Subscribe
Share
Share
Embed
Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Hello, and welcome to the second episode of the Confluence Mailbag Podcast. I'm Bill O'Grady, advisory director at Confluence Investment Management. Joining me today, as always, is Mark Keller, CEO and CIO of Confluence. The idea behind this podcast is to replicate the question and answer sessions from the AG Edwards Investment Strategy committee's open mic sessions from earlier this century. As a reminder to submit questions, email us at mailbag@confluenceim.com.
Bill O'Grady:That's mailbag@confluenceim.com. Each month, we select four to five of the most common provocative and interesting questions we receive, and Mark and I address them. So without further ado, let's tackle the first one. Question comes in. What is the single greatest threat to the upward trend in the stock market over the next three years?
Bill O'Grady:I'll start on this one, Mark. I think in in this particular time frame, the biggest concern I have is a complete breakdown in The US China relationship. China and The US economy are almost in a mutually assured destruction situation. China is an export and investment driven economy that struggles if it can't export and it can't invest. And its primary target of sending out its exports has been The United States.
Bill O'Grady:The US initially, in fact, a long time, welcomed these imports. It it held down inflation and improved consumption. But over the past decade or so, there's been a retrenchment on on this, and the Trump administration is taking increasingly aggressive steps to try to break China's ability to export to The United States. And although China is is rapidly shifting its exports to other parts of the world, Europe and and emerging economies, there's no way that these other areas of the world can replace American consumption. Meanwhile, The US remains vulnerable to China, not just for many basic goods.
Bill O'Grady:It's also the the financial markets are are dependent upon China sending its its saving to The US. One of the exercises I've done recently is just to plot The US ten year yield against the exchange value of the of the Chinese yuan, and and it was a remarkably strong fit. In other words, when the Chinese yuan devalues, the yield on the ten year goes up. Reason this happens is is that if you're an emerging market economy and you're trying to keep your exports competitive and China weakens its currency, you have to weaken yours too. The way you do that is you sell treasuries out of reserve to try to drive your currency down and consequently drive the dollar higher.
Bill O'Grady:Longer term, past three years, what I worry about the most is that we get a shift in the labor capital balance. US policy has been skewed toward capital since 1980, and after the Berlin Wall fell, it it it became positive toward capital in in an even bigger way. And a reversal of these policies would would have a strongly negative effect on financial asset values. And in in the stock market, it would simultaneously compress margins and lower multiples. So we have some evidence of that, but so far, policy in general remains still pretty friendly to capital.
Mark Keller:I I agree with you on the the China one, Bill. I think that's a single greatest threat right now. I'll I'll toss another one out there that is beginning to worry me. Something that usually doesn't cause a rapid conclusion to a bull market, but it has in the past sometimes done it. That's the bond market.
Mark Keller:What do I mean by that? Well, we're we're we're all you know, listen. Nobody in Washington seems to worry about deficit spending. Well, the party out of power always complains about it, but it's disingenuous because as soon as they get in power, they start spending money like mad and and making the deficit bigger. And, you know, frankly, rarely has the have the bond market really exercised a lot of discipline on Washington.
Mark Keller:You know? Well, we're seeing that the the British bond market do that right now to the current government. It it did it to the last one too, but we haven't seen The US bond market do that. And I don't, you know, generally worry about the the fiscal situation until it is a threat to the stock market until things get extreme. But you could kinda see how things could get extreme here and have a see a sharp upward move in treasury rates.
Mark Keller:The, it isn't generally a huge threat unless the stock market is really expensive. Oh, well, that's good. Oops. Yeah. Oops.
Mark Keller:We we we have that. A really sharp upward move in interest rates ten years and out especially can can catch Wall Street off guard. And this is exactly the situation we saw in the mid eighties. We saw the PE on the S and P go from high single digits to about 20 within five years. A very similar kind of situation we've seen here since the bottom in COVID.
Mark Keller:And the PE is even higher. We're probably 24, 25 times forward earnings right now on the S and P. If the government tries to control the long end of the curve as they did with UE and particularly if they exercise financial repression, something you've written about extensively, they may be able to keep everything kind of moving as they are. But what we saw back in 'eighty seven was the the bond market, which had been strong peaked in August, I believe of that year and sold off really sharply. The the stock market pretty much ignored it for about two months.
