Not so much. The print’s not that surprising. I mean, who among us that hasn’t filled their gas tank would know that we’re gonna 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 gotta be a high for me for maybe ever.

I don’t know. But I think that’s not shocking, and we’re probably gonna go a little higher in the next few months. I think what’s encouraging on the whole front, though, is I still see quite a bit of disinflation going on in a lot of the parts of the rest of the marketplace outside of energy and those tied very closely to that.

And I 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 they’re in the low 90s. They’re not really much different than they were in March.

Gasoline prices are about — national gasoline price, pump price — 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 has 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 gonna go to zero for the month.

You know, you could still get a flat month at $94 oil if a month earlier it was $94 oil. And so the thrust of this inflationary, I think, is gonna start to calm down, you know, unless we truly get back in a situation where we’re gonna 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 gonna 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, that’s not unexpected. A lot of that’s kind of embedded already in the financial markets.

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 gonna 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 idea that rates would go lower. But that seems to be sort of a question mark now, I think, with what’s going on in the economy and inflation, everything.

Jim: Yeah, I think there’s gonna be drama at this point. Not so much they go lower, but it’ll be whether do they hike now or do they not? I mean, that’s gonna be the immediate thing. I think, once we get beyond this first action or first meeting where they have to make a decision officially about whether they’re gonna — they could hike.

I mean, you’ve got a 10-year treasury that’s gone up to almost 4.5%. 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 from the private market suggesting a Fed hike at this point.

I think personally that’d be a mistake if they did that. I’m probably in the minority on that view at the moment. I’m not as worried about — you know, the real issue if you’re raising rates for inflation — I don’t see what a Fed hike right now is gonna do any good for bringing the price of crude oil down. I don’t think it has anything to do with it. The price of crude oil, we know what’s driving that, and it’s all about a conflict, geopolitical conflict, and that’s not gonna 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’s gonna make any difference. It’s not gonna quicken that process. But they may tighten for a period. I’m hoping, and my guess is they won’t, and maybe Warsh will have some impact to that as being the new Fed chair, but he’s just one vote on that.

And we’ll see where it goes. I mean, this is gonna have a lot of stuff hinging on it. Friday’s payroll numbers will factor big in this decision and how people feel about it as well. But I’m not too worried about that, ‘cause ultimately the economy’s gonna dictate this.

Justin: Right.

Jim: It’s either gonna slow down or it’s not. That’s where it’s gonna come down to.

Justin: Mm-hmm. Is that the market’s expectation, do you think, that they will be hiking throughout the year?

Jim: I think it is right now. Yeah. I think that’ll be wrong, but that’s where I think the kind of the average expectation is. And certainly a one Fed hike out the gate, that might even be more probable. 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 this.

Justin: 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 that’s sort of happening in the market, and that’s what this first chart, I think, highlights.

Jim: Yeah. It starts to get to this. Basically, what I have in there is the blue line is basically the division going on within the stock market. It looks at the relative price performance of 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 on a cap-weighted basis, how they’re doing relative to the rest of the stock market, which I call old era stocks. And you can see what the blue line’s done. We had that big boom in the dotcom era in the 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 old era stocks.

When you... 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. And that only makes up about — not even 13% on nominal terms. Less than 10% of GDP is made up 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 old era spending on Main Street. It’s going right into the stock market.

So when you look at this, for me, when I think ahead of how this plays out, you gotta ask yourself the question: if you’re worried about what the stock market’s gonna do, you gotta say, “Where’s that red line going in this chart?” Is new era investment spending gonna continue to climb relative to old in the economy? ‘Cause if it does, that blue line’s probably gonna fall. 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 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 this chart. 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 a look at what has 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 put in a position where they’re kinda 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 across all four of our major policy variables on average.

You can see it’s got a pretty close relationship here. 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 can certainly see it in amongst this bull market, where we’ve had mostly tightening going on most times since the 2022 inflation spike.

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 dollar’s come off, real money supply’s 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 at 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 era 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 era 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? New era spending’s probably gonna be strong. And if cash starts to dry up relative to new era spending levels, then in the future, new era spending’s 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. The lags aren’t perfect here, give or take. But 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 US Economic Surprise Index. And all that does 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; if it’s worse, it goes down.

