Is the Market Still Climbing the Wall of Worry? (With Dr. Ed Yardeni)

KATHY JONES: I'm Kathy Jones.

LIZ ANN SONDERS: And I'm Liz Ann Sonders. 

KATHY: And this is On Investing, an original podcast from Charles Schwab. Each week we analyze what's happening in the markets and discuss how it might affect your investments.

Well, hi, Liz Ann. Markets have had a week to absorb the latest signals from the Fed, and of course, we're getting the latest PCE numbers, that is the deflator for personal consumption expenditures, the metric that the Fed uses as its benchmark for inflation. So how do you think the markets are going to be reacting to where we are right now? I have to say, when I look at the stock market, it seems sort of impervious to bad news. I mean, it's set back for a few days and then it comes roaring back to the upside. What's going on?

LIZ ANN: Yeah, and we don't have the benefit of having in hand the PCE numbers yet because we are recording this before they have come out. But I think the real story of what's going on in the market, whether it's reaction to expectations around Fed policy or individual economic data points, with probably the most important being anything inflation related and anything labor market related. I think you're right, at the index level, the market does seem impervious, but I think some of the rotations and shifts under the surface maybe tell a more accurate story of what's going on. And to me, one thing to watch is we've had not every single day, but we've had this recent trend of cyclical outperformance and the strongest breadth readings coming in areas like energy and materials and industrials and financials and I think to the extent that we see further deterioration in the economic backdrop, you could start to see some shifts under the surface back to maybe not necessarily traditionally defensive names, but as we've spoken and written a lot about this era, call it the post-pandemic era has brought areas like tech and communication services into that defensive categorization. We think of defensive as traditionally things like consumer staples or health care utilities. But I think the reason why many of those mega-cap, tech-tech-oriented names are considered defensive now is simply because they've got really strong cash flows and strong balance sheets, and they've got an earnings trajectory that looks pretty stable.

So, it's a different way of thinking about defensive, but that's what I pay attention to on a day-to-day, week-to-week basis is some of those underlying leadership shifts, I think all else equal having rotation under the surface is a healthy backdrop. It's allowed for breath to expand It's certainly a better backdrop for equity investors than the bottom falling out all at once if you kind of correct some excesses via process of rotation So I wouldn't mind if that's what continued but I do think with sentiment fairly frothy there is some risk that we get some volatility to the extent, whether it's inflation data or broader economic data, you know, misses. So, your area, Kathy, is where volatility has been greater, less so this year than last year, but the bond market has been the volatility story, not the equity market. So, what are your thoughts on the latest data, and particularly since the Fed meeting, which we talked about at length in the last episode, what your end of the markets are thinking and what is being priced in at this point.

KATHY: Yeah, in the fixed income markets, things have quieted down a bit. It's becoming a waiting game. So, every piece of data is getting scrutinized in terms of what it means for Fed policy, especially the inflation numbers being particularly important because the Fed needs those numbers to cooperate before cutting rates. And that's gotten the Treasury market volatility down a bit. And yields have mostly gone sideways now since the Fed meeting, just sort of waiting for those definitive signs to signal a shift in policy. But meanwhile, it's been interesting to me in the investment-grade corporate bond market, what we're seeing is very steady and strong demand, and that's pushing yields closer and closer to Treasury levels. So, the yield spread is very, very low compared to history between investment-grade corporate bonds and Treasuries.

Now some of that has to do with just demand for yield, particularly in higher credit quality bonds. It is a global trend that investors are reaching for yield. And particularly with the idea that the next move by the Fed is down, the next move in yields will be lower, they're trying to step in and capture those yields now for the longer term. And in the corporate bond market, we've also seen private credit buyers increasing their market share. And that has also contributed, I think, to this decline in yield relative to Treasuries, this narrowing of those credit spreads. So, you know, as long as the economy looks healthy and there's some risk appetite out there, as we've seen in the stock market, that trend is likely to continue. It's a topic that I want to discuss with my colleague, Collin Martin.

It's something he's been highlighting, and I think we're going to get him on the podcast here pretty soon to expand on it.

