Transcription
I don't give point forecasts anymore, and the reason is because the people that have point forecasts are continuously, you know, revising them. And I think it just creates more volatility in their own lives as opposed to getting a point estimate right. Everybody was cutting their year-end targets during the February to April drawdown, and that was a mistake. And now everybody is raising their numbers.
I don't operate in black and white. I operate in shades of gray because the one thing I've learned in the 40 years in the business is that there is no such thing as a sure thing. And when you're giving a point forecast, you're basically saying there's a sure thing. I think it's more helpful actually when you give a point forecast if you talk about what the risks are to your forecast. And they could be upside or downside risks, and [music] what plan B is if the base case scenario doesn't come to be. So that's basically how I operate, but that's from years of having worked both on the sell side and the buy side. So I deal more with, uh, direction, and I spend most of my time across the asset classes trying to depict what's priced in at any moment in time, and then whether or not I disagree with what the markets are telling me. You know, people always say that the markets are right, but were the markets right, you know, in the summer of 2007? When you look at what happened, not just in the next year, but the next two years, just as one example. There's countless other examples. So sometimes you have to either agree with the market or disagree, and the question is, you know, what's priced in.
And it is ironic because there was so much recession fear back when the Fed was tightening policy so aggressively in 2022 into 2023. [music] And I think what a lot of us underestimated was the power of fiscal stimulus and [music] primarily not just the subsidies by the Biden administration, which were huge for the construction of manufacturing facilities, but it was really that $2 trillion combined stimulus checks of the household sector where the first time ever 100% of stimulus checks [music] and $2 trillion is not exactly chump change. All that money got spent, and it was a gift that kept on giving and served as a massive antidote to what the Fed was doing over that period. It's why the inverted yield curve didn't work this time. It was the power primarily of those stimulus checks, which are now basically in the rearview mirror.
I would say that as far as the market's concerned, I am concerned the multiples can stay elevated. The multiples only make sense if we're in the sort of real interest rate environment we had 5 years ago, not in the real interest rate environment we have right now. You always have to take a look at where the market's trading, any market benchmarked [music] against the risk-free real interest rate. And on that score, you know, when I look at almost every multiple that you could come up with, price to sales, price to IBITA, price to book [music] in so far as that still matters in today's environment. The Buffett indicator that has its limitations too, but price to sales are price to sales, and you look at the trailing and the forward, and you [music] look at the cape multiple, which is my favorite because it goes back more than 100 years. And you know, when you're at 38 [music] on the cape multiple, and it's not a timing device, but I always find that valuations, while not a timing device, at any point on the continuum, either act as a tailwind or a headwind. We've only been this high on the Cape multiple, the Schiller multiple, three other times in history, and it was back at the end of 2021, and nobody was calling for a bare market in 2022, but we did get one. And it was saved by ChatGPT in the fall of that year. And then you're back in '99, 2000. And before that, well, we're even above the level of 1929. Each one of these valuation metrics that I mentioned are more than two standard deviation events. I guess we could say that it's different this time. Maybe ChatGPT and the shift in the technology curve is bigger than the internet was. Time will tell.
But the point that I'm making is really two things. The first is that I don't normally go balls to the wall bullish on anything when it's trading north of a two-sigma event. I just don't do that. I think we are in a bubble, and I think as Bob Frell famously said, bubbles go further than you think, which is where we are right now. But they don't correct by going sideways. And I just don't invest in 2 SD events, no matter what. But I find other things to [music] deploy the money, and we've been doing that. It's very interesting that as we're sitting here, the first thing we're talking about is the stock market, and I imagine we'll get into gold and silver. But gold and silver and the gold and silver mining stocks have actually smoked the S&P 500 this year, and they're not a trade on the MAG 7. They're a trade maybe on something else that's going on. But if you're taking a look at what the S&P 500 has done in gold terms, not in deflated US dollar terms, the S&P 500 is down 23% this year. So that again is if you're measuring it against something historically that's been stable, which is the gold price.
I said before that you want to take a look at what's priced in. [music] And when we back out the valuations, what we're able to ascertain is that the S&P 500, as its own asset class, is discounting for the next 5 years, to 2030, is discounting 15% EPS growth on an average annual basis, which is double the historical norm. Now, maybe we'll get that. History shows there's a 1 in 10 chance that over a 5-year period, you'll get double the average growth rate in earnings. Investors should know that that is what you're buying right now. You're buying a market that's anticipating a 2x on the historical earnings trend benchmarked against the historical record.
I don't think it's noise. And, you know, the reality is that what didn't happen in the recession scare of 2022 and 2023 is that you were not seeing declines in employment that you're seeing right now. Now, we don't have a non-farm payroll report today, and we'll see how long that's going to take. But in the past 4 months, the only reason why non-farm payrolls haven't gone down is because of the skew of the birth-death model. And outside of health and education, which is non-cyclical, employment's been declining for the past several months. So you're seeing serious erosion. It's not noise, it's a pattern.
