Is Jerome Powell Lucky or Good? — ft. Robert Armstrong

25:02And we have the freedom to intervene and to make sure that the labor market stays as strong as it is right now. So their view, what they presented was a fundamentally optimistic view. We don't have to worry about inflation anymore, so we can act firmly to make sure the labor market stays strong. And what does Robert Armstrong think of that view? I think that it is true that inflation looks beaten. And I don't have to worry as much about public embarrassment if it comes back as Jay Powell does. So I'll just say that. I think we got the beast whipped. uh the numbers are just really good uh we're either at target or close to target on most measures even the measures we're not quite at target they're moving in the right direction and we live in a world that just suddenly doesn't look very inflationary like commodity prices oil is cheap iron ore all that stuff is cheap we have china out there we have a global economy that's frankly, struggling.

26:05The U.S. is the bright light of the U.S. economy. But with the rest of the world struggling, what's going to push up inflation again? So I think that is true. So fact check true on that side. On the other side, I think they're not probably totally comfortable with the rate of change in the unemployment rate. So the unemployment rate is 4.2 % in the last reading, which is a fine reading. If America should go through its history with 4.2 % unemployment, we will be very happy, right? But the rate of change is a little bit worrisome. You know, it was down there in the threes and it's moving up at a pretty good clip.

26:42So that, and we don't know exactly why that's happening. And that's the rub. We don't know whether we can trust that number or not, but the direction of change in that number might be causing a little bit of perspiration down at the Fed and elsewhere. So, Robert, given the rate cut, who do you think are the winners and losers here? Let's go through real estate, stocks, commodities. You touched on commodities a little bit, bonds and emerging markets. Who are the biggest winners and losers here over the next 12, 24 months? Okay. Big winner. Anybody who had too much debt and was about to explode as a result.

27:19So these zombie companies. That means sectors of real estate. Right. Right. You want these rates to come down as fast as you can. If you are unable to make the payments on your buildings because you have a floating rate loan and you paid a lot for the building, the building's worth less now, any change in the rate definitely helps you. I just want to press pause there for a second because I immediately hear that and I think, okay, there might be alpha or dislocation. I would imagine the commercial real estate REITs have been absolutely taken out to the gravel pit and shot. If they are now going to have less or more room in the collar to wait until vacancy rates go down, are they potentially a buying opportunity?

28:07I mean, I'm sure there's buildings out there that are an opportunity, but the market has been reasonably efficient on this front. In other words, like the real estate investment trusts in the stock market that actually have good quality assets in them, and you can see how the lower rate environment is going to benefit them, those prices have already had a pretty decent move. So we're not at rock bottom prices on the good assets. This is probably an environment where somebody who's really an expert at picking through piles of crap and extracting the gold nuggets from them. That's a mixed metaphor of some horrible kind, and I apologize for it, is probably going to be able to do quite well.

28:58But, you know, I think, you know, office real estate, for example, if you have a big, not great, by which I mean not particularly new office building in midtown Manhattan, and you were underwater, you're on your loan, meaning the proceeds from the building are not covering your loan, it's a floating rate loan. This was a lifeline from the Fed. And that's very important. And you can extend that point to banks generally. banks, mid-sized banks, there's always something awful somewhere on the asset side of the balance sheet. And this really helps to something awful. So banks are a funny case, right?

29:37Because they actually earn a little more money in general when rates are higher, right? Because they can charge higher interest. So that can be good for them. But the higher the interest rate goes, the higher the chance some awful thing explodes in your balance sheet and knocks a huge hole in your business. So in the case of banks, there's contrary forces. Lower rates make you a bit less profitable in your everyday business, but they decrease the probability of a kind of tail event that destroys you. So banks have been actually, people care more about the tail risk, so bank stocks have been doing actually pretty well.

30:13Getting into other asset classes, because asset class, anything that pays a dividend, anything that you own because it gives you cash flows, like a utility stock might be a perfect example of this. The lower the rate you can get on a treasury goes, the more you like your boring utility stock that pays a 3.5 % dividend. Because six months ago, you're sitting there and you're like, I can own three-month treasuries at 5.5%, where I can own this utility stock yielding 3.5 % and have risk too on top of a lower yield. It's a terrible idea. But now that the risk-free rate, the treasury rate is coming down, any stock that has a yield on it becomes more attractive.

