WEBVTT - The Big Macro Force That's Been Driving Stocks Higher for Years 0:00:02.720 --> 0:00:14.000 Bloomberg Audio Studios, Podcasts, Radio News. 0:00:18.040 --> 0:00:21.080 Hello and welcome to another episode of the Odd Lots podcast. 0:00:21.120 --> 0:00:23.320 I'm Joe Wisenthal and I'm Tracy Alloway. 0:00:23.560 --> 0:00:25.640 So, Tracy, one of the things that we've been talking 0:00:25.640 --> 0:00:28.280 about a fair amount everyone's talk about it, I guess, 0:00:28.400 --> 0:00:32.160 is how the biggest most profitable companies in America. They're 0:00:32.200 --> 0:00:35.040 still really big and they're still really profitable, but they've 0:00:35.080 --> 0:00:38.400 switched from being throwing off tons of free cash flow 0:00:38.640 --> 0:00:40.800 to big investors spending a lot of money. 0:00:40.920 --> 0:00:41.560 Yeah, that's right. 0:00:41.760 --> 0:00:44.360 So we've had years and years and years of big 0:00:44.440 --> 0:00:48.840 tech basically I guess, generating infinite Yeah, once of cash, 0:00:48.880 --> 0:00:53.000 it feels like, and now they're switching to actually spending 0:00:53.040 --> 0:00:56.640 some of that cash to build very expensive data centers 0:00:56.720 --> 0:00:58.600 and things like that. And you're right, it is kind 0:00:58.640 --> 0:01:00.600 of a change for the market. Yeah, right, Like, we 0:01:00.720 --> 0:01:05.160 haven't seen that scale of investment for a very long time, 0:01:05.240 --> 0:01:08.520 certainly not I don't think in our lifetimes have we I. 0:01:08.480 --> 0:01:10.480 Don't know, No, it doesn't feel like it. 0:01:10.520 --> 0:01:13.720 I mean, you know, I guess maybe we'll get into 0:01:13.720 --> 0:01:15.920 this in the conversation. You know, I think if you 0:01:16.200 --> 0:01:19.560 go back to like PREGFC era when a lot of 0:01:19.600 --> 0:01:22.080 the really big companies in the index were like, you know, 0:01:22.120 --> 0:01:24.360 Exon was the biggest company in the for a long time, 0:01:24.480 --> 0:01:26.720 so they would have always been having to like spend 0:01:26.760 --> 0:01:29.600 because you can't just sort of like passively collect oil, 0:01:29.600 --> 0:01:33.080 et cetera. But it does seem generally true that the 0:01:33.120 --> 0:01:37.240 big theme, both with financials and tech is this incredible 0:01:37.280 --> 0:01:41.280 ability to generate huge returns with fairly modest capital outlays, 0:01:41.319 --> 0:01:44.600 whether we're talking about equipment, plants, or even human labor. 0:01:44.800 --> 0:01:46.759 Well, the other big switch is just you know, if 0:01:46.800 --> 0:01:49.880 you look at it, just at the tech sector basically, 0:01:49.920 --> 0:01:52.200 which has been you know, the dominant force in our 0:01:52.360 --> 0:01:55.320 equity markets for a while now. But for much of 0:01:55.360 --> 0:01:58.400 the two thousands, the investment was in sort of like 0:01:58.600 --> 0:02:03.440 intangible you know, sas type stuff, and now we're switching 0:02:03.480 --> 0:02:06.240 to really like brick and mortar. They're paying to build 0:02:06.440 --> 0:02:10.160 energy capacity, and they're paying for actual chips and actual 0:02:10.200 --> 0:02:13.480 buildings to house a bunch of air conditioners and servers 0:02:13.520 --> 0:02:14.079 and all of that. 0:02:14.639 --> 0:02:17.400 No, it's totally true. This is the big theme, right, 0:02:17.639 --> 0:02:18.040 is just this. 0:02:18.160 --> 0:02:19.679 So the question is like, Okay, they're still make a 0:02:19.800 --> 0:02:22.520 ton of money, They're still very profitable, and maybe these 0:02:22.760 --> 0:02:24.840 these investments will pay off in a massive way at 0:02:24.840 --> 0:02:28.480 some point down the future. But can investors expect the 0:02:28.520 --> 0:02:31.240 same level of returns that they've seen in the past 0:02:31.560 --> 0:02:34.600 if there's this big switch in terms of strategic decision 0:02:34.639 --> 0:02:37.720 making in terms of capital outlays and so forth, taking 0:02:37.720 --> 0:02:40.360 on debt, what does this mean for the markets? What 0:02:40.360 --> 0:02:43.080 does this mean for investors? And I don't know the answer, 0:02:43.120 --> 0:02:44.040 but maybe our guest. 