00:00:20
Hello, I'm Jeff Brown for Knowledge at
00:00:22
Wharton. The stock market is up, not up
00:00:25
as high as it once was. The economy
00:00:27
seems to be improving a little bit, but
00:00:29
maybe not as much as we'd like. We're
00:00:31
trying to make sense of it all and today
00:00:33
we have two Wharton professors with us,
00:00:35
Jeremy Siegel and Scott Richard. Thank
00:00:38
you very much.
00:00:39
And I'd like to start with each of you.
00:00:41
I'll start with you, Professor Siegel.
00:00:42
Uh
00:00:44
we look at these signs of the economy.
00:00:45
It does seem like things are improving.
00:00:47
On the other hand, we had kind of a
00:00:49
false start a year ago and I think a lot
00:00:50
of people were burned by that. So,
00:00:53
should we believe it or should we not
00:00:54
believe it?
00:00:55
a head fake. Things were going up in
00:00:57
April and
00:00:58
through March.
00:01:00
I think things are far more real now. I
00:01:03
The employment numbers are much better.
00:01:06
The private payroll expansion is much
00:01:09
better. Remember, just at this time we
00:01:11
had you know, we just had the
00:01:12
anniversary of the tsunami and
00:01:15
earthquake in Japan.
00:01:18
And then Europe got much worse. Now, no
00:01:20
one can can talk about Europe later. No
00:01:21
one can say that that couldn't flare up
00:01:23
again, but there's been a lot of
00:01:25
measures that have taken. Those stifled,
00:01:27
I thought, the recovery that was
00:01:29
proceeding at the beginning of of this
00:01:31
year. We take a look at even the home
00:01:33
building cuz that's been the most
00:01:34
depressed area. National Association of
00:01:37
Home Builders suddenly moving up. That
00:01:39
was dead last year. Did not move up in
00:01:41
March and April. I mean, today at Wall
00:01:43
Street Journal I saw an article about a
00:01:44
revival of of real estate in Phoenix.
00:01:47
How could you believe that?
00:01:49
Yeah, I mean, it was one of the worst
00:01:51
and all of a sudden they they see
00:01:53
a recovery there. So, the think these
00:01:56
green shoots are much stronger now than
00:01:59
what we had a year ago.
00:02:01
I completely agree with that. We are in
00:02:04
the beginning of a serious recovery. Uh
00:02:07
both in jobs and in output.
00:02:10
Mhm.
00:02:10
And um
00:02:12
I expect stock prices and bond prices
00:02:14
will react accordingly.
00:02:15
With the bond market going up in yield
00:02:18
and down in price.
00:02:21
Finally, we've been saying that for
00:02:22
ages. All right.
00:02:23
Well, the forward rates all show uh
00:02:26
significant rises
00:02:27
Uh-huh.
00:02:28
uh in bond yields built in.
00:02:30
So, you lose money, if you will, if they
00:02:33
don't go up that much.
00:02:34
Okay. Okay. But, you think it's more
00:02:36
solid this time than it was a year ago.
00:02:38
That's your your bottom line on that.
00:02:40
All right. Well, let let's uh zero in on
00:02:42
the stock market for starters, then
00:02:43
we'll talk about the bond market. So, uh
00:02:45
Professor Siegel,
00:02:46
the we've talked over the years a number
00:02:48
of times about what are kind of the the
00:02:50
the the the the gears and levers inside
00:02:53
the market that you look at to to to see
00:02:55
what's going on. Things like P/E ratios
00:02:58
and that sort of thing. What are you
00:02:59
looking at now and what are they telling
00:03:00
you?
00:03:00
Well, I I think, you know, when you take
00:03:03
stock price, actually you can take asset
00:03:05
prices. I mean, the the the two things
00:03:07
that are important are cash flows and
00:03:08
the discount rate, which for stocks are
00:03:11
earnings, basically, and the interest
00:03:13
rate environment in which you find those
00:03:16
earnings.
00:03:18
Uh
00:03:18
uh
00:03:19
it was very favorable last year,
00:03:21
actually. It is more favorable to me
00:03:25
this year because interest rates are a
00:03:26
lot lower now, especially those
00:03:28
long-term interest rates,
00:03:30
uh than they were a year ago. So, uh the
00:03:33
P/E ratio is about the same as a year
00:03:35
ago, 12 13, as we had last year.
00:03:39
That's what we're looking
00:03:39
Yeah, that's the forward-looking on the
00:03:41
next 12 months.
00:03:43
Uh 12 13 on that. Lower than the
00:03:45
long-run average is 15. And in an even
00:03:49
almost well, in some ways a record low
00:03:52
interest rate environment. Uh
00:03:54
So, you know, the the question is is
00:03:56
those alternatives
00:03:58
that you have out there are
00:04:01
you know, not attractive at all.
00:04:04
You know, a lot of people
00:04:06
tell me nowadays, well Jeremy, there's
00:04:07
not just you know, bonds out there.
