Irene:

Hi everyone. Thank you for joining WisdomTree's Office Fours on The Fed 'March'es into Q2 on Hold where you will hear from Professor Jeremy Siegel, WisdomTree senior economist, Jeremy Schwartz, our Global Chief Investment Officer, and Kevin Flanagan, our head of fixed income strategy.

Jeremy Schwartz:

Thanks, Irene and professor, it's always great to be with you. I'm sure you're even more excited when you see a lot of green on the screen and new highs in the S&P. We've been talking about broader participation in the rally. We see that a little bit today with the comments from Powell, but always great to get the professor's reaction on what he sees, what he expects, and what we're going to see going forward. So professor, I'll take it to you to share your thoughts.

Professor Siegel:

Thank you, Jeremy. This was more dovish than I thought it was. I give a little warning this morning. I thought the dot plots were going to show one, I mean two cuts. It did show three by the skin of your teeth. There were nine that were at three and one or more and there were eight that were two or less, but it seemed like if one person changed their opinion that would've changed a headline. They definitely moved up 2025 and for the first time in years and years they're moving up their long run.

Now, we've talked about this for a long time. Our star, the real rate at equilibrium is not a half percent anymore. I don't even think it's three quarters. I think it's one and a half at least, which would really make the long run three and a half. The history of the Fed is way too slow at moving that. They moved it down way too slowly over the years from four and a half down to two and a half, and now they're going to move it up also too slowly, but that's one reason why I think basically the long bond at 4 2 7 right now is exactly where it was at 1 59, 1 minute before the Fed announcement. It just didn't move. Now 2-years moved down of course because there was fear that there was going to be a more aggressive Fed.

Really he's totally balanced now. I liked, and this is really good for stocks, his statement is that any unexpected weakness in the labor market is reason to lower. I mean, this is saying I'm looking at that too as I should. It's my dual mandate. I've got inflation. It's not where I want it, but it's low enough that if I see weakness in the labor market, I'm going to lower. I mean this is very positive clearly for equities going forward.

Also, by the way, he mentioned none of our indicators show weakness in the labor market and in fact, he explicitly mentioned unemployment claims, which is of course a number that we've been talking about all the time that I look at very closely, and it was also showing absolutely no weakness in the labor market.

I was a little disappointed. He talked about wages not being a problem, but he didn't talk about one of the reasons wage isn't the problem is because productivity is high. I thought he should have thrown that in because it is high and that's one reason why you can have lower wages, lower inflation, even with the wages at 4% or so.

Another thing he mentioned, this has been a theme that we've been talking about for months if not years. He said, yeah, rent will eventually get into our CPI to push it down by the second half of the year. We don't know when he said, I don't know when though. It's sort of like we don't know when those crazy statisticians at the BOS if we're only going to do something right here and get that rent in there. But you know that Jeremy and I have been doing a real rent index. We show year over year under 2% if you use real rent indexes and rather than the BOS rent indexes, he seemed to nod his head saying, I don't know when that's going to kick in, but that's going to be a downward move.

On the other side, there are two things to watch and these are not bearish for stocks, but there's something to watch. The downward movement of sensitive commodity prices is over. The Bloomberg and the other indexes have broken their down trends. I'm not saying they're starting an uptrend, but that big downward movement that we've seen over the last 12 to 18 months is over with sensitive commodities up and down. And I don't just mean oil, which although down today has definitely been on the firm side. So we definitely see that.

Something else which I've been encouraged at. Now we don't get the M2 money supply and it's lagged until the fourth Tuesday of the month, but I follow weekly deposits at banks. It has been rising. Now it's only 1% above a year ago, but it had been totally stagnant and over the last five to six weeks I've actually seen some increases. That comes out Tuesday at one o'clock for those of you who want to check out that data, that's encouraging. That's a major part of that money supply. We want that to grow at a reasonable rate. We may not need it to grow at five, five and a half because of substitutes such as our USFR that can be used that are not counting them to money supply but should be since money market mutual funds are. But nonetheless, that is growing again, so we're not getting pressure from that.

Another very positive thing that should be mentioned, he does not want to repeat of 2018, '19 when they were lowering quantitative tightening lowering reserves and suddenly the bank said, ouch, and there was a little bit of a disturbance chaos in the Fed funds commercial paper market as a result of that and he said, we're going to lower the rate now, not ready to say when. Is it June or September? I think they're going to probably lower to maybe 40 to 50 billion a month rather than the 95 billion that they have today. But that's a cautionary. We don't know how much is just enough for the banks. Obviously we underestimated that number five years ago and we pinched them so we want to approach this quantitative tightening slowly.

