Will Surging Energy Force the Fed's Hand?

0:05Will there be no landing? Welcome to the Real Vision Daily Briefing. It's Monday, September 18, 2023. I'm Ash Bennington, joined today by Jim Bianco, president of Bianco Research. Jim, always great to be with you on these shows and elsewhere. Yes, thanks for having me. And to everybody watching us, wake up, because it's been that kind of day in the market. Yeah, it's been a little sleepy. Where'd we close on the day? Is it perfectly flat? It is essentially flat. The S &P's up a whole six basis points or two points overall. all. All right, Jim. So let's talk a little bit about the broader thesis, the broader context here.

0:41I use that phrase, no landing at the top of the show. It's something that you used in your note to us earlier today. Explain what no landing means in the context of this background. Yeah. So I got to give Torsten Slock and Apollo the credit for coining the phrase. We all talk about a hard landing, which is a recession. We talk about a soft landing. And so in keeping with With the airplane metaphor, a no landing is the plane doesn't land. It just keeps going. The economy just keeps producing positive quarters. That's what a no landing is. I happen to be in the no landing camp. But as the show unfolds, I'll actually make the case that that is not as bullish as people think.

1:26I know people have been to it like want to tear my tonsils out because they're all bearish and they all don't like the no landing idea. But no landing means higher interest rates is what that means. And that may become a serious retardant to any kind of a rally in the market moving forward. So the idea here, Jim, is with no landing scenario, essentially you just keep putting together positive quarter after positive quarter in terms of growth. You see growth in earnings. You see multiple expansion. And you see ultimately inflation rising. All of that except for the multiple expansion. expansion if you produce positive quarters and people demand things and they push up prices and they push up interest rates you'll get more earnings but multiple expansion would only come about multiple expansion for everybody that just means the p e ratio gets bigger right the price goes up it goes up faster than the earnings number go that's multiple expansion but that would only work if you have stable to lower interest rates but if you have inflation becoming problematic And I'm talking 3%, 4 % problematic, as I like to say, not 8%, 10 % or Zimbabwe problematic.

2:34But if you have that kind of 3%, 4 % inflation, that will prevent the multiple expansion. So if earnings are going to expand 6 % or 7%, maybe the stock market expands 6 % or 7%, maybe. and if you wind up with 4 % inflation, on a real basis, you're not making a whole lot of money in the stock market. That's assuming everything goes right. Then you have to factor in that there's always a surprise somewhere down the line. No one can predict it and that that could be a problem too. So when you talk about no landing, when I talk about no landing, too many people hear, oh, quarters and earnings and here comes 5 ,000 and 5 ,500 on the S &P.

3:20Yeah, unless you want to tell me that interest rates, that the market's going to be able to continue to ignore higher and higher levels of interest rates. And I think that that's going to be the problem, is that those interest rate levels will keep going up and provide tougher and tougher competition for the stock market. Well, it's a great point. And just curiously, how long do you think the equity markets in the U.S. are going to be able to avoid an impact to the performance from the increase in rates? I jokingly would say through July, and it's now September, because basically the S &P, the S &P today is at the same level it was at in July.

3:58And it kind of stalled out once we started to really see rates move through 4 % and we're at 431, 432 on the 10-year note. Now, it's not enough to crater the stock market, but it is enough to really put a lid on it. Let me say the same thing in a different way. um university of chicago and ibbotson associates have done some long-term studies in the stock market over many many years the stock market should be expected to earn you nine percent that's what their studies have shown over the last two years the stock market has returned you zero over the last three years it's actually pretty close to nine percent uh because you were down big last year and up big this year uh that's where your zero comes from uh okay in 2019 you could have said the same thing.

4:43So over many, many years, the stock market would give you a 9 % return. But your alternative, if you didn't like the stock market, was zero in a money market fund or 20 basis points, to be more specific. Today, if you don't like the stock market, your return is 5.5 % or something approaching 5.5 % in a money market fund. That's well over half of the return that you would get from the stock market with no risk at all. No market-based risk at all, is what that is. That's very, very different. So the whole concept of TINA, there is an alternative. It is a money market fund. And it will give you over half of what wealth managers will tell you will be the long-term return of the stock market.