0:02:44.320 --> 0:02:46.720 Well also, I mean you and I. I think for 0:02:46.760 --> 0:02:48.680 the past twenty years, we have all gotten very used 0:02:48.760 --> 0:02:52.840 to everyone saying that the tech sectors overvalued, right, even 0:02:52.880 --> 0:02:56.760 as it throws off infinite amounts of cash. Everyone is like, ah, 0:02:56.880 --> 0:02:59.200 so overvalue, the market's at the top, the markets at 0:02:59.200 --> 0:03:01.320 the top. That has been the case for pretty much 0:03:01.400 --> 0:03:04.919 like my entire mature investing age lifetime. 0:03:05.400 --> 0:03:07.560 Right, And so you bring up a really another important 0:03:07.600 --> 0:03:12.160 dimension of this, which is just that valuations by traditional metrics. 0:03:12.200 --> 0:03:14.800 I mean, I remember, you know, early on. 0:03:14.680 --> 0:03:16.880 What was the Schiller the Schiller. 0:03:16.720 --> 0:03:19.000 Cape ratio, and there's like, no, it's like this has 0:03:19.000 --> 0:03:21.040 got a mean revert and this is we're at the 0:03:21.120 --> 0:03:24.760 ninety eighth percentile of historical valuations, and it keeps going up. 0:03:24.720 --> 0:03:27.320 And so mean reversion is always around the corner. 0:03:27.440 --> 0:03:29.560 Joe, it's it's it's always, it's always. 0:03:30.200 --> 0:03:32.079 But no, this is another question. Why didn't it mean 0:03:32.120 --> 0:03:32.600 revert right? 0:03:32.639 --> 0:03:36.080 And why have just the multiples that we've seen on 0:03:36.200 --> 0:03:39.000 traditional price to earnings ratios. You look at them, they 0:03:39.000 --> 0:03:40.960 make it go crazy, and they got to come down. 0:03:41.920 --> 0:03:43.240 Why haven't they right? 0:03:43.280 --> 0:03:46.080 That's also an interesting question that we need to get 0:03:46.080 --> 0:03:48.880 answers to, even beyond the specific capital question. 0:03:48.960 --> 0:03:49.920 Yeah, let's do it all right. 0:03:49.920 --> 0:03:51.840 Well, I'm very excited to say we do have the 0:03:51.840 --> 0:03:54.560 perfect guest today because we are speaking to someone who's 0:03:54.560 --> 0:03:57.400 really done a lot of research on some of these 0:03:57.600 --> 0:04:01.680 exact questions, including he published a paper co authored a 0:04:01.720 --> 0:04:04.040 recent paper that really caught my eye back in January 0:04:04.040 --> 0:04:09.360 called a Macroeconomic Perspective on Stock Market Valuation Ratios. So 0:04:09.400 --> 0:04:12.080 it's good data. You brought up the earnings metrics. We're 0:04:12.120 --> 0:04:14.000 going to be speaking with Jonathan Heathcote, one of the 0:04:14.000 --> 0:04:16.159 co authors of this paper. He's an economist at the 0:04:16.200 --> 0:04:19.400 Minneapolis Fed. We're going to talk all about this. So, Jonathan, 0:04:19.400 --> 0:04:20.520 thank you so much for coming on. 0:04:20.560 --> 0:04:23.080 Odd lots, thanks a lot for having me yeah, I 0:04:23.120 --> 0:04:25.039 should just say right at the side, I'm I should 0:04:25.080 --> 0:04:28.000 give a disclaim. I'm an economist at the Federalists of 0:04:28.000 --> 0:04:30.919 Bank of Minneapolis, and anything I say is going to 0:04:30.920 --> 0:04:32.920 be my views, not those the Federalist of Bank of 0:04:32.920 --> 0:04:34.599 Minneapolis or the Federalists of system. 0:04:35.320 --> 0:04:37.440 Thank you for getting the disclaimer out of the way. 0:04:37.480 --> 0:04:39.920 We are very used to hearing that from FED researchers 0:04:39.960 --> 0:04:42.480 and economists. So the title of the paper, I think 0:04:42.520 --> 0:04:45.719 Joe already said it, a macroeconomic perspective on stock market 0:04:45.839 --> 0:04:48.920 valuation ratios. Why did you decide to look at this 0:04:48.960 --> 0:04:51.880 particular topic at this particular moment in time too? 0:04:52.960 --> 0:04:55.720 Yeah, so, actually we started out before we worked on this, 0:04:55.800 --> 0:04:57.800 