Neil Dutta & Skanda on Why the Recession Signals Are All Wrong

20:42Michael Batnick:All right. So I was going to say, like, what the hell is leakage? What do you call it? Import leakage. Import leakage. Okay. It's new to me. Is that a thing that's been in the economist lexicon or? Go ahead. You want to take it? Yeah. So it's basically, so there's all this spending happening domestically, but that spending could be for products that are produced outside of the U.S. And so you think about what SK Hynix produces or what all sorts of Japanese and Korean manufacturers are producing for all your tech hardware or the energy systems behind it. That's all stuff that's coming. That's value-add.

21:17That's GDP that's really not showing. It's not US GDP, but it is US spending.

21:21Michael Batnick:So why not just look at global GDP? Surely it must show up there. Well, I just think that there's a little bit... It does. I mean, in a sense, just because the dollars don't show up in GDP doesn't mean that it's not, like it's vanished or something. You know what I mean? Like, so I think what economists miss about this is that there are lots of kind of linkages to other areas of the economy that are not neatly captured, I would say, by GDP, like simple GDP accounting. Like Nix tickets. Like Nix tickets, like consumer spending, like municipal government finances, right? Like the California Legislative Office talks about how over half the growth in income tax withholding is a function of all the RSUs that are vesting, right?

22:00It's like, that's your meal ticket, right? If you're a worker in one of those big companies. It's probably, it's juicing, obviously, global growth. But more importantly, it's helping corporate earnings. And that matters because it finances a wealth effect through consumer spending. And again, that's not something that is neatly captured by a simple accounting identity. So it's almost like saying, yeah, I mean, residential investment, six or 7 % of US GDP, but not really because we import all the drywall and lumber from Canada. Like, it's a bit, I don't know. I think it's like one of these arguments.

22:34Neil, you're being too kind. I think actually like this whole like, ah, it's not really counting the GDP because it's imports totally misses the point of what a boom is all about. It's about the spending. The spending is sitting on some company's balance sheet. It's affecting their risk. It's showing their risk appetite currently and it might affect their risk appetite in the future, right? So like business cycles are risk cycles. They're about the willingness to spend, to spend on labor, spend on capital. And when the spending stops, that's when you get the recession. And when we talk about recession, We're not really talking about GDP.

23:00We're talking about whether the stock market goes down a bunch and whether you lose your job. That's really what we're talking about. So all of this GDP accounting stuff can really miss the point. You have a huge volume of spending relative to the size of the economy. It's going to sit on a bunch of balance sheets. They might be able to handle it. We're talking about some of the best balance sheets historically in terms of a lot of the big mega cap tech. But it's still quite remarkable that we've had the scale of spending. It's growing so fast. And with that comes risks and also obviously just growth in the present.

23:31Michael Batnick:So it's all about spending, which is driven by the labor market. And of course, the equity market, duh. But if people have their job, they're going to spend their money. Do you think that there's anything that the average investor can look at, whether it's on the economic side? Like, I kind of feel like the traditional playbook is like not really useful here in terms of like what leading indicators used to say. Is it going to be like a concurrent slowdown where it's like stocks get killed, spending pulls back, and it's just going to happen when it's going to happen? and there will be very little warning.

23:57Michael Batnick:I feel like people have been looking for warning signs just for the last 15 years. It's true. I mean, you always have to look behind your shoulder for something. But I think if you look back to the dot-com boom, right? Was there like a macro signal that told you this was over? Or was it that earnings started to miss around April 2000, Intel? You had a lot of these sort of events through 2000. Depends who you ask. I mean, there's a lot of vibes too, right? Yeah, there's a lot of vibes. But it's like, I don't think I could point to, aha, it was housing starts turned in 1999 or 2000, and that caused the cyclical slowdown.

24:26It's like, I don't, I think it's really about the stock market. It is about, it's about tech.

24:30Michael Batnick:Some people will point to like, I think there was a Barron's article that came out of it one weekend and the next week the stock market killed and then it just started to unravel. But like, was it the article that caused the stock? I mean, it was obviously going to burst either way. It was a bunch of spending that got pulled forward in terms of IT systems, Y2K, a lot of that stuff. And then you keep spending, you keep spending. And it's like every exponential curve is always underestimated in real time. And at some point there is an S-curve. I mean, the other thing of course is that the Fed was hiking and - That's true.

24:54But the stock market was still going up concurrently as the Fed was hiking. So it wasn't necessarily, I mean, this whole notion that like, oh, the Fed should step in and like hike to blow this whole thing up. I mean, first of all, I'm not sure that they really can. But all you'd be doing at that point is exacerbating the stresses in the areas of the economy that you were just talking about, like housing, like some of these credit sensitive areas. And the key distinction between now and then is that the labor markets were genuinely overheating back then. There's really no evidence that, I mean, we could talk about, you know, things getting more stable relative to where they were six months ago.

25:28But it's not like you're seeing, like, broad-based wage pressure.

25:31Michael Batnick:Are you guys worried about credit card delinquency? That's been a topic that's come up recently. Not yet. I would say there's probably some signs that the household sector will eventually face stresses if, like, the job market isn't good. Right now, we're seeing signs that are the opposite. But if we are, like, this is still not yet a point to me where the household sector is pretty flush in terms of liquidity. it may be disproportionate in terms of distribution. So a lot of the spending is - It's getting worse at the margin. I agree. I mean, it is getting worse. I mean, even the Beige Book talked about it yesterday, right?

