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Speaker 1: Hello, and welcome to another episode of the Odd Thoughts Podcast.

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Speaker 1: I'm Tracy Allaway and I'm Joe Will Joe, what is

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Speaker 1: the most overused quote in all of financial journalism and commentary?

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Speaker 1: I don't even know where to begin with that question. Um,

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Speaker 1: I don't know. I I'm stumped. Well, it might not

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Speaker 1: be that obvious, actually, okay, in my humble opinion, it

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Speaker 1: has to be the quote by James Carville, the Bill

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Speaker 1: Clinton advisor, about the bond market. Did you ever hear

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Speaker 1: that one? Oh? Yeah, yeah, I love that quote. The

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Speaker 1: one about James Carville saying that he wishes or he

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Speaker 1: said if he wanted to, if he gets reincarnated, he'd

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Speaker 1: like to come back, is the bond market. Because that

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Speaker 1: can scare everyone, right, something like those along those lines. Yeah,

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Speaker 1: that's a pretty good paraphrase he said, so that I

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Speaker 1: could intimidate everyone. And I have to say, if you're

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Speaker 1: if you're a financial writer, I guarantee you, at some

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Speaker 1: point or another, you have probably begun a column or

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Speaker 1: a story with that quote. But I think that's probably

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Speaker 1: fair to say, and I'm certainly guilty of it, I

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Speaker 1: have to admit, But there's a reason that it resonates

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Speaker 1: so much, which is that the power of the bond

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Speaker 1: market is something that we're constantly discussing. And Joe, you'll

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Speaker 1: remember a couple episodes back, we did have, uh, one

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Speaker 1: episode where we were discussing the return of the bond vigilantes. Yeah,

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Speaker 1: absolutely right, and uh, it's what the bond vigilantes. Uh,

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Speaker 1: it's this idea that from time to time, policy makers

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Speaker 1: have their actions rejected forcefully in the bond market, and

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Speaker 1: they're cowed into action by what the market is telling them,

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Speaker 1: so to speak. That's right. So it's the idea that

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Speaker 1: the bond market can act as a constraint on fiscal

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Speaker 1: policy by basically raising a government's borrowing costs. And the

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Speaker 1: reason we bring it up now is because in addition

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Speaker 1: to the US context, you know, we had that big

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Speaker 1: rise in US bond yields and people were talking about

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Speaker 1: whether or not bond vigilantes were coming back because the

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Speaker 1: US was embarking on this big fiscal expansion. We've also

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Speaker 1: seen the power of the bond market in recent weeks,

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Speaker 1: as demonstrated by what's been going on in Europe and

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Speaker 1: specifically Italy. Yeah, the old, the old euro crisis story

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Speaker 1: is coming back in Italy. That's right, It all feels

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Speaker 1: very two thousand and twelve, we saw a big blowout

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Speaker 1: in Italian bond spreads. Everyone got very excited, started dusting

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Speaker 1: off the old fiscal playbooks from circa you know, two

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Speaker 1: thousand ten, two thousand eleven, two thousand and twelve, and

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Speaker 1: we all got to talk about the bond market reaction

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Speaker 1: to Eurozone political and fiscal drama once again. So that

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Speaker 1: was very exciting. But of course, you know, we do

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Speaker 1: have this ongoing discussion about the bond market in general,

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Speaker 1: but also how it relates to US equities, and on

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Speaker 1: that note, because we had the big rise in US

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Speaker 1: bond yields earlier this year, we have seen short term

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Speaker 1: rates on government debt actually go above the US dividend

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Speaker 1: yield for the first time in many, many years. Yeah,

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Speaker 1: I've seen a bunch of versions of this chart lately,

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Speaker 1: and you mentioned the idea of bond short term bond

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Speaker 1: yields going above dividend yield, but there have been various

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Speaker 1: variations on it, but the general theme seems to be

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Speaker 1: that for the first time in a long time, you

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Speaker 1: can get paid a decent amount of money owning short

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Speaker 1: term government debt, which is carries very little real risk,

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Speaker 1: and the competing yield you can get from equities, whether

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Speaker 1: we're looking at the dividend yield or just the straight

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Speaker 1: up earnings yield, which is the inverse of the pe ratio,

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Speaker 1: is looking less juicy by comparison, exactly right. So we're

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Speaker 1: talking about a lot of different things here, and the

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Speaker 1: reason we're doing that is because we actually have a

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Speaker 1: really fantastic guest for this episode who is able to

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Speaker 1: thread all these different subjects together. And he is actually

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Speaker 1: the person who coined the term bond vigilantes. So that's exciting.