Now, I've been one of these that's say don't get over excited about that, but it's good that they are cognizant of it and don't want to repeat of 2019. So basically from what I can see, all the right words are coming, not overly anxious, just like he wasn't overly encouraged about the inflation coming down last year and saying stampede him to lowering rates. I'm not overly anxious about two numbers that are slightly higher than anticipated going into that and that basically seems to be the message. The next meeting is May 1st. Of course we have another cycle of CPIs, PPIs to go through and see if there's any really weakness in the labor market going forward.

There's also been more talk, as you all know about the strength and labor market power coming from immigrants boosting that labor supply. But from what I could see, this is a green light for stocks. Now they're fully valued, so it isn't like we're going from an undervalued position to shooting up, but nonetheless, this is a green light for stocks. The economy is still moving. GDP this quarter that's ending looks like it's going to be around 2%. JP Morgan, Goldman's over at high ones. I believe that Atlanta's a low two, so they're very close. It looks like a 2% quarter and that was a big jump as we know that the estimate is that GDP for 2024 is actually going to be 2.1. This was 1.4. I mean I'll have to go back on my records. To have a 70 basis point jump in a yearly GDP growth number over a three-month period, I don't remember seeing it that high.

Now one has to realize if my memory serves me in December of 2022, they were forecasting 0.9% GDP for 2023, way underestimated. And they started this year by underestimating it also, but they've jumped it up to a number now that certainly is virtually what the number it looks like in the first quarter of this year. Kevin, what is your reaction here?

Kevin Flanagan:

Well, professor, I wanted to ask you a question. So when we've been doing these for a while now and the expectation was March was going to be, let's call it, even though it's cutting rates lift off, that's a moot point now. I think we can all agree to, and now June is sort of like the new timeframe for when the rate cuts are going to begin, but we've been talking in our investment committee that maybe let's not get bogged down with when the cuts begin, but what are they going to look like? What is this episode of rate cuts going to look like? And a couple of weeks ago, Vice Chair Jefferson was talking about 1995 as being a parallel when they began cutting rates after raising rates 300 basis points in '94, they then started cutting rates in July of '95, then December '95 and one more time I think in January 96 and that was it. Should we take any lessons from '95 into what we're going to see now?

Professor Siegel:

Kevin, I think it's very dangerous. People they point to one historical. There are so many things different about the economy today then, we're talking '95 is 30 years ago and I remember it, but I would really be reluctant to take any parallels. I mean, this is recovery from COVID, which of course we didn't have an epidemic for a hundred years. There's something, we didn't have a money explosion like this ever before and then a money contraction. So there are things that are going on that are just so out of historical precedent that when people bring me back to one, I kind of shrug my shoulders more than anything else. I think it's really dangerous.

People hang on these estimates of these FOMC participants and the truth of the matter is they're not really forecasters. They're not better than any other forecasters, maybe not even as good as the average private forecasters. Do they really know? No, they say I'll wait until the data comes through and I nudge one way or the other. If they're a little hotter, we'll hold. If it's a little cooler, maybe that's the time to go down.

We only have really one month until the May meeting and the month of April could we get weakness that's that much. I did mention that even though 4% is there, in fact their unemployment target for the end of this year as I'm looking at it is 4 0. 4 0 would grab some headlines. I mean, it's a political year. I mean obviously the Republicans will say, my God, it's highest in two and a half years. It's moving in the wrong direction. Would there be pressure on the Fed? The Fed is supposed to be independent, but it is a political animal. It's going to be as independent as it can be.

Right now, Chairman Powell is grinning ear to ear. Listen, this could not have been a better scenario. Remember how many mainstream economists, unfortunately not me included, although once I respect that said it was absolutely impossible to reduce inflation without substantially increasing the unemployment rate. And I said, this looks very different for me, for a number of reasons could happen. I didn't say would but it could. So they're grinning end to ear. They're really not on the hot seat as they were for so many months when they were so delayed in terms of rising inflation. They're really sort of happy.

If the economy continues to chug at a 5.3 Fed funds rate with no slowdown and as long as commodity prices have stabilized and the deposits seem to be on a slightly rising trend, you can really ask your questions, do they really need to cut? And by the way, I said I thought four four and a half percent was a long run 10 year, and I still say that, but if I would say, what are the risks on that? I would say the risks are on the upside.

Kevin Flanagan:

So just to follow up-

Professor Siegel:

On that, if there are risks on the upside, I mean what are we now on the 10-year? 4 27. Yeah.

