In the latest episode of Stansberry Investor Hour, Dan and Corey welcome Bob Elliott to the show. Bob is the co-founder, CEO, and chief information officer of Unlimited, a firm that uses machine learning to create products that replicate index returns. Bob drops in to share his valuable perspective on inflation intricacies and supply-chain issues.
But first, Dan and Corey address the unique challenges the housing market is facing right now... particularly how homeowners are holding on to their properties due to historically low mortgage rates. While advantageous for homeowners, this trend has reduced housing supply and subsequently driven prices upward.
Then, they turn their attention to central banks and discuss how effective these institutions are. Both Dan and Corey voice doubts about the ability of central banks to steer the economy in the right direction amid these challenging conditions. They also express skepticism about central banks' ability to achieve their target inflation rate of 2%.
Bob Elliott then joins the conversation to provide his insights on the current state of the Consumer Price Index. He highlights the underlying inflation in the economy, which is closely tied to wages and service prices, resulting in a stable inflation rate of 5%. He explains...
Once we started to get a flattening out of oil prices... and used auto prices... those going from falling to flat has a positive pressure on inflation.
Bob also delves into the gradual nature of housing cycles and the dynamics of the housing market throughout and following the pandemic.
That's the nature of these cycles... They don't progress rapidly. They aren't the kind of force that will drastically alter the Federal Reserve's outlook within the next three months.
Lastly, Bob highlights that the previous housing cycle in the U.S. lasted for seven years, spanning from the summer of 2005 to 2012. He explains that numerous structural and tactical factors influence these cycles. However, as input costs decrease, construction activity is expected to increase, which will eventually stimulate economic growth.
Co-founder, CEO, and CIO of Unlimited
Bob is the co-founder, CEO, and chief information officer of Unlimited, a firm that uses machine learning to create products that replicate index returns.
Dan Ferris: Hello and welcome to the Stansberry Investor Hour. I'm Dan Ferris. I'm the editor of Extreme Value and The Ferris Report, both published by Stansberry Research.
Corey McLaughlin: And I'm Corey McLaughlin editor of the Stansberry Digest. Today we talk with Bob Elliott of Unlimited Funds and formerly of Bridgewater Associates.
Dan Ferris: And before we do that, we're going to talk about housing and the lack of it available on the market today.
Corey McLaughlin: And remember if you want to send this a note, send it to [email protected]. Tell us what's on your mind.
Dan Ferris: That and more right now on the Stansberry Investor Hour. Housing. So, we all that there is or I hope we all know that there continues to be a structural shortage. We're at multi-year lows of housing inventory in the United States, and one of the reasons for that is that people don't want to sell their house if they have a 3% mortgage for, you know, a 30-year fixed 3% mortgage. So, I mean I'm not – mine's 2.8 and I told my wife, she wanted to move in 2021 to be closer to the grandkids I was like, "Uh yeah OK this will work out but we are never moving again."
Corey McLaughlin: Right. Yeah. I think we talked about this. I don't remember when it was, many months ago, but this idea, and I'm with you, yeah. I refinanced I refi-ed at under 3% as well because obviously it made financial sense, you know, and I think a lot of other people attempted to do that as well, if they were paying attention. And those same people, why would you move? If that matters to you, if your mortgage rate matters to you, why would you move in this environment and double your costs? And of course that does keep housing prices elevated, I think, because no people or fewer people want to move and sell.
Well, then that means there's fewer opportunities to buy those same houses and so despite everything, this economic slowdown where we're talking about housing prices are still, you know, maybe they've gone down a bit in certain, you know, it's a local kind of deal, but overall I think we're not seeing a housing crash by any means, you know, which I think we've heard you know some people speculating about months ago. So, to me, it makes the case for owning real assets again in this inflationary world.
Dan Ferris: Yeah, it does make that case. There's an interesting paragraph here from an article in the Wall Street Journal, the article you sent me yesterday when you said, "Let's talk about this." The article is called The Home Buyer's Quandary Nobody's Selling, and they talked to this young couple that doesn't want to move because they've got a 30-year fixed mortgage rate of 3.4%, which they locked in in 2021. And they don't want to have to take on a 6% mortgage.
They said it's – it says, that type of home they would want to buy would cost them about $1,100 a month more than they currently pay. And this fellow they interviewed said, "I don't feel comfortable paying what I still think is an inflated price for a home and on top of it paying twice the interest rate." Somehow this spurt of though, you know, I've had this idea that you just take everything from the last 20 years and invert it.
Our past podcast guest and my friend Vitaly Katsenelson kind of put that bug in my ear and I thought, "Wow, he's right." And I really ran with it and I feel like this is another set of expectations that we built up over the past few decades that is gone. Like, you're never going to get a sub, you know, 3% or sub-3% mortgage again. And you're never going to feel like, you know, I don't think home prices are going to crash. I think the structural shortage is really going to keep them not elevated, but you know, it's going to keep them from dropping much.
So this guy's like, you know, he's saying it's an inflated price for a home, but I think his expectation is in the past and I think what looks like an inflated price is probably just the normal price now.
Corey McLaughlin: Right, and that that fits with that idea that I think we both agree on of the higher rates for longer. Like, it's not like if you wait, if you're waiting to move now, you know, maybe now's the time to move instead of 10 years from now. So if we're really flipping the past 20 or 40 years around and this inflation sticks around and the central banks of the world keep trying to fight it and the governments of the world keep screwing things up with all the spending and on and on it goes, I mean, why wouldn't we be headed down the path of higher rates in the future?
