Is Imperialism Good for Your Portfolio?

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31:12We're back with Prof G Markets. fourth quarter earnings season kicks off later this week with all of the big banks reporting and we'll break down the results on next monday's episode but today we want to zoom out and focus on the broader shift reshaping the industry one of those shifts is deregulation the trump administration has made several moves to loosen banking rules that includes rolling back parts of dodd frank the post 2008 framework that was designed to limit risk taking and the result is it is a really good time to be a bank and we can just look back at the year 2025 the big bank stocks rose 30 percent over the course of the year uh that's nearly double the gain of the market at large the s &p so rob uh looking ahead to well let's i guess start with last year, which was the strongest year for banks since the pandemic.

32:10What do you make of what happened last year in the banking industry? And what can it tell us about the year ahead? A couple of stars aligned here in a really nice way. The first and most obvious one is that banks do as well as the economy that they're sitting in. And the American economy was pretty good. And that's where you have to start anytime you want to talk about banks. When the economy is strong, people borrow money, people pay back the money they borrowed from you before, all of that stuff. They deposit, they make deposits in your institution, etc. So that's good. Then you already hit the second important point, which is with the election of Donald Trump, the regulatory overhang lightened significantly.

32:56And, you know, the most important for the big banks aspect of this is there were all these rules that hadn't arrived yet, that they were kind of coming down the pike that were going to increase the capital requirements of the big banks even more than they already have been increased. They were, of course, massively increased and hardened after the financial crisis. This is to say how many dollars of actual equity capital you have to have for every dollar of loans or assets or whatever you have out there. So we were worried that what they call Basel III endgame was going to mean, you know, JP Morgan has to hold two more dollars in addition to the 11 or 13 dollars they already hold for every hundred dollars of assets.

33:40Looks less like that's going to happen. Acquisite, you know, mergers are getting easier. They're getting executed faster. for all this good stuff. So regulatory, right? Good. That is good. Now for the tricky part where listeners should either pay attention or just tune me out altogether. One or the other. Take your pick. Take your pick. So back when interest rates were really low, before 2022 and there was inflation and rates got higher, any asset a bank bought then has a really low yield on it. If you bought a mortgage or even a business loan or 20-year treasury, you bought it at a yield of just a couple of percent.

34:24When interest rates go up, the price of all those assets has to reprice to the new interest rate, which means the value of those assets goes down, right? So if you buy a mortgage bond with a yield of 2 % and rates go to 4%. The market value of that asset has to go down to make its yield 4 % too. Okay. The sound of your listeners going to sleep, I can hear it now. So this was a very bad occasion for certain banks. It hurt a lot of banks. This was at the root of what happened to Silicon Valley Bank last year, et cetera. But what's happening now is that assets that were purchased back when rates were really low are rolling off of banks' balance sheets.

35:12So you lose a loan you made in 2020, you replace it with a loan you're making in 2025, you're getting rid of something that yields 3 % and replacing it with something that yields 7%. And that was going on last year, and it's going to go on even more this year. So there's this natural lift under banks' income just as the old world stuff rolls off and you replace it with higher yielding new stuff. So that's, and final point, and now readers, listeners who tuned out can tune back in, for the very big banks, when you have very active capital markets, as we had last year, that's very good for your investment banking and your trading desk.

35:56So, I mean, if we were to look at what happened in 2025, all of those things that you describe leads to one of the strongest years we've ever seen for the banking industry. And by the way, just a side note, this is ironic because when Trump comes in, the whole message is the guys on Wall Street have won for too long and we're going to hand it back to Main Street. It's not about getting them rich. And what do you know? I mean, everyone on Wall Street is getting richer than basically ever before. Than ever before. I mean, let's look at just the big bank stocks and their performance over the year.

36:29I mean, I mentioned the banks index, but that includes all of the smaller banks. Let's look at the big, big banks. JP Morgan gained 34%. Citigroup gained more than 60%, 63 % over the year, which was kind of unbelievable. And for all of those reasons you describe, you have these regulatory conditions, which are better. You have more M &A, global M &A volume was up more than 40 % for the year, which means that your investment banking business is crushing it. Also, one thing that I would add there that you didn't mention is the volatility that we saw in the stock market, which is so good if you're a trader.

