Transcription
The equity wealth effect on spending has been dominant. And the low end, I mean, they're spending on necessities. They'd rather not have to share one plate of pasta with a family of four if they don't need to. But they are borrowing to survive right now because their job prospects are meek and wage growth in nominal terms is subsiding at a time when inflation has remained, shall we say, stubborn. So, that's impacted their real incomes.
The high end has been the dominant force. Make no mistake about that. And that again comes down to why. Why has it been this shift in the curve of high-end consumer spending? It certainly wasn't happening in 2022 during the cyclical bear market. And then it's really accelerated just in the past year. And so, yes, it's been the equity market, the impact it's had on wealth creation, but the psychology behind that, that it's okay to continue to spend more and more of of my after-tax income. Maybe the savings rate gets to zero. Nothing says that it mathematically it could even go negative.
I guess if you believe that Donald Trump was the principal source of the bull market in equities, I don't really think any president, including Ronald Reagan, is that powerful that they can influence Mother Nature. The markets will just move in cycles. And the markets are incredibly driven by psychology. In fact, when you go back historically, you'll see that, you know, almost half of a typical bull market is multiple expansion, not earnings growth. And then in a bear market, 80% of the bear market is the multiple contracting. That's what John Maynard Keynes famously coined. Markets are more volatile and go into far more amplitude in terms of the magnitude of the cycle than the economy does.
But you see, I would say that we've never reached a stage, especially now that 72% of the household sector financial as balance sheet in terms of percent share of financial assets, 72% is in equities today. It's higher than it was during the dot-com craze. So, everybody is all in at the same time and everybody believes, cuz you have a equity risk premium of zero or negative, that everybody believes that equities have become a risk-less asset class. That's going to be, I think, the big surprise is, you know, we talk about mean reversion. What happens if the equity risk premium mean reverted or the price-earnings multiple mean reverted? And so, I the answer always is, well, valuations only matter when they matter. Yeah, and then you have your head sliced off.
So, as an economist who is focused on the fundamentals, and maybe that's gets me into trouble, because when you have a situation where real organic after-tax personal income is running zero year-over-year, but consumer spending is up 2 and 1/2 to 3%. That is a wide divide that is not a sustainable economic model. I'd rather have incomes accelerating and consumption weakening so that I could say, "Hey, we're going to get catch-up. Consumption's going to catch up to incomes." That hasn't happened yet, but that's why I'm bullish on the economy. But it's flipped. Like, basically, outside of the wealth effect, what drives consumer spending is real income. So, you see what I'm saying here is that flat real incomes, 2 and 1/2% spending growth, and that 2 and 1/2 percentage point gap is all the stock market equity wealth effect on spending. And if that goes away, you'll be at zero in consumer spending growth. And there won't be enough AI spending around to make up for that loss, cuz AI is not 70% of GDP, nor will it ever be. But the consumer is. So, that's really what's at stake here.
All I can say is, who knows what the stock market's going to do. I mean, I have my views. If you're a macro bull, I wouldn't be pointing to Donald Trump's policies. I'd be praying if you're a macro bull. If you're praying for the Fed to not cut rates, you're praying for higher rates, praying for an ongoing consumer spending binge, you better be hoping that this bull market is going to stay here for a long time, cuz that's what's driving the biggest part of economic growth. There's a lot of air underneath the economic data. I don't trust an economy where there's no job growth. Are we relying, therefore, all on productivity growth?
You know, let me give you an example. In the 1960s, you know, you've got the microprocessing chips. And when you look at the data, productivity is going 2, 3%, employment growth is going 2, 3%. You go to the 1970s, you know, with the mainframe, and productivity 2 to 3, employment growth 2 to 3%. Microsoft goes public in 1986, you get the software boom. Productivity is running 2%, employment growth is running 2%. If you go to the internet, if you go to the peak of the tech boom in the first quarter of 2000, both productivity and employment growth are running 2%. Right now, we have 0% in employment and we have over 2% growth productivity. So, this year could be great. Like, you know, we know we got the income tax refunds, we've got the capital commitments in the hundreds of billions of dollars from AI. I think the economy this year, on average, I think we should be okay. The second half of the year I'm a little concerned. 2027, I think there'll be an incredible vacuum because we'll be past the peak of the AI spending boom. We will not know at that point how much overcapacity there is going to be. Past the peak of fiscal stimulus, we'll probably have change in the midterms, so they're going to have split government, which means fiscal gridlock. And then it comes down to what the stock market's going to do. I have a view on the stock market. I'm not particularly bullish, but then again, other people have a different view.