LIZ ANN: That's awesome. And speaking of guests on the podcast, on this week's episode, I'll be sitting down with, or I guess figuratively sitting down with Dr. Ed Yardeni, who's president of Yardeni Research. You, Kathy, probably have a similarly long span of time of knowing Ed and reading and seeing his research. I think I've known him for, it might even be close to 35 years in his and my long history in this business, but he runs Yardeni Research, as I mentioned, which is a provider of global investment strategies and asset allocation analysis. Ed was previously the chief investment strategist at Oak Associates, also Prudential Equity Group, Deutsche Bank's U.S. equities division in New York. He was also the chief economist of C.J. Lawrence, Prudential-Bache Securities and E.F. Hutton, so quite a resume. Ed also taught at Columbia University's graduate school of business and was an economist with the Federal Reserve Bank of New York. Ed also held positions at the Federal Reserve Board of Governors and the US Treasury Department in DC. Ed holds a PhD in economics from Yale University, having completed his doctoral dissertation under Nobel laureate James Tobin. He's frequently quoted in the Wall Street Journal, the Financial Times, the New York Times, Washington Post, and Barron's. In fact, Ed was dubbed "Wall Street Seer" in a Barron's cover story. He also appears frequently on CNBC, Bloomberg television, and Fox Business. 

So with that intro, Ed, thank you so much for joining us. You and I have known each other a long time, but before we get into the meat of what I know is going to be a great conversation, what's the best way for our listeners to follow you? Is it Yardeni.com?

ED YARDENI: Yeah, it's just yardeni.com. It's that simple.

LIZ ANN: And it's a really great website. It's easy to navigate. So that's my plug for your site. But I want to start a big picture and talk about this very unique cycle, which is the ultimate understatement. But I think for around the same span of time, our view and your view has been very aligned in terms of this whole notion of rolling, rolling recessions, possibly morphing into rolling recoveries and how that has led to a cycle that can't as easily be defined and led to a lot of missed calls last year for recession. So just lay out your thesis and when you started to feel that gel in your in your mindset and how you would define that to our listeners.

ED: Well, for me, the tip off was that starting in 2022, we heard more and more people anticipating a recession. And in a very short period of time in 2022, it seemed to me that we were looking at the most widely anticipated recession of all times. So, my contrary instincts did come out a little bit. I don't try to be contrary just to be contrary. But when there's such a deluge of pessimism, all very well and logically argued, it made me do more work on what that view might be missing. I tend to try to present a balanced view, it's just that when the other side is so overwhelming, especially on the pessimistic side, I tend to come out as an optimist. And my optimism was based on my assessment of what causes recessions.

The widespread view, which was very logical, is that if the Fed funds rate basically in two years goes from zero to 525, 5.25%, that's got to cause a recession. How could it not? All these people that have debt at very low interest rates that might have to refinance, suddenly you've got to pay more to borrow money to buy a car and a house. How could that possibly not cause a recession?

And what I was arguing is that the process of recession historically has been tightening of monetary policy, at some point causes the yield curve to invert, which is a signal that the bond investors are starting to believe that if the Fed keeps going, something's going to break. And so it makes sense to buy a bond at 4%, even if the two year is at 5%, because there will be a financial crisis and then the Fed will have to lower rates.

And then when the financial crisis hits, it often has become a credit crunch, which means an economy-wide credit crunch that even good borrowers can't find financing. And it's the credit crunches that cause the recession. It's when you can't get credit that you clearly get a recession. This time around, the process worked almost all the way. We did, in fact, have an inverted yield curve. We did, in fact, get a financial crisis back in March of 2023, but this time the Fed came in very, very quickly with a liquidity facility that stabilized the system remarkably well. And so, we didn't get a credit crunch and we haven't had a recession. And even before all that happened, yes, I agree with you, Liz Ann, it did look like it could be an environment of a rolling recession. I've been doing it for a while, as we both have, and I remember back in the mid-1980s, I think I coined the phrase "rolling recession" when there was a lot of concern about a recession in the mid-80s when the price of oil came down and Texas and Oklahoma went into a very severe recession, but the rest of the country could do pretty well.