Dan Ferris: Yeah I think the higher for longer still makes a lot of sense. You know, everybody looks at CPI, the Fed looks at PCE, and CPI has, you know, the year over year change has dropped from like 9% to whatever they are now, 4.9 – 4.93 I think it is. And, you know, PCE has been like within, you know, something like I want to say 30 or 40 bps of 5% for a year and a half. I mean, it's just like sure it's come down from its peak but it's still like, you know, 4.8 or so.
So the Fed's favorite – that's the Fed's favorite gauge of inflation, personal consumption expenditures, PCE. So I don't know. It's still way the heck above their target rate of 2%. Right? I mean –
Corey McLaughlin: Yeah, I mean, it's over – it's more than double what the supposed goal of the Fed and other central banks, which, by the way, is a completely – I don't think people understand, it's a completely kind of made up number. It was something that the major central banks agreed to years ago, the people involved, for no real reason other than it's what they could all agree to, that at the time, for what made sense for policy.
And so now that doesn't – maybe that does not make sense anymore. Right?
Dan Ferris: Right.
Corey McLaughlin: I think eventually, you'll probably hear a year from now, "OK, we're – inflation's at 3.5%. We've won," I think is how it's going to end up.
Dan Ferris: Right, and that's not going to be good because that rate is probably too high. And I think what's going to happen is that they're going to doggedly attempt to beat it back down to 2%, and eventually they will really – they will have to cause a recession, I think, to get it back down there. So I don't know. Of course, you know, we've both been kind of bear – kind of. Pretty – I've been really bearish and I know you've been really bearish too, but I just don't see how, given that set of parameters, we kind of get out of this without a recession, without problems, without the stock market kind of going sideways and being volatile for, you know, another year, two, three, five, I don't know, 10.
You know, big, gigantic mega bubbles are generally followed by sideways markets for 10 or more years. So, like none of that would surprise me.
Corey McLaughlin: Right and –
Dan Ferris: Believe me, I want to be bullish. I want to be optimistic but I just –
Corey McLaughlin: Right, and I will say, I mean, you call me super-bearish or more than kind of bearish. I mean, personally I am, you know, I'm not like not invested in the market just because of these things we're talking about. If anything, I want to – it's a place where you're able to beat inflation a bit, done the right way. So I think in the meantime of all of this, you know, to be invested in high quality companies that are rewarding you along the way makes a ton of sense to me and finding those places that, in a higher rate world, that work, I think you got to kind of let it work for you too.
So I mean, yes, I'm bearish in the like central banks I'd say more than anything, being able to do what they say or want to do. Not necessarily like I'm bullish on like humanity in the long run, but I'm – if I could bet against the Fed and win, I would. But, you know, a lot of times you can't win by betting against them and you just – that's why they say don't fight the Fed.
Dan Ferris: Right. I don't want to fight the Fed, but the thing I'd bet against is that they know what they're doing and that they really can control a $26 trillion economy from the top down, dorking around with interest rates and acting like they know what the right interest rate is. They don't. They really don't. I think the more they try to set it and the more they try to control it, the less we get to an interest rate that makes sense for the world. You know?
I think the market is probably better at that then the Fed – I know the market is better at it than the Fed couple ever be. It's just the way things work. You know? Big complex things that, you know, involve enormous aggregates of humanity all acting in their interest to some degree. Like, that's too complicated. You can't set it from the top down, and trying to breaks it. It doesn't – trying to doesn't help. It hurts.
Corey McLaughlin: Plus, you have regional banks failing right under the Federal Reserve's nose. Like, the thing that they can control, they can't even control. Like, the first thing Jerome Powell says when the Silicon Valley Bank thing is happening is, "How did this happen?"
Dan Ferris: Aren't you supposed to tell us that? Yeah.
Corey McLaughlin: So, sorry. You go ahead.
Dan Ferris: Yeah, that's the thing they're supposed to control. No, you're right. I mean I was just thinking about this interview, this recent interview that Jamie Dimon did, and he was talking about that. And he was like – he surprised me, I have to say. Like, I think of him as like, you know, the Duke of Manhattan, you know, Defender of the Status Quo, Protector of the Banking Realm.
He's like, you know, royalty or something, you know, because his fortune and his bank are protected by the Federal Reserve, so, you know, it's like god almighty appoints the monarchs and he's one of them. God did not see fit to protect your fortune and mine, only King Jamie's. And His Grace recently gave an interview, but he surprised me because he wasn't stumping for a big, coordinated government central bank solution to the regional banking crisis.
He said he thinks it's at the tail end and he was like not stumping for more regulation, you know, and more supervision. He was like, "Well you know let's get it clear, the people who are to blame for this are like the management teams, the executives, the boards of directors at the banks." But he also acknowledged that there were some incentives in place for certainly the worst of the banks to do kind of dumb things with money.
But, you know, I normally think of him as a guy who defends the status quo, you know, protects whatever's in place and he's like a patriot and whenever the government says, "Hey, I'm on board," but, I don't know, even he wasn't doing that. And he was actually worried about inflation too. He was like, "What if we get another uptick and, you know, rates are higher for longer?"
And when you hear a guy who you think of as the keeper of the status quo saying that, it makes an impression.
Corey McLaughlin: Right. Now is some of that maybe do you think, you know, JPMorgan's the biggest bank on the block and, you know, essentially they could benefit a bit from these smaller banks going out of business and like you were talking about last week with the regulation piece, a lot of times the regulation helps the biggest. Right?