37:07I mean, just the more it goes up and down, which it did, the more trading activity happens and the more money you make from facilitating those trades. So trading revenue was up 15 % last year. So I think the question then is, you'd think that because we had such a big year in 2025, we're probably not going to have that kind of year again in 2026. But I'm not so sure because I don't see any of these conditions changing. And then I would add one other thing, which is it seems that the IPO market is going to explode. Explode might be a strong word, but it seems like it's going to really come online this year.

37:49If you've got SpaceX in the pipeline, potentially open AI, potentially anthropic, that would be a great thing for the banks too. These would be some of the largest IPOs of all time. So my preliminary thought is 2026 is going to be a great year to be a bank as well. But I want to see what you think. I think that's probably true. I mean, there will be more of this replacement of bad assets with good assets. That will still happen. I think that, as you say, there's every reason to think barring a crash or something awful, that the trading and investment banking business will be good. And I think as the economy is positioned right now, the economy seems pretty solid to me.

38:31So all the conditions are in place for good performance. But you have to remember, at the beginning of 25, bank stocks were cheap. They're not cheap anymore, right? And so the reason people were excited about owning banks is that the stocks look like bargains. They don't anymore. I've been hearing a lot of chatter in the space where people are like, is JP Morgan a good buy at this price? I mean, you can understand why Citibank went up 60 % because it's a troubled bank historically. And it went from being mediocre to being slightly less mediocre. And those kind of transitions is where you really make money in the stock market.

39:13Not from good to great. the big money is from like trouble to slightly less trouble you know but you don't do but you don't do that twice right you know uh and so it's going to be hard in terms of stock market performance it's going to be hard i think for the banks to repeat what they did last year but i think performance wise your central case has to be that they're going to be just fine yes okay i think that's a good good way to frame it the pressure on the stock will be the multiples yeah by the way one thing that i find quite interesting that tom lee um who who's the head of funstrat he says that he says that he thinks that bank stocks are going to eventually and in the near future receive tech like multiples because he thinks that there's all of this Oh, we don't.

40:08It's like, I'm just going to get on my hand with my broker and sell everything. When Tom Lee says that banks are going to trade like tech stocks, I think it's time to hit the door. You don't like it. You don't like it. Well, I just think they're banks. You know what I mean? His view is that there's so much power in AI. I mean, so much layoff potential, really, that these are extremely human capital intensive businesses. Yeah, that's fair. Which could open up new opportunities for multiples. I mean, if JP Morgan decides to AI charge its business, then suddenly you have a company that looks more, when you look at the business, looks more like a software company than, say, a bank with a bunch of physical branches.

40:53I got two things to say about that. One, yes, high fixed costs and human capital costs are part of the reason that bank stocks traditionally trade at something of a discount to the market. The other reason is that their earnings are very volatile because they're sensitive to the economy and to the stock market. And that's not going away in the AI world. That's not going anywhere. So that factor will keep multiples down. Two, this world in which AI gets a lot of people fired may be a world that will arrive at much more profitable companies in certain sectors. But it's going to be a hairy ride to get there.

41:31So like I was just looking the other day at this bank, Truist, which your listeners may or may not know of, but it's a very large regional bank that was built out of a merger of two quite big regional banks, BB &T and SunTrust five years ago. The stock's been a dog ever since the merger. And they did fire the people. They had something like 58 ,000 employees as two independent companies. And now they got 38 ,000. And they got more assets. So like mission accomplished on firing people, not by AI, but by doing a merger. Right. But you hear the war stories about what it was like getting from point A to point B, the culture clash, the people who leave because they're pissed off at everybody, the, the Sturm and Drang, right.

42:21You know, you, if you, if the thesis is banks are going to fire a third of their people, Like, is it going to be fun to be at those banks while that's happening? And if the people inside the institution are like afraid for their lives, do you really want to own it while that is happening? Yeah, that's a great point. It's all a lot easier said than done. I mean, we may get there. It'll take some time. It'll take some time and some pain. Yes. This is a nice transition to something that you've been talking a lot about in your newsletter, which I want to get your thoughts on. You've been saying that, I mean, just for some context, we usually say on this podcast that consolidation is kind of a bad thing.