LIZ ANN: Now, the Fed having stepped in with the bank-term funding facility during the time of what we now generally think of as the mini-banking crisis because it didn't morph into a more contagious event. That's part and parcel of your, and I think you also coined this, the "postmodern monetary theory." So, what are some of the other characteristics of that? And I know you said in the recent report you wrote on it that you've gotten a lot of feedback on that. I'm assuming mostly positive, but much like your coining of "bond vigilantes," you may have something with this one.

ED: Well, you know, modern monetary theory is not modern. It's not monetary. It's not a theory. It's a notion that the government can run huge deficits as long as it prints its own money. And if the inflation pops up, you whack it with taxes as necessary. And it got a lot of credibility there during the pandemic, because that's what the government's been doing, spending a tremendous amount of money running huge deficits. And it did stimulate the economy. It gives a lot of fiscal stimulus, but it also brought inflation back. So, it's kind of a play of words if we figured, "Well, you know, I still view it as a crank kind of theory." And so, I came up with my own MMT, and that is the Postmodern Monetary Theory, which really isn't a theory, and it isn't modern. It actually goes back to people who worked on Wall Street like Al Wojnilower and Henry Kaufman, actually Irving Fisher back in the Great Depression, maybe was the first theorist along these lines. He lost a lot of money in the Great Crash and then spent a couple of years trying to figure out what he missed. And he started to come up with this debt theory. And very often, everybody focuses on monetary policy. Sometimes we focus on fiscal policy as the drivers of the business cycle. But there's also the debt cycle. And the debt cycle, you know, it's like Rodney Dangerfield, the comedian who never got the respect. Not enough people think about the credit cycle. 

And, you know, if you just look at a chart of the Fed funds rate, the inverted yield curve, the recessions and put in lines for financial crises, virtually all the ones since the 1960s have been associated with financial crises. Now, another part of the story I've been telling for the past couple of years is that you also have to have a very strong opinion and understanding that's based on the data of the consumer, because you don't really get recessions when employment is at an all-time record high and personal income is at an all-time record high, because that's purchasing power. And one thing I have learned about consumers in America is when we're happy, we spend a lot of money. When we're depressed, we spend even more money if we have it. And certainly, with the three rounds of helicopter money, checks that were deposited in millions of people's accounts, there was lots of money during the pandemic. And since then, employments continue to go up to record highs, personal incomes gone up, and guess what, consumers are spending. But I think what economists really missed about the consumers is they got really hung up on this idea of excess saving. That during the pandemic, we had two months to save a lot of money that we couldn't spend. And then we all got cabin fever. So, once they let us out, we all wanted to go shopping. Shopping releases dopamine in our brains. It makes us feel very good. But we couldn't buy services. There was still social distancing and services. So, there was this big buying binge in goods.

And then at some point that started to pivot toward services. But the pessimists have been saying, "Yeah, that's wonderful. It's not going to last." As a matter of fact, Jamie Dimon, obviously somebody who's really plugged in, the head of JP Morgan, expressed the opinion in May of 2022. That long ago that we were going to have a hurricane because the consumers were going to run out of excess savings, and they would be forced to retrench.

And the excess savings by most estimates at its peak was maybe a three trillion or two and a half or even two trillion. It was serious money. But the projections of many of the pessimists would be gone by now, certainly by the end of 2023. And yet the consumers are still spending money. And I think what they missed is that much, much bigger than excess savings is what people have been stashing away for retirement. Households altogether, young and old, have a record $155 trillion of net worth, an all-time record high. Half of that, $75 trillion, about half, is held by Baby Boomers. And maybe, you know, I have a little bit of an advantage because I'm a Baby Boomer and I look around me and I look around me and I see my friends retiring. I have five kids, so I'm still working for a living. But my friends had two kids and they're already adults on their own doing quite well. And so the Baby Boomers that I know that are retiring, a lot of them have paid off their mortgages, their expenses have gone down, and they've figured out during the pandemic that the meaning of life is, in fact, retiring and going out to restaurants and traveling, and then along the way, check in with the healthcare services to make sure you can travel and feel good and do all those things. 

