Summary

  • WHAT: New York Foreign Press Center On-the-Record Briefing – Wall Street Briefing Series

  • WHEN: Tuesday, December 17, 2019; 8:30 – 10:15 AM

  • WHERE: Stifel – New York 787 Seventh Avenue (between 51st & 52nd Streets), 4th Floor Executive Boardroom

  • BACKGROUND:  This briefing is part of a series organized annually by the New York Foreign Press Center to give the foreign media access to Wall Street experts. 

    Barry Bannister will focus on: Stifel’s equity market outlook for 2020 and beyond; Forecasts for the dollar, oil, and treasury yields; Key factors to watch including: monetary policy, the economy, trade, Brexit, corporate earnings, and the U.S. presidential election.

    Stifel is a diversified global wealth management and investment banking company. Stifel operates the largest U.S. equity research platform, covering nearly 1300 companies across all relevant sectors.

Stifel – New York 787 Seventh Avenue (between 51st & 52nd Streets), 4th Floor Executive Boardroom 

MR NESI:  Well good morning, everybody.  Thank you for joining us today, especially given the weather.  Appreciate you all making the effort to come on in.  My name is Victor Nesi.  I am co-president of Stifel Financial and head of our Institutional Business at Stifel Financial.

Not much of a commercial for you, but I’ll give you a couple quick minutes on Stifel.  I don’t have any slides, because Barry will have plenty of slides for you, so you can take that for granted.  Look, over the last decade Stifel has grown to be one of the preeminent firms on Wall Street, focused principally on the middle market.  We have over 2,000 – actually more than 2,400 – retail brokers with over $300 billion in assets under management.  That makes us roughly the seventh largest in the United States.  We have the largest equity research franchise on Wall Street in the U.S.  We cover over 1,300 stocks in the U.S., and that number is growing internationally as well as we continue to do transactions and bring on capabilities globally.  We’re one of the top 10 underwriters of IPOs as well, both here as well as over in the UK.  We have leading franchises in technology, biotech, financial institutions – companies like Lyft, the RealReal, Peloton, all those IPOs we’ve been involved in and have prominent roles in.

We’ve now become a global firm, as I described earlier, with franchises in the UK as well as on continental Europe where we just completed an acquisition for a company called MainFirst, which is a significant provider of research with over 400 companies covered on the continent, as well as with GMP, where we – with which we just closed in Canada, providing us a significant franchise there.  While others on Wall Street have been shrinking or finding ways of restructuring their business, over the course of the past decade Stifel has continued to invest in our capabilities and the products that we can offer out to our clients in order to be more relevant to each one of them.

Since over that decade and even longer, Barry has been with Stifel.  He’s been an award-winning analyst.  One of the nice things about Barry is that he can make – he can see the marketplace, and he can provide projections and views over long trendline timeframes as well as short trendline timeframes, from his calls on the commodity cycle back earlier in the decade to more recent opportunities that he’s mentioned as to what’s happened in the marketplace.  If you were here last year, you know that some of Barry’s projections that he made least year at this event certainly have come through this year.  We’re all looking forward to it.  He heads up Stifel’s institutional equity strategy research group, and with that I want to turn it over to Barry and give him the microphone.

MR BANNISTER:  Thanks, Victor.  Appreciate it.

MR NESI:  Sure.

MR BANNISTER:  As Victor said, I’ve been with Stifel since the company bought a company called Legg Mason Capital Markets in 2005.  And Ron Kruszewski – sorry, I almost called him Captain Ron – our CEO, is an excellent acquirer of other companies.  He sniffs out value and he finds good people and good businesses.  And I’ve worked for a lot of firms on the Street, and this has been a thrill to be here now for it looks like almost 15 years.  Prior to that, I was at UBS when it was Swiss Bank and Dillon Reed and S. G. Warburg.  I was on the Warburg side, it’s a British investment bank.  So I was there throughout the 1990s, and – should I mike up?  Am I going to be okay?  Do you want me to wear a mike?

PARTICIPANT:  No, no, it’s okay.

MR BANNISTER:  Okay.  And throughout the 1990s – and so I did a lot of investment banking, a lot of industrial banking and research.  And then prior to the ‘90s, in the 1980s I was on the buy-side, investment and management.  And so I’ve been around a long time, I’m a lot older than I look, just well-maintained.  No, I’m just joking.  (Laughter.)  But yeah, I’ve been around for 35 years doing this.

And so about – as Victor mentioned, about 10 years ago I switched over to the strategy role.  And when I was an industrial analyst covering companies like Caterpillar and Deere and United Rentals and Tyco and Ingersoll Rand and Fluor and Foster Wheeler and Jacobs, names like that – I covered most of the cyclical side of the economy.  So I was very big and involved with commodities and with currencies and making forecast on the Fed and so forth.  So it was a natural fit to kind of go over to the strategy side, because a lot of my friends and competitors in the business started out as cyclical analysts and ended up as strategists.  So here we are.

So I – the strategy role kind of came naturally, but it has been – I actually think it’s a harder job than being an analyst, because it’s certainly more broad, and it’s more visible.  There’s no place to hide when you’re wrong.  And so we’ve been doing this for 10 years, and probably had the real hang of it for the last four years.

And so let’s go through some charts.  Now, when I was here a year ago, and I was just looking at the cover of my presentation to you all a year ago, to the press, we were concerned about the S&P.  It was then 2738.  It had just come off from 28 and change – hundred.  And if you recall – I don’t know if you remember this – but October to December of last year, we lost about 4,000 Dow points and 400 S&P 500 points, in three months.  We bottomed around December 24, -5, -6, and what happened?  Well, Chairman Powell at the Fed pivoted, became dovish.  We had been concerned and expressed concern that the Fed had been simply too hawkish.  And so what we had favored for the last year up until last October, early October this year, were what we call defensives.  These would be stocks that survive when the Fed is too tight, stocks that do well when bond yields fall – which was our call.

So this is just a screenshot of our October 5th, 2018 equity view where we had said we prefer the defensives, the policy-driven market is unwinding, the Fed is tighter than they realize, the dollar is going to rise further, earnings estimates are going to be cut, the Fed is not going to react fast enough, so you want to buy consumer staples – health care, utilities, telecommunications, REITs, things like that.  They did very well, actually, for about a year up until October of 2019.  And that’s when we pivoted, too.  I was in Denver October the 7th, Monday.  I’m a member of something called NABE, the National Association of Business Economists.  It’s a great group, by the way; you should join it.  They get great speakers, and major figures at the Fed and the government announce major policy changes at this conference.  So I tell you, for the money and for the time, it’s the best group I belong to as far as cost-benefit.

But NABE had a meeting in October 7th in Denver, their annual meeting.  And I sat maybe five feet away from Chairman Powell, and he was being interviewed by Fidelity’s chief economist, whom I’ve known for decades.  He’s great.  And they announced this program where they’re going to expend the balance sheet well over a quarter trillion – maybe a third of a trillion dollars in reserve additions by buying T-Bills from banks.  And this was in response to the disaster that happened in the repo market, which you all are familiar with, where repo rates shot up because of a shortage of reserves in the system.

So I saw the significance of that, and I realized just as Powell did and said several times, this is not truly QE, but it’s pretty close to QE.  Pretty close.  And it is a pivot in policy.  And sure enough, the market took off the first week of October.  And we said, look, President Trump is going to settle on a mini-deal with trade on China.  We said the Fed sort of gave in to kind of a mini-QE – it’s our term, not theirs – to improve global liquidity, and Brexit looks like it’s going to move along without being disorderly.  And so we’re saying we’ve been in defensives for a year; we’re going to go with cyclicals, cyclicals being industrials, financials – it’s all listed here – materials, technology, basically the cyclical side of the economy.

So let’s go through a few key slides.  I like this clicker; it’s so fast.  (Laughter.)

So we wrote our 2020 outlook a few days ago, and we said – we made this call back in early October, which was pretty good timing as far as the cyclical rotation out of the defensives occurred right then.  To just – if you really want to get ahead in this business, just follow the Fed, right?  Don’t fight the Fed.  I’ve lost money every time I ever fought the Fed.  Follow the Fed more than anything, and understand currency rates, yields, and so forth, because that’s what’s going to drive the market.

