Economy’s Bombshell: What Markets Aren’t Telling You — Eric Basmajian

[00:00:00] Eric Basmajian: they really should not be in the business of allocating credit people that are not owners of assets will do uh disproportionately were worse when people are talking about affordability is it [00:00:11] Speaker 2: just the the level of home prices is still high compared to historical averages or other costs of home ownership going up our next guest is eric basmadjan founder of epb research and one of the sharpest voices on the business cycle today he returns to the show to walk us through two central arguments and theses that show us where the business cycle is headed and where the economy is ultimately headed first the american housing market has quietly broken families are paying more and more for less and less even as the country now funds almost none of its own investments and leans on foreign capital to close that savings gap second this record-setting stock market is not the leading indicator most investors would believe it is so the two questions on every investor's minds if the economy is weaker than the tape suggests how do you position for it and what breaks first if the world stops financing america we'll find out this video is sponsored by kaoshi the largest prediction market in the u.s unlike a sports book you're trading peer-to-peer on real world events from economic data to political outcomes and the price moves based on public opinion not a house go to the link in the description down below or scan the qr code here and use my code lin lin new users will get ten dollars when they trade ten dollars right now traders are predicting that there's a 59 chance that the 30-year mortgage rate will go above 6.7 percent this year for reference is currently at 6.5 percent so if you place 50 on this trade and you're right your payout could be 82 dollars so how high will interest rates go this year and what happens to the housing market once rates rise we'll discuss all this with eric today welcome back to the show eric good to see you again the hardest man uh working [00:01:56] Eric Basmajian: man in uh in finance david lynn that's you back no that's you you're you've been writing non-stop let's [00:02:02] Speaker 2: start with one of your more recent pieces dated june 23rd happy start of july by the way eric we're speaking on the first of july right before the jobs numbers come out so um you know we can speculate as to what the numbers could be tomorrow but uh by the time this interview airs we'll probably get a better sense of what the data is going to be the stock market is not a leading indicator this is the market is a is better at calling the end of a recession than the beginning here's a part of the economy that actually leads the cycle on how to track it i'm not going to spoil this i'll let you do that [00:02:33] Eric Basmajian: all right so the basis of this article was to try and put some data around the concept of the stock market being a leading indicator and the truth of the matter is that if you take uh historical data stocks do perform as a leading indicator uh and that's why they're they're in a lot of popular leading indicator metrics like the conference board leading index it contains the s p 500 as a leading indicator but there's some nuance to that that i think people miss when we talk about a leading indicator we're talking about leading it at the peaks of the cycle and at the troughs of the cycle so the tops and the bottom when you look at stocks or the s p 500 especially in the last several decades they do not lead the economy at business cycle peaks they actually tend to be coincident and sometimes even slightly lagging when calling for a business cycle peak however stocks do a good job of anticipating business cycle bottoms so for example the stock market bottomed in march of 2009 the official end date of the recession was june 2009 so there was a three month lead time of stocks compared to the economy but the stock market peaked in october 2007 which was just two months before the start of the recession and really the stock market was just a couple percentage points from its all-time high even in march of 2008 and you think about the uh covid pandemic where the stock market was not at the forefront of what was going on either so the stock market does not do a very good job of predicting peaks in the business cycle it does a much more reliable job of predicting bottoms in the stock market uh or in the economy excuse me so what we tried to do in this piece was to one run through the historical record to prove that that's the case and then show what actually leads the economy and the the stock market more regularly and when we run the analysis what we find is what we call the cyclical part of the economy is what really is the leading indicator the cyclical economy being construction and manufacturing both the growth and the employment of those two categories so that the way the economy generally unfolds uh especially when you're at business cycle peaks is that the federal reserve tightens monetary policy the tightening of uh credit and interest rates impacts construction and manufacturing first because those are of course the most interest rate sensitive sectors the slowdown and job losses that occur in construction and manufacturing are what start to pull down the earnings of corporate equities then the stock market responds to that and then the aggregate economy or those gray bars on your chart start to appear so it it actually tends