Dan Ferris: Right, and he sort of acknowledged that. And it's funny, he says, "You know, we didn't," – the Dan Ferris is asking about being too big to fail and he said,
"I don't even know what that means anymore." I'm like –
Corey McLaughlin: OK, yeah, that means, I know what that means. Yes.
Dan Ferris: Yeah. He said, "We didn't mean for it to be an advantage." I was like, "So you know exactly what it means. It means that you have a huge advantage because you can't fail and you get to scoop up all these other banks and you know, I mean, he's got to say certain things just to keep up appearances or whatever, but we all know the situation. You know? He's backed... regional banks aren't. They can fail... he can't. He gets to scoop them up for a discount and doesn't have to worry about paying the pesky common and preferred shareholders off. But I will say overall, my impression of him was actually improved slightly by that interview.
Corey McLaughlin: Yeah, I caught a bit of that too and I think if – correct me if I'm wrong and I might have missed this part, or not thinking on it correctly but they're preparing for a higher-for-longer rate environment, not the cutting part that a lot of the other parts of the market are. They're preparing for – they're like hedging for higher rates, if anything.
Dan Ferris: Yeah, he subtly mentioned, you know, we didn't buy all those crappy overpriced bonds that everyone else was buying. So, you know, and he said – I forget how he put it. I'm sorry. I don't remember the quote, but it was very clear that he's still worried about inflation and still worried, you know, what if rates are higher for longer.
So, you know, he's been talking about the economic hurricane that he thinks is coming and now inflation, rates higher for longer. Not exactly the status quo if you look at the way – I mean, since the regional bank thing started, the two-year has gone from like 5% to 4%, the 10-year's gone from whatever, 4% to 3.4 or something like that.
So, the bond market thinks, you know, inflation is less of a problem than this regional banking thing. And I think it's probably more of a problem. I think we get Treasurys and bonds in general kind of rerated later this year maybe. I don't know about timing, but it just seems like – and you look at the futures market, fed futures are like – fed futures are basically saying the Fed's going to hold for the next two meetings in June and July and then cut rates in September. I'm like, they're almost 300 basis points above their target for inflation. You're high. What's – that's crazy to me.
Corey McLaughlin: Yeah, and if that's the case and you say this regional banking thing is more isolated and it passes, then that doesn't give the Fed incentive to cut rates or at least keep – you know, if anything, they'd be inclined to keep them where they are at the very least.
Dan Ferris: Right, if Dimon is right and we're at the tail end and it's almost over or something, then the Fed will see that too and probably agree with them and they'll say, "Well, we don't need to worry about the banks. We're not going to break anything else there. We need to keep rates higher for longer or raise it another 25 bps or something. I don't know. But we'll see. We'll see how close we get – how close it gets to the target in the next six months.
Corey McLaughlin: Yeah, I mean, I think a lot of that hinges on where the economy will be at that point, recession or not, what job losses look like. Those are starting to pick up a little bit more already. What I don't think we'll have much of an impact is the debt ceiling debate, but I'm just – and I bring this up because as we were talking about yields, Treasury yields, I brought up the one month, right, so this is stuff that is reacting sensitively to the debt ceiling discussions, or whatever you want to call it. One-month yield is at 5.7% right now as I'm talking and that's up from 4.5 like a week and a half ago.
And it just boggles my mind, like the stuff that we're kind of seeing, because I think people are not feeling. I mean, they're not – people want to avoid this – the risk of a default, which – but I just wanted to bring this up because it was one of the more notable kind of moves I've seen lately that might be on some people's mind, but already I'm seeing that the congressional budget office saying, "Oh wait, the government can handle stuff until July."
Like, Janet Yellen said, like that X date, you know, when the default would happen would be in June, but now the latest reports I'm seeing is like, oh, they can handle things through various maneuvers until July. So I'm just pointing this out that I think that whole thing will be resolved the same way it's been 80 plus times in the last, you know, however many years. It will be a higher debt ceiling one way or another.
Dan Ferris: You know, yeah.
Corey McLaughlin: Sorry, that was a bit of a tangent.
Dan Ferris: No, no, no, no, no. I agree. The debt ceiling is worth talking about because it's so ridiculous that anybody thinks it's not going to go up. It's so ridiculous that anybody thinks the U.S. could default on its debt. You know, it's just – Dimon was talking about it like it could actually happen. He said, "It's potentially catastrophic and it's already affecting the bond market," and blah, blah, blah. I'm like, "Not going to happen." It's a bunch of bluster. Nobody – like no politician wants to go down in history by saying, "Yeah, we're the ones who caused the U.S. to default on its debts."
That's – you know, besides the fact that it's the U.S. dollar, so you know, even if the Treasury can't issue debt, the Fed can like print whatever it wants and buy as much Treasury debt as it wats to. And people say, "Well, that's terrible," and it is terrible, but you know, it's not freaking Argentina. It's the U.S. dollar and there's, I don't know, I think a $15 trillion debt outside the United States that creates a hell of a lot of demand for dollars and 80% of the world's transaction volume, all the stuff we normally talk about, it's just there's too much demand for dollars to worry about that right now.
Corey McLaughlin: All right.
Dan Ferris: Yeah. I think we agree on some things here and I hope – look, I hate inflation. I hope it is done and I know you do too. We all do. But it's foolish to get too smug about it, I think. And it's also foolish to worry too much about the freaking debt ceiling. Of course they're going to raise it.
