Cat Hess:
Thank you for joining today's Office Hours. Today, we are honored to have Professor Jeremy Siegel, senior economist to WisdomTree, as well as Jeremy Schwartz, our global chief investment officer, and Kevin Flanagan, head of fixed income strategy, to discuss their views on the FOMC meeting. And with that, Jer, the floor is yours.

Jeremy Schwartz:

Well, thank you all for joining. The professor is coming back from a cruise across the Mediterranean, but coming back with some really interesting takes. And we've got the Fed meeting, but also the professor's been..some of his tune. We'll hear an update from that.

We also would like to get what's on your mind. We have some survey questions here, sort of two simple questions. First about when will the first rate cut happen? Just to see when you think things will turn around. And second is how high will the terminal rate be? We didn't give a range here, but you could give some sense of where you think this lower bound of the Fed funds target... Do you think there's going to be one more hike, two more hikes? We should put a no more hikes scenario, but greater than 6% is also an option here as well. Professor, we'll give you the floor. Give us your latest thoughts on the Fed and your assessment of the economy.

Professor Siegel:

Thank you, Jeremy. Well, sorry, we couldn't make 14 in a row for the Dow for 130-year record. It looked that way at one o'clock, but higher rates squashed the market. And that's what we're going to talk about, higher rates. By the way, I thought this was one of the best, if not the best, news conference that Jay Powell ran at the Fed, and there's several reasons for that. First of all, he's become very... stressing data dependence. Not any really preconceived notion, "1, 2, 3, more. I think we need two..." Repeating what the committee says. Really, he just talks about how many data points there're going to be. This is the way the Fed should be. This is a very good.

Secondly, his discussion was much more that there are balanced risks. It's not just upside inflation, but there could be downside real economic activity because of the decline in the labor market that we've seen. Now, again, I'm going to talk about that in a moment because the economy has been extremely strong, but he seemed to acknowledge that much more. I'm sure there were several members of the FOMC that were not really in favor of the increase in rate. They went along, there were no dissents, but talked about what they saw as softening in the economy and the dangers of rising rates. He talked about the latent effects of policy much more than before. He also pushed back on wages causing inflation. He had done that in the past, but he talked more about that. He also talked about, "We don't have to get inflation down to 2% before we start lowering." In fact, he said, "That would be wrong because then we'd have way too much momentum on the downside if we did not start lowering rates by the time that inflation hit our target." In many, many ways, it was far more balanced.

Over the last two weeks, two, three weeks actually, and it reflected in last week's commentary that we send out, and actually, comments I had made earlier, I have been looking at the forward-looking data very closely. In particular, the money supply, M2, which stopped falling and has now begun rising again, although at a moderate pace. Commodity prices, which also have stopped falling and started rising. And home prices on the Case-Shiller index, which had fallen pretty sharply from the high that was reached in June of last year, also, has been rising, comparable federal home indexes have all been rising.

When I see forward-looking indexes rise, that means to me that the economy can withstand higher rates than I had thought that the economy could withstand. In fact, I think almost everyone in some extent, including the Fed, which as you know, forecast for this year, less than 1% GDP growth last December, and of course we just came in at a 2.4 for the second quarter after a 2.0 for the first, so the only way we're going to get a .9 is a real deep recession in third and fourth quarter, that does not look in the cards. So again, growth has surprised on the upside, including the Fed, for everybody. I mean there may be one or two stragglers out there on that.

Well, what does that mean practically? It means that where I had thought that the bite of these higher rates would take effect in the third quarter pretty substantially, I'm not at all convinced that's going to happen. And as a result, where I had thought the rate would be falling, Fed funds by the end of the year, I don't think that that's going to happen. Now, whether there is going to be another one increase or not, I'm not going to argue that point right now. But maybe higher for longer, if you want to use that terminology, in terms of the rates.

Also, the terminal rates that the Fed funds and the bond rate we'll get to, I have raised that. I had thought that we would get TIPS down to zero 10 year. I now think it's perhaps closer to 1%, maybe one and a quarter. I thought we'd get Fed funds once we reach the 2% target, down to 2%, 1.5 to 2%. I now think it's going to be 2.5 to 3%. So, there'll be a mild upward slope of the term structure, but at a higher rate than before. Now, why is that? Because the economy, for various reasons, has raised the rate at which the economy is slowing. And I think there's two reasons why these real rates are going to be higher. One is certainly real growth, but again, not just past real growth, which has been, again, much faster than people thought, but future real growth. Maybe it's the excitement of AI, maybe it's the fact that the economy has not slowed.