31:00So that is a relative winner. You've been covering the notion that there might be a small cap or a mid-cap renaissance, not the Fed is cutting rates. First, can you break down the thesis of why those stocks might perform better in this environment? And second, can you explain why you're a skeptic that this will actually play out? Okay, let's take one step back and talk about the background. It has been remarkable in the last 10 years, say, but acutely in the last five years or so since the pandemic, that one class of investable asset has been way better than all the others. And that class is large, growthy American stocks, humongous, primarily tech, but not just tech, but humongous American growth stocks.

31:50And it is amazing. It has been amazing watching those stocks kind of pull away from everything else. So you're looking not only at small caps and mid-cap stocks, but you're looking at international stocks and you're looking at, you know, all sorts of things. And you start to look at small cap stocks or even mid cap stocks and think these things are so cheap now. And it's been such a great run for the big stuff that we, we're going to, we got to get some mean reversion at some point in the history. You know, when you go to finance school, which is not something I recommend you do. But when you go to finance school, they teach you that over the long run, smaller stocks should actually perform better than large stocks because they're riskier.

32:36And if I'm going to buy shares in your small company that is kind of buffeted by the winds of the big economy, I should get paid extra for taking that extra risk. So it's what they call a factor, a return factor. And so over time, I should outperform if I'm willing to bear the volatility of small cap stocks. Over the last five years, the opposite has happened. By the biggest stocks, I've made much better returns than small ones. So now we're thinking, so you've been sitting there in a diversified portfolio where you own some small caps. Small caps have been acting like crap for 10 years. And you think something good's got to happen.

33:14So now you think, Okay, the thesis is rates go down, small caps are more indebted, and they have more floating rate debt than big caps. And when rates go down, they will benefit more. So the picture is debt burden higher on small stocks. Therefore, when rates go down, they will get, they were hurt more on the way down, and they will be helped more on the way up. This is a very tidy economic story of the sort that Wall Street loves to tell. You know, the kind of analyst note on this writes itself. The problem is when I actually looked to see this effect, myself and my colleague Aiden looked to see this effect, we couldn't find it.

33:55In other words, we looked at the interest expense of small cap stocks and how much has gone up when weights were rising. We didn't see a very large effect. So there's nothing to reverse, as it were. Now, you know, maybe we're wrong. You can cut the data a different way, et cetera, et cetera. but um i i don't see i don't see the grounding for this very nice sounding theory in the actual balance sheets of the actual small cap companies that make up the indexes you might invest in i just want to go back to jerome powell and the fed and rate cuts for a second i think if you're not blinded politically i think we basically can all agree that Jerome Powell has done a very good job so far.

34:40But you wrote an article, which I found very interesting, where you asked the question, is Jay Powell lucky or is he good? Could you explain why you're asking that question? And what do you think? Has he been lucky or has he been good? I was inspired to write that article by a friend of mine called Brendan Greeley, who we were talking about this. And his description of the process is the Fed is sitting there and they have a huge lever in the Fed office, which is called monetary policy. And when things go wrong, they yank this huge lever. And things change and they either did a bad job or a good job.

35:23But what nobody knows is the lever isn't attached to anything. It's just stuck there in the wall. and the reason you might argue that he's actually been lucky is we had a very specific shock to the economy in the pandemic there was massive shock to supply there was an accompanying shock to demand when all those checks went out and what you have when you have a shock like that where there's less stuff to buy or people initially can't buy anything because they're stuck in their house and they have tons of money to buy stuff. Those shocks are just going to take a certain amount of time to work their way through the system, right?

36:02It's like my metaphor of this that I always use is the pig working its way through the Python. And so Jay Powell comes along and just when the pig is about halfway through the Python, and he's like, oh, the Python, it's going to burst or whatever. He's like, we are pulling the lever, monetary policy, ka-chunk. And then as it happens, the pig keeps passing through the Python, inflation comes down. And really, whether the monetary policy had anything to do with the fall in inflation, which was just the supply chains unravel, people spend through their stimulus checks, things. And if he had done nothing, might we have seen a very similar path to lower inflation?

36:42And I think the answer to that question is yes. If the Fed had just left rates alone, we would have been seeing a similar, maybe not identical, but a similar decline in inflation as the shocks of the pandemic simply disappeared into the background. And I'm just a journalist. I wouldn't want anyone to take my word on this, but I talked to a lot of big shot economists and some of them on the record and some of them on the record were like, yeah, that's probably right. It's mostly the passage of time. Time heals all wounds. And then the Fed is helping kind of at the margin, probably a lot through signaling, right?