All right, you know what, there's somebody who has a lot more to say about this and probably knows a lot more about it than we do and his name is Bob Elliott. Can't wait for you to hear this conversation with him. So let's do that. Let's talk to Bob Elliott. Let's do it right now.
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All right, it's time for our interview. Today's guest is Bob Elliott. Bob is the cofounder, CEO and CIO of Unlimited Funds. Prior to founding Unlimited, Bob was a senior investment executive at Bridgewater Associates where he served on the investment committee and created investment strategies across equities, fixed income, credit, exchange rates, and commodities, including many used in the flagship Pure Alpha Fund.
He also built and led Ray Dalio's personal investment research team for nearly a decade. He's the author of hundreds of Bridgewater's widely read daily observations and directly counseled some of the world's foremost policymakers and institutional investors on economic and investing issues.
All right Bob, welcome to the show. Thanks for being here.
Bob Elliott: Thanks for having me. Really appreciate it.
Dan Ferris: I have to say, I consider having you on the podcast a bit of a feather in my cap. I mean, we've never had anyone who had worked at Bridgewater before, and, you know, you weren't like the receptionist at Bridgewater. You know, you did some pretty important stuff. So, I just – I can't help myself here. Can you just talk a little bit, because the culture of that firm, you know, the firm itself is famous for you know, all the things it's done, but the culture of it is famous and that's usually not the case. What was it like?
Bob Elliott: Yeah a lot of focus has come to the culture. In reality, I think it's less novel than many people might imagine.
Dan Ferris: There we go.
Bob Elliott: There are characteristics of high-performing organizations, whether they are finance organizations or elite business organizations that typically lead to the best outcomes, and I think in a lot of ways what we see with Bridgewater what I experienced at Bridgewater for the core of the business is it is very aligned with that, which is, you know, you have an intellectual intensity to search for the best ways to do things, whether it's trade markets or the best way to run the business.
And then you have, you know, a willingness to be open-minded to the thoughts of others that are around you who could have good ideas that that come along. And so, you know, I think that those sorts of two core elements of the culture, you know, you can read about Netflix and you can read about the Army Rangers and you can read in all sorts of different circumstances... you basically get same elements that work out.
Dan Ferris: All right so I had to ask about Bridgewater. It was kind of, I don't know, I feel like it was almost required, but really I can't resist kind of diving in because as you and I are recording this, the latest Consumer Price Index dropped. And I hadn't looked at the exact numbers. In the press, we see, you know, it went from 5% last month to 4.9 this month. But it actually went from 4.985 to 4.93 and we had a short interchange on Twitter, you and I, about this. You know, I said, "Is this cause for celebration?"
And then you came back and pointed out, "Yeah, and what about the fact that we're 300 basis points above the Fed's target." And then I read a great thread that you did and a couple other things that you posted about this. And you pointed out the PCI is like 5% solidly for months.
Bob Elliott: Yeah, I mean I think we are squinting at incremental baby improvements about what's going on with inflation and I think there's a lot of hope in the market about the fact that the Fed may be making progress on inflation, but when you look at the actual numbers, for instance if you look at core CPI, if you just try and boil it down, right, because the Fed is not going to – you know, the Fed is getting the gist of what's going on.
They're not going to make policy decisions based upon a particular nuance on airline fares for one month. Right, which meaningfully depressed the month over month core services ex housing number. Right? They're not going to make a bet based on that.
What they're going to do is they're going to take a couple of months of information that synthesize what's going and pretty much when you look at wherever the Fed looks at whether you like it or not, whether you think they should be looking at other things or not, that doesn't matter.
What matters is what they're looking at what they see is 5% inflation on a longer term and also shorter-term basis, whether they're looking at CPI or PCE, whether they're looking at you know, PCE services ex-housing or core CPI or you know, core CPI ex transportation, medical insurance numbers, kind of whatever they do, they see 5%. And that makes sense because wages are growing about 5 or 6% and so these sort of core, meaning the sort of underlying inflation in the economy should you know, should be growing well above what their target is and that's what we're seeing.
Dan Ferris: Right. You also pointed out something – like I've been telling people, when it goes from like, you know, year over year from 9%-ish to 5, like you don't get – maybe that's better, but it's not great and even if it goes down to the target, like the purchasing power is gone. Right? And you pointed out something I felt was similar today. You said the disinflationary impulses, and I think you pointed to oil and maybe one other thing, are behind us and I'm telling you, you know, it looks to me like there's – I don't know if it's a consensus, but it looks like a consensus to me that they're ahead, that this is a trend. We're in a disinflationary trend. I found that just very, very interesting.
Bob Elliott: Yeah. I think, you know, in some ways, the pace at which oil prices fell and the supply chain issues were resolved in the second half of 2022 surprised most people, myself included, in terms of just how quickly those issues were resolved. And what they did is they created a big disinflationary impulse on the inflation numbers. And so, as an example, the shift from oil prices going from, you know, being at $5.00 a gallon at the at the gas station to being $3.00 a gallon, that's a pretty big shift in terms of prices. And then similarly going from you know used autos prices rising rapidly to then falling, that was another relatively significant shift in the overall price structure.