Again, today we had additional jobless claims that fell again. Remember, that number was going up in May, and really stoked my fears that was the beginning of a substantial slowdown. Well, in June and late July, it disappeared and is now going down to the numbers we had earlier in the year. This is not an uncontrolled boom, this is not an overweight tight labor force, at least not yet, and I don't think so, but certainly it is not the progressive weakening that we saw before.

What does that do in terms of stocks? Well, the probability of a recession is down. I was on CNBC three weeks ago when I was still worried about over-tightening on the Fed, and I said 50-50 chance of recession. I would now say it's probably 25% chance of recession, not out of the question. But one of the reasons why I think it is less likely is not just the inherent strength of the economy, the ability to continue chugging along at real rates that are substantially higher than they've been for years before, but I think the Fed is more in line with what the true reality is. In other words, seeing two-sided risk. Well, what does that mean? I think they are in a position now to react to any weakness faster than they would've been earlier this year. In other words, by seeing the two-sided risk, if we really do see weakness in the labor front, there's going to be a bigger clamor to, hey, not only stop raising rates, but actually lower raising rates.

Don't forget, a couple of weeks ago we had a retirement of James Bullard, the super hawk from the St. Louis Fed. We have two pretty dovish voting member for this year, 2023, on the FOMC that have made their voices, I think felt in terms of the two-sided risks that they see. So, if the Fed is in fact more likely now to be less dogmatic about the inflation, seeing the progress, that means they are more likely to lower rates if we see the weakness. That's good for stocks and that's good for the economy. It's also good for value stocks if we want to drill down a bit. Clearly, value stocks are the cyclical stocks by and large, by saying that there's the lower probability of recession, that automatically puts them in a better light, and particularly with the valuations that we see on them, and Jeremy and Kevin could talk about the valuation. Some of our funds that are value-based, they seem to me to be particularly attractive.

So yeah, I mean, I would say I was overly worried when I saw the money supply going down, when I saw housing prices going down, when I saw commodities collapsing, and the Fed being so dogmatic on continuing to raise rates to the end. Now, when I see those three indicators turn around, the strength of the economy remaining and the combination that Fed Chair Powell seems to be much more flexible, all that has allayed my fears.

Now, I said that that's good for value stocks. All this does mean higher interest rates than I would've thought before. So, I mean what drove the market? Despite strong economic activity and all the rest, what drove the market down at the end of the day is that the 10-year was up in yield considerably. The TIPS which got down to 146 on the 10 year, I think is now in the upper 150s. In other words, it's going to have to contend with a higher discount rate. Earnings are great, no question about that. Yes, we've had some misses, but the beats have been very, very good in terms of what we've seen this week.

We've seen very little diminution in the forecast of earnings for 2024. Normally, we see a deterioration of about 50 cents a week in a year-forward forecast. We have not seen that so far, which shows actually a strength in terms of that. We have not much warnings from the firms that have reported that they see inherent in weakness. Clearly, there are areas that are weak. But clearly, we are seeing a much stronger kind. Good for earnings. Does mean higher rates that capitalize that earnings. Does mean less probability, in my opinion, of recession. Means a more responsive Fed in case there is a downturn. None of this is guaranteed.

And by the way, yes, we still have an inverted yield curve, 60 years that has been the single most reliable indicator of a recession. However, we have some very unusual circumstances with respect to COVID. I mean, it was the first pandemic in over 100 years, so maybe 60 years of good predictions from the term structure will also not come across. Not a guarantee by any means. And by the way, let me remind you that we have had inversions at the tail end, that are just about now 15 to 18 months later, that we begin to see the downturn and we could. Listen, fall could come around, people could get their credit card bills, take a look at the interest rates they're paying and say, "Whoa, I'm going to have to cut back." That's possible. Certainly, that's possible. But I think the Fed would be more responsive now than its attitude earlier this year.

Also, what I brought up a number of times we are in political season. The Democrats know that the worst thing that could happen to them is a recession in 2024. There will be a lot of political pressure on the Fed to lower rates if there is weakness in the labor market. And by the way, not incorrect, given that the Fed does, remember, have a dual-mandate to unemployment and inflation. I've said for a long time, ringing out one more percent of inflation, particularly by attacking wages, I think is definitely wrong. And by the way, again, Powell backed away, "We're not really targeting wages. We kind of look at them as some indication, but it was not a direct target." Clearly, there's pressure, since the wage earner has fallen behind inflation, for him and her to catch up. And there's going to be more and more political pressure on that front as our elections approach, so he has to be sensitive on that particular point. He should be sensitive on that particular point. The battle against inflation is one. I said it was one a year ago basically, and in fact, if you use proper indicators, we know as we at WisdomTree have computed that inflation has, in fact, leveled out if you take into account proper housing indicators going forward.

