Full Transcript: Paul Eitelman on the Case for Accelerating Growth

A Look at the Forces Shaping Markets Headed Into 2026

Justin: Paul, thanks so much for joining us and welcome to Excess Returns.

Paul: Yeah, pleasure to be here.

Justin: You are the Global Chief Investment Strategist at Rus Russell Investments, where you help shape the investment allocation and portfolio strategy that’s responsible for managing and advising on hundreds of billions of dollars, if not more.

And one of the things that you and your team are responsible for are putting out. Pieces of research, thought leadership pieces, pieces on the market that you disseminate to market participants and those that do business with Russell Investments. And recently you put out your 2026 outlook titled The Great Inflection Point where you made the case for accelerating AI adoption.

Renewed US economic momentum, the potential for market leadership to broaden out next year beyond the magnificent seven. And so what we thought we’d do today, which would be really interesting, and I think fun conversation is kind of work through each of the themes that you highlighted, and then try to think about what this actually means for investors, what’s happening underneath the surface, and how investors might wanna think about positioning as they head into next year.

And so it’s gonna be fun, I think in depth conversation about all these things. And for people that want to actually get the report, they can go to Russell Investments underneath the insights tab and then search in there. But you can also just Google the great inflection point Russell Investments, and it’ll bring you right to that right to that report.

So. So anyways, the first thing I wanted to do, and I think this is a great way to just sort of frame up how you guys think about investing is talk about your, your, your CVS framework, which is cycle value and sentiment framework. And take a minute to explain sort of how that, I guess, captures the way that you think about developing investment strategies and what you’re advising clients on.

Paul: Yeah, I guess for us it, it starts with a philosophy that financial markets are pretty efficient but not perfectly efficient. And I think what we’ve seen a lot of episodes of over the last couple of decades is during moments of crisis, financial markets can overshoot fundamentals, particularly when investors become panicked about economic prospects.

So for us, that cycle valuation, sentiment process is important for two reasons. It gives us structure to help. Avoid making those same behavioral mistakes that some other investors are exposed to. And then second, we can kind of lean in and take advantage of those dislocations when we’re seeing them in real time.

So to kind of go through it, each of those three building blocks, the, the cycle is just roughly speaking the fundamentals that we’re seeing that matter for asset classes. So think about things like economic growth, earnings growth, what the Fed’s doing with interest rate policy. So a lot of attention into those real term, real time dynamics around the business cycle.

Valuations are the price that you have to pay for those fundamentals, which really does matter, particularly as investors stretch out their time horizon over the medium to longer term. And then sentiment’s really a workhorse for us, and there’s two pieces for it. One is leaning into momentum strategies, which do work under normal circumstances.

But I think the really interesting feature. Around that idea of behavioral finance and trying to exploit overshoots in markets is we on a daily basis measure market psychology and look for moments of panic. And when we get those big bouts of risk aversion, what we tend to find is that forward returns in markets tend to be much stronger than normal, and we can kind of take advantage of that insight to our advantage in our portfolio strategies.

Justin: Yeah, I love that. Those are all very important levers that at different points in time, at different points in the cycle are gonna matter, maybe more or less, but having the overlap too, where they all kind of meet can kind of really inform, I think, the way that you’re thinking about sort of the risk and return opportunities in the market among different asset classes.

So try to sort of relate that to this report, the, the great inflection. Point that you put out for your 2026 outlook and sort of what changed in your view in those things? And I think we’re gonna talk about some of those in detail, but if you could just at a high level, what sort of makes you confident that the re-acceleration into next year is likely to continue?

Paul: Yeah, I mean, if you look back to April of 2025, investors were grappling with some really big questions, some very significant policy change. From the US administration, we had an equity market that was down peak to trough almost 20%. So we were seeing some signs of pretty extreme risk aversion, a lot of concerns amongst economists around the possibility of an economic recession.

But we haven’t had that, and I think the business cycle’s been very resilient to those policy changes. And not only has it shown resilience, but as we’re kind of thinking about. The catalyst into 2026, it looks to us like we’re shifting from a period of headwinds, most notably, trade policy and immigration restrictions towards an environment that is showing more policy tailwinds, into the year ahead.

As we kind of move into the sweet spot of some of the stimulus effects from the one big beautiful bill act, we’re seeing some very favorable financial conditions, et cetera, that lead us to think that the growth environment is shifting from resilience to potentially even reacceleration. And more strength as we move into the new year.

Justin: One of the big themes that you highlighted was this accelerating AI adoption and talking about how there there’s likely to be some more positive returns on these investments being made into ai. But I I, before we get into some of the stuff on that, I just wanted to ask you like, how do you look at.

Artificial intelligence and what we’re seeing in ai relative to other transformational technologies in history. IE the internet, IE railroads, maybe telecom, like how do you kind of, where, where, where do you stand on where AI is relative to some of these other breakthrough technologies in the past?

Paul: Yeah. I mean, it’s, it’s early to say exactly where all the chips are gonna fall on this major technological wave that we’re going through right now, but I’d say it’s probably closest in terms of parallels to the Industrial Revolution. And if you kind of think back to that in the most simplistic terms, the Industrial Revolution disrupted.

Human muscles in favor of machines, and that really transformed the industrial sector globally. What we’re seeing with ai, at least in terms of the potential of what it can deliver, is the ability to disrupt the human mind and meaningfully impact and supercharge the services sector, which is a major part of not only the US but most of the other developed market economies today.