So there's been a lot of spending in those kind of areas. And guess where the big employment gains have been? They've been in restaurant workers, hospital workers, the services economy generally. So you put it all together and you got a consumer that's resilient for a lot of good reasons. 

Oh, and by the way, the other thing I know from my own personal life is that because I've got five kids, the two younger ones got out of college and I'm still paying their credit cards. I had to kind of rein them back and put a limit on them, because obviously if you don't, they'll spend you blind. But my kids gave me a good insight into consumer spending. And so, all these polls that you hear about people saying that they're living paycheck to paycheck, I bet you a couple of them might've been my kids being surveyed saying that they run out of money by the end of the month, and they forget the fact that they really don't, because I'm helping them out.

LIZ ANN: So how much of continued resilience in consumer spending? And there are minor cracks that you see, particularly if you go down the income spectrum and you look at delinquencies picking up, especially subprime and autos and credit card loans. How much is the labor market key? Because I think that's been the big differential. You can do all the analysis you want. I agree with you on savings rate or excess savings that the traditional savings rate is down enough that it would suggest a slowdown, but I think it's confidence in the labor market. So, sort of a two-part question: Do you agree with that? Is that key? And what's your outlook for the labor market?

ED: Employment is absolutely the key. It's probably the first major economic indicator we get at the beginning of every month. And I use it to get a proxy for wages and salaries because we get employment, we get average hourly earnings, and we get the average work week. So, you can use those three variables to calculate a proxy for wages and salaries in personal income. That release also shows the average workweek in manufacturing. So, you can use that to predict production and production and employment and wages are actually part of the index of coincident economic indicators. So, you get a lot of insights from the employment report. So, I think I completely agree with you. Employment is the key and historically there's no way that there's ever been a recession with employment continuing to rise into record high territory. You've never had a recession with construction employment going to record high territory, even with housing starts, single family housing starts being weak. So, employment is the key. 

But again, I've had lots of people ask me, "Well, yeah, but if consumer credit is at an all-time record high and we're seeing delinquencies going up, isn't that going to cause a recession?" And the answer to that is those things can worsen recessions, but they don't cause recessions.

Unless you have extremely widespread defaults by consumers and businesses, you don't get a credit crunch. And so far, so good. Even in the commercial real estate area, you have to distinguish between various areas of commercial real estate. Not all of them are doing badly. It's the downtown office buildings that are doing badly. And again, with the rest of the consumer, I saw a survey that showed that 40% of people who own their own homes do not have a mortgage. So again, I think that probably speaks to the demography of the aging Baby Boomers. They've probably paid off their mortgages along the way. And again, that gives them more spending power in other sorts of areas. So, I think we all have to keep track of the labor market. As economists and strategists, Liz Ann, you and I, we watched the weekly initial unemployment claims, and they remain stuck just north of 200,000, which is extremely low. That correlates very well with indicators of job availability. Are jobs hard to get? Are they available, job openings? And all those indicators currently suggest that the labor market still remains quite firm.

LIZ ANN: Yeah, and I was going to ask you about productivity broadly and your outlook for that. But let's wrap AI into that. And how much can we quantify at this stage AI's impact on productivity, which has been pretty resilient.

ED: Well, I've been promoting this idea about the 2020s, that it's going to be like the 1920s. So, I think at the end of the decade, we will call this the roaring 2020s. I've tried to be balanced about it and say, "You know, while I tend to be an optimist, that I think it could be a great decade up ahead here. And there's still plenty of years left." And I think productivity is going to make a big comeback and we're going to see the consumers have more real income because that's what happens you have productivity, it keeps inflation down, everything. Productivity is just a wonderful variable if it's growing and growing solidly. So, I do think there's an aspect of the roaring 2020s up ahead here. And I think the market, the stock market, started to actually discount this story back in November 30th of 2022. That's when OpenAI introduced ChatGPT.

So as soon as I heard about it, like a week later, I signed up for the $20 a month version. And I said, "Man, this could be really great. I'm not going to have to work anymore. You know, this thing's going to write my daily briefings." And so I gave it a whirl, and then I spent more time correcting its errors than it was worth. 

LIZ ANN: I agree.