we were working on a paper on the US net 0:04:57.839 --> 0:05:01.479 fign asset position and I noticed that, you know, the 0:05:01.520 --> 0:05:04.080 value of US assets minus AUR liabilities that had been 0:05:04.120 --> 0:05:08.960 declining really fast over the last ten years, and historically 0:05:08.960 --> 0:05:10.760 people had mostly thought about that in terms of the 0:05:10.839 --> 0:05:13.320 US running big current account deficits running up a bigger 0:05:13.320 --> 0:05:16.359 and bigger debt with the rest of the world. And 0:05:16.400 --> 0:05:19.480 we realized that the kind of international gross asset positions 0:05:19.480 --> 0:05:21.280 had gotten really big and a lot of the decline 0:05:21.279 --> 0:05:23.200 in the net foreign asset position was driven by the 0:05:23.240 --> 0:05:26.080 fact that foreigners had invested a lot in US equity 0:05:26.080 --> 0:05:28.679 markets and a lot of foreign direct investment into the US, 0:05:29.400 --> 0:05:31.960 and when the US markets were booming much more so 0:05:32.000 --> 0:05:33.680 than the rest of the world, that was driving up 0:05:33.680 --> 0:05:36.120 the value of these foreign investments in the US, and 0:05:36.120 --> 0:05:38.760 that was driving down the US net foreign asset position. 0:05:39.200 --> 0:05:41.480 And so after that we kind of became more interested 0:05:41.520 --> 0:05:45.280 in trying to understand what's driving valuations more generally. I mean, 0:05:45.279 --> 0:05:47.480 our background's not really we're not really in finance. We're 0:05:47.520 --> 0:05:49.680 sort of more macroeconomists. But we've been working on this 0:05:49.720 --> 0:05:52.279 for a few years now and that's where this paper started. 0:05:52.560 --> 0:05:55.440 This seems like, just from a sort of theoretical big 0:05:55.480 --> 0:06:00.800 picture perspective, this link between sort of macro economics and 0:06:00.839 --> 0:06:03.040 stock markets, and it doesn't feel like all of these 0:06:03.080 --> 0:06:06.000 are worlds that talk past each other, and the macro 0:06:06.040 --> 0:06:08.720 people aren't talking about stock market valuations that much, and 0:06:08.839 --> 0:06:11.200 stock market people they think they don't even have to 0:06:11.200 --> 0:06:14.320 care about macroeconomics in many cases. But this strikes me 0:06:14.360 --> 0:06:16.800 as interesting, how like novel is this or talk to 0:06:16.880 --> 0:06:19.240 us about this attempt to bridge the gap between the 0:06:19.279 --> 0:06:19.960 two worlds here. 0:06:20.400 --> 0:06:23.800 Yeah, I think there's a lot of strong connections. And 0:06:23.839 --> 0:06:27.279 we've talken about the same things in a slightly different frame. 0:06:27.360 --> 0:06:29.719 So one thing macroeconomists have been talking about for a 0:06:29.720 --> 0:06:32.679 long time, for example, is the fact that it looks 0:06:32.720 --> 0:06:35.840 like labor share of output is being drifting down over time, 0:06:35.960 --> 0:06:37.960 So a larger share of the piece seems to be 0:06:38.000 --> 0:06:40.400 going to owners of firms and a smaller share as 0:06:41.120 --> 0:06:44.800 wages to workers. And obviously that ties directly into thinking 0:06:44.800 --> 0:06:48.000 about valuations. If they're firms making bigger profits, that's going 0:06:48.040 --> 0:06:50.440 to drive up valuations. So I think there's a lot 0:06:50.440 --> 0:06:54.320 of connections. I think for a long time historically there 0:06:54.360 --> 0:06:56.600 was a sense that it was kind of really hard 0:06:56.640 --> 0:07:00.320 to understand valuations. They were driven by wild, various in 0:07:00.400 --> 0:07:02.880 risk premia that had not much to do with kind 0:07:02.880 --> 0:07:05.680 of standards, slow moving macro stuff, and so you know, 0:07:05.720 --> 0:07:08.880 there were two separate, two separate camps, one studying the finance, 0:07:08.880 --> 0:07:11.760 one stetting the macro and it was hard to connect them. 0:07:11.760 --> 0:07:13.440 But I think, you know, I think people are working 0:07:13.440 --> 0:07:15.040 on that, and I think there's a lot of connections. 