Prof G Markets: Ozempic’s Market Impacts and Surging Bond Yields — with Downtown Josh Brown

25:22Why do you think that these interest rate increases haven't caught up to the economy so far? How does that relate to the yields that we're seeing in long-duration bonds? It turns out, and this is the thing when they write the textbook chapter about this period of time, this is what will be the gist. It turns out that the economy is way less sensitive to short-term or overnight interest rates right now than it had been historically. Think about why. You had basically a two-year, almost three-year period of time where companies could refinance and then refinance again and then refinance again. And there simply was not the need to have rates reset on a lot of debt.

26:06Homeowners did the same thing. Think about the people you know who own homes. Most of them spent the majority of 2021 bragging about how low they got their mortgage rate to be. The consequence of that is when the Fed starts hiking rates, there is a severe lag relative to history in terms of when we start to feel the effects of it in the economy. Corporate balance sheets went into this rate hiking cycle in the best shape they've ever been in. Most homeowners, like a typical household, went into this rate hiking cycle as flush with cash as it's ever been. and go on down the list, all of the people who would normally be affected by higher borrowing rates, there was just a huge period of time before it actually mattered.

26:53And in some places, it still doesn't matter. Put that aside. Typically, where you would see the most sensitivity to rates would be in the housing market. You would see, historically, you take rates from, well, you take a mortgage rate from 3 % to 7 % under normal circumstances. And we're not in normal circumstances. Under normal circumstances, you would have probably seen home prices drop 20%. Why didn't that happen? Because people are locked into these low rates. They're in no rush to sell. We've got different demographic phenomena in the form of people retiring and not giving up their primary home.

27:29Retirement home is now a four-letter word in the aftermath of COVID. Not a lot of seniors are in a rush to go off to one of these places, given what happened during the pandemic. So you've got a lot of reasons why people will not sell. In the absence of selling, you don't get that decline in home prices. There's just not enough supply. Go through all of the major metropolitan markets that make up the Case-Shiller Home Price Index, and you just are not finding enough supply come on to move prices lower. And perversely, because there are so few homes for sale, and because there's still going to be this percentage of people that have to buy a house no matter what the mortgage costs, we actually still have bidding wars in some markets.

28:14So the Fed has not been able to affect the housing market as it historically had. And a lot of that is still coming from that weirdness is still emanating outward from 2020 and 2021. So that's, I think, the main reason why we really haven't seen prices reset and we haven't seen a bigger economic impact. Companies just don't need to borrow. They're flush with cash and homeowners are just they refuse to sell in many cases and don't need to. Josh, if the equity premium that you get for buying stocks has been starched out because of the increase in interest rates in a very reductive way, isn't it a good time to sell stocks and buy credit?

28:56This is the big push and pull that's been affecting the markets all summer. It probably started at the end of July. Stock prices topped out so far for the year. And we've really seen people have trouble, people that are operating on this model, they've had trouble rationalizing owning certain areas of the stock market relative to what they can get risk-free in effectively overnight bonds. A six-month T-bill yielding north of 5%. Why am I going to buy the equity of, for example, a utility stock that's currently yielding 3 %? You say to yourself, so let me get this straight. I can have a risk-free six-month yield of 5%, or I could be in the equity of a REIT.

29:42Like I could be in a utility stock. I could be in a consumer packaged food company. I'm getting a lower dividend payment, and I have all the volatility of the stock market. And people are opting for the former, not the latter. And that's what has created this huge burst in volatility that we've been living through in the last six weeks. And stocks really haven't come down. I mean, there's been a little bit of a career. It doesn't make any sense to me. You think, okay, interest rates go up, stocks come down, but stocks have not come down anywhere close to proportionally. I think we have to qualify what we mean when we say stocks.

30:17If we're referring to the S &P 500, it is absolutely true that there's been a much more resilient tone. Look, Apple's in a 12 % drawdown. Tesla's in a 40 % drawdown. We can't say stocks haven't come down. But I think what we can say is that the larger the market cap of the company, the less of a drawdown we've experienced. And actually, we did this research last week. If you break the stock market, the Russell 1000, so this is all the large caps that trade, not just S &P. If you take the Russell 1000, you break those companies up into deciles. The thing that has determined whether or not your share price is higher on the year is the size of the market cap.