So we rotated because the cyclicals had de-risked.  And we list in this report 25 of what we call reflation or value trade stocks that should do okay, do very well, beat the market significantly, and they’re mostly industrial and materials and energy and financials and technology.  Now, there are risks to our call.  There’s always going to be risks, right?  Okay, anyone who tells you that they’re absolutely sure there’s no risk, they’re just an idiot and they don’t know what they’re talking about, because this is a business that’s constantly at risk.  Right, it’s constantly unsure and every day you walk in, you’re concerned.  It gives you an ulcer to be in this business too many years.

So what are we worried about?  We’re worried about a recession, actually.  It’s just a question of when, and we keep – we’re delaying it, but it will come and we have an idea of what would cause it.  We’re worried about policy, and not just Fed policy missteps, which they are prone to do, but policy everywhere, whether it’s geopolitics policy, whether it’s Iran, whether it’s the ongoing events that we’re seeing in China right now, the trade policy, and so on.  Policy is still important.

And then I have a kind of an outlier view that there’s a risk in 2020 of a bit of an oil shock.  I’ll talk about that later, but that’s a big risk to me that around the holidays, around July 4th, American holidays, people who are driving their cars – you don’t want 4 and 4.50 and 5 dollar gasoline.  You will not get elected if that happens.  And the people who have the power to affect the price of oil know that, and so their maximum leverage occurs in the summer of 2020, and so keep an eye on oil.

So we think our 25 stocks are going to outperform.  This is what I was talking about earlier:  In the year up until that pivot we did on October 13, 2019, the green, meaning real estate, utilities, staples – tech is just a stalwart; it’s cyclical but it’s just – it never seems to have a bad year, which is frustrating because you want to time it a little bit, but it just romps ahead – it’s like the Tom Brady of sectors – comm services, and then healthcare.  So four out of five is not bad.  I mean, the defensives dominated in that year.  Now we’re seeing a shift, like a wave back towards cyclicals doing very well, and there’s healthcare, of course, and that’s strictly a political call.  What happens with healthcare is that as the people who wanted to nationalize healthcare fell in the polls, the sector rose.  It’s just that simple.

So we’re seeing this wave go back towards a more cyclical profile to the S&P 500.  So we just looked at – we did a screen of various variables that constituted a weaker dollar, more reflation, a slightly higher yield, and it pushes you into names like Caterpillar and CSX and Deere and materials like Dow, Freeport, and LyondellBasell.  We like the ConocoPhillips and EOG and Valero.  In tech, Micron, NVIDIA, Intel.  In fins, the Schwab, the Morgan Stanley, the Bank of Americas and so on.  So just a group of stocks.

Let’s take an equal-weighted index.  So equal-weighted, 25 stocks.  So if you had $100, you’d be putting an equal weight into 25 names.  Let’s look at their year-over-year relative strength.  So those stocks, equal-weighted, relative to the S&P 500, and then year-over-year change of that relative ratio.  Huge outperformance back in 2013, if you recall.  Huge drop in ’15, early ’16.  Enormous rise back in ’17 and ’18.  Enormous drop in ’19.  And now we think another rise.  So it’s a nice move, and it doesn’t require much for those stocks to work, and you can see about half that move looks like it’s done, so there’s half to go.

Well, just as the Fed drives global dollar liquidity, China has a huge impact on global GDP.  So there’s a bit of a symbiosis there, a relationship between China and the U.S., right?  One is important for global liquidity; the other is very important for global growth, particularly outside the U.S.  And so we measured Chinese aggregate stimulus, which is all bank lending, non-bank lending, and local government financing vehicle issuance for infrastructure, and we measured – we do it as a percentage of M2 for China, one, because the Chinese GDP statistics are not as good as the PBOC’s money statistics.  So it gives us a stasis, a base for measurement, and we see the huge China stimulus in ’13/’14, then the big downdraft in ’15/’16, the huge updraft in ’17 and the big downdraft in ‘18/’19 as they tightened up credit.

What they’ve done year to date, and it works with a lag, is they stimulated a whole lot – nobody remembers this.  China put a lot of stimulus into the system back in the first quarter of 2019, nine months ago, 10 months ago.  And it works with a lag.  In other words, it takes time.  It’s like a – it’s like medicine.  It takes time to go through the system.  And it’s enough – what they did was enough to drive the global PMI to about 51 in our model, 51 and a quarter.  And why does that matter?  Because under 50, you’re a shrinking world.  Above 50, you’re a growing world.  So when we feed in a 51.25 forecast, which is our model by June of 2020 for the global PMI, the purchasing managers’ index, it’s about 52.5 for the U.S. PMI.  Now, we’re at 48 now, so we need some help.  We’re still shrinking.  The U.S. is still industrially in a – close to a recession.  But if what you see is a rise to 52.5, far below the 60 and 59 that you got in the last five years, that’s worth about a 2.1 yield on the 10-year yield in the United States.  Two is a very psychologically important number.  If we can get the yield curve – we’re at about 1.50, 1.55 on the short end – if we can get the yield curve steepening to over 2, with more than 50 basis points of rise of the yield curve, then a lot of those fears of recession that we had in the last six months would vanish, and those cyclicals that I named should outperform.

The other factor that we’re considering, and this is probably the single most important macro question right now, is this:  What’s going to happen to the dollar?  Because if the dollar goes up, it’s usually a flight to safety and a tightening of global dollar liquidity.  Dollars are more precious, so they cost more.  That’s why the dollar goes up.  We need the dollar to go down because it would symbolize better growth overseas and it would symbolize more reflation, more inflation.  We’re desperate for a little bit of inflation in a world with overcapacity.

So our work shows that the Fed injecting the reserves – they were shrinking their reserves in the system at a minus 30 rate – it should go to plus 20, which is in line with some of the recent peaks.  And that would lead the dollar, which is shown upside down here, to go from 125 recently to about 112.  And if the year-over-year change goes down 8, 9 percent year over year in what’s called the broad dollar, which is roughly 50/50 emerging market/developed market currencies, so it’s everything from the Chinese yuan to the European euro – if the dollar weakens slightly, as we expect, into ’20 – it’s not even slightly, it’s pretty moderately – then with a lag, the black line should go up.  And what’s the black line?  That, again, is your cyclicals relative to defensives.  It’s things like industrials and materials and financials, energy and technology, relative to very scared defensives like staples, health care, utilities, and real estate and communications.

So we think this is a trade.  And let’s face it, for five years all you’ve had is trades.  Just as I said earlier, you had the huge downdraft where you wanted to own the thing and you did not want to be cyclical into ’15 and then you had the huge recovery around the time of the election in 2016 until the summer of ’18 where you wanted to be cyclical, and then the huge down-wave where you did not want to be cyclical and you wanted to be defensive.  And now we think a wave up – it’s just one big up-and-down wave.

The other thing that happened that we saw is that the yield curve inverted, and you all are familiar with the yield curve, right?  The yield curve is the difference between the 10-year yield and the shorter-term yield.  And so when you invert, the curve does this.  Shorter-term rates are above longer-term yields, and that’s not good.  If you’re familiar with trading terminology, the whole world is a carry trade.  Why would you want to invert the curve, make short-term money cost more than long-term yields?  You’d be upside down if you were an investor and – or a debtor.

So essentially, the Fed had to un-invert the curve.  And what we did that was different is we took a 50-day average of the curve – and that’s the red, and this is incredibly important.  From – when you take a 50-day average, you smooth the curve, right.  You get rid of those little blips where you have a day or two or a week where you’re inverted.  And there have been eight of these since 1969 – one, two, three, four, five, six, seven, and then eight.  The eighth one occurred on the 20th of June, 2019, 50-day moving average of the ten-year, three-month curve.  And they have led recessions by an average 315 days; that’s ten and a half months plus or minus four months at one standard deviation.  So that puts you in a recession theoretically in May of 2020 plus or minus four months.