0:07:15.560 --> 0:07:18.840 Okay, well let's dive into the paper's conclusion then, because 0:07:19.160 --> 0:07:22.000 I think everyone when we talk about high valuations, the 0:07:22.000 --> 0:07:25.360 temptation is always to be like, no, the people who 0:07:25.440 --> 0:07:29.520 are satisfied with these high valuations, like they're the crazy ones, right, 0:07:29.600 --> 0:07:32.400 Like I'm the one that sees the truth. But your 0:07:32.520 --> 0:07:36.040 paper actually sets out like a pretty reasonable explanation for 0:07:36.120 --> 0:07:39.960 why these high valuations have persisted and have not mean reverted. 0:07:40.120 --> 0:07:43.560 As Joe mentioned, talk to us about both, I guess 0:07:43.840 --> 0:07:47.080 the labor component in your paper as well as the 0:07:47.120 --> 0:07:48.000 investment component. 0:07:48.800 --> 0:07:51.480 Yeah, sure, so, you know, I think Joe was mentioning 0:07:51.520 --> 0:07:53.720 a minute ago the price earnings ratio. That's the sort 0:07:53.720 --> 0:07:56.240 of a classic valuation metric people have looked at for 0:07:56.280 --> 0:08:00.160 a long time, and the idea always was that, well, 0:08:00.200 --> 0:08:04.120 if prices get too far ahead of profits, then maybe 0:08:04.120 --> 0:08:06.320 that GAP's going to narrow again going forward, So either 0:08:06.360 --> 0:08:08.120 you're going to have to have really fast growth in 0:08:08.160 --> 0:08:09.960 earnings or the prices are going to come down, so 0:08:09.960 --> 0:08:14.520 you're going to get low returns. And people have looked 0:08:14.520 --> 0:08:16.960 at that ratio. Shila has like the famous version of it, 0:08:17.000 --> 0:08:19.360 and the problem is that it's been drifting up and up, 0:08:19.440 --> 0:08:21.680 the price earnings ratio, and it's been kind of way 0:08:21.680 --> 0:08:23.840 above its historical average for a long time, and that 0:08:23.880 --> 0:08:28.080 gap just seems to keep getting bigger. So we were 0:08:28.160 --> 0:08:29.800 kind of went back to that. We looked at it 0:08:29.880 --> 0:08:33.000 in macro data instead of financial data, but it looks 0:08:33.080 --> 0:08:35.679 much the same if you look at standard financial accounts, 0:08:36.200 --> 0:08:37.959 and we went back to nineteen fifty two. Yeah, you 0:08:38.000 --> 0:08:40.480 see this big run up in the price earnings ratio, 0:08:41.320 --> 0:08:44.160 but no, there are other metrics you can look at. 0:08:44.200 --> 0:08:45.560 And another thing you can look at is you can 0:08:45.600 --> 0:08:48.959 look at prices relative to free cash flow, and it's 0:08:48.960 --> 0:08:50.520 sort of a similar ratio. It's just that you've got 0:08:50.559 --> 0:08:52.960 pre cash flow and the denominator, and the only difference 0:08:52.960 --> 0:08:56.120 between earnings and pre cash flow is in measuring earnings 0:08:56.160 --> 0:09:00.520 you subtract a measure of depreciation. In measuring precash instead 0:09:00.520 --> 0:09:04.480 of subtracting depreciation, you take out all capital expenditure. And 0:09:04.520 --> 0:09:06.800 then the nice thing about free cash flow is sort 0:09:06.840 --> 0:09:08.480 of a measure of everything that's left at the end 0:09:08.480 --> 0:09:10.440 of the data to be paid to the owners of 0:09:10.440 --> 0:09:12.880 the firm. So you take the sales of farms, you 0:09:12.920 --> 0:09:16.280 subtract the input costs, payments to labor, subtract their taxes, 0:09:16.280 --> 0:09:19.760 subtract their capital expenditure, everything that's left is money that 0:09:19.800 --> 0:09:23.040 the firm can pay out to its owners. So if 0:09:23.040 --> 0:09:25.080 you look at that ratio the value of all the 0:09:25.120 --> 0:09:27.680 firms in the US relative to the total cash flow 0:09:27.720 --> 0:09:31.480 that're generating, it bounces around a bunch over time, but 0:09:31.559 --> 0:09:34.600 it doesn't have like a long, long term drift. It's 0:09:34.640 --> 0:09:37.120 not like it's kind of systematically moving up over time. 0:09:37.200 --> 0:09:39.920 So if you look at that ratio, you'd say, maybe 0:09:39.960 --> 0:09:43.040 the market's not so overvalued today. Maybe prices are roughly 0:09:43.120 --> 0:09:47.319 where they, you know, roughly within historical range compared to this, 0:09:47.679 --> 0:09:49.680 to this ratio, this strikes me as. 0:09:49.679 --> 0:09:52.240 Very important, and so we should just pause on this 0:09:52.280 --> 0:09:54.800 point or stick with this point for a second. So 0:09:54.880 --> 0:09:57.680 we've all seen the shoulder cape and various other versions. 