Mark Keller:And then all of a sudden, bang. It caught up very quickly. The competition from yields was got very strong very fast. And we and then we just saw all kinds of technical factors drive the market down very sharply and very quickly. I'm not predicting that in the near term, but conditions are right for it.
Mark Keller:I think the bond market has sold off enough recently to cause that, but I would be concerned if yields on long treasuries were to move up into the mid fives higher. I think that would represent a pretty meaningful threat to the stock market.
Bill O'Grady:I tend to agree with you. I don't think it's imminent. And the one other important caveat in the historical comparison to 'eighty seven is in 'eighty seven, the Fed and the Treasury pretty much ran it straight. You know? They they when William Macchesky Martin, you know, established monetary policy in its modern form in 1951, the idea was you'd let the long end kinda dictate to you what people were feeling.
Bill O'Grady:That has changed. We now see both the treasury and the the central bank attempting to manipulate the long end. The multiple rounds of QE over the last fifteen years, the treasury under Yellen skewing borrowing toward toward T bills, means that I think they will take steps to prevent the long end from yield from rising a whole lot, which means that instead of the long end becoming the, you know, the boogeyman, it's probably gonna be something else. If if I had to guess, it's probably the dollar. I'm not really sure a weak dollar could bring down the S and
Mark Keller:P. Mhmm. And you're right about that. And we're also seeing treasury and and bank regulators taking steps to loosen lending requirements and bank, you know, capital requirements, etcetera, on the banking industry. Why?
Mark Keller:Because I think they want them to buy treasuries. Yeah. I I think And and they want greater demand for treasuries. Let's face it. Banks aren't lending a lot to American business anyway right now.
Mark Keller:They want the banks to become the the the next big buyer of treasuries. And, yeah, I agree with you. They're gonna take all kinds of steps to prevent my worry from coming to pass. But, you know, reg regulators don't always get what they want.
Bill O'Grady:No. That's right. And and, you know, there's always this concern that no matter how hard they try, the market could overwhelm them. And and and that's a distinct possibility. I don't know.
Bill O'Grady:I guess I think they just have a lot of tools at their
Mark Keller:disposal. Mhmm.
Bill O'Grady:And in '87, they were still running things as if well, we we let the long end go where it wants to, and and it did. And I I was working in the industry at that time, and you were too. And I was working in banking. One of my favorite anecdotes from that period was is that a lot of the older people I worked with had money saved. A lot of them had money at one
Mark Keller:of
Bill O'Grady:the big discounters. And after the crash, they were all calling, trying to liquidate their portfolios, and they could never get through. And finally, the portfolio started to recover, and we had the first buy the dip. And it turned out later, apparently, all these firms just took their phones off the hook because they couldn't handle the call volume and ended up saving investors. But, you know, one of the problems that's developed is that now we have created this buy the dip mentality, and and now it's like dips barely give you a chance to get in.
Bill O'Grady:And I my fear is one of these times you're gonna get a dip, and it's gonna keep dipping.
Mark Keller:Mhmm. Yeah. And I I I was in doing sell side research in the brokerage industry. So I was in this, you know, on on this side of the street back then. And it was forty eight years after the nineteen twenty nine crash, which sounds like a long time, but there were people my age in the business who for who for which my age now, that is, for which that was still a a living memory.
Mark Keller:They were old. They were old. They, yeah, they had gray hair and old and they and they they they limped. Yeah. Like, I kinda like I am Probably smoked too.
Mark Keller:No doubt. No doubt. That's a snacko. Let's let's not go there as a nonsmoker in the brokerage business. Let's just say I was was a minority and not a favored minority.
Mark Keller:That's right. Can tell you. But it was twenty nine to thirty two was a living memory for all the the old timers in in who were working in the business back then. And so, you know, there there there was kind of a anticipation, oh, this is gonna happen again. And that was part of the reason why that got Yeah.
Mark Keller:Went so bad so fast. We did not have a recession after that.
Bill O'Grady:I know.