The trouble is that the sort of underlying inflation in the economy which, you know, which is related to wages and service prices, that didn't really change much. And so once we started to get a flattening out of prices in oil prices and a flattening out of prices when it came to used autos, actually a bit of an uptick, and used autos I'm using as just kind of an indication of the similar prices in a lot of durable goods. Those going from falling to flat has actually a positive pressure on inflation. And that's essentially what we're seeing, which has allowed inflation, on a shorter-term basis, to kind of remain stable at this roughly 5% level and way too elevated for the Fed's preference or target.
Dan Ferris: Right, and that target I feel like we should acknowledged the target. Two percent. And here we are at 5%. I mean, the target itself I find a bit odd. Why target 2%? I've never quite understood it. I think we all know it's arbitrary, but why have it at all?
Bob Elliott: Well, I think I think the 2% target, it's a balance is the reality of it. We want to have a little bit of inflation in the economy because otherwise in down cycles you risk falling into the deflationary trap that places like Japan have fallen into over the course of the last, you know, 20 or 30 years, and where people withhold spending on expectations of lower prices in the future, and because debts are in nominal terms. You want to continue – deflation is particularly risky given that debts are nominal and you have to pay back the nominal dollars. And so that creates a deflationary trap or risk of a deflationary trap.
So you want it to be above zero. You don't want it to be too high. We start to see meaningful distortive effects both in asset prices and in economic activity once you get sort of above three. You start to see, you know, stocks and bonds start to become more correlated. People start to adjust their investment behaviors based upon those expectations. And so, you know, the short answer is you kind of don't want it above three and you kind of don't want it below zero. And so –
Dan Ferris: Yeah, 2%.
Bob Elliott: You know, that's – is it 1.5? Is it 2? Is it 2.5? Like, the difference between those different levels is pretty you know, pretty trivial, but it's somewhere between zero and 3 is ideal.
Dan Ferris: So I just wanted to get your take on that, but getting back to what we were talking about, as we look at the market, I mean, you can look almost any place now but, you know, the CME has this FedWatch tool that they use to gauge sort of what the futures market is predicting.
And it's basically at this point, the next two FMC meetings flat, no change, and then start cutting in September. It seems to me like that is a tad, oh, I don't know if it's optimistic. If you think cuts are an optimistic thing, then you could say it's overly optimistic. It just seems like the market is in for a bit of a surprise and maybe a repricing to debt and equity.
Bob Elliott: Yeah I think when you look at that basic pricing and, you know, part of what I was trying to draw people's attention to today is, OK core inflation core PCE is at 5%. The unemployment rate is at 3.4%, the lowest in 50 years. Under those conditions, the Fed does not cut interest rates.
And so in order to get the types of cuts that are being priced into those markets and particularly in the short end of the bond curve, you pretty much have to expect a relatively significant decline in inflation, an acute almost instantaneous decline in inflation, because remember it's going to take the Fed three months of data to realize what they need to do. Right? They don't respond on a month-to-month basis... they respond, you know, they want to see some smooth set of data.
So you'd have to expect an instantaneous decline in inflation, which seems improbable, or you'd have to expect a total cratering of growth, which, you know, I think there were some folks who were concerned about that related to the regional banks. We haven't seen that play out. We've seen, you know, the banks are not doing great, but they're certainly not creating a massive instantaneous credit punch.
And so, you know, to get that sort of pricing, that sort of dynamic, you're basically expecting like a complete halt, almost instantaneous halt of the economy, you know, similar to like when Volcker first came in and raised interest rates 700 basis points and the economy stopped almost on a dime, but even then it took a few months for that to happen. You're kind of – it's kind of expecting that sort of dynamic in the economy at a time when, you know, there's not a lot of pressures lining up for that to actually occur.
Dan Ferris: Right. And overall, one of the things that I've tried to pay a bit of attention to is do I think we're looking at a recession or don't I. And I have to admit, I was in the recession camp for some time, but at this point, you know, put it this way, you're going to have to show me a lot more than, like, you know, housing prices falling off of some massive, you know, high, or whatever, to believe that that's more likely. As a portfolio decision, I say prepare, don't predict.
So, you know, if it happens, I'm prepared. But thinking ahead, I don't see it. Again, this points me to like, you know, bond yields falling and, you know, fed futures predicting cuts and all that, and I feel like the markets are just in for a nasty surprise.
Bob Elliott: Yeah, I mean, it's pretty tough. I highlighted, you know, recently that nominal final sales growth for first-quarter GDP was 7.5% percent annualized. And basically nominal final sales in the U.S. has been growing at the same pace for the last two years through the first quarter. No, that's pretty incredible when you think about it... 7.5% nominal GDP growth, you know, basically hasn't been achieved sustainably in this country since, you know, the early '80s and late '70s.
And so that's a very strong set of nominal growth in the economy that, you know, is not really aligned with a recessionary dynamic going on. And I think an important reason why that is because income growth is very strong and that's one of the things that I think many people who have only sort of lived through cycles like COVID, which was a pretty unique cycle, and a credit-driven cycle like 2008 don't necessarily appreciate that you can have this sort of let's call it an income-driven cycle where income growth continues to support spending.
And that's really what we're seeing is that you're getting income growth, you know, for the cohorts that have high propensity to spend that is at 6 or 7% annualized nominal income growth . You have productive capacity of the economy that is, you know, I don't know, 1.5%. You have individual labor productivity that's been negative for a few years. And that all aligns with, you know, continued tightening of the overall economy until you break that labor part of the cycle. Like, that's the thing is you can't just slow credit. Credit has already slowed. Credit had weakened considerably through the first quarter. But nonetheless, nominal final sales growth was at 7.5%.