30:58So the top two deciles are the only deciles where the stocks on average are up on the year. The bottom eight deciles, so let's say 800 of the Russell 1000 on average are actually negative. And it's pretty cleanly delineated by how big the company is. And that makes sense. That makes sense because think about it. A company like Apple that's got access to hundreds of billions of dollars worth of cash, when they sell bonds, they effectively sell bonds at a AAA rating. It's almost like a sovereign country whose house is in order selling bonds. Why would Apple be sensitive to a higher interest rate?

31:38It doesn't hurt them one bit. Maybe there's a second derivative where it hurts their potential consumer. We haven't seen that show up in the earnings or in the demand for their products at all, not yet at least. So that's what you say, the stock market, Scott, this is important. You're referring to the S &P 500. The S &P 500 is by definition dominated by these larger market cap companies. And these are the companies that have the least need to refinance at higher rates and will be therefore hurt the least by higher interest rates. Should really be the S &P 7, right? The Magnificent 7. The Russell 2000 is in a huge decline.

32:15The Russell 2000 are the smallest 2 ,000 publicly traded companies in the U.S. market. These are not tech companies for the most part. These are biotech, smaller banks, industrials, healthcare companies. They have gotten absolutely killed. So we have to be careful when we say the stock market did this, the stock market did that. There's a lot of strength. in the Apples and the Microsofts, and that is masking all of the weakness below the surface. Do you think that there's more pain ahead? I mean, when interest rates were rising, everyone said a recession is coming. And now, I mean, you make a good point about the Magnificent Seven.

32:55And it sounds like what you're also suggesting is that there's going to be more refinancing ahead. So where do you stand on the recession question? Do you feel like maybe in the next six or eight months, there could be a recession coming? There could always be a recession coming in any six or eight month period, and I won't be the person that sees it first. Here's what I want to tell you. It is not impossible to have rates where they are today and have a stock market perform well. And as evidence, go back to the 1990s. Do you know what the average yield on the 10-year treasury was throughout the 1990s decade?

33:30It's about 5.2%, pretty much where we are now. So the shock here is the speed with which rates have moved, the reason for why they're moving, sticky inflation, right? And now the new question is, well, for how long will they, quote unquote, stay up here? Meaning we have gotten so accustomed in the investment markets that at some point something would break and then the Fed would have to step in and start cutting rates. I mean, this is basically what life has been for the last 30 years. 1987 the lesson that alan greenspan took away from 1987 was that he could prevent a stock market crash from spilling over into the real economy he did it he cut rates during the crash and actually most people don't know this the s &p 500 finished 1987 positive literally so that was the takeaway and then every crisis since then it was the same playbook not long after nine years later 1998 you had a global currency crisis.

34:31Asia had a meltdown. Russia devalued the ruble. The Fed was cutting rates into an expanding economy. They were not cutting rates to save GDP growth or for employment's sake. Literally, they cut rates to save the market. And guess what? It worked. 1999 is one of the greatest stock market years in history. So this has been the playbook. The Fed has done this over and over and over again. That is what the market has come to expect. We used to call it the Greenspan put. Now we call it the Fed put. So now the question is, well, the Fed has hiked a lot. Nothing has really broken yet of consequence. We lost a couple of banks out West that were doing stupid shit and we probably should have lost them anyway, but we really haven't had a systemic issue.

35:12So when will the Fed be cutting rates? That's still how people are thinking about the next upside catalyst. It's crazy, but this is what we've become accustomed to. If you started trading and investing in the last 20 years, it's all you know. The Fed has to cut rates sooner or later. So now it's this higher for longer question. I can't resolve it, but let me say this. From 1958 through today, nominal yields, this is important, the distinction, nominal yields, not inflation adjusted, averaged 5.7%. So we're at five and a quarter. So we are well within the history going back to 1958. Real rates, real yields, So what that means is the nominal yield minus whatever the inflation rate is, average 2%.

35:58We are just hitting 2 % now in real rates. If the 10-year is at 4.7 and we think inflation should finish the year 2.7 to 3, we're just about 2 % real yields, which again is normal. What's not normal is what's gone on in the last month. Long-term yields have been moving. At the end of June, you had a 30-year at 3.85%, and this week it's at 4.85%. The TLT, which is the ETF that owns long-term bonds, that's where, if you're following along at home, that's where you can see the damage. Absolutely hammered. The TLT is down 43 % from the highs of late 2020, back when we thought interest rates would be zero forever and we were all going to die of the pandemic.