So it just picks up net positive surprises, net negative surprises in the economy. What that really is, is a momentum measure of economic growth. ‘Cause typically, when the economy’s accelerating, all of our expectations are behind it. We’re kinda 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 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 can see it’s gone straight north here in recent months, 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 can see it’s a pretty darn good relationship. 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 in 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 if you get disappointing reports in the economy, it 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’s got me a little concerned about perhaps a correction of sorts.

Last comment I’ll make — I don’t wanna rush, we’ll come back to this a little bit later — but you also gotta think of the other tightening forces that have been applied on the economy here, kinda quietly in the background in the last few months. Most of which are tied to the geopolitical conflict. Geopolitical conflict hits, what happens? Oil goes through the roof. Well, now the inflation rate’s up, as you pointed out earlier, Justin. The inflation rate’s rising. 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.

So real wages have been negative of late. You’ve also got — because oil went up and inflation went up — interest rates have gone up. Not only 10-year yields but mortgage rates and across the spectrum, a tightening force overall. Got people expecting Fed tightening to come through. The dollar was depreciating. It’s started to appreciate again or strengthen 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 percentage of GDP has contracted by two percentage points, from about 7.2% stimulus to 5.2% stimulus.

So you’ve got tightening — and the 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 gone up. So you’ve got monetary tightening, you got rate tightening, you got dollar tightening, you got fiscal tightening. What is that gonna do? It’s probably gonna slow the economy down, and that’s kinda 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 and go away. Or whatever rhymes with J.

Jack: This idea of new era spending against old era benefit — it’s been one I’ve been thinking about a lot recently, because the new era spending is kinda being done in advance. But you’d argue, like, for this to continue for a long time — ‘cause that’s kinda 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?

Mm-hmm. Because that’s what’s gonna be the revenue that’s gonna come back to them that’s gonna allow them to keep spending. I mean, do I have that right?

Jim: Yeah, I think so. And that’s the other thing that bothers me, Jack — this even much more so than the dotcom 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, 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 and large companies, consumers. That was a very different world than what we have today.

What we have today is 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. Kinda 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 kinda question its sustainability, and that’s kinda what these next charts get into a little bit, Jack, that makes me a little leery of this whole situation we’re into here.

This first chart just looks at this bull market since October 12th, 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 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 12-month earnings per share of what I call new era parts of the S&P — information technology and communication services — and the rest, 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 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 to 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 the stock market’s going gangbusters. And 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 sector. 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 of itself, will probably fall in on itself if it doesn’t pro- create the... I still think AI and everything else will create benefits, but I think it’s taking a lot longer than it has in the past. And we’re living off a very bifurcated situation in the interim.

I’m just shocked when I look at no earnings advancement for 9 of the 11 sectors in the S&P 500. I bet if I looked at small cap 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, it just looks at price action, and people are more aware of this one. This just divides the S&P 500 into New Era and Old Era. Now, it hasn’t been quite as bad. Old Era stocks have gone up, not terribly. It’s just that New Era stocks have just gone up so much more. Just unbelievable. And it’s kinda getting worse. If you look at what’s happened year to date, Old Era stocks are up just slightly. I don’t know, in the low percentage points. But New Era stocks have just gone through the roof year to date, and most of this has occurred just since the March 30 low there on the blue chart. The March 30 low, they’ve just skyrocketed. It, this chart looks very much like the chart of an AI stock, but it’s just the New Era stocks within the S&P 500.

And the red line looks like it’s in a foreign world. It’s living on Mars, while the blue line’s living here in the United States. There’s not any participation. I just question how much longer can that go on before something kinda 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 these big moves, when the New Era stocks start to outperform dramatically faster than old era stocks — that is, when the blue line starts really ramping up higher than the red line does — when that’s happened, I’ve laid out four other times in the past during this bull market where that’s occurred, 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, primarily among new era stocks.

You can see the last four times that’s occurred. And 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.

Jack: Going back to your idea about these benefits going down — it’s interesting ‘cause I see a dichotomy. I mean, you talked about they probably will, and I kinda think they will too. I see, when I use AI in my life and I talk to other people who are running small businesses, you do, you do feel like the benefits of AI are going to spread down to everybody.

I had to redo our website — our website for Excess Returns wasn’t great — and we did a new professional website. I did it with Claude in, like, three hours. Like, the whole thing from like end to end, to being a live website in, like, three hours. But I can’t, like, quantify that in terms of thinking about what that actually means for the economy.