ED: I said, I might as well just write, I might just as well write this before. So, my initial inclination is that it's a lot of hype and that it's kind of like autofill, you know, when you use Word to write something, and it anticipates what you're going to say next and so it fills in. So, it's like autofill on steroids and speed, which gets you back to Benjamin Franklin saying, you know, "haste makes waste." So that's what AI came across to me at first. But upon thinking about it some more, I think companies are going to be able to feed AI software just their own data that's not polluted by all the noise that's on the internet. I'm actually concerned that the internet's going to have more and more garbage in it because the AI that's generating the garbage is going to accumulate and it's going to start coding itself. I've actually seen examples of this where, you know, it just gives you, to give you confidence in what it's doing, it gives you a source. And then you look at the source and it's nonsense.

And then you ask a similar question and it gives you not the original source, but what it just wrote with the source. So, it can be a flawed concept. Indeed. It's just, it's artificial. It's not intelligent. It's just taking a guess as what's next. But again, companies, if they just feed it their own data, it could be retailers, it could be manufacturers that is clean data and it's not polluted by just being actually open to the internet, I think it will allow calculations and ways of doing things much better because it is basically very fast computing. But there are other issues with electricity and all those other issues, but all in all, billions are being spent. And maybe eventually trillions will be spent in this area. And so I think something good will come out of it all. But I was talking about productivity making a comeback this decade, even before I stumbled upon or they stumbled upon AI, because I think labor shortages are forcing companies to use technology to increase productivity. And what's unique about the productivity revolution now at this point is that the technologies that are out there really are applicable to any business model, whereas back in the 1990s, the technology that was available back then was basically Wintel, Microsoft Word and Excel. And if you had a bunch of secretaries, and Selectric typewriters, you can get rid of that pool of workers and be much more productive and let everybody type their own documents and letters and things like that. And if you had a bunch of bookkeepers, you could have Excel lead to productivity. But other than that, it wasn't really that useful in many, many other kinds of companies. This productivity, the technology is there today. And so, I think productivity has already started to show signs of a major growth cycle. It started in 2015, actually. We bottomed out at 0.5% at an annual rate, looking over the previous five years.

And now we're up to almost 2%. That's after some volatility around the pandemic, but we're up around 2%. We had a really good year on productivity last year. And I think we're going to go up to 3.5 to 4.5%, which probably sounds very delusional to a lot of people, but we've had previous productivity booms that got us that high as well.

LIZ ANN: I want to I want to weave in this macro conversation with thoughts on the market. You said earlier in our conversation that you're not contrary just to be contrary. I say a version of that all the time. I'm never a contrarian just for the sake of being contrarian. But every once in a while, you get sort of a funny feeling in your gutter. The spidey sense kicks in. And when I hear people like you and think about last year with the vast majority of economists forecasting recession and tied to that were pretty grave concerns about the profit cycle and expectations that the weakness that we saw in the earlier part of the year was going to persist and that we wouldn't end up what we did end up with, which is back into double-digit positive growth in the fourth quarter. But I can't help but think, "Was that the wall of worry that the market likes to climb?" And now that everyone's dismissing any concern about the economy, any concern about profits, does that trouble you? Does that weave into a perspective on sentiment, having gotten a little bit frothy?

ED: Yeah, it makes me rein in my bullishness quite honestly. You know, at the end of last year, I was predicting 5,400 on the S&P 500 by the end of this year, which was the highest number out there among strategists. And, you know, I was sort of in the delusional camp. People thought that, you know, that no way that's going to happen. And now we're what? One, two percent away from 5,400 and so people say, "Are you going to raise your number?" I said, "Well, instead of raising my number, let me talk about my number next year, which is like 6,000 and maybe after that 6,500." So, I still think it's a bull market, but yeah, I do think valuations are certainly stretched. And from here on, I think it's got to be driven by earnings. Earnings have to drive it and earnings have been actually improving.