Again, you'd have to look at those commodity prices. Oil is inching up, commodities are inching up, housing is beginning to inch up, although most of those very thin markets, many of those deals are cash deals. People don't want to give up their mortgage rate of 2-3%. So as a result, we don't have a real thick market there to judge it, but there definitely is a turnaround in that sentiment there. Is it possible that if commodity prices continue to rise... By the way, I should also mention the falling dollar, which, by the way, is very good for earnings, certainly for the multinationals going forward and it has been a source of no more foreign exchange headwinds as there was so severely earlier this year and late last year that we had.

But is it possible that we see this upturn in combined prices and home prices begin to ignite inflation again? I doubt it, but not impossible. Now, if in fact that means that we need even higher rates, again, I would consider that to be... I don't think that's going to happen. I don't think that's in the mindset. This is really a bounce off the bottom, but there is firmness in M2 commodity prices and housing prices. Again, after being down 20-25% before, so somewhat of a bounce. But there's also higher lows and higher highs. It's more than just a dead cat bounce off the bottom. That's something that you want to actually look at.

Again, I'm not giving any warnings on inflation. I'm just saying I see a turnaround from deflation and given the level of real interest rates have been elevated means that at this particular point, I certainly don't see the Fed easing without some real deterioration in those real indicators. Again, nothing is impossible, but certainly given the data that we've seen in the last few weeks, it'd be unlikely. Should we look at the poll here and see the results?

Jeremy Schwartz:

Sure, we've given people a good amount of time. That'd be great if we could see the poll results and do some comments on them.

Professor Siegel:

Yeah. Later in 2024. Probably some people say 2025. And how high will the terminal fund be? 575. All right. So 550 is I guess one more hike, right? Is it 550? I mean, it's in a range for five and a quarter to five and a half. So five and a half to five and three quarters. The Fed funds market, by the way... Again, remember, Fed funds is an underestimate of the true expectation because of the edging ability of Fed funds against shocks to risk assets. So you have to add maybe an eighth of 10-15 basis points to, let's say, the January Fed funds rate. I'm not looking it up right now. You can. I would say to actually get an unbiased estimate of what actually it is, and it's probably one more hike in that range. But it will be dictated by the data and it is not set by the Fed at this particular juncture and there's a lot of data obviously coming out between now and that September meeting.

Kevin Flanagan:

Professor, there was a question that came in and I thought this was interesting and I wonder if, I wouldn't say we marginalized it, but it didn't seem to get much attention in terms of economic impact and it was the mismatch between fiscal and monetary policy. Could you comment on that? We did have the Infrastructure Bill get passed, so are we marginalizing the impact that fiscal package could be having as it begins to work its way through the economy?

Professor Siegel:

Well, my understanding is that that's a multi-year package in contrast to the excessive shots that were given in the COVID crisis of 2 trillion, 3 trillion immediately or within three or six months. This is multi-year, and I think the first year, and I might be wrong on this somewhat, is something like 500 billion, 400 billion. That's a stimulus but not an outsized stimulus. It's not like we were really pushing all of the levers, plus on fiscal, while pulling all the levers back on money. I would say the fiscal stance is pretty neutral, actually net. It might be slightly stimulative, but nothing like what we had in 2020 and 2021. So I don't know if we're really having what I would call a dramatic mismatch right now between overly stimulative fiscal and very restrictive monetary.

Jeremy Schwartz:

There was a question coming back to one of your indicators you mentioned has stabilized but also was at the core of your inflation thesis. Somebody asked to explain the money supply correlation to inflation in general, and maybe you could talk about it recently too.

Professor Siegel:

Yeah. Of course this goes back to Milton Friedman and the monetary research he did that garnered the Nobel Prize. There's no very close one to one year to year relationship. Usually inflation lags by a couple of years, 18 to 24 months off the M2 money supply. Again, this is M2. Let's be very, very careful. This is not the Fed's balance sheet. The only part of the Fed's balance sheet that is in M2 is currency. None of these excess reserves are in M2. So again, the Fed is reducing its balance sheet. M2 could still be going up as long as bank deposits are going up. And we have seen some reflow on bank deposits and that's because if loan demand goes up, the economy's chugging along, banks give out loans. That increases the money supply, increasing liquidity in the economy.