36:50Short duration is now not moving anymore. BIL is the ETF you can use to see short-term treasury bonds. That is done moving. And so all of the action this past month is in the long end. Remember how I started this off. I told you long-term bonds are first now figuring out what the short-dated bonds have known for a year and a half. Josh, if you think about 2024. I try not to. But if you're forced to, aren't we just so overdue for an actual recession at the same time you usually don't have them in election years? Doesn't it feel like at some point, and back to your point, if you predict a recession for long enough, eventually you'll be right.

37:31But doesn't it feel like we've been dancing in the raindrops for so long and there are so many winds that are slowly picking up in our face? Well, you need a shock. People are not all of a sudden going to, of their own volition, decide it's a recession and curtail their lifestyle accordingly. So you need something to happen. In 2000, it was the tech bubble blowing up. It was a very mild recession. In fact, most people didn't feel it at all. If they weren't invested in NASDAQ stocks, you have to almost convince them that there was one. Fuck, I got run over by a truck. I literally, I got run over by it.

38:07You mean there was something outside of the technologies? I was living in San Francisco. I'd started to come like a red envelope. I literally, like that was Vietnam for me. You were the pets.com sock puppet. All right, but most people, but you'll concede most people weren't. What happened five years later in the great financial crisis is different. It affected everyone. This is not that. We do not have borrowers extended to the extent that they were. The credit quality of the recent vintage mortgages that are buying all these homes is way better. The banks have significant regulation if they want to play fast and loose with lending.

38:45They can't. They can't hold the stuff on their balance sheet. They've got to mark their portfolio to market if it's held for sale. If it's held for maturity, that's a separate portfolio and that's treated differently. But the financial controls are there. Yes, there's shadow banking. Yes, there are some lenders doing some crazy shit over the last couple of years, but nobody that's systemically important. And that's a really big difference between whatever we're about to go through in 2024 versus what we've gone through historically. So you need the shock. What is the exogenous shock that's going to happen that's going to all of a sudden make the recession real?

39:20Until then, look, last year, 2022, they were doing these CFO surveys. They were asking thousands of CFOs at public companies, is it a recession? And unanimously, they said, yeah, recession's coming. So paradoxically, if everybody gets themselves prepared for a recession, it's hard to have one because you don't have people acting out the way that they normally would at the tail end of a boom. So we might have almost like talked ourselves out of a recession this year. I don't think we can forestall it forever. A recession is always coming. But like the timing is really difficult. And then the severity and then the duration.

40:02What if we had a two quarter recession? I would argue Silicon Valley had a recession last year. In fact, the tech layoffs peaked in January of 2023. We had mass layoff announcements every day of the week in the entirety of the second half of 2022. And then look at startup valuations. Scott, you know more about this than I do. It's possible that we had a localized tech and telecom and media recession. it affected Netflix way more than it affected somebody who owns a gas station. And, you know, we've had those before in 2015, 2016, Texas had a recession. Most people don't understand that a price of oil collapsed.

40:44And if you lived in Oklahoma, Texas, certain parts of certain regions, you know, you experienced what felt like a recession. We have clients that are executives of oil companies. They told us about it. So it is possible to have a rolling recession that doesn't go nationwide, all segments, all regions, all at once. And that becomes a trickier world to navigate if that's where we are. But that fragmentation lines up with the fragmentation that we're seeing everywhere else. I was listening to Warren Littlefield talk about the 1990s and the must-see TV era and how Cosby would get a 52 share. That means 52 % of the people watching television were watching Cosby.

41:25That world doesn't exist anymore. So if you have that level of fragmentation elsewhere in the economy, why couldn't we say overall certain parts of the country or certain cities might have a recession and others might avoid it? If you were to pick one thing, Josh, that we're missing about the economy, the markets right now, where you think there's some dissonance or disconnect between reality and what's being reported in media, what would it be? I'm hearing a lot about the death of the 60-40 portfolio. I've been hearing it since January. Most of the people saying it, they're journalists, writing articles that you will click on.

