#961 - What to Make of December PCE? With Jeremy Schwartz

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0:34What to make of December? PCE. Welcome to Real Vision Daily Briefing. It's Friday, January 26, 2024. I'm Ash Bennington, joined today by Jeremy Schwartz, Global Chief Investment Officer at WisdomTree. Jeremy, welcome back. Thanks so much for having me, Ash. Good to talk to you. It's always great to have you here. Boy, we have such a great setup from the macro numbers to talk about here with you today. We were just talking about this a little bit off camera. Strong GDP, decelerating inflation. Dare we say it, should we get excited? Is this a Goldilocks scenario? We've been using the term Goldilocks.

1:10We started saying it at the, you know, through the end of last year, we thought inflation was coming down and the trends are even better than the official numbers. And we'll get in. We can get into some of that about what we think is really even much cooler inflation than you get from the BLS. But real GDP coming out higher than people expected. All the real-time indicators, we look at weekly jobless claims every week. That's one of the only high-frequency indicators you get every week. And you had to hit a 60-year low in that. You're not really seeing people losing their jobs in a big way. It's actually nice that that ticked up a little bit this week because it was so hot in some ways.

1:48You know, not people, people not losing their jobs last week. But yeah, we would call this Goldilocks, that the Fed tightened rates a lot. It's not causing a recession as far as you can see today. And inflation is trending well. So here are the numbers. Q4 GDP, 3.3 % on a seasonally adjusted annualized rate basis. PCE, 0.2 % month over month. Year over year, 2.9%. As you say, these numbers looking quite favorable, moving in the right direction, certainly. So let me ask you this. Why is everyone so hesitant to use the phrase Goldilocks? And why do people, so many of them in this economy, feel so much pain right now and so much anxiety?

2:31What is the underlying driver? How do you think about that? Well, everybody thought we'd get a recession last year. So maybe there's been a few people who didn't think you get a recession, but a lot of people were surprised with the dramatic tightening you wouldn't. The inverted yield curve, we've been strongly inverted for a while. And the question is, when would that translate? Eight of the last eight times we've had this inverted yield curve led to a recession. And the question is, can we avoid it this time? There's definitely a possibility that we do avoid it this time. And, you know, each of the last times they had to invert the curve, they were dramatically hiking rates.

3:06Inflation expectations had been rising. They were raising rates to bring down inflation expectations. This cycle, people thought it was transitory. I mean, you heard the Fed really say it was a transitory. And, you know, really, the long-term inflation expectations haven't jumped. So you might be skating through this cycle without it. Productivity is a big part of the story right now. It's one of the things that we thought could offset negative job growth last year. We had a very strong rebound in productivity after a dismal 2022. I think you're going to continue to see productivity be strong.

3:38We're believers in the AI story over the next five, seven years. And so that could be another thing that cushions some of the job losses that come out. I think you're going to see that from tech companies in particular. We saw that with the year of efficiency at Meta. strong gains last year as they got rid of some people, but didn't lose any real revenue, sales, profits, all that. They did fine. I actually thrived by being a little bit more lean. I think we're going to see that. You're starting to see that at Google. You're starting to see drips and drabs of that. We've 1 ,000 workers here, 200 workers there, but they might have more significant versions of that.

4:15And so you might see more tech layoffs being replaced by AI, but generally overcome that and have positive real GDP. So that's part of our baseline view. But to your point - Let me ask you this about productivity, since you mentioned it. What do you think the secular drivers are there? Is this an AI story, or are there other secular drivers that are pushing to support that number? Well, last year, I think it was a rebound from a terrible 2022. So you had some of the worst productivity in the last 80 years in 2022. So - So it's base effects last year. Some of it is coming back. I mean, there was this question of what were all these, we hired over 5 million people in 2022, very little real GDP.

4:54Like, what are they doing working from home? Are they on their phones? What are they doing? There's all these questions about why it was so bad. Last year, it was a nice rebound. Going forward, I don't think we've really seen the AI beneficiaries yet. And so I don't think you'd say it's the new technology that's really driving it forward. but we do expect it will. So that's why I said the next five to seven years, we expect it to go up. If you look at the last decade, it was only around 1%. And the very, very long-term data on productivity says it's about 2%. So it's been really trending quite low and disappointing, but we think it can get back towards the 2%.

5:35So that's one reason why we're structurally more bullish on that. Yeah. So we're talking about this idea, this notion of the Goldilocks scenario. I guess the sort of two counter cases, the Scylla and Charybdis that we were trying to steer between, on the one hand were all those recession calls that everyone seemingly had out in 2023. And on the other was the so-called no landing scenario where you saw rapidly, you saw the thesis was that you wouldn't have the decline in inflation at the rate that was hoped. We've avoided both of those so far. So let me ask you again, Why do people feel so much pain and so much anxiety if the data looks so favorable?