to be somewhat of a circular argument for people that use the stock market to predict where the economy is going to then tell them what the stock market's going to do it really amounts to a trend following strategy which we write in the articles perfectly fine and valid as long as that's what you're intending to do it's not to be confused with economic analysis because the economic analysis the historical record shows there's a pretty clear pattern to the way these things move and it's the cyclical part of the economy the construction and manufacturing that has the lead over earnings and that has the lead over the the broader [00:06:10] Speaker 2: economy okay let's talk let's talk about ism manufacturing in more detail just a bit uh while you were um explaining that i pulled up this chart on my screen this is oil this is a very crude representation no pun intended crude oil of what could happen to the economy it just so happens that every single time except for 2020 going back to 1990 every time oil has risen it tends to have been a leading indicator for those gray bars the exception was of course covet when actually oil went towards zero for a very short period of time and actually in 2022 is as you recall oil spiked up right before the feds started raising rates and that actually preceded two quarters of negative real gdp contraction i believe it's been revised but at the time it was technically a recession although not ember officially designated no gray bars there but the stock market did fall by the order of 25 30 in 2022. so oil has been a pretty reliable leading indicator thus far is that just a coincidence or is there some economic theory behind [00:07:14] Eric Basmajian: this so it's a little bit of a coincidence i would classify this more as an amplifier rather than uh the real driver of the cycle because if you keep this chart up what you'll notice is that the real acceleration in oil prices in the 2008 recession didn't really start until the end of 2007 and then it really spiked into 2008 when the recession was already underway this that sequence in 2008 really began in 2004 and 2005 when the federal reserve started to tighten monetary policy by the time we got to 2006 we had a big slowdown in construction activity and the economy was hemorrhaging hundreds of thousands of construction jobs in 2006 so by the time that oil spike happened we already had lost over a million jobs in construction and then that oil spike was sort of the straw that broke the camel's back the consumer in aggregate was already under pressure from the falling labor market specifically in construction and then the spike in oil prices caused additional pressure you juxtapose that to what happened in 2022 was you did have an oil spike and it did put a little bit of pressure on the economy but at the time the labor market was so hot coming out of covid that it didn't uh it wasn't enough of a vulnerability in the economy for that oil spike to cause the trigger so really what has to happen is the economy has to be in a vulnerable state generally with job losses already occurring in the cyclical uh more sensitive sectors and then a spike in oil prices or an external shock can act as an amplifier but if the economy has a strong foundation and is adding jobs specifically adding jobs in those really uh sensitive cyclical sectors it has the ability or a better ability to withstand uh those external shocks okay so the ism manufacturing index which you referenced earlier [00:09:18] Speaker 2: uh fell to 53.3 in june down from 54 in may slight contraction but still above the 50 mark which is the point of expansion versus contraction um what do you make of this trend uh still above 50 but slightly weaker um start of a broader trend or just consistency yeah so what we're seeing in [00:09:41] Eric Basmajian: manufacturing the ism manufacturing uh index is a great index um but we we try and look at other metrics like industrial production because it gives us a more granular breakdown of what's going on on the subsectors if you look into the ism manufacturing report they put out a pdf report that comes with the index they do have some commentary about what's going on at the sector level but something like the industrial production index from the federal reserve breaks it down a little bit more specifically and what we see is there's a fairly broad weakness that was going on in manufacturing for the last two or three years but as this ai build out has started to uh pick up its intensity it's really flowing through the manufacturing accounts uh in the construction i'm sorry in the manufacturing of computer equipment so in the industrial production accounts we're seeing explosive increases in the production of computer equipment and that has started to broaden out a little bit there's a little bit of a multiplier effect going on where it's starting to bring in other industries as well so i would say that the manufacturing sector was in a prolonged slump you could even say a mild recession because there was both production declines and job declines from 2022 to 2025 if you have production declines and employment declines that really is the definition of a recession uh it was very mild but it was fairly prolonged so from 22 to 25 you had a very mild recession going on in the manufacturing sector as this ai build out really started to come through it put a huge impulse through computer equipment production that's caused a pop in some of these broader manufacturing indexes as well as some very early