And if, in fact, some of these technologies start to kick in a lot sooner than widely anticipated, that could do the trick. But it is somewhat hard to find anything that's particularly cheap. I know some people have been saying that it's a very narrow market, only a few stocks have led the way. So, you would think there's a whole host of cheap stocks out there. But that whole idea of breadth has missed a very important point: the reason that the market looks narrow is because some stocks have done so extremely well that piddling 20% gains since October of '22 just don't match up to 50% and more gains in a handful of stocks. But it has actually been a pretty broad bull market. And so, it's hard to find a lot of things that are like screaming buys.

LIZ ANN: And especially this year where you have seen this sort of stealth rotation going on under the surface, which you wouldn't really pick up if you were just looking at the index level. And all else equal, I think that's healthy with breadth breakouts in areas like materials and energy and industrials and financials. So, let me ask specific to those obviously cyclical sectors, what could shift the market leadership back toward defensives, whether we think of traditional defensives like, you know, consumer staples or healthcare, or maybe this era's defensives, which are actually many of those mega-cap kind of techie techs like stocks because they represent strong balance sheets and a positive earnings profile. So, what could cause that? Some concerns that may not manifest itself in a big problem at the index level, but cause another rotation in terms of what's working and what's not?

ED: Well, as you said, people are starting to get downright optimistic about the outlook for the US economy. It's hard to find any bears anymore. The bull-bear ratio is running around 4, which historically is extremely high. I think what the concerns are that I have out there is first and foremost the geopolitical concern.

Again, we've both been doing this for a while. I think we both know that geopolitical crises have actually turned out to be great buying opportunities. People get all panicked, the market goes down. They call the UN together and there's a ceasefire and the sell-off turns out to be an opportunity. This time around, the geopolitical situation looks a lot dicier to me than some of the ones we've experienced in our careers.

And we've had, you know, I mean, I was a kid during the Cuban missile crisis, so I didn't, it wasn't part of my career. My career started in the late 1970s, but there were plenty of things that popped up every now and then that turned out to be buying opportunities. I would say that while I've been talking about this being the roaring 2020s, I will not dismiss the possibility that this could still turn out to be the great inflation of the 1970s.

We had an inflationary spike when Russia invaded Ukraine and the resulting energy crisis then, especially in Europe, was pretty awful. And it certainly was a contributor to the inflation surge that we had in 2022 and 2023, without a doubt. Now the Middle East is on fire. And the amazing thing is that the price of oil has remained remarkably stable, but it's starting to get to, to not even inch up, it's up like something like 20% in the past few months. And so, I am concerned that if the Middle East situation gets a lot uglier and it does, in fact, cause a regional war that involves Israel with Iran, and maybe even brings in the United States and other allies into this battle, then the price of oil could spike up.

And then it would be very, you know, we lived this in the 1970s. And again, I was in grad school in the 1970s, but I recall the shortage of gasoline and the inflation that occurred back then. So that's something I'm concerned about and watching. So, I'm watching the price of oil carefully. I'm watching the Middle East developments carefully. Another issue is, and one of the reasons that I think I've been getting the inflation story correct, is I pointed out that while the pessimists were saying that the only way you bring inflation down is by having a recession, the Fed's going to have to cause a recession to bring inflation down, I pointed out really early last year that it didn't look like China's recovery was all that great coming out of its lockdowns of Covid. And I started to speculate that maybe this real estate disaster they had there was something to be taken seriously, that they'd be in a recession for a long time. Property bubbles in Japan, in the past, in the United States in the past, once they burst, they take years to overcome the deflationary consequences. And so, the Chinese are trying to stimulate their economy by stimulating their manufacturing. The consumers are just too depressed. They got a huge negative wealth effect between property prices down and stock prices down.

And so, the Chinese government seems to be basically saying, "OK, we'll just try the same old same old model, stimulate manufacturing and export it to the rest of the world." And what they're doing is creating deflation. I don't know that they're putting the German auto industry out of business, but it's certainly hurting. I think Tesla is going to have a big competitor with the Chinese electric cars. And so, the Chinese are exporting deflation. And that could be a problem for some of these cyclicals that are anticipating that we're going to have a commodity boom here because the world is suddenly going to come back as China comes back and as Europe comes back. Europe's also in a recession and they've got their own issues with aging demography, but also a really botched transition from fossil fuels to clean energy. I think the global economy is not doing that great, quite honestly. On the other hand, on a relative basis, the US is doing extremely well.