And so it has a lot of. Potential That’s quite consequential for investors to think about over the, the next several years here.

Justin: One of the major questions in the markets right now is are we going to see a positive return on the hundreds of billions? Eventually, trillions of dollars that are, that are being spent on this AI build out, whether it’s data centers, whether it’s the investment into some of these.

Companies that are leading AI and that’s even, you can even go the MAG seven to some extent because a lot of those major growth companies are also investing heavily in their own businesses in ai. And I thought you had a really interesting chart in here that shows that some of these AI investments are starting on the margins to actually pay off.

So can you just kind of talk about what you’re seeing and what you’re looking at and why this is important?

Paul: Yeah, well, I mean, we’re seeing adoption rates for generative artificial intelligence start to pick up in the real world now. So in terms of AI use at work, the numbers are increasing. They’re up to around 40% today in the US and increasing with each new survey that comes out.

And so I think we’re starting to get some data now around how successful those. Generative AI deployments are in the real world. It’s not something unfortunately that you can go to a financial statement to pull up and get exactly how much right. These technology deployments are helping the bottom line, but there are a number of surveys from the hyperscalers themselves, consulting agencies, et cetera, that are trying to measure this concept.

Of return on investment from AI as this getting kind of put to use in the real world. And the numbers are a little bit mixed across which survey you look at, but I think the mosaic here is one where there are actually now some real tangible benefits where companies seem like they’re being able to deliver more in terms of output, in terms of goods and services with the same input in terms of workers and and capital.

And they’re seeing some real benefits. To their bottom lines through efficiency gains and productivity growth. And my sense is we’re in the pretty early innings of this sort of tailwind cycle potentially building going forward over the next couple of years.

Justin: Yeah, and I think that’s one of the points you made in this sort of J curve example, which kind of just talk to that.

What does a J curve actually indicate with these new types of technologies? Like how would you interpret that and where are we maybe on the J curve here?

Paul: Yeah, so J Curve’s a concept that economists tend to like as we’re thinking about new technologies and what basically what the that shape captures is in the earliest innings of a new technology.

There’s a lot of challenges companies have to invest in, deploy those systems into their work streams. They have to figure out where they can find real advantages. Workers have to learn how to use the, the new technology through training, getting real world work experience. And so you tend to have some growing pains where in the early innings you often find no real productivity benefits, sometimes even headwinds onto corporate performance.

But as that technology progresses and deepens and companies and workers become more familiar with it. The tailwinds build over time. And so my sense kind of hearkening back to that conversation we were just having on ROI, seeing some green shoots on ROI now it feels like we’re starting to move up that j curve in a more positive direction now with some incremental tailwinds into 2026 and those very likely building.

Into 2027. As companies kind of deploy this more and more effectively in the productivity and pro, profitability gains build over time,

Justin: how do you, I’m curious the Mag seven has kind of gone from like asset light, high profitability to plowing billions and billions into these AI investments.

So they’ve become much more intensive with their deployment of capital. Does that. How do you think about that? ‘cause I mean the, the Mag seven has been these large technology stocks for the last 15 years have been one of the major drivers of the returns in the broader market, specifically large cap indices at a market cap weighted.

So how do you view this heavy investment and does it change in your mind the profile of these companies? To some extent,

Paul: it is changing their profile over time. I mean, the hyperscalers have had. Enormous successful businesses with very little physical capital deployed record free, c free ca, free cash flow margins that’s been supporting the aggregate market is starting to change.

I mean, the CapEx figures for the hyperscalers alone today are now in the hundreds of billions of dollars. In the aggregate. I don’t think we’re seeing. Too much leverage in the system yet, but it is at the company level starting to shape dynamics where in a couple of instances, free cash flow margins are significantly depressed.

We’ve seen a couple of the hyperscalers come to public and private debt markets to help sustain their CapEx, and that’s really raising some serious questions amongst investors. I, I think from my perspective, we’re not seeing major vulnerabilities on that front yet, usually around these leverage cycles.

But it’s gonna be a really key issue around how much profitability they can generate going forward. What I would say, obviously we don’t know where this will land, but it looks. To be a very competitive space where a number of the hyperscalers are competing with one another. Around even the lar large language models really competitive.

The leaderboards seem to be changing almost every single month in terms of who’s at the top of the stack with the most effective model here. And that’s gonna be interesting to watch how it evolves going forward. If a company can kind of emerge to the top, or if it remains hyper competitive, in which case normally you’d think.

About pricing being a challenge and profitability being a challenge around all of these investments. So it’s really gonna be a key issue over the next several years here now.

Justin: And just one last one on ai. What do you think the possible risks, downsides are here? I mean, one some people prognosticate that it’s gonna wipe out a lot of white collar jobs.

Another issue is the demand of energy and how that affects energy prices in this country. I mean, you just had Bernie Sanders come out today. This isn’t necessarily totally along these lines, but he’s basically making a push for a maturing stopping the building of putting a halt on stopping the building of these data centers for whatever reason that is.

So I’m just curious, like when you think about some of the possible, other downsides maybe to society, if that’s the right way to put it. Like how do you think about that?

Paul: Yeah, I think energy demand is one. Key risk. We have a pretty inefficient electrical grid in the United States. And so when these data centers pop up into regional economies, it does seem to be really pressuring systems.