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Speaker 1: Oh wow, So now I feel very um self conscious

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Speaker 1: from having tried to give my feeble definition of the term,

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Speaker 1: because we are literally going to talk to the originator

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Speaker 1: of it. All right, Well, without further ado, then let's

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Speaker 1: bring in our guest. It's Edyar Denny. He is president

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Speaker 1: of your Denny Research and thank you so much for

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Speaker 1: joining us. Thank you very much, and by the way,

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Speaker 1: I think you got it most okay, few, that's a

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Speaker 1: big relief. Uh that's a shame because my first question

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Speaker 1: to you was going to be to ask you to

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Speaker 1: embarrass Joe about his definition. But I guess I don't

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Speaker 1: get to do that now. No, I think I think

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Speaker 1: both of you got it right on. So should we

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Speaker 1: start with bond vigilantes and just go back in time

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Speaker 1: and talk about how you came up with that term?

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Speaker 1: Was back in the summer of nineteen eight three, I

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Speaker 1: noticed that bond yields were rising, and that created a

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Speaker 1: lot of concerns that the bond market would push us

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Speaker 1: back into a recession. And I argued that the bond

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Speaker 1: market was probably turning into a bunch of bond vigilantes

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Speaker 1: who would, as you folks mentioned, would intervene if they

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Speaker 1: felt that the policymakers weren't doing right by keeping inflation down.

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Speaker 1: And I think there were three or four episodes in

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Speaker 1: the nineteen eighties where bond yields rose, and wouldn't you

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Speaker 1: know it, subsequently, nominal GDP growth slowed substantially, and then

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Speaker 1: bond yields came down. So I would say the heyday

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Speaker 1: of the bond vigilantes was that was actually the nineteen

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Speaker 1: eighties in the United States. Now, something I've always sort

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Speaker 1: of been a little bit unclear on with respect to

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Speaker 1: the term is the idea that people in the bond

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Speaker 1: market who are buyers of bonds or traders of bonds

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Speaker 1: somehow take on the role of the vigilante who enforces

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Speaker 1: justice on their own. Or is it more that bond

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Speaker 1: market or bond market participants, in the course of their

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Speaker 1: normal assessment of risks and trading and positioning their portfolios,

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Speaker 1: suddenly take a vigilante like role towards policy makers. So

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Speaker 1: is it a more active, conscious thought, I guess, or

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Speaker 1: is it more sort of descriptive of the relationship that

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Speaker 1: naturally emerges during times when a government is being punished

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Speaker 1: for policy mismanagement. Yeah, I think depends on the circumstances,

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Speaker 1: depends on the policy mistakes. If the policy mistakes are

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Speaker 1: blatantly obvious to everybody, or at least everybody in the

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Speaker 1: bond market, then the posty saddles up and starts pushing

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Speaker 1: bond yields high here and maybe higher than you would

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Speaker 1: think justified by today's fundamentals. But the bond ma jilanies

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Speaker 1: are concerned that the way the policy is going things

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Speaker 1: are going to get much worse than they have to

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Speaker 1: kind of jump in aggressively. But there's other times when

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Speaker 1: bond yields go up sort of the natural course of

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Speaker 1: things without necessarily implying that the bond markets kind of

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Speaker 1: taken over the streets. So I have a related question

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Speaker 1: about the time frame that we're looking at, because often

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Speaker 1: the trajectory of sovereign debt doesn't change on a day

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Speaker 1: to day basis. Just to be clear, you could have

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Speaker 1: news about a big policy change and then the bond

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Speaker 1: market reacts to it, But normally you get sort of

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Speaker 1: a gradual direction that you're heading in. So when we

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Speaker 1: see something like what happened with Italy, let's see in

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Speaker 1: late May, when suddenly the market seemed to wake up

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Speaker 1: to the realities of Italian indebtedness, what exactly is going

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Speaker 1: on there? How our bond markets actually reacting to the situation. Well, again,

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Speaker 1: this is consistent with our discussion that it depends on

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Speaker 1: the circumstances. There's no kind of unique definition of or

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Speaker 1: explanation for spotting the when the bond jilantes are actually

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Speaker 1: doing their thing. It's sometimes it's we know it on

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Speaker 1: a coincident or retrospective basis. But in the nies, the

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Speaker 1: bond vigilantes were concerned about the rebounding inflation and that

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Speaker 1: the FED wasn't being tough, enough was behind the curve

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Speaker 1: and they had to get ahead of the curve to

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Speaker 1: bring inflation down. In the case of Italy. Now, in

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Speaker 1: the case of Greece a few years ago, the issue

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Speaker 1: wasn't inflation making the comeback. The issue was much more serious,

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Speaker 1: which is a credit quality. It's one thing to own bonds,