00:04:10
There's there's you know, all these
00:04:12
other assets that they talk about and
00:04:14
commodities and private equity and and
00:04:17
you know, venture capital and all the
00:04:18
rest, but you shouldn't be fooled. I'm
00:04:20
sure that Scott will agree. I mean,
00:04:22
fixed income is still the biggest asset
00:04:24
class. I mean, that that you have to
00:04:26
compare it to. You can't you know,
00:04:28
they're not on all equal footing in
00:04:30
terms of size. Fixed income is is the
00:04:33
big comparison there and there there the
00:04:35
comparison is just I think
00:04:36
extraordinarily favorable.
00:04:38
So, with PE ratios low, the risk level
00:04:41
of stocks looks relatively low and you
00:04:43
can make nothing in bonds or anywhere
00:04:45
else.
00:04:46
But what I think risk level on stocks,
00:04:47
you know, I mean, they could go lower.
00:04:50
The bears are you know, they they they
00:04:52
like to point well, Jeremy, you know, we
00:04:54
had PE ratios of seven and eight back in
00:04:56
the
00:04:56
in this late 70s and 80s and I say,
00:04:59
yeah, and that's when interest rates
00:05:00
were 15 and 20% and there was a lot of
00:05:02
competition there. There isn't any
00:05:05
competition. So, to see a a PE ratio of
00:05:08
13
00:05:10
in an extraordinarily low interest rate
00:05:12
environment
00:05:13
is is really extraordinary. I mean,
00:05:15
again,
00:05:16
And that's good. That's a positive sign.
00:05:17
extraordinarily
00:05:18
positive going forward and I think
00:05:21
people are beginning to you know, to to
00:05:23
put their toes in the water and and buy
00:05:25
a little.
00:05:26
All right. Um
00:05:29
We've looked when you look at the stock
00:05:31
market, of course, anyone who's in the
00:05:32
market for a mutual fund is experienced
00:05:34
in this. They say, we were the best
00:05:35
performing fund in some you know, period
00:05:38
that they've selected and you can always
00:05:40
argue what period should use the entire
00:05:42
20th century, the last 10 years, the
00:05:43
last two days. You You what what today
00:05:46
given what the market has done over the
00:05:48
last few years, would be sort of a
00:05:50
a good period to look back and say how
00:05:52
well are stocks doing or how poorly are
00:05:54
they doing?
00:05:55
Well, I actually think that this period
00:05:57
is not that unlike the 1950s.
00:06:02
Mid-1950s, we had very low interest
00:06:04
rates and low valuation of stocks.
00:06:06
People were very frightened then. They
00:06:08
still had memories of the Great
00:06:09
Depression and the the tremendous stocks
00:06:11
collapse that had there. They didn't
00:06:13
believe the post-war recovery was real
00:06:15
because so many economists were talking
00:06:16
about a relapse into another depression.
00:06:19
The fear was there and if you remember,
00:06:22
that was one of the best times to start
00:06:24
accumulating stocks and one of the worst
00:06:26
times to start buying bonds
00:06:29
at that time. And I'm wondering whether,
00:06:31
you know, 10-15 years from now we'll
00:06:32
look back on that and say exactly, I
00:06:34
think, the same thing.
00:06:36
So, it would be risky to be sitting on
00:06:37
the sidelines now.
00:06:39
I think I think you're missing out on
00:06:41
great values in stocks,
00:06:43
you know, even in terms of the dividend
00:06:44
yield. Uh
00:06:47
This is the first time since the 1950s
00:06:51
that the dividend yield on the S&P 500
00:06:53
has been higher than the 10-year
00:06:55
government bond. So, and stocks have
00:06:58
growth and inflation hedge properties
00:07:01
that the bonds don't have. And if you
00:07:03
want the inflation hedge properties in
00:07:04
the bonds and you go to TIPS, their
00:07:06
yields are negative, incredibly so, in
00:07:09
my opinion.
00:07:10
So, there's really no yield there at
00:07:12
all. So, again, I mean stocks are
00:07:16
really, I think, the only real game in
00:07:18
town for for yield going forward.
00:07:20
So, so a person who's, say, in or near
00:07:22
retirement should really consider
00:07:23
dividends as a as a source.
00:07:25
you know, good blue chip dividend paying
00:07:27
stocks, low PE dividend paying stocks. I
00:07:29
think that that's going to be your best
00:07:31
best answer.
00:07:32
of the some of the telephone stocks are
00:07:35
paying over 5% these days, so.
00:07:37
I wouldn't stay with any one or two. I
00:07:38
mean, I would try to be as diversified
00:07:40
as possible. I mean, I don't pick
00:07:41
sectors or stocks, but you know, if you
00:07:44
go and I diversify towards
00:07:46
a a value portfolio that that is
00:07:49
dividend tilted and dividend weighted, I
00:07:52
think that will be very good performing
00:07:54
going forward.
00:07:56
So, people who look back or read the
00:07:57
stories about sort of the lost decade,
00:07:59
which now not referring to Japan, but
00:08:02
referring to the US stock market, that
00:08:04
would be too short a perspective for
00:08:05
Well, we remember we started that quote
00:08:07
lost decade in 2000 with a PE ratio of
00:08:11
30 on the market.
00:08:13
Right.
00:08:13
In March of 2000. And you know what?