We’re seeing at least in isolated cases already some upticks in electricity prices. And that could have some real consequences for consumers. So I think that’s one challenge, both in terms of how. Quickly, the technology can scale, but then also some blowbacks onto the economy to think about from a consumer perspective.

Another risk that we’re monitoring, and it kind of ties into the conversation we’re having around this big CapEx cycle, is as we project these numbers going forward, again, probably not an issue today, but if you look out to the end of. This decade, our estimate is that these very large companies could need to issue almost a trillion dollars into public and private capital markets.

And that’s a lot for markets to absorb. So far it’s been okay that a lot of these deals, if anything, have been oversubscribed. But that’s a lot of capital that markets are gonna need to put into this one sort of new technology to sustain it. And I think the pricing around that is another important risk to have in mind.

The labor market’s an interesting one. At least so far we are seeing some AI impacts, but our own work, and I think the academic studies in this space suggest the impacts for now are pretty modest, where it’s only really showing up in the most exposed jobs, whether that be software engineering or customer service.

In those spaces, there’s been a little bit of a. A hiccup in, in labor demand where companies are scaling back on how much they’re hiring in terms of early career workers. We’re not seeing as much in the way of sort of AI driven layoffs here. I know there’s stories about that and anecdotes and companies are talking about that story, but probably weaker evidence of those sort of more damaging or disruptive effects.

But it, it could ultimately become a bigger issue over time and we’ll have to kinda keep tabs on it. Ultimately, those labor markets will come down to. The breadth of jobs that AI can impact and provide real productivity gains for, and just how big, from a magnitude perspective those benefits are for each of us as workers.

And if the gains are profound on both of those dimensions, this could be enormously disruptive to the labor market over the next couple of years and potentially cause a downdraft in employment before we reach some kind of. New equilibrium. We’re not seeing that yet, but I think it is one of those medium term risks that have top of mind here.

To your point.

Jack: Yeah. To your point, it seems like, and if anybody who has kids that are just graduating college or if anybody themselves who are just graduating college, it seems like that’s where the biggest impact is right now. Like it’s making it, maybe companies are looking at that new hiring.

Is is the first area that maybe AI will supplant to some degree?

Paul: Yeah, I think that’s right. That seems to be the first area right now and then. Over the horizon is sort of what’s next. I’m a dad of a a 3-year-old and a 6-year-old, and it’s it’s a little scary just how transformative this could potentially be for the labor market over the medium term.

So.

Jack: I even wonder if my kids like will go to college by the time if you have a three or 6-year-old, I mean, who knows what it’s gonna look like by then could be a completely different world. Just before we switch to the economy, I just wanna ask you one more on ai. How have you, like, have you seen a lot of personal benefits, whether in your own life or in your work at Russell in terms of using ai?

We always like to ask guests, like how, how they use it personally.

Paul: Yeah. I mean, I had my own learning curve. I’d say for the first three to six months I was watching late night YouTube videos. And as a dad of two kids, I was often falling asleep to those. Late night YouTube videos as I was trying to get smart on the technology.

But today, here in late 2025, I’m using generative ai AI every single day at work. And I, I’d probably say the biggest level up for me is as a researcher, getting smart on whatever issue I’m, I’m really facing and trying to disentangle from a financial market perspective or a question I’m getting from clients.

Ai. Allows you almost instantaneously to generate a really sophisticated literature review of what some of the smartest academics or professionals are saying on a topic. That was a. Task that as a researcher would typically take an analyst a day or more to execute before. And I’ve found AI to be really excellent at that sort of early stage of research.

We’re not using it as an output just yet in making sort of final investment decisions on it, but to really speed up that research process has been really effective for me. So that’s been the biggest win.

Jack: So as we shift to the economy, I wanna talk about your theme of, of re-acceleration here. And before we get into, you have a great chart, which we’ll put in the podcast.

It looks at each of the individual factors that’s impacting the economy right now. But before we get into that, can you just talk at an overall high level, how you’re thinking about the economy and what the case is for this re-acceleration as we head into 2026?

Paul: Yeah, I think the highest level in terms of the case for Reacceleration is a sort of mix shift around US policy dynamics where 2025 was all about significant policy change.

Some of that involving headwinds with steep new tariffs. Immigration restrictions. But as we move into 2026, not only have we experienced some of those headwinds, and the US economy has been resilient to those, but the, the mix shift is turning more positive, where we’re seeing more tailwinds and support for growth from fiscal stimulus, from loose financial conditions, et cetera.

And so when we do the math, that’s shaping up towards an environment where we see growth likely to accelerate into 2026, which is, I think, important and positive from a fundamental perspective.

Jack: The first thing you have in the chart, which is on on down arrow is tariffs. And tariffs been really interesting because it seems like what economists thought the impact of tariffs were gonna be has been very different than the actual impact.

So either maybe they’re not as big a deal as we thought, or maybe that impact is lagged and we’re gonna see it. Like over time. So how are you thinking in general about tariffs and their impact as we head into 2026?

Paul: Yeah, I think this was probably top of mind for economists when they were thinking about recession risk back in April of 2025.

But it seems like the issue’s been absorbed very well by the US private sector so far. We’ve seen some of that get absorbed by the corporate sector in terms of incremental hits to corporate earnings. Even with that hit, corporate earnings have been really robust, so companies have kind of managed through this, through a lot of dynamism and.