And we were cruising for a recession until the Fed backed off and the administration settled on a trade deal.  We really were cruising for a recession.  And we were definitely heading into a recession, if you recall, during the 20 percent drop in the fourth quarter of 2018 and retail sales down, what, 4 percent when the Fed was just overly tight and the new Chairman Powell was just making huge mistakes – we were definitely.  So he pivoted then, he pivoted again in October, January, October – perfect, perfect.

So the administration, which has a few people there that understand economics – Larry Kudlow, prominently – brought in some senior economists from outside like Larry Lindsey, and in October, they had – early October, they had a briefing and they said, look, we’re headed with this inversion for a recession and you’re going to see rising unemployment after that 50-DMA curve inverts starting at day zero, which is these days.  Unemployment rises about six months before the recession or the election of 2020 if you’re not careful.  So now we’re seeing the liquidity, we’re seeing the trade settlement, we’re seeing every effort made to prevent a recession or delay one.  So we have it all going for us.  It’s kind of like we have that going for us, which is nice, and what we’re seeing now is that it’s bullish cyclical, bullish reflation stocks, there’s a curve.

The thing that I had picked up on and – at our last press briefing, one of the major papers that was here wrote a very nice article about it and we were just absolutely right on this call, and that was the Fed always failed to appreciate that the real start of the tightening cycle was May of ’14, when something called the Atlanta Fed shadow fed funds rate began to rise.  What is that?  That’s essentially where would rates be if they could go below zero during a period like QE and forward guidance.  Essentially, Yellen took office two months before then, said in May of ’14 around that time, “I’m going to raise rates.”  The market interpreted that immediately, long before the actual rate hike in December 2015, a year and a half in advance, the market said wow, a new hawkish chairman is – or chair is in the job and we have to react to that.

And so the cycle essentially began at – according to the theoreticians, came up with this -299 (ph) rate.  It was a 540-basis point five-year rate cycle.  We had not done one of those in 30 years, and it took us to this outer limit, which I explained elsewhere, and the bottom line of that was that the Fed drove us to the brink of these gray bars, which is what?  Recession.  And you can see that we are perilously close to recession risk.  They have vastly – had vastly overtightened.  They went to 2.4 when the rest of the Western countries – what we call G10 ex. U.S. GDP-weighted, so that’s the UK, Germany, France, Italy, Japan, Canada, Sweden, Switzerland, Benelux – their GDP-weighted yield was zero.

And here’s the Fed stupidly at 2.4, the highest spread in decade – decades.  And so we were way too tight even at 2.4, believe it or not, and we’ve cut three rake height or three rake cuts, three-quarter point and we’re trying to see now, are we going to make this, are we going to get by.

So there’s enough confidence on our part that we’ve delayed the gray bar, the recession, that it’s going to be okay.  We cannot afford trade war right now.  We cannot afford an oil shock.  Because what we find is Conference Board Consumer Confidence – and you can see it right here – it looks like it’s peaking, the 12-month average in purple.  When your consumer confidence is topped out and it’s only been here twice before in the late ’90s and in the late ’60s – and both times, you know what happened.

What happened the next five years after the late ’90s?  You had a massive tech wreck and huge wealth destruction, big bear market.  What happened in the late ’60s, ’69, within four or five years you had major oil shock, massive bear market, massive wealth destruction.  So the last thing you want to do is rock the boat with a trade war and an oil shock potentially in 2020, which is why we had to come to some sort of a agreement on the trade front.  So we got that.

So we think our group of stocks will out-perform – if you can avoid a recession – and the way we define “recession” is very different than most analysts, we don’t look at the real GDP as much as we look at what’s called nominal GDP, which is real GDP plus inflation.  And we don’t just look at the quarterly annualized; we also look at year-over-year comparisons, and on a year-over-year comparison, the nominal economy – this is the real plus the inflation part – at 2.5 to 3 – let’s call it 2.75, I circled them – this was a recession back in two – in ’90 . This was a recession back in 2001.  This was obviously a wipeout during ’08, ’09, and I would posit – and I just said it on a network TV show this morning at 6:15 that late ’14, early ’15, which went to 2.5 nominal GDP was as bad as these prior two recessions here, that we technically had a recession at the end of ’14, beginning of ’15, and industrial production, for its part, for example, went to minus-4 percent year over year.  Since 1945, we’ve never had that kind of negative industrial production year over year without a declared recession.

So technically, we are only four years into recovery had we maintained the kind of industrial economy we used to have back here that we just simply don’t have here.  We had no recession declared here because we’re not an industrial economy.  As a consequence, if we can avoid that outcome and bottom out around 3.5 and go back up on nominal GDP, which is what our model forecasts, then the change in the growth rate, which is the bars here, should drive my 25-stock portfolio relative strength, which follows it perfectly up.  But like I said, half the move is gone already.  It’s been a very powerful move since October.

So where do we go?  Well, I mean, we – we know that if the dollar weakens – that is, goes from being up 10 to being down 10 percent year over year – oil will go from being down 30 percent to up 60 percent.  And we know that if oil goes up 60 percent, then the energy stocks are going to vastly outperform the market between now and the summer.  I mean, personally, I bought a bunch of energy in October, just me.

The other one is financials.  I mean, we’re all geared to financials.  You’re a financial press reporter, I work in the financial services industry, we’re all geared to financials.  When we look at the yields on the financial stocks, the dividend yields, the percentage of all the stocks in the S&P financial sector that are yielding more than the 10-year paper of the USA, it was about 75 percent recently, and it was way above the S&P proportion.  So financials minus S&P, so how many more financials yield more than the 10-year than the S&P as a whole?  It peaked.  We think it peaked in November.  Why does that matter?  Because as the yields plunge, the yields fall means price up.  Financial stocks always outperform.  So if I had to pick three, it would be energy, financials, and tech right now.  Those would be my three picks.

Now, what if we’re wrong?  One day we will have a recession.  And I’ll conclude with this and then we’ll do Q&A.  One day we will have a recession.  One day we will have a Fed that over does it, but there’s no way they’re going to do that or want to do that in the next six months.  They’ve already said they would rather overshoot on inflation.  I don’t think Xi Jinping in China wants a lot of instability right now.  I don’t think the U.S. or Europe really wants it as well.  Our risk is more from EM countries, particularly places like the Middle East, but if we look at it, the combination of either the Fed or oil have caused every recession in the last 50 years’, 60 years’ data.

And so when we do get a recession, which is inevitable one will come someday, then this is a daily chart starting back in 1996 of defensives relative to cyclical.  So what is that?  It’s an equal-weighted index of all the staples, that’s like Coca-Cola, Proctor and Gamble; utilities like Southern Company and Duke Power; healthcare is like Abbott Labs and J&J; and real estate, that’s a REIT stock, like Simon Properties; relative to industrials, that’s like Caterpillar and United Rentals; materials, that’s like Dow Chemical and Black (inaudible) – financials – obviously JP Morgan and Bank of America – energy, technology, and the super discretionary ones, that’s retail.

So if you’re going defensives relative to cyclicals, it typically gets, on this index starting at 100, it gets to one – it gets upwards of to here.  So what we’ll have is somewhere at the top we think that this group will outperform by 20, 25, 30 percentage points.  I hope to plan to time that.  Okay?  Right now I’m in cyclicals.  One day I’ll go back to the defensives, and that time has not come yet, so we’ll see how it goes.

So I have some appendices, which sometimes there’s questions related to the titles.  One is our earnings outlook.  We think it muddles along with 4, 5 percent growth.  We have said for a long time that the Fed caused most of the turbulence since 2018.  If you recall, the S&P peaked on January the 26th, 2018, almost two years ago, at 2880 or so.  If you inflation adjusted the price, we were flat for two years after January 2018, and we’re now heading up again.  So the Fed has retreated, thankfully.  We do think active money beats passive money, but the decade return from 2020 to ’29 will be low point to point.  It will go up before the top and then will go down dramatically and end up – it’s kind of like running to stand still or running on a track, you end up at the same point you started at.  But actives should be passive in a lower return market for a variety of reasons.  Value, as opposed to growth, value should return, but it requires policy commitment to outright reflation.  When do you reflate?  When deflation is either too much of a risk or when you’re fighting a war or your financial system’s in so much trouble that you’re just creating money left and right it requires reflation.