43:10because it generally involves a monopolistic entity going in and buying up all of the smaller players, which reduces competition. It leads to potentially price gouging. We generally are not huge fans of when a big bank goes and buys or a big company goes and buys another small company. Your view that you've been talking about, and I want to hear more about it, is that consolidation in the banking industry would actually be a good thing. Why do you say that? I think it would be pro-competitive. I think that what you look at, I don't know what, I should actually figure out this number, but what percentage of the profits in the banking industry are made by JP Morgan?

43:52And then if you put JP Morgan, Bank of America, Wells Fargo, Citigroup, and US Bank together, they're just squeezing most of the profits out of the industry And there's your oligopoly. Right. Right. You know what I mean? And the fact that there is 1 ,970 other banks in America that are squeezing out tiny little drops of profit doing local banking doesn't mean the industry is really properly competitive. And from an investor point of view, the small, you know, the regional banking industry has been a terrible place to invest. And so I think consolidation of that issue would be good for investors.

44:40I think it would be pro-competitive for the industry. The problem is the more I read about it and the more bankers I talk to, integrating a bank merger is a nightmare. Why? Why is it a nightmare as opposed to anything else? Okay, so one reason is because it's such a human capital industry. So the first thing that happens when BB &T and SunTrust get together is that everybody at the competing banks calls up the best banker at the merging banks and is like, you really want to put up with three years of bullshit while these guys screw around changing their name and re-upping? Why don't you come work for me instead?

45:20And that bank, that banker, maybe it's a commercial banker who makes loans to banks or it's somebody, a trader, whatever, you know, they just walk out and they take a lot of their clients with them. Right. That, you know, the, you know, as people used to say about Goldman Sachs, our assets go up and down in the elevators every day. And to a certain degree, that is true of, of all banks, you know, even like a traditional, like branch banking bank. and you go through the disruption of a merger, all of that is at risk, you know? So that's a big problem. Also regulation in banking is so much stricter than every other industry.

46:00So you got the regulators on the top, less so now under Trump, but you have the regulators on the back while you're on your back, while you're trying to do it. Uh, that's another issue. And, you know, culture is really important in banking, you know, vibes, you know, it's, it's a, it's a people business again. So you mess with that corporate culture and you got an issue. So it's just really hard to do. Not say it won't happen. I just like the more I talk to bankers about this process of consolidation, the harder it looks to me from the outside. Something you also mentioned in a previous conversation is that if you're the head of a regional bank, you're the man of your town, which is a really important point.

46:42And you don't want to give that up. No, you're like, you're the, you're the national bank of wherever, like, you know, whatever it is, you're, you're the head of name, the town you want, you know what I mean? Middletown, wherever. And you're ahead of the national, like a Middletown. You were the man at the country club. You're the head of the rotary, you know, everybody loves you. And you got this great job in this great life. And like, basically the deal, if you sell your bank, you're no longer the man anymore. and you're looking down at all the people who work for you and say, you say, look, it's been great.

47:17We just got bought out at a premium valuation. It's great for the shareholders. A third of you are going to get fired. Goodbye. Yes, exactly. Which is another example I would, I would add of people don't think in terms of economics or we are not what there are moments where there are things outside of economics that are outside of money that trump money. And it happens in a lot of situations. This would be one of them. I'm the head of the Rotary Club and I'm the CEO of the regional bank here. Yes, technically speaking, this would be a better deal, but I don't want to give up these things that I enjoy in my life.

47:55And, you know, I don't want to hurt the people around me. And, you know, the opposite mal-incentive also applies. So they don't have, if you're the head of a small regional bank, your CEO, you have a strong incentive not to sell. If you're the buying bank, you have a strong incentive to overpay. Barclays, the investment bank, did a great chart of this. There's an incredibly strong correlation between bank size in terms of assets and banker CEO pay. So if you run a bigger bank, you just get paid more money. So whether it's good or bad for the shareholders, you do an acquisition, maybe you overpay, it destroys value, whatever.