Clever pricing practices, consumers as well. I mean, we’ve had some inflation, particularly amongst goods, prices from tariffs. That’s been a bit of a hit to household real incomes in terms of moderating that driver of spending. But consumers continue to kind of engage with the economy here, and so we’ve had those headwinds.

But we’ve managed through it and I think looking forward, those tariff rates have now plateaued at a high level for a couple of months. So that trade policy has started to settle down and as we’re looking out over the year ahead, we’re still viewing trade policy as a headwind, but it’s a fading headwind for the outlook that we’re estimated to be at around a half a percentage point to growth at its peak around, call it May of 2025, when there was the big threats against.

China, for example, that tariff drag onto growth was closer to a percentage point. So still a headwind, but a fading headwind onto the outlook is sort of our take here.

Jack: And how about immigration? That’s one I kind of missed coming into the year. I didn’t really think through it that much. But if you think about it as a labor supply, as a function of what’s going on with immigration, then you could argue that’s a headwind as well as we had into 2026.

So how are you thinking about that?

Paul: Yeah, in the simplest form, economists often decompose growth into how many people you have and how productive those people are. And so I think naturally through that lens, when you have a world of immigration restrictions, meaning some detentions, some deportations of individuals out of the United States, a reduction in immigration inflows through visa restrictions, that’s been.

A drag onto the working age population growth for the United States. And so it is a headwind we think a manageable one. We’re, we’re calculating it to be around three tenths of a headwind to growth, but it is there sort of top of mind causing some disruptions onto both aggregate demand, but also some pretty specific disruptions into the labor market recently as well.

Jack: The third one you had is uncertainty. And it is funny, like if I look back at myself throughout the podcast, I’ve probably found myself saying we have an above average level of uncertainty, pretty much like all the time. Like I, I, so clearly I have to be wrong about that because we can’t always have that.

But I do kind of feel like we have an above average level of uncertainty right now. So how do you think about that, that when you carry it to an economic outlook though, the impact of uncertainty on the economy?

Paul: Yeah. The Federal Reserve Bank of New York actually had a. Academic debate on this topic recently, they, it was really around this idea of trade policy uncertainty, how consequential it is, is it still high or not?

And so there’s a lot going on. I would say this theme of uncertainty was pretty extreme. Back in April and May of 2025, we had radical policy change, the biggest increase in tariffs since the 1930s. I think it was pretty natural to expect, and we see some evidence for it that. Consumers and businesses held off on important decisions for a couple of months due to all of that uncertainty and policy change.

But because the economy’s been resilient, it seems like that picture is starting to change. Trade policy has settled down a little bit. The administration has pushed towards. Some deals. If you look at alternative measures of policy uncertainty or uncertainty in financial markets, like the vix, the volatility index, that’s back down to pretty normal levels.

There’s a similar measure in credit markets called the excess bond premium that’s at historically low levels. And it, if I put myself in the shoes of a sort of corporate CEO in a world in which my bottom line’s pretty strong. My stock price might be at an all time high here right now. I think that stability likely offers some confidence that maybe we’ve kind of progressed through the worst of this, and that that headwind, if you will, onto important decision making might be alleviating going forward.

So we still have it as a headwind, but it’s now really quite small and really even questionable if it’s really operable still at this stage.

Jack: So I think we’re, we’re moving to the ones that are moving in the positive direction now. And yeah, one of them, and this is an interesting one because people define this in many different ways, but one of the things I think all of us are seeing now is financial conditions are maybe moving in a more positive direction.

So how do you think about defining financial conditions and then what do you think about them going forward?

Paul: Yeah, so financial conditions in my mind are a blend of different asset prices that matter for household net worth. How people make decisions. So within that composite, we’re looking at things like equity prices, we’re looking at home prices.

We’re also looking at asset prices that matter for corporate decision making. So credit spreads are an important determinant of financing costs for the corporate sector, mortgage rates in terms of the real estate market. And when you kind of build all of them up into a composite, I guess what we’re seeing right now is markets have gone.

Almost in a straight line up and to the right from those lows in April of 2025. It’s been a really v-shaped recovery. Equity prices are close to all time highs. Home prices, obviously it’s a, a local, local by local market in terms of some regions being weaker, others being stronger, but at the national level, home prices are still close to all time highs and so.

Through this financial conditions lens. It’s a pretty supportive picture here where household net worth is near record levels, and I’d say particularly for higher income households that are most exposed to these very large gains that we’ve seen in equity markets here over the last couple of months.

That’s very likely to be as a tailwind on consumer spending. And we’re seeing that in some of the really detailed bank data on credit card spending, that the higher, higher income consumers really holding up here and helping to, to support consumption growth.

Jack: And how about fiscal? You have, fiscal is another up arrow here.

Obviously we’re not seeing the kind of fiscal policy we saw back in 2020, but we still are seeing a supportive fiscal policy here. So what are you seeing there?

Paul: So that’s all about the, the one big beautiful Bill act that was passed in July of 2025. And I think there’s two tailwinds that are coming out of that stimulus.

The first is for households where. Through the changes to provisions and taxes on tips through changes to the salt cap houses, likely to have a bigger rebate check in April of 2026. And that always can provide a little bit of a support for consumption growth at least our expectation here of the next couple of quarters.

