Nicholas Colas, Co-Founder of DataTrek Research, provides critical insights on the current economic climate, inflation, and potential market downturns. In this episode of Wealthion, Andrew Brill hosts Nicholas Colas, Co-Founder of DataTrek Research and Former Chief Market Strategist at Convergex Group. Colas offers his expert insights on the current state of the economy, highlighting the risks of inflation and a potential market crash. He provides valuable advice on how investors can navigate these turbulent times and protect their wealth. Join us as we delve into the indicators pointing towards economic slowdown, discuss strategic investment approaches, and explore what the future holds for the market.
Nick Colas 0:00 In a market downturn, you'll probably lose less money being in value. So if you're worried that we've peaked out, if you're worried that growth has driven too much of the gains, so you swap and devalue, okay, you'll lose 5% instead of seven or 10%. Is that great? Is that what you want? Does that make you feel better? Does that put the thumbs back on the shelf? I'm not sure it does. So at the end of the day, you also have to think okay, even value for us as a trade just like small caps are a trade em is a trade. There's a lot of great trades occasionally, that the market offers us. But structurally speaking, US stocks and growth stocks have been the big winners, and there's no reason that that's going to change. The growth is ultimately in a handful of companies driving really important technological change. Andrew Brill 0:42 I'd like to welcome Nick Colas back to wealthion. Nick is the co founder of data trek research. Also the former chief Market Strategist at converge X group. Nick, welcome back to wealthion. Nick Colas 1:02 Oh, thanks so much for having me. Andrew Brill 1:03 Now, let's get right into it. I know that a lot of indicators are, you know, economic indicators falling closer to where the Fed would like them. What's your take on the economy right now? And is it slowing? And there's that all that talk about recession? Is that coming to fruition? Do you think? Nick Colas 1:23 Well, the economy is absolutely certainly without a doubt slowing. We're seeing that across a wide variety of indicators. Most recently, the latest Atlanta Fed GDP now print, which as of yesterday is looking for just 1%, 1.7% growth in the second quarter. And it was looking for like north of three at various points during the quarter. So as the machines gotten more data about how the quarter has progressed, it's clearly showing slowing in the economy. We're also seeing that with continuing claims that were out last week, they hit a new high back to November 21. So the labor market is slowly cooling the economy is certainly cooling. I'm not really worried about a recession just yet. I understand why people are. And for many people, it's felt like a recession for the last couple of years because of inflation. But by the numbers, we're not seeing yet the kind of turning point that would indicate we're surefire going to have a recession in the next 6-12 months. Andrew Brill 2:15 So you think that soft landing or really no landing is a definite possibility? Nick Colas 2:20 It absolutely is. And I think you have to go back to the history of recessions in this country back to say 1970. And every single one was caused by some kind of shock, things don't just slide into recession without something else hitting the economy. So could be an oil shock, like in 73, or 79, or 1990. It could be the financial crisis could be the pandemic crisis, it takes a lot to derail the US economy, which is one of its primary virtues. And so I'm not super worried about a recession, I am worried about a series of very slow growth quarters, which will make it harder for companies to grow earnings. But at a top down level, not really worried about recession, because I don't see the kind of shock that would cause a recession. Andrew Brill 3:00 Even in this geopolitical environment, you don't see energy like oil, like a sort of that sort of shock. It seems to be stabilized between 78 and 85. So it really hasn't, with everything that's gone on, you would think that it has the possibility of shooting up. But that's not one of those things that you really worry about this time. Nick Colas 3:18 I absolutely do worry about it. Because you're right. oil is oil price shocks are the number one cause of recessions for the last 50 years. And so I do think about it a lot. We even had an oil spike in 2008. Going into the financial crisis, we were predestined to have a recession no matter what my rule of thumb is, when oil prices double over a given year, you're all but certain to have recession. That's been the track record since 1970. It would take a pretty big lift in oil prices to create that kind of shock now, but it's certainly possible. And one thing we tell clients kind of nonstop, is never be underweight energy in a portfolio, because energy is your only a hedge against that kind of shock. You know, for example, in 1990, we had a very big surprise shock with Iraq invaded Kuwait. And the oil sector energy sector was the only one that worked. And it worked fantastically well, for the first couple of weeks after the invasion when nothing else was working. So energy stocks are one very important hedge against the kind of risk we're talking about. Andrew Brill 4:15 Go back to the first quarter of this year, energy stocks