Mark Keller:The shock of everyone. And I kinda see this as a similar situation because I don't see a risk with the kind of stimulus that we are pumping into the economy, particularly with the the, you know, the big the big beautiful bill, the BBB as people are calling it. It I just don't see a near term recession from particularly from policy here, but I can see that those two markets getting out of whack. And I'm kinda watching that
Bill O'Grady:right now. I I think that's a reasonable concern. I I share your position on recession too. You know, between '85 and '90, we had a situation that was affectionately referred to as the rolling recessions. Various sectors or various parts of the economy, regions of the economy would would suffer greatly, but the overall economy maintained positive growth.
Bill O'Grady:And I wouldn't be at all surprised if if that's what we see going forward.
Mark Keller:I I I agree. And but getting back to your first answer. Yeah. I think a breakdown of The US China relationship is the biggest threat out there in the near term. Near term, I mean, the next two or three years.
Bill O'Grady:Well, if you think about it, China is really the only pure competitor The United States has. And, you know, if you look at with with the administration's trade negotiations, they're getting lesser powers to cave. You know, the Vietnamese caved. Right now, we're watching South Korea and Japan. It's quite possible by the time this comes out that will be resolved.
Bill O'Grady:It may not be resolved ideally, but it probably will. But China can push back. And that that's that's why I rated it as the biggest issue over the next three years.
Mark Keller:Well, we've already seen that on the rare earths distribution, haven't we? You know, they they have a lot of levers that they can pull if they wanna get nasty. Yep. Mhmm.
Bill O'Grady:Let's move on to the second question. How have tariffs both real and threatened impacted your buy sell process? How does confluence separate out the hyperbole from the actual policies? Will this administration continue to delay implementation of tariffs with key trading partners like China and Europe? Or do we anticipate new trade agreements over the summer?
Bill O'Grady:First off, the way that I have been framing the whole tariff situation is part of president Trump's management of his coalition. He has a widely diverse and broad political coalition that he has stitched together, some of which are free traders, some of which want to see significant barriers enacted, some of which want only sectoral tariffs. And he is he's trying to manage that. And so the way I view it is is that he he makes a very broad statement like the ones we saw, the reciprocal tariffs we saw, in the first quarter. And then he watches the reaction, and then he adjusts.
Bill O'Grady:And so so far, he he hasn't really dug in on anything, but back away, we're probably gonna end up with a universal tariff, a floor of 10%, and a ceiling probably somewhere between 2025% overall. Some areas of the of the world will get hit harder than others. The ones with less power will probably suffer more, and the ones with greater ability to push back will probably suffer less. I I do think we'll have lots of negotiations. A full blown trade deal takes years to negotiate.
Bill O'Grady:I mean, it tends to run to thousands of pages. But a a general framework, I think, will emerge. And, you know, there's lots of room to negotiate. I mean, one of the things we saw in the late eighties with with the Japanese was, well, if you build your plants here, we'll cut you some slack. I could easily see that kind of negotiation come through.
Bill O'Grady:Mhmm.
Mark Keller:As far as the buy sell process go, how it affected? Well, it's just one more regulatory input. We're used to this. As I've mentioned many times, I grew up in the business by following the electric utility industry, very highly regulated, not just by state regulators, but by federal regulators, EPA, etcetera, nuclear regulatory commission. These people can change your business and your lives very quickly.
Mark Keller:A lot of businesses are like that. You know, just ask the health insurers right now. With the massive changes to Medicaid that are are go going on. As equity analysts, this is just kind of stuff we deal with, on a pretty regular basis. Is it new?
Mark Keller:Well, yeah. It's it's newer than some of these others, but we're I guess, you know, you you over the years, you just get, you know, you get blindsided by regular regulations so often. You you you just try to not be blindsided anymore. And and you just we all play pay very close attention
Bill O'Grady:to this stuff. And and the two of us and others here at the firm watch this stuff a lot, and we gather outside help on this as well. And it it is something that we pay a lot of attention to. In terms of asset allocation, where a lot of this ends up is, you know, we try to avoid the sectors that are being adversely affected. Although, you know, you also keep a a gimlet eye on them because eventually they get so cheap that Right.
Bill O'Grady:You know, that it it becomes a compelling story. You do have to avoid, you know, catching the falling knife. One of the great things about our industry is we have lots of colorful aprisms for those sorts of things. But it does actually create opportunities too.