signs of an improvement in manufacturing employment which is something that we'll look for in in this upcoming report so i think that the manufacturing sector was in a very mild prolonged slump and the evidence shows that that's bottoming out and maybe even broadening out for a little bit of an upturn that's juxtaposed to what we think is really the only weak sector left in the economy which is [00:11:58] Speaker 2: which is housing and housing construction okay perfect let's talk about housing in just a minute uh so it to sum up here we have the best quarter for the stock market since 2020. this is according to uh the street closing off june 30th now if the cyclical economy is already rolling over well the market prints strongest quarter in six years does that divergence strengthen your case that stocks lag the [00:12:22] Eric Basmajian: cycle rather than lead it so it's not entirely inconsistent with what's going on so we see we see mild weakness going on in the cyclical sectors primarily just housing we we had some weakness in manufacturing although that's starting to improve and we have to remember that stocks as is commonly referenced in mainstream you know media or when everyone talks about the market it's always referring to the s p 500 which is dominated by you know mostly technology companies those are really at this point services oriented or or uh parts of the economy that are more tethered to that aggregate sector they're not as cyclical as uh the stock market used to be or even other assets so when we talk about the stock market or the s p 500 it's really going to be closer to the aggregate economy it's not going to be a leading indicator we see some pressure going on in the cyclical economy construction and manufacturing but if we look at the the whole picture of that cyclical economy it's a pretty narrow decline right now where it's just residential construction non-residential constructions performing well there was weakness in manufacturing that looks to be subsiding a little bit so right now we're just seeing declines in residential housing it hasn't even spilled over to uh large declines in residential construction employment there's been some mild declines there so we see the weakness it's consistent with interest rates for uh mortgages that are in the mid sixes to high sixes i do expect the housing construction uh market to re remain under pressure the question is will housing uh and housing construction decline enough to drag the rest of the economy down that's always how recessions begin and right now we're seeing just still a really a moderate decline in housing construction and housing employment and it's not yet enough to offset the strength that we're seeing really from the ai generated uh build out going [00:14:26] Speaker 2: through the rest of the economy so going back to rates how high will the 30-year go this year 30-year mortgage rate is currently sitting around 6.5 percent between 6.49 and 6.6 and now uh the prediction market this is kaoshi we have here an 82 chance according to traders that we're going to get above 6.6 which is the current level and a 60 chance we're going to get above 6.7 so people are expecting traders in particular are trading are expecting the rate to go up slightly um how first of all how does this match your expectations and if we're expecting higher interest rates for mortgages what does that mean for construction for demand for selling activity all those things you referenced earlier yeah so what's [00:15:12] Eric Basmajian: going on in the housing market i'll try and explain it as as precisely as possible is there's always two sides to any uh sector when you're when you're analyzing it it's the production or growth aspect and the employment aspect so when we look at housing in particular we see very large declines in production so the number of housing units under construction has dropped 20 or 30 percent building permits have come down new home sales have come down that's really measuring the growth or production element element to the housing sector the corollary to that which generally tracks closely is employment so how many people are building those homes that has not declined that much it's declines just a couple of percentage points against a 20 or 30 percent decline in production so if you have a huge decline in production but just a small decline in employment the difference must be coming out of profit margins and that is what we're seeing in the home building sector the home building sector in aggregate has seen profit margins fall from 20 percent in 2022 down to 11 now so that's a 900 basis point drop in home builder profit margins it's very large at any other point in really history if there was in a 900 basis point decline in profit margins for home builders that would have led to a massive layoff cycle because the average profit margin is about 10 so if you're at 10 and you get squeezed by 900 basis points you're at one percent and companies would be forced to engage in large-scale layoffs to protect those margins but because of the stimulus and so many things that happened during the pandemic profit margins were pushed all the way to 20 percent which is double the long-term average so that 900 basis point compression that we've seen has pushed margins to 11 percent which is still slightly above where they've been over the course of their history so they're not under acute pressure to get rid of their labor now if we see mortgage rates stay elevated and they do stay where the markets