The end of life as we know it, 2020, 2040, and how to position – that’s funny, but it’s not funny, it’s funny in a macabre sort of way, but that’s a pretty interesting long-term view that we have, and I can show it to you, of how things are going to change dramatically in the next 20 years.  And then sector charts, and I can show you that later.

So that’s a longwinded intro.  Let me just takes some Q&A if there’s any interest, otherwise, I’ll go through a couple of key slides in each section that I think is important.

Yeah, go ahead.

QUESTION:  You mentioned that the two risks are trade war and oil stock.  My first question:  What kind of —

MR BANNISTER:  No, Fed and oil.

QUESTION:  Fed and oil.

MR BANNISTER:  Did I say trade?  I meant Fed – the Fed or oil can cause a recession.

QUESTION:  Okay.  So for the oil, what kind of scenario are you considering?  Like there will be a over supply situation or (inaudible)?

MR BANNISTER:  I wish.  One of the problems with Fed policy is that it works like a blunt instrument, right.  It’s like using a sledgehammer to put a nail so that you can hang a picture on the wall, right, it’s a very big instrument.  And if the Fed gets what they wanted, which is more confidence in overseas growth and a weaker currency and a higher inflation rate in the United States, and more – we get the trade piece going on with the administration – if we get what we wanted, then typically less worry – when we worry less about foreign growth is when the dollar tends to weaken.

In other words, the dollar is a flight to safety, but when you don’t feel like you need a flight to safety, you fly back to risk.  And so your emerging market currencies would rise, everything from a Vietnamese dong to Korean won.  I mean, they all go up.  And then your major currencies in Europe and Japan would tend to strengthen a little bit, a little bit as well.  Now they say they don’t want currency strength because they’re too worried about deflation, but if the U.S. is leading global growth, then essentially – and the liquidity picture’s improving, then those currencies can go up and it’s a good thing.  It’s a self-fulfilling prophecy.  And because they’re leveraged, they’re actually good investments.  Emerging markets in Europe, for example, and value, which is financials and energy and industrials and so on, tends to work.

So this is the call we’re making.  But if the dollar, which again is upside down, so I flipped the dollar here, the dollar back in the crisis of ’08 in a flight of safety went to 17-and-a-half percent year-to-year growth, and it had prior been negative, so it was a huge pop in the dollar.  And naturally, when you have a high dollar, you get weak oil.  Oil on the right side was down 60 percent year over year.

Back when Janet Yellen had tightened more than she realized – as I said earlier, she opened her mouth in the spring of ’14 and said I think we’re going to tighten rates one day.  We didn’t hike for a year and a half, but the shadow rate, which is the rate that reflected policy, started going up, and the dollar started soaring, and oil collects $90 a barrel.  And it was a big wipeout for the industrial and energy patch, and we were at about 12-and-a-half percent year-to-year growth in the dollar and about -50 on oil.

Powell’s premature tightening, not understanding the rest of the world was dragging, and the Fed as an institution, and I was there when Bullard – President Bullard said we’re not going to respond to every tit-for-tat in the trade war, and I thought your job is not to make policy, it’s to adapt to policy reality.  The Fed has to deal with a somewhat volatile administration, and you have to adapt to that at the Fed.  In other words, you can’t fight it.  And so I knew a mistake was brewing, and sure enough we had about seven-and-a-half percent year-to-year growth in the dollar and a 20 percent-plus drop in the price of oil.

So what we’re seeing now is our – based on our model and our forecast, it’s about -7.5, -8 percent year-to-year drop in the dollar, better global picture of growth outside, but that’s huge leverage.  As you can see, oil goes from being down 30 to being up 50 or 60.  Now that’s a little outlandish because 50, 60 would put you at $85, $90 a barrel by next summer.

I used to be a pilot when I was younger, just as a hobby, and we had a saying that there are old pilots and there are bold pilots, but there are no old, bold pilots, okay.  As a strategist, I’m not going to go out there and say, “$90 a barrel by the 4th of July,” because you can – it will either make you a hero or it will hang you.  So I’m just saying oil up a lot and we’ll see how it goes.  But if oil goes up significantly, what are the scenarios?  Well, for one, if you’re Iran and you’re suffering under the maximum pressure sanctions and you’re depleting your reserves, and you’re seeing internal unrest, and you’ve eliminated some of the subsidies on fuel, and the fuel price is about to go up, and there won’t be any subsidies for the consumers in Iran this summer, and there’s riots and there’s unrest, you have an incentive to cause trouble in the region so that – knowing the President’s running for reelection and people are very simple when they vote.  They say, well, how much did gasoline cost me and do I have a job?  They don’t want to be unemployed and paying $5 a gallon, that you can probably exert maximum pressure on the U.S. in the summer of 2020.  So I would be building up, as we are, air defenses around Saudi installations.

Saudi, for its part, has a prince, called MBS, who put his Aramco onto the local exchange, called the Tadawul.  The Saudi exchange is like a little exchange, a baby exchange.  He wants to list Aramco probably – my guess, Shanghai or Hong Kong and London.  Not New York, because we have the whole 9/11 legislation.  They don’t want the lawsuits.  So getting yourself to London and in China, to the big boy exchanges, you need $2 trillion valuation to get people excited.  What’s 2 trillion on Aramco?  It would require about $80 a barrel.  So what would you do?  You would take out your oil minister and replace him with a loyal prince – did that.  You would go to the local exchange and stuff a lot of shares into wealthy Saudis and Emiratis and locals, and then, not to disappoint them, you would do a three-month deal on OPEC where you cut your own production and took down some of the cuts, and then demand compliance from Iraq and Nigeria – but you’ll probably get it from Iraq because they’re in such disarray they can’t ramp production – and then what would you do in March of 2020 at the next OPEC meeting?  Cut it another 500,000 barrels a day.  Drive up the price of oil into the summer.  What will the administration do?  What are you doing?

If anything, we’ve learned MBS and Trump have a very difficult relationship.  So the combination of Iran maximum pressure and Saudi tells me that we’re going to have some fireworks in oil at the same time the dollar’s doing what the Fed wanted it to do in the summer of ’20.  And oil at $85, plus or minus, a barrel – not a good thing for holiday sentiment, not a good thing for consumer sentiment on our prior chart.  And that’s why I wanted to – and by the way, you make money, where do you go?  You buy S&P energy stocks.  They go off the chart.  They go up dramatically.  They go from being down in the twenties percent year over year to up in the twenties year over year.  I think – like I said, if you give me $85 a barrel, I could easily see the consumer fall out of bed.  And when that happens here, here, here, here, here, here, and here, we’ve got a recession.

The other thing is this:  That doggone yield curve is smart.  When the yield curve inverts, it’s – it reminds me when I was – I was at the end of my buy side career in the ’80s and then just about to start on the sell side of New York in the ’90s, and we had this thing called the Gulf War.  And the curve inverted on 7 July ’89.  Now, some of that was Fed policy, and savings and loan disaster, and other things, but how did the market know three months before Saddam Hussein invaded Kuwait that the market was going to – that it had to go into a bear market?  It went down 20 percent in the summer of ’90, and then the invasion.  How did the market know in the summer of ’98 that Russia, Brazil would default and the long-term capital management would go down in flames?  But the market went down ahead of that.

So some of it’s what Soros calls reflexive, back-and-forth feedback, but part of it is that amazing ability of the market to just see things into the future.  So when the curve on a 50-day average basis – 10-year – three-month yields goes above 10s on a 50-day average rolling basis on 10 February of ’69 or 10 July of ’73 – the Yom Kippur War was months later – or 16 January ’79 or 28 November ’80 or 7 July ’89 and so on, that if I look at the day, June 20th, 2019, the curve inverted on a 50 DMA – it’s uninverted now, but it did it for months – and I look at the lead time to the next recession, and I look at each of these days and set it equal to zero – so day zero is the day in 1969 the 50-day average inverted, the day in ’73, the day in ’79, the day in ’80.  So you set that equal to 100 at day zero, the current market, 180 days before and possibly for as much as a year after until the summer of ’20, it’s up then it’s down.