was I think, the leading sector if I remember properly, and let's talk about that, you know, the first half of the year is over now. And the stock market has done incredibly well. And historically, it could continue to do well, you know, a lot of people like Oh, it did so well, where it's going to take a downturn it might slow but do you see the stock market just falling off a cliff? Nick Colas 4:22 Absolutely not. You're right. The cadence of returns this year so far have been pretty interesting because in q1, for example, the s&p was up 10% And q2 was only up 4%. So we're clearly slowing now. We were way overbought at the end of March and we but we still had some further gains so it speaks to your point about can 10 us gains, I do think we're in for a period of some volatility for next month or two or three, simply because things have gotten a little bit too crazy in big tech in the US. And there's nothing else that really reflects that kind of strength. And whenever you see that kind of one sided markets, with very low correlations between sectors or between US stocks versus non US stocks, you invariably get some kind of pullback that kind of resets the table, and then allows you to move higher after that. So we've had a great first half, particularly in US stocks, not so much outside the US, we'll talk about that. But I do think we're gonna suffer some volatility for next month or two, and then a stronger fourth quarter. Andrew Brill 5:40 It seemed that in the first quarter, a lot of stocks did very, very well, second quarter, it was mostly technology that led the way. Do you see a technology pullback? At some point? I know, look, when we talk about Nvidia, there was a pullback, do you think and now that I don't think the AI bubble is over. But I think that maybe people after the second quarter just took some profits off the table and said, Look, I'm gonna take this, I'll let it go down a little bit. And I'll put my money back in. Nick Colas 6:09 Yes. And we have to look at sort of the market outside of the US as well. So in the second quarter stocks outside of the US, you know, the ACWX ETF, it was down half a percent in the second quarter, and the s&p was still up 4%. So it's clear, people are kind of hiding out in big tech hiding out in US stocks. And for a lot of very good reasons. There's still good growth here. But we have to look at it realistically and say, There's got to be a reset coming doesn't have to be profound doesn't have to be a big shock. But it does have to be a reset. Andrew Brill 6:39 So instead of huge gains, maybe like baby steps of thing, like in video, if it just keeps moving up a little bit at a time instead of the $10, $12 a day were in good shape, because that volatility you spoke of earlier, when things shoot up, they're bound to kind of fall off a you know, a pretty big chunk as well. Nick Colas 7:01 yeah, it doesn't even mean that they have to go down very much, but it means that they have to stop being such a hot boil. So for example, Nvidia kind of reached Cisco peak at the beginning of last month, beginning of June, and has been kind of trailing off since. And if the hit if history repeats itself, it's probably in for some churn for the next month or two, because you get these big gains and the market has has to digest them. In the meantime, they're always looking for other things to play. So that's how you get that that very low correlation between sectors and stocks in the market overall. But ultimately, those kinds of correlations, and we see this in the vix as well, very low vix readings, they don't have to go back to 20, which is a long term average, but a 15 vix with a pullback in the market. That makes a lot of sense to me. Andrew Brill 7:43 is there right now, the VIX, I think, is in the neighborhood of 12. the volatility is sort of low, I guess. Nick Colas 7:50 It is I mean, the long term average of the VIX back in 1990, when it started is 20. And the standard deviation around that is eight. So 12 is a one standard deviation below the average reading. And typically speaking, you do get long periods of sub average VIX is during bull markets, we had the 90s, the 2000s, a very long stretch in the 2010s. So I wouldn't be surprised to see the VIX stable at 20 for the rest of the year, because that's what it does during bull markets and during what we call mid cycle markets when there's no recession clearly in the offing, but at the same time, you know, as an investor, you want to be thinking about not just okay, where are we right now for the next couple of years. But where are we for the quarter? Where are we for the month? And in that regard? I think we're just a little bit exposed to a pullback. Andrew Brill 8:35 Now, Nick, I want to ask you, we talked a lot of economists. And then we talk to a bunch of market evaluators like yourself, market analysts. And if you talk to economist, it's gloom and doom recession is coming doesn't matter what you do. It's on its way. But when I talk to you as a market analyst, like no, actually things are looking okay. Why is there such a discrepancy in the numbers or in the way people look at the numbers? Nick Colas 9:01 I think the biggest reason is that the stock market doesn't discount GDP. It discounts corporate earnings. And that's a big differences. So an economist can be pretty cautious on the economy. And I can totally understand why things are beginning to creep, higher unemployment, the