5:24And if we get no landing and inflation continues to stay sticky and those rates continue to creep higher, it could be more like two-thirds of what you can get in the stock market in terms of what you can get in a money market fund. And there will be a lot of people will say, two-thirds of what the stock market will give me with not any risk, sign me up. And I think that there's a lot of that. Look at the inflows in the money market funds. Look at the inflows in the short-term bond funds this year. They're booming for exactly that reason. And yet, on the equity side, we're still outpacing the historical rate of return on the S &P year to date.

6:02We're at about 16.5%. So far, you pointed out some flatness over the summer, but still longer term, 16.5%. Five-year return on S &P 500 is over 50%. It's still really hot. Yes. But then there's also the concentration in the market. We cannot forget that. 16%, you're right, is what the S &P is. About 70%, 60 % of that gain is seven stocks. Those are the magnificent seven. And whenever we put a moniker on it, it usually is not a good sign for the long term. Anybody's old enough to remember the nifty 50 from the 70s as well. And so all those stocks are associated with AI. I get it. I understand what's going on there.

6:46But you start looking at the stocks, like the other 493 companies in the S &P, they're up about 5 % for the year. Uh, you look at the Russell 2000, it's up, uh, as I look at my screen, it's up 4 % for the year, the Russell 2000. And then there's another index called the, um, Russell micro cap, which is the set, the bottom half of the Russell 2000 companies. So just so everybody knows, Russell 2000 is company 1 ,001 to 3 ,000 in terms of size. So not the top 1 ,000 companies. The, so the micro cap is company number 2 ,000 to 3 ,000. Those companies employ 12 million people, so they're not insignificant.

7:29But collectively, that index is down on the year. So the further away you get from AI, the more the market struggles. Why? 4 % interest rates, 5.5 % money market rates, 7 % mortgage rates. That is taking a toll on the return of these companies. But it's unclear whether or not it's taking a toll on the economy. Don't confuse the stock market's return with the economy. They're not the same thing. And if it's not taking a toll on the economy, and I don't think it is, that's the no-landing scenario. And that's why he said no-landing isn't a bullish scenario necessarily because it's a story for higher interest rates.

8:11By the way, here are some numbers that you already know, Jim, but for folks who don't, year-to-date on NASDAQ Composite up about 32%, almost exactly on a year-to-date basis. This NASDAQ 100, the largest companies in that index, up 40 % year-to-date. So there's the dispersion story you're talking about. Yes. The NASDAQ 100 year-to-date is the best year ever right now. And even better than 99, because 99, when it was up 80 % for the year, most of that gain came in the fourth quarter. We're not quite at the fourth quarter yet. But it has been extraordinary what you've seen. But again, it's seven companies.

8:48The NASDAQ 100 or QQQs, half that index is seven companies. And those companies are just going ballistic right now because of two letters, AI. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

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10:10Let's switch gears here a little bit, Jim, and talk about what you see in the bond market right now. What's the setup there? How are you viewing this from the bigger picture perspective? So if I'm in the no landing camp, what I'm also trying to say is while interest rates are providing a competition for stocks, they're not providing any kind of a retardant for the economy. The story of the last 18 months has been 100 % chance of recession, as Bloomberg said in the summer of 2022. We're going to have a recession in six months, a soft landing, a hard landing. All of that's been wrong. All of that has been wrong.

10:48The problem with the economy to date has been there has been no problem with the economy. It continues to produce positive quarters. It continues to produce 200 ,000 jobs a year, a month, excuse me, according to the payroll report. So when you look at the bond market and you keep talking about where's the slowdown, there is no slowdown. Well, there's going to be a slowdown. You've been telling me there's going to be a slowdown for 18 months. I guess if you say it until the end of time, eventually there will be a slowdown. But I'm not necessarily seeing it. So when it comes to the bond market, what you're seeing is creepingly higher interest rates.