37:20Like the high priest of our economy, which is the chair of the Fed, stands up and says, this is a very serious matter. We're taking this very seriously. We will do what we have to do. And that changes people's mentality, which helps inflation on the margin. But I think in most cases, most of the time, central bankers need a lot of luck. And I think Jay Powell got some. So it sounds then like we're being a little bit too obsessive about rate cuts. I mean, if that's true, if they don't have that much effect on the economy, and if it sounds like what you're kind of saying is that it's mainly a story that Wall Street interprets and then reacts to, and that's why we see those price changes in the stock market, then perhaps are we, you know, taking this a little too seriously?

38:08Are we obsessing too much over Jerome Powell and his decisions? It's hard to say. It's like, uh, it might be useful that we all think the Fed has more power than it really does. That might give the Fed enough power to actually help us sometimes. Like maybe this is a useful illusion, a kind of, it's like a religious convention that helps everybody calm down and, you know, allow, you know, and then the Fed can use that kind of, spiritual authority almost to calm animal spirits and help things at the margin. But I think, why do we, why do we, people like me, obsess so much? 25 versus 50, this number versus that number, they do this.

38:54I think it's because action by the Federal Reserve is a discrete and easily describable phenomenon. You can quantify it. You can say what time it happened. You can say who did it, who made up their mind. And because the economy is like this huge, poorly understood, very confusing, multifactorial nightmare of a mush, having something that is actually clear and that you can pick apart and is understandable on its own terms, that's the kind of stuff we like to talk about. Otherwise, you just spend all day not knowing what the hell you're talking about and being afraid. Yeah, exactly. I mean, I'm exaggerating slightly for effect, but you get my point.

39:50As people with an analytic bend of mind, we are attracted to talking about things that are susceptible to analysis. rather than the real world, which often is not. Yeah, and unexplainable and indescribable. Exactly. Oh, it's just awful. Yeah. Stay with us.

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41:52We're back with ProfitG Markets. I want to quickly shift gears here to Intel, some news brewing that Qualcomm is looking to come in and acquire it, potentially an investment from Apollo. What are your thoughts on Intel's fall from grace? What's going on here? I used to cover this company a lot more than I do now, so I don't want to come off as presenting myself an authority of what's going on in the day-to-day operations. But I think it's a very interesting story for somebody who's been covering tech markets for a long time. It's a very interesting story of a company whose position seemed unassailable, certainly 20 years ago, and even maybe 15 or 10 years ago.

42:38We talked about Wintel as this monopoly. Microsoft made the PCs and the operating system. Intel made the chips, and it was like Intel had these advantages of scale that were just undefeatable, and they were going to be on top of the chip industry forever. And things happened, most notably the mobile phone and, presumably, the iPhone in 2007. And it was like, whoa, maybe the assumption was we compute now, and we will always compute in a certain way, sitting in front of a computer, tapping the keyboard, la, la, la. And if that had remained true, Intel would have remained dominant. Then the mobile phone comes along and we start computing with that.

43:20And it's like, they are unable to kind of make that transition. A chip designer called Arm, originally of the UK, now owned, you know, listed in the US, came along and said, we make these chips that actually are not as good as Intel chips. however they use very little energy so they don't run down your mobile phone battery and intel was like oh these aren't good or they you know and whatever and you know and lo and behold it slipped away from them so the interesting question about this for me is we assume google will always dominate internet advertising we assume meta will always dominate uh social media we assume go down the list microsoft etc etc you know We had trouble imagining a world 20 years ago where Intel's dominance would be broken.

44:14What are we forgetting to imagine? What are we unable to imagine about a world 10 years from now in which it's not Google, Meta, NVIDIA, these guys that just appear to have a lock on everything? I'm very bad at imagining the future. I can't even imagine. I'm bad at visualizing the present. Maybe Scott can see the future better. I'm willing to hallucinate. I'm not even sure. Imagine is an hour. But he does it convincingly. If you look at the MSCI emerging markets index versus the developed markets, it looks just historically out of whack. Or it looks as if mature markets are really expensive and emerging markets are really cheap.