Now, what we saw and I lectured on was the largest single yearly increase in history in 2020 in the money supply. And then for two years, we had very high increases in M2 money supply and then suddenly we had the biggest decrease in 85 years. Actually, the first negative growth of the money supply in 2022. The money supply continued to go down in the first few months of 2023, but has turned up in the last two months. It has turned up for the first time since the squeeze of the Fed started. That's what's encouraging me.

Now it's more that it isn't going down anymore that I fear too tight. That's what it should be. I wanted actually the Fed to slow down from a 10% rate down to a 4% or 5% rate rather than go negative and now increase it at a 4% and 5% rate. I thought that shock was too great. Nonetheless, in the last two months, we've had about a 4% annualized rate. It's too short of time to call it a trend. And by the way, if there's a lot of weakness in the economy, you'll see M2 money supply go down because banks won't be extending those loans.

But there is a lag. It is not contemporaneous, but the money supply stopped going down. That means that deflationary forces still might come from earlier, but don't forget we had 40% increase in money, now a 5% decrease and now a stability. So we've never had swings like that ever. So in a way, a stepping on the brake of an extreme proportion, but now letting the pedal off the brake, which is giving I think alleviation of bringing the dollar down, commodity prices stop going down and also helping on that housing front in terms of the pricing of housing.

Kevin Flanagan:

We've got a couple of questions that were QT related, the balance sheet related, and since you just mentioned it, I thought it would be good to throw it in. One of them had something to do with the fact that it could be playing a, I guess, significant role in the inversion of the curve. And the other was... The question is, when do you think the Fed will begin to reduce its balance sheet? Well, they are already reducing their balance sheet, but I think the question is more when do you think possibly they could begin outright sales, say, of mortgage backed securities or something along those lines? What are your thoughts on that?

Professor Siegel:

I think they are selling the mortgage backs. I think their goal is a hundred billion a month, and I think it is mostly mortgage backs. They want to get rid of their mortgage backs. They want to go into a pure treasury basis, which they were in continuously for 95 years until the financial crisis. I think they want to get rid of all their mortgage, but that might be putting some pressure, by the way, on mortgage rates. And one reason why they might be a little bit higher, they're usually two points above the tenure, now they're three. Part of the reason is inversion of the curve. Higher short rates will give you a higher spread also. But some might be that they're getting rid of their mortgage backed securities, they're getting rid of their treasuries, but at a slower rate. But that does add to supply in the marketplace.

By the way, the fiscal deficit, which I think is still about a trillion, trillion and a half dollars a year now, far less than COVID, which was three or four, but still a deficit is adding another trillion, trillion and a half to the supply of treasuries. Of course, growing economy and inflation reduces those real values of treasury. A 5% inflation on a $30 trillion debt is a one and a half trillion dollar reduction in real value. So you have to have a one and a half trillion dollar deficit just to replace the real value of debt that's reduced through a 5%, let's say, inflation rate over a one year period just to get you on par.

And then you have economic growth that would actually cause for even greater demand for treasuries on top of that as a proportion of all other assets. So there's plenty of sources of demand shrinking real supply because of inflation, increasing nominal supply because of the deficit, but not a huge deficit, not an outlandish deficit, and some increase in supply through the quantitative tightening. I think Gundlach mentioned, and it was true yesterday, that the 10 year was exactly the same as it ended on December 31st. Today it's probably a little higher, but throughout all what's going on, really, there's been very little movement in the 10 year bond over the last six to eight months.

Jeremy Schwartz:

Maybe this is a question for both of you to comment on, Kevin and Professor. There've been a few questions about what levels of yields become interesting for long bonds. We talked about the inverted yield curve. Professor, you gave your number on the real rates, so you could tie that to a nominal bond expectation maybe. Last high of this current cycle, I think it was 425, we got back down, now we're at four again. Where do you think bonds become attractive long run to each of you? And Kevin, how do you think about that on fixed income portfolios?

Kevin Flanagan:

I mean, we've been proponents of we'd rather be late than early to the duration party. And Professor, you're absolutely right. I love to say if you were Rip Van Winkle and you fell asleep and you saw where the 10 year yield was then to where it is now, you'd wonder, well, what's the big deal? But in the meantime, we've gone, Jeremy, to your point, four and a quarter to 330 to 380 to 330, back to 4%. So there has been a lot of volatility and that's why we continue to talk about floating rate treasury notes, our USFR, where you're getting 45.5% without that kind of volatility in the market. And you don't have to essentially put your chip on the table into duration saying that, "Hey, I think the 10 year... This is at 4%, I think we're going to 3%."