So it speaks to the fact you have to slow incomes, and the way you slow incomes is you've got to start to hit asset prices and then by hitting asset prices as you start to change the propensity to spend, and then once you change the propensity of the spend you start to hurt earnings. And then once you hurt earnings, you finally start to get some loosening in the labor markets. But that is the path and we're not so far down that path is the reality.
Dan Ferris: Right. You started just now talking about price increases. One of the things, and I've looked at a lot of conference calls, and there's been some press about companies giving up sales volume, lower sales volume in favor, it seems, of price increases. I don't know what to make of it, honestly, given other things. Yeah.
Bob Elliott: Yeah, I think that dynamic is actually really interesting in the market. I'm an auto guy by heard, having grown up in Detroit and followed the auto industry for a long time, and I think for many decades the propensity or the basic approach was high volume sales with, you know, through discount is the is the basic issue and I'm sure anyone who's bought a car remembers going to the lot and negotiating way below MSRP in order to get a good deal.
And I think for in a lot of ways COVID, because of the supply chain restrictions that occurred, started to reframe what was the most effective way to become or be profitable from an auto industry perspective. And so what they did and said is because of the supply chain issues, volumes declined considerably, but because nominal demand was still elevated, prices could rise. And so those companies saw elevated significant profits despite the fact that they were delivering less units than they had before.
And so that's a very interesting lesson because what it tells you, if you're sitting there, is you're saying, "Well I actually do have constrained supply and constrained capacity, whether it's direct in the sense of you're an auto company and there's only so many factories you want to be operating at a time, or whether it's even like a McDonald's, who's like, "I only want to hire a certain number of employees because if I try and hire too many employees then I have to start pay the paying them more than I'd want in order to maintain my margins."
And so that lesson actually has started to seep into the corporate strategy which is given the constraints in supply in the economy both labor and physical supply, let's raise prices and see how far we can go. Let's keep supply constrained so that we don't have to pay up for that supply. And then that affected a lot of companies are seeing is that's actually a good deal. And if that happens, if that structurally happens, that's a big shift structurally in an economy if companies are pursuing price growth ahead of volume growth to achieve their outcomes.
Dan Ferris: Wow, that would be quite the sea change. And, you know, one could argue, I'm just thinking, you go back 40 years to whatever it was, 15% or 16% Treasurys, and that whole period all the way down to 2020 taught us that that's just the way it is. You sell volume... you compete on price. That's life. That's normal.
So I feel like a friend a friend and former podcast guest Vitaly Katsenelson he told me a couple years ago I said just take the last 20 years and invert it. And I feel, you know, everything equity valuations, bonds, yields, the whole shebang and, you know, bull market, whatever. And I feel like you've hit on another inversion.
Bob Elliott: Yeah, inversions are very interesting. And this is not just, you know, I think the auto industry was a leader, so to speak, in this dynamic and in elucidating this dynamic for, you know, corporate executives and other places. But this is not an auto industry only dynamic that's going on. Like if you look at McDonald's, you know, they had double digit same store sales reported in their earnings report. And how did that come? Well, two-thirds to three-quarters of it was from price increases versus volume.
You look at a company like, you know, a company like Pepsi where the vast majority, you know, they basically had zero volume growth give or take, and pretty good, you know, high single digits low double digits nominal sales growth and they're learning that lesson.
And so like slowly, you know, the airlines are a good indication of this, which is they have a constrained number of pilots and planes, and so what are they doing? They're raising prices on airfare and they just keep raising prices on airfare in order to continue to elevate their profits despite not introducing a whole heck of a lot of additional supply.
And so this isn't just like one corner of the market. This has like become, you know, a fad in the corporate community and it's a totally different fad than what anyone basically has seen in their professional careers that's managing money right now.
Dan Ferris: I feel like we should mention housing because it is an important macro sector. And again there was this really incredible dynamic caused by the pandemic. You know, we all started working from home. People were getting out of cities. Housing prices just soared. I mean, that one quarter it was just like 20-plus% if you look at like Case-Shiller or something.
And, you know, this is like the biggest single increase in that type of period that the data contained. But now, maybe we're on – we're clearly on the other side of that. And a lot of people like want to say, "Look, this is not 2008." And that's great. Good. I'm glad it's not 2008 because that was very unpleasant. But, you know, we did learn that housing prices can fall and they can fall for like longer than you'd ever suspect. Right? I mean, we did learn that, at least.
Bob Elliott: Yeah, I think housing, even the housing cycle in the U.S. we kind of think about the housing crisis and often our minds go to the acute financial crisis that emerged in the in the fourth quarter of '08. And that was a very acute crisis, once there was real recognition that the banks were undercapitalized and would take substantial losses on their mortgage portfolios.
But the reality is that how did that housing cycle work out? Well, it started to slow in the summer of 2005 and bottomed in 2012. OK that's seven years. Like in the world of an investor, a trader, like a seven-year cycle, you know, you could be dead in seven years.
Dan Ferris: Figuratively and literally, yeah.
Bob Elliott: Hopefully not for any of us, but, you know, the idea that, you know, the housing cycle is very slow moving and I think people have overestimated how fast the cycle is going to move. And then I think there are some elements that are incremental in this housing cycle.