42:01So I get it. I understand the mentality. The 60-40 portfolio right now today is actually a healthier proposition than at any time in the last 15 years. I want you to think about this. There are no rules of thumb in the market that work. There's no right PE to buy stocks at, price-earnings ratio. There's no right dividend level. There's nothing that works formulaically so much so that we could say, oh yes, this is the right answer to that. There's something that gets really close. The relationship between starting yields of a bond portfolio and their subsequent forward returns is really strong.

42:42Like I mean like an R squared, like 93 % or something. Meaning if starting yields for long duration bonds of a 30-year treasury are 5 % right now, there is a extremely high, almost 100 % probability that your returns over the next 30 years from this starting point will be something on the order of 5 % a year. Now it's lumpy. It's not going to line up each year. Oh, there's my 5%. That ain't how it works. You're going to have a lot of volatility in the price along the way. But if you think about a 10-year treasury yielding 5%, you could almost set your watch to the idea that 10 years from now, you will have received a 5 % return.

43:29That's total return, not just the income, the coupon, but the price and the yield. So if we know that that relationship is as close as you get to an iron law of finance, that starting yields today will dictate forward returns. If we know that, then arguably the 60-40 has never made more sense in the last decade and a half than it makes today. I'm giving you a starting yield. Let's say you buy the Barclays Aggregate Bond Index. That's like the S &P 500, but for fixed income. it's almost all treasuries and a little bit of very highly rated corporates right if i'm giving that to you at four and a half percent there's a very high likelihood that over the next 10 years you'll be able to look back and say wow i earned about four and a half percent a year so that's a really good starting point for the fixed income portion of a 60 40 way better than three years ago when the best you could hope for from the bonds was low volatility and virtually no return So as a portfolio manager, as a financial advisor, somebody that's helping people make this decision with tens of millions, hundreds of millions of dollars, that's one of the biggest misconceptions that I want to clear up.

44:42Two, spreads have not blown out. And until they do, I'm going to define that in a minute. Until they do, stop saying recession. It's like ludicrous. What are spreads, credit spreads? When you buy a corporate bond, you're getting a higher interest rate than you would get from an equivalent maturity in a treasury. So if I lend money, for example, to Microsoft, I should be, maybe Microsoft's a bad example. It's almost like a sovereign nation. let's say any other stock you could think of salesforce.com if i buy a 10-year bond from them i should be getting a higher return than if i buy a 10-year treasury why i'm accepting more risk therefore i should be getting more income for taking that additional risk this is like 101 okay all right until we see a scenario where the yields on corporate bonds are blowing out meaning going substantially higher than the equivalent maturity treasury bond, then we are not in a situation where recession is even on the menu.

45:47That will be one of the things that happens that tells you things are deteriorating. When people are less willing to accept the risk of those corporate bonds, therefore the bonds sell off, therefore the yields go higher on those bonds, that will be when you know that we are truly pricing in a deterioration in the landscape. The bond investors will be a lot more risk averse than the equity investors. They will not hold a bond that they don't think they're going to get paid back on. And you will see spreads blow out. You'll see the treasury yield stand still and you'll see the corporate bond yield start to shriek higher.

46:24And that's a canary in the coal mine that just has not happened yet. And in fact, you want to laugh? Look at year to date. High yield bonds, junk bonds and investment grade corporate bonds are actually outperforming treasuries year to date. Not only are they not pricing in any kind of deterioration, they're actually doing better than treasuries, which is perverse. It shouldn't be that way, but it is that way. And I don't think most people understand that. Just to wrap up here, and I really enjoy hanging out with you and Barry. My sense is one of the amazing things about the market is that at the end of the day, none of us know.

47:01Barry knows. The rest of us don't know. Other than Barry. But we do know some things. You were talking about the 5 % rule. The only truisms I've come to is that one, diversification, and two, patience, or just time. That if you're diversified and you're willing to put stuff away for a while, pick any five S &P stocks since the beginning of the S &P, if you hold them for 10 years, no one's ever lost money. Isn't at the end of the day, the only thing we know is diversification and time? You have to have a philosophy that says, long-term, overall, I'm willing to bet that American companies are going to increase their profits and that investors are going to be willing to pay more for those profits as time goes on.