labor markets weakening, growth is weakening, but corporations managed through those problems they managed through in order to create higher earnings. That's just what they do. So the stock market can work reasonably well. Even if the recession is slowing. And there's a risk of the economy slowing there's a risk of recession, because corporations are working to tighten the belts cut costs and generate earnings growth. And that's what stock markets discount that's GDP is interesting to the stock market. But it doesn't no effect really on corporate earnings unless there's a big recession. And because of that the stock market will look at earnings and cash flows and returns on capital in which businesses are doing best and shuffled capital off to those and if it means in the case of what we're having. Now we have a handful of companies doing extremely well with very high earnings growth, extremely high return Ron capital, that those groups are going to work and drag the market higher. Andrew Brill 10:03 Does Doxy talk about with it the high earnings growth, that's a select few and they're kind of blowing up the the indices are small caps following suit, or is there a time for them to do better as well. Nick Colas 10:16 Small caps have been just the heartbreaks heartbreak trade for the year, they're up 1%, as of the end of the first half, they had a decent first quarter of 4.8%. They give almost all that back in q2 down 3.6%. And they will yesterday's pullback, they're very close to flat. Look, small caps are kind of a unique beast in capital markets, I think pretty broadly misunderstood. They are often great trades coming out of recession, when high yield spreads decline when interest rates decline. Small caps do really well, they're a great trade for a year or two. But they have some structural problems when you think about how a small cap index is created and maintained. Because ultimately, the very best stocks, the ones that have grown the best the ones that have gotten to the top of the market cap heap, they get shuffled off into the Russell 1000s or into the s&p 500. And they leave the Russell 2000 for the s&p 600 Small caps. So you're perennially losing your biggest winners. And if you look at how markets work over long periods of time, there's a great paper about this by a professional named best advisor. And he looked back from 1990 to 2020, across stocks around the world 64,000 stocks. And he found that only one to 2% of all the gains in capital markets for 30 years, was created by just one to 2% of companies. So those companies and you know the ones that was Apple, Amazon, alphabet, Tencent in China, j&j, Exxon Mobil, a handful of companies create all the returns in equity markets over a long period of time. And we're seeing a microcosm of that right now in the large cap space, but the small cap space keeps losing those names. And so doesn't have as much of a leg up in terms of keeping performance high, because it loses those high performing names that it really should keep for investors to enjoy those gains as they get bigger. Andrew Brill 12:06 And it's almost like when you do a really good job they ask you to do more is a small cap, if it does really well, well, we're gonna move you up to the next the next level. Yeah, and leave the other small caps in the dust. Nick Colas 12:17 It's a very difficult space to be so the Russell's underperformed the s&p over the last 10 years, but I think 200 basis points. And this dynamic has a big reason why. Andrew Brill 12:25 Is it time for us to get out of gross or take some money out of growth stocks and put them into value stocks? Nick Colas 12:34 Yeah, that is shortly the question of the hour growth has had this tremendous run, you know, the problem with growth indexing, and let's take the s&p 500 growth index, as an example, is super concentrated. Now they that index is 60%, weighted to the top 10 names that we all know who they are. And that's an unhealthy level of concentration. So what we've been telling clients is, if you're an s&p growth, consider swapping into just the s&p 500. Because at least you get some more diversification there, I wouldn't abandon growth entirely. And I would look at value very carefully. But just realize that the growth trade has gotten super concentrated at the upper end of the market cap range. And you'd have to have a lot of single stock exposure in indices like the s&p 500 growth. Andrew Brill 13:16 We got a lot of questions about volatility and people that don't have the stomach for it. Is it safer to just go into the value stocks now? Because you're worried that look, you know, the run was so high or so rapid? And did so well? You know, if I'm going to want to stop taking my Tums, what do I do? Nick Colas 13:41 Yeah, it's another great question and a great point. And I would say, put it this way, in a market downturn, you'll probably lose less money being in value. So if you're worried that we've peaked out, if you're worried that growth is driven too much of the gains, so you swap into value, okay, you'll lose 5% instead of seven or 10%. Is that great? Is that what you want? Does that make you feel better? Does that put the Tums back on the shelf? I'm not sure it does. So at the end of the day, you also have to think, okay, even value for us as a trade just like small caps or a trade em is a trade, there's a lot of great trades, occasionally, the market offers us, but structurally