48:39You double the assets you're managing as a banker, you can double your income. So you have the, there's a conflict of interest between the CEO and the investor. And you, and like, you don't want to, you just don't want to be that involved in an industry where management and investors have different interests. Yes, exactly. And it's the same thing that we see in, say, venture capital, where, I mean, the whole industry seems to be getting overrun by the management fee. And that is, you're not making money on the 20, you're making money on the two. And that basically incentivizes companies and firms to just buy up as much stuff as humanly possible.

49:21Same thing is true in fund management. And that's why all funds tend to look the same. the important the thing that's going to make you retire rich is retaining you know hopefully growing but like retaining assets and earning that two percent yeah you don't even need to invest well you just need to invest lots yeah yeah you just so so you you have a strong incentive like not to screw it up then you have to like really you know go for it you know it's it's a huge issue we'll be right back and for even more markets content sign up for our newsletter at ProfitMarkets.com slash subscribe.

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52:34We're back with Prof G Markets. So Rob, you are one of our first guests of the year. So we want to get your take on what is in store for 2026. so we are going to go through some of the predictions that you shared in your unhedged newsletter and i'm just gonna ask you questions and hear more about what you think is gonna happen can i just say something as a by way of press this like i don't think these predictions i don't think my predictive powers are particularly strong right you know there's this guy dan davies who's a writer and he says the reason to make predictions is that otherwise you don't know what to be surprised about.

53:13Do you know what I mean? Like when events happen, the natural tendency is always to be like, oh yeah, I saw that coming. You know what I mean? And once you go on Ed's podcast and you say it out loud in front of everybody, at least people will call you up and tell you what an idiot you are when it turns out to be wrong. You know what I mean? That's literally the main reason to do predictions is to discipline. Yes, exactly. So it's not because I have some crystal ball because I think about markets all day. Nobody does, right? But it's an accountability machine in some way. 100%. And also an important way to catalyze the conversation and frame what we should be thinking about and watching for as the year continues.

53:57I'll just say our listeners are very familiar with this because Scott makes many predictions. In fact, he makes a prediction every single week. Some of them are right, some of them are wrong. We try to keep track, but let's get into it. And let's start with this first question, which is, are we in a bubble and will the bubble burst? And you say, yes, we are in a bubble, but no, it won't in 2026. Well, that's just numbers, right? I mean, this, as I said on my own show this morning, in finance, either you believe in valuations or you don't. I believe in them. We are in the top, not even decile, but what's after decile, like a hundredth or the 95th percentile.

54:43We're in the 95th percentile, the 97th percentile of how expensive risk assets are related to history. And always before in history, that predicts low returns over the long term, over the next 10 years or so. As you might think, pay a lot for something, right here. The profits aren't going to be as high. And in history, those low profits over the long term, over the next 10 years, don't come with a slow deflation. They come with a big step down. So history says, primarily for this reason, but also for others, we are in a bubble now. But the problem is that long term, you know, do we have that big step down in 2026 or 2031 or one year in between.

55:33I have no idea. And while I'm waiting around for it to happen, I'm giving up returns. So if it happens three years from now, and I've been sitting on the sideline not owning stocks, what have I achieved? So this is just probability. The probability is we won't have a pop this year because most years we don't.

55:56It's that dumb, right? Is that really your reasoning? Because most years we don't? Most years we don't, you know, even at these levels of high valuation, these things can go on for quite a long time. And I would add on top of that, the general setup is pretty benign right now. The economy is strong. We can talk about the somewhat wobbly labor market, which is a red flag, but in terms of growth and spending and activity and a lot, by a lot of measures, things are good and perhaps even getting better. We might have Fed cuts coming. We definitely have massive fiscal stimulus coming.

56:38It's an environment that is quite benign, which means there's less possible triggers for the deflation of the asset bubble that we're in right now. I would completely agree. I guess the way I have been thinking about it is, I mean, if you believe that there is a bubble and you're trying to think about how to invest or how to bet on whether or not it pops, the idea of betting on it popping in a year where we are about to see this flood of fiscal spending that is going to prop up the market, where we are seeing interest rates coming down, it's just a bad bet when you look at the reality of what else is happening.

