Webinar Replay

Is This the End of the Line?

November 1, 2023

During this Office Hours replay, Professor Jeremy Siegel WisdomTree Senior Economist, Jeremy Schwartz Global Chief Investment Officerand Kevin Flanagan Head of Fixed Income Strategy discuss the results of the October FOMC meeting. As part of the discussion, attention is given to not just the formal policy statement but also Chairman Powell’s press conference and the Fed’s updated Summary of Economic Projections.

This event was simulcast on Zoom.


Hi, everyone. Thank you for joining the special edition of WisdomTree Office Hours Post Fed meeting that's titled, "Is this the end of the line?" where you'll hear from Professor Jeremy Siegel, WisdomTree, senior economist, Jeremy Schwartz, global chief investment officer, and Kevin Flanagan, head of fixed-income strategy.


Jeremy Schwartz:

Thanks, Irene, and Kevin, professor, always great to be on with you on these Fed days. Today we got a nice market reaction to the Fed. It's always great to get the professor's take on what he's hearing. We'll give a little bit of how to be thinking about positioning across all assets from equities, fixed income.

We manage the model portfolios with the professor and we'll talk about some of the latest trades we've been thinking about in those model portfolios. But professor, I want to kick it off to you to give us your reaction. What did you hear from Powell today? What did the market like?


Professor Siegel:

Yeah, we can tell how the market reacts if we just take a look. Now it's up 222, pretty good, and I agree with that totally. I saw flexibility. I saw a recognition that as he said, that we have to look at the downside as well as the upside. I saw much less conviction that they had to raise in December.

As you may remember, in the September FOMC meeting, Powell said, "Well, most of our participants believe one more raise would be appropriate." He did not stress that. He said, "December will be what December will be. We'll be looking at the data." He didn't want to be bound by the September forecast for the next FOMC meeting.

My belief is at this point, and we still have six weeks, we have two employment reports, two more inflation reports, an awful lot more going on certainly, and that could change the picture, but I think he's done. And if it's a close call, I don't think he wants to raise rates 12 days before Christmas.

I think people, certainly those that are in the housing market and those are in the borrowing credit are saying, "My goodness, it's already high enough." So my feeling is that they will be on hold and I think, again, I think the most important thing about and market is he going to be flexible if he sees weakness? And as time goes on, I see more and more flexibility there. I think that that's important.

I also think, by the way, he got a unanimous vote and I know that there were some hawks there that feel that we should hike again. He brought them all in line. He loves consensus. As you know, there's been over a year and a half of consensus, and I think that was also a positive for this. He didn't mention, a little surprising, he didn't mention potential threats from the Mideast situation that could raise the price of oil because, well, partly oil has actually fallen and certainly recently.

And also when you take a look at the data, it is true that since the last meeting, inflation data has been not better than expected. Not terrible, but the other data, one thing, one word that I thought was missing if I were to critique him, he was asked, "Well, how could the real economy doing so well?" He should have said, productivity is one of the factors. What he said was increasing the labor force, supply side normalization, and all that is true, but really what's given us this GDP surge, despite the fact that hiring has been good but not anywhere near what was true last year has been a bounce back in productivity.

As I've often said, last year was the worst productivity year in 80 years and this year we're getting a bounce back and I see that bounce back continuing through the fourth quarter and into 2024. I think we should also mention that Stanley Druckenmiller was on CNBC at 7:00 AM. I don't know how many people listened to him. He's very frightened about the deficit, and I was just looking at Jeff Gundlach who was also on CNBC commenting on the Fed action, who's also said, "I'm worried about the deficit."

I'm not as worried about the deficit as they are. Not that it isn't a problem, I just don't see it as an immediate problem. It seems like Gundlach said that rats will go up and down because he looks at a recession. I don't see a recession coming. I'm not saying it can't, but I don't see it's coming. And again, if Powell's going to be flexible and start lowering rates, I think that would stabilize risk assets quite dramatically if there is a pull down in real economic activity.