are somewhat projecting high six percent range that will continue to pressure home builder profit margins and we'll see those numbers go from 11 to 10 to 9 to 8 and the lower you get the larger the probability that those companies will have to start engaging in more aggressive layoffs and that's what will start to propel the downside through the rest of the cycle so that's really kind of the x factor or the linchpin of the whole cycle is how do the mortgage rates interplay with the profit margins of the home builders and do they compress margins enough that it triggers a layoff cycle because those unemployed people will then start to create the downstream stress on the rest of the economy that's really the way a downturn evolves and where we've been stuck in this process is the interest rate increases have caused a slowdown in housing activity but it hasn't caused a drop in housing construction employment because it's still been buffered by really high profit margins and we'll have to see if that uh that game [00:18:34] Speaker 2: ends towards the end of this year and what i should have on the screen here just to illustrate your point is the one year performance of the itb which is the ishares us home construction etf since one year ago it's up about three percent since its peak in september 2025 it's down about 13 percent compared to the s p 500 over a one-year basis um it is uh underperforming let me just pull up the exact percentage here yeah the s p is up 19 versus 3.8 just on a year to date basis um both are up slightly with the s p up nine percent and the itb up five and a half percent so underperforming the index overall people talk about the affordability issue still being top of mind but i was reading that the um according to the case chiller uh report that came out recently home prices went up about 1.1 percent only from a year ago um and that's near a three-year low when it comes to the growth rate so when people are talking about affordability is it just the the level of home prices is still high compared to historical averages or are other costs of home ownership going up besides just the value of the [00:19:42] Eric Basmajian: home itself that's a really great point it's really twofold so it's the fact that home prices are elevated relative to income so if you are a cash buyer home prices relative to income are certainly above historical averages and then you have uh interest rates that have been elevated relative to our more modern historical norms so you have the combination of high prices and high interest rates that's causing a high monthly payment relative to uh people's income but you're you're spot on that the cost of home ownership has increased as well uh in a really big way there was an article i believe it was in the wall street journal that that measured the increase in uh excuse me there was an increase in um inflation from the start of covid until now has been about 30 percent or so and then they listed the increase in various costs of home ownership like maintenance and that's gone up almost 80 percent since the start of uh since covid began in 2020. so you're seeing various elements of home ownership that have gone up twice as fast as the overall cpi uh so housing is expensive people may have locked themselves into mortgages that are uh higher than uh what would be advised as a percentage of income and then they're getting squeezed by uh increased home ownership costs as well uh of course i'm referring to the uh home buyers of 22 and and beyond not the the lucky people that that were able to refinance in 2020 and 2021. that's [00:21:22] Speaker 2: right do you see higher energy costs and perhaps higher cpi of non-energy goods overall affecting home [00:21:29] Eric Basmajian: building activity this year so home building activity is going to remain structurally squeezed we have big problems with our national uh investment accounts where uh i recently just published an article uh on my substack as well as on my twitter where we look at the investment accounts of the united states and we can measure how much of our gdp we're investing in various uh categories on a real net basis so after inflation after depreciation and we used to invest something like five percent of our gdp on a real net basis in residential structures now it's down to one percent so we have a real reduction in the amount that we're investing in residential uh construction that's going to just put secular pressure cost pressures on that entire sector um so it's it's going to be an area that i think remains uh difficult uh regardless of what happens with energy costs just because of the structural underinvestment that's been going on over the last 20 years and what's likely to persist we have to look at these numbers on a real net basis which means after inflation after depreciation we can sometimes get fooled by the nominal number but really what what matters for housing stock and what people feel on a day-to-day basis is real net investment and that's suffered quite dramatically in the residential sector [00:23:02] Speaker 2: okay i don't know for sure if this chart illustrates that point but i want to bring it up anyway this is from your post your substack post net national savings has fallen from around 11.5 percent of gdp in the 60s to roughly 0.7 percent today yet net investment still runs near five percent because of the rest of the world funds the difference uh here's that chart the savings gap i want to show you something else in just a bit uh but explain