speaking US stocks and growth stocks have been the big winners, and there's no reason to think that's gonna change. The growth is ultimately in a handful of companies driving really important technological change. So you can swap into value but then you're gonna have to stuck with a swap back into growth or swap back into the s&p 500 When that move is over, and that makes sense. That sort of creates two issues, you have to resolve it as an investor versus just sticking with whatever happens with volatility. Knowing that over the long term, you're in the right space. Andrew Brill 14:48 What do you say to someone Nick, who says you know what, I'm going to time the market or I'll never time the market. When is the right time to do this switch Nick Colas 14:57 It is a very difficult question to answer. because it is comes down to a very personal set of choices about how much risk do you feel comfortable taking? And how much do you know, why are you doing what you're doing? It's very important as an investor to have a general outlook for what you see happening in the economy and in the stock markets, and in macro conditions in politics, and kind of put that all together into a worldview that says, I want to be long these kinds of assets for these reasons. And then you kind of have to stick with them. The worst thing investors do is let their emotions get the better of them, and you will sell at the bottom and buy at the top. And in order to avoid that, you've got to have a game plan. And for data tracking, the way we express it to our clients is our game plan is to be structured overweight, growth, and US large caps against basically everything else in the investment equity investment universe. And we know there's gonna be some volatility along the way. But that historically generates the best returns, it focuses on the handful of companies that are going to win, which is what the long term record says you should do. And if you have to eat some volatility along the way, that's the price of those returns. We try to help investors pick pick points where volatility might increase, like we talked about the top of this call, the next couple of months do look choppier for us. But at the same time, either you lighten up or you just accept the volatility is coming and half of the game is being prepared. If you think the volatility comes in, it does, you're prepared, it hurts a little bit less when you see those draw downs. Andrew Brill 16:25 When you say it looks a little choppier than it was what are the economic indicators you're looking at that dictate you know what maybe the third quarter will be? I know that the summer months are in there, and things tend to be a little bit slower in the summer months? What are the economic indicators you're looking at to say, Yeah, you know, maybe it's not as rosy as it was, but still not going to be bad. Nick Colas 16:47 They're not so much economic indicators, although we talked about how the economy is slowing, but not yet in recession, not yet shrinking. And so we want to make sure that we're not at a economic tipping point, and nothing in the data says that we are, we're seeing still very modest initial claims every week, we are seeing some uptick in continuing claims, which tells us okay, demand for labor is slowing a little bit. We understand the Fed is very focused on now on just not just inflation, but also on job growth and sees the labor market slowing. So the backdrop is slowing growth, but not recession. So that kind of checks the box that we're not walking into a buzzsaw in terms of an immediate recession, then we look at stock market indicators. And the chief ones we use are correlations, how much is one asset tracking the other. And we do it by looking at an average of big s&p sector correlations. And that's important because when investors get too confident, invariably, correlations go down a lot. And that's because of picking and choosing, hey, I want to be long Tech, I want to be long energy, I want to be long financials, and they're picking and choosing which ones they want to be in, in a sort of peak enthusiasm, peak confidence market, those correlations get very low. That's where they were just two weeks ago. And so it tells us, and there are levels similar to say July of 2023, when the market topped out for the summer, and then had that very tough decline through October. We're at similar levels to those now, the same thing goes for US stocks versus non US stocks, because investors have favorite US stocks so much. There's been a big break in the correlation between us and non US stocks. So those two things are signaling to us that there's a bit of overconfidence in the market, a bit too much of just picking the obvious winners. And typically when that happens, you get a pullback, because something comes along and kind of makes investors question Was that the right trade? And they kind of bailed out of it. And the correlations go back up again. Because when when markets go down, everything goes down and correlations tighten up? Andrew Brill 18:41 Do you see pullbacks coming more pullbacks coming? Or are we sort of on a level playing field right now and just waiting for something to happen to either go down or go up? Nick Colas 18:55 I think we are. If I had the bias, my answer would be saying we're walking into q3 earnings season right now, that will have its usual we have some very high expectations for a bunch of very