6:15Well, real wages have barely broken ahead of inflation. If you look at the wage growth versus inflation or last four years since the pandemic, you've had about 20 percent cumulative inflation and wages are up about 20 percent. So the average worker just keeping up and, you know, you hear some concerns from time about a wage price spiral. We see no evidence of that. You need wages going dramatically ahead of that productivity variable that we talked about. If you have 5 % higher wage costs, but they actually produce 5 % more, it's not really inflationary. It's really wage growth and excessive productivity growth for firms.

6:52So one, people shouldn't be worried about that. I'd say the average consumer, if you didn't own a home, right, two-thirds own a home, one-third don't own a home. If you don't own a home, you look at your home prices. They're up 47 % when wages are up 20 % over the last four years. That doesn't include mortgages, right? Mortgages going from 3 % to 7%. So the cost to buy a home, dramatically higher. And that's one of the things you could say, people are looking at just the increase in home prices and saying, you know, it's very much out of my reach unless somebody gives them, you know, the down payment and helps them buy the house.

7:29Yeah, or you already own one, right? If you own it, you're feeling good. You're feeling quite good if you own your home at a 3 % mortgage. But now you're trapped and you can't move. Yeah. And by the way, the other point to point out about when you look at wages versus inflation, those are lumpy. Those are not evenly distributed. So if you're somebody who's been in the same job, like me, for example, for the last several years, generally your employer doesn't come back to you and say, hey, we want to just give you a 20 % increase because of inflation. It's balancing out as new jobs roll on, old jobs roll off.

8:00but it doesn't mean it's evenly distributed. And for people who are in that position of having relatively similar earnings, even if they've gotten some small cost of living increases, probably been outstripped by inflation. That's a shout to Real Vision. We got to get Ash getting some bigger wage growth here. But yeah, no, for sure. You know, the problem is they know I love my job, so I don't have a whole lot of negotiating. Yes, it is the job levers is where you saw the biggest jump. And even there, you're seeing, You can say one of the signs people are that there's a little bit less job openings, a little bit less job hopping is one of the signs of those signals for the economy is maybe people are getting a little bit less confident there of where we are in the economy.

8:43If we said, is there a crack in the Goldilocks narrative? You know, we look at money supply as one of the key issues. And money supply has not been growing at the 5 % levels that we would like it to be growing. That's sort of 2 % to 3 % inflation, 2 % to 3 % real growth. So money supply is one variable. that is something we'd like to see better. And the job hoppers are another thing. They're not showing as much confidence in the economy, but the rest has been pretty strong. Jeremy, now that we've teed it up in sort of broad terms, I know you've got some charts to make some specific points that you want to walk through.

9:18Let's take a look at those, Brian.

9:24Okay, Jeremy, jump in. Walk us through what we're looking at here. So I think this first one is, you know, we've been doing our own calculations of inflation. And, you know, one of the key numbers is shelter. And so this one, if I could see it right, is basically the headline CPI with real-time shelter versus BLF shelter. Our real-time shelter, we've done it a few different ways. This one is using the apartment list rental prices. And, you know, essentially what's happening in the BLS numbers. Let me just jump in here to explain so folks know what they're looking at. So the BLS number, that's the gray line.

10:04That represents the official headline CPI with the official shelter data. And the blue line is your proprietary modification. That's your real-time shelter. And it's showing actually less inflation than being stated in the BLS number. Is that roughly correct? Much less. So the official BLF shelter is over 6%. The apartment list is negative one. So when you plug that into the actual CPI, it's your redo CPI with this different measure of shelter. Instead of a headline number of 3.3%, you get less than 1%. I mean, it's a dramatic difference. And it shows you how important shelter is to driving the CPI that we have.

10:46And in court - So why do we see this difference? And how have you corrected for it? Well, the BLS number has a very lagged way of calculating shelter. It's like there's been some papers. The San Francisco Fed actually did a paper on the BLS survey method. It could take 12 to 18 months for what's happening on day-to-day rental prices to get into the way they calculate it. There's all sorts of debates about what is the proper way of measuring this number. But the BLS is very, very lagged. It's not a symbol of what's happening real time. And so there are indexes, like the Zillow has a rental index.