Because that was one of the questions here, I think, that you were alluding to, Jeremy. Is this a good time? Are bonds cheap at this stage of the game? I was actually looking at this to write a blog. It seems every time we've gotten to that point over the last say 8, 9, 10 months, we get to 4%, we get a rally, but it's very short lived. It's a visible rally. It could be 40, 50 basis points, but then it snaps right back up again. And I don't think that's what you want to see in the bond part of your portfolio.

Professor Siegel:

Yeah. I mean actually now, I had originally thought that we would see the long bond of three by the end of the year because I thought we'd see more weakness in the real economy. I don't see that as much anymore. And in fact, if you would ask me, given the strength of what data we have seen recently, I would say that I would more likely think the long bond is going up in the yield now than down, and we may penetrate four on the upside and maybe... What was the 12 month high, Kevin? Was it four and a quarter?

Kevin Flanagan:

Yeah, I mean, intraday, it was 433, but it closed at a four and a quarter. I mean, here we are again at 401 as we're talking.

Professor Siegel:

I wouldn't be surprised to see that. Now, people say, "Oh my God, what does that mean?" Well, we're in a strong economy with strong earnings, it wouldn't affect stocks all that much. Not going to be good for the bond holders. Again, it's going to be great for those people rolling short such as USFR does if you want to avoid that, but yeah, what I thought we were going to see a lot of weakness and bringing that long bond down to three, I don't see that anymore as the most likely scenario or as a likely scenario. Again, no scenario is impossible as we all know. All of a sudden, another strain of the pandemic could come and you'll see the long bond at two again, but it seems to be far unlikely given the strength that we've seen at these real rates and the forward-looking pricing indicators which are the most sensitive, the dollar which is really sensitive, I think the bias is higher yields. That's going to be a challenge to stock.

If the yields would stay in the, let's say, 360-370, I would say the stock market could have another 5% or 10%. Yields going up to four at a quarter, could put a cap on how enthusiastic people are going to get about equities given that earnings are not in a beating by good margins and forecasts are getting rosier and recession scenarios are getting less likely. All that together would cause stocks to be choppy maybe with an upward tilt depending on how high yield go, but certainly restrain. I'd rather be a stockholder in a bond order almost all the time and I'd rather be one now. I really think with the strength that I'm seeing right now, we could see a steepening... by the way, steepening of the curve, stronger growth, that's good. In a way we want this, we want to bring a normal curve back because that's a non-recession signal. I don't think we're going to get the long bond to five and a half, which would restore normality, but if we can get that long bond up in yield and lower that inversion, that's positive for the economy and positive for risk assets.

Kevin Flanagan:

So, Jeremy, the professor, let me volley one back to you guys. Regional banks question came in. It almost seems as if we don't even talk about regional banks anymore as to compare where we were a couple of months ago. So I just wanted to get your thoughts on that and I know Jerry you've been talking about the bank run, the bank walk, things along those lines and you continue to see, professor, in their policy statement talking about the potential for tightening in credit conditions from the regional bank fallout. So I wanted to get both of your gents' opinion on the regional banks and in terms of equities as well. What does that mean in that area of the market?

Professor Siegel:

Well, I think you're going to get more consolidation. I think a lot of regional banks are going to be rolled into some of the bigger banks very honestly. I don't think there's going to be deposit runs. I don't think we're going to have a banking crisis or anything like that, and the truth of it is even though people are talking about stabilization of commercial real estate, many of the regional banks they have floating rate loans on that, but they have to charge SOFR plus two points, so they're rolling at seven and a half. These older buildings can't afford seven and a half. The owners are basically going to give the keys to the banks and say, "Hey, you got it," and the banks don't want it. So they'll probably make deals to keep it lower and as long as their depositors don't run away.

Jeremy Schwartz:

That's the tricky issue.

Professor Siegel:

... They could probably limp along for a while. If the depositors say, "Hey, I can give five and a half on treasuries short term with zero capital risk, I'm not staying in these bank accounts," then the only way is actually to merge these in to larger banks. I think we're going to get that, again without a banking crisis or anything like that, we're just going to get a lot of mergers of these smaller banks that are heavier in the commercial office real estate, I should specify office because commercial real estate outside of office is doing quite well, but the offices and the extent that they have it, they're going to be strained.