0:09:58.200 --> 0:10:00.640 What you're saying is if you just and not always thought, 0:10:01.160 --> 0:10:02.880 let's just measure free cash flow, that's all I care 0:10:02.880 --> 0:10:04.800 about if I'm an investor, just how much money comes 0:10:04.840 --> 0:10:06.080 back to me at the end of the day. But 0:10:06.160 --> 0:10:08.880 you're saying that when you look at the entire market 0:10:09.120 --> 0:10:12.560 through this lens, it just does not have the same 0:10:12.840 --> 0:10:16.880 extreme drift outside of normal ranges that you see when 0:10:16.880 --> 0:10:18.720 you look at price turnings ratios. 0:10:19.240 --> 0:10:21.760 Yeah, that's right. I mean it bounces around over time. 0:10:21.880 --> 0:10:24.360 But if you look at where it was, say in 0:10:24.440 --> 0:10:26.920 nineteen eighty, so that was a low for stock values. 0:10:26.960 --> 0:10:28.480 If you look at it in nineteen eighty and you 0:10:28.520 --> 0:10:31.439 look at it in the second quarter of twenty twenty two, 0:10:31.720 --> 0:10:33.800 that ratio of value a free cash flow is the 0:10:33.840 --> 0:10:37.920 same in both cases is about the historical average. Now 0:10:37.960 --> 0:10:39.800 if you look over the last three years, you know 0:10:39.960 --> 0:10:42.000 that ratio has kept moving up. So now we are 0:10:42.040 --> 0:10:46.200 above the historical average, but we're not wildly outside the 0:10:46.280 --> 0:11:00.679 range that is spluctuated in over the last sixty seven years. 0:11:04.920 --> 0:11:07.280 And just going back to the labor and investment component, 0:11:07.400 --> 0:11:09.360 if we think about it very simplistically, I think you 0:11:09.480 --> 0:11:12.120 use the pie analogy earlier, Like if you think about 0:11:12.160 --> 0:11:15.240 that cash as a giant pie, less of it is 0:11:15.280 --> 0:11:18.360 going to labor, less of it has been going on investment, 0:11:18.440 --> 0:11:21.480 and more of it is being spent or returned to 0:11:21.960 --> 0:11:23.920 capital i e. The shareholders. 0:11:24.559 --> 0:11:25.240 Yeah, that's right. 0:11:25.320 --> 0:11:27.360 So if you look at the price earnings ratio, it's 0:11:27.400 --> 0:11:29.960 not like earnings haven't grown. They've grown pretty fast, and 0:11:29.960 --> 0:11:34.640 they've grown pretty fast because the share of the output 0:11:34.679 --> 0:11:36.440 that's going to workers has been going down, and the 0:11:36.440 --> 0:11:38.600 share that's going to owners of firms has been going up. 0:11:38.960 --> 0:11:42.920 So earnings have grown, but cash flow has grown even faster. 0:11:43.040 --> 0:11:45.720 And cash flows grown even faster because firms have been 0:11:45.760 --> 0:11:48.560 able to generate these extra earnings without doing a lot 0:11:48.600 --> 0:11:51.440 of extra investment. I think what investors care about at 0:11:51.440 --> 0:11:52.520 the end of the day, what they may be want 0:11:52.559 --> 0:11:54.400 to care about, is, you know, how much income is 0:11:54.400 --> 0:11:56.760 actually they're going to be receiving. And if firms are 0:11:56.760 --> 0:11:59.360 going to do a lot of investment to keep sustaining 0:11:59.360 --> 0:12:02.200 those earnings, that's income that can go to the owners 0:12:02.200 --> 0:12:04.880 of the firm. But that investment seems to have been 0:12:05.360 --> 0:12:07.720 relatively weak over time, and as a share of firm 0:12:07.800 --> 0:12:10.720 value has been declining, so cash flow has grown fast. 0:12:11.040 --> 0:12:14.160 Talk to us about this measure of labor share. Obviously 0:12:14.240 --> 0:12:17.880 on an individual basis, for an individual company basis, you 0:12:17.880 --> 0:12:20.480 can just like you know, find out how much is 0:12:20.600 --> 0:12:23.960 going to labor versus other things at the aggregate level, 0:12:23.960 --> 0:12:25.920 which is where you're working. At the macro level, this 0:12:26.080 --> 0:12:28.439 lit line, and I've seen it for years, People talk 0:12:28.440 --> 0:12:30.600 about labor share and it's generally going down. 0:12:30.920 --> 0:12:33.079 How robust is that measure? 