57:25Look, there's midterms coming, baby. You can't believe that Scott Besson and Donald Trump are going to throw the kitchen sink at this economy. And 2027 be damned, they're going to do everything they can for 2026. 100%, which is why my view on 2026, and we said it on a previous episode, I just think returns are going to be kind of eh. Like it's going to be, you have all of these downward forces, which are related to what you're saying, that valuations are too high. You also have all of these expectations around AI. And I don't think that people really understand where the ROI is going to be and what the ROI is going to be.

58:10I think it will likely disappoint people as it has done throughout history. The one good thing that I would note is that we're not seeing huge amounts of leverage and huge amounts of debt. Very good point. These companies are spending, you know, they're spending on data centers with money that they have for the most part. There are a few outliers. They might get crushed. But would that pop the entire thing? Would that cause a real correction, a real crash, especially when you've got those forces propping things back up? I think no, and then it all kind of goes in sort of a semi-flat line. I mean, one thing that is interesting about where we are now, as opposed to in 2008, say, is that—and this is the kind of sentence that gets you in trouble, but I'm going to say it anyway—most or all of the leverage seems to be in the government.

58:59In 2008, there was leverage in households and also in companies. And since then, households and companies have cleaned up their balance sheet with the assistance from governments, which have this infinite appetite for debt. That's such a good point. So that doesn't sound like a very good sustainable solution and way to live your life as a world to me, but it might make, at least in the short term, a crash less likely because the crashes we know, in developed countries at least, they tend to happen. and they started with households panicking or private institutions. And somebody will write in and find an exception to me.

59:38But most of the debt is in the government and they've got a printing press, which leads to the next important point, the big spoiler. The thing I'm worried about most is inflation, right? When you have all this debt in the public realm and you're forcing all this stimulus into the economy fiscally and you're cutting rates and the economy is doing pretty well, and you've reduced the labor supply by throwing all the immigrants out. I can't predict inflation. You know, I don't even, I don't understand that. But like, if there is inflation, all the nice things I just said are not true, right? You know, inflation goes up, the 10-year yield goes to 5.5%.

1:00:22You know, it's a different game. Yeah, you said that I was, that was on my list here. the biggest risk in 2026 will be inflation. What do you make, just a quick side note, what do you make of the inflation report that we saw recently where it came down to 2.7, which shocked me and then I learned, I mean, I guess I'm sort of answering, but - Give me your take first. Let me just ask you, what did you make of it? No, that's fair. You know it as well as I do. Well, I guess I don't believe it or I didn't believe it at first I always hate being the guy who says, I don't believe the numbers. But then we talked with Mark Zandi, and he basically took us through all the reasons why the data was completely flawed.

1:01:08And so in reality, we're actually still at 3 % based on the analysis that they did. Yeah, I mean, it looks to me, and again, the data is flawed, and we have this gap. And it's surprising. We have this gap from the government's shutdown. And it's surprising how that affects the data in months. Like all this stuff is kind of path dependent and all this stuff. But, you know, what it looks like is we're still above target. Goods is maybe getting a little bit better. Services outside of housing is not. That was kind of my takeaway. And that's the bit that's like dependent on wages and et cetera, et cetera.

1:01:44So I think it's hard to say. You can't say we're at target. but I think it's hard to look at all the numbers all in and say things aren't getting a little bit better. Right. That's why I say I'm not predicting anything. I'm not saying I'm not that's that I'm not saying that I think inflation is going to happen for whatever, what it's this X, Y, or Z probability event. What I'm saying is it's the worst thing that could happen now. Within the realm of probability. All the things that are good going into next year depend on inflation staying under control. Right? And so if something should happen in that area, you know, we got to reconsider all of our assumptions.

1:02:31For all of the reasons that we're outlining here, I don't see it improving. That's really why I saw the 2.7%. I'm like, bullshit. No way. and i was very relieved to see the analysis which said i'm right okay well i'll give you i'll give you two reasons you know you you can take these or leave but these are two things why it might improve uh the first reason is we lap at some point this spring we lap the uh april tariffs so like you know that if that turns out to be a one-timer right we lap that and so that falls out of the goods numbers. Yes, that would be huge. If that happens, yes, fair enough.