Jeremy Schwartz:

Yeah, I've been conflicted in the sense of the professor's call on this cyclical rotation is very good for small caps, very good for value. What you find in small value is you find a lot of the banks and so I've also said that I also agree exactly with what the professor's saying. The pressure on depositors could come from more options that make it easier to spend off treasuries, which we obviously believe in at WisdomTree. There'd be more options to do that. So, I think the banks still aren't paying the 5%. You saw the PacWest news this week and then the regional banks rallied on it, but the headline today was PacWest interest costs soared 23 times in six months, and so these banks are still not paying the appropriate rates, which is still a challenge. I think that's still a-

Professor Siegel:

Jeremy that could be going from 20 basis points to 30 basis. That's a 50% rally in their interest cost.

Jeremy Schwartz:

It's 23 times though, it is a big number.

Professor Siegel:

Well, yeah, I'll go, so it could be going from five basis points to one maybe, who knows?

Jeremy Schwartz:

Yeah.

Professor Siegel:

They're going to be challenged and this is something to consider. A lot of financial advisors, they don't know where the market's going. Then when the people say I want something safe, they say, all right, how much do you have in your bank account? What are you getting? Now I can get you into five and a half percent treasuries and CDs and things like that, let's look over that. That's a win-win for them. That could cause a drain and it could be triggered just by, it's like the straw breaks the camel's back. If the Fed keeps on going up a quarter point, more people say, "All right, that's enough. I'm not getting that 0% on my accounts" and they're going to do a lot more active money management, loss of deposit funds for those that are, now again to the fact if they have good assets, they just raise their SOFR and they're going to collect more on that score. But to the extent that they're locked in or have commercial office space, that will be challenging.

Again, you're right, the PacWest. Actually, I looked at the graph of PacWest. PacWest, of course as all regional banks did, shot downward on the SVB news last March. The price that it reached, I think within a day or two, they are now, it went lower, but the price it finally got settled at, it was exactly the price that it hit on the day that SVB or two days after SVB went under. So it's like really a lot of investors had a right on those regional banks.

There was an article in Bloomberg about Barry, the short seller that made money in the financial crisis, making a killing on the commercial banks. To PacWest, but actually you read it and you made about 5 cents or 10 cents a share, it didn't really make a big killing. Really, they brought it down and that's seemingly what it was worth. So you're getting a good dividend yield. Listen, you can hold steady with a great dividend yield, you don't need a stock to go up, but we'll see how that plays out.

Kevin Flanagan:

This is a US based call, but there's a question that came in about some of the divergent growth outlooks and rate policies between the US and the rest of the world. Jer, I wanted to throw this one to you, especially looking at it from Japan. We've gotten actually quite a few inquiries on Japan. I was wondering if you could throw some comments out on that.

Jeremy Schwartz:

Yeah, and there's some talk today that some of the moving interest rates was the speculation that they go away from their yield curve control or at least there's some hypotheticals that they start talking about tonight at their policy meeting that you get further support on higher rates and they're one of the few central banks who still hasn't done much to move things away. Japan, to me, is still one of the interesting value stories in the world. We're at 20 times P/Es for the US, 20 times forward P/Es with the tech stocks at 30 and the non-tech at 17. Our dividend weighted Japan is at 12 times earnings. So it's a healthy, healthy discount. They've got much higher yields. The dividend weight of Japan is basically on par with dividends almost as US high dividend stock. They were known as such a low dividend country for so long, but now real representative of small cap value but with sort of more larger cap, more cash rich companies.

So I'd actually say for people who look at small cap value in the US, you get the same exact yields in Japan, div weighted, and if you follow Buffet with his 5% extra, he did it on a currency hedge basis by issuing bonds, which is basically getting a 5% carry, you get that by hedging the currency too, people might say, "Hey, the yen's going to go up if they move away from yield curve control," but you could get this 5% carry in the meantime without taking any currency risk. So I think that's still an interesting idea.

I think going away from China and the regional diversification is sort of an interesting play for Japan and there's a lot of speculation on China, are they going to up their stimulus? I'm getting a little bit of lukewarm feeling on that from our China contacts. And we have Liqian, who's from China, she's actually traveling China for a month, some of the local news I'm getting from her, just talked to her today, is you see a lot of travel, you see a lot of busyness, but don't expect major stimulus measures. She doesn't think the government really is in the position to do all that. So anyways these area a few comments on Asia and Japan.

Professor Siegel:

Jeremy, would you recommend hedging the end or not?

Jeremy Schwartz:

Long run? Well, I like the 5% carry short run, but I do say long run. Why? I was saying what Buffett did forever is saying why, you think the stocks are cheap, why take this extra currency call? Now, Japan was one where they were oppositely moving historically. The yen was an offset as sort of the risk-on, the risk-off trade. It's lost some of that recently.