And then he thought that rates were, Gundlach I'm talking about, rates would go back up again because everyone would see how big the deficit is. Well, I don't know. I mean if rates go down, then the deficit does gets better from that. A recession does increase deficit because tax revenues do go down. Listen, as I've often said, we are spending too much, but the debt to GDP ratio in my opinion is on a mild increase for the next five to eight years. Then it starts kinking upward in the middle of the 2030s more than anything else. We've got to do something about entitlements, et cetera and so on, and I think things will be done by then.

One has to remember that a lot of things might be done much sooner than then because as you know, a great deal of the Trump tax cuts expire at the end of 2025, and unless the Republicans will control both the Presidency, the House of Representatives and the US Senate, not impossible, but not what the odds makers think is going to happen, unless they control all those three of those branches, you know that many of those tax cuts are going to be totally rewritten and they're going to be higher taxes and there's definitely going to be higher taxes on the higher end to be sure.

So it's not a matter of there's no way to raise taxes. Tax increases because of the budgeting process have sunset clauses and they have to be negotiating 2016, 17 increases. We're now seven, eight years away, and that's exactly what the budget process is for. So again, I'm not as worried about the deficit right now. I don't think that's going to be a major force in the economy.

I'm very positive on stocks. I think stocks selling at 16 and a half, 17 times, and I guess they're back to 17 times next year's earnings. Yeah, it's true, next year's earnings maybe shaded a bit, but that's still a very, very, very, very cheap rate. And of course that's including the magnificent seven when we talk about the S&P 500, which are what, Jeremy 30% of the market value?


Jeremy Schwartz:

Yeah, if you look at the tech, the expanded tech is approaching 40%. Magnificent seven probably a little bit less than that, but yeah, around 40% is the-

Professor Siegel:

Yeah, including some of the communications and a couple of others. Sure. So as you know, once you subtract out and get into the value sector, you're at 13, 14. Once you get into the small midcap sector, you're 11 and 12. And in a way, Gundlach said it's something I'm buying this credit because it's already discounted and even if we go into recession, it's not going to get worse.

At 11, 12 times earnings. You are in fact virtually pricing on recession levels. So anything not as bad as that is could be strong upside for that class of assets, which has certainly been very, very beaten down. November is I heard some people say that was the best month of the year. Actually, I think our data stocks are the long run over the last 25 years, I think it's been the second best after April, but it is a close second best if you believe in seasonals. December is also a fairly good time.

Obviously anything can happen, anything can spin out of control. That's what makes the market the market. Take a look at the long bond. I see 476 right now. I'm talking about the 10 year. It started out above 490 today. There were three I think reasons. The first was the funding was not as bad as expected. The long end issuance, as you know last July, that kind of shocked the mark. I don't think that was a whole reason why real yields rose over that period, but it was certainly attributed as one of the reasons.

And then I think the ISM reports were weakish. Definitely you get to 46 when 50 is an expectation on all of them. That bears looking at. Tomorrow we get jobless claims, which has been very, very strong. Friday of course, we get the employment report. The ADP report showed a deceleration into the mid one hundreds. We'll take a look at that on Friday. So there's an awful lot of data that's coming that's going to shape certainly monetary policy going forward.


Kevin Flanagan:

So professor, we have a bunch of questions that I know there's limited time, so I wanted to try to put a few of them together and one of them, I think you kind of touched on, why were economists projections so wrong about a recession for this year? You were talking about productivity and then take it to the next step would be if we don't see a recession for next year, what would be the catalyst for the Fed to cut rates? So if you could answer a little bit more on that first, why was everyone so wrong about the recession call this year?


Professor Siegel:

Well, I was calling for a slowdown, and let me be honest, I was very worried at the pace they were tightening. I was very worried about the decline in the money supply, but the decline in the money supply, what I saw towards the summer was commodity prices stabilizing. I saw jobless claims, an early warning originally going up, but then going back down and I began to say, this economy has a burst of productivity that can support higher yields, and I did make a turnaround and my feeling is don't stick to something when you see something else happen.