For the housing cycle, we had a relatively significant rise in mortgage rates that created a slowdown in housing that kind of created a blow off top, I'd almost say, of like, you know, there was all the sort of frothiest stuff kind of post-COVID, right after COVID kind of started to fall. But then, what happened was, as mortgage rates sort of stabilized a little bit, you know, housing kind of picked up a little bit like, you know, if you look at the MBA application surveys that come out weekly and you can see them, you know, you're seeing a little bit of an uptick in the first half of the year. If you look at the SLOO survey for, you know, mortgage demand, it's picked up in the first part of this year.
And so what we're seeing is we're kind of seeing like a wiggle back upward in the context of what is probably a seven-year cycle where we, you know, get a reset of housing affordability that comes through a combination of falling prices and rising nominal incomes that eventually will get housing prices back to something a lot more reasonable than they are now.
But like, this is going to be – we're going to be talking – five years from now, I'd be happy to come back on your podcast and we'll still be talking about how house prices still are a little expensive and it's still going to take some time for them to fall because that's how these cycles work. It's not fast moving. It's not the thing that's going to change the Fed's picture over the next, you know, one, two, three months. It's just not what it is.
Dan Ferris: So yeah, and I said I admit to having been concerned about housing, among other things, but I always said that if I'm wrong about this, it's because there is still a structural shortage, effectively. You know, there's still not nearly the – you know, the supply and demand is not conducive of a bust. There's no rest there.
Bob Elliott: I think that's actually a really important point because there's sort of a structural supply problem, which is basically after the 2008 crisis, nobody built any homes for years and years. And so you had millions more household formations than you had housing stock creations. And so that obviously has struck – you know, we haven't made up for that following the housing crisis from 15 years ago.
And then, you know, I think there's a more tactical issue, which is important, which is that housing supply, particularly of existing homes, is relatively constrained as well because basically if you were a homeowner, you locked into a 2%, you know, mortgage rate before COVID or during COVID. And so you're sitting there going, "Well, unless I've got some exogenous reason to move, like, you know, a change in a job or a retirement or, you know, a family life circumstance, there really is no reason to move."
There's no reason to transact because you lose the benefit of that low long-term mortgage. And so that that's actually a very interesting dynamic because what happens with that is that there's no new home supply. Or sorry, there's no existing home supply.
Like in my area in Fairfield County, I think it's down 80 from pre-COVID. Supply is down 80 – that's incredible. Right? You know, there's basically no supply. And so actually that's beneficial for the new home builders, because the new home builders are the only ones supplying new units that can be bought by the people who are engaged in incremental demand, right, those new household formations, etcetera, etcetera.
And so that's actually, it sets up – because builders and building activity is a transactional activity. It's not an investment activity. And so that's actually beneficial. That squeezed supply, that constrained supply is good for builders. That's why we're seeing some stock price strength in those names. And it's also good for economic activity because it means that homes continue to get built because it makes sense to continue to build.
Dan Ferris: Right, and some people look at lumber and say, "Oh boy," it was – it soared and effectively crashed. "Oh, that's bad. That's bad for housing." It's great for home builders.
Bob Elliott: Yeah. Everyone thinks that homebuilders love rising prices. Right? Home builders don't care about whether the prices rise. What they care about is what their cost is, their input cost is relative to what they can sell the house for. Right? That's what they care about and how much volume they can pump through. Right? That's what they're doing. And honestly, that volume part of it is benefited from rising home prices, but it doesn't necessarily have to be.
And so to the extent that we're seeing input costs decline particularly, you know, in 2021 lumber costs were so high that a lot of people actually delayed construction because it was so expensive. Right? Combination of the underlying cost plus the supply chain issues. Right? It created a lot of elevated expense in building materials and challenges getting labor.
And so in some ways, we're kind of dealing with a little bit of an overhang of that. For the home builders, what they really care about is just that margin times volume right, margin times volume, and it's OK as long as there's demand for new homes because there isn't a lot of existing supply and the margins are good. They're just going to keep building houses.
Dan Ferris: All right, Bob. Let's figure out like what do you what do you do with all this as an investor? Your new firm is Unlimited Funds and you were at Bridgewater for some time, so if you don't know, nobody does, what to do with all this information. And I've heard you. I have to say I've heard you talk about recently I think it was CNBC, you kind of didn't like equities here. I mean is this the alternative investment guy talking his book or what are we saying here?
Bob Elliott: I think we're in this sort of somewhat unusual circumstance where the macro cycle is a very slow-moving cycle toward weakening that's necessary in order to get a softening of the labor market in order to bring down inflation. Right? That's kind of, we're on that path. And so often when we talk when I talk to people, it's like, "Well, don't you realize that XYZ shows that there will be a recession at some point?"
The answer is like, yes, there will be a recession at some point and we're moving in that direction, but it's slow. It's very slow because macro cycles are very slow, much slower than most people want or imagine they are. And so, I think the thing that that we're seeing is that sentiment is whipping around the reality, which is like, you know, the reality is too boring for Finn Twin. Right? If you wrote about the reality every day you'd say like each day, you know, a thousandth of a basis point of underlying GDP growth has, you know, has slowed and people would be bored to tears by what you're saying on a daily basis. Right?
And so sentiment is whipping around. Asset pricing is whipping around. The reality is kind of meandering slowly to softening. And so actually some of the most interesting opportunities that are in the market are the places where that sentiment, for one reason or another, has been whipped around enough so that it's sort of offsides relative to the slower-moving reality. And so if you look at the asset markets today, you know, as an example, coming into March, I'll give this example, coming into March, when you looked at the bond market, you know, the bond market was pricing higher for longer pretty aggressively in a way that actually looked a little offsides to the upside.