And I’d, I’d argue even more important than the household piece is a number of the provisions in that act for corporates where there’s favorable expensing provisions for corporates to engage in more investment in equipment manufacturing structures. RD allowing kind of immediate expensing of those items, freeing up corporate free cash flow.

And we see that helping to support CapEx into the new year. And so coupled together that sort of fiscal package, if you will we estimate is worth a tailwind of around three tenths of a percent onto growth through the year ahead which is important, positive. Yeah.

Jack: And then the last one is one that I think people were most optimistic about with the Trump administration, which is this idea of deregulation.

And I think we are seeing some of that. So you see that as a, as a tailwind going forward, right?

Paul: Yeah. I mean, this has been one of the most ambitious deregulation agendas from a US administration since the eighties under Reagan. There, George Washington University has a database called Reg Stats where they try to count up all of the economic significant rules that each administration has put out.

The Trump administration has the lowest count since the eighties, so this has clearly been a priority for them, particularly in the energy and financial services space. Cleaning up red tape, making it easier for businesses to engage in the real economy and grow. I don’t think we got that much benefit from it in 2025 around that idea of uncertainty and just how much other change was happening at the same time that we actually had some frozen CapEx decisions, but.

If we’re right, that conditions settle down here and the broader economic picture is pretty healthy. I think that idea of deregulation as a tailwind could have sort of more teeth into 2026 and offer a little bit more onto growth here for the yeared.

Jack: One of the things I found when I was doing research for this is you’ve talked about the distinction between hard data and soft data and how you use it.

I forget where I saw it, but can you talk about that and, and how you view those two pieces of data when you’re analyzing the economy?

Paul: Yeah, I think. The starkest place this has showed up is for the US consumer. And so when economists are talking about hard data, we’re looking at actual measures of dollar or volume based consumer spending.

So the retail sales figures that get published, the personal consumption expenditures numbers that go into GDP, for example, that’s hard data, but that’s what consumers are actually doing. With their spend. Soft data is measures of consumer attitudes, consumer confidence, whether that’s University of Michigan survey or similar surveys.

And so normally you’d think those two lenses would rhyme in an economy. Consumers are feeling better, they spend more. Right now there’s a, a huge divide and what we’ve seen is pretty resilient, pretty steady consumption growth in the hard data, but abysmal. Soft data. So when consumers are responding to surveys and talking about how they feel, in some instances, those confidence figures are as bad as they were at the bottom of the global financial crisis when the unemployment rate was above 10%.

And so this has been a huge gap and a huge puzzle for economists to deal with my own sort of lived experience. And certainly what we’ve seen over the last three years is that fundamentals matter more than the soft data for. Actual consumer outcomes. And so we’ve been leaning positive into this uncertainty and puzzle because we’ve seen a pretty healthy labor market, at least up until recently, where wage income’s been positive because we’ve seen that record household wealth that we were talking about being a tailwind.

And so we leaned into that positive insight as opposed to the confidence numbers being very weak. And so, at least for now, the uncertainty has been resolving towards. The hard data and our expectations that can continue.

Jack: Do you think the soft data will come around? I mean, this, this kind of gets to the idea of the vibe session, which Kyla Scanlan coined that term that people have talked about.

Like, do you think the soft data is gonna come around here as, as the economy continues to grow and, and maybe the, the, that gap will, will narrow?

Paul: Yeah. I don’t know. As best as I can tell, there seems to be two drivers of the disconnect. One is we live in a world of hyperpolarized politics in the United States and half of the United States doesn’t like the US administration.

Half of the United States likes the administration, and so that’s creating some distortions to the numbers. The other effect is around inflation and not so much that. The inflation rate itself is as high as it was in 2022, but consumers just really don’t like high prices at the grocery store or wherever else.

And that seems to have been a meaningful drag here disrupting attitudes. And so as I look going forward partisan politics is just sort of a way of life here in the United States. I think the inflation picture over time. Is settling in. At least we’re not seeing the four to 5% inflation numbers anymore.

It seems like we’re settling into a new world, a little bit above 2%. So my hope is the soft numbers will gradually catch up in a healthy economy, but the divide is still very stark and has a long way to go. And

Jack: that may play a role in my next question, which is this idea that we’ve had many economists calling for a recession for a long time.

We had the yield curve invert. We might have had the som rule triggered but we haven’t had the recession. I’m just wondering if you have any thoughts on why that is. Why so many expected us to get a recession, but we didn’t actually get one.

Paul: Yeah. I’d say a couple of things. First economists are really bad at forecasting recessions.

They’re, they’re almost impossible to forecast. And so I think the community as a whole needs a little bit of a hubris, if you will, around our ability to, to make these calls. In terms of where things have really broken down. You mentioned one of them. So under this. General view that these things are hard to forecast.

One of the indicators that has been most useful in the past that’s had the most forecasting power was the shape of the yield curve. This idea that yield curve inversions for the last six decades have always preceded economic recessions. A lot of economists leaned on that. That insight failed in 2022 and 2023, where the economy held up into very aggressive fed hikes and restrictive.

Monetary policy. I think the third issue that stands out to me more for 2025 was in real time in April we were confronted with really dramatic policy change. And I think what some forecasters did was to take those announced tariff rates, literally run them through their trade models, get an estimated drag on growth.