Now, I wasn't predicting recession, I was predicting a slowdown and I was worried. The money supply, by the way, started increasing again, April, May, June. July, and August began a little decline again, and I want to see, that again bears watching, but if you want to talk about why we haven't basically had a recession is, one of the reasons is this comeback in productivity because we have had only about one third the increase in payroll gains that we'd had in 2022, yet we're running at two to three times the GDP growth and the only way you can do that is a productivity gain.

Yes, there's been a little bit, and Powell did mention a little bit better labor force participation, but productivity has been a big source of that gain. You could call it coming back from work from home, disciplining work from home, people realizing they couldn't do nothing anymore because the job market wasn't quite as tight as it was and they would get fired if they didn't do anything. People started doing things and from the worst productivity, again in 80 years in 2022, we've had only a partial rebound.

As I said, I expect it could continue into 2024, even with payroll being in the area of 80, 100, 150, 1,000 gain per month. So I think a productivity under estimate a fact that we began to have stabilization of some of the key variables, including the money supply and commodities, the dollar which would going way up began to go down again. So all those things began to keep demand higher than they otherwise would've been.

Kevin Flanagan:

Now how about for next year? What gets the Fed to cut rates to reduce rates?

Professor Siegel:

Well, I think, okay, so let's face some political facts. I mean, Fed does not, everyone pretends that they're only motivated by economics, but nothing in Washington is only motivated by economics. Politics is always there. We are 12 months away from presidential election. Political pressures are, and this looks like it's going to be a close election, political pressures are going to be very, very strong on the Fed.

Remember two things. The Fed is a creation of Congress. Congress could tomorrow come together and say, we abolish the Fed and there's no constitutional recourse because it isn't in the Constitution. In fact, the Constitution says the House of Representatives should control the money supply. Maybe you don't want that to happen, neither do I, but nonetheless, I'm saying there are political realities here.

There's also political realities, and I've been speaking to these yes, inflation running a little higher. Yes, it's hard for him to squeeze down that last one to two percentage points, but is he going to squeeze down those last one or two percentage points and put a million people out of work in an election year that promises to be close. In A man who says, Jay Powell, "I love my job," which means it sounds like he wants to be renominated, which comes just a few months after the election. So now put all those things together.

Are you not going to be sensitive to any slowdown in the economy and be so stubborn on inflation that you're going to keep on raising no matter what? Remember, the Fed still does have a dual mandate so that if they see you say our weakness, they say, "Listen, this is our dual mandate. We temporarily have to ease off on the inflation mandate," even though over the last year and a half he's basically saying, we're not going to do anything until we get inflation down.

The truth of the matter is it can fall back on the dual mandate, which is what Congress passed, and use that as a reason to reduce the rates if we do see weakness. And if we do see weakness, think about this, if we do see weakness and the unemployment rate starts rising and recession talks are going, if the Fed starts lowering rates and we start lowering 50, 60 basis points down to 4, 3, 3, you don't think stocks will be supported despite the fact that earnings won't quite meet the 2024 level?

It's much more important in the long run that you have long run growth rather than you have when one or two years of subpar growth, as long as you get back on track and if the Fed is willing to lower rates, if they see weakness, that guarantees that you will get back on track as we always have done in the past.


Jeremy Schwartz:

A few questions come back. You mentioned upgrading your forecast for long-term rates, and so you've had a huge spike in real rates, and there's a few questions that came in about where do you see long-term interest rates? Give us a little bit of your outline of how that view evolved.


Professor Siegel:

Yeah, well, again, real long-term rates have fell precipitously from 2000 when the 10-year tips was well over 4% down to minus 1.5% during the early phase of the pandemic. Now it's 2 point... Oh, what do I see it right now as? Actually 2.34. Actually almost hit two 50 a couple days ago. That's a big increase, but not where it was and not even to where, by the way, when it was first floated treasury inflation where Texas secures in 1997 as 3.5%, but that is a big rise.