Mark Keller:Yeah. No, it absolutely does. You know, in this whenever a regulatory or legal event occurs, that or tax event that knocks a stock down, hits hits unexpectedly. And this certainly hit like that. I think we were all looking for tariffs.
Mark Keller:I don't think very many people on Wall Street were looking for tariffs on everything at 50%, which is pretty close to what we got in early April. And you you you saw that people weren't expecting that by the by the market reaction. So yeah. But but these kind of things do happen. So we you know, what you do is you you you look at the, you know, the market immediately discounts this new regulatory adverse development.
Mark Keller:And and then as an analyst, your your decision is is the discount overdone? You know, you run your numbers because you these are businesses, and and you run your numbers. Yeah. Okay. The value versus the of of the business now?
Mark Keller:Is it is it too cheap relative to this negative development or or not? And then you with that, and this is particularly important on this, you have to look at the permanence of the of this adverse regulatory development. Is this temporary or permanent? And that's been the big issue right now. We we they have been extraordinarily temporary because the, you know, we're we're kind of it it's almost as if the negotiating process is being broadcast to the world in real time.
Mark Keller:So it's kinda tough to tell what's a negotiating tactic and and what is a real permanent tariff.
Bill O'Grady:Tariffs are just one element of this, but this is a problem that we've seen evolving now, really for the past decade is that, when you get these enormous swings in policy, how do businesses make long term investments? And, you know, it wasn't that long ago that everything EV was an alternative energy, was was where you were going to make money and fossil fuels were dead. And that's completely reversed, and who knows? It could reverse again at some point. You try to look for the longer term trends, but you you you simply have to acknowledge that sometimes I I guess the way to to think about it is we went for a long period of time with a general consensus of of how things should go.
Bill O'Grady:And now we're revisiting that consensus. That's been something we've been talking about here for a long time that we we've been warning people that the existing order was was breaking down and something new was emerging. And when you're in that something new is emerging part, there are missteps and overstretches, and and that's just something that you have to have to deal with.
Mark Keller:Absolutely. The Trans Pacific Partnership, you know, this grand trade deal, was about ten years in the making. By the time it was delivered to Washington around 2015, it wasn't sure it was gonna pass. And by 2016, both candidates of major parties came out against it. That was that was to me.
Mark Keller:That was that was the proof that we're in a new world and that the the the trade world that had been that was for the previous forty years or so was changing. And we don't know what the new world is gonna look like.
Bill O'Grady:No. That's what we're in the process of of doing. So the next question is if you polish off your crystal ball and fast forward to the November time frame and you assume we have more facts and clarity on tariffs, budgets, and taxes, what do you believe the economic and market landscape will look like going into '26 and beyond? I I do think we'll get some clarity. My viewpoint has been that the in broad brush strokes is that we're going to see dollar weakness, suppressed interest rates, continued large cap outperformance, and foreign outperformance.
Bill O'Grady:This is typically what you see in a modest upward inflation environment. Again, there'll be hiccups and corrections and all through that, but I think that's kind of the direction of travel that I've I've been expecting.
Mark Keller:I I I agree. You know, we just talked in the previous question about all the all the changes that are going on. We you know, policy hasn't settled yet, but I think when it does, you we're gonna see exactly what you said. Weaker dollar, I think, is gonna be really hard to hard to overcome. I think that's just the way we're we're gonna have is is a a weaker dollar, and that has all kinds of implications.
Mark Keller:Foreign investments Oh, yeah. Inflation. You know, equity and fixed income investors don't often consider the currency, particularly here in The US because, you know, everything we do is denominated in dollars. You know, we only have two countries next door that have different currencies, and and they are highly dependent on us. We just don't think about the currency that much.
Mark Keller:But I think if we're going to think seriously about this and deeply, we've got to look at the impact of the currency.
Bill O'Grady:Yeah, I've been currencies was the first market I analyzed. So in March of next year, it'll be my fortieth anniversary of working in the financial markets. And if you look at the long term chart of any of the major dollar indexes, it's pretty apparent you go through long cycles in currencies. And we've been in an upcycle now for quite a while, and this administration looks like one of its key policies is is to bring about dollar weakness. Effectively, we're trying to shift some of the burden of our policy adjustment on foreigners, and one of the ways you do that is through your exchange rate.