26:01They talked about we're seeing uptick in mortgage delinquencies and credit card delinquencies and agricultural delinquencies. I mean, I guess the thing is, do you think it's a body in motion that stays in motion? And if you do, then you better pray that the labor markets start to accelerate. Because if they don't and wages continue to slow, then those problems are going to just get worse. And so, yeah, I mean, I agree that it's very low. But if you're a bank, I would probably want a provision for more loan losses over the next year. If you think about the 90s comp or the late 90s comp, labor market's definitely not as strong as it was then.

26:38And so there's clearly like a sense of if this labor market does not show any sort of real pickup over the next six months, we will be talking about sort of all the left tail stuff again.

26:46Michael Batnick:But can that be good that it's not as strong? Like, it's not causing wage pressure? It could be. The other side of it is inflation is a lot more of a problem this time than it was in 1999 or 2000. And so we have inflation that's tied to tariffs, inflation that's tied to the AI boom itself. There's inflation that's tied to, obviously, the closure of straightforward moves. So if you think about airfares are a lot higher now, and a big part of that is jet fuel. If you think about AI boom and its impact on, basically, if you want to go buy a laptop now, you can see the price, right? It's not what it used to be.

27:13And there's all sorts of computer hardware, memory shortage having its impact. And so this is all a lot of sectoral stuff. It stinks. It's kind of like the 2000s in a lot of ways. If you remember, there was a lot of random inflation that kind of creeped up around then. So that's not great for the consumer, right? The consumer's got to pay the bill on that. It means they're either enjoying not as much of a standard of living improvement or in some cases a standard of living reduction. So that's the downside here. So we have like not as good on the labor market, harsher on the inflation side this time around relative to what was the 90s, which was kind of nirvana in terms of labor market being pretty strong.

27:48but inflation not really rearing its head.

27:50Michael Batnick:Josh and I talk a lot on the show about the wealth effect and what drives people to spend more money. And I've mostly rejected the idea that people spend money based on how much they think their house is worth. Because you don't see it on the screen. Yeah, no, it feels good. Sure, I suppose. But your investment account, it leads to overconfidence. I mean, it just does. You can take money out of your investment account, pay for a home renovation or a toy or whatever, and in 10 days, the bucket is full again because the semiconductors just keep giving you free monopoly money. So that, like, I think there's no doubt about it that is driving a huge amount of the spending today.

28:29Michael Batnick:In 2022, the stock market did go in reverse. It was a bear market and it didn't last five years, but all of the names that everybody loved got cut in half for the most part. Like Amazon, Facebook, NVIDIA fell two thirds, it's like legitimately lost like a lot of money. And people didn't stop spending, at least as far as - No, because we had income growth. Okay. Yeah. That's the key difference between now and then. So if we - And we had a lot of pandemic savings. Yeah, so I know it's not apples to apples at all. But so you're saying that if, what would it take for the spending to slow down? Would it be the stock market or the labor market or both or who knows?

29:08Well, I think, so there's a couple of things. I mean, I think right now we're sort of, for us, I think for economists, it's like, is it linear or nonlinear? Which part? The slowdown in consumption. Right now, you're basically in a linear, I think a linear slowdown in consumer spending. Consumer spending is growing about 2%. A little below, a little above, it depends. But more or less, that's where we are. If you start to see layoffs in any meaningful extent, not that we have outside of technology, that'll probably hurt consumer spending pretty quickly. that's one option. The other way would be you get a market correction of some kind.

29:52If you just assume like savings are stable, like consumption will probably naturally slow a little bit anyway, because income growth is so slow. But does it matter? That doesn't mean it's going to like fall off of a cliff. You know what I mean? Like it's just, okay, we're instead of growing two, we'll grow like one to one and a half.

30:07Michael Batnick:In a world where these hyperscalers and others joining the party or spending$700 billion of CapEx, does it matter if the consumer pulls back a little bit? A little bit is not enough, right? Consumption is generally pretty smooth anyway. So really, when you think about, people say, oh, the U.S. consumer is the economy, but investment's the business cycle. Investment is the thing that's volatile, that moves with the business cycle. And right now, it's risk on, right? There's clearly a lot of capital commitments that are tied to this. There's all sorts of planned spending, planned additions of energy, of data centers that haven't happened yet.

30:36And as long as there's the belief that this is going to keep continuing, which is the case right now, that's going to happen. And that's what's going to drive sort of where the market goes and market sentiment. And I think that's just, we're in the middle. What's so unusual about this is that it's like equipment investment and like non-residential business fixed investment that's driving it. And that's what's interesting. I mean, if you're talking about business cycle economics, right? Like typically the investment piece that cracks is residential investment, right? So what's interesting about this is that, because typically if you look at it, I mean, equipment like non-residential business investment, CapEx, that actually follows growth.

31:14It doesn't, it's not a leading indicator historically, right? I mean, basically the way it works is companies think growth, it's the accelerator effect is what we call it, right? Like companies think growth is going to pick up and so they start investing more. What's unusual about this cycle is that it's not like growth expectations are really taking off in any material extent. But you have this sort of spectacular capital spending boom nonetheless. So that to me is like, to your point, why are all these traditional things not working? We don't think of tech as a cyclical sector, right? We think of it as housing, manufacturing, maybe some segments of consumer spending.

31:50But tech is the cyclical thing. It is the thing that matters. It's driving all the vol in terms of GDP, in terms of why we're getting the outcomes we're getting in the stock market too, right? So we don't have a leading indicator for the tech outside of like, if you're really locked in on some particular names and maybe certain orders for this tech supply chain, maybe then you can have a read into the leading indicators of this dynamic. But it's really just about like business fixed investment. That's all tied to AI.