00:08:16
When you start with 30, you're not going
00:08:17
to have a good decade. I mean,
00:08:21
Japan started in in 1989 with a 90 PE
00:08:26
and they did not have a good 30 years
00:08:28
after that.
00:08:29
You know, I mean, when you start from
00:08:31
high valuation, but that's why people
00:08:33
say, "Well, can't this next decade be
00:08:34
lost?" And I say, "Not starting from
00:08:36
these PE ratios."
00:08:39
is one of the class you might want to
00:08:40
look at, which is real estate.
00:08:41
Uh-huh.
00:08:42
Okay. Clearly, cash is absurd
00:08:46
with
00:08:47
single-digit
00:08:49
yields. I mean, in basis points, 10, 12
00:08:52
basis points. And then bonds, I don't
00:08:55
understand why anybody in their right
00:08:57
mind wants to lend the US government
00:08:59
money for 10 years at under 2%. It makes
00:09:02
no sense to me at all. So, if you rule
00:09:05
out cash, you rule out bonds, stocks are
00:09:08
very attractive as Jeremy said. But real
00:09:10
estate also has a lot of attractive
00:09:11
attributes
00:09:12
this you're referring to real estate
00:09:13
investment trusts or actually going out
00:09:15
and buying of investment property?
00:09:17
Either one. Especially if you're if you
00:09:19
have the nerve in some of the sand
00:09:21
states where things have really been
00:09:23
crushed. Now, the rental markets already
00:09:26
are reflecting this. Rents are up
00:09:28
nationwide. But we've never seen more
00:09:32
affordable
00:09:34
prices on single-family housing since
00:09:36
the records have been kept. It's between
00:09:39
the low mortgage rates and the low
00:09:41
prices, this is the best opportunity
00:09:43
that anybody have seen in 40 years of
00:09:46
records.
00:09:48
Now talking about real estate, I mean
00:09:50
when people are considering their own
00:09:51
home, they've historically been told
00:09:54
well you you've got to stick around for
00:09:55
four or five years to break even given
00:09:58
the cost of buying and selling title
00:10:00
insurance things like that. If one were
00:10:02
considering an investment property,
00:10:05
how long a holding period would they
00:10:06
have to commit to do you think at
00:10:08
minimum?
00:10:09
Depends on the market of course, sure.
00:10:12
If
00:10:13
But is it in the six It's not a
00:10:14
six-month flip buy and flip kind of
00:10:16
market?
00:10:17
housing for the one you occupy is a
00:10:19
consumption good. It's not an
00:10:21
investment. If you're not collecting
00:10:23
rent, it's not an investment. You're
00:10:25
consuming the house property.
00:10:27
And and rental properties, that's just a
00:10:29
straightforward present value
00:10:30
calculation. How much is the rent I can
00:10:33
collect versus the cost of carrying the
00:10:35
house, the P&I, and the insurance, and
00:10:38
the taxes. And I think that you'd have
00:10:41
to be fairly foolish to as we've all
00:10:44
learned to invest on the on the come, on
00:10:46
the capital gain that you're planning to
00:10:48
get out of that house.
00:10:50
I I'd like to mention supple and I I do
00:10:52
agree with Scott here, but the REITs
00:10:55
itself, the REIT index has really
00:10:57
totally bounced back. I mean, it's
00:11:00
within I think 10 or 15%
00:11:03
of its high that it reached pre-crisis.
00:11:06
But so is the stock So is the stock
00:11:07
market.
00:11:08
market is also within that.
00:11:12
In some of these individual properties
00:11:14
you're talking about, and I do agree
00:11:15
that like the affordability index is at
00:11:17
a record high. And if even if you look
00:11:20
internationally, US real estate is
00:11:22
unbelievably cheap on an international
00:11:24
basis as well.
00:11:27
So again, the REITs the REITs themselves
00:11:30
I think have gotten a good bounce. I
00:11:32
still think they're probably okay as
00:11:34
investment, but if you can if you can
00:11:36
get into the rentals in in particular
00:11:38
places,
00:11:39
I think
00:11:40
you might you might score very well.
00:11:42
But but again, that's a multi-year
00:11:44
problem.
00:11:45
requires a little bit more specialty in
00:11:47
terms of being able to do that.
00:11:49
And no liquidity. There's no liquidity
00:11:51
there as opposed to stocks which are
00:11:54
among most ultimately liquid.
00:11:56
short. Okay. And and retail and that's
00:11:58
one reason they're back up.
00:12:00
Now Professor Siegel, yeah.
00:12:03
You mentioned the foreign markets in
00:12:04
real estate and there are also of course
00:12:05
foreign markets in stock and and in the
00:12:07
past you've been quite a strong advocate
00:12:10
of people having a pretty substantial
00:12:12
holding in international stocks. How
00:12:15
have things changed? Is that still a
00:12:17
good idea?
00:12:20
an an excellent idea.