11:30What has been the high? The 10-year note bottomed at 51 basis points in August of 2020. What's been the high of the cycle? This morning, when it hit 437, was the high of the cycle. It backed off a little bit by the end of the day, but the highest print we've had was this morning. The two-year note came within two basis points of setting the high print of the cycle. Those are 16-year highs in those interest rates. Why are those rates going up? No landing, higher crude oil prices, fostering to stickier inflation, suggesting that interest rates at a minimum cannot come down and that maybe the Fed, while I agree the Fed will not raise rates this week because it's not priced in, they'll probably raise rates one more time before the end of the year.

12:20And I'm not so sure that they're done even after that next rate hike, that there might be another rate hike after that. I'll remind everybody that, oh, but, you know, there's going to be one more rate hike and they're done. The same people have been wrong for a year and a half. You know, my favorite metaphor on this was back in February of 2022, so 20 months ago, Jamie Dimon came out and said, I think the Fed could raise rates six or seven times in 2022. That's six or seven 25 basis point hikes. Wall Street was like, really? The Fed's going to be that aggressive? They're going to raise rates six times?

12:56No way. I can't believe they're going to do that. Well, he was wrong. And Wall Street was wrong. He didn't raise rates six times. He raised rates 21 times in 2022. So they've been completely misjudging this entire cycle. So what I'm arguing is there's going to be a rate hike in November and maybe more in 2024. Just more of the same misjudgment that we've seen for the last 20 months. By the way, for those who are wondering, you get to that number by aggregating the 25 basis point hikes. That's why there are so many in a period of time where it couldn't happen. Right. 21 hikes is 425 basis points of interest rates moving up for the year.

13:32Yeah. Listen, while we're talking about interest rates, fixed income, and energy, I want you to take a look at a conversation I had this morning with Harris Kupperman and Louis Gov. This is from part eight of our How to Profit from Crash or Boom right here on Real Vision, where we look at these questions thematically and systematically. Let's take a look at the clip. So I think we're moving into a world where energy is the new anti-fragile asset class. It's the new thing that actually diversifies your portfolio. Meanwhile, nobody owns it. Nobody owns it because it's a very small part of benchmarks, because of ESG constraints, because of a terrible decade, basically between 2013 and 2021 or eight years.

14:14There's lots of reasons to not own it. But what's going to happen, I think, is the more energy remains an anti-fragile asset class, and again, it was again in August, the more, you know, so much of the world's money now is managed by computers that it's going to start popping up in all sorts of quant models where it's like, oh, energy actually is a good diversifier and you're going to start seeing the flows. And right now, all the guys that are long energy are guys like Kapi, myself, guys who are almost religious about it. We're not in there for the next 20%. We're in there for the next 300%. Jim, I really enjoyed hosting this conversation with Louis and Cuppy earlier today.

14:56It's an interesting point, this idea that energy becomes the anti-fragile asset, hard assets, rather than government bonds, rather than U.S. Treasuries. What are your thoughts? Well, I agree with them that right now, the setup in energy is incredibly bullish. The prices have been moving almost in a parabolic stance. The fundamentals of energy have been very good. The fundamentals, I would break them down two ways. We all know that the OPEC plus, which is Russia and the Saudis, are voluntarily cutting back in supply. And everybody's blaming everything on them cutting back on output in order to have higher prices.

15:40And that has something to do with it, no doubt. But if you gaze your eyes over at the demand side of the equation, demand for crude oil is booming in the United States. Now, we're nearly 20, 21 million barrels a day of consumption of crude oil. That is an all-time record. That is a sign of no landing. What gets you to an all-time record in crude oil consumption? Growth, GDP moving forward and stuff. You put together a pullback in production by OPEC +, record demand, which is more than offsetting whatever weakness you're getting out of China. And then you throw in a 40-year low in the SPR, and you've got a cocktail for explosively higher prices.