44:55Do you think we're on the precipice of sort of this great rotation back into emerging market returns? Okay. So you need a theory. To answer that question, you need a theory of what drove this cycle and why that's over. right? And I'll offer you a theory of what drove money into big cap American stocks to the cost of emerging market stocks and some other kinds of stocks. We have a world that is a wash in savings. So we have a very imbalanced economy in places like China and Germany. They generate a huge amount of savings. America, of course, is the deficit side of that. We're save. And so there's all this global savings.

45:38Some of it's in the United States too. And it needs some place to go. I think we may have talked about this before. And all that kind of savings glut is what some economists call this. And sometimes they link it to inequality. So there's this group of economists at Princeton and elsewhere, Atif Mian and his colleagues, call it the savings glut of the rich. We live in this unequal world where rich people in certain countries have all these assets and they need some place to send it. And America is simply the easiest place to send it. The market is big. It can absorb your money easily. The capital account is open.

46:17There is no legal problem. There are large companies, et cetera, et cetera. So like America, big cap stock is like the most receptive place to absorb this extra savings that is developed in our unequal world. Whereas like you want to invest in like, you know, what are the problems in China and how do you, which countries do you pick? And everybody's at war and it's a nightmare and you don't do it. So whereas the last time we had an emerging market cycle, which was like, this would be late nineties, early two thousands, emerging markets were doing great. There's this story about how the rest of the world is catching up.

46:52This is the next big opportunity there. You know, uh, the BRICS, Brazil, uh, India, China, Russia, uh, there's going to be, there's going to be this great catch up and there was a great story and money was chasing in that direction. So what is the shift in global money flows and or the narrative that is going to push money back into the emerging markets? Because it's not going to be just because they're cheap. If there is an Armstrong's law in finance, it's that things that are cheap need a reason to correct. There's got to be a story about what's going to happen. So what's the story that what changes in the narrative that gets money flowing back to mexico uh etc etc to brazil to indonesia to south africa turkey you know and i'm not sure what i can't think of what that is but isn't it just so you know i never missed an opportunity to miss an opportunity, but isn't there a thesis around that asset classes are cyclical, that when they become so underinvested that any incremental amount of activity capital gets a greater return and that these things are just so oversold?

48:07It should attract money in theory, but I think you need a catalyst. So one example of this is India, which as of a few months ago was the best performing stock market in the world. And the most expensive, yeah. And the most expensive. It became super expensive as a result because there wasn't enough stuff to invest in over there and money wanted to go there. But there was this notion that A, there was a narrative that two things happened. A, under Modi, whatever his other sins may be, the place is open for business. It encourages business. The administration is there to encourage rather than inhibit.

48:50business activity, and B, the money that was getting the hell out of China needed somewhere to go. And if you wanted an emerging market play and you thought China was no good, it had to go to India. So that narrative started getting around and those stocks went bananas. So the cyclical thing, it definitely helps once the narrative changes, but you need the catalyst. So low prices are something like potential energy. Now I said we shouldn't use science metaphors, but I'm going to break my own rule. The cyclical thing, the fact that the available returns are suddenly high because the prices are low, is potential energy.

49:28And we're looking for a catalyst here. And I don't know what it is, especially in a world that's at war, is very unstable. America is kind of still looks like a safe haven in some way. So I don't know, maybe not yet. Maybe we can start a narrative here, though. This could be where it starts, Scott. There you go. This is where it starts. What about – I'm curious. One of the unintended consequences of this kind of historic escalation in interest rates was I don't think anyone saw real estate prices skyrocketing. I certainly didn't, despite in the face of massively increased interest rates. Do you think there's a chance that these kind of unexploded devices of a low interest rate mortgage that has prohibited people from selling or discouraged them from selling their homes that decreasing interest rates might free up liquidity and we might have conventionalism thrown out the window again and see a decline in housing prices with a decline in interest rates?

50:22I was even more surprised than you were by what happened in real estate. I got every article I look back and I wrote about real estate during the pandemic, I look back at it with shame. I did not say I was really crushed by this. so we know that in general throughout history real estate prices are sticky down right once real estate prices rise to a certain level it's very hard for them to fall below it and that's because they're slow moving assets and people will just hold them and wait right if you buy your house for 300 grand or a million dollars and you you're just going to really hesitate to sell it at a loss.