Professor Siegel:

Yeah, I honestly think it's lost, it's lost a lot. It's just not as critical in the world economy and people have so many other ways to risk hedge. Treasuries are great. Also, risk-off as long as it's not inflation that you're hedging against. Again, any sort of banking crisis you want to be in long treasuries, any pandemic, war, I'm talking about these geopolitical events, you want to be in treasuries. That will give you a very short term good hedge if that's important to you. It's always, it's a bad hedge against inflation obviously and has those risks going on and by the way, it's another reason why I think yields might be gone higher with people saying, "You know what, I know I got whammed, it isn't as good as I thought," and with that they're just not as anxious to hold it.

I think we had 40 years of basically no inflation where it served as a great risk hedge against bear markets, financial crisis, even the pandemic, the emerging market crisis, the real estate crisis in 1990, commercial real estate crisis, they were really good hedges and then came the bear market caused by the inflation and fed tightening and they were the worst hedges possible. And people are going to be saying, "Hey, these are not all right. They'll work sometimes and they'll work others. I'm not as enamored on them. I'm certainly not going to get down to 1%, 1.5%." Oh, well, 57 basis points is how far the tenure went, and I think in 21." But a lot of people are saying, "Hey, you know what, I'm just looking for something else." And that by the way will yield, that will lead to higher, longer-term yield as we've stressed that the risk hedge asset ability of any asset, the beta, the lower the beta, the lower the yield and the better the asset is bid.

And if it's not viewed as a good hedge risk asset, it's going to lose that beta and its yield is going to be higher and a lot of people might think it's impaired. Also, the fact, as we mentioned, higher growth going forward, if we're optimistic on rebounding productivity, if we're optimistic on AI and its possibilities, real GDP, et cetera and so on, that also will raise real yields and not impair stocks because all those rebound to the profits of the stock market.

Kevin Flanagan:

Here's one on the macro side for you, professor. Talking about the potential for consumer discretionary spending going to diminish once the extra money that was saved with COVID is gone, what are your thoughts on that? Is consumer spending more resilient than we think?

Professor Siegel:

Well, that's a very good point. That's basically... See, price, generally when there's a tremendous injection of money as there was, 40% actually total money between March of 2020 and March of 2022...that's going to lead to a burst of prices that's going to erode away that extra money, and a lot of that is being eroded away and a lot of people are forecasting that, that will mostly be eroded away by the fall or late fall. Some say early spring. It depends on what base you actually use as far as that's concerned. But employment is still strong. I mean, I could talk about the downside risks. I still think for a new homeowner that doesn't have equity in his home who's buying a home today 80% mortgage financed, the cost is 150% more than it was three years ago. That's the biggest chunk out of an individual's budget.

If you're buying a new home on an 80% mortgage, you have very little discretionary money for the average individual to spend on restaurants and trips and all the rest. We haven't seen a lot of those purchases yet, et cetera, but if that begins to bite, all those credit cards, everyone's having fun this summer, they're traveling, they're eating out, those credit cards. One reason why historically the biggest crashes in the market come in the month of September and October is, basically, let's party over the summer and the bills come due in the fall. Tuition bills for parents. I mean, we could go on and on to talk about, whoa, could that strike? Yes, it could, and the Fed has to be really alert if it sees that type of slowdown happening and saying, "Whoa, I'm not going to be dogmatic here."

I don't consider it to be strong because employment is still so strong. Don't forget, two-thirds of Americans own their own home so they have home equity. That has gone up tremendously. There's a lot of untapped home equity. I'm talking about the strains of the new homeowner. Of course, there's been a lot made of the fact that there's going to be a resumption of the student debt payments in October. It's going to drain some amount away from spending. I mean, you can talk about these negatives there. Could it be the straw that breaks the camel's back? Of course, it's possible, but at this particular point, the other strengths are still very, very apparent.

Jeremy Schwartz:

I'm going to wrap in two questions that are semi-related. One talked about, there's another economist saying the S&P…around 3,500. And then they asked the question, how much do you think we could fall into a recession? But then another question is related that really I wanted you to comment on, but just using that as the backdrop or a preamble to the question was, for a moderate investor, people coming in with new money, you could get 5% in floating rate treasuries or, with all these things on the horizon, how do you think about allocating new money to work today with 5% treasuries versus the recession risk and all those other things?