00:12:23
There is more growth, you know, well,
00:12:27
abroad and I'm
00:12:28
excluding You know, you have basically
00:12:31
the United States, you have the other
00:12:33
world developed countries such as, you
00:12:35
know, Japan and Europe and those have
00:12:38
moved into a slow growth
00:12:40
period to be
00:12:41
to be sure, but the emerging markets
00:12:44
have bounced back and
00:12:46
not only have they bounced back, but
00:12:48
their valuations
00:12:50
for rapid growing
00:12:53
countries and firms are still extremely
00:12:56
reasonable. I mean, I was just looking
00:12:58
at the Shanghai composite
00:13:01
selling 10 to 11 times this year's
00:13:04
projected earnings and even with the
00:13:05
come down of the squeeze in in the in
00:13:08
the Chinese market Hong Kong is like at
00:13:10
12, Singapore is you know, at at 15.
00:13:15
They're all 15, 16 which I think are
00:13:18
very good valuations.
00:13:21
You know, one of the things that I've
00:13:22
mentioned this before, people say are
00:13:24
these emerging markets for real? And I
00:13:27
think
00:13:28
I think we definitely know the answer is
00:13:30
yes because we had the biggest economic
00:13:33
shock in 2008-2009
00:13:36
since the Great Depression of the '30s.
00:13:37
If it was going to knock anyone out,
00:13:40
it would have been the emerging markets.
00:13:42
They've come back much stronger than any
00:13:44
of the developed markets in terms of the
00:13:45
economies themselves. Some of their
00:13:47
stock markets are not quite back to
00:13:49
that, but their economies are now over,
00:13:51
well over the peak of what they were in
00:13:53
2007.
00:13:54
If you look at I have data since 1972 to
00:13:58
look at corporate values. That is both
00:13:59
the stocks plus the corporate bonds.
00:14:02
That's grown about 1% faster than
00:14:04
nominal GDP.
00:14:06
So, why? Well, two things have been
00:14:09
going on. One is labor's share of the
00:14:11
economy has been falling. And the other
00:14:13
one is we are participating in a global
00:14:16
expansion. The US companies themselves
00:14:20
without diversifying globally give you
00:14:22
global diversification. Clearly, they
00:14:25
can't keep growing 1% faster than the
00:14:27
economy or they become the economy. So,
00:14:30
sooner or later they're going to have to
00:14:31
level off and grow at the rate of the
00:14:33
economy. But I don't see that happening
00:14:35
in myself in the short run because of
00:14:38
the
00:14:39
increasing and continuing globalization.
00:14:43
Okay.
00:14:44
I don't know what you think.
00:14:45
Uh no, well, I I definitely agree and
00:14:47
that's why some of these comparisons
00:14:49
people look at ratio of stock market
00:14:51
value to GDP is not appropriate anymore.
00:14:53
I mean, 45% of the profits of the S&P
00:14:56
500 are now coming from abroad. So, you
00:15:00
know, you need to look at world GDP
00:15:02
which is growing faster than US GDP. You
00:15:04
know, I mean, that's that's I think the
00:15:06
most important criteria and and why I
00:15:09
think that that divergence can go on for
00:15:11
an awfully long time.
00:15:13
Before we switch from stocks to bonds, I
00:15:15
just want one last question which is
00:15:18
what worries you the most if if
00:15:19
something were to derail all of this?
00:15:22
What what would it What would it be?
00:15:24
Well, you know, I I
00:15:26
I always have in the back of I'm not
00:15:28
happy about rising oil prices.
00:15:30
Um
00:15:32
We're learning
00:15:33
War in Iraq.
00:15:33
Well, war
00:15:35
Any sort of war in the Gulf that closes
00:15:37
that and sends oil up to 250. Um and is
00:15:40
in some scenarios is is obviously a
00:15:43
threat out there.
00:15:45
Um A longer term threat is if and I
00:15:48
don't see this happening, but if this if
00:15:50
if if the emerging market stop growing.
00:15:52
I mean, China and India political things
00:15:54
happen and uh
00:15:56
you know, because I think the growth of
00:15:57
the emerging markets are very important
00:16:00
uh for us economically. They're the new
00:16:03
middle class that are going to be buying
00:16:04
so many of the goods as we retire
00:16:07
as the baby boom population retires over
00:16:09
the next 20 years and and and they're
00:16:11
going to be the demanders of goods and
00:16:13
grow much bigger than the middle classes
00:16:16
that now exist in Europe and the United
00:16:17
States. So, and that's a longer term
00:16:20
issue. Uh you know, if if something
00:16:22
disrupts their growth, I don't see that
00:16:24
happening. Short run, it is probably the
00:16:26
the oil question and uh war or
00:16:30
attacks in Iran.
00:16:31
I agree with Jeremy that um we're I
00:16:34
think this
00:16:35
is going to be the century of wealth
00:16:36
creation. You've got 2 billion people in
00:16:39
the last 20 years who have come out of
00:16:41
abject poverty
00:16:43
into the cash economy and a huge growth
00:16:47
in the middle class in India and China.
00:16:49
And that's nothing but good news.
00:16:52
And I don't see anything that will cause
00:16:54
that to derail if unless their
00:16:56
governments adopt very bad policies. The
00:16:59
government can always do that and
00:17:01
there's nothing you can do about it, but
00:17:03
both the Indian and the Chinese
00:17:04
government seems seem to have shed it
00:17:06
their socialist policies and have
00:17:09
embraced market economies and
00:17:12
we should see quite a bit of growth
00:17:14
continuing out of those countries.