Looking at the market being down almost 20% and saying, this is really bad. And I think it was fair to say there were some real risks during that period, but there was also the potential for a lot of policy dynamism. So if I think back to the conversations we were having kind of t plus one after Liberation Day at Russell Investments, not only were we talking about those big tariff rates and potential drags, but we’re already looking at a number of important trading partners.

Offering to take their tariff rates down to zero. Seeing the potential that the administration could move towards taking some deals. And that opportunity for policy dynamism we thought was important to think about in terms of the balance of risks and scenario probabilities. And I think maybe some economists were looking down instead of looking up and thinking about that possibility for the economy and policy itself to be dynamic, which it always tends to be.

Jack: And to defend the economists a little bit. To your point, this is a really hard thing to figure out. Like if you think about when tariffs came on, first of all, we haven’t had tariffs in forever. Yeah. Second of all, we don’t even know what the tariffs are gonna be because the policy’s changing on a day-to-day basis.

So for anyone to try to project the impact on the economy going forward was effectively an impossible task.

I wanna ask you about recession risk going forward. So it seems like with your, your take on a re reaccelerating outlook, you don’t think there is much recession risk, and we’ve obviously just talked about the idea that it’s very hard to forecast a recession, but how do you think about that going forward?

I mean, do you see the potential, like for a recession if, if you had to put it in percentage terms, do you think it’s a very small percentage?

Paul: So if, if you didn’t know anything about current economic conditions and just looked at how often recessions have occurred over history, you get a number like 15%.

So a lot of economists use that as their benchmark to think about if recession risks are higher or lower than normal. We’re relatively upbeat for the year ahead, but still see some downside risk. So our recession risk es estimate for 2026 is 25%, so a little bit higher than normal. When I look at the consensus of other forecasters, their odds are closer to one in three.

So I’d say we’re a little bit more upbeat than the rest of the market, but still seeing some risk. And one of the key risks that stands out to me right now is what’s happening to the, the labor market. And while I’m glass half full on the prospects here, I think there’s no doubt that hiring has slowed to unusually weak levels.

And if that continues and extends into 2026, that could put more pressure on the consumer over time. And so I think that’s really one of the key watch points for me is if we start to get a stabilization or an inflection up in labor demand that will be a really important positive. If we don’t, then those, those bear cases start to get a little bit more tangible and real here for next year.

Jack: It would seem like the labor market’s one of the toughest things to analyze right now, because going back to what we talked about earlier, we’ve got this whole immigration thing playing into this, but then we’ve also got like the cyclical factors impacting the labor market. It seems like tho those things together make it a very challenging time to analyze what’s going on.

Paul: Yeah, it’s really hard and that’s been a, a focus for us in our, our work here over the last couple of months. As best as we can estimate these things. It looks like those immigration restrictions. And the step down in government hiring have driven about 85% of that slowdown in job growth, which is interesting and it’s a bit of a double-edged sword in terms of thinking about the outlook.

Those policies in terms of immigration in a smaller Washington DC are very likely to remain in place for 2026 and could leave hiring at pretty subdued levels. I think the positive story that I would argue is more important for financial markets is if that’s right, it’s not really the private sector coming under distress that’s driving this market slow down In hiring.

It’s more of a policy choice. And if you kind of go back through the history of past business cycles, usually the, the normal arc of a slowdown into recession is driven by fundamental deterioration from the private sector where they’re seeing shortfalls. In aggregate demand, they’re seeing pressure on their bottom lines and they start cutting back on hiring and ultimately laying off their workers.

That doesn’t seem to me like the mechanism that’s in place right now, and that gives me some confidence that the outlook can hold and potentially build here into 2026.

Jack: Just a couple more on the economy. You mentioned inflation earlier and, and inflation seems like an interest. It’s an interesting place right now because it is above the Fed’s target and you have two camps here.

You have some people who say that that’s a concern, we’ve gotta get it down. Well, as other people say it’s pretty stable where it is. It doesn’t seem to be having too much of a negative impact, so the Fed doesn’t have to be too worried about it. Like, how do you think about that?

Paul: Yeah. Inflation’s been a big issue since 2022.

When I look at the drivers of inflation today. We are getting some higher goods prices through tariffs. Our belief is that’s likely to be a one-off driver and poised to fade here in the second quarter and through the remainder of 2026. There’s the shelter piece to inflation, the housing market that seems to be gradually cooling off.

And so your, your tariff drivers for inflation should be moderating. Your shelter drivers of inflation should be moderating. And then there’s everything else that, everything else is almost half of the inflation basket and tends to be driven by more cyclical dynamics. And I, I’d say that’s where we have a little bit more concern into 2026, that in a world where the starting point for the economy’s pretty healthy, we still have an unemployment rate in the fours.

If growth starts to re-accelerate, that could over time start to put a bit more pressure onto capacity again put a bit more pressure onto labor markets again, and start to kind of set the stage for more inflation pressure towards the end of 2026 and into 2027. More of that standard sort of cyclical driver of price inflation.

So we see those risks building over, call it the next one to two years. But right now the labor market’s still pretty soft given some of those policy changes that are keeping hiring very subdued in the short term.

Jack: So you think the Fed’s right? I mean, it seems like the Fed is maybe a little bit more focused on the labor market right now than they’re focused on inflation.

Do you think they’re right to do that, at least for now?

Paul: Yeah. The, the Federal Reserve tends to focus more on the labor market because if they get that wrong and the labor market rolls over, then they end up missing on both sides of their mandate at the same time. Because they have a, a full employment mandate.