32:17Michael Batnick:So tech AI, it's sucking everything in. We're going to get to some of the work that you've done on everything looking like a semiconductor stock. The framework that I'm working with today, and by the way, things change so fast and people act like what's happening today has been in place forever. Like nobody wanted the mag seven stocks in the fall. These things were getting destroyed. Oracle got Oracle fell by 60 % because people were like, there's no way that Sam Altman is able to pay that five-year$300 billion contract. There's no way. And all of a sudden it's hot again. And people are like, oh, bubble.

32:48Michael Batnick:So the way, the way that I see the world today is that everything is being driven by the investment boom, by the, by the build out. And I don't know when the handoff happens, but how much of the world is even using these tools, the agentic AI stuff? Like what's interesting about where the tenure was before the war and today is that you got the closure and the inflation picking up concurrently with the crazy boom in Anthropics revenue going from like 9 to 45. And it happened at the same time. And the point is, nobody's even using these things. And all we're hearing about is the shortage of compute.

33:34Michael Batnick:So to suggest or to think or to use the framework that like it's late or we're getting long in the tooth, I kind of think it's just starting. It's really hard to know in real time. And it does seem like - The best approximation is what we can see in the present. What I can see in the present is risk on, right? I can see just that there is a lot of appetite. The capacity on compute is clearly very much tight as far as Anthropik's concerned. And at the same time, they are seeing revenue growth. So that's all reasons to keep investing, right? Reasons to keep being optimistic. At some point, there are, I'm sure there is a point where exponential curves become S curves, but that point is not right now.

34:10Michael Batnick:I love that you said that because all we could observe is - Is that the line's going up. Yeah, it's going up. What's happening today? Who knows? I guess one thing I was thinking about, and I really enjoyed your conversation with Denise last week. you know, she's great. This whole notion of like, it's early, it's not a bubble because the earnings are so strong. And, but I also would say at some level, like the earnings are tied to some kind of temporary phenomenon with this. At some point, the data center buildout will stop and the earnings won't be there. So what are we really talking? I mean, just because it's not, just because the PE multiple isn't like ridiculously high doesn't necessarily mean - I agree, that tells you nothing.

34:51Yeah. So I think that there's a little bit of that going on on the street. The other thing I would say is this is like a really, I mean, people talk about, I mean, I go to clients and it's like, oh, productivity boom. Like, you know, this is a very unusual productivity boom. Like, what is the point of investment? Ultimately, the point of investment is to raise household living standards. Can we say that that's what's happening with AI? Like, if anything, it's a really weird productivity boom when the prices for information technology commodities, like Skanda was talking about, software, laptops.

35:21It's actually going up. Like you pull up those charts in the 90s or 2000s, it was deflating month after month after month, sometimes at accelerating rates. You go back to that period too. Again, very strong productivity growth. You know what we also had? Very strong growth in real income, right? Like there should be some relationship between stronger productivity and stronger real compensation. We just had negative real compensation growth this year. So right now, all the growth is flowing to margins, I guess. And I don't, I mean, that to me is like, this is why I say, is it really a productivity boom?

36:00It's not yet raising household living standards. And I don't know how long that can continue. I honestly think for productivity, a lot of what people are talking about are things that happened in the previous, call it one to three years. Like you look at Q1 data on productivity, not great. If you think about the supply shocks that are hitting because of, hey, price of gasoline is much higher than it was in Q1. Price of all sorts of energy, airfares. You have a lot of other shortages and other shocks that are materializing too. Cattle prices. Yeah, right. Cattle and beef, all that stuff is going to feed through as well.

36:32If that's happening, that's probably going to also weigh on productivity too. And so productivity growth is not actually as rosy now as it probably was in 23, 24, 25. But doesn't the, who's productivity? That's right. the macro data stats that the Fed might look at that their productivity I do think is like even in terms of diffusion you're right that we actually haven't seen mass adoption of AI in terms of in the real economy

36:59Michael Batnick:nobody's using it I mean I know our listeners probably are like you know you guys are but in the real world yeah there's limits even in terms of large corporations I mean we use it of course you do if you're a smaller company or a smaller organization you probably can adopt these tools you don't have to worry as much about security risks and that stuff. If you're a larger company, there's all sorts of walls. You can only use CoalPilot. You can only use these types of tools. You can't use those because they might ultimately present security risks. And so actually adoption may not I think it's a long way to go.

37:28There's also a measurement thing with this. I mean, everyone's looking at the ramp index. I like the ramp index. What is that even telling me? It's like, oh, look, OpenAI is going down and everyone's using Claude now. Okay. I mean, I don't even know what to do with that. I would just say that if it's a genuine productivity boom. I mean, people, it feels like everyone assumes that like everyone's margins will expand because of this.

37:52Michael Batnick:But they are. Margins are at an ultimate high. Estimates are going up. Ultimately, costs need to come down to households. All right. So we'll talk about it in a second. I just want to end the topic with this. So Neil, you said we ran a one-year daily return correlation between every S &P 500 name and the semiconductor ETF, SMH. 15 non-tech S &P 500 companies, collectively worth$2 trillion in market cap, now move with semis at correlations of 0.5 or higher. 12 of these 15 are industrials, names like Vertiv, Eden, Caterpillar, Cummins, Hubel, Hubel, Hubel, Hubel, Comfort Systems. I don't even know, I don't know a lot of these companies.

38:35Michael Batnick:Whatever, you go on. You say these are not tech stocks. They trade like semis because their order books have become AI CapEx order books. Caterpillar sells backup generator sets and engines into hyperscaler data centers. Vertiv sells cooling and power management. Enon sells electrical components and GE Vrnovus sells gas turbines for data center power. This is kind of interesting. The gig sector classification has not caught up with the economic exposure. It sounds so good when you read it back to me. It's good stuff. Buy that guy's research. But inside the stock market, I was talking to ChartKid and Sean today.