Now, what is the cause of the big rise? It's partly the Fed, sure, but it is also the stronger growth. Remember, almost all forecasters were less than 1% GDP, we are going to be over two. By the time this year ends, it's going to be two to two and a half, so that's a one and a half percentage points increase. Also, optimism about the future. AI is real. Now we can question about how fast it's going to be implemented, but nonetheless, to say that that could not accelerate growth from 0.9%.

Listen, when I was young in the 1950s and sixties, 4% GDP growth, now population was growing faster, but we also have faster productivity growth then, believe it or not, can we approach those levels as before? Well, maybe not four or four and a half, but certainly better than one, faster productivity growth. And then a major factor.

Bonds are now not seen as good a hedge risk again, hedge against equity risk as they were before. Treasury bonds are fantastic hedges. If you have geopolitical risk, if you have recession risk, if you have pandemic risk and all that. They are terrible hedges if you have inflation risk. Now, I asked you the question, what is your probability that we have inflation risk? How do you think it changed over the next 10 years?

And I do think we're coming down from where we are today, so I'm not saying we're going to flare up again next year, but think about your perception of inflation risk over the next 10 years compared to what you thought in 2020 and 2021. And all I was hearing from people is we all believe that technology is going to continue the downward force on prices as it did for 40 years and you know as well as I did in 2021, I said the 40-year bull market in bonds was over. 40 years.

The longest bull market of any major class in world history was over and it was with a bang. So when you look ahead next 10 years, are you saying, "Do I want to owe bonds in a world that could be inflationary even tips?" Because if the Fed has to move against inflation, got to raise those real rates too so you're going to be harmed on that. So what happens to the correlation between stocks and bonds? It goes from bonds being a real great hedge negative beta asset to bonds being not so great a hedge, a zero or positive beta asset, and that raises real yields and that raises nominal yields.


Jeremy Schwartz:

So there's a few implications of that. I'm going to come back to the professor in a second, Kevin, but just for your perspective, he's talking about the risk of duration and then we had a few questions from people on, well, what's the best way to get into fixed income today with all these Fed considerations. As we think about positioning our own models for fixed income, do you want to talk a little bit about your current views on and how we position in models as well?


Kevin Flanagan:

Yeah, and professor, it's not the first time us bond guys have heard our better days are behind us. We hear that a lot.


Jeremy Schwartz:

Hey, he's giving you higher for longer.


Professor Siegel:

Actually, you know what? Your better days might be ahead of you because your worst days have just been behind you.


Kevin Flanagan:

So I mean, we've been of the mantra we'd rather be late than early to the duration party. That hasn't necessarily changed in a C-change kind of an environment. We have on the investment committee level, we've been very deliberative where we've been reducing our underweight position in terms of duration to get closer to the ag. But if you're looking at where we are now, there still is volatility in the back end of the curve.

What we would suggest would be more of a barbell kind of approach where you use something like treasury floating rate notes on one end and then maybe something core like, benchmark like on the other side of the coin. I think it helps to manage some of the rate risk and volatility that you would see there. I don't think we're in a position yet to kind of put your chip on red on that roulette table and say, "Okay, the tenure is going to rally to three and a half percent here." I don't think we're there yet.

But 2024 is going to be an interesting time because the question I asked you before, professor about the recession, everything seems to have gotten pushed back. Rate cuts, recession, and what will 2024 hold? I mean, will we eventually see those rate cuts? Will you see the rally in duration, which I do think you will? I do think you see some rally in duration, but the question is we're now starting at a much higher point than where we were in the last Fed rate hike cycle.

I mean, remember the Fed raised rates I think it was to two and a quarter, two and a half were 300 basis points higher than that even if the Fed is done. You have a 10-year treasury approaching 5% where it was more with a two handle back then. So a little bit different way of looking at it.

And I've been speaking about a lot of investors or advisors have not seen this kind of rate environment before. I mean, we're back to a pre-financial crisis kind of levels and readings that you're seeing. And I think it's going to be interesting to see how portfolio managers respond. One of the questions we saw come in here with rates in the four to 6% range historically.