00:17:16
Let's talk about bonds a little bit and
00:17:18
the and the interest rates. It does
00:17:20
seems like it's been years that we've
00:17:22
been saying
00:17:24
we and other people, well, you know,
00:17:26
interest rates are more likely to go up
00:17:28
than down.
00:17:29
And I'm not
00:17:31
blaming you.
00:17:31
Eventually we're going to be right.
00:17:33
I'm not blaming you guys.
00:17:34
I say the same Everybody says this. So,
00:17:37
you know,
00:17:38
Except for tips.
00:17:38
Tips are negative.
00:17:39
Have we ever seen negative?
00:17:40
Just give Put this in perspective.
00:17:43
Professor, have we Have we ever seen a
00:17:44
period where
00:17:46
rates have been so low persistently for
00:17:49
so long?
00:17:50
Not since the Great Depression.
00:17:51
Uh-huh.
00:17:52
This is a post-war new. And uh we've
00:17:55
seen low rates uh at the 10-year point
00:17:57
and the like, but never cash this low,
00:18:00
the Fed funds this low for this long.
00:18:03
Um and uh
00:18:06
Chairman Bernanke has announced that he
00:18:08
intends to keep it there
00:18:09
uh through 2014, and the markets seem to
00:18:13
be buying this.
00:18:13
Yeah, that that that was quite a
00:18:15
remarkable announcement, very
00:18:17
unprecedented. And I I'm just curious
00:18:20
how do the markets react? I mean, so
00:18:21
much of the coverage of the bond markets
00:18:23
is, you know, the speculation, well,
00:18:25
what are they going to do? What are
00:18:26
rates going to be like in the future?
00:18:27
Has this changed that element? Has it
00:18:29
calmed them down? Uh is it Are they just
00:18:32
ignoring it? What's the reaction?
00:18:33
No, I think they've Nobody in the
00:18:35
markets ignores the Fed.
00:18:37
Okay.
00:18:37
Okay. Uh they are the 800-lb gorilla.
00:18:40
Mhm.
00:18:40
And long rates are just averages of
00:18:43
short rates. So, you have to figure out
00:18:45
you have to be looking at the Fed. Of
00:18:47
course, the Fed has much, much more
00:18:48
control over the front end of the yield
00:18:50
curve than they do over the long end.
00:18:52
So, the reaction in the market is we've
00:18:54
seen a very We have very steep yield
00:18:56
curves. The rates are not all that high,
00:18:58
but the curve is very steep. And
00:19:01
the forward rates are even steeper.
00:19:04
So, the market its reaction is that as
00:19:07
the
00:19:08
as I read it, as the economy strengthens
00:19:10
in the coming year, the Fed is going to
00:19:13
be holding down the front end of the
00:19:14
curve.
00:19:15
And so, the only way the curve has to go
00:19:18
is to move up. It's to steepen. And
00:19:21
that's what the forward rates look like,
00:19:22
and that's what I expect will happen.
00:19:24
And
00:19:25
whether the Fed changes its mind and
00:19:28
then eases before the end of 2014, I
00:19:31
think will be very endogenous. It
00:19:32
depends on what happens to the
00:19:33
unemployment rate and inflation.
00:19:36
Inflation right now is more abundant,
00:19:37
but they may have printed a lot of
00:19:39
money. And I don't know whether they're
00:19:41
going to be able to reel it back in in
00:19:43
time to keep the inflation from coming
00:19:46
out. Uh in past years, if when the
00:19:49
economy was stronger, they had printed
00:19:51
anything like this amount of money, this
00:19:52
huge uh easing they've gone through in
00:19:55
the last few years, uh people would be
00:19:57
very worried about inflation.
00:19:59
So, it does look like rates will come up
00:20:01
in the next couple of years, few years.
00:20:03
yeah. And they that's what's the
00:20:05
market's forecasting as well. That's
00:20:06
what the forward
00:20:07
And I'd like to just remind people that
00:20:09
it's always difficult for for laymen to
00:20:11
remember this relationship between
00:20:13
interest rates and bond prices and how a
00:20:15
rising rate can cost you money if you've
00:20:18
bought a bond earlier that pays less.
00:20:20
That's correct, and that's a danger for
00:20:22
people who are looking at bond mutual
00:20:24
funds and think they're safe. How how
00:20:26
would you gauge that danger these days?
00:20:28
can buy a mod bond mutual funds in all
00:20:30
sorts of flavors. You can go everything
00:20:32
from a money market fund, which probably
00:20:34
is safe, okay, to
00:20:36
But yields zero.
00:20:38
Yields zero, right. Well, no free lunch.
00:20:42
Okay, on out to There are short-term
00:20:44
bond funds, which are yielding something
00:20:46
like 1% and are relatively exempt,
00:20:50
relatively immune to interest rate
00:20:53
movements. And then you can go on out to
00:20:55
longer bond funds, 5 years, where what
00:20:57
you say is very true. When yields go up,
00:20:59
eventually these funds are going to
00:21:01
suffer.