16:25is the price of crude oil is up 36 % in 10 weeks. And the positioning, according to the commitment of traders, they're not positioned for this. They are not necessarily, you know, everybody's all in and all along. They're nothing close to that. There is still a high degree of skepticism when it comes to this rally in crude oil. So I could see this rally continuing. From my perspective as a macro investor, what the data that screams is, that it screams headline inflation. Oh, but it's headline inflation. The Fed will look through that. Yes, they will. And they'll conclude they cannot cut rates.

16:58They can never cut rates with higher headline inflation. So you can cancel the 2024 cuts unless the economy falls off a cliff, which I don't think is going to happen. And they more likely might have to respond to higher inflation in 2024 by raising rates even more than just the one more cut at the end of the year. By the way, with the connection, the linkages, the feed through from headline to core, do you see that happening? Yes, there is always a feed through. The economy runs on energy. Energy is in input processes and transportation costs. It's in everything right now. So eventually what will happen with the big rise in crude oil is it shows up in gasoline.

17:39It shows up in energy. It shows up in headline. Eventually, input costs are going to go up. So that's going to get passed along, too. Eventually, transportation delivery costs are going to go up. That's going to get passed along. And all of those are in core. Now, those are second order effects. They don't occur right away. But if this 36 percent rise in crude oil continues or at least holds, it will show up to some degree in core. And remember, core inflation is still over four percent and it probably will stay that way maybe to the end of the year. And there was a time two years ago when we would have looked at 4 % core inflation and found that completely and totally unacceptable.

18:22Right. And now I know Wall Street's trying to say, hey, we've fallen to four. Everything's OK. No, we've fallen to a level that's unacceptable. And that's why I think this whole idea that the Fed's going to declare victory and cut rates next year is really premature. Sure. We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing.

18:47Jim, we talked about the energy picture from the cyclical perspective. Let's talk about the structural aspect. We talk about rising demand here in the United States, obviously significant rising demand from a structural perspective from the global South, all over developing Asia and elsewhere and supply remains meaningfully constrained due to effectively government policy interventions. Does that sound to you like a recipe for longer for higher in terms of energy prices? Absolutely. Absolutely. You've got that. You're right. You know, the whole green movement, the ESG movement, the Saudi 2030 project, which is there, that's seven years from now where they want to be off of fossil fuels as a dependency in the Saudi economy by 2030.

19:32That's why they're overpaying for soccer players right now, because they're trying to diversify their economy away from anything that they can that's not fossil fuel related. All of that is going to feed back into higher prices. Demand for energy is there. We're running at around 103 million barrels of energy a day worldwide. As I said, about 21 million of that's from the United States. The other 80 or so is from the rest of the world. That number, even by 2030, is expected to be at least 110 million barrels a day, if not higher. And what are we trying to do? There was a protest today on Wall Street.

20:15Over 1 ,000 people on Wall Street were protesting to end fossil fuels. So they want us all to pay$25 a gallon. And then we know what's going to happen at the pump. And we know what's going to happen to the economy if that happens. Look, I get it. You want to end fossil fuels for environmental reasons? Okay, that's fine. But just protesting that we just shut it all off is a recipe for economic disaster. And so that's not the way that we're going to have to do it. You're going to have to find viable alternatives for fossil fuels. And while we're working on some, whether it's wind, solar, maybe nuclear in a safe way, they're still not quite there.

20:56You know, electric EV for cars, they still need to be powered from something. And that power is coming from fossil fuels in some degree or another. So, yeah, the energy story does seem to be very bullish, especially as they talked about in the clip. Coming off of 10 years of where energy investors were just pommeled. It was a terrible time to be an energy investor for the 10 years ending about 2021. So that's one of the reasons why there's a high degree of skepticism in energy, because all the energy bulls have been blown out. They're gone. All that's left are the energy skeptics and the energy bears, because they're the only survivors in that market.