All right and then we have SVB and the various issues there. And now we have a bond market that's pricing, you know, a few hundred, you know, a few cuts through the end of the year, which is probably offside to the downside in terms of interest rates. And then similarly I think when you look at stocks, you know, you've certainly got some froth, you've got some elevated valuations. You haven't really had the makings of a durable bottom, which would typically require both a decline in earning earnings well as a decline in valuations.
And so, you know, when you look at that relative to the slow-moving reality or, you know, stocks are kind of, in some ways, look like they might be either pricing, you know, a continued rosy scenario which seems implausible on a longer-term time frame, or they're sort of pricing it like there'll be a decline and then the Fed will ease and then things will go back up and then everything will be fine, which is like a little bit the cart before the horse.
And so, you add that up and you kind of get a picture of where it's like, oh, bonds don't look that great in this environment, particularly on the short – two-year bonds don't look particularly good." And longer term bonds as well. Neither do stocks look that great because they look a little too rosy. And so both of those things kind of work out to be something that's like not great. And you know, for most investors, I think what that means is looking for other options that might be mispriced.
Like, you know, in some ways I think gold offers a lot of interesting opportunity given, you know, it really does benefit from either a higher inflation scenario than expected or from higher, you know, tail risk environments than expected. And so, you know, that's an area you can look at in addition, if you open the aperture a little bit from just the traditional stock and bond investing.
Dan Ferris: All right. So Bob, I think it's time for my final question.
Bob Elliott: That was quite the tour of everything, structural inflation, housing, the economy, asset prices. We've gone through basically all of it.
Dan Ferris: Yeah, well, I had to hit all those points having you on. Either that or we'll have you on every day, you know.
So the final question is the same for every guest no matter what the topic. Even sometimes we have nonfinancial guests, and it's the exact same final question.
And you [inaudible] what it is. Right? You don't know the question?
Bob Elliott: I probably [inaudible] more prepared, but –
Dan Ferris: Good. No, no, no, no, no, it works best that way. It works best that way. So the final question is simply if you could leave our listeners with a single thought today, what might that be?
Bob Elliott: Diversification is the key to building durable wealth and the reason why that is –
Dan Ferris: Boom.
Bob Elliott: You know, we all can sit here and pontificate and talk about what we think is going to happen and what we don't think is going to happen with markets and economies and things like that, but the reality is that even the best of us are only slightly better than, you know, 50/50 in predicting what's likely to transpire.
And if you're going to be successful at building wealth over time and building a strong asset portfolio, I think the key to doing that is diversification. I think most investors don't appreciate – they might think 60/40 stocks and bonds, that might give them enough diversification, but particularly in times of elevated and rising inflation, stocks and bonds are not particularly useful. So look, if things work out OK and, you know, growth is strong or inflation comes down, you're going to be fine in 60/40.
The real risk is that inflation is more durable than you expect and so finding those assets that help protect you from elevated inflation like gold or commodities or things like that, increasing your diversification to a diverse set of possible macroeconomic outcomes will help you protect yourself from a range of circumstances that could be meaningfully detrimental to your long-term preservation of wealth. I don't know if that's what you were looking for.
Dan Ferris: Yeah, great answer and I knew it would be. Yeah. Yeah.
Bob Elliott: I like diversification. What can I say?
Dan Ferris: All right, diversification, a one word answer, diversification. Yeah. I'm really glad that you decided to come on the podcast. Thanks so much for being here.
Bob Elliott: Yeah, it was great. I really enjoyed it. It was a lot of fun. I feel like I've gotten to know you a lit bit on Twitter and so it's nice to finally get to have an actual conversation that we can hear each other.
Dan Ferris: I know. I have to say first of all @bobeunlimited on Twitter. Please follow Bob. He's a great follow for investors. All right. Well, listen, we – you mentioned five years. We're not going to wait five years to have you back on. But, you know, maybe six or 12 months we'll check in and see where all of this giant incrementally moving machine is going.
Bob Elliott: Yeah, that'd be great. I'd love to get back on.
Dan Ferris: All right. Thanks a lot.
Bob Elliott: Thanks so much for having me.
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I am so thrilled to have had Bob on the show. His Twitter follow is really great. Bob is one of the people who I follow him regularly and I always want to know what he has to say. If he's on CNBC, I make sure I watch it because, look, I have some very kind of extreme views about things. I think we're in an episode like what followed the 1929 and 2000 Nasdaq bubble and the, you know, the Japan bubble. I'm afraid that we're in in that kind of environment. That's pretty – that's an extreme environment.
So I need somebody with the kind of experience – need – I want. I want to be reasonable about all this and I want to think it through. I don't just want to react, and following Bob helps me kind of stay a little more rational and think more deeply about things rather than simply adopting a viewpoint and sticking to it no matter what. You don't want to do that. Right? You want to have strong convictions lightly held. You know, you want to know what you think.
If you think there's going to be a recession, it doesn't mean there's going to be one. If you think inflation is going to take off like a rocket ship, it doesn't mean it's going to happen. It may mean that it would be prudent to prepare for these things, and Bob's advice, and to a certain extent my own for the past couple years, has been fairly similar. This is the time to make sure you're prepared for a wider than usual variety of likely scenarios.
So really happy to have him on the show and I almost can't wait for six months or 12 months to go by. So that's another interview and that's another episode of the Stansberry Investor Hour. I hope you enjoyed it as much as we did.
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