systematically important names. I'm not saying they're gonna miss but even if they just meet expectations or beat by a little that might deflate the market a little bit by saying, Wow, I thought they're going to be by 10% only be by the usual seven. And that could cause the pullback that we're talking about. Andrew Brill 19:22 And there's a lot of cash on the sidelines. I guess. Right now if you put it into high yield money market, you're getting 5%. Anyway, what has to happen for that money to get put back to work in the markets. Nick Colas 19:37 Yeah, the history of this is very, very clear. We've looked at this back to the 1980s. The only thing that pulls money out of money market funds is lower yields to the Fed literally has to go through the rate cut cycle, and even then it takes some time the first cut doesn't really reduce money market fund balances. It's the second third, fourth fifth cut, where rates come down pretty noticeably where investors say okay, I used to be getting five I've not only getting four, maybe, okay, I'll invest some in longer term assets because I want those longer term better returns. But it takes quite some time that money on the sidelines historically stays on the sidelines for quite a lot longer than you think. And it's only serious Fed rate cuts that say to investors, Okay, it's time to get out of 2%, yielding money market funds, and buy corporates or buy stocks or buy other assets. Andrew Brill 20:24 Do you see a cut coming this year? The data certainly is trending in that direction. Do you see? And that's all the talk is that I think there's at least one built into the market at this point. Do you see one coming? Nick Colas 20:37 Yes, absolutely. You know, the thing that has convinced me of that, as continuing claims data last week, ticking up to new new multi year highs, that tells me the labor market really is slowing. I think we're gonna see confirmation of that, in Friday's jobs report. And I think we're gonna get two rate cuts this year, one in September, one in December, because it's very clear that the labor market is slowing enough that the Fed has to pay attention to that the last thing they want is for a labor market driven recession to start happening in the back half of the year, or the first quarter of next year, they've done a reasonably good job of keeping the economy on the right track for the last two years, even with those very aggressive rate hikes. And the last thing Powell wants is to kind of ruin his legacy of having dealt with a pandemic dealt with the inflation and not crash the economy. And I think his bias is to cut sooner rather than later, as labor market cools, so to see to this year, and to in the first half of next year, basically a cut every quarter starting in September. Andrew Brill 21:36 Very nice that's music to a lot of people's ears. I know, I read an interesting article, since we're talking about unemployment. And we always hear about the CPI and the PCE, but the Fed really keeps an eye on that unemployment number, don't they? Nick Colas 21:50 They do. I mean, you know, there's a dual mandate at the Fed one is inflation on the other one is labor markets and full employment and they were at the margin, we'll have to keep full employment. But it's very hard to parse because embedded in the labor market data is wage growth. And wage growth has been running much higher than pre pandemic for many years now. And that wage growth, to some degree enables inflation. And that's a difficult sort of feedback loop for the Fed to manage. So they're trying to bring inflation down in part by bringing wage inflation down, which in turn is driven by reducing demand for labor by cooling the economy. But it's a very tricky balancing act. And while historically speaking, as we talked about shocks create recessions, the Fed is also attuned to not leaving the economy so weakened, that even a minor shock would cause a recession. So cutting rates sooner rather than later, is the best way to do that. Andrew Brill 22:41 I read a an article, and it's, I guess, without laying people off, there's open jobs that companies are now cutting, they said, Okay, you know, we're just not going to fill that job. So in essence, they don't have to lay anybody off, but they're not hiring anybody either. So the rate of hiring is going down the number of open jobs per applicant, I guess is going down Is that something the Fed looks at as well. Nick Colas 23:05 It is Powell talks about this literally at the top of every press conference at the CIA to his go to move basically. And he compares the jolts data which is actually is out today, with of job openings to the number of unemployed people, and the ratio is still much higher than one to one, there's actually more nominal openings than there are unemployed people, which tells you there's still quite a bit of demand. Interestingly, this was also the case just before the pandemic, this labor shortage America has been it has been dealing with actually predates the pandemic and predates the very high level of openings to unemployed, it's coming down, but it's still higher than it was at the end of the last expansion in 2019. So openings do have to continue to come down. And let's face it, the openings data can be a bit squishy. I think we all know companies post jobs that they're not really intending to hire for, unless some superstar happens to come along, which is rarely the case, obviously. So