to us what we're looking at here and how [00:23:28] Eric Basmajian: this affects the broader economy sure so uh one of the things that that you learn in economics is that savings equals investment and the word investment trips people up because they think sometimes about investing in the stock market but in economics when we mean savings equals investment we're talking about the investment account in in gdp so investment in structures equipment and intellectual property so savings has to equal investment and domestically we save but we also can borrow savings from the foreign sector so if you go back to the 60s and 70s in this chart you can see that our domestic savings rate was very high so we were able to fund our own investment the blue line in that chart has grinded down from you know 10 11 percent to virtually zero and if we have zero net national savings that means that we can cannot fund any of our own investment why has this happened to put it quite simply the government budget deficit has uh increased to such an extent that it's eating up all the savings of households and corporations domestically we're still able to invest because we run a large trade deficit so we have a lot of capital coming in from overseas that's able to fund that gap that savings gap that we have so if we have zero savings nat uh uh nationally but we're still investing five percent it's because we're getting that five percent from the foreign sector so at the at the at the moment that's not really a problem as long as that stays in equilibrium but that means that we're really relying on the foreign sector to fund our savings and if for any reason in the future foreigners decide that they don't want to fund uh the united states anymore we'll have a savings shortfall that we'll have to make up either through higher domestic savings or much lower uh domestic investment and that would be a painful adjustment the reasons for why they may want to invest less in the united states is a long conversation and may or may not happen but it does uh uh lead to some level of vulnerability that we have a large reliance on foreign capital to fund our domestic investment i wonder if this is related to [00:25:50] Speaker 2: this following chart probably not maybe it's just a coincidence or a correlation uh but this is from doug casey's uh twitter post but this is a chart showing something pretty interesting the divergence between real wages and productivity which started around the same time as the real the net savings rate that you talked about started to uh started to uh widen in a gap now here we have prior to the 1970s the two variables real wages and productivity roughly tracked each other meaning that as real wage as productivity increased so did real wages so did people's living standards most people benefited from the increases in productivity through higher real wages says this post over the last four to five decades this divergence have become has become wider and wider as people have realized a slower pace in the growth of the real wages while productivity has increased dramatically productivity means higher profits for the corporations and for the the shareholders uh while the worker actually earns less and actually a separate chart that i can show you later shows the labor share of profits declining over the last four to five decades that number shows us how much of the worker earns relative to how much the corporation with the company earns and that number has been falling dramatically over the last four to five decades i wonder how all these things play together but it has been an alarming trend over the last couple of decades that real wages haven't kept up with productivity gains can [00:27:30] Eric Basmajian: you explain why sure and if you go back to the article that that i was on before i have a chart that i think may help explain this uh if you scroll down just a little bit there's a uh there you go that chart right there the one just above it uh that one works too either that one perfect that one's great so what you can see here is what we were talking about before was the fact that the overall level of investment in the economy has gone down over time but that actually is there's a there's a worse mix that's going on under the surface because that was just looking at the top level of all investment but there's been a shift or a change in the blend of investment so if you look at the left hand side we're looking at the real net investment of residential and non-residential structures and you can see just how much that's declined over the years if we look at the right hand chart what we're looking at is the real net investment in equipment and intellectual property equipment is broad but the big increase has been in computer equipment and then intellectual property things like software so what's happening in my view is that the gains in the economy or what's absorbing all of the investment is computer equipment ip and software and those gains are accruing to a smaller share of the population as well as really towards the companies that own the ip where the majority of people interact on a day-to-day basis with the physical economy residential housing and non-residential structures which includes things like hospitals power grids water systems so the lion's share of the population is interacting with an economy that has uh to to put it you know somewhat uh hyperbolically uh in eroding capital base that that capital base is really the source of their productivity uh and that's