You know, you mentioned the ADP number. The first thing I go to with ADP is the small business sector, cuz the small business sector is on the front lines of the economy, and they can adjust their payrolls much more quickly than large companies. And the small business sector employment declined 40,000, which is huge. We haven't seen declines like that since the summer of 2020, when COVID was still ravaging the economy and most of the economy was closed. And the small business sector is a leading indicator. And there's other things too, right? Like you've got the service sector, ISM employment has been below 50 four months in a row. For manufacturing, it's been below 50 now for eight months in a row. And as you had mentioned from the JOLTS numbers, you know, we're seeing on a trend basis a big decline in hiring activity. The Challenger numbers, for example, on hiring year-over-year, that's fallen dramatically. And I think this is important, the hiring rate going down, because if, in fact, the other side of the debate is right, but a lot of people are saying that the decline in the labor market is supply-side related because of all the immigration restrictions, I think that's a factor, but it's a two-bit factor. I think that there is a fundamental decline in the demand for labor because if companies are scrambling to replace the people that are being pushed out of the country, you'd be seeing job openings going up. That's not happening. But you'd be seeing gross hiring activity going up, and that's not happening. And you'd be seeing companies scrambling, and in that scramble, they'd be raising wages, but wage growth is actually moderating. So we're seeing a fundamental erosion in the demand for labor. And I think it's obviously important because employment ultimately leads disposable income, and disposable income then leads consumer spending. [music] And consumer spending is roughly 70% of GDP.
Now, it may well be that the stock market looks through all this because, you know, when you have $9 trillion mega-cap growth companies, you have basically the same share of classic growth in the S&P 500 that you had back in the late '90s and 2000s. So by definition, the S&P 500 has morphed into a growth index and it's lost a lot of cyclical properties. So who knows, maybe the first time ever we have a recession, the stock market just breezes by because it's effectively a long-duration animal. It doesn't mean that's the same for the S&P 600 or for the Russell 2000. But that has been the case for the S&P 500. It's morphed into a growth index by definition. Therefore, it's got a longer duration expectation. I mentioned what's priced in on a 5-year basis.
However, let me just say that for the people talking about GDP, it's not the only measure for economic activity. And [music] we all talk about how so far this year, there's actually been no growth for 92% of the economy, called the part of the economy that isn't touched by AI directly or indirectly. You know, 92% of GDP is actually flat so far this year. It's all OpenAI, and the same concentration in the economy as there is in the stock market. There's, it's not just autos and housing. There's a lot of areas of the economy that are struggling right now, but the AI story is carrying the day. There's no doubt about it.
But something else has happened that people that are saying the economy is so hunky-dory, that actually in the second quarter, the biggest contribution to GDP growth was the tariff-induced plunge in imports. Imports went down so much in the second quarter, arithmetically, it contributed 5 percentage points to headline GDP growth because imports are a negative in the GDP numbers. So when they go down, it provides a huge boost to GDP. Outside of imports, real GDP was actually -1.2%. And the fact that the consumers hung in very well, but you can't talk about the consumer in the aggregate really, because you got to take a look what the critical factors are. The critical factor, and you can see it in the savings rate. The savings rate in the past 4 months has come down more than a full percentage point because you've got the stock market boom. So you've got this ongoing K-shape to the consumer. Basically, when McDonald's is telling you that people are skipping breakfast, you can't therefore then say, "Oh, well, things are hunky-dory with the consumer." There's a segment of the consumer, and it's the high-end that's driving the bus, and that's because of the stock market. It's not because of the labor market.
And in actuality, I don't know anybody can look anybody straight in the face and say, "This is a great economy," when in the April to August period, real personal disposable income, you want to talk about the labor market, what is the income after tax in real terms that the labor market is spitting out, negative 1.2% annualized, and yet real consumer spending growth is up 2.6% over that period. That's the fallout is the drop in the savings rate linked back to the equity wealth effect on spending.
Now, I'll just make this one last point, which is this. There's another asset class that also bulks large on the household balance sheet, which is called residential real estate. And we just got the Case-Shiller numbers this week on home prices. They're down four months in a row. And what we found historically is housing leads the equity market. Residential real estate leads the equity market. There's a 90% correlation between residential real estate valuation and equity market valuation. We haven't seen this play out yet, but I debated a lot back in 2006, 2007. I set for the record back then, and back then it wasn't about AI. It was about the democratization of finance and the fact that everybody can go and buy a home. At that point, the supply-demand curve started to shift, as they're doing right now in residential real estate. I said then, I'll say now, no cycle ever ends well. And this took time to play out, but it played out big time. No cycle ever ends up well in a real estate deflation cycle. And this thing just started getting going four months ago.