What’s more telling is earnings should not be very good.  So if we continue to see weakness of earnings at day zero, which could go down 15 and 25 percent in 2020 and 2021 from the peak, the summer of ’19 – and if earnings go down that much, what’s the weakest link in the market today?  It’s credit.  We’ve leveraged up corporations to buy back stock.  We’ve turned out the debt, and we’ve gotten really low Treasury yields, which you can add a spread to, but I’m not being compensated enough on an absolute basis for default risk at a 5 percent yield on high yield; I’m just not.  If I’m buying a junk bond, I don’t give a damn about spreads.  I care about the five-yield nominal against my default risk.

And so the concern I have is that the curve told me that sometime in – I’m perfectly willing to push it out one sigma to the end of ’20.  But a recession is a risk, and you can see how a rally, a powerful rally – I don’t want to call it a sucker’s rally, but a powerful rally – from October to May or June would suck in a lot of people and then wash them out.  And so we’re only making the call through this late spring, early summer of ’20.  And I wish the ayatollah would call me before he causes trouble, because then I’d be a genius.

Any questions?  Yeah.  Go ahead.

QUESTION:  Just one very basic one.  If oil rises, what does that do to the overall – to other sectors, other than energy?

MR BANNISTER:  It’s always bad for consumer discretionary, like Amazon to Target to TJ Maxx, to everybody.  It’s bad for restaurants, obviously, terrible, because average people who spend all their money at the gas pump have no money to go to Applebee’s.

And it tends to be inflationary, which puts the Fed in a bit of a conundrum, because you don’t want to tighten in an oil shock when there’s war and disarray.  But then you know that you got inflation, so your P/E multiples come down, so it can be bad for technology and other high P/E multiple groups, because they need that high P/E to justify the valuation to justify the price.  So high P/E and consumer would be most hit if that happens.

And one of the hard things about the being in strategy is it’s kind of like – I don’t know – it’s like being married.  There’s a limit to what you want to be honest about.  You don’t want to talk about everything, because people hate it, like, when you just pour it out on the table and you just say everything that’s on your mind, right.  So you got to hold back a little bit; you can’t tell everything about feelings and whatnot.  Well, when you’re in strategy and you’re talking about “I’m bullish for six months,” and then you’re talking about risks beyond six months, then all the people think – because they hear the part about the six months and beyond, but they don’t hear the part about the positive.

I do think that our trade – this is the 25 equal-weighted reflation stocks relative to the S&P 500 – will go up about 1,500 basis points more than the S&P 500 by probably mid-year, probably around May, June, so somewhere in this 10 to 15 percent outperformance right there, mid-year.

I have a lot of concerns beyond mid-year.  So I will take this, if I can get it, as a good call.  But I will be – I won’t be taking the summer off; I won’t be going to the beach.  I’ll still be working from Memorial Day on, because I do think that between Memorial Day and July 4th there’s going to be a lot of fireworks in the market and the economy.  A lot of risk.

QUESTION:  One question:  So what’s the weight of U.S. dollars in your broad dollar package?  And you also have a slide to show that supply and demand appears to matter less for oil, right, than the broad dollar.  So if there is a oil shock in mid-2020, so after the oil shock, what’s the performance of the broad dollar?  Will it be good?  Can you talk —

MR BANNISTER:  Yeah, that’s a good question.  It’s possible that the dollar – like I said, the dollar weakens, meaning upside down.  So it goes to -10, let’s say, and then it shoots back up and these industrials and cyclicals sell off.  And if you look at the broad dollar, it’s – we use the Fed’s broad dollar, which – broad nominal.  We’re using nominal, but nominal in real dollar which is inflation adjusted to follow each other.

The broad dollar is around 51 percent EM currencies and 49 percent DM, or develop market, currencies.

QUESTION:  What’s the weight of the U.S. dollar?

MR BANNISTER:  The weight of the dollar?

QUESTION:  Yeah.

MR BANNISTER:  Well, the dollar is – it’s an index of the dollar, so it’s weighted by country that we trade with.  So for instance, China is 16 percent of the broad dollar.  The Eurozone is, I think, a dozen percent, like 12.  So each of the trading partners has a weighting and it goes all the way down to small countries and their tiny weighting, so it’s a pretty – it’s a broad index of the dollar.

And it’s – JP Morgan broad.  If you want to look at it in Bloomberg on an instantaneous basis, or trade-weighted broad dollar on Bloomberg – on your Bloomberg terminal, just type in “trade-weighted broad dollar,” and they take you to the Fed.  Go to DES description; it’ll take you to the link where the Fed gives all the weightings, if that’s what you want to see.

So like I say, it’s like – it’s a little bit like antacid and then going out for a big dinner, right?  You get the relief, but then you really overdid it and then you get the pain later.  So we do think that the broad dollar will weaken, meaning from 124 to 112, and then we think it could very well strengthen again as you look out to late 20 and 21.  But let’s deal with the next six months, because I only have visibility out six , and I think the six-month visibility is a classic – let me show you this.  I’m not sure I brought it with me.  Sometimes I have it.  It’s a chart that shows the – in fact —

QUESTION:  15.

MR BANNISTER:  No, it was like – it’s the last one.  One of the more interesting facts – and you should know this if you have any money and you invest in 401k or anything like that, and if you think you might live 20 or 30 more years, then you might want to know this.  One of the more interesting facts since – I could go back to 1945, 1950, 1960, 1970, it works – is that one of the interesting facts is most of the money in the stock market has been made between November 1st and April 30th.

So let’s say in 1950 you’d put $10,000 into the S&P 500 and you owned it from May 1 to October 31.  That’s the only months that you owned it, and the other six months you’re like Jesse Livermore, in reminiscence as a stock operator, you’re just wallowing around in a vault – in a bank vault with your physical cash, not earning a return, just rolling around in the money because it’s fun.  So May 1st to October 31st, so Memorial Day to Halloween, you’re in the market with your initial 10,000.  You never put any more money in.  But your brother-in-law, who likes opposite season sports, so he’s more of a summer sports person, invests November to April – November 1 to April 30th.  So the other six months.  You’re in these six – May to October – he’s in November to April.  And you both let the $10,000 you put into the S&P 500 ride, just let it alone, don’t put any more money in.

Look at any period along the way, start at any period along the way.  At the end of 70 years, you – the May-October investor – have $61,000.  Brother-in-law has $1,995,368.  The money is made over the winter.  Why do you think we had Beethoven and Bach and Mozart?  Weather in Northern Europe is horrible, so they’re inside composing, they’re not outside eating and drinking wine and eating grapes.  And so it’s amazing that November to April, northern hemisphere, is when money is made.

And so what we did that’s different is I do a lot of statistics and a lot of computer programming – me and my associate.  We took the strong six months – November to April – relative to the weak six months – May-October.  So all we did is divide this column by this column, and we did something called a log transformation and we put it on a linear chart.  And we showed that since 1950, we have never broken down below one and a half standard deviations and we’ve never broken out above one and a half standard deviations.  So this is the outperformance of November to April.

Now, it’s not going to work every year.  So you can see it worked really, really well from the crisis low in ’08 through 2012, and I got a lot of calls back then about seasonality.  “Go long November 1st, go short May 1st,” but then for six years it didn’t work, because you went from almost one and a half sigma up to one and a half sigma down.  And this year, it bounced twice at one and a half sigma down, and it’s starting to go back up.

Now in the six months – May to October – the S&P total return was three – 3 percent.  We will beat 3 percent by a wide margin November 1st to April 30th, and that will shift this line back up, back up.  So it’s only done – these shifts occur periodically, and it’s just as a factor you want to be seasonal long.  And typically, when seasonality does work, you want to be in cyclicals because they have the most gearing to economic and cyclical growth, the most exposure.