becoming increasingly expensive because of the lack of investment and it's functioning much worse which is hindering their productivity but productivity in the economy as a whole continues to to hold up because of the large gains in ip and equipment which are accruing to really a narrow share of the economy and a narrow share of the uh the companies so some people may say the shift from investing in structures to investing in high tech is good and that's what a uh more advanced society should do but the investment has suffered so much in the physical economy that in my view it's that's what's causing a really disproportionate uh outcomes that's what's causing that k-shaped economy where some parts of the economy are interacting with this physical infrastructure much more regularly and it's a much larger share of their personal income and they're seeing declining standards of living in those areas while you have certain segments of the population that are really heavily invested or using computer equipment and ip and they're obviously generating most of the gains so maybe between all of those charts we we kind of paint the story here but that's my [00:30:43] Speaker 2: angle of what i think is going on okay uh and this is the chart that i referenced earlier workers are getting a smaller piece of the pie here here you have the labor share of income by quarter american workers are taking home a smaller share of the nation's income capturing less of what the economy produces due to several long-standing issues ranging from the erosion of union membership to well that's to tax law changes that have steered more gains to ceos that's editorialized this is cps news anyway this is a chart showing the data here and i'd like to get your explanation not cps news's explanation as to why that happened and generally speaking why um workers can't be paid more i wonder if this is correlated to the gains in the s p 500 over the last 70 years by the way as uh profits have risen because uh share uh the labor share of income has declined that has contributed to the outperformance of the stock market at the expense perhaps of the ordinary american worker or perhaps everyone's just [00:31:38] Eric Basmajian: better off because of this trend how are you interpreting well well you're right and there's there's a chart on my twitter it may be difficult to find but really the inverse of this chart is corporate profit margins so corporate profit margins from 1990 till today have gone straight up something from eight percent pre-tax to twenty percent pre-tax so of course that's really been a driver of why there's been such a decades long strong bull market because you're buying companies that used to have on average eight percent profit margins now they have on average twenty percent profit margins so their earnings are increasing faster than the economy and also people are likely willing to pay a higher multiple for a twenty percent profit margin company versus an eight percent profit margin company i think that there are a lot of reasons for why this is happening so it could be dangerous to try and pin it on just one or two but i think that there are uh a few things that stand out to me are number one is the monopolization or industry concentration that's happened to really across every industry everyone will point to big tech right away but you can see this across every industry if you take home building for example i think that the numbers were something like in the 1990s the top 10 percent of home builders built something like eight percent of all homes now the top 10 percent of top 10 home builders build something like 50 percent of all homes so there's been a massive consolidation in the home building sector you obviously everyone knows the concentration that's going on in health care and health insurance companies and then you look at um of course the big technology companies so this this massive industry concentration across really all sectors of the economy in my view allows those companies to have larger economies of scale uh they can of course command higher profit margins and they also if they own really the entire sector or there's a duopoly uh or an oligopoly in an industry it makes it difficult for uh employees to bargain for higher wages because they have less uh you know competitive power over you know maybe just two or three monopolistic firms as opposed to maybe a world five six decades ago where there were 50 companies in an industry that were all hyper competitive towards uh you know the best product and now you have every industry dominated by three or four uh players who also by the way have an incentive to regulate uh for new competitors to have a difficult time coming into the market so i think that the hyper concentration of um companies across sectors is one of the large reasons for for why this is occurring one quick point is everyone will immediately say it's globalization because the line starts to go down around 2000 and that's when china came into the wto there was a paper that was written on this it's called the rise and fall of superstar firms uh and it really went to great lengths to try and understand why this is happening and that drop in 2000 was more related to the internet and network effects as opposed to globalization because if it was globalization you'd see the impact across all firms that were importing and exporting but the median firm didn't really see much of an increase in profit margin it was that there were a a larger shift to fewer