We should be very concerned about the K-shaped to everything, especially the consumer from a social stability standpoint. We should be very concerned about an economy that's running on all the things we're talking about. I mean, fiscal stimulus and AI spending with no job creation. I'm not in the recession camp any longer. I haven't been for a long time, but that doesn't reduce my concern that, benchmarked against expectations, I think the economy second half of the year is going to seriously disappoint. You have so much priced in. The consensus is so wildly optimistic that you don't have to have a recession call. But if you get GDP growth second half of the year running 1 to 2% and with that higher unemployment, that's going to be a big surprise to the markets and a big surprise to the Fed. And that's really where I'm at right now.
One of my recent moves was to extend bond duration out to the 30-year cuz I like where real rates are. And I have a very benign inflation outlook. And I like how bonds are valued against the stock market. And I think inflation and inflation expectations are going to drop measurably between now and end of the year. So, I like the Treasury market. I like all aspects of it. The front end I like as well cuz there's not enough Fed rate cuts priced in. The Fed has talked everybody out of it. I'm on the other side of the trade as the FOMC hawks. And I like the long end.
There's parts of the stock market that I like. Obviously, aerospace defense to to us has been a no-brainer and one of the few sectors to be going up through this conflict with Iran. You know, we've been long utilities, healthcare, energy infrastructure. In Canada, we've been favoring the pipelines. But most of our equity concentration, and people should know that in the Rosie model portfolio, I'm not 0% in stocks. In fact, we're 50% in equities. It's just that 15% of that has really been in the US. We have 35% in Europe and Asia. And notwithstanding the fact that Europe and Asia are more susceptible to the disruptions we've had because of the war and energy prices, we still like that diversification in those other markets because they command a superior valuation. So, we like those particular regions. We like US bonds we bought recently. We think there's too much inflation and RBA tightening, so we bought Australian bonds. And in the equity market, you know, we're very sector-specific. So, like I said, the hard assets that spin off a revenue stream. We're very cash flow sensitive. Like I said, the pipelines and the utilities, energy infrastructure. We do like healthcare. We've been there. Again, one of our recent moves was into the equal weight consumer staples sector. We don't want to own like two names, Costco and Walmart. And the equal weight consumer staples. So, it's a very, shall we say, defensively structured, yield-oriented, capital preservation type of asset mix that we have right now. We're still somewhere between 5 and 10% on gold and the gold miners. I used to be higher, but here's, you know this as as well as I do, that you don't make money till you book a profit. We like gold. We don't adore it as much as we used to.
Depending what happens in the Middle East, this could be a game-changer for me cuz there's a risk, depending on how this goes, that I become a permabull. Well, I'm putting out a report where I'm saying we don't have to win the gold medal. The silver medal will be just fine. So, the silver medal is basically that the Iranian regime, it might not go away. And I'm not really don't know anything about regime change. That's difficult to do from the air. But defanging the root of evil on the planet, and then the next thing that happens is the Abraham Accords. When you think about bringing Iran into the global order, 90 million people, young, vibrant, educated population. This could be really big stuff. Bringing Iran into the world economic order, and not just that, but then paving the way for, at least, say, economic relationships between Israel and the Gulf countries and other Arab countries. Well, I could tell you, we could be talking a month time that I'm redoing my whole asset mix based on what happens out of this cuz I won't have any desire I have no satisfaction owning global aerospace defense. In fact, I hate owning it, but I do it because we want to make money. I would love to have an excuse to take that position off. Peace is a good thing.
And the one thing I'll say with reference that I didn't mention before, what could come out of this? Imagine if the geopolitical risk premium in the oil price comes out permanently. And everything that I'm thinking about right now is going to lead to lower oil prices. The question is, will it come in time for the midterms for Donald Trump? But then you'll have me back on and I'll say, "Okay, I'm going to go back and say yes, there there was one presidential policy that indirectly led to much lower oil prices without having to drill, baby, drill." And that's a successful resolution out of this war with Iran because we take out the geopolitical risk premium out of oil, we end up getting more production, and then Iranian production into the world supply. And then I'll probably do another shift out of my energy exposure. But that will breathe life into real purchasing power. That might get me bullish on the low-end consumer. Let me remind you, they don't drive, but lower oil prices are good for consumers everywhere.