So we think that seasonality is going to work and it puts us more into a – I’d be more interested in Caterpillar than Procter & Gamble for the six months November to April for sure.

Go ahead.

QUESTION:  You spoke about -4 percent decline in industrial production.

MR BANNISTER:  December 2014, year over year.

QUESTION:  Yes.  Now, what is the state of the steel industry which is facing a hard time despite the fact that we have had tariffs of 25 percent to cushion the steel industry?  And now, with the prospect of this trade deal coming through, and it looks as though tariffs will be removed.  So what will happen to the steel industry?

MR BANNISTER:  Tariffs don’t make you stronger any more than getting a pass from having to work out or practice for a football team makes you any stronger.  You make more – you get more strength by competing and being in the field and sweating and hurting and playing.  So tariffs are not really a reason to have bought or owned steel.  But if we get the Chinese stimulus a little bit in Q1, they’ll do just enough to keep the party going because they have the 100th anniversary of the party coming up and they don’t want to have a wipeout or a bad year, plus they’ve got Hong Kong and some other issues.  They just don’t want to have a bad economic picture.

After the 2020 elections, you will probably get a U.S. highway bill or U.S. transportation bill.  And when I was an industrial analyst for many years – I remember TEA-21 and ISTEA and all the other acronyms – we got the – Obama did a good infrastructure bill, but it was basically a maintenance-level bill.  It was about 400 – about $350-400 billion a year.  Just enough to maintain the U.S. physical infrastructure, which is very old and out of shape.

So what you’ll probably see after the 2020 election is a – it’s been delayed by the politics, but you will see a highway bill get passed and a fiscal stimulus.  Now, if you get fiscal stimulus, just like the tax cut two years ago, it’s good for steel because you’re going to be building highways and bridges and roads and so on.  But when you get that, the fiscal stimulus, just like the tax cut of 2017/18, led to, obviously, tighter Fed policy.  The Fed will go opposite fiscal.  So if fiscal is loose – highway bill, tax cut – Fed tightens as an offset, because that’s their job, to offset.

So by 2020, into ’21, if we haven’t had a recession yet due to oil or other factors, the Fed will say, look, I gave you guys a one-year pass, I did not raise rates as we had generated a little more inflation.  Now we’ve got a large fiscal program.  Industrials are doing well, steels are up and whatnot.  I think it’s time to hike rates.  And what we will find is it will take a surprisingly low rate hike to cause trouble, just like it did this time, because there’s so much debt in the system and so much capacity globally that you can’t afford a high cost of money.  And that was our conclusion, and we were right.  The Fed didn’t realize the 2.41 percent funds rate was massively tight.  They thought it was okay.

QUESTION:  So you are saying that the logic —

MR BANNISTER:  Yeah.

QUESTION:  — behind imposing these tariffs was – was not quite justified?

MR BANNISTER:  Well, I like – in the sense that – from an economic standpoint, so taking off the strategist hat and putting the economist hat on, the world is and was a highly imbalanced place, right?  You had countries that saved too much money, which is unspent income, and that would be like China, Japan, the European Union – particularly Germany – over the years.  And then you had countries that saved too little, and that would be like the U.S. and UK and France and even India over the years.  And so the over-savers needed to save less and spend more, and the over-spenders needed to spend less and save more, and preferably invest.  So rebalancing some foreign direct investment to the U.S. is a good policy.  Rebalancing trade between countries – so you buy my stuff, I buy your stuff – is a good policy.  And everyone can grow in a more sustainable fashion.  But just having one country that produces and exports and one country that consumes and goes into debt is not a permanent way to operate.

So trade policy changed some of the balances between countries and the direction of investment flows, but it’s disruptive, and that’s why it’s been so hard to deal with.  But long term it’s good for everybody.  It’s good for China.  China cannot survive with half the GDP going into fixed investment, capital spending and buildings.  They need a bigger, stronger, more robust consumer economy, and it should be approximately 1,000 basis points – 10 percent of GDP up on consumption, and then 10 percent of GDP down on fixed investment, to have correct balances within the country.

So if they consume more, that’s great, and if you have – buy more U.S. goods, great, and if you have robust trade and protection for intellectual property, great, because then innovators can make money, and having more private lending and less reliance on state companies and state lenders, great, because the private people tend to be better at growing and making money and coming up with ideas than big state companies.

And India, like I mentioned earlier, India has lacked investment for many years.  India under Modi, he needs to do more to encourage investment, and that’s why he has the Make in India program and why he’s trying to grow the country that way, because they need more investment, just like the U.S. needs more inbound investment and external exports.  It’s a complicated thing, trade and economics, but it works.

Yeah.

QUESTION:  Could you talk a bit about tech stocks with the tech-lash and why you see them rising still?

MR BANNISTER:  Tech has been a little bit like Frankenstein.  We tried to kill the monster and it just never died.  I mean, we gave technology – the global semiconductor industry sales advanced four months, went down to minus 15 percent growth, which is almost like the 2008 recession crisis lows of the financial crisis.  Stocks didn’t really do that much to the downside.  I mean, Micron and a few others took a hit, and Intel took a hit, but they held up better than I thought.  And the software did just fine.

So we’re seeing the turn now – we’re seeing a turn start, and I’m more optimistic.  But a Silicon Iron Curtain and a trade war – I mean, all the stuff we threw at it and nothing really knocked it over.  So that’s one thing that’s working for tech is just it has such strong unit growth that the slightest amount of pricing power is enhancing – we like the semis, as I mentioned.  That was the tops on our list of stocks.

QUESTION:  And regulatory risks or breaking up Google and Facebook and all that?

MR BANNISTER:  Yeah, and they’re in the comm services sector.  They got moved.  They got taken out of tech.  So tech now is just pure Apple and hardware and IBM, and it’s Microsoft, and it’s Salesforce, and it’s Micron and Intel.  It’s all semis, software, hardware, stuff like that.  So there’s no more – no more of this Facebook stuff.  That’s all over in communications.

Yeah, there’s regulatory threat, for sure.  Politicians are a jealous bunch, and anytime a private industry has a lot of power, whether it was during the Roosevelt administration – Teddy – I’m going way back to when I first started in the business – Teddy Roosevelt, he was a trust buster.  That’s a joke.  You got it.  (Laughter.)  He was a trust buster because the big trust companies and the big banks, like J.P. Morgan, they had too much power, right?  So the politicians will go after who has that much power, and obviously social media has a lot of power so they’re going after them.  But then the opposite party will always seek to rein in the one party’s ability to control that social media platform because the control of information is what we call propaganda.  So we don’t want the government telling – particularly one party in the government telling social media what can and can’t be displayed on the platform.

So it’s tough.  I mean, the smartest move made was Bill Clinton, I think, many decades ago where he said – he gave them the – made them into, like, a common carrier or platform where they were not liable for the content.  In other words, I don’t like this guy; he’s saying something really obnoxious, but I’m not going to be the one to tell him not to say it.  You have to just shut him off.  But I’m not liable for what’s sold and what’s done.  I’m just providing the medium for other people to interact.  And if you read Niall Ferguson’s book, tower and square, he talks about the movements between networked economies and hierarchical economies.  So you go from a hierarchy to a network, a hierarchy to a network, from the tower to the square.  The cover is a picture of Siena, which is a tower and a square.  And when you go to distributed information, the square, you get just anarchy because everybody has an opinion and they just – it just changes what is truth.  And you go to the tower, it’s more hierarchical and there’s order, but oftentimes there’s conflict between states because states are powerful and they can fight each other.

So you go from one to the other, and I would argue that we’ve been going more from the tower to the square, and it’s just going to get more anarchistic for everybody.

QUESTION:  But for a thing like Facebook stocks, does that —

MR BANNISTER:  I’m not a – we have a – our Facebook analyst is like 25 feet away, so I can bring him in here if you want to see him.  (Laughter.)  But if – there’s the Snapchat and the messaging system and the online platform.  I mean, they all kind of fit together.  So breaking those up doesn’t make a lot of sense, right, because they all kind of jibe with each other.  And it’s just people talking, and I think the hierarchical people resent the fact that the people in the square have more power than the people in the tower.