Bill O'Grady:So, everything else that goes along with that. The one thing that I would point out is that, you know, for the past twelve, thirteen years, we have had a really spectacular outperformance of US equities over foreign equities. And a big supporting factor in that has been dollar strength. And if that does reverse, we would expect at least some degree of reversal in that foreign stock versus US stock relationship as well. This next question is is really kind of a deep one.
Bill O'Grady:I'd be curious about your outlook on the economy and markets giving declining birth rates, both The US and globally. Also, thoughts on the impact this could have regarding social security. So, Mark, why don't you, lead off on it? You've been thinking about this
Mark Keller:a lot. Yeah. For a long time. And and tell you what, let's let's let's set the social security aside for just a moment, and let's just focus on on the first part of that question, which I think is much more important. You know, I I realize Social Security benefits are important.
Mark Keller:I don't mean to imply that they're that they're not. But but I think the the first part of that is the question is the one that a lot of people don't understand. In my opinion, and I think a lot of people, it is virtually impossible to grow an economy without a growing population of consumers. Everyone likes economic growth. But when your population is declining, it it becomes very, very difficult to grow.
Mark Keller:You can export your way out of it for a while. That is you expand the population of consumers by using other countries' consumers. That works for a while until those other countries get tired of of you displacing their manufacturing. It's also nice to have a growing supply of of labor, and that helps in a lot of ways too. In particular, growing population of labor means growing population of people with income who, oh, by the way, are also consumers.
Mark Keller:It's easiest to grow your population of consumers biologically. But we have found in the Western world that is harder and harder to do. And and therefore, there's really only one other way to grow the population if you if you are if your birth rate is below the replacement rate, and that's through immigration. It's just been, frankly, one of the secrets of The US economic growth that we've seen over the past several hundred years is that we have historically done immigration pretty well. But it does come in waves.
Mark Keller:It ebbs and flows and government policy has definitely affected this. We have, you know, when when you and I were little tykes, Bill, we didn't realize it, but we were at one of the lowest ebbs of immigration in American history. I think only about 5%, maybe less of The US population was foreign born back in the 50s. And one of the results of that was labor was really getting tight and expensive. And as a result of that, the union movement was strong.
Mark Keller:And we were seeing inflation over the next fifteen, twenty years start to rise. Policymakers decided we needed more people in the country, and so they revised the immigration laws in the sixties, and, we started bringing more people in. You know, I I try and stay out of the whether the the whether how whether this is good or bad. This is just the facts. This is what people do.
Mark Keller:And then when you see, the percentage of foreign born get into the mid teens, you start seeing pushback from from the populace because of usually because, you know, I mean, the the root is competition, labor competition. And so then policy start to change and they go the other way. And we've been observing that. In fact, the percentage of foreign born has been approaching 20% of the population. And historically, in US history, that hasn't lasted very long.
Mark Keller:The pushback becomes so strong that policy has changed. And that's exactly what we're seeing right right now. I I am somewhat optimistic, however, because and I guess I always am. A fault if you're understanding. Yeah.
Mark Keller:Yeah. I've said many times that's why I'm equity guy. If you're not an optimist, it's hard to be an equity person. But foreigners of whatever ethnicity, religious background, etcetera, tend to have higher birth rates than folks who are whose families have been in The US for for generations. And and those higher birth rates are good.
Mark Keller:Now can create social discomfort. But again, if you haven't got a growing population of consumers, it's really tough to grow. So this is one of the things, though, that does concern me is I think almost certainly we're gonna see immigration come down. We already are dramatically rather fast. And after all, is one of the big reasons Trump was elected.
Mark Keller:And he is executing a anti immigration policy. These new consumers in the country have been additive to consumption. And if we're going to reduce that, our consumption is going to come down. It's going to be tougher to grow. But again, for all the problems we think we're having in this area, other countries are having much more trouble.
Mark Keller:They either having no immigration, which is a problem with many Asian countries. So there's no way to fix their demographic problem. None whatsoever, it seems. Or you have countries like the European countries who frankly don't do immigration well. They don't assimilate.