I think it's also companies getting a lot more realistic about what their demand for labor should look like and what should be. So openings have come down quite a bit as well. And it all reflects the companies are getting a lot more realistic about the economic situation, which they can see a slowing the effect of inflation on consumers, which has been horrendous, and having to reset their business models and reset their cost structures to deal with the world as it will be not the world that we had in 22 when demand was off the charts and inflation was hot. But still everything was pretty strong. And companies are getting a lot more rational about their cost structures. And that's what propels earnings. And that's what helps stocks. Andrew Brill 24:31 As we head into earnings season now that the second quarter is over. Obviously, companies may not because the economy is slowing may not do as well, but it's always the forward looking guidance. And if rates do begin to come down, if the Fed does cut, it'll be a little bit easier to borrow money for companies to put more into r&d or building new things and you see maybe the like a one quarter slip with earnings. And then because rates might come down forward guidance, because let's face it, that's what usually pushes the stock price up or down. It's not how you did it's because the earnings are what happened in the past. And it's like, okay, what are we doing in the future? So with rates coming down, do you think that the forward guidance of this earnings season might be better than we expect? Nick Colas 25:28 Well, it's a tricky dynamic, because the phenomena you describe really exist in small cap stocks. So they often require extra capital to finish their growth plans, could be a biotech company, it could be an industrial, it could be a high growth name that just isn't making a lot of money right now, but needs access to capital. For them, the lower rates are going to help a lot because it does reduce their cost of capital. So on small caps, super important issue. But small caps also don't have the same advantages that larger companies do in dealing with a slowing economy. So they're probably already running pretty lean, they don't have a lot of factories to cut. So they're going to see an earnings hit. So if a smaller company is worried about the economy, they probably do guide down, because they're looking at their cost structure and saying we don't have a whole lot to cut. Now larger companies have the economies of scale to deal with a slowing economy better. So for them, they might say, look, there's no reason to cut our guidance or sound cautious on the second half of the year, we're doing the right things, we have a lot of advantages. If we need to cut some some headcount modestly, we'll do that if we have to cut some outside spending, we'll do that. But they have a lot more in the cost structure that could potentially trim in order to make those earnings expectations. And the point you're raising is super important, by the way, because s&p 500 earnings are expected to go up every quarter for the rest of the year. But anywhere from three to 5%. than usual growth rates sequentially is more like two. So stock market analysts are looking for some very heavy growth numbers and kind of all time record earnings by the back half of this year, in order. And they want companies to confirm those. And companies are kind of over a barrel where they have to meet analysts numbers, and so they don't want to guide down. So the obvious offset is we've got to cut costs, think you're gonna hear a lot about cost cutting, and margin management on q2 calls. And that's how we get to the earnings numbers analysts expect and that's what justifies the s&p at a record high level, but the Russell obviously not because the small smaller companies don't have the same advantages. Andrew Brill 27:26 Are we looking at big tech still? Or are there other sectors that people are thinking, oh, you know, second quarter is going to be really good for this this sector? Nick Colas 27:36 Well, I'll tell you, like, for example, if they take the industrials which you know, had a pretty good first quarter and not so go to second quarter. And that's one space where expectations are extremely low analysts are looking for basically flat revenues, flat earnings, large cap industrials are an interesting space because that group worked really well and then didn't. But all the things we're talking about here, looking at, you know, how the economy is shaping up looking at how companies are cutting costs to create earnings growth, that affects industrials, more than most they have a very high fixed cost structures, they can cut those cost structures and improve earnings. So that's one area we'll be looking at in the second quarter for some better news and expectations, because as you pointed out, it's all about expectations, right? If you can beat by a couple of percent more than the market expects, your stock goes up, if his expectations are low, all the better. Andrew Brill 28:24 You know, we just got through the first presidential debate, and obviously earlier than we expected. Do you see a switch? You know, we we read that we see the news, we read all about how each candidate did and I won't get into that. But do you see a switch in different stocks that are sold off or bought because of what happened in the debate and what you know who everybody thinks is going