Kevin Flanagan:

So I just wanted to follow up on that because it goes right into one of the questions we've got and something Powell said at the Humphrey Hawkins testimony last week that the Fed doesn't necessarily have to wait for inflation to get down to its 2% target.

Professor Siegel:

That's correct.

Kevin Flanagan:

So let's just say for argument's sake, it gets to two and a half and they're itching to go. Is that a potential policy mistake? Do they reignite inflation if they cut rates?

Professor Siegel:

No, I don't see it. Certainly, no. As I say, what I look at sensitive commodities outside of oil, the oil is a factor, but often you have to understand it has some unique supply characteristics. I look at those weekly unemployment claims. I look at that weekly deposits and liquidity that's provided by the banks, and you could also look at spreads between junk bonds and AAAs and you can look at financial conditions index. These are really sensitive indices that would indicate some sort of tightness in there or anything like that. And I don't see them. All I am saying is can my prices stop going down? And deposits are, thank goodness, rising modestly again. That's not inflationary, but it is no longer deflationary.

Now, one should also say about the housing that is held up so well, we had a really strong housing starts. Builders are buying down those mortgages. They're buying them down to 5%, which means they're putting it into price. Whatever that cost is, I haven't calculated 10% or whatever the mortgage is or whatever. They're just adding it to the price and then everyone thinks, well, home prices go up five, 7% a year always. It doesn't matter. People don't understand it. Well, it matters where you're starting from, but they're selling homes as a result of that. But they're buying down those mortgages over there. The real true, I mean right now the no point 30 year mortgages are over 7%, seven to seven and half no points. And that's pretty stiff at today's prices. So I'm wondering how long housing can stand on that. But let me go back to Kevin.

Let's put it this way, if inflation continues to go down by their measures, even if real activity stays where it is, 2% real GDP, unemployment claims within the range, et cetera and so on, they should lower rates on that because Powell has repeated that the fact is they don't think the real rate should be this high. Now I think the real rate is higher than think, but not this high. And so they would be lowering rates just to keep the real rate from getting higher at that point. The most beautiful spot of all is to keep the economy chugging and the unemployment rate, I mean the inflation rate to keep on going down and then the lower rates as a result to an absolute smoothest landing that you can't even feel the bump on the runway.

But right now, nothing disturbs the scenario that we have been offering here. I think the stock market's in a strong up trend. I guess there are momentum players. There always are momentum players. I cannot answer the question whether this is the beginning of a, is this a '96, '97 beginning of the bubble? It's way too early to tell whether this is now. Nvidia 35 times forward earnings is certainly not expensive, but those bubbles can form at any time in any market.

Jeremy Schwartz:

Yeah, I was going to go with a related question because coming into the year we talked about broader participation and today's market moves. You saw small caps outperforming. Is that part of the thesis too that hey, the Fed is now showing their flexibility, lowers the probability. When you talked about the S&P at fair value, small caps at 12 to 13 times earnings in many places are definitely not their normal value.

Professor Siegel:

No, they're not. I mean, I would have to look at each of the, you know better than I Jeremy about the weightings on each sector. I mean, what is the tech rate? What is the tech percentage on the Russell 2000?

Jeremy Schwartz:

Much, much smaller than large caps.

Professor Siegel:

Yeah, much smaller.

Jeremy Schwartz:

It's much...

Professor Siegel:

And of course, and the financials much larger and they're smaller financials, they're not the JP Morgans. And they're obviously, I mean listen, the commercial real estate, it's going to keep those depressed for a long time. Now, as long as, listen, we've talked about this. If that firm is paying a dividend and is not going under, in other words, you'll do well by holding it at a depressed price. But I don't think the pressure is off on commercial real estate. I'm not saying it's increasing, but I mean that New York Community Bank would still after supposedly knowing, not knowing, a lot of banks are looking the other way on what they are. Now, I think investors, I mean some people think investors are still being fooled. I'm not so sure they are. But it's a lemons problem. I don't know whether you're fooled or not so I have to price you very carefully.

Now, as far as other small firms are concerned, yeah, mean the infrastructure spending that's taken place, the fact that interest rates will eventually go down, but I think right now, I mean what is, well, prime rates usually what 300 basis points above the Fed funds. So that's about eight, right? I mean, if small firms are borrowing prime or maybe they're at what SOFR and not LIBOR. It used to be LIBOR. SOFR plus one two, if they got really good credit ratings and they're on a floating basis, so they're still six to seven. Now, that's much higher than inflation. You've got to have a good profit margin if you've got a lot of rolling short term debt. I mean, it's so much different when interest rates were basically zero and inflation was three 4%, so your inventory was going up and now compared to now when that has reversed.