00:21:02
Uh Offsetting it will be some spread
00:21:04
tightening as the economy recovers. The
00:21:07
corporate spreads are not all that wide
00:21:08
right now, nor are they nor are
00:21:10
mortgages.
00:21:12
So, should the investor who wants a
00:21:13
portion of the portfolio in bonds assume
00:21:16
that this is going to even out over
00:21:17
time? That the turnover in the fund will
00:21:20
get new higher yielding bonds and it
00:21:22
won't matter, or should they be worried
00:21:23
about it?
00:21:23
I would expect to earn your yield.
00:21:25
Mhm.
00:21:25
Right now.
00:21:26
Okay.
00:21:27
I don't think you're going to get some
00:21:29
coupon and I expect capital losses to
00:21:32
come in against the coupon. So, if
00:21:34
that's what I mean by earn your yield.
00:21:36
If you hold it to maturity, that's
00:21:38
about the best you're going to do.
00:21:39
But the bond funds I mean, if they're a
00:21:41
long-term bond fund, they'll always be
00:21:43
selling a bond that gets too short and
00:21:45
buying the long and you will get that
00:21:46
capital gain. You'll never recover it.
00:21:48
Right, you'll get the capital loss.
00:21:49
The loss.
00:21:50
Right.
00:21:50
Or yeah.
00:21:51
I misinterpreted your question.
00:21:53
I thought you were talking about buying
00:21:54
bonds,
00:21:55
With a fund you can't hold to maturity
00:21:56
the way you can hold to maturity like
00:21:57
you can with an individual
00:21:59
bond.
00:21:59
Right.
00:21:59
Okay. So, people should be aware of the
00:22:01
bond market right now.
00:22:02
be very wary of it.
00:22:04
Okay.
00:22:04
And
00:22:05
I would not be a bond buyer at these
00:22:06
yields. Like I said, why do you want to
00:22:08
lend the US government money for 10
00:22:10
years at 1.75%
00:22:12
when they're running trillion dollar
00:22:13
deficits?
00:22:15
All right. Now, of course, we're
00:22:16
constantly hearing about the situation
00:22:18
in Europe, the debt crisis in Europe,
00:22:21
and it's a little bit mystifying to many
00:22:23
of us how that affects us. We know
00:22:25
vaguely everything's interconnected, but
00:22:28
how does it affect us? What's sort of
00:22:29
the mechanism in which troubles in
00:22:31
Europe affect markets in the United
00:22:33
States?
00:22:34
They're a huge trading partner.
00:22:36
Mhm.
00:22:36
And if
00:22:37
they go through these serial defaults,
00:22:40
like I liken it to a bank run, okay?
00:22:43
Greece has defaulted.
00:22:44
I imagine the market's going to turn its
00:22:46
attention to Portugal next.
00:22:49
Okay? And Portuguese spreads are already
00:22:51
very wide and have been widening.
00:22:53
Um these are less worrisome because
00:22:55
they're small. They're small amounts of
00:22:57
GDP. But if they start to fall and then
00:23:01
the next one is Italy or Spain. Those
00:23:03
are big and real. The joke about Italy
00:23:05
is it's too big to save.
00:23:07
Okay? And uh if their economy becomes
00:23:11
compromised, these are people who buy a
00:23:13
lot of goods and services from the
00:23:14
United States and that's going to hurt.
00:23:17
That's going to hurt everybody who
00:23:19
exports.
00:23:20
Okay? From farmers through
00:23:22
manufacturers.
00:23:24
So, that's the mechanism is trade is
00:23:27
really the mechanism I think.
00:23:28
And And do you feel that that that
00:23:30
they're getting a grip on this situation
00:23:32
in Europe or not?
00:23:34
Truthfully, no.
00:23:35
Okay? I think that um they're getting
00:23:39
they're moving in the right direction.
00:23:41
But for a currency union to work, you
00:23:44
need several things. That's what they've
00:23:45
got. We've got a currency union in the
00:23:47
United States. We've got 50 states and
00:23:49
one currency. We have a lot of labor
00:23:51
mobility.
00:23:53
Okay? And that's what makes our currency
00:23:55
union work. They have very little labor
00:23:57
mobility in Europe.
00:23:59
Not
00:24:01
on the laws. There you're allowed to
00:24:02
move, but in fact, there's very little
00:24:04
labor mobility. So, they don't really
00:24:07
have a mechanism that's going to allow
00:24:09
huge differences in labor productivity
00:24:12
across Europe to equilibrate. The normal
00:24:15
way of doing that was, for example, with
00:24:17
Greece, they would have had a drachma.
00:24:19
And the drachma would have fallen in
00:24:20
value.
00:24:22
Okay? And then everybody's labor
00:24:24
productivity
00:24:25
per unit of currency would have worked
00:24:27
out. So, the euro would have stayed
00:24:29
strong, the drachma would have weakened,
00:24:31
and the Greeks would have been
00:24:32
competitive in the in the European
00:24:34
market. Same thing's true now of
00:24:36
Portugal, Spain, and Italy. They have
00:24:38
real problems in unit labor costs. Their
00:24:40
unit labor costs are very high compared
00:24:42
to Germany's
00:24:43
and they don't have a mechanism for
00:24:45
adjusting.