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Speaker 1: and when inflation is going up, it's another thing to

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Speaker 1: own bonds that become worthless. And so I think in

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Speaker 1: the Italian situation, the bondageants were saying, no mass I

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Speaker 1: don't know how you say that in the tai the idea,

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Speaker 1: the ideas. You know, we're not going to accept an

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Speaker 1: Italian government that basically renexcent it's Euro obligations and and

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Speaker 1: is at risk of actually being downgraded by Moody's. Moodies threatened,

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Speaker 1: and I still I believe the threat is still on

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Speaker 1: that if the new Italian government behaves fiscally responsibly, Moody's

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Speaker 1: will sort of empower the bond vigilantis by downgrading the credit.

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Speaker 1: One thing that I find to be interesting about Italy

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Speaker 1: I was I traveled there in early during one of

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Speaker 1: their previous elections, and I imagine if you ask the

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Speaker 1: average American what the U S tenure yield is h yielding,

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Speaker 1: you would get a range of either numbers or just

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Speaker 1: completely blank stairs Like that's not something that many people

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Speaker 1: think about, but in Italy it's kind of like they're

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Speaker 1: dow Jones or S ANDP. Everybody knows what is the

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Speaker 1: term low spread is in the news and politicians talk

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Speaker 1: about it. Everyone's acutely aware are of the spread of

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Speaker 1: Italian bond yields to German bond yields, and so it

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Speaker 1: really does have that effect of policy makers conscious of

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Speaker 1: the spread and wanting to bring it down for domestic

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Speaker 1: political reasons, because you know, prior to the monetary unification

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Speaker 1: the introduction of the of the euros to the Eurozone,

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Speaker 1: spreads between Italy and Spain on the one hand, and Germany,

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Speaker 1: France Netherlands on the other hand, was actually quite wide.

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Speaker 1: In other words, Italy and Spain were viewed as relatively

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Speaker 1: risky compared to the German yields. Then the euro was introduced,

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Speaker 1: and lo and behold, everybody came to the conclusion that

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Speaker 1: European bonds were all the same, that Italian, Spanish, Greek, Irish,

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Speaker 1: Portuguese bonds, that they all should have the same low

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Speaker 1: yield as Germany. And then obviously there was a route

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Speaker 1: awakening in two thousand ten eleven twelve with Greece and

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Speaker 1: now once again with that with Italy. That there is

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Speaker 1: credit risk, and the risk is that you'll have a

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Speaker 1: gregit or I don't know, has there anybody coup with

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Speaker 1: that it'll leave what it it'll leave, it'll leave. I

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Speaker 1: like that one. I knew there's something out there, So

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Speaker 1: that raises credit risk issues. So let me segue to

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Speaker 1: something else that's happening in Europe or um on the

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Speaker 1: edges of Europe, depending on where you stand politically. But

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Speaker 1: over in Turkey we've also seen some financial drama where

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Speaker 1: President Urdawan is basically exerting influence on the central bank

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Speaker 1: and trying to prevent them from hiking interest rates at

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Speaker 1: a time when arguably there is a lot of inflation

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Speaker 1: and they should be hiking interest rates. So if you

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Speaker 1: were to ask Urdawan about bond vigilantes, I'm sure he

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Speaker 1: would probably um shake away any of their concerns and

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Speaker 1: say that the bond market isn't the right entity to

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Speaker 1: be exerting political influence over fiscal decisions. So I'm just

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Speaker 1: curious do you think the bond market should be influencing

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Speaker 1: political or fiscal decisions. Well, you know, I I tell

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Speaker 1: people I'm not a preacher. I don't do good or bad.

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Speaker 1: I do bulish or parish, and you know, I deal

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Speaker 1: with the facts on the ground. And the facts on

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Speaker 1: the ground are that Turkey has dependent on capital inflows

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Speaker 1: from abroad, and that's partly because their yields have been

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Speaker 1: higher because there there's seemed to be a credit risk,

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Speaker 1: But they weren't terribly higher. The Turkey was getting some

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Speaker 1: pretty good rates until Urduan decided that he didn't like

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Speaker 1: an independent central bank. Now, look, the bond vigilante is

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Speaker 1: always sort of have an issue with the central banks,

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Speaker 1: but it gets to be much much worse in terms

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Speaker 1: of their reaction if the central bank is deemed to

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Speaker 1: not be independent, to be latently politically driven. So what

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Speaker 1: we're seeing here is kind of global bond vigilanty. It's

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Speaker 1: certainly not locals in Turkey that have pushed their interest

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Speaker 1: rates up in their currency into the ABYSS. That's been