11:24This one has the apartment list. The Cleveland Fed has another one that's more real-time that's even lower, the sort of deflationary forces than the apartment list that we're using, and this one that shows negative 1%. So there's just a different way of surveying, and it's kind of crazy the way the BLS does it. But in core CPI, it's 40 % of core CPI is this shelter. So it's like, do you really want to use and say, hey, we have a real inflation problem? Hey, inflation is 4 percent. Core CPI is 4 percent because of a crazy number. And so, you know, the real time data says we're less than one. This is saying the Fed should say mission accomplished.

12:05We're much less than that underlying inflation that you're seeing on the official number. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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13:23If we can bring that chart back up just for one second. Jeremy, this is really fascinating, really compelling, and really interesting. Because what you're saying here is that your methodology shows more accurate reflection of what's really happening in the world. The other thing that's really interesting when you look at this chart is what you see is that the BLS number actually, according to your model, dramatically understated the rate of shelter inflation when it was peaking. So what you're using is a higher frequency data series here to try and get a better snapshot of what's actually happening.

13:54Boy, this is incredibly interesting stuff. And as you say, if this is true, it suggests mission accomplished. I mean, what's really interesting about this, and for people who aren't macro folks who don't follow this nearly as closely as you do, that, you know, most of the analysis that you hear out there when people, you know, go on cable news shows and they pontificate about what's happening with inflation, they're giving you their interpretation of this traditional data set. What makes this conversation so interesting is that, Jeremy, you're bringing your own data and saying, hey, we don't disagree with the interpretation.

14:26It's that we don't think the data is accurately capturing what is happening from the macroeconomic perspective. Really, really interesting stuff. And it also could say, what is it likely to do? You could see the relationship. There's a definite relationship between the real-time spiking and the other one being lagged and it catches up. It tells you that this will likely come the Fed's way. Right. So there's going to be a downward for people who are worried, well, is inflation going to be sticky? Is the Fed not going to be able to do anything because inflation will be sticky all year? And I've got some good friends who are in that camp.

15:00Well, this survey method of the of the shelter should give some cover to the Fed that inflation is going to trend downward for them. There's obviously risks to that thesis. And the primary risk today is what's going on in the Middle East and the shipping supply chain disruptions and things people can ship around Africa instead of going through the Suez Canal and even the Panama Canal has some issues. So there's all sorts of supply chain disruptions there. Goods inflation likely to be high. I'm not expecting those things to be easy resolutions that's going to solve overnight. The shipping seems to be a real issue and you expect it to have some goods inflationary issues.

15:40But should the Fed say we need to address those supply chain issues? Can they even address those supply chain issues? It's not our base case that they really should go after that. This shelter is going to provide them a lot of cushion for inflation coming their way this year. Well, this is really interesting. And obviously, we're talking about two different things here when you're talking about, for example, the choke points in the Red Sea. I read that article about the Panama Canal and the drought this morning in the Wall Street Journal. Really interesting as well. But obviously, these are exogenous factors to this model.

16:15But boy, this chart, really fascinating stuff. This is worth the price of the show alone, if you've just tuned in to see this chart. Really interesting stuff. And by the way, we should say you got something of a confirmation today on a print on PCE that shows inflation decelerating, presumably precisely as this model would suggest. Yep. You're basically trending the last six months of core PCE well within their 2 % target. So all the different signposts are showing you that I think inflation is not going to be a major issue. So we've been saying the Fed is no longer one of the primary risks for the market.

16:51Before the December meeting, we were a little worried the Fed could be stubborn and say, even if the economy starts weakening, unemployment starts rising, we see more layoffs. They could say, we have this 1970s risk. And there had been some commentary from some of the Fed people saying, hey, we can't do a stop and go policy. This higher inflation risk like the 1970s is there. and frankly because we think they've gotten everything wrong this entire cycle we didn't have confidence that they would be as good going down on the rate as they were going up they'd be as stubborn hiking as they were you know in terms of lowering rates when they have to they could have been stubborn saying inflation very risk we think if necessary as you heard from Powell if necessary they will cut which is if unemployment starts rising they'll cut um and that's a key So we think they definitely lowered the probability of recession in December.

17:45And that helped us upgrade some of the risky assets in portfolios that we have discretion on. Jeremy, let me ask a question. And this is sort of the looking forward aspect versus where we are right now. I suspect that one of the reasons why there may be so much pessimism, you know, it's interesting. And we obviously have an election year when you listen to, you know, both sides who are going to be running in their camps, talking about the economy, they, I think, are correctly identifying that there is a lot of cynicism, anxiety, general discontent, malaise almost, in the American people right now.