Professor Siegel:

You get 5% nominal in treasuries. At a 20 PE, you get 5% real in stocks. At a 17 PE, which I think you said was value, that's a 6% real, real yield in stocks. If you want a real yield in treasuries, the 10-year TIPS I believe is 1.6%. So there's your premiums to value stocks that you're getting a 4.5% annual premium in value stocks relative to 5% treasuries. Wow, that compounds an awful lot if you're putting long term money away for 10, 20, 30 years. That's how I would look at it. Clearly, for a real risk averse person, he or she's been collecting income, I hope it's tax-exempt. Don't forget, treasuries are not tax-exempt. They're only state local tax-exempt. Unless you got them in a sheltered account, you're going to be paying up to 30% taxes on those and maybe more. That reduces its yield. You can, of course, go into munis, and avoid that federal tax. But that's at a lower rate yet. And, again, not protected against inflation going forward.

Jeremy Schwartz:

Very good. People, there's a Daily Dashboard. If you haven't checked out our Strategies page, from the top of your links on your homepage, you go to Strategies on the Markets. It is a link from that Strategies page. You can find our Daily Dashboard, Daily Market Snapshot. It's got a 20-page report that I look first thing every morning. It has things like the TIPS Yield Curve across time. You can see where the latest is, how it's changed. It's got valuation. So you could check out the PEs on the tech, the non-tech part of the S&P, all of our different indexes, value indexes. And the non-tech S&P is what's at 17 times. You can go to high dividend stocks in the U.S. at 12 times, large captive stocks at 15 times. So there's definitely really interesting opportunities away from the S&P at 20 times. So I think that you should definitely check out that Daily Dashboard.

Professor Siegel:

12 PE ratio is an 8.5% earnings yield real, which is...

Jeremy Schwartz:

Wow, that's a good number. That's high-dividend U.S. I've been talking about that. DHS is our ETF for high-dividend U.S. But the large cap U.S. is a different basket of stocks that I think is an interesting opportunity today.

Kevin Flanagan:

I want to throw this one out. I saw this question come in. What do you make of the lack of breadth in the rise of the S&P 500?

Professor Siegel:

It's widened out. I mean, yeah, those magnificent seven being, what, 70% of the increase or 80, whatever? It is remarkable. I've commented on that before that, basically, except for those real speculative, the Zooms, the DocuSign, the Pelotons and all that, and some of the EV stocks, the same stocks that led the great rally post-pandemic, are leading the post-bear market rally again. Very unusual that the same group would lead the rally, but they are global firms. Most of them are coming in with earnings, again, that are good. And, again, now instead of headwinds of foreign exchange, they have tailwinds of foreign exchange with the dollar down, and, of course, they had that ability to not be as sensitive to the economy when recession fears were much higher. That's one reason why we've had a little broadening out as the economy has stayed strong and some of those recession fears have diminished.

Kevin Flanagan:

I see we're getting closer and closer to that five o'clock threshold. Jer, any good questions out there?

Jeremy Schwartz:

No. This has been a very good conversation. I'm going through if there's anything else I think that's a must as we wrap up. We haven't really talked on geopolitics, Professor, and, obviously, you're focused more on the macro, but there's a number of things from the impact of Russia-Ukraine on commodities and, obviously, there's the Asian dynamics. How do you think about that risk generally as you think about stocks?

Professor Siegel:

Part of the commodity rebound actually has been on the agricultural side and some of that is related to Ukraine. So it's not just the fact that there's a lot of demand there. Some of that is potential supply disruption there. One should mention it. I mean, obviously, there could be a sudden flare up. Could there be tactical nuclear? Could there be a surprise attack by China onto Taiwan? Although, I think given the situation in China today, unless Chairman Xi wants to divert the attention from slow economic growth to a more nationalistic "Let's get Taiwan" stance, he has other concerns right now on his plate. There's always geopolitical risks. There's always oil, Iran risks, Middle East, which is always bubbling. We've lived with those for the last 60 years and I think we'll live with those forever to come.

Jeremy Schwartz:

Professor, we appreciate you always giving us the latest takes on the economy, the Fed, and giving your latest takes on behind the markets every week, and we'll keep in touch. If people aren't listening to that show, we have a podcast to get the professor's comments, again, on that strategies page On the Markets link. You can find the professor's comments and all of our dashboards there as well.

Professor Siegel:

Jeremy, do you want to mention tomorrow's show?

Jeremy Schwartz:

Tomorrow on Behind The Markets, we have Torsten Sløk, who's the Chief Economist from Apollo. The professor be with us for the hour talking to Torsten. We get his daily comments and Torsten has a lot of interesting comments on the economy and what's happening in the credit markets. It'll be an interesting conversation with Torsten.

Professor Siegel:

Absolutely. Thanks.

Jeremy Schwartz:

Thanks, professor.

Professor Siegel:

Have a great weekend.