So, again, Niall Ferguson’s book, it’s a good read.  As always, his books are a little bit wordy, but it’s a good read in terms of understanding this social dissolution that’s going on.

But I want to show you this, because one of the things that I do – I mean, yeah, we do all the micro analysis of, like, the spread between U.S. and foreign rates and yields, and we do things like funds versus neutral and how the Fed miscalculated – a lot of micro detail.  But I think the only reason I still do this and why it’s still fun is I get to do things like 100-year charts, and I can show relationships and changes before other analysts figure it out.

So let me show you a couple of really cool charts.  Okay.  This is commodity prices, U.S. commodity index, since 1795, the – around the time of the formation of the United States.  And so it’s a 10-year compound growth rate, so if the index itself is a hundred and goes to 200 over 10 years or 120 months, that’s a compound growth rate of 7.2 percent a year.  Money doubles every 10 years at 7.2 percent.  So that’s – you get the idea.

So it’s an index growth rate.  It starts in 1805 because we started in 1795, and you see Napoleonic Wars, War of 1812, and then a huge depression by 1825, and then populism outbreak and Andrew Jackson is picked.  He’s actually – his bust is in the back, behind the desk in the Oval Office if you look for it.  Civil War, 1864, and then a bust and a long depression, 1878 to the 19th century, the birth of the progressive era and populism in the United States, and Teddy Roosevelt and whatnot.  And then the peak in – after World War I in commodities, and then the bust in the 1930s and the Great Depression and bank failures and FDR and populism, and then a rise.  But that was only World War II.  And then a bust and a rise, and it peaked in 1980, when Reagan beat Carter in 1980 in November and we had 12.37 percent compound growth for 10 years in commodities.  Oil was up elevenfold in 10 years.  It was quite a wipeout.  Actually, in 11 years it was up fortyfold because Muammar Qadhafi and – it was the first oil battle of ’71, ’72.  And then a bust, and then a rise back when we modernized China, and then a bust, and the Fed and the debt, and the June of ’18 was basically in line with Great Depression lows.

And what do we have now?  We have populism.  Populism is real, and it will endure, and it will end with a conflict, and it is reflationary.  How far?  Well, that’s 50 years.  That’s 55 years.  That was 60 years.  The next one is, let’s say, 60, 65 years.  That puts you around 2040, plus or minus.  What happens in 2040?  The median baby boomer was born in 1958.  They turn 82 in 2040.  Most people who were born in ’58 don’t live past 82.  So half the boomers will be gone and half will be going.  The younger generations will have accrued a lot of debt to deal with the boomers, and then it’ll be okay, boomer, bye, and the boomers will be shoved off, and you’re not going to pay back that debt.  You’ll just inflate it away, and the policies will be aligned thus so.

So we know this is coming.  We know that government never gets more than 30 percent of its revenue as a percent of GDP, and it spends 35.  So we have a structural deficit until we tax consumption, which we will never do because it’s regressive and you can’t win in a democracy with a consumption tax.  So we will print the money, since it’s easier than trying to tax it, and with more debt you get less GDP.  So what is this?  This shows that in the 1960s, you got 80 cents of GDP for every one dollar of household debt, business debt, and government debt, what we call non-financial debt.  And then in the 1980s, with another debt cycle – this is debt to GDP – we have the corporate cycle, and we got about 70 cents and then it fell.  And then we leveraged up the households and we got up to about 55, 60 cents, and now it’s down and falling.  It looks like it’s going to hit about zero in the late ’30s, early ’40s.

When 100 cents of a new dollar of debt goes to pay interest on old debt, you’re in default.  You can’t grow.  And that’s 2040.  So when we add it together, how would you position?  If I were young again, if I was 27 instead of 57 and I was starting out, I would want to be a global value investor, a global value analyst, because we know that value relative to growth – short duration, cash-flow intensive, asset intensive, pricing power-dependent companies like energy, materials, industrials, and technology and financials – they are typically short end, and then the long-term investors, the people who have to think long-term, who build for the long term – like social media and building out technology infrastructure – that’s growth.  Drug companies start research, way down the line you make money.

So we know that value relative to growth follows the commodity cycle.  It’s .84r squared monthly for 80 years.  So if you zoom in on this shorter-term period since the ’20s, 1925, if we are beginning a major seven-year to 10-year value cycle – we’ve only had three in the last hundred years – the last three times it happened – November ’39 to ’41, the S&P got cut in half and value beat growth.  Same thing happened here, ’73 to ’75, cut in half, but value beat growth.  Same thing happened here, 2000 to 2002, but value beat growth.  So if we do see a bottom for value, it’s just a sign that within a year we should be concerned, because it’s a major rotation in what leads the market.  It will compress the PEs, it will lead to destruction of capital.  It’s not necessarily a good thing at the beginning of a value rotation, just like the tech wreck was not good in 2000 to ’02, just like the oil shock, ’72 to ’74 – they happened in ’73/4 – just like November ’39 to ’41.  We don’t need to go there.  You know what happened then.  That was World War II broke out.

So I don’t think it’s a seven to 10-year value cycle.  I think it’s a six-month trade at this point.  But watch this, because if it’s a longer cycle, it’s not going to be good.  And that probably describes when the Fed overtightens, which is probably going to be ’20 into ’21 or oil shock.  One of the two is going to cause you damage.  So it’s a good trade for now.

Oh, go ahead.

QUESTION:  Okay.  You said earlier that 2020 might be a good year for stock pickers versus passive investing.  Can you talk a bit more about that?

MR BANNISTER:  Yeah.  Certainly it has been so far.  Just recently this rotation caught a lot of people off guard.  So obviously, the value relative to growth – let’s just use that as a mantra right now – value relative to growth is way down here, meaning value’s extraordinarily out of favor.  And the only other time in the last 40 years that’s been anywhere similar would be during the ’99 peak of the tech bubble into March of 2000, when the NASDAQ peaked over 5,000 but then fell about 80 percent in the next two years.

So value is very out of favor, growth is very in favor.  So what is value?  It’s heavy on financials.  It’s very heavy on energy, and it has some utilities.  And it has much more materials, what’s left of it, and a little more real estate.  Now, we saw the rally due to the falling 10-year yield in the defensive bond proxies, utilities and real estate.  So now it’s the cyclical growth candidates and financials and energy, relative to what?  Technology and consumer discretionary.  Technology, a little more vulnerable to – besides trade, obviously PE compression and economic risk.  They very much need the economy and the cycle to grow because they’re constantly trying to outrace their own deflation.  Their own pricing level is falling, so you’re selling more units and the price cuts are driving down the revenue.  And then consumer discretionary – nothing worse for consumers than loss of income, loss of job, and higher oil price, for example.  So fins and energy for now, and then on a relative basis that’s the trade.

Now, on a more complex basis, there’s this work.  I don’t know if you’re familiar with CAPE, or the cyclically averaged PE or adjusted PE.  That’s the 10-year average inflation-adjusted earnings divided into the price.  So it’s the PE – I’m trailing 10-year real or inflation-adjusted earnings.  The other one is Tobin’s Q, which is priced to replacement book value, and then household stocks as a percent of financial assets.  That’s the stock holdings of households as a percent of stocks, bonds, cash.  Only those three.  No real estate.

So we set the post-World War II average equal to 50, and we show that in the late ’40s and early ’50s, you – very few people owned stock.  Why?  Because the 1929 crash and the Depression was kind of a bad memory.  And so 20 years later, the younger generation remembered what happened when their parents jumped out a window and they decided, “I’m not going to buy stock.”  But in 1948, if I bought stock, in 1958, my trailing 10-year return is approaching 20 percent a year, meaning that was a really good time – some would call it happy days, Fonzie, Chachi, Mr. C.  1948 to ’58 was just a really good time to own stocks, and yet you didn’t want to own them here.  But in ’68 you wanted stocks; by ’78, Jimmy Carter was wearing cardigan sweaters, talking about malaise.  It was the end of the world.