0:12:33.200 --> 0:12:35.760 How that single number because it looks pretty bad for 0:12:35.800 --> 0:12:38.600 workers when you look at the long term labor share trend. 0:12:38.960 --> 0:12:45.040 How like methodologically or sort of intellectually robust is this data? 0:12:45.200 --> 0:12:48.320 Yeah, I think it's something the macroeconomists have been looking 0:12:48.320 --> 0:12:51.320 at for a long time. I think it's pretty robust. 0:12:51.600 --> 0:12:55.600 If you look at the corporate sector, you just measure 0:12:55.600 --> 0:12:57.880 it in the national accounts. You can look at wages 0:12:57.920 --> 0:13:01.200 and saturdays of employees and you can compare that against 0:13:01.240 --> 0:13:04.520 the output of the corporate sector, and those wages and 0:13:04.520 --> 0:13:09.080 salaries have fallen by about eight percentage points since nineteen 0:13:09.120 --> 0:13:11.240 eighty I think from nineteen eighty to twenty twenty two, 0:13:11.320 --> 0:13:14.199 so that's eight percentage points to GDP. That's a big change. 0:13:14.920 --> 0:13:16.480 You know, if you look at the non corporate sector, 0:13:16.480 --> 0:13:18.600 you're looking at small businesses. That's hard as a measure 0:13:18.640 --> 0:13:21.240 because kind of hard to say for a small private 0:13:21.240 --> 0:13:24.000 business how much of their output is really payments to 0:13:24.040 --> 0:13:27.240 labor versus payments to capital. But for big corporations it's 0:13:27.280 --> 0:13:29.680 sort of straightforward. There is there is an ext you know, 0:13:29.760 --> 0:13:33.080 one wrinkle to that, which is that you know, some 0:13:33.160 --> 0:13:36.240 firms have been paying more, they've been compensating some of 0:13:36.240 --> 0:13:39.160 their workers with stock options and things like that, and 0:13:39.200 --> 0:13:41.360 so that kind of complicates it a little bit because 0:13:41.679 --> 0:13:43.360 you know, you want to call that a payment to 0:13:43.440 --> 0:13:45.000 labor or you want to call that part of income 0:13:45.040 --> 0:13:47.280 to capital. So but putting that aside, I think it 0:13:47.320 --> 0:13:50.160 is there is there has been a big shift with 0:13:50.280 --> 0:13:53.800 less income going to labor, more income going either to 0:13:53.840 --> 0:13:56.400 capital or just as pure rants to the owners of firms. 0:13:56.520 --> 0:13:59.000 Wait now, I'm really curious in your own research, how 0:13:59.040 --> 0:14:03.040 did you classify stock based compensation. Was that an increase 0:14:03.040 --> 0:14:05.240 in labor? Was that an increase in capital? 0:14:06.920 --> 0:14:07.640 Yeah, we just. 0:14:07.559 --> 0:14:10.560 Follow the We just follow basically the national accounts, so 0:14:10.600 --> 0:14:12.960 the Pewer Economic Analysis and the flow of funds. They 0:14:12.960 --> 0:14:16.439 put together this data set called the Integrated Macroeconomic Accounts, 0:14:16.840 --> 0:14:18.680 and it's really just a version of the standard National 0:14:18.720 --> 0:14:21.920 income and Product accounts, and they classify labor income the 0:14:21.960 --> 0:14:24.960 standard way, which is wages and salaries. And I think 0:14:24.960 --> 0:14:28.760 they include in that standard national income measure when stock 0:14:28.800 --> 0:14:30.960 options exercise, that counts as part. 0:14:30.800 --> 0:14:32.520 Of the wage income. 