39:11Michael Batnick:So healthcare is breaking out. It's been stuck in the mud for a while. Industrials look awesome. That's 20 % of the S &P. So for as much like people talk about, oh, it's just the MAG-7, Daniel, chart, throw chart 12 on. This surprised me. And I look at the market pretty damn closely and I don't think I knew this. Probably because they diverged like very recently. But the MAG-7 are up 7.3 % year to date. 7.3 % year to year for the Max 7. Not bad. But the 493 are up 12.6%. Huh? Did you guys know that? Well, I knew about it. It's a big spread. You mentioned it, I think, last week, right? I forgot about it.

39:50I have other things on my mind. I do listen. But I think what that analysis is showing is that this is going to support a lot of the equal-weighted indexes because it's such a profound effect on the broader economy, right? Like Caterpillar is probably part of that S &P 493. I think I was reading that Generac is doing better now because of the data center build out to build back up power for these facilities. So that's why I say, just because, I mean, is the equal weight, like historically, we look at that as a sign of market broadening. But if the AI tech capex boom is touching lots of industrial names, as an example, and lots of freight, right?

40:35That stuff needs to move around the country. That's also probably helped by all this. So is it really a sign of breath, or is it just a sign that things are really concentrated into one area of the economy? How much is traditional non-residential structures doing?

40:53Michael Batnick:So when you say one area of the economy, you mean corporate profits? No, I mean like the tech sector, the tech boom. Damn it, Eli, I was trying to do a segue. I meant corporate profits. So go ahead. I mean, it just seems like the breadth and the boom go together. too right it's just that there is you see companies like what ford is kind of trying to sell batteries now ford's trying to provide batteries to support this sort of power boom right so we have it's just become it sort of touches so many other sectors and even beyond whatever rational logical um connection between like oh this affects power which affects like transportation it's more like it's a risk on environment and so this is one which transactions happen and correlations do go to one in both directions.

41:35So if it's an environment where investment appetite is particularly solid, that's one in which other companies, other sectors have a chance to participate as well. The other thing I was thinking, I'd love to hear your thoughts on this, Michael, is that when people, when clients ask me, do you think the market's pricing in a slowdown? See, you're looking at it like, but I don't know. I mean, discretionary stocks don't look great, right? I mean, that's what Jeff has been telling me. Discretionaries, underperforming consumer staples.

42:10Michael Batnick:Which discretionary stocks? Equal weight. He's been pointing that out. I mean, restaurants don't look good. I mean, you can say that's all because of people taking the fat shot. I will say that, unironically. I think that it's not like their same-store sales are doing particularly well. Or, you mentioned healthcare. I mean, that's not necessarily a cyclical sector. But, or, I mean, what about what's going on with like financials? Right. I mean, so when people's like, I mean, maybe the market is like, it's, you know, is the market pricing in some slowdown? No. So tell me why. No. Okay. So I'm looking at the equal weight discretionary over staples and it's still in an uptrend, but flattening.

42:51Michael Batnick:It looks fine, whatever. It's sort of neither here nor there. But I think some of the story is it's really hard to separate. I don't think consumer discretionary stocks are necessarily always a reflection of the consumer. and restaurants are a great example of this. A lot of these names, Cava is like the poster child of this. A lot of these names came public sort of recently, were in vogue. The valuations were stupid. The slowdown happened. Consumer preference changed. Shake Shack, nobody wants to eat a f***ing burger for lunch anymore. The stock is getting destroyed. Is that a reflection of a slowing macro environment?

43:24Michael Batnick:I don't know. I don't even know what the dollar stores tell you anymore about the state of the... It's how many Neato's we're buying. Well, yeah. But seriously, you look at Dollar Tree and Dollar General. When they're going up, is that because that particular consumer is doing better? Is it because the middle-income consumer is trading down? I have no idea. Now, obviously, you can listen to the conference calls, and they'll give you a little bit more information. But I think it's really tricky. So I don't think the market is pricing in a slowdown. I think it's sort of hard to say that. Maybe the P.E.

43:52Michael Batnick:is coming in a little bit, which is probably healthy. Like, there's a little bit of a governor on the stock market. But I don't know. What do you think? I mean, I think the consumer is spending in total at a reasonable pace. But I think one thing that's going to be changing is they're facing more inflationary pressures. And again, there's obviously energy, but it's also like food prices. If you think about a lot of what is being guided on the staple side, right, suggests they're going to pass through a lot of costs. So you think about all the pet chem prices that are in all your household cleaning products, in your household paper products.

44:22It's basically, there is assuming, okay, we're going to be able to preserve our margin. And that means we're going to pass it through to the retailer, to the consumer. So if someone's going to hit the squeeze, it might be the consumer in that case. And that's really like a real consumption squeeze. So the money can keep flowing, even though we may not necessarily be getting richer.

44:37Michael Batnick:Let me ask you guys this. I think a lot of this is investor preference. For example, Clorox. I don't know anything about the business. I don't follow the stock. But guess what? The stock looks terrible. Is Clorox undergoing some stress? Is there a competitive landscape? Yeah, I'm sure there is. But if you look at a stock like Hyatt, which is at an all-time high today, and Delta, which is at an all-time high today. I don't care what Domino's Pizza stock is doing. That's a completely idiosyncratic story that has nothing to do with the broader consumer. Now, if I'm Domino's Pizza CEO and Chipotle CEO, and I'm telling the analyst that it's a consumer macro pressure story, of course you're going to say that.