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Speaker 1: foreigners who have been looking for good opportunities. I thought

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Speaker 1: that Turkey was relatively stable and that their fiscal monetary

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Speaker 1: policies were you know, relatively acceptable and then when they

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Speaker 1: turned unacceptable, they left. So this is an example of

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Speaker 1: the policies saddling up and leaving the country, which is

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Speaker 1: what happened in Turkey and as a result, rates spiked

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Speaker 1: up dramatically um and the currency took a dive. And

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Speaker 1: you talk about how the bond vigilantes saddle up in

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Speaker 1: sort of random times throughout history. So there are a

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Speaker 1: few episodes in the U S and the eighties related

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Speaker 1: to anxiety over inflation, and now of course Greece and Italy.

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Speaker 1: And one of the things that we know about markets

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Speaker 1: and extreme market moves, markets are complex systems and we

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Speaker 1: never really know what catalyzes any extreme moves. We could

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Speaker 1: try to pinpoint something. We're like, oh, you know, maybe

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Speaker 1: there was some data release or some comment that are

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Speaker 1: delan made, or something that a politician in Italy said,

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Speaker 1: but we know that these are at best just approximations,

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Speaker 1: and it's very hard to really talk about why a

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Speaker 1: market shifts from one regime of potential complacency to another

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Speaker 1: regime of uh, sort of the market playing disciplining force.

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Speaker 1: In your work looking at the bond market, do you

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Speaker 1: have any insight into what it is that sort of

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Speaker 1: how the how the posse all sort of coordinates and

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Speaker 1: gathers up or settles up and shifts from one mode

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Speaker 1: into the other. In the world, we live in information

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Speaker 1: flows the speed of light. We all get the same

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Speaker 1: information of what an important posce of makers saying in

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Speaker 1: Turkey or a new potential government what their leaders are saying,

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Speaker 1: So we all have that information at the same time,

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Speaker 1: and over the years, the bond market just kind of

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Speaker 1: forgotten the rules of the game, which is the bond

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Speaker 1: market first and foremost wants to make sure that inflation

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Speaker 1: remains down. But maybe I shouldn't say first and foremost,

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Speaker 1: because just as important, and actually much more important, is

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Speaker 1: making sure that you get your money back. And so

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Speaker 1: it's both the the inflation rate and the credit risk.

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Speaker 1: And very often what happens is the bond market gets

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Speaker 1: its way. The policymakers here the message being sent by

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Speaker 1: the bomb Julians, or they put up their hands and

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Speaker 1: they say, all right, we'll give you what you want.

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Speaker 1: That was sort of Carvills quote that you mentioned, basically

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Speaker 1: fising Clinton to make sure you satisfy the bond market.

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Speaker 1: Then everything else will fall into place. So I'm going

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Speaker 1: to shift into a different regime now to try to

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Speaker 1: draw a connection between what we've seen happening in bonds,

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Speaker 1: specifically in the US with the recent rise and rates,

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Speaker 1: and what's been happening in the equity market and here

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Speaker 1: as well. And you have been very influential because you

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Speaker 1: actually came up with a model that's well known in

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Speaker 1: the investment world now, or at least you put a

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Speaker 1: name on the model. It's called the FED model. Could

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Speaker 1: you possibly walk us through how this works? The term

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Speaker 1: I I gave it was the FED Stock Valuation Model,

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Speaker 1: and back in n it was the summer nine the

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Speaker 1: FED released its Monetary Policy Report. I don't think anybody

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Speaker 1: ever reads that report, but I I skimmed it and

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Speaker 1: saw that the FED actually was trying to come up

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Speaker 1: with some way to uh determine whether stocks were overvalued

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Speaker 1: or undervalued. You will recall it was in the green

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Speaker 1: Span Fed German green Span gave his famous speech wondering

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Speaker 1: out loud, He asked the question, how do we know

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Speaker 1: whether stocks are fairly valued? Overvalued or undervalued? And his

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Speaker 1: staff must have scrambled us try to help the boss

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Speaker 1: figure out the answer to that question. Then they came

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Speaker 1: up with a model that actually been around for a while,

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Speaker 1: just hadn't been given as much attention to prior to

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Speaker 1: them mentioning in the Monetary Policy Report. Then my pointing

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Speaker 1: it out, and uh, I think kind of took a

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Speaker 1: life of its own. But the basic idea is that

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Speaker 1: the stock market must be influenced by interest rates. Uh.