In ’82, as I was getting out of college, undergrad, nobody wanted to be a stockbroker.  I had never even heard – I went to a good school and I had never heard of Goldman Sachs.  Seriously, I was 22 years old.  I mean, nobody in 1982 – in fact, if you watch the movie Trading Places, Eddie Murphy, they were commodity traders.  Nobody in ’82 wanted to be in stocks.  But ’92, my dog was outperforming, just stepping on stock names on the paper over the page you – “Double Digit Returns.”  (Laughter.)

’99, everybody owned stocks in the tech bubble.  By ’09, your trailing return for 10 years was -3, meaning you lost 1 percent of your price and only made back the dividends for 10 straight years.  In ’09 during the crisis, stocks got cheap again, so that by ’19 you did 16 percent of your compounded for 10 years, 10 years later.  So if I take these, turn them upside down and push it forward a decade, I get this.  It’s just flip it, push it forward a decade, lays nicely on top.  And what it shows is, is that because I flipped – I put 2019 into 2029, I advanced it a decade right here, with fairly high confidence, we think the S&P total return will be somewhere between one and five, coming out around 3 percent a year.

So one – 1 or 2 percent price, 2 percent yield.  That’s all you’ll make if you bought SPY Spiders on the 30th – this is 30th of June data – 30th of June 2019 to 30th of June 2029.  All you’ll make is 1, 2 percent at most price and reinvested dividends.  Four percent a year versus just coming off of 17 percent a year is kind of a letdown, okay.  So the Fed, through its actions, frontloaded through the PE multiple and most of the return of 20 years into the first 10, which was ’09 to ’19.  The Fed did this, and they did it on purpose because if you want people to consume, you’ve got to reflate their wealth.

So given that this – again, they lead by 10 years, push them forward a decade, you can see out to ’29.  Do – you could do fancy math like we do.  I did a z-score and showed that at a 1.5 sigma z-score, it’s worth about a zero return on the next five years.  Same thing here, 1.5 z-score is a zero return.

You can roughly estimate the price level.  I don’t want to use this for more than a 10-year forecast or five years, up to 10 years.  But if you do a daily or a monthly forecast, the blue line is the actual and this is what the model predicts.  One standard deviation.  And we pretty much stayed in it for 35 years, 40 years.  And it’s saying at least through the late 20s, you’re not going to really go up.  We’re going to go flat to down, and we’re at the high end, we’ve blown through the range.  And it feels very housing-bubble-ish, tech bubble-ish, and it’s like a sucker’s game.  It’s like musical chairs.  We’re all dancing, there’s 21 of us, there’s 20 chairs.  Somebody is going to be left standing.  So you’re just – you’re trying to pick up the pennies in front of the steamroller in this bull market, which is how they always feel at the end.  It’s like everybody gets on board, and then it’s “Pfft.”

So we’re overvalued, overenthusiastic, overconfident.  The White House is pretty confident.  I don’t know if you guys have noticed, but overconfidence kills in this business and it’s something to worry about.

QUESTION:  But what would happen for us not to invest in ETFs anymore, but to actually just (inaudible) stocks?

MR BANNISTER:  Well, the point of that is – what’s so cool about that is this is the index investor, right?  The S&P 500 index investor, the person who buys the index, is going to do fairly poorly.  I mean, we know that they are buying at a level that has only been seen in the late ’60s, and then in the very end of the ’90s it was a blow-off, and then of course, we paid for that.

So we know that if you buy the Spider index, you’re looking at roughly 3 percent a year for 10 years.  If you’re an active manager and worth something to somebody, maybe you do five and that’s 2 percent more than the index, which is why active tends to do best during soft markets, because you’re beating the index and the index is under pressure.

When the index is galloping ahead, you’re better off with what’s called a momentum strategy, where you buy it the bigger it gets, like Apple, and you sell it the smaller it gets.  And that’s indexing.  So indexing rewards bull markets; active managers are rewarded by soft markets.

And then just on the same subject, if we overlay value to growth – or excuse me, growth to value – so this is growth relative to value, it roughly aligns with the compound growth rate of CAPE, Tobin’s Q, and household equity.  And it looks toppy for growth right now.  It’s either going to be a long top, like here in the ’50s, ’60s where you had two years of value winning, two years of growth, three years of value, two years of growth, four years of value, two years of growth, and so on up and down.  Or it’s a major top.  And I tend to think at this point it feels like one of these again now.  Having overvalued and having to backstop the central bank the risk – and they will have to backstop risk – then I’m just trading off between value and growth doing this.  Is that the macarena?  I think so.  Yeah.

So I feel like value versus growth, it’s a trade now, and I feel like it’s a value risk on right now.  And then it’ll be more defensive and then it’ll be growth, and then it’ll value again.  It’s just a trading market for 10 years, ending up 3 percent a year with dividends reinvested 10 years from now.  That’s it.

QUESTION:  I had a follow-up question about this passive and active.  So much money flowing into ETF market, especially from retail investors.  And if this active beating passive next year, do you think those retail investors, individual investors will lose confidence that might affect growth effect?

MR BANNISTER:  I didn’t bring the chart, unfortunately, but what we find is that bond inflows have vastly dominated really for 10 years.  So people who bought bonds which have just trounced stock, whether it’s active or passive, the inflows to bond funds have trounced the stock inflows for 10 years, three years, five years, the whole period.

Why would you buy bonds?  Well, in the United States at a household level, most of the wealth is held by the Baby Boomers, and most of the – and their parents, and the parents are rapidly dying off, so it’s Baby Boomers now more so – and these people, as I say, were born median age 1958.  So the crisis hit at your 50th birthday in ’08.  You ever turn 50?  Okay.  You’re starting out – it’s like you can’t play the sports you used to, you’re slowing down a little bit.  Your runway in your career might be 10 more years, that’s about it.  You don’t want to take too much risk.  So you found that the crisis caused a revulsion to risk among 50-plus-year-old people.  We see it.  We have thousands of brokers.

And those people have been more and more emboldened by the Fed’s policy of pushing rates and yields down essentially, because it’s inflated bond markets.  And then, of course, all the overcapacity and buybacks of stock have increased cash flows, the Trump tax cuts further cash flow.  I mean, it’s been hard to lose in a bond bet.  I mean, I’ve got people who are over 65, 70, 75 years old who are buying junk bonds in large size because it’s a good yield.

But as one of my mentors once said, more money has been lost reaching for yield than at the barrel of a gun.  And I would be a little bit leery of low-grade bonds, but it’s even better than equity because when you think back to the crisis – don’t you remember the crisis in ’08?  I do.  It’s like yesterday.  Junk yields were going up dramatically – I think they hit 21 – but equities accelerated to the downside the higher the yields went, and that’s because when they sort out the bankruptcy table, who gets what, equities rank below junk.  They get nothing.  They’re wiped out.  So you really have to pay attention in the coming years to spreads and loan officer surveys and credit default swaps and credit, because a good equity analyst will be looking at credit now as a – learning about a credit and looking at it pretty closely.

And so the – you asked me about the flows.  So most of the flows went into bonds, and I feel like some of those people who are, again, the median boomer this year today, right now, is 61.  The middle boomer.  61 year olds who in the next three, four years lose a decent chunk of their net worth would become more populist, no doubt, be definitely in favor of more fiscal spending, government spending, and would be looking for other people to blame for the – for their losses, which was pure greed.  And so I think credit is the weakest link in the economy, but it’s not breaking yet, of course, and we’re bullish for now.

But as an equity person, you really have to be knowledgeable of credit.  Just like in the last three or four years you had to be very knowledgeable of macroeconomics because it was about the Fed – Fed, Fed, Fed, Fed, Fed – and understanding trading and global imbalances and how rebalancing occurs and so forth.

MODERATOR:  Hey, Barry, I think we’re pretty much out of time at this point.

MR BANNISTER:  Oh, yeah.  Wow.  10:30.  Thanks for having me.

QUESTION:  Thank you very much.

QUESTION:  Thank you for coming.

QUESTION:  Thank you so much.

# # #

U.S. Department of State

The Lessons of 1989: Freedom and Our Future