to be elected president? Nick Colas 28:49 I mean, there's some obvious sort of churn in names like the Donald Trump's SPAC. So on a single stock level, you absolutely do. At a broader market level. It's more of a macro dynamic. We were just in in Europe visiting with with a lot of institutional customers and to a meeting every single meeting, the first topic was the US elections. Now part of it's because we're a US based firm, and the European investors want to hear our point of view. But it was very clear to me that a lot of them are just not going to invest a lot in the US incrementally until the election is over. So creates a bit of a freeze on global asset flows, because they just, they're very sensitive to economic and political disruptions. We saw that in the UK, we saw that in France. And they feel that the US they'd rather just waiting to see who wins not just the presidency, but also Congress before they make a lot of incremental investment decisions. So it could create a bit of a near term freeze on global capital capital flows into US stocks simply because not that they're looking for bad news or worrying about what might happen. They just want to know what is going to happen. That kind of uncertainty has a tendency to reduce investor interest. Haven't heard that as much from us clients yet. They're still focused on you know, how do I beat the mark? Get the third quarter. But it definitely from a global perspective, I see that happening. It's a bit of an interesting dynamic where again, they're not worried about one candidate winning over the other, they just want to know who's gonna be in charge. Andrew Brill 30:12 I love that, they may not have shared it, but I'd love to get their take on who they think would be the better president. But you know, let's talk about bonds and interest for a minute, the debt, Nick is gone crazy. And it's going to cost us down the road. But obviously, lowering interest rates is going to help the debt rise slower, I guess, then, than it has been, how do we get out of this rut? And and you know, where and who is worrying about the debt, it seems that double eat both these candidates will continue to spend, our debt will continue to rise. And it's going to create a an even bigger problem than it is now. Nick Colas 30:52 Yes, it's a super important dynamic, I make two points. The first is, what's really interesting about this latest round of incrementally, much larger federal debt, isn't it yet hasn't yet really affected bond prices. So if you look at real yields real X inflation yields over the last call it 20 years back to 2004, 5, 6, you'll find that real yields are no higher now than they were pre financial crisis or anywhere on 2%. So if you take inflation expectations have a little bit over two. And real yields make the balance, you get to the four and a half percent 10 year yield that we have now. So real yields are no higher than they were pre financial crisis when you think they would have because pre financial crisis, we're running 60% debt to GDP, now we're doing 120 nominal. And yet, yields are not reflecting any kind of incremental risk. We also see it in a corporate bond market. So again, you think that if people were worried about the federal debt, they might want to buy triple A double A corporates, because they're very safe. And they're very well run companies with great competitive advantages, great cash flows. And yet the spreads of triple A's double A's single A's over Treasuries are just as the same level now as they were pre financial crisis. So the market has not yet incorporated the federal debt problem that we all recognize, into bond prices, because the dollar has remained the reserve currency. If the dollar is up, call it 34%, since 2010, versus a basket of other currencies. So there's nothing yet triggering markets to acknowledge that the debt issue is a serious one bit simply because the dollar is still the world's reserve currency, fiat currency. So we're not yet seeing the tension in markets that you would expect, given these very large deficits. And that's both a good thing and a bad thing. The bad thing is it doesn't create any catalysts for change, which I think we would all agree that the US needs. On the positive side, it does maintain the government's ability to borrow, which is very important for economic growth. You know, more broadly, the issue about the debt is, again, this comes from conversations we have with a lot of European investors, they don't so much mind that debt, because they feel the US economy is better structured than any other global major global economy. So it's the switch, the Swiss have a great economy, but it's a very small, the US has a very strong economy with a lot of innovation and a lot of growth, and a lot of systematically important companies. And they see that is kind of the offset to higher federal debt levels. So yes, they would also like the debt to be lower, they think it's kind of unwise to issue so much debt, but they recognize that the money goes into the US economy, which is still the best structured economy in the world, both in terms of its labor force, flexibility, and in terms of innovation. So we ended up with a situation where, yeah, that that is crazy. But at least he's going into the US economy, which is by and large, a better structured economy, both for the current and for the future, than anything else in the world. And the issue with capital is