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Speaker 1: It certainly is influenced by short term rates in terms

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Speaker 1: of the business cycle, but in terms of long term rates,

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Speaker 1: they are an alternative to the stocks. The difference between

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Speaker 1: bonds and stocks is if you buy a bond and

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Speaker 1: hold the maturity, you'll you'll you'll learn the coupon, and

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Speaker 1: depending on whether inflation is or isn't a problem, you

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Speaker 1: give some of it back and maybe purchasing power stocks

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Speaker 1: on the other hand, I give you a yield based

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Speaker 1: on their dividends, but they also have a lot more

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Speaker 1: upside if things work out pretty well, and then of

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Speaker 1: course they have downside if they don't. So and what

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Speaker 1: the Fed did is uh. They showed a chart of

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Speaker 1: the ten year U S. Treasury bond yield, and then

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Speaker 1: on the same chart they showed the SMP five hundred

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Speaker 1: forward earnings yield, and as Joe mentioned, that's just the

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Speaker 1: flip side of the pe. Instead of price divided by earnings,

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Speaker 1: take earnings divided by price, and so it's the earnings

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Speaker 1: yield of the snp FI currently. Well, let's say it

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Speaker 1: may the earnings yield was six for the SMP five

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Speaker 1: D and the body yield is more like three. That

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Speaker 1: implies that stocks are undervalued. The problem with this model

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Speaker 1: has just been arguing that the stocks are undervalued ever

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Speaker 1: since two thousand and one two and two, which on

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Speaker 1: balanced really wasn't a bad call. I mean, look how

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Speaker 1: much higher we are now than we were back then,

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Speaker 1: but it certainly did not anticipate the two thousand seven,

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Speaker 1: two thousand and eight mega bear market. You gotta use

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Speaker 1: it with some caution that then others. The model really

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Speaker 1: worked very well prior to when the FED discovered it,

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Speaker 1: they covered it worked like a charm, and then it

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Speaker 1: worked for another couple of years. Told you to get

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Speaker 1: out in two two thousand one, and then it wasn't

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Speaker 1: really a much use since then. Yeah, So this sort

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Speaker 1: of gets to where I was going, which is that

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Speaker 1: there is an intuitive appeal to the model, which is

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Speaker 1: that you have this risk free asset class that tells

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Speaker 1: you up front how much you're gonna get paid, and

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Speaker 1: you can discount that future stream of cash flow is

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Speaker 1: a very predictable way. And then you have this risky

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Speaker 1: asset class and you don't really know much, but you

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Speaker 1: can sort of see how it compares or what it's

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Speaker 1: offering versus the risk free rate. But as you said,

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Speaker 1: and as many as others have pointed out in finance,

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Speaker 1: it's the only problem with it is that it often

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Speaker 1: doesn't work and you can't really use it to time

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Speaker 1: the market. So how should an investor incorporated into their

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Speaker 1: practice if it sort of often fails at timing the market?

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Speaker 1: How glad you asked that question, because I've been very

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Speaker 1: often in my career, and I've been used for forty years.

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Speaker 1: And by the way, I gotta plug my book and

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Speaker 1: wrote a book called Predicting the Markets, and I do

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Speaker 1: discuss this model in great detail. But I think one

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Speaker 1: of the things I've learned over the years is that

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Speaker 1: the bondary lanes aren't the only players in the bond market.

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Speaker 1: There's also central banks, and one of the reasons that

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Speaker 1: the bond yields have stayed so low is because the

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Speaker 1: central banks, specially since two thousand and eight, have kept

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Speaker 1: them extremely low. And the other factor is inflation. And

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Speaker 1: I think there's been some very powerful structural secular forces

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Speaker 1: that have been keeping inflation down. And the number one

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Speaker 1: preoccupation of the bondary jiantes is inflation. In the United States,

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Speaker 1: they don't worry quite as much about the credit quality

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Speaker 1: of government bonds. So far, so good, I should say.

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Speaker 1: But here's here's what I've come up with, and that

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Speaker 1: is that the stock valuation model. In some ways, it's

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Speaker 1: sort of it's misleading because that term doesn't really say

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Speaker 1: what it is. It's it's the stocks versus bonds valuation model.

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Speaker 1: And it may very well be that it isn't that

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Speaker 1: stocks are grossly undervalued. It maybe that the bonds are

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Speaker 1: grossly overvalued and the yielder has been kept too low

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Speaker 1: by the central banks, and now that they're normalizing, we

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Speaker 1: should see a more normal relationship in this model. But

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Speaker 1: I really think the model actually still is useful, not

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Speaker 1: as a stocks versus bonds asset allocation model. I think

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Speaker 1: industri should view it in more as a corporate finance model.

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Speaker 1: I found that we can relate the buy back activities

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Speaker 1: that we're seeing in the SPI companies to the spread

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Speaker 1: between the forward earnings yield, again the inverse of the

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Speaker 1: pe and the cost of borrowing in the corporate bond market.