LIZ ANN: So, talk about the Fed reaction function, maybe specifically if things really do escalate from a geopolitical crisis perspective, either in the current kind of hot areas or others. What does that do to their reaction function to more traditional inflation trends? And what's your thinking around the current embedded expectation of a June start and you know three cuts this year? Are you in line with that or do you have a different perspective?

ED: I've had a different perspective from the beginning of the year, because at the beginning of the year, the market seemed to be discounting five, six, seven cuts in the Fed funds rate by 25 basis points each, starting in March. And I just couldn't understand where was that coming from. 

LIZ ANN: Ditto, ditto. 

ED: And I think where it was coming from is all these people that were wrong about a recession, kind of their fallback was, "Yeah, but it's going to be kind of a weak 2023, and if the Fed doesn't lower the Fed funds rate, we will get into recession. And with inflation coming down after all, maybe they're going to try to keep that from happening." The economy still looks pretty good. Inflation is coming down. And even people at the Fed have been saying that if inflation continues to come down and stays down, then they'll have to lower the Fed funds rate because otherwise, real Fed funds rate will be too restrictive. I don't get that one at all. I mean, adjusting an overnight interest rate for a year-over-year CPI, what is that number? I mean, who wakes up in the morning and says, "I'm going to have to change what I do in terms of spending and my business model because of a real federal funds rate?" Maybe the real bond yield matters, but the real federal funds rate just doesn't do it for me. The notion is that there's long and variable lags in monetary policy, which again, I'm a contrarian on. My view is that there really is no long lag between tight monetary policy and recessions. As soon as monetary policy causes a crisis, we're getting pretty close to having a recession. 

So, I guess I don't understand why Fed Chair Jerome Powell recently suggested that the Fed is just waiting to get more confident about inflation going down to 2% before they start easing. But he made it sound very much, very dovish. He made it sound like we can expect the rate cuts. And by the way, the FOMC, the Federal Open Market Committee's summary of economic projections also show that the median expected outlook for the Fed funds rate by the entire committee is for three rate cuts this year. So, the markets were way ahead of that, thought there'd be a lot more. And now the markets have come back and said, "OK, they're going to be 3." And I'm saying "Maybe two, maybe right after the election, November and December." And I will not be surprised. And as a matter of fact, I advocate no rate cuts whatsoever, not signaling a rate cut for now. There's no reason to and there's no reason to signal that you're going to be data dependent, to wait for the data to show you that the economy really needs rate cuts. And if it doesn't, because if they cut rates, without that being obviously necessary, you're going to get a meltup in the stock market. And the problem with meltups is you've got to know when to get out, and then you've got to get out, and then what? So, I'm not rooting for a meltup, but it could happen. And we may be in the early phases of it. It could be more like, you know, if we're doing decades, it could be like in the 1990s, where we're like in 1996, when Alan Greenspan at the end of the year famously said, "How do we know if it's irrational exuberance?" And people are asking that right now.

LIZ ANN: They are, and that's why I always remind people when I get questions about sentiment that one should never consider it as a market-timing indicator, particularly when sentiment gets in the frothier end of the spectrum, because it can get there and stay there for an extended period of time to your point, three plus years in the case of the late 1990s. But you have to have it in your mindset as a backdrop, because when you're so far on one end of the spectrum, to the extent there's some kind of negative catalyst, you know, the contrarian move could be more significant than even those fundamentals would suggest just because sentiment gets one-sided. So, you know, I'm going to close here because I think that's a good way to end things. You have been very optimistic about the economy, very optimistic about the market, and that has been absolutely the right call, but you're also, you know, you're an analyst, you understand how cycles work. You are a sentiment watcher like I have been for my 38 years in this business. And I think even in the context of roaring '20s and things look much better than what the pessimists believe, I like your reminder that there are risks and that you need to be mindful of them. So, thank you for sharing both sides of your perspective. But I love our conversations, Ed, when we've done them one-on-one over lunch or over the airwaves or in person in meetings. So, it is just such a pleasure to have you. And I know we're getting, you know, figurative and hopefully, hopefully literal in the case of things like reviews on this episode. So, thank you so much for joining us.