21:36So we're going to have to create a whole new generation of energy bulls, which will bring about higher prices, too. Yeah, that's very well said. Look, it's about 4.20 p.m. Eastern time here. I'd like to be off fossil fuels by 5 p.m., but the reality is it's just not going to happen. I just don't understand how this transition in energy takes anything less than decades. If you think about the infrastructure requirements, the technology requirements, the time takes to logistically move those into place, we're not getting there by 2030. I'm not trying to be cynical about it. I just don't see how it happens.

22:11Right. You are correct that the issue is not that we don't want to be there. The issue is, you know, how do we want to be there? And as a matter of fact, this feeds right into, you know, the big labor market potential with the UAW strike. And that UAW, for the first time in their 88-year history, is striking all three companies at the same time. At the heart, we all focus on they want a 32-hour work week and a 35 % pay raise, and they want a return to defined benefits. But really at the heart of this is the administration and everybody's push to force the auto companies by 2032, that's in nine years, to have 50 percent of their fleet sales to be EVs, electric vehicles, where it's 3 percent right now.

22:58And the UAW sees that and sees the way that EVs are made, and they're like, we're going to lose all our jobs. And that's ultimately what is behind that strike. It is a forcing of EVs onto the big three when we're really not ready for it. We're going to get there eventually, but forcing it sooner is just creating more havoc than it would potentially benefit. I don't know if the electrical grid is there. I don't know if the amount of rare earths that we need for all the batteries are there. But we're going to jam it down and we're going to say, you know, California has already outlawed the sale of internal combustion engines in 2035.

23:44That is in 12 years. There will be no more sales of internal combustion engine cars in California. Are we ready for 100 % EVs in the state of California? The simple answer is no, we are not ready for 100 % EVs in the state of California. But we're pushing headlong into it. The UAW is very nervous. They're seeing that as a byproduct of this, they're going to lose a lot of jobs. And that's the real motivation behind their strike. I mean, I guess California could always walk it back in the event that they weren't able to get there. They could change the law if it was going to be catastrophic for the economy.

24:18I mean, look, I think Teslas seem like the greatest third car known to humankind. But would I buy one for my first or second? It's just not practical, right? Am I wrong about this? No, you're absolutely right. Because 80 % of Teslas that are sold are the ones with all of the bells and whistles and the highest option and the most expensive cars. Because you're exactly right. They are bought by somebody who has an$80 ,000 SUV and has a$70 ,000 sedan. And in the middle, they put in a three-car garage a Tesla. And that is the perfect car for that demographic. Right. And they love it. But is it the perfect car?

24:56And absolutely they love it. Why wouldn't they love it? Because when they have to take a long trip, they all get in the SUV. And they've got the second car and the third car. But as the main daily driver for people that's going to be parked, I live in an urban area in Chicago. It's going to be parked in the street, not in a garage. Is an EV really it? And do you want to leave an EV with a battery half-charged overnight in a Chicago winter when it's five below zero? And good luck and see what the charge is left on that battery in the morning. These are great cars. Don't get me wrong. But they're specific for a certain use.

25:32I don't think they're ready for wide adoption use, kind of like the internal combustion engine is. Why? Because we spent 100 years perfecting the internal combustion engine for wide adoption use. We're not quite there with the EV. Yeah, I know Raoul loves his, but I tease him. He lives on an island that's, I think, 10 miles wide by a mile high at its widest point. Right. So he could drive the whole island on one charge. And, you know, but Ash, if you had to get into your car and you had to drive to, you know, Washington, D.C., you're going to take an EV or you want to want to take an internal combustion engine car?

26:09because you don't know how long it's going to take and you don't know where your charge is going to be when you're three quarters of the way there. Yeah, there's charging stations along the way and stuff, but it's a lot easier to take an internal combustion car and it's a lot less stressful. Yeah, absolutely. By the way, I love the idea of hybrids. I might buy a gas electric hybrid. Right. Well, you know, you've always got that option as well too with a hybrid that you've got the gas. But like I said, don't get me wrong. These are great cars and I think they're fantastic and they are the future, except to say they are the future, so let's force them on everybody now is where the problem comes in.