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Speaker 1: And I on an after tax basis, and right now

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Speaker 1: I reckon on an after tax basis, corporations can borrow

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Speaker 1: money like maybe for four on average, you know, good

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Speaker 1: and bad quality averaging them together. And the fow journeys

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Speaker 1: field is a six percent, So you almost have a

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Speaker 1: fiduciare responsibility if you're running a corporation to borrow that

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Speaker 1: cheap money and buy back your stocks. And so I

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Speaker 1: really think that I've sort of savaged the stock valuation

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Speaker 1: model by pointing out that it actually has worked. But

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Speaker 1: that is a bonds or stock model rather as a

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Speaker 1: buy back model, and buy backs have been driving this bullmarket.

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Speaker 1: Two things there. It's a really interesting point. Does that

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Speaker 1: mean that the major risks to equities now are that

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Speaker 1: the buy backs actually stop, as a lot of people

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Speaker 1: have been concerned that they might end. Secondly, is the

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Speaker 1: major risk also a derivative of what might happen two

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Speaker 1: bonds if we start to see inflation come back, or

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Speaker 1: if central banks start to wind down their extraordinary stimulus. Yeah,

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Speaker 1: I mean, I think you gotta right right right on

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Speaker 1: the money. And that is since buy backs have been

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Speaker 1: the major reason why we've have had this bull market.

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Speaker 1: You remember back two, a lot of the bears were saying,

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Speaker 1: it's all sugar high, it's being driven on fumes. They

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Speaker 1: couldn't see who the heck was buying. It wasn't institution,

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Speaker 1: it was in retail. And I was saying, wait a second,

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Speaker 1: there's another buy here that's being ignored, and that's the

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Speaker 1: corporations buying back their own shares. And it's been trillions

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Speaker 1: of dollars of buy backs. Now I'm terribly worried anytime

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Speaker 1: soon that that's going to stop because we've got a

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Speaker 1: bunch of money coming from repatriated earnings as a result

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Speaker 1: of the tax law change at the end of the

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Speaker 1: last year, and I think a lot of that money

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Speaker 1: is going to continue to go into two buy backs.

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Speaker 1: And the bond yield even though it's come up, but

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Speaker 1: it's still below the forward earnings yield the S ANDP,

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Speaker 1: so there still could be some borrowing in the bond

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Speaker 1: market for buy backs. But as a general statement, if

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Speaker 1: something happens that for some reason stops the buy backs,

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Speaker 1: then it's hard to see how this market keeps going higher.

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Speaker 1: It's not too hard to see how might go uh lower.

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Speaker 1: Now that perhaps the the biggest risk out there, more

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Speaker 1: than the buybacks, is that inflation makes her comeback. We've

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Speaker 1: all gotten pretty lulled in thinking that inflations tame the

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Speaker 1: people looking forward every single day. I'm looking at for

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Speaker 1: it for a single day now because I expected to

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Speaker 1: come back, because I've taken a professional forecasting position that

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Speaker 1: inflation is dead. So you know, um, if it ever

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Speaker 1: comes back, I'm gonna look pretty silly. So I will

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Speaker 1: change change along the way. I try to be flexible

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Speaker 1: and open minded about these things. But yeah, I mean,

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Speaker 1: if inflation makes a comeback, all bets are off, then

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Speaker 1: you get higher bond yields, maybe dramatically higher body yields.

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Speaker 1: Then the FED models suddenly would come into play in

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Speaker 1: a vicious way, showing that the spike and bond yields

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Speaker 1: is fatal for the bullmarket. So reapplying your sort of

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Speaker 1: altered FED model of forward earning field versus corporate borrowing costs.

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Speaker 1: Thinking back to this approach in the pre crisis period

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Speaker 1: to thousands six two thousand seven. I'm curious a whether

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Speaker 1: that would have been a more useful signal than the

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Speaker 1: sort of pure earnings yield verse tenure rate, and b

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Speaker 1: how much is the problem still that you know, forward

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Speaker 1: earnings yield is just a guess and very few people

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Speaker 1: would have really predicted that earnings would have were about

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Speaker 1: to drop off a cliff during the Great Financial Crisis.

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Speaker 1: My bottom line on what causes bear markets is bear

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Speaker 1: markets are caused by recessions. And as you know, economists,

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Speaker 1: there have been that many recessions and get economists keep

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Speaker 1: missing them in because they are don't happen that often.