45:11Michael Batnick:But I can show you a million other examples that completely refute that story. If anything, what you're pointing out is actually very real in the data of goods to services. So we see in goods, obviously consumer spending is kind of not as great. We're not seeing the spending in terms of food and staples and even whatever else you get in the grocery store. But if you see it in terms of services, in terms of air travel, even though airfares are going up quite considerably, the actual volumes of air travel are quite robust. Restaurants haven't been that great. Restaurants have not been as great. I think restaurants are also facing a big food squeeze.

45:44So your costs on the food side have gone up, especially for Shake Shack.

45:48Michael Batnick:I really think, I completely underestimated the GLP-1 story. And it is having a material impact on areas of the economy. It really is. So in that sense, you also get the rotation there too. If you're not going to spend as much at the grocery store, you're not going to spend as much in certain types of food services experiences, but you might spend it on other kinds of recreation services. You might spend it on accommodations, resorts. And I do think we'll see that story play out as well. All right. Shifting gears a little bit. Greg Ip wrote a story, The Record Divide Between Corporate Profits and Worker Pay.

46:20Michael Batnick:And Denise was on this, Denise Chisholm was on last week talking about falling unit labor costs, being a tailwind for the stock market. Great for the stock market, pretty shitty for society. So Greg said, to understand why people are so miserable about the economy, look no further than Thursday's report on gross domestic product, not how much GDP grew, but how it was divvied up. Worker compensation, wages and benefits grew 0.8 % in the first quarter, while domestic corporate profits jumped 2.7%. Daniel, charts on please. As a result, labor's share of gross domestic income sank to 51%, the lowest since records began in 1947, and profit share climbed to 12.1%, the highest since 1950.

47:01Michael Batnick:So just go back and forth between these charts. So this is corporate profits basically hitting all-time highs. And the flip side of this is wages just not getting their fair share. And this is ripping the country apart. Is this not being accounted for properly, or do you think this really is the story? I think it's probably two things I can think of. One is the labor market has been underperforming. So when we say like, hey, given like what we're seeing in the labor market being so sluggish, the consumer looks pretty good. And given these facts like, oh, okay, well, it's happening despite the labor market not being as good.

47:33This is quite impressive. But the labor market is sluggish in a lot of ways. Like benchmark to what we saw in the 2010s even, this is slower than that. And yet we're also seeing the structural trend of a lot of this is also about the tax system, right? The tax code has sort of created a lot of biases in a way that makes it just, you're going to be more inclined to try and stay at the margin, steer away from W-2 income towards either trying to own your own business. There's obviously a lot of stuff with capital versus labor. I'm not going to get too much into that, but these are all ways in which there's going to create some bias.

48:07And some of that might be real and some of that just might be classification. So it's not just like some big political thing. Superstar firms is probably another. That's right. What's that? Like just like firms that have really high margins. We have more of them in our economy. Therefore, naturally, as a result, profit share goes up.

48:24Michael Batnick:But this is very much impacting the political landscape and how people vote. And this is like a huge part of the story. Yeah. I mean, I think if you aren't owning your own business, right, and you're basically relying on a W-2, then what exactly is like – what does that labor market look like? I'd actually argue right now we're seeing a pickup in white-collar employment. We're seeing a pickup there, which is kind of defying all the odds and prognostications on the AI, replacing white collar. But for blue collar, it's not necessarily all great, right? It's actually, if you look at a lot of different types of employment there, job growth has not been as fantastic.

49:03There's a lot of construction jobs tied to building data centers outside of that. Not so great. And even manufacturing. If you're maybe working for Boeing, obviously jobs are being created because they're ramping up production after all their snafus. Outside of that, not as impressive, I'd say.

49:18Michael Batnick:Neil, do you think that those lines, forget about converging, do you think they stop diverging? Is there a breaking point? So I think I sent you this chart, but basically if you pull up a chart of like nominal GDP. Chart time, Daniel. And like sort of nominal compensation growth. Like, I think it kind of speaks for itself, right? Like, nominal GDP is growing about 6%. And nominal compensation, like wages and salaries mostly, is running below 4%. Has this ever happened? I mean, I'm sure it's like, it's rare. It's weird. Like, the disconnect is quite unusual. Now, there's a number, I mean, and I've said this to our clients, and I'll say it to your audience.

50:03how you feel about how this thing reconciles should dictate how you feel about the trajectory of policy going forward. Go on. Well, I mean, if you think that all this spending is going to lead to a meaningful inflection higher in labor income and tight job market and people seeing stronger wage growth, then you should be very hawkish. I mean, you should expect, right? So if the gray line converges towards the red line, then it's not like, I think Scanda has a forecast for like one hike at some point. Yeah. In the next year. Forget that. I mean, they're going to go 75 to 100. They'll take away all the insurance cuts from last year.

50:43Okay. So that's at least 75. The Fed never, I don't think, really just goes once. I mean, but if you think that we'll see that that slowing in nominal wages and salaries will pull down to some extent consumer spending from like maybe 2 % to 1, 1.5. You continue to see this sluggish growth in residential investment. You continue to see sluggish growth in structures investment. So if that red line converges onto the gray line, well, then maybe the Fed can wait it out. Maybe the Fed can wait it out. And so I think that to me is the kind of conversation. So I think Scanda is a little bit more on the hawkish side of things right now than I am.

51:23It's unusual for us to be that unaligned. But that's kind of where the debate is right now. So, you know, for me, like, in my career, I've always put more weight on labor and housing. And so that's why I probably sit more on the dovish side of things at the moment. You know, how can you, you know, as an example, like, apparel prices have been rising very, very rapidly over the last year. But what's happening to the real volume of clothing that's being sold? It's actually contracting. Like, how can firms make that stick? Right? It's very difficult to make the price increases stick if labor income isn't there.

52:02Where else is it?