18:23And I suspect that one of those factors is what you pointed out earlier, which is this 20 % inflation over roughly whatever it is, 36, 40 months, a very short period of time for a lot of inflation. So it's interesting because the nature of inflation and the way it inflicts pain is it's It's clearly cumulative. So on the one hand, you have this substantial kind of pig through a Python inflation moment where it's like those prices have gone up. It's impaired people, individuals, balance sheets. It's obviously had an impact on the quality of life for a lot of Americans. And at the same time, what you're seeing here is this dramatic deceleration from this chart.

19:02How do you sort of reconcile the pain that people feel in the present moment with the slowing down of the second derivative, the rate of change here? Well, most people have jobs. I mean, unemployment is at historically low levels. That should be comforting. Now, more people have second jobs to keep up with the inflationary pressures. And there has been some talk about all the rise of temporary or secondary third jobs that people have to have because prices are so much higher. So I'm not going to discount that issue. Again, if you don't own a home, that's a real struggling issue. Long term, though, productivity is what drives wage growth.

19:40And that's where I think we can be optimistic that we think we're in a new age of more rapid productivity gains. And I think that will help feel the underlying wage growth for some. Now, there could be some disruption where some of the higher priced people might become redundant because AI could be an equalizer and help bring the skills up for everybody. But, you know, in the short term, it's like the people who could use it the best had some rewards to be able to use it. But I think over time it is a little bit of a level. It helps equalize talent across the board. So it'll be interesting how that evolves.

20:16In terms of the election implications for the markets as investors, the sentiment can swing both ways. And obviously, you know, it's a close call to see where things are going to settle. There's pros and cons. Obviously, today it looks like Trump and Biden, we could all think we want some new candidates. And that I think is a general sentiment from a lot of people that they want new candidates. But it looks like vigorous young men, perhaps in their 60s. It seems like they are the candidates. And there's pros and cons of each. You know, with Biden, you'd say you get more of the same, less new uncertainty.

20:52You know, Trump measured his success by gains in the stock market. So, you know, if you're an investor, he's like, hey, he's saying, is he doing a good job? is the market going up? So if he shoots himself in the foot with different policies and that's causing the market to tank, maybe he'll backtrack on some of that. But, you know, he has been more tariff oriented, Trump has, and tariffs, we're sort of free market, libertarian type people, or at least I am. And I think that is, the tariffs are not great. But, you know, I think the longstanding geopolitical tension is there with China. I don't think that's going away.

21:27And I think that's - By the way, it is fascinating to see this split in the Republican Party between folks who are kind of pro-MAGA, pro-tariff versus the free traders. It's really interesting in many ways to see this very clear and distinct shift in the Republican Party internally, let alone with the conversations with the other side. Listen, I wish this conversation were four hours because there's just a million things that we could talk about. But I do want to pull on this thread because this chart that you showed was so powerful and it's so interesting to look at this thesis of inflation decelerating far more rapidly than the Fed and the other government agencies that are collecting this data, BLS specifically, suggest.

22:12So let me ask you this. If we were to pull that line of thought through, what does it suggest about what may happen in terms of rate cuts next year if, in fact, there's a significant deceleration and the rate of inflation, as you suggest, Chairman? Well, the inflation going down means they become ever more restrictive, that real rates are higher. And they say they're well into restrictive territory today. They're admitting that. Meaning they become ever more restrictive at the current policy standpoint. Yes, without changing rates, because inflation is so much lower, they become ever more restrictive.

22:46So I think the signposts, we're watching that money supply. We want money supply growing 5%. If it was contracting last year, it hasn't contracted. I mean, it contracted a lot in the Great Depression, but it really didn't contract in the previous 90 years. So that's a very, you know, if that's not growing again, that's a challenge, and that's another sign that they're overly restrictive. But we think they'll be able to cut because of this inflation coming down. But if the economy looks so strong right now, they'll say, why should we cut? You know, all the economic data, the real GDP being higher, jobless claims being low, they could rightly point to a strong economy allowing them to stay.

23:29They just don't want to overstay their welcome staying too high because they can turn. And that money supply is one of those signposts that they should be thinking about cutting. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

23:48Jeremy, as we're talking about this, I want to bring in a clip, a conversation between Jan van Eck and Raoul Pal actually today on the Real Vision platform, because it touches on some of these points, some of these broader macroeconomic issues that we're discussing right now. Let's take a look at the clip. You know, you still have, you know, so if you think about sideways 2.0, there's three main macro ingredients to anything to our governments, right? So you look at fiscal policy. Is the U.S. government going to spend a lot of money this year? I doubt it, right, because the Republicans are in control of the House.