companies and then the average went up a lot so it wasn't a really broad distributed increase where every company that was importing and exporting did much better it really was uh more of a concentration story and an internet story at the risk of rambling just to highlight the point is that if you were uh maybe in the 1980s and you wanted to buy a hammer you had to drive to your local hardware store and buy the hammer and for for the most part you were a price taker of whatever the the hardware store listed it at because the cost of you trying to price match would be driving maybe 20 minutes or 30 minutes to another hardware store now with the internet you can look at 500 hammers and you could buy the lowest price and it would be at your door in 24 hours which makes it much more difficult for that local hardware store to compete against a larger technology driven company that can benefit from those uh platforms this is also is really where the profit margin has come from [00:36:05] Speaker 2: it's also kind of inversely related to the unemployment rate when you just take a look at this these two variables side by side here i'm just going to overlay this i don't know i can't overlay it but anyway uh if you look here at the spike during covet 2020 my my explanation like to hear yours is that um as the labor market really tightened and unemployment dropped uh you had wages rising as competition rose and then as the labor market normalized it started falling again as the labor market started to see more slack uh so potentially if this continues declining it could highlight uh weaknesses in job prospects [00:36:44] Eric Basmajian: um maybe that's an indicator i think you're exactly right it shows more of a structural trend in um employees ability to bargain for higher wages yeah well that's unfortunate another explanation is uh [00:36:59] Speaker 2: that the fed is responsible for uh not engineering and i want to use that word but basically creating this k-shaped recovery here a k-shaped economy that we're seeing uh this is an article from reuters uh it says that um kevin warsh is unlikely to deviate from greenspan and how they've dealt with asset bubbles which is to say they're going to keep he's probably going to keep this bubble running for longer his rationale hinged on the assumption that the fed could never be certain what was a bubble and what was a structural investment boom attempting to second guess markets could cause unnecessary economic damage or distortions and distract the central bank from its congressional mandates on prices and jobs do you agree [00:37:42] Eric Basmajian: i think it's pretty difficult for the fed to um to do the opposite of perpetuating bubbles uh the the incentives really are for them to create conditions that are positive for asset prices um and if you try and trace it back to uh you know their their mandate um you know engineering declines and asset prices are not uh politically popular and they can uh overlap with big increases in unemployment so in their quest to keep uh uh in unemployment low they tend to uh favor the employment side of their mandate over the inflation side of their mandate and that fuels more speculative uh asset uh environments whereas if they kept interest rates higher that probably would preference more real physical investment as opposed to financial investment um so i think that the fed on balance has has done uh has done a lot to improve asset markets and even more than their interest rate policy i think has been their uh balance sheet policy of buying um long-term securities but primarily mortgages i think that they're uh wandering into the mortgage market after 2008 uh was a mistake uh and had they quickly corrected it maybe after the mortgage uh industry stabilized in 2010 2011 we wouldn't have had the problems we have today but it's been completely unreasonable for them to continue buying mortgage bonds uh for uh the last 10 or 15 years uh certainly during the pandemic um you could make the case that it was reasonable for them to buy mortgage bonds in 2008 and 2009 because of the severity of the housing crisis but we didn't even have one month of declining home prices during covet and they reflexed to buying trillions of dollars of mortgages which caused you know large increases in home prices and it was uh really unfounded so i i think that those policies have done quite a lot of damage and uh warsh in the new fed seem to be talking a game of uh returning to the inflation target and uh warsh in his past has been a critic of large balance sheets um we'll see if he's able to follow through on those things but i think it would be a good thing for the fed to uh really try and shrink their balance sheet and if not shrink it get rid of the mortgages that are on their balance sheet they really should not be in the business of allocating credit um you can make the case that engaging in the treasury market is part of their purview uh that's probably a longer discussion but but mortgages are a tough case to make if your thesis is [00:40:29] Speaker 2: that it's uh not in the fed's incentive or interest to pop the asset bubble through restrictive or um overly restrictive monetary policy let's say then is the investment conclusion ultimately just [00:40:42] Eric Basmajian: don't fight the fed and stay long well i think that if you go to back to the chart that we were looking at of the labor share of income going down which is the inverse of the profit margins as long as the that you have that secular increase