it has to go somewhere. And so capital chooses destination, and is still to us choosing the US, even with it that even in spite of the depth, because the other dynamics in the economy are so good. Andrew Brill 34:00 I was reading this morning that the yield curve has been inverted for quite some time, but is now sort of trending in the right direction is this is what you're seeing? Nick Colas 34:10 Yes, I was actually just looking at that yesterday, potentially right about this week for our clients. You're right, it has been really, really stagnant ly negative for several years now. And we all understand why and what that means. I don't know that the yield curves gonna and invert, say this year, because we're going to need, you know, not just a couple of rate cuts, but the virtual certainty of further rate cuts in order to bring the short end of the curve down. So no, unfortunately, I think the yield curve on the plus side it hasn't, you know, it's called the recession indicator, right? When twos or 30 days yield more than 10s You're gonna have a recession. That hasn't happened yet. And the signal basically is kind of broken right now. So on the good side, it hasn't created the kind of uncertainty and the kind of contraction that it usually does a negative side I think might be lingering with this inverted yield curve for a while longer. Andrew Brill 34:59 One of my last questions, Nick, is AI still the craze? Is it still It seems to people are wondering, oh, it hasn't been knocked off his pedestal? Is it still the craze? Is it still something that we're getting into? Nick Colas 35:13 It is, it absolutely is. And I'd say, you know, my biggest sort of top down view of the world is that the stock market right now looks very much like a combination of the 1980s and the 1990s. In the 1980s, from 84 to 86, the Fed finally decided it's a fight with inflation from the early 80s was over. And it cut Fed funds from 11 to 6%, between 84 and mid 86. And we're getting the same kind of dynamic now. And that created a very strong run in the s&p, the s&p doubled in two and a half years through June of 1987. So you have had a very strong run just on Fed rate cuts. The other part of the story in today's market is the late 1990s, with that massive run in internet window.com stocks, and we're getting the same kind of dynamic in with the AI stocks now. So it's not just the AI craze, which I think resembles the.com bubble in its earlier phases very strongly. But it's also the Fed rate cuts. And you can put those two together, the intersection of that Venn diagram is the current market. Those are two very powerful forces, the difference between now and the 1990s. And I lived through that age and was at SAIC capital with Steve Cohen, when that was hitting its peak. And the difference now is you have a handful of companies because generative AI requires a ton of capital to implement. So you can't just start a website at $10 million and go public in a year or $200 million, you need a couple 100 billion dollars to build a good Gen AI model. And that limits it to a handful of companies. So we're getting all the concentrated energy of a of a.com style boom, but just in the handful of companies, and we all know the ones they are. So that macro backdrop is very good for equities, very good for the next couple of years. But at the same time, it's going to feel very awkward, very scary, because it's not a couple of 100 companies going public that we can all pick and trade and choose. It's going to be a handful of companies are the big winners, and they're probably most of them already public. Andrew Brill 37:10 Are there a lot of tentacles to this companies that are going to feed off of the AI craze and do well because like are there some small cap stocks that have technology that AI is going to need? And are there a lot of different avenues to AI that will help a lot of different companies. Nick Colas 37:29 You know, there should be but there really, unfortunately, are not just yet. So for example, SMC AI, huge winner from Gen AI over the last 12 months really one of the more dramatic stories in markets, aside from the big tech names, not a lot, not many people know about it, but it's been fantastic. Unfortunately, it just left the Russell last week in the rebalance. So we just lost one of the few great nai plays out of the Russell 2000. It's now the Russell 1000, which is where it should be based on market cap. But again, this isn't the dynamic that we're talking about the top of this conversation, were small cap stocks just don't hold on to those kind of big winners. Now, will there be another one perhaps, but invariably, it'll graduate out in the next year. Andrew Brill 38:12 Oh, Nick, thanks so much for joining us. We this was fabulous. I think a lot of great information. As always, where can we find you either on social media or read your newsletter. Nick Colas 38:24 Just go to Data Trek research.com. And there's a little box at the top of the website where you can sign up for a two week free trial. Andrew Brill 38:30 Excellent. Thanks so much. We really appreciate you coming on and it's always a pleasure to have you. Thank you. Nick Colas 38:35 Thank you so much. Andrew Brill 38:36 That's a wrap on another discussion here on wealthion. And thank you for joining us. If you need help being financially resilient, please head over to wealthion.com. 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