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Speaker 1: But I think I don't really know if any model

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Speaker 1: that you know really timed it perfectly to get out

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Speaker 1: in two thousand and seven two thou and eight. I

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00:25:47,040 --> 00:25:51,240
Speaker 1: know there's the Chill or Cape model, there's the buffet

434
00:25:52,280 --> 00:25:55,560
Speaker 1: stock market evaluation to the GDP model that they were

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00:25:55,600 --> 00:25:59,000
Speaker 1: all signaling that stocks were very expensive, and they did

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00:25:59,000 --> 00:26:04,679
Speaker 1: the same thing in in two thousand and so I

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00:26:04,720 --> 00:26:08,560
Speaker 1: would say that there are there are alternative valuation models

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00:26:08,560 --> 00:26:11,200
Speaker 1: that have been more useful with the benefit of hindsight.

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00:26:11,920 --> 00:26:15,080
Speaker 1: The problem with a lot of those models is especially

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00:26:15,080 --> 00:26:17,840
Speaker 1: the Keepe model, the the Schiller model is it looks

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00:26:17,880 --> 00:26:20,680
Speaker 1: at earnings over the past ten years, and so it's

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00:26:20,680 --> 00:26:25,200
Speaker 1: always going to be more bearish than evaluation metrics that's

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00:26:25,240 --> 00:26:28,639
Speaker 1: looking forward, which is the said model, or just a

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00:26:29,119 --> 00:26:32,400
Speaker 1: straightforward forward pe. So I think you want to look

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00:26:32,400 --> 00:26:35,080
Speaker 1: at evaluation models. You want to look at all of them.

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00:26:35,160 --> 00:26:38,000
Speaker 1: You want to decide for yourself whether you think the

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00:26:38,119 --> 00:26:41,960
Speaker 1: stucts are a little price and that there's potential downside.

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00:26:42,440 --> 00:26:44,800
Speaker 1: But what you really got to get right is the

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00:26:44,840 --> 00:26:49,520
Speaker 1: next recession. If right now SMP forward p s around

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00:26:49,880 --> 00:26:53,879
Speaker 1: sixteen sixteen and a half, that's not cheap. It's not

451
00:26:54,280 --> 00:26:57,040
Speaker 1: terribly expensive either. But if there's not going to be

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00:26:57,080 --> 00:27:00,480
Speaker 1: a recession for the next several years, then you could

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00:27:00,520 --> 00:27:02,879
Speaker 1: go up. If there's a recession right around the corner,

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00:27:02,920 --> 00:27:05,000
Speaker 1: you don't want to be in stocks. I think the

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00:27:05,040 --> 00:27:07,959
Speaker 1: expenision is gonna last a while longer, and so I'm

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00:27:08,040 --> 00:27:12,720
Speaker 1: terribly concerned that evaluations are to extend it. All Right, Well,

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00:27:13,119 --> 00:27:16,760
Speaker 1: that has been an absolutely fascinating conversation and it's such

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00:27:16,800 --> 00:27:19,960
Speaker 1: a pleasure to have the inventor of the bond vigilantes

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00:27:20,080 --> 00:27:22,800
Speaker 1: term actually on the podcast. To discuss it, so thank

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00:27:22,840 --> 00:27:38,680
Speaker 1: you so much too, So Joe, I love that conversation

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00:27:38,800 --> 00:27:42,840
Speaker 1: because partly because we managed to cover so much ground

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00:27:42,920 --> 00:27:45,680
Speaker 1: and we really kind of thread the needle between US

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00:27:45,760 --> 00:27:49,320
Speaker 1: bond vigilantes, what's happening in Europe, not just Italy and Turkey,

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00:27:50,160 --> 00:27:53,520
Speaker 1: but also what's happening with US equities so and all

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00:27:53,640 --> 00:27:57,440
Speaker 1: round general topics of thoughts podcast. I would say, yeah,

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00:27:57,520 --> 00:28:00,320
Speaker 1: it was really good and very timely, because, as you know,

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00:28:00,720 --> 00:28:04,160
Speaker 1: that term bond vigilante is controversial and some people think

468
00:28:04,640 --> 00:28:07,080
Speaker 1: it's kind of a myth. But I think Italy is

469
00:28:07,119 --> 00:28:11,000
Speaker 1: a very crisp example where you see the market reaction

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00:28:11,160 --> 00:28:15,879
Speaker 1: in the bond market immediately applying pressure to politicians and

471
00:28:15,920 --> 00:28:19,560
Speaker 1: they look to that number and feel like, okay, we're

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00:28:19,600 --> 00:28:23,119
Speaker 1: getting a rejection from this crucial market, and to some

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00:28:23,240 --> 00:28:26,600
Speaker 1: extent that forces them to consider reversing course. So the

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00:28:27,040 --> 00:28:30,320
Speaker 1: metaphor works very nicely in this context. I think, yeah,