51:01So you will just wait until there's an opportunity to sell it for a gain. So, and even, you know, the real estate crisis that we saw in 2007, 2008, what you had there was forced sellers, right? So there were people who literally had to sell because they were bankrupt. They didn't have the money or whatever, and they were putting the keys in the mailbox and all that. So if you were going to see a price disruption, you have to answer the question, who are the forced sellers going to be? Right? Because we know that people who are underwater on a piece of real estate who do not have a gun to their head, just sit there.

51:48So that is the puzzle you kind of have to solve. But I certainly hope the market unfreezes because it's a mess. And it's extremely bad, especially for young people who are trying to get on the property ladder right now. We have a terrible, and I think this is something that is relevant to this election. I don't never talk about politics, but I think one thing about markets that is extremely relevant to this election that does not get discussed is that we have a housing affordability crisis in America and it makes people mad, especially young people. And that anger will in some way or another that some political scientists will explain to you is going to affect the election.

52:30Yeah, I wanted to go there. And this is just to wrap up last question from me. I feel like you do a really good job of identifying what stories are happening in the markets, how people are interpreting the data and spinning them into stories that leads to action. And that is sort of the job of the two candidates in this election. So I'd love to get your take, not necessarily on the overall campaign, but more on their economic proposals. What kind of stories do you think Trump is trying to tell? What kind of story do you think Harris is trying to tell? And I'd love to get your take on which one is going to be more compelling to the American people.

53:11Okay. I don't know that I'm going to answer the second half of that question, but I'll answer the first half of the question, which is this. So Trump wants people to believe that everything is terrible. And just, I mean, it's awful. And that's his thing is, you know, he's, that's the product he's always sold. And he has a tremendous advantage in telling that story. You know, a little while ago, I was saying, I think inflation is, is defeated. And I do believe that. But the simple fact is that the price level in America through the pandemic changed 20 to 25%. So every time you go to buy anything, excepting probably gas, you remember when prices were really different.

53:55And that's going to be a negative emotional experience that you have every time you look at a price. And maybe the government and the Federal Reserve made the right trade-off. We're going to very much stimulate this economy. We're going to cut rates into this economy. And we're going to keep unemployment low. and if we get some inflation, we'll live with that. And you could have, in theory, done a different trade-off, more unemployment, less inflation, or whatever. But Trump has a story to tell that is reinforced by an actual human being's experience, looking at a price and getting mad. So I think that side is quite simple, actually.

54:33On the Harris side, I find the story a lot more vague. So she's talked about prices a little bit by talking about, oh, it's these companies that are gouging you. I don't think that's true, but she's trying to deal with that story. But I think she, and perhaps wisely, has largely stayed away from the economy.

54:57And, you know, she's running on the fact that, as far as I can tell, as not a politics person, she's like, Trump is a chaotic force. We don't want to go back to the reprisals and the chaos and the lies and et cetera, et cetera. But it seems to me, maybe you guys feel differently, Except for a few phrases, she's almost steering clear of the economy. Yeah, which is strange because the economy has been great. Yes, but Trump has at his back this one incredible emotional fact, which is the price of just food, housing, whatever. And even if someone's employed, I mean, I may have said this to you before because I rattle on about it endlessly, but there's a terrible asymmetry.

55:39uh if you ed or you scott get a promotion you think to yourself why did ed why ed is wonderful scott is wonderful it's me aren't we great we finally got that promotion that we deserved or we kept our job because we deserved it uh you know if the price of eggs goes up that's the government's fault right and that fundamental and but the two are actually related you may have kept your job or gotten that raise because of the same thing that caused the cost of eggs to go up. But that fundamental asymmetry plays to the side of the party that wasn't in office. And that strikes me as being an important economic reality.

56:18No one ever blames the economy for their success. No, they certainly don't. I know it's certainly not responsible for my success, which has been a wonderful story of bootstraps and similar things. Hard work. Man, it's been great. It's a great American story. That's right. Robert Armstrong is the U.S. commentator for the Financial Times and writes the unhedged newsletter. 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, and it shows. Wow. Thank you very much for coming on, Robert. Thanks, Robert.

56:54We love having you. I wish my answers were as good as your questions, guys. Go on. Go on. Thanks so much, Robert. All right. Thanks for having me on. This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our associate producer is Alison Weiss. Our executive producer is Catherine Dillon. Mia Silverio is our research lead. And Drew Burrows is our technical director. Thank you for listening to Prof G Markets from the Vox Media Podcast Network. If you liked what you heard, give us a follow and join us for a fresh take on markets. on Monday.

57:55In love, love, love, love