52:03Michael Batnick:So areas, all right. Kevin Warsh. Oh, God. Well, not your favorite. I think last time you were on here, you were not so happy about the prospects. Look, I mean, someone has to do the dirty work. I mean, you can't get half the people on the street to actually say what they really think about them. So I guess if one person has to do it, I guess I will. You know, that's sort of how I think about it. I mean, that's one of the benefits of working at a smaller place. You don't have to be like a diplomat. But yeah, I don't know. I mean, what's the upside? What's the upside of what? Him. Oh. Well, he's in charge now.

52:36He's the boss. Well, I mean, I think it's as likely that the Fed captures him than he captures the Fed, right? He's going in there talking about regime change, I think. If I were a betting man, I would say that the Fed is more likely to influence him than the other way around. I think actually it's a bit of like Chinese finger trap, right? It's the harder you try to pull away. The harder you try to push for a dovish case, the more you're likely to kind of stoke a reaction from the rest of his colleagues. Well, because he's a hack. Well, yeah, if you make bad arguments. Well, if you make bad arguments, don't be surprised when, like, the staff or your colleagues just smack you down, right?

53:13And I think that's the big issue with, like, he's kind of trying to throw in trimmed mean. I'm actually a data guy now. Yeah, look at his career, Michael, if you've ever seen him. You know, when he first got, when he was a governor, he never gave actually speeches on the economic outlook. Like, you know, it's like, oh, here's Governor Warhol or Laurie Logan, like, talking about the economic and policy outlook. He never gave those speeches, really. If you go through his, like, record, like, most of his speeches are, like, sort of, like, very kind of, like, high-level, like, philosophical. He's, like, freaking going around talking about Immanuel Kant and these people that you've heard in literature class in your freshman year of college or something.

53:55I mean, it's very bizarre to be talking in those terms for a central banker.

53:59Michael Batnick:Can't people change? I think the change is very curious considering it happened during a period where he was actively campaigning for a job. And so to me, that's the knock on him. I saw somebody. But trim mean, it's just not going to work. Do you know what I mean? Which part? Like going in there and being like, oh, look at this trim mean measure. It's lower than everything else. Like if his job is to go in there and try to convince the people around that table that we're about we're on the precipice of a golden age. I mean, you hear them talk about this all the time, like pull a Greenspan as if Greenspan didn't hike aggressively in the late 1990s.

54:36Anyway, so he's going in there to sell this golden age thesis. Basically, what that means that we're on the front edge of a productivity boom. That means we have a lot of spare capacity. So don't do anything. Yeah, we have a lot of spare capacity in our economy. that means we actually have more room to cut rates. That's what he's going in there. That's the pretense under which he was brought in. So, Skanda, were you done?

54:57Michael Batnick:I can keep going. Skanda knows that. So, Skanda, my question to you is how much power does he have to influence policy? Can he just say we're cutting, we're raising? I think he can't just snap his fingers. He's got some bully pulpit power. He's got some ability to set the agenda at a meeting. Like those are like for like a really shrewd operator. There are ways to leverage that well. But it's certainly not something so unitary. It's a, you vote at a committee. You vote among a set of people that's each got one person, one vote. And there's a set of members. Some of them are part of the board of governors and some of them are regional Fed presidents.

55:40And you already saw what, four dissents at the last Fed meeting. One of them was on the more dovish side, but three were on the hawkish side. That's a lot of dissents. And they're probably going to dissent again because they're going to say, ah, yeah, we should drop this easing bias, but we really need to be moving towards a tightening bias. We already got something. That'll be the next battle. That'll be the next battle. And so we're headed in that direction. I would separate what I think the Fed should do from what the Fed will do. So what do you think they should do?

56:04Michael Batnick:What do you think they will do? I think they should steel themselves. In fact, there are a lot of supply shocks in the economy. And there are a lot of supply shocks that are really hard to look through. The first thing you do is don't underestimate their scale and duration, which I think a big part of what got in trouble in 2021 and 22, which is that it's just these things can last a lot longer than you think because they take a long time to travel through the value chain. Different companies are moving their margins. The scale of this stuff can be a lot larger than you think in real time. So don't go in basically underbaking these forecasts.

56:36Michael Batnick:So dumb question. How much do you think the overnight rate impacts? How does it have to do with supply shocks? It doesn't really. But the biggest issue is that the Fed has been underbaking where inflation is supposed to be by this point. And when you keep making the same error, you're liable to say, oh, I must be missing something really big. I must need to raise interest rates to keep inflation expectations anchored. And I think we're headed down this path. I mean, I'm basically being bearish about the Fed because of the reasons Neil pointed out, which is that they are going to confuse this stuff.

57:02They're going to look at the inflation data. They're going to say, oh, it's hot. It's hot for so long. It's in too many different components. because it's so broad, because it's lasted so long, it therefore must be something we have to do something about.

57:14Michael Batnick:So you think they should look through it, but they won't. So he thinks they should do what my call is. His call is that they won't. That's why he's negative. So I think that's an interesting framing. I mean, we'll see. I mean. But the market is pricing at a rate hike. Show chart 13, please. So this is the implied Fed funds rate we're looking at through the end of September, 2027. What is this line telling us? It's kind of the cowardly compromise of saying that there is either going to be a set of hikes, right? If the Fed's going to hike once, They're going to hike multiple times, or they're just going to stand packed.

57:40I think it's going to be hard for them to steel themselves through what might be some more inflation and a broader pickup. And at a time when financial conditions, at a first cut, pretty supportive, the interest rate currently is roughly around neutral, modestly restrictive. And at the same, the labor market's not showing the same downside risk. We're moving away from the left tail. Inflation has got some right tail properties. I do think it's largely supply, but that's a hard— when you have all these things moving in the same direction of the hawkish-duvish debate— They're not going to go once.