00:24:46
And that's what worries me.
00:24:47
Well, do you think that going to the
00:24:48
euro was a mistake? Is that what all
00:24:50
this is pointing to?
00:24:52
Going to the euro was perhaps not a
00:24:54
mistake. What was a mistake was going to
00:24:56
the Euro without having a mechanism in
00:24:59
place to make sure that unit labor costs
00:25:01
across the Eurozone were going to remain
00:25:03
competitive.
00:25:05
And they had no such mechanism in place.
00:25:07
Now, you mentioned that nobody would
00:25:09
make no sense to lend the US government
00:25:11
money for earning nothing.
00:25:13
Well, I wouldn't lend them to them.
00:25:14
But there are other opportunities in the
00:25:16
bond market. There are corporates, there
00:25:17
are municipals, and there are junk bonds
00:25:19
or high yield as they like to say. What
00:25:21
what do you see sort of looking across
00:25:22
that spectrum uh
00:25:25
what looks appealing or unappealing or
00:25:26
more dangerous or less so?
00:25:28
Yeah, I don't see anything awfully
00:25:30
appealing in the bond market uh
00:25:32
at all across the the whole sector. Um
00:25:35
and that's because of I'm worried about
00:25:37
rates going up. Now, if you hedge out
00:25:39
the rates, then the question becomes are
00:25:41
any of the spreads attractive? Mortgage
00:25:43
spreads are a little bit wide, not
00:25:45
tremendously wide. Corporate spreads are
00:25:48
a little bit wide, not tremendously
00:25:50
wide. A lot of the value in
00:25:52
corporations, if you had the nerve, was
00:25:54
available a year ago. But they've
00:25:56
tightened into a lot. So, I don't see
00:25:58
any real great values across the whole
00:26:00
bond market. I don't know about you.
00:26:03
No, I I I I tend to agree.
00:26:06
Um interest rates
00:26:08
are going to go up.
00:26:10
Um
00:26:11
again, they're at zero on on the short
00:26:13
term. I personally do not think that
00:26:15
Bernanke is going to be able to hold
00:26:18
rates uh until 2014.
00:26:22
I think the economy's going to improve
00:26:25
and
00:26:26
uh or inflation is going to increase
00:26:29
enough that he's going to have to pull
00:26:31
the trigger
00:26:33
uh and then Now, a lot of people ask me,
00:26:35
"Well, Jeremy, what's going to happen to
00:26:36
stock market?" I say it'll be a shock
00:26:38
when that happens, but if you go through
00:26:40
history, the early phases of Fed
00:26:44
tightening are not bad for the stock
00:26:46
market. Stock rallies continue. It's
00:26:49
only at the end when they really
00:26:50
squeeze, you know, tight to you know,
00:26:53
slow the economy that's getting out of
00:26:54
control in terms of inflation and and
00:26:57
and resource utilization, that you
00:26:58
really begin to see the the bear market
00:27:01
beginning. So, yeah, I'm not I'm not
00:27:03
saying on the day when Bernanke
00:27:05
you know, says, "We're we're now
00:27:07
thinking of, you know, withdrawing the
00:27:09
accommodation." There will be a
00:27:10
short-term shock there, and I consider
00:27:12
that a buying opportunity because
00:27:14
history shows us that often times stocks
00:27:17
uh recover very quickly from that and
00:27:19
continue on to the new highs as long as
00:27:21
earnings are growing. Because remember,
00:27:23
there's two things that affect the stock
00:27:24
market. Uh it's interest rates and
00:27:26
earnings. The bond market's only the
00:27:28
interest rate. So, they don't have if
00:27:30
the if the economy's going to be
00:27:31
stronger, you're going to do really well
00:27:33
on the earning side, and that's going to
00:27:35
be able to bring the the the stock
00:27:37
market up where bonds can't go.
00:27:39
Now, you know what I thought of was
00:27:42
some sectors of the bond market, like
00:27:43
the banks, I think are very attractive
00:27:45
right now. But that's a view that the
00:27:49
financial sector is healing and not
00:27:52
uh going down the tubes.
00:27:54
All right.
00:27:54
There's one other sector I want to ask
00:27:56
you about because of your background in
00:27:58
the mortgage securities market, and that
00:28:00
is
00:28:01
uh am I correct that that that the
00:28:03
private securitization market is still
00:28:06
pretty much dead?
00:28:07
More abundant.
00:28:07
Uh and
00:28:10
does that matter? I mean, is there
00:28:11
something else uh I mean, I guess it's
00:28:13
Freddy and Fran- Fannie have stepped in
00:28:15
to fill that breach. Um
00:28:17
is it important that we have a private
00:28:20
securitization market? And if it is,
00:28:22
what will it take to get it going again?