1:03:15And on the kind of services side, we do have a bit of a mushy labor market, which tells you maybe wages, wage growth won't be that strong this year. And, you know, although a lot of things surprise me, surprise you, people do teach you back in school that inflation and wage growth are very intimately linked. And it's hard to get hot inflation when wages aren't going up. So I'm not sure I buy those arguments either, but I guess those would be the standard ones that the inflation doves would roll out right now. Definitely. Most of, I mean, the basis of my belief is really tied to tariffs. And who knows what's going to happen with tariffs at this point, especially we've got the Supreme Court ruling in the pipeline.

1:03:57So, you know, this is going to be an ongoing conversation. But in a tariff world, I'm like, it only goes up. I do want to keep us moving because you have more predictions um will ai euphoria cool you say yes kind of linked to the bubble but let's just get a quick why because it's already happening i love these predictions uh nvidia has been going sideways the stock's been going sideways for four months uh meta is struggling oracle is struggling there is a sense visible in market prices that the market is becoming more cautious about this narrative. And of course, the dream scenario, what we should be all happening, is that we have kind of incremental caution rather than a moment of freakout, that this kind of just cools down.

1:04:49And, you know, look, as somebody, as a really smart investor, Patrick Kayser at Brandywine Global put it to me this week, he was talking about the moment you're worried about is not that revenue that like AI data center spending just suddenly stops in the middle of 2026. That's not gonna happen. The cranes are already there. The purchases are made. The cement is rolling. The moment you're waiting for is some moment in 2026 when people look out to 2027 or 2028 and they can see the end of the runway out there. Right now, the road just goes on forever, right? But the moment we're waiting for, Because the market discounts forward.

1:05:33The market doesn't care what's happening today, right? So at some point, the worry is that you see the end of the runway sometime in 2026. And I just feel like, I don't know, my guess is no. It's not a high probability prediction, but I am reassured by the fact that the market is already exercising a little bit of discipline. It is interesting, the discipline that we're seeing in the markets. And I think one of my predictions for AI is that the winners in AI are going to be the ones that can signal a level of responsibility. I mean, if you look back at the previous couple of years in AI, you were rewarded for being unrealistic.

1:06:17You were rewarded for saying, we have this gigantic idea. It's going to be artificial general intelligence. We're going to take over the world. And then people gave you money for saying that. I think that it's beginning to flip now, where if you start talking with that sort of technobabble language, you begin to get punished. And it's the companies that are signaling the level of responsibility. And usually signaling that means you are actually being responsible. And so a company that I think would be rewarded, as an example, would be Anthropic this year versus OpenAI. Okay. So this is a question I would put to you that I was thinking about earlier today.

1:06:52So let's suppose, and I have no, I should emphasize at the outset, I have no grounds for thinking this is going to happen whatsoever. Let's suppose the wheels properly come off OpenAI this year, right? Like they try to raise some money and they can't. Or like the revenue stops growing and they have some horrible conference call. They try to sell the thing. You know, pick your scenario. Wheels come off badly at OpenAI. How big an event is that for the market at large? I think it's gigantic, personally. I mean, the amount of money—the good news is that the market is beginning to sort of understand that possibility.

1:07:33So that$1.5 trillion that they said they were going to spend, over time—I mean, immediately you look at Oracle, and the market says, it's real, it's great. And you see Oracle's shoot-up, it goes crazy. Eventually, they started to discount that$1.5 trillion because they realized it's less realistic than we thought. But on top of that, I think that open AI has become such a symbol of the AI story. I mean, the gains, the biggest moment in the past five years is the launch of ChatGPT. And that was the seminal moment where we kind of have to measure what has happened since then. And since then, 75 % of the gains in the stock market have been AI.

1:08:14It's all AI related. So I think because of the power of that story, if you have a blow up similar to what we saw with FTX, I think it might be another good example. That was sort of what anchored the whole crypto story. If that just comes off the rails, I think that really shakes people's confidence. Yeah, no, I don't know what to think about it. That's why I asked you, is because I don't know what to think about that. I can imagine a scenario where the world's like, look, Google's still Google. Microsoft is still Microsoft. NVIDIA probably takes a monstrous hit that day. And eventually, I think that would happen.