58:15They're going to go 75 to 100. If they start to go, don't be surprised if it's three hikes in a row.

58:21Michael Batnick:So, Neil, you're a market economist. If you knew that they were going to go, what, three times 25? If they're doing it for the reasons he's talking about, it would be very bad for the economy and the capital markets because it's basically your hiking rates, not because demand is like... We're trained to think rate hikes are okay because it means that the economy is strong because demand is there and that means earnings are there. But the economy is not that strong. Well, that's... Yeah, the economy is not horrible. It's fine. It's okay. It's okay. It's not overheating to the point that it needs to be so cool.

58:52It's very uneven. I mean, I thought the Beige Book this week was very interesting. I haven't seen a Beige Book like that in a while. It's a very uneven economy, I think, is a fair kind of characterization of it. But if the Fed's hiking and it's because like we have this sort of like broad like growth and labor markets are fine, like I think the markets are going to be fine with that. But if they're hiking for the reasons that Skanda is talking about, like that is not a good outcome. Like hiking. It's like remember what remember what Josh was talking about last week?

59:21Michael Batnick:I have no idea. Well, he was talking about how like it makes no sense to hike because of oil prices going up. Now it's like, OK, now you're going to hike because cattle prices are up. Now you're going to hike because, you know, I mean, can the Fed control the flow of oil through the Strait of Hormuz? Absolutely not. Can it does it have any power over the El Nino? Like, no, it does not. The one thing I wanted to come back to on Warsh was I did find it fascinating, like in the last week that Bernanke, what did he say about like his views on the balance sheet? He called it a meaningless statement.

59:50I thought that was really fascinating because obviously Warsh worked for Bernanke. and the balance sheet for whatever reason is like Kevin Warsh's hobby horse and Bernanke just took a big massive crap all over that. So I think it's kind of like emblematic of how he actually feels about him without saying it.

1:00:08Michael Batnick:I want to get your guys' take on this. A listener emailed us about the labor market. He said, many of the distractors of this bull market, I think he meant detractors, often say the lack of jobs and the lack of good high paying jobs and knowledge services are reasons for doubt and concern. The latest report from the Bureau of Labor shared that the number of job openings is now at a two-year high with 7.6 million open jobs. More interesting is that the largest jump in openings was in professional and business services, adding 668 ,000 positions. Combined with the past two months of higher than expected non-farm payable data, do we think sentiment is ready to turn and finally embrace that AI is not going to eat all the jobs and is in fact, helping to grow and create opportunities for workers?

1:00:59Well, first, I mean, I sort of reject the premise that AI will actually eat all the jobs. I mean, you know, that's kind of like the lump of labor fallacy. I never really bought into it. It's really hard to talk about like AI taking away all the employment with, you know, the unemployment rate at 4.3%. I mean, on a prime age employment is still fairly good. I mean, so I don't really buy into that. I mean, I will say that you don't want to get too much into the indicator macro. Like, I don't really believe that professional and business services openings went up by 700 ,000 in a month. It's fake postings?

1:01:32I mean, the data are real. The news is fake. I mean, you know, to bar from Trump. I mean, it's like anything else. You could find a different indicator. Like, the Indeed job postings numbers are weaker on net over the last few weeks. So, I don't think the signal from that report really comes from openings, frankly. I mean, it's like openings are like the fakest thing.

1:01:54Michael Batnick:Oh, well, here's more tangible. It's hires and quits that matter a lot more. Here's more tangible reading. Initial jobless claims. Was it last summer when they started to go up and people were getting, I'm sure, I know Josh said this. These don't usually slow down. Like this is the ultimate object in motion, stays in motion, everything. And they did slow down. They peaked and then they normalized. Are you guys surprised at the low level of initial claims? Just how like okay the labor market has been? I am surprised that we saw such a big slowdown in job growth in 2025. And it kind of stabilized on its own, right?

1:02:28So that's something that is one of those like object motion, status in motion. I think there's a lot of good reasons to take that seriously. Like there's a lot of information in the present. There's just respect. But it did start to show stabilization. And so we started to see that probably around the jobs report in December. You started to see signs of like, okay, things post shutdown. We're starting to like just show the kind of stability that job growth was not going to keep falling off a cliff. And I think it's actually most interesting on we have a white collar. So if you think about there's a subset of professional business services that really matters because it also includes things like temp help jobs and a lot of other things that are not exactly high wage.

1:03:04There you are seeing a pickup. You are seeing a pickup in job growth. And so hiring is picking up there. And if you're really trying to put it together, is this because, like, what is the macro fact that's driving this is not, like, completely obvious. But I think if I take one step back, it's, look, it's been a soggy labor market for that segment for about three years. Basically, you had the sort of tech session of 2022. You had basically, okay, the Fed is hiking, so therefore we need to be on watch for a session. We overhired during the pandemic. We need to slow down. Then it became, well, this AI stuff is so risky.

1:03:37Should we really be increasing headcount? But like the actual cost of capital signal has long been signaling it's okay to spend.

1:03:45Michael Batnick:Well, also, don't you think it's just so, it would be so deeply unpopular for JP Morgan, for example, to start doing massive layoffs. Like, do you think that companies, and I know JP Morgan's an extreme example, but do you think companies in the aggregate have any sort of hesitation to do that for fear of some sort of retaliation by either their own workforce or larger forces at play, political forces or the such? I think there's actually a lot of risk that you lose a lot of knowledge to be able to orchestrate future solutions. So you end up letting go of someone who is responsible for a key system.