0:14:32.640 --> 0:14:35.040 But you know, when they're granted that, you know, so 0:14:35.080 --> 0:14:37.720 there's some details there, but you know, they're supposed to 0:14:37.720 --> 0:14:40.000 be at least partially captured there in that waging commissure. 0:14:40.640 --> 0:14:44.040 Okay, And on the investment side, what about intangibles, because 0:14:44.040 --> 0:14:46.480 this is the thing that constantly comes up when we're 0:14:46.480 --> 0:14:50.880 talking about of valuations and the broader macroeconomy. So much 0:14:50.920 --> 0:14:55.080 of what companies do nowadays, especially in big tech, has 0:14:55.120 --> 0:14:59.400 to do with intangible so you know, ephemeral brand value 0:14:59.480 --> 0:15:02.560 and things like that. Would that have been captured in 0:15:02.840 --> 0:15:03.960 that investment number. 0:15:04.720 --> 0:15:07.320 Yes, So they've changed a little bit over time the 0:15:07.400 --> 0:15:09.640 way they try and measure investment, and they're trying to 0:15:09.680 --> 0:15:13.520 capture more of investment and intellectual property, investment in software 0:15:13.560 --> 0:15:17.520 and stuff that wasn't historically captured. There's still a question 0:15:17.560 --> 0:15:19.400 about how well they're capturing that and how much of 0:15:19.400 --> 0:15:20.080 it is measured. 0:15:21.320 --> 0:15:22.760 But in terms of. 0:15:22.720 --> 0:15:24.920 Measuring free cash flow, one reason we like the free 0:15:24.920 --> 0:15:27.680 cash flow measure is that in terms of the income 0:15:27.680 --> 0:15:30.320 that's available to go to the owners of the firm, 0:15:30.760 --> 0:15:33.920 it doesn't really matter whether that spending on intangibles that 0:15:33.920 --> 0:15:36.160 could be counted as a purchase of an intermediate input 0:15:36.800 --> 0:15:40.000 that's subtracts from value added or could be counted as 0:15:40.040 --> 0:15:42.520 a capital investment. Then it's going to subtract from investment, 0:15:42.560 --> 0:15:44.040 So the free cash flow measure is going to be 0:15:44.040 --> 0:15:46.040 the same either way. So I think that's a nice 0:15:46.040 --> 0:15:47.800 thing about free cash flow. It is just a measure 0:15:47.840 --> 0:15:50.280 of the income that's left over after the firm's paid 0:15:50.280 --> 0:15:52.120 all its bills, and it doesn't really matter whether you 0:15:52.560 --> 0:15:56.120 count those bills as an input cost or capital expenditure. 0:15:56.200 --> 0:15:59.640 So I think you know, that's one advantage of looking 0:15:59.680 --> 0:16:00.760 at this cashplumation. 0:16:01.440 --> 0:16:04.920 So when you embarked on this paper, how much was 0:16:04.960 --> 0:16:08.200 it in the was your thinking? You talked about the 0:16:08.200 --> 0:16:11.360 intellectual origins of it with your prior research, but how 0:16:11.440 --> 0:16:15.080 much was it motivated or driven by this current twenty 0:16:15.160 --> 0:16:17.280 twenty six or probably twenty twenty five when you started 0:16:17.280 --> 0:16:20.320 a reality that there is a very big change in 0:16:20.360 --> 0:16:23.160 corporate behavior afoot. We don't know how long it's going 0:16:23.160 --> 0:16:26.000 to last, but this is the big story of arguably 0:16:26.040 --> 0:16:28.440 the last two to three years, is how much these 0:16:28.520 --> 0:16:32.800 very profitable companies have seriously shifted into investment mode. 0:16:32.960 --> 0:16:35.080 Yeah, I would say we weren't that We were maybe 0:16:35.120 --> 0:16:36.920 a little behind on that. We were work on this 0:16:36.960 --> 0:16:40.080 for a while, so I think you know, that's not 0:16:40.840 --> 0:16:43.520 something that was particularly on our radar. We've kind of 0:16:44.640 --> 0:16:47.080 tweaked onto that a little bit more recently. Now, it's 0:16:47.120 --> 0:16:50.440 true that that investment on AI sented investment by the 0:16:50.480 --> 0:16:53.120 big tech firms that's been booming. Other kinds of investment 0:16:54.640 --> 0:16:57.240 have been kind of weak. Residential investment for example, it's 0:16:57.280 --> 0:17:00.920 been weak. So investment overall, yeah, look kind of relatively 0:17:00.920 --> 0:17:04.480 strong for the whole US economy, but it's not outsized 0:17:04.600 --> 0:17:09.159 and aggregate. So yeah, I think it's definitely a question. 