If unemployment spikes, obviously that’s a miss. And during an economic recession that damage to the labor market, that damage to aggregate demand tends to solve any other inflation problem that you might have in an economy. So whenever there’s labor market risk the Federal Reserve in particular and most central banks do the same, tend to really prioritize those.

And so I think it was a pretty. Clear and easy case for the Fed to deliver. The three rate cuts that we got towards the end of 2025. Their policy was probably a little bit restrictive. Hiring had slowed quite a bit. They wanted to get rates back down to more normal levels. From here though, now that policy is towards more normal levels is, I think it’s gonna take a much higher bar for.

Actual labor market weakness rising unemployment to kind of get them to keep going into 2026. And given our outlook is for stronger growth, not weaker growth I think it’s quite likely that we’re right on the cusp of a protracted fed pause here where we may have even already seen the last rate cut for the Federal Reserve in this cycle.

Jack: So your, your third theme in the report is one a lot of us have been waiting for, for a long time, which is the, for the rally to broaden beyond the Mag seven. And you talked about how you think maybe this might be the year that starts to happen. So can you talk about why that is?

Paul: Yeah. That theme’s really around this idea of broadening fundamentals, supporting broadening returns.

And so for most of 2023 and 2024. a lot of the activity and a lot of the earnings growth in particular was driven by those magnificent seven hyperscale or superstar US technology companies. I’d say we’re seeing that start to change already, and our expectation is, that’s likely to continue to change where fundamentals are broadening and becoming more positive at sort of an economy wide.

And a couple of data points. For me on that regard. For small cap, for example, they went through an earnings recession in 2022 and 2023 through the third quarter of 2025, they actually moved back to plus 30% earnings growth. That’s off of a weak base, but they’re back. In positive territory again, which I think is really encouraging.

We’re stabilization and an improvement in their board earnings estimates too. So I think some green shoots there for small cap and the same things coming through globally. It’s not just a US story, but across international markets. Now too, the emerging markets are seeing earnings upgrades. Europe is seeing.

Earnings upgrades. And so I think that fundamental delivery, if it can continue is a really nice catalyst to potentially have returns start to broaden out into 2026.

Jack: And this probably relates back to the AI theme as well, ‘cause to the extent the AI benefits can carry across the economy that should also help from a broadening perspective.

Paul: Yeah, exactly. That’s, that’s one of several drivers that we’re seeing. I think this idea that the benefits of AI are spreading from builders to users. S supports this idea of sort of more diffuse profitability across the corporate landscape. Interest rates are still high-ish, but they’ve come down from peak levels in 2022.

And so for a lot of smaller businesses, that’s quite important in terms of their financing costs that are more consequential than they are for larger corporates. So there’s a couple of things happening here, but we see that kind of constellation as supporting a broadening of. Profits and particularly into what’s been a pretty lopsided market for a number of years, and pretty lopsided valuations stronger fundamentals and broadening fundamentals, we think can support broadening returns as well.

Justin: One of the charts you have in this report is the equity market contrarian indicator, and it really is amazing to see how much and how emotional investors can be over time and rightfully so at different. Sort of points in the market when different things are really worrisome. But I’m just wondering like, I, I mean, to talk to that idea, which is the importance of sort of behavioral finance and understanding that investors oftentimes are very emotional, especially when there’s times of.

Economic weakness or market weakness or what have you. And then what, what sort of, I guess the takeaway would be in looking at a chart like this and then maybe where we stand today based on these sentiment levels.

Paul: Yeah. I, I think number one what we do see is evidence that there are bouts of extreme changes in investor psychology.

The, the chart captures. It is a composite of almost a dozen different indicators, but collectively it tries to measure that mood of the market on a real time basis. And when the line’s high, that’s evidence of a panic. When the line’s low, that’s when we’re kind of pushing towards euphoria, and you can see a lot of those big vertical spikes on the page During past periods of market stress and crisis, the global financial crisis, the Eurozone debt crisis.

We had COVID the tariffs more recently in April. Investors had real things to be worried about at those moments in time. A lot of headline risk. But those moments were some of the best opportunities to be invested in the market. And so this insight’s really important for us twofold. Both it, it helps to convey a, a stay invested message, which is just a really critical philosophy during.

Periods of market volatility. And it’s also really useful for me as an investment strategist because when I’m looking at those fundamental risks and thinking about downside risks to the business cycle, when I have this sentiment lens saying, Hey, everybody else is worried right now too, that’s a really important.

Ballast against those behavioral risks that I might be facing as a professional investor and can kind of keep me more grounded in thinking objectively about the return opportunity set. And I’d say particularly in April of this year, this was a really powerful tool for us as we were kind of engaging with the balance of risks and thinking about portfolio strategy going forward.

Justin: Walk us through how a firm like Russell Investments takes this idea, these ideas. This conviction you have about certain things and sort of changes. It’s the way that maybe some of the allocations are. Structured or portfolio strategy. Like I could, I think I could articulate back to you like probably you’re, what you’re saying is like equal, I’m just this general equal weight, the s and p 500 and be upping your international exposure a little bit and thinking of a re-acceleration here and not being too conservative with your equity exposure.

So, but help us kind of connect the dots between sort of. All of this great research and how it actually translates into how portfolios and investment strategies are being built and managed.