1:04:20You let it go of someone who's able to build the next set of things that actually leverage the technology. I mean, it's not obvious to me that who's most exposed to AI? We don't really know. We don't know which kind of jobs are actually most exposed. Oh, aha, these jobs are going to be the ones that are easily automated. It may very well be the case that's the white-collar people who need to be actually executing a lot of the sort of how to take advantage of the technology itself. I mean, you do see specific areas in the job market that are booming right now because of AI. But I would just say that layoffs are usually the last thing to go.

1:04:53I mean, by the time layoffs are showing you something in terms of a signal, like it's over, buddy.

1:04:58Michael Batnick:So let's leave the audience with this. And you guys are great. Skanda, how can people find your work? So employamerica.org is a great place to go. You can access our research. We have some public research if you want to subscribe to. We have a few different distributions there. If you want to follow me on Twitter, right now I'm probably posting mostly about the Knicks. But I promise after the series ends, and hopefully well, we'll be back at it. And we're usually breaking down a lot of data related to jobs and CPI and PCE and everything the Fed's tracking. All right. Neil, we've got a QR code.

1:05:31Michael Batnick:If people are watching this, they could flash that. Yeah, you can also find me on the New York Knicks Instagram account. Hell yeah. Yeah. Where else are you posting? I post on LinkedIn. I like the longer form content. We obviously post charts on Twitter as well. Okay. X, excuse me. Okay. Speaking about an area where they cut to the bone. And you know what? I'm actually glad that more tech people didn't follow his lead. Like there was a lot of fear about that. Like they cut everybody at Twitter and it still works. And I know to the degree that it works, but it's still doing its thing. All right.

1:05:59Michael Batnick:I want to leave people with this. Everybody wants to know when it's going to end. I get it, right? It's just how we're wired for better or for worse. And maybe it's tomorrow. Maybe it's in 2032. And when I say it ends, I mean the cycle turns, okay? So what is one or two things, pieces of actual evidence or actual data that you guys would look to for this particular cycle? Because we know this is a unique one. So what are you going to be keeping an eye on? You want me to go first? Sure. Well, I would say at the end of the year, I think, you know, into next year, maybe the conditions are not as favorable as they are at the moment, right?

1:06:39Like, so we probably don't get as much of a fiscal push, right? Like the one big, beautiful bill tailwind is going away by the end of the year. That transitions to more of a headwind. If the Fed is on hold, even as nominal compensation growth remains weak, I mean, everyone's talking about a passive easing of policy because of inflation. But for the labor market, that's a passive tightening of policy. So those two things are kind of on my mind. That was way too smart. I don't know what you just said. Skander, what are you doing? Yeah, business cycles are risk cycles. And so the risk and the willingness to actually spend is what we should all be caring about if we're trying to think about the big macro risk, the big drawdown you want to avoid, or the big risk to your job.

1:07:24Michael Batnick:It sounds like you're saying credit spreads. maybe credit spreads that would be my answer yeah so credit spreads are a very good proxy so especially episodic though by the time it turns i know but but but i feel like it's like the easy here okay here's the thing um the during i i think it was liberation day the the thing that kept me like moderately comfortable with the direction of the economy is the credit market really wasn't freaking out it like it just it just wasn't and so you're right by the time like it really shows it'll probably be too late. At least that's kept me on the right side of the positive trend.

1:07:58To me, when you think about where's the balance sheet constraint that's going to cause this, right? And so it could show up in corporate credit spreads. It may be something that's… The things to me that are most likely are something that where it's the willingness to spend with the non-tech companies on AI expenditure. That's really what we should actually be focused on because for them, it's an expense. And they need to see payoff on that expense at some point. whereas if it's just spending by the hyperscalers it's all part of their moat it's part of how they're trying to make sure that they stay competitive but for the non-tech companies are they seeing a return on their investment?

1:08:32I'm sure they are seeing something but you're obviously hearing about token expenditures so when that gets stretched which is kind of the scenario we think about with 2000 where it was a lot of front-loading of expenditure around Y2K at some point just got tired of it it's like I don't need to keep spending more and more I'll just spend the same amount And that's itself important.

1:08:50Michael Batnick:What's nice is that NVIDIA is now breaking out their revenue by Hyperscaler and everybody else to give us maybe a better sense of like, no, we're actually, we're not just reliant on these, you know, these behemoths. All right, boys, how are we feeling for the rest of the series? Better than I did 24 hours ago, I'd say. We took their heart out yesterday. I think they're a resilient bunch. They're not the Cavs. Like, Castle's a dog. He's not going to give up. And so is WunB. No, it's not going to come easy, but I also, I felt like the Knicks, I still do. The Knicks are the more mature team. They'll handle it.

1:09:24And I think they needed that. The Spurs needed that game more than we did. I think they're pretty exhausted from the previous series. Good.

1:09:31Michael Batnick:Wemby ran out of steam. Yeah, he ran out of steam the last few minutes. I still doesn't feel, I still can't believe this is happening. It's been so long. I mean, it's funny you mentioned PJ Brown. I mean, I remember I was an 11-year-old kid. I hated that guy. When the Knicks, you know, in 94, I still remember that series. A series we should have won. That one's a little bit foggy. I was nine. So I don't remember as well as you did. We were up 3-2 in the garden. And we should have won that game. To me, I'm just more cynical after two decades of Dolan. And it's like, how is this coming together?

1:10:10There's no time for cynicism. Sorry, no time for cynicism.

1:10:12Michael Batnick:We're done with that. All right. Thank you, everybody, for listening, for reaching out. You guys were awesome. This was so much fun. And Skanda, would love to have you back. This is just really great. Thanks, guys. We'll see you next time. Appreciate you watching.

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