I mean, why do people think that at this time it's different rates need to be artificially low for stocks. And I was going to ask you gentlemen that kind of question. Does a sustained 5% treasury market where I mean, think about it. We almost had from a one-month bill to a 30-year bond two weeks ago. Almost everyone was about 5% yield. Does that represent a challenge for equities or not?


Professor Siegel:

Well, the equity, what's called equity risk premium, the difference between stocks and real bonds, it's back to more normal. I mean, we have 2.4 on 10 year tips. The S&P at 17 times earnings is looking for around a 6% real. So that's a three and a half percent equity premium and guess what? My 220-year, Jeremy in our 220-year average, we had bonds, real bonds of three and a half, and real stocks are six seven, that's 3.2%.

I mean, it's back to normal. Yes, it's lower than it was before. And by the way, we're getting real yields back to normal. I still think they're going to be lower than what they had been. I think they're going to settle down. I see long bonds maybe at four, four and a quarter, and I see the Fed funds three and a half, something like that, mild slope there, upward slope.

So I do believe that I'm going to rally, but let me tell you, I think the stocks are going to do better than bonds under those circumstances. And let me remind people, believe it or not, and yes, the market was too high, but when tenure tips were 4.3%, the PE of the S&P 500 was 30. Now that was too high in 2000 and it came down.

But if you take a look through history, when if back to let's say pre-crisis levels of real rates, the average PE ratio was 16, 17, 18. Only time actually, if you take out the double-digit inflation, which suppressed PE ratios to eight and nine, you're at 17. So this idea that people, I have people telling me, "Oh my God, it's the lowest equity risk premium in 40 years." Yes, that means stocks are going to crash. No, that does not follow.


Jeremy Schwartz:

I know we targeted a shorter call today. And so just reflecting on that, the professor talked about upgrading his equity outlook for people who can consume model portfolios, a lot of people on different platforms here. We do have Siegel branded models on a number of platforms. In the latest rebalance we did reflect some of this note that you're hearing today about being optimistic on stocks versus bonds. So you could see some of that in the Siegel models.

You could follow up with us on the details of all those trades, and there's a lot of commentary to support that. Professor, I think what's on everybody's mind, I know it's on my mind watching the headlines and news, its Chris writes in a question about being scared about death in the war in Middle East, and how do you think about equities from a market perspective with all these wars? I know that's on everybody's mind on a daily basis. How do you respond to that?


Professor Siegel:

One of the oldest expressions on Wall Street is stocks climb the wall of worry, and when skies are blue, you're at the top, not at the bottom. And yeah, what's going on? Words are not good. And if they get worse, yes. Are you going to get a reaction in risk markets? Of course, is it going to be an opportunity to buy? It always has been, and unless you're a timer, values are good enough for me to be absolutely a buy and holder here.


Jeremy Schwartz:

I think that's certainly the message we're conveying in all of our Siegel models, and we appreciate always that take "Stocks for the Long Run" is a good handy reference guide in all these crazy dynamic situations. Kevin, any closing thoughts? Irene?


Kevin Flanagan:

No, I was just thinking as well to your points about what's been going on, unfortunately in the Middle East and still in Ukraine, and that has been on investors' minds, but as we move into 2024, I hope, professor, we continue to have these dialogues because I think it's going to be important to try to navigate monetary policy. It seemed a little, let's call it maybe a little easy because we kind of knew they were going to keep raising rates. Now things get a little bit more interesting as we get ready to turn the calendar.


Professor Siegel:

Yeah, December will be definitely more interesting and we'll see the dot plot for 2024 much more clearly then.


Jeremy Schwartz:

And just one other conversation he's got, we do these office hours a few times a week. We obviously get the professor a little bit less than that, more around these big inflation days or Fed days for the ones focused on geopolitics coming up in two weeks. Look out for a group called Corbu. We do a lot with them on geopolitics. I think they have interesting insights on all those issues. So for people who want to drill into that specific issue, look out for another office hours in a few weeks. Thank you, professor.


Kevin Flanagan:

Thank you.


Jeremy Schwartz:

Thanks, Kevin.


Professor Siegel:

Thank you, everyone.