00:28:24
Yeah, those are great questions. Um
00:28:26
Fannie and Freddy can only securitize a
00:28:28
loan up to a congressionally set
00:28:30
ceiling, which under special
00:28:33
circumstances it's now up to about 625,
00:28:36
but the actual ceiling's about $200,000
00:28:38
lower than that, and there's a lot of
00:28:40
political pressure to return it to the
00:28:42
actual ceiling, to not make it a uh a
00:28:45
jumbo loan securitizer. There's
00:28:47
essentially no jumbo loan market.
00:28:50
How important is that? Well,
00:28:52
if you're the average person who's
00:28:53
buying the average home price in the
00:28:55
United States is a couple hundred
00:28:56
thousand dollars, it's not important at
00:28:58
all. Because there are lots and lots of
00:29:01
conforming Fannie and Freddie conforming
00:29:04
loan money available. If you're buying a
00:29:06
jumbo loan or if you live in an
00:29:08
expensive market like California or New
00:29:11
York, it's very important.
00:29:13
Because you can't buy a house, which
00:29:15
means that the person trying to sell you
00:29:17
the house can't sell it to you even
00:29:19
though quote rates are low, people can't
00:29:21
get the loans.
00:29:23
Um, so what's it going to take to get
00:29:25
that going? I think you're going to have
00:29:27
to see house prices turn to some
00:29:29
strength so that the underlying
00:29:31
collateral,
00:29:33
house price,
00:29:34
uh, looks good enough for people to be
00:29:36
willing to lend against it. Nobody in in
00:29:39
Wall Street days there's an expression,
00:29:41
don't catch a falling knife.
00:29:43
Okay? And that's what people look at the
00:29:45
housing market as, a falling knife.
00:29:48
Uh, now we have some signs like Jeremy
00:29:50
mentioned about Phoenix turning and we
00:29:53
may see other cities turning, but I
00:29:55
believe that the mortgage lenders in the
00:29:57
bond market are going to take a
00:29:58
wait-and-see attitude. They're not going
00:29:59
to get in front of this.
00:30:01
All right.
00:30:02
Let's just finish up. I want to ask each
00:30:03
of you to just sort of look forward to
00:30:05
say a year from now.
00:30:07
What do you think things are going to
00:30:08
look like uh, in in the the economy and
00:30:11
and the markets that you're following?
00:30:12
Well, since I I believe this recovery is
00:30:15
real, we're going to see a stronger
00:30:17
economy. I I think the stock market's
00:30:19
going to be higher. Um, you know, I I I
00:30:22
wouldn't be surprised 15% could even be
00:30:24
more. Um, we know one year projections
00:30:26
are so so uncertain. I think the
00:30:28
interest rates on Treasuries will be
00:30:30
substantially higher. I think within a
00:30:32
year Bernanke is going to have to bring
00:30:35
forward the tightening date and that
00:30:38
announcement could very well well be
00:30:40
made next 12 months. Um, and the rising
00:30:43
economy and as Scott said, I think we'll
00:30:45
stabilize the home price situation,
00:30:48
which is not such a very very attractive
00:30:50
and and start lending on
00:30:52
in that market.
00:30:54
And you know,
00:30:57
we will be healing
00:30:59
in an economic sense
00:31:03
in the next 12 months.
00:31:05
The big unknown is the elections.
00:31:07
Okay. We have a
00:31:09
very very big tax hike built in at the
00:31:12
beginning of next year at the end of
00:31:14
12/31 of this year. The rates return to
00:31:17
the pre-Bush tax cut rates.
00:31:19
If the House and Senate or
00:31:22
White House if we're split among
00:31:24
Democrats and Republicans, it could be
00:31:26
that it's impossible to do anything
00:31:28
about that. Uh
00:31:30
and I think
00:31:32
that will not help. That will slow the
00:31:34
recovery
00:31:36
to hit the recovery with a big tax hike
00:31:38
right in the middle
00:31:40
of of the recovery.
00:31:41
know, I've always been saying you're not
00:31:43
going to get an agreement until the
00:31:44
elections and I'm not saying that you
00:31:46
know, it could be a Republican Congress
00:31:48
and a Democratic president, but at least
00:31:50
they'll know that's the way it is for
00:31:51
next 4 years. I mean in a way, all
00:31:53
right, this is my two years straight.
00:31:55
Well, two years for the house. Okay. But
00:31:56
I mean this is the way that you know,
00:31:58
it's it's
00:32:00
it's going to be. This is and they're
00:32:02
going to have to make it
00:32:04
because as as Scott said, if we go back
00:32:07
to those old that would be a fiscal hit
00:32:10
that any even a strong recovery will be
00:32:12
totally derailed. Uh so my feeling is at
00:32:14
that particular point or this is our
00:32:16
strength, these are our negotiating
00:32:17
points and they're going to come to a
00:32:19
deal.
00:32:20
Okay. So we're optimistic, but there are
00:32:22
a lot of big ifs out there. That's the
00:32:24
bottom line.
00:32:24
Whenever there's an election year,
00:32:26
there's a big if.
00:32:27
All right. Well, we'll hope to come back
00:32:28
again and talk about it as things
00:32:30
evolve. Thank you very much.
00:32:32
Thank you.
00:32:33
Thank you, Jeff.
00:32:56
Mhm.