1:08:47I think you see the crash and then eventually people would realize, actually, this doesn't mean it's over. Yeah, yeah. It's just that this is a project that failed and on to the next path. Yeah, yeah, yeah. Exactly. Moving on. Interesting prediction here. Will U.S. stocks trail the rest of the developed world? You say, no, they won't, which is the reason that's kind of relevant is because last year, the S &P rose 16 percent and then the rest of the world ripped higher than that. So you say that's not going to happen. And by the way, to further congratulate the rest of the world, they ripped higher in their local currencies.

1:09:29They didn't even need the weak dollar to beat the US. A couple, I mean, earnings growth is just like comparing to Europe and Japan. I'll restrict the discussion to Europe and Japan just for simplicity's sake. Our economic growth is stronger and our earnings growth is stronger. And at the beginning of last year, it's a bit like the banks. the lower earnings growth and the lower economic growth was very much priced in to European and Japanese indices. Now they have a higher hurdle to jump. And so I just feel like they had a great year next year. I'm a kind of politics aside, American exceptionalism believer, meaning I think there is a reason that U.S.

1:10:16markets get a premium that makes perfect sense. And we're now into the normal range for that premium, better earnings growth, better economic growth. Okay, I think that makes sense. We also have here, you say that cyclical high volatility stocks will outperform defensive low volatility stocks. Why do you say that? And then also, what are cyclical stocks? So cyclical stocks, we talked about banks, which I think are good. These are just stocks that are very tightly, they respond very much to the underlying economic growth. So like a classic example would be a construction company. You know, if the economy is shrinking, put the cranes away, nobody's calling.

1:10:58And if it's growing, you can price any way you want. So you're going to be like the economy plus or the economy minus. So that's a cyclical stock. I mean, look, fiscal stimulus, cutting rates. We had a kind of sludgy fourth quarter that seems to be ending. And a lot of the sickle stocks, as opposed to tech stocks, are still not bonkers in terms of what you're being asked to pay. So I think the economic background is good for them. And growth investors are probably looking for somewhere to go that isn't tech, right? And again, this is one of these predictions that's easier because it's already happening.

1:11:39Over the last month or so, banks, materials, industrials, they've gotten a nice lift. Again, this is a perfect example of the inflation problem. If inflation perks up, the rate cuts come off the table, the investors are going to run out of industrials, banks, cyclicals at top speed. So this is a perfect example of how inflation gets loose. All of these predictions change. All bets are off. Final prediction here. Will the Fed funds rate end the year below 3 %? You say no. Why? And also just what do you make of what's going to happen to the Fed in 2026? We've got a new Fed chair who will come in.

1:12:29We don't know yet, but someone's coming in in May. Jerome Powell's out. A friend of mine, Ed Al-Husseini, who is a fixed income guy at Columbia Threadneedle, is one of my best sources and a friend. He put this in this way. He said, we're heading into a situation where the chair of the Fed is going to be a dissenting vote. Right? Which is kind of new. And I looked this up and one of my colleagues came back to me and said, actually, under Reagan, Chair Volcker, even the great Chair Volcker, Paul Volcker, did get outvoted by the committee once or twice. So it's not unprecedented for the chair, but it's like a weird and novel situation.

1:13:16How important is it that we seem likely to get a Trump patsy as chair of the Fed? And I guess I'm thinking maybe that's just another vote. Like the press conferences are a little weird, granted, if they keep having press conferences. uh but you know may you know may the guy just gets outvoted and there's a long history of people getting appointed by politicians who are then in safe jobs like they're supreme court justices or they are fed chairs and then disappointing their former master because they're safe so you know that i'm i'm but i will admit that this one does keep me up awake a bit more than the other predictions.

1:14:07I was partly saying we're only getting one or two cuts because I wanted to be provocative. You know what I mean? Because everybody's out there saying it's going to be, whether it's Warsh or whoever it is, which Kevin it is, they're going to come in there and it's going to be like suddenly the whole committee is going to be calling for 50, 100 points of cuts right off the bat. And I just wanted to push back against that narrative. I think it's a really important point. And I think it's sort of an important reminder of how the Fed actually works. And for those who don't know, there is a committee, and each person on the committee gets one vote, including the Fed chair.