0:17:09.960 --> 0:17:12.040 I think, as you said right at the start this story, 0:17:12.080 --> 0:17:15.520 that farms have been able to generate a bunch of earnings. 0:17:16.880 --> 0:17:18.840 Some of these farms that are generated a bunch of runnings, 0:17:18.880 --> 0:17:20.760 especially in tech, they've done it without a lot of 0:17:20.920 --> 0:17:23.840 capital expenditure, and that's meant that the cash flow has 0:17:23.880 --> 0:17:26.920 grown really strongly, and now they are starting to spend, 0:17:26.960 --> 0:17:28.639 So it is it is a question going forward is 0:17:28.680 --> 0:17:30.640 that spending gonna you know, is it gonna pay off? 0:17:30.880 --> 0:17:33.360 So at the moment, I guess, yeah, I guess there's 0:17:33.359 --> 0:17:35.760 a bunch of companies whose cash flow temporarily is negative 0:17:35.840 --> 0:17:38.359 right now. The storic people made big pre cash flow, 0:17:38.359 --> 0:17:40.439 and so that's the question investors are thinking about. 0:17:56.080 --> 0:17:59.679 How do you think about aggregates versus I guess sectors 0:17:59.800 --> 0:18:02.280 or you know a handful of big tech companies in 0:18:02.320 --> 0:18:05.200 those data, because again you are looking at the aggregate 0:18:05.280 --> 0:18:07.920 numbers like the macro variables. But if we think about 0:18:08.200 --> 0:18:10.680 the market right now and who's actually spending money, it's 0:18:10.720 --> 0:18:12.600 like a handful of tech firms, right. 0:18:13.560 --> 0:18:16.560 Yeah, that's right. We have been mostly looking at the aggregates. 0:18:16.680 --> 0:18:19.560 We've started looking a little bit at the farm level 0:18:19.600 --> 0:18:24.960 data in CRISP and compustat and you know what you see, 0:18:25.119 --> 0:18:26.880 what we've seen so far looking at the firm level 0:18:26.920 --> 0:18:29.560 data is that, yeah, it's a relatively small number of 0:18:29.560 --> 0:18:31.800 firms that account for most of the growth in value, 0:18:31.840 --> 0:18:34.840 most of the growth in the total stock market value, 0:18:35.359 --> 0:18:38.960 maybe say fifty firms. But those fifty farms are the 0:18:39.000 --> 0:18:42.040 same firms that have had the fastest growth in cash flow. 0:18:42.080 --> 0:18:45.400 So cash flow and value have grown roughly in lockstep 0:18:45.480 --> 0:18:48.600 for say fifty fifty of the biggest firms in the US. 0:18:49.440 --> 0:18:52.359 And so these, I mean, I guess a bunch of 0:18:52.400 --> 0:18:54.320 these are big tech firms. And it's these big tech 0:18:54.320 --> 0:18:58.359 firms have been generating mountains of cash and the high values. 0:18:58.359 --> 0:19:00.639 They're not built on sand, they're not built on expectation 0:19:00.760 --> 0:19:02.800 that we're going to make big future profits. The profits 0:19:02.800 --> 0:19:05.800 are then now, and I guess the question is, you know, 0:19:05.920 --> 0:19:08.240 are those profits gonna persist going forward? 0:19:09.160 --> 0:19:12.120 Let's get back to the labor share component. I mean, 0:19:12.680 --> 0:19:15.199 one of the things that comes up is this question 0:19:15.280 --> 0:19:20.119 of like, is the booming stock market based on the 0:19:20.160 --> 0:19:24.760 perpetuation of inequality? Right to some extent like this idea. 0:19:25.200 --> 0:19:27.160 You know, back in the twenty tens, everyone and all 0:19:27.160 --> 0:19:29.359 these corporate leaders and people would go to Davos and 0:19:29.359 --> 0:19:32.639 they say, oh, we really care about inequality, right, you know, 0:19:32.720 --> 0:19:36.280 it sounds nice, et cetera. But also everyone wants the 0:19:36.280 --> 0:19:38.679 stock market to go up. Seems if we tease this 0:19:38.760 --> 0:19:42.080 out a little bit, that there is some tension, right, 0:19:42.240 --> 0:19:44.239 is that it seems like there's some tension with if 0:19:44.280 --> 0:19:48.080