47:51You have to make that bet to be a long-term investor. Your fundamental backdrop of everything that you do has to be that companies get better, products get better, technological advances occur, and the quality of life improves. And as a result, more money is made because the company's doing that or doing that with a profit motive. If you have a world philosophy that differs from that, you're probably not going to be a great investor. You might be a great trader. And some of the better, shorter term macro traders are way more bearish than that statement I just made. But for most people that are not going to try to fight the world and convince 100 million investors that I'm right, you're wrong.

48:34Like for most normal people who are just going to allocate and be patient, that has to be the philosophy that you have. I think the real thing that I would want to say though, especially to your audience, Ed, how old are you? 24. Okay. Do you want the stock market to go up or down this year? up please why i want to make money but you're buying you're buying stocks on a regular basis okay if you haven't figured out the trick yet i do cnbc and the audience skews rich and old not like too old i love the audience but they're older they're not you they're not 24 oh but boss cnb the average age of a cnbc viewer is dead all right all right i mean jesus christ stop it's it's older than our elected leaders.

49:17Fine. Listen to me. The CNBC audience, they have most of the money that they're ever going to make already invested. Of course they want the market to go higher. Yeah. That's not you. You are a forced buyer of stocks and bonds every two weeks when you get your paycheck, assuming Scott is paying you. Someone will be paying you. For the next 50 years, You have no choice but to buy into a 401k, into an IRA. You're a forced buyer. Why on earth would you be rooting for higher prices? Why do you want to buy stocks from my parents at higher prices? How does that serve your interests? It doesn't. The number one thing I want this audience to hear from me, you have got to flip your mentality around.

50:00If you're not using the money inside of the next two years and you're a forced saver, by the way, I am. I'm 46. I'm allocating a 401k adding to it every two weeks right if you're a forced buyer and not using the money why on earth would you want to be buying at ever higher prices it makes absolutely no sense now the one thing that younger people should root for the market to at least be stable for is they're probably the first people to get fired when share prices drop and companies start laying people off and restructuring. Okay, fine. So from that standpoint, you're probably not rooting for a crash.

50:38You should absolutely not be rooting for 14 % annual returns because all that's doing is guaranteeing that you're going to be paying more and more and more for your investments. You want to buy low. Nothing could be better for your generation, Ed, than a lost decade where stocks are volatile but go nowhere. Because in the subsequent decade, when we go from Dow 35 ,000 to 55 ,000, you will have accumulated that much more, that many more shares in these companies. And again, you are forced to. We have organized this country around a 401k. Literally, it's the only way to survive is to have an investment portfolio.

51:18Almost nobody can live on their wages alone throughout the course of their lifespan. So I want you to stop rooting for new record highs and focus on your career and let the markets do what they will do and never feel despondent about sell-offs or volatility. Those things are helping you accumulate more stock as time goes on. That's great advice. Awesome. Josh Brown is the co-founder and CEO of Ritholtz Wealth Management, a New York City-based investment advisory firm managing more than$4 billion in assets for individuals, corporate retirement plans, and foundations. Josh, I just love, I love how you just kind of break it down and I think you're just a huge asset.

51:58Whenever I see you on CNBC, I actually turn up the volume. Thank you, Scott. Thanks, brother.

52:14Okay, let's take a look at the week ahead. We'll see the consumer price and producer price indices for September, and we'll see the minutes from the Federal Reserve's last meeting. And finally, third quarter earnings season kicks off with JP Morgan, Citibank, Wells Fargo, and PNC reporting. Scott, do you have any predictions for us? We're beating a dead horse here, but the indices that track the snack food industrial complex and some of the bigger retailers that sell foodstuffs, Kroger's, Walmart, PepsiCo, Coca-Cola, I think we're going to see fairly serious drawdowns. And there's just going to be more and more in the media about the impact of these breakthrough drugs.

52:58This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our executive producers are Jason Stavros and Catherine Dillon. Mia Silverio is our research lead and Drew Burrows is our technical director. Thank you for listening to Prop G Markets from the Vox Media Podcast Network. Join us on Wednesday for office hours and we'll be back with a fresh take on markets every Monday.

53:19Lifetimes

53:24You help me In kind reunion

53:35As the world turns And the dark light In love, love, love, love

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