1:14:56So the question is, what power does the Fed chair really have? And, you know, there's power in the sense that they set the agenda for the committee. They decide which things are going to be talked about and how the conversation is going to proceed. They're also the person who gets on the TV and talks to the country about what is happening. But it is a really great point. It's like, but also they just have one vote. There's no doubt that the way central banking works is less through the actual impact of the interest rate and more through signaling and messaging. You know, the actual interest rate, we're talking about quarter point increments at a rate that very few people in the economy pay, right?

1:15:46What's important, and so where the chair can have sway is everybody on that committee knows that they're sending a message as a group to the world, right? So there is pressure for them to, you know, one or two dissents are okay, but the world does not need a split committee from the Fed. And the committee is, the Open Market Committee is aware of that. So, you know, we're going to have an interesting experiment in kind of group dynamics here that we haven't had in many decades. Such an interesting point. I really hadn't considered that. And I love it because it's such an obvious point.

1:16:26Okay, let's take a look at the week ahead. We will see inflation data from the Consumer Price Index for December. We will also see the Producer Price Index for November. And of course, we will see earnings from JP Morgan, Bank of America, Wells Fargo, Citigroup, Morgan Stanley, and Goldman Sachs. Rob, this is the part of the show where we asked Scott for a prediction. But we've already kind of heard some predictions from you. Yeah, you've already done it to me. You give me a prediction. I ask you for a prediction. I'm not going to give one. I'm not going to put myself in that position. Instead, I will ask a more general question.

1:17:02Is there anything you're watching closely this year or anything that you're looking forward to this year, or perhaps anything that maybe you're excited about this year, and it doesn't have to be markets related? Well, for the last two summers, I, uh, I've done each of the last two summers, I did a triathlon. Wow. And like, this is the year at like a man as a man in my mid fifties, I think this year I'm going to try to get really see what you can do with a 55 year old body. and the answer uh maybe not very much but uh but you know that's my kind of thing i mean it's sort of a trite new year's resolution but like i'll do a couple more of these races gonna try to slim down a little bit and just see what what sparks of youth i can recapture and we'll see how it goes i love that so these triathlons what what's the how how far are you running and swimming and what is it?

1:18:03It's an Olympic distance. The two I did in the last two summers are Olympic distance. So you swim about a mile and you ride your bike for about 25 miles and you run for about six miles. And what that really turns out to be is two bullshit events and a run.

1:18:21The run is where you pay. That's where you pay. The rest is easy. I love it. So is it going to happen? Are we going to, Are we going to see you in a triathlon this year or you're mulling it over? Yeah, again, I'm going to do it again. I've signed up. You know, I put the money down. So, you know, the sunk cost fallacy may drag me into it. Well, I love that. And we're going to need to get a selfie and maybe we'll have you FaceTime in. Maybe we'll record an episode while you're running. That will get clicks. Please don't. Running, by the way, is a slight exaggeration in terms of what I do. It's not exactly walking, but it ain't running either.

1:19:00Robert Armstrong is the U.S. commentator for the Financial Times, and he writes the Unhedged newsletter. He also co-hosts a podcast by the same name. Previously, he was the FT's U.S. financial editor and chief editorial writer. Before becoming a journalist, he worked in finance and studied philosophy. Rob, thank you so much, as always, and thank you for standing in for Scott. Yeah, this was fun. It's great talking to you. Absolutely. This was fun. Thank you, Rob.

1:19:30This episode was produced by Claire Miller and Alison Weiss. Mia Silverio is our research lead. Our research associates are Isabella Kinsel, Dan Shallon, and Kristen O'Donoghue. Benjamin Spencer is our engineer. Drew Burrows is our technical director. And Catherine Dillon is our executive producer. Thank you for listening to Prof G Markets from Prof G Media. Tune in tomorrow for a fresh take on the markets.

1:19:57Lifetimes

1:20:02You help me In kind reunion As the waters

1:20:19And the dark flies And the dark flies