Mark Keller:The US is a remarkable assimilation machine. We we call it a melting pot. And it's not a smooth and easy process, but if you look back through our history, it's kinda remarkable.
Bill O'Grady:Yeah. There's there's really no other country in the world that does it better than us. The British are close, but I've observed the same thing. Once you get north of 15% foreign born, you start to see problems develop. And one of the issues with immigration is that enough economic studies have shown that that it is most likely a net benefit to a to a country and economy.
Bill O'Grady:The downside is is that the benefits and the costs are not equally distributed. Mhmm. You know, if if you live in a in a border state, you you deal with a lot of the costs of immigration. And if you don't compete with immigrant labor, immigration just makes your life better. I will say for cities like St.
Bill O'Grady:Louis, has been really positive. The Bosnian immigration wave that we saw a decade ago pretty much saved South St. Louis. It it went from being in decline to a vibrant recovery with rising real estate values, new businesses, new restaurants, new cultures. It was it was pretty fantastic.
Bill O'Grady:Doesn't always work that
Mark Keller:way. No. No.
Bill O'Grady:But I've been I've been just watching this for a while, and I've been telling people that we're we're getting to a point where traditionally we've gotten a pushback. The other thing I would add is that, you know, for most of my career, I was a commodity analyst, and commodity analysts are known for only focusing on supply. We almost spend no time on demand, and the reason is is that commodity demand is usually a function of population growth. Population always grew. So, you know, you can study it, but you do one model and you're usually done.
Bill O'Grady:And you use that model until you retire. Falling birth rates are actually starting to skew that a bit, which which is is really interesting. You know, we we don't have experience with falling food demand, and we're not yet. What what tends to happen is is that as people get richer, they're, you know, they they they eat more and they eat more of different things, higher higher cost food. But is we're starting to see some early inklings in oil demand that slower population growth is starting to have an effect.
Bill O'Grady:Mhmm. It's the the demand is starting to flatten out a little bit. These are these are big changes. And, you know, there there's other issues that we talk about in house. You know, China hasn't fought a kinetic war since the nineteen seventies when they had a border tussle with the Vietnamese.
Bill O'Grady:It's now become a country of of only children, and we we don't know what a country going to war with an army of only children looks like. Because if you get the normal level of fatalities, you're wiping out generations of families' hope for their next generation. I we we just don't know how this goes. The other element that you end up with is that you get a move to automate. You have to automate to maintain productivity because you're you're getting fewer workers.
Bill O'Grady:I think a lot of this discussion around artificial intelligence is being driven by that. Robotic automation too. China is aggressively investing in robotic automation because they are suffering a decline in their population. And if they're going to replace that labor, they're kind of stuck with using machines to do it as much as possible.
Mark Keller:Mhmm. As I wanna underscore what you said about the cost of immigration not evenly distributed. This is you know, and it's it's both geographically and class distribution. You know, someone's complaining that that there's not enough immigration because he can't get his his lawn and and gardens cared for properly. You know, he's in the upper class, and he probably thinks immigration is just fine.
Mark Keller:And this policy is is is terrible. On the other hand, if you're in a lower economic classes and and you run a you know, you're competing against someone who's you're you're a roofer and you're competing against it. It might be a completely different thing. You know? It's it's this is and this all go you know, the and this this seems new to people, but it's not.
Mark Keller:Right. You know? I mean, you you you and I were are are are descendants of Irish and Germans respectively, and there was a time when when our ancestors weren't weren't looked unkindly.
Bill O'Grady:Actually, it's still the case.
Mark Keller:Oh. But I mean, my my my grandfather changed his name from Gustaf to Gus. Yeah. There you go. He pre World War one, it was or and during World War one, it was
Bill O'Grady:That was
Mark Keller:It was not good to be a German.
Bill O'Grady:Yeah. That's right.
Mark Keller:And so we we these are these are not new things, and and they're difficult. And we're going through it now. And, again, I'm an optimist. I think we'll come out the other side. Okay.
Bill O'Grady:Let's have a wrap this question up with a couple of quick
Mark Keller:notes on Yep. Social Yep. Yep.
Bill O'Grady:I think we're both in agreement. This is going to we're gonna means test it. We're probably going to raise the FICA threshold. I've heard talk of creating a