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00:28:30,320 --> 00:28:32,560
Speaker 1: and I love that anecdote you have of your visit

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00:28:32,600 --> 00:28:35,520
Speaker 1: to Italy where everyone on the street is talking about

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00:28:35,720 --> 00:28:39,360
Speaker 1: the two year Italian bondial a t I can't remember

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00:28:39,640 --> 00:28:43,560
Speaker 1: either one. I think let's spread, yeah, let's spread um

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00:28:43,640 --> 00:28:47,000
Speaker 1: that's fantastic. So the other really interesting part of that conversation,

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00:28:47,040 --> 00:28:50,000
Speaker 1: of course, is the FED model, and you've actually seen

481
00:28:50,040 --> 00:28:53,600
Speaker 1: it making a little bit of a comeback given the

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00:28:53,640 --> 00:28:57,080
Speaker 1: concerns over the rise in US rates, so that's interesting

483
00:28:57,080 --> 00:29:00,040
Speaker 1: as well. Yeah, and again this is another one of

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00:29:00,120 --> 00:29:04,280
Speaker 1: these controversial things where some people say, no, it's not useful,

485
00:29:04,320 --> 00:29:06,920
Speaker 1: you can't really do anything with it. Others say it's

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00:29:06,960 --> 00:29:10,600
Speaker 1: important for understanding some level of the stock markets richness

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00:29:10,680 --> 00:29:13,560
Speaker 1: or cheapness. But I really liked that last point he

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00:29:13,600 --> 00:29:16,080
Speaker 1: made a lot, which is that look, in the end,

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00:29:16,200 --> 00:29:20,360
Speaker 1: what causes bear markets is economic downturns. So no matter

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00:29:20,760 --> 00:29:27,080
Speaker 1: how great your valuation model is, there's no shortcut for

491
00:29:27,480 --> 00:29:29,280
Speaker 1: trying to have a view on what's going to happen

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00:29:29,320 --> 00:29:32,040
Speaker 1: in the future. If you wanted time the market and

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00:29:32,160 --> 00:29:35,440
Speaker 1: you don't have some ability to look ahead a little

494
00:29:35,480 --> 00:29:38,640
Speaker 1: bit in terms of what's going to happen in the economy,

495
00:29:39,000 --> 00:29:41,920
Speaker 1: no matter what your valuation model is, you're probably not

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00:29:41,960 --> 00:29:44,560
Speaker 1: going to do very well. Right, Although I have an

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00:29:44,560 --> 00:29:48,040
Speaker 1: opposing pet theory, which is that if you consider that

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00:29:48,160 --> 00:29:51,000
Speaker 1: the recovery that we've seen since the two thousand eight

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00:29:51,000 --> 00:29:56,480
Speaker 1: crisis took place mostly in financial markets. Then maybe it

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00:29:56,520 --> 00:29:59,600
Speaker 1: makes sense to think that whatever recession is coming up

501
00:29:59,720 --> 00:30:03,280
Speaker 1: is going to be sparked by financial market turmoil as well.

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00:30:03,320 --> 00:30:07,000
Speaker 1: But that's sort of controversial, so I'll stop there. Tracy,

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00:30:07,040 --> 00:30:08,960
Speaker 1: do you want to be a guest on a future

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00:30:09,680 --> 00:30:13,200
Speaker 1: episode and and I can interview you about your theory

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00:30:13,280 --> 00:30:16,720
Speaker 1: of financial markets in the real economy. You're inviting me

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00:30:16,800 --> 00:30:19,920
Speaker 1: to be a guest on my own podcast. Thank you, Joe.

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00:30:20,200 --> 00:30:24,560
Speaker 1: Thanks Joe, No, I won't, but um, it's an interesting discussion.

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Speaker 1: I enjoy discussing it with you. Now, Joe, that's enough

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Speaker 1: for me. Okay, okay. This has been another edition of

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Speaker 1: the Odd Thoughts podcast. I'm Tracy Alloway. You can follow

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00:30:35,160 --> 00:30:38,640
Speaker 1: me on Twitter at Tracy Alloway and I'm Joe Wisn't All.

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00:30:38,760 --> 00:30:41,720
Speaker 1: You can follow me on Twitter at the Stalwart and

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00:30:41,920 --> 00:30:45,400
Speaker 1: you should follow our producer tofor Foreheads on Twitter at

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00:30:45,480 --> 00:30:49,440
Speaker 1: foreheads t, as well as the Bloomberg head of podcast,

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00:30:49,480 --> 00:31:00,920
Speaker 1: Francesca Levie at Francesca Today. Thanks for listening to