ED: Always great. Thank you.

KATHY: Well, that was really interesting, Liz Ann. You know, I worked with Ed back at Prudential in the late 80s and 1990s. Very impressive economist, market analyst. And so, with the stock market up on the year, what are you watching for as we approach the end of the first quarter?

LIZ ANN: Well, Kathy, I'll go back to what you said with kind of the bond market and wait-and-see mode right now and yields being relatively stable, kind of in a range. And I do think that at any point where yields start to move, because we have a more concrete idea of what the Fed's going to do this year, what's the start point of rate cuts, how many that could be an equity market driver, too. And of course, next week is a huge week.

We already talked about what we can't talk about on this week's podcast because we're taping this in advance of GDP revision and the PCE data, but next week is just chock full. We've got both ISM services, ISM manufacturing, and these days the components are often a tell as well, whether it's the prices paid components, that gives you a read into inflation outside those traditional reports. You get the employment components. We get the JOLTS data next week as well, which brings job openings and things like the quits rate. And then we get the big one at the end of the week, which is the jobs report. And that's always important. But I think particularly given that two months ago, it was pretty much across the board, a hotter-than expected-report. And then last month was sort of the ultimate mixed bag where if you were an economic bull or an economic bear, you could find a nugget in the report that supported your view. So

I think that's quite important and could be a needle mover one way or another for the equity market. What about you, Kathy? What's on your radar in the week ahead for fixed income for the Fed, for the economy?

KATHY: Well, of course, as you mentioned, all those numbers are important, but the inflation and payrolls numbers are paramount because that's what's going to drive Fed policy. But I'm also watching some of the other major central banks. We've seen this sort of standoff now where some of the central banks are kind of waiting, I think, for the Fed to move, or they're not sure they're ready to move, and there's been this kind of, "Will we have synchronized rate cuts or will the Fed lead the way?" which was the previous expectation, and now perhaps not, kind of a very interesting dynamic going on within the other major central banks. Of course, we talked about the Bank of Japan that recently raised rates out of negative territory for the first time in decades, but then recently the Japanese yen hit the lowest level in 34 years, since 1990. That's a bit counterintuitive. So, I'm keeping an eye on that because it may lead Japan to make changes. The Ministry of Finance has already sort of threatened to intervene in the markets, in the currency markets, but will this move the Bank of Japan to be more aggressive in terms of their rate hikes or tightening policy or less easing policy? The foreign exchange market often seems to really react more quickly than other markets to some of these big changes. So, keeping a close eye on that to what it means for central bank policy around the world. But with that, I think we have, unless you have some final thoughts, Liz Ann, I think we're ready to wrap it up.

LIZ ANN: Yeah, the only final thought I'd have since we talked about volatility, and I mentioned equity market volatility being so low and has been low really since about November of last year. In and of itself, that doesn't suggest we need to be on guard for an increase in volatility. But I do think that there's a lot of complacency around volatility and there's a lot of trading that's being done that's a bet on volatility staying low. And I don't know, the Spidey sense in me just says if we get some kind of catalyst, it could provide some volatility into the mix and investors just need to be on guard for that.

KATHY: And with that, thanks for listening, everyone. Be sure to follow us for free in your favorite podcast app. And if you've enjoyed this episode, please tell a friend about the show or leave us a rating or review on Apple Podcasts. 

And, as always, you can follow our latest updates on X, formerly known as Twitter, and LinkedIn. I'm @KathyJones—that's Kathy with a K—on Twitter and LinkedIn.

LIZ ANN: And I'm @LizAnnSonders—Sonders is S-O-N-D-E-R-S—on X, or Twitter, and LinkedIn.

KATHY: Next week, I'll be speaking with fellow podcaster Dion Rabouin. He's a reporter at the Wall Street Journal and he hosts the Journal's "Take on the Week," which focuses on economic data and sort of major trends in the economy. So, we'll his take on the week and learn more about what a financial journalist really does. So, stay with us.

For important disclosures, see the show notes or schwab.com/OnInvesting.