But I have to assume as the technology diffuses down, people are gonna realize that they can create a lot of efficiency or create revenue or whatever with this technology.

Jim: I think you’re right. I don’t know. I’m not an expert on AI. I think some of it, for me, it’s just like Google on steroids. I Google something and it can come back much more organized than it used to, but I could have done that before if I really wanted to look up stuff, 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 it’s gonna 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 — 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. And then there’s a lot of that we use just for fun, too. Looking up information on other things that probably is detracting us from what we should be working on, if you will.

So I don’t know where it’ll go, all of it. I think, though, the odds strongly favor that when you have some technological major breakthrough, ultimately it tends to create greater productivity, at least in some measure. But I’m not sure we can keep doing what we’re doing on this chart for that much longer when something breaks 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 gotta change a little bit.

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 if you referenced the ‘90s before, 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 grew throughout it. With this bull market, tech has been a huge part from the beginning. I’m just wondering, do you think there’s any implications of that?

Jim: Well, in this bull market — I think we have a chart of that coming up — the market cap. It’s a good question. I do think that there is something not as stable in something that is growing so rapidly and impacting so much of the growth rate of the economy, much more than it used to in past innovations.

I think — I don’t know what the data is exactly like when the railroads were first starting off or the Industrial Revolution — but I suspect that, as far as sustainability, it’s hard that those things ever got to the size of dictating almost the entire gain of the stock market and 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 kinda was big and now has 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 need to see ‘em. This is actually that chart in another way. This 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. Seven, eight percentage points in two months. You wanna project that out, we’ll be — before the end of the year — over two-thirds of the economy comprised by new era stocks.

It’s not gonna 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 stock market, now it accounts for half of it, basically. That’s unbelievable.

And where will we be if this is two-thirds? 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 employment. So I’m just concerned about some of this. I’m not saying it’s gonna die or go away, but I think it’s gotta slow down.

Jack: Yeah, and I think your point agrees with Andy’s, which is his idea was there’s only so much GDP pie. Tech can’t be everything. Tech can’t keep taking over the entire economy. There’s a certain point where it just can’t grow anymore.

Jim: Well, years ago, Jack, I used to say — I think this just came out in the 1990s when we were doing the dotcom run — I used to say, “Well, we’re gonna have to redefine our S&P 10 sectors,” which it was 10 sectors back then. “It seems stupid to have a sector called technology, because everything’s gonna be technology.”

That was my argument. Everything’s gonna be technology. The only thing going will be technology eventually. So we’ll have to — maybe we’ll call it the innovation sector or something, but you can’t call it tech, ‘cause everyone’s gonna be using tech and doing. But in reality, 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 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.

Justin: And it seems, too, like every time the rally starts to broaden out — and you kind of see it in this chart — like, the beginning of this year, it was really great for value stocks and a lot of these other sort of non-New Era stocks. And but then, like, it turned on a dime, in whatever it is, April or something like that.

And it’s weird that 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 we have gotten these fits and starts.

You can comment in on this, Jim, but it’s the same old playbook when, I don’t know, things go back to the large cap tech.

Jim: I think 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 tightening.

And as I showed earlier in that chart, much of the old economy needs policy support to grow. That’s how it grows over time. It gets liquidity growth through monetary stimulus. It’s a 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. Generally has a weaker dollar, which makes us more competitive to foreign producers and the like.

This one’s been opposite of that. We’ve been pounding old era 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 old era 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 gonna grow, because no one has this new toy and everyone’s gonna 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 era pursuits.

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, 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 old era pursuits pick up was because that’s when we were easing. That was some of the brief window —

Justin: Mm-hmm.

Jim: 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 geopolitical conflict, and it all went back to the same place again. And I think that’s why I’m saying we still could have a pretty big shift back away from new era pursuits to old era if we’re 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 kinda what I’m sorta betting on, on average over the course of this year. But I don’t —

Jack: Just one quick thing 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 — if I came on hard economic times, the things that I would cut before the iPhone — 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 in hard economic times. It’s like at the top of things you’re not gonna get rid of.

Jim: 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 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 Warsh and the Fed and fiscal authorities in Washington. 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 gonna come to find out there’s a whole cycle involved in innovation that’s gonna be mightily important for an economy which now bases so much of its existence on that part of the world. And we’ll see where that goes. I don’t think we understand it very well yet.