in profit margins then with or without the fed the market will continue to do well and really what that means is is two things one is it's good for the stock market because a larger share of gdp will be flowing to corporations but it taken to an other extreme it's bad for society because all of the income pie is going to corporations and not to households so it will perpetuate the k-shaped economy and people that are not owners of assets will do uh disproportionately were worse so yes as long as that profit margin chart is on a secular multi-decade rise and that continues stocks will continue to do quite well i do continue to think that uh there you go i do [00:41:42] Speaker 2: this is an excellent chart by the way uh just sorry i mean to cut you off but here we have no profits per unit of gross value added of non-core non-financial corporate business so profit per dollar of value added over the last 70 years has gone from zero point basically three and a half cents to 24 cents [00:42:00] Eric Basmajian: incredible right exactly right and so as long as that chart continues to go up into the right then stocks will continue to do well and things that obviously cause that to go up would be the labor share of income coming down that would be one of the biggest drivers um so so that's the the more structural long-term view so to the answer that is yes what we do at epb research and what we uh try and articulate to our clients is the only thing that disrupts that trend on a cyclical basis is what's happening in the cyclical part of the economy if you do see declines in construction and manufacturing as well as all the different sub sectors which we track then that's something that would cause a cyclical decline in the market uh secular declines if that profit margin chart you know peaked and had a multi-decade decline then yes the market would be in for several bad uh several bad years but really if is if the market is the economy is moving towards a recession then you know assets are gonna have more volatility and a higher probability of those left tail or really bad months uh if the economy is not moving towards a recession markets tend to be really one directional low volatility and almost no probability of those left tail events uh and that's really what we try and uh share with our clients every week and every month is all of the data that comes in sequenced analyzed and trying to answer that question of are we moving closer to recession are we moving further away from recession and then based on that answer should you stay uh long assets will will the big large cap indexes remain well supported uh or are we in a a cyclically vulnerable regime which in that case the market can still go up but your probability of having volatility and left tail events is definitely elevated that's something that every investor should be aware of excellent well give us a sense or a [00:44:02] Speaker 2: teaser of what you're working on uh for your upcoming videos or your upcoming written work on your [00:44:08] Eric Basmajian: newsletter so we just put out that um that piece on the uh net national savings and investment identity which i think is a is a bigger structural piece that people will find interesting and in a couple days we'll also have it out on our youtube channel uh and in the uh client work that we're doing we're really laser focused on the dynamics between what's going on with monetary policy how that's impacting the housing market uh production and activity how that's impacting home builder profit margins and if they see that transition to layoffs in the home building sector because that is almost always the trigger of what uh cascades downstream stress to the rest of the economy i think there's a misconception about how recessions develop in that all of a sudden consumers just stop spending or there's really this you know all of a sudden type of event when we go back in time it's really a cascade or a sequence it almost always begins with early job losses in cyclical parts of the economy those job losses are small as a percentage of the total but it's those people who lose their jobs that start to create the downstream stress and create the pullback in spending that drives the later part of of the cycle so that's really what we're focused on that's what we're going to be focused on in the report that that will probably come out by the time this is this is published uh but that's really i think right now the hot spot that you should be focused on i don't think people should be paying as much attention to the ai build out story you know of course it's it's been extreme it's added a lot of growth but normally recessions don't begin in those categories of investment it's really what's going on in the more cyclical areas of the economy and that causing pressure in some of those other categories so that's what really what we're focused [00:45:55] Speaker 2: on excellent well thank you uh you're one of the brighter spaces in the financial research realm so i encourage everyone to check out eric's work i'll put the link to his channel on youtube as well as his uh newsletter and website as well as his social media in the links down below so check him out thank you eric appreciate your time as always speak next time thanks so much david thanks for watching don't forget to like and subscribe and use my code lin lin when you sign up to kaoshi remember new users who use my code can get ten dollars when you trade ten dollars link down below or scan the qr here to get started