Paul: Yeah. To use one sort of past experience around the sentiment insight in April of 2025, when we’re seeing all of this panic, you can imagine a lot of war room conversations within our investment division trying to kick the tires on the outlook.

How we want to reposition into extreme market volatility. Leaning into this inside of panic, we, we took the opportunity of April to rebalance a lot of our portfolio strategies add back into areas of the market that had sold off pretty aggressively, whether that be equities or high yield credit.

And so this insight helped us in our portfolio strategies in real time as I’m thinking about this point here. At the turn into 2026, our economic outlook is pretty upbeat that supports a stay invested posture we think is being appropriate in portfolios. And then critically, that idea of AI benefits broadening broadening fundamentals globally, we think argues and strengthens the case for global diversification in portfolios where a lot of markets, whether it be small cap within the US.

International equities whether it be emerging markets or Europe a lot of those areas are trading at cheaper relative valuations and into a world where their fundamentals are starting to catch up in a positive way to the US mega caps, we see that as supporting those sort of global diversified exposures and, and leaning into those areas of opportunity in a measured way in our strategies.

Justin: And how are you thinking? That’s great, thank you. And how are you thinking about like alternatives and real assets? Like how did those sort of manifest themselves in, in the way that you would be advising portfolio construction here?

Paul: Yeah, so we, we always want exposure to both growth and resilience. And I think there’s a lot going on in the world right now that’s maybe a little bit different than decades past.

There was several decades in a row where. In the United States inflation was pretty dormant at 2%. Central banks, if anything, were struggling to get inflation up to 2%, and that was a world in which bonds were king as a diversifier because the only thing that was really moving the needle was upside and downside risk to growth.

And bonds are excellent at diversifying against growth shocks in portfolios, but the world shifting there’s new challenges to supply chains, it seems like we have. New geopolitical issues cropping up all the time, and those supply side factors have more of an inflation component to them and could contribute to more inflation volatility over the medium term.

And that creates the need for thinking more broadly about targeted ways to get more diversification into portfolios. Historically real assets whether that be infrastructure or real estate, have been nice compliments to traditional 60 40. Portfolio building more resilience and diversification to inflation risks.

So we see that as a, a core strategic allocation with particularly interesting opportunities in defense into this changing geopolitical environment. Also, a lot of energy demand and needs and some nice exposures that can be targeted within the infrastructure space to that. Trend.

And so real assets in our view are a really important compliment in addition to stocks and bonds for shaping a, a well-rounded portfolio for the environment that we see, not only for the year ahead, but for the next decade. Yeah,

Justin: we recently had James Grant who writes the grant interest Rate Observer, and it’s kind of sort of like a histor market historian, and he kind of was making the point that these interest rate regimes both up and down can last a lot longer than many people think.

So real assets could certainly play a much more important role in a period where interest rates are higher than we’ve used to over the last 40 years, up until a few years ago.

Paul: Yeah, the yield’s better for sure. I mean, there is a protracted period there where your nominal yield was below expected inflation, and that was, I think, a tough pill to swallow for a lot of investors.

But that’s changed. We’re looking in the US at treasury yields that are whisker above. 4% into expected inflation. That’s a little bit north of of two. And so at least you are now as an investor able to preserve your purchasing power in bonds. But we think it makes sense to look even a little bit more broader than that to build more resilience into portfolios for a range of different shocks that could face us over the next several years.

Justin: So we have two standard closing questions we’d like to ask you. The first one is, what’s the one thing you believe about investing that most of your peers would disagree with you with?

Paul: Yeah, I might bend the question a little bit. There’s this famous Warren Buffet quote that is good to be fearful when others are greedy and greedy when others are fearful.

I really like and agree with the idea of being greedy when others are fearful. We talked about this idea of Marcus moving into a panic and that creating a lot of opportunity for patient investors to be in the market. I think what’s a lot harder is to identify when everyone’s greedy and to time tops in markets.

That’s actually really dangerous. It’s harder to identify in real time and missing out on the updates in markets can be just as damaging if not more damaging than avoiding downturns. And I guess like one example I think back to many years ago is this famous Greenspan speech from December of 96. That’s when he introduced.

The idea of irrational exuberance for the first time. And he was eventually right, but the Nasdaq absolutely ripped for three or four more years before it ultimately hit its peak. And to kind of miss out on those really good returns as an investor can be again, just as damaging as being exposed to the, the drawdowns.

And so for us, we as a core really want to be invested through the market cycle. So I kind of push back a little bit on the be fearful when others are greedy point. It’s just really hard to get right.

Justin: Yeah, totally agree. And the last one here, and maybe it’s somewhat along the same lines, you would answer it the same way, I’m not sure, but based on your experience in the market markets, what’s the one lesson you would teach your average investor?

Paul: Yeah, I probably fell in love with markets as a teenager. My parents’ financial advisor recommended. I read Jeremy Siegel’s book Stocks for the Long Run. Which is an amazing book on the history of financial markets. But like the core point from that book, if you’ve read it, is just around the amazing compounding that you can get as an investor, getting your money to work for you for the long term.

And so I think that stay invested principle is philosophy number one helping to improve financial security for people and then where we can trying to add value. On top of that, exploiting sentiment overshoots. But really that, that compounding, the investing for the long term, the staying invested theme is probably principle number one for us.

Justin: Great. Thank you very much, Paul. We’ve enjoyed the conversation. Yep, my pleasure.