Couple other things that makes me... 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 Seven. I mean, Mag Seven has killed it. Those big venerable Mag Seven — 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 run 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 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 Mag Seven’s not only getting beat by small little no-name companies, it’s also getting beat by companies without any profits, and that changes the feel of this thing.

You know, one of the great things about this tech run was it wasn’t just dotcom names without any earnings. It was these well-known, 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 —

Justin: Oh, I bet that’s parabolic.

Jim: That’s parabolic. And it’s multiple... Justin, to your point, the Goldman Sachs AI Beneficiaries Index has gone from, like, 35 times earnings to over 70 times earnings just since the end of March.

So that’s as hyperbolic as any of the rest of that. 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 fully registered yet.

Jack: But —

Jim: We’ll see.

Jack: So this next chart is oil, and obviously this has been a big part of the story here, what’s going on with oil, and this was actually in your piece where you were talking about this idea that a correction may be coming. So what were you getting at on this chart?

Jim: Well, I’m just laying out oil back to 1970 here and 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 the 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 necessarily during its rise. In fact, during the rise of some of these, the 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 gonna label those same dates on the S&P 500 since 1970. And you can see, for example, in 1974 — or excuse me, 1972 — the market peaked, but when oil peaked in January ‘74, look what happened after it peaked. 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 the sense... The piece I put this in, I entitled it “Buy on the Cannons and Sell on the Trumpets.” And what I meant by that was — I think it’s the sense that, “Oh my gosh, maybe we’re gonna make it through this. Oil went up to $100, $120 and we had this geopolitical conflict, and now it looks like it’s winding down. Woo, I guess we’re gonna be okay. It’s okay to stay in stocks.” And that’s kind of what March 30th was about, right?

March 30th was the first time when Trump and Iran both blinked together a little bit and said that maybe we’re 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 while it’s peaking. And I’m not sure that’s well appreciated.

I put this out recently because I think it 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 in the S&P 500 and the 10-year treasury yield. And what you look back historically — 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’s 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 — healthy enough to support higher yields, ‘cause it’s worried 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.

But it gets very different in a negative correlation. When you’re negative, it’s primarily worried about inflation. In that situation, if bond yields rise, stocks generally fall, ‘cause 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 the stock market’s looking at it as if yields go down, it must mean inflation is weakening.

Indeed, initially when we got this, the 30th started out you had a bit of a drop in yields and stocks took off. We’ve still kinda 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 red line here is the 10-year treasury yield, and the blue line is that same chart I just showed you inverted. So when correlations are negative, like they were in the early nineties, bond yields are at the highest. When correlation’s very positive, bond yields are at their lowest. ‘Cause 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 gonna come down. If you couple that at a time when the economy’s also slowing, I think we’re gonna quickly go from inflation to growth as being a primary worry, and this blue correlation is gonna fall down in there to positive territory, allowing, I think, bond yields to fall further.

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 the end of this year — we could see where the war ends and rates go down because the bond market’s 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.

So we could actually — eventually, when people decide that lower rates were not gonna recess, then we might get back to a situation where lower rates — or rates stop falling — then the stock market can take off again, if you will. But I do think it’s important to look at how do we get from where we are today 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 as your biggest fear to growth. And that’s kinda where I think we might go yet before this year’s over.

Last few here, I just got a couple one-offs that I think are interesting, worth mentioning. This chart overlays the S&P 500, which is the blue line there on a log scale, with a ratio of core capital good orders per job, the red line. And in some ways it’s kind of rather remarkable. And you could say, “What’s driving the stock market? What has been driving the 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 country. How much are we investing in our labor force? That’s all that’s mattered.

Once we invest less in our labor force, guess what? Stock market goes south. And once capital investment per job goes up, stocks do great. It’s really a 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 per job, and it rolled over pretty big in April.

And we’ll see where it goes, but I do think it’s gonna be problematic to some extent, if for no other reason than at least real capital good orders are gonna 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 goods per job starts to fall on a regular basis. And that could bring some pressure to our stock market overall.

Justin: Jim, are those capital goods — would that be including things like what’s going on with the AI build, like that type of stuff? Like data centers —

Jim: It’s in there.

Justin: Yeah.

Jim: It’s in there.

Justin: So that could be —

Jim: It’s not just that. It’s old and new, it’s all of it.

Justin: Yeah.

Jim: But it’s definitely in there. Yep. But it’s just kind of interesting it rolled over in April too. I think. And it also depends on what the denominator’s doing. To your point, Justin, the job growth changing too.

Justin: Mm-hmm.

Jim: A little bit. This chart I just put out, I guess earlier this week, and I just thought it was kind of interesting. I’m not sure what to make of it. It’s a busy chart, but I call this a bull market of booms.

Justin: That is interesting.

Jim: I just find it interesting. I’m still kinda thinking about this, but I got several different things in this chart. Probably need glasses to read it. But the two that started this bull really were the Mag Seven —

Justin: Mm-hmm.

Jim: And Bitcoin. Which is basically the blue line and the purple line in there. They really started — and they didn’t just start, 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 kinda stopped booming finally. And summer of 2024, they kinda both peaked out.

And if you look at that, Bitcoin’s gone down a lot over almost two years now, and Mag Seven 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, and Mag Seven relative to the S&P, has really lost its luster, if you will.

No big deal. Because as soon as Bitcoin and Mag Seven kinda topped out, guess what? Gold took over. Gold took off for the races. Another market boom. And then it kinda peaked out, you know, last year a little bit. It’s really come down hard relative to the commodity prices there as shown.

No big deal, because as soon as it — yeah, ‘cause oil took off. Oil took off. It went from gold to oil, the black line at the bottom there. And then, you know, oil’s 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 don’t know quite what to make of it except it’s kinda 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 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 — it doesn’t go from 100% stocks to 100% bonds, it goes from 100% new era to 100% old era. And 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 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 kinda 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 is just kinda fun and a question mark too. The blue line here is the relative performance of technology stocks in the S&P 500, and the red line is a 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, on a total return basis. And what I wanna 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 30th lows — 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 30th, after it was pulling back, or billionaires know something the rest of us normal people don’t. 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 gonna start coming in on AI now — or maybe they’ve been out for reasons that they understand that we don’t really know. We’ll see.

Justin: Yeah, I don’t know for sure, obviously, because we don’t know what’s in the data.

But what’s interesting about the technology sector is — and to your point about the Mag Seven — there’s been a lot of these names like Micron, Oracle, IBM. These — I would say second-level tech companies — have kind of ripped here, like over the last month or so. And so 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 a shift in sort of some of the more speculative, or let’s say 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 to add on to that.

Jim: I think it’s a good observation. What I talked about a little bit earlier too would just support that, you know, kind of being made up with unprofitable tech companies now and small cap tech companies. That could be part of that. Maybe the billionaires were owning the Mag Sevens and really made no change in that. And Mag Seven’s done a little bit better than they have over that period, but not a lot. So that could explain what’s kinda gone on. It’s become a more speculative tech market that maybe the billionaires have been sitting in some of the more stable large companies.

I hadn’t thought about that. It’s a good point.

Jack: I do hope, Jim, though, at some point I can be with the billionaires, you know. So maybe I can find out what they’re doing. Wherever their secret meetings are, I hope I get invited.

Jim: Be with you. Be with you on that one. We’d both be going to the Knicks game here soon if we were in that category.

Jack: Yeah, that’s right. You almost have to be a billionaire to go to the Knicks game right now. That’s right. To justify that expense. And I think a lot of the billionaires probably wouldn’t spend what it’s costing to get tickets.

Jim: Probably wouldn’t either. That’s how they made a billion.

Jack: Yeah, that’s exactly right, is by not doing that. But just briefly as we wrap up, are there any main takeaways you want people to have here as we head forward into next month?

Jim: Well, I’m nervous about where we’re going, because it’s got such a head of steam on the upside. It feels like death warmed over to suggest any kind of correction when you got this much momentum, and it could go on for a while. But I’m just trying to keep myself thinking ahead, a year from now or whatever, rather than tomorrow or next week or next month. And I’ve always kind of invested for a year out.

And I just think we’re gonna 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 at one of these episodes I’ll say mea culpa 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, I guess.

Justin: All right. Thank you very much, Jim. We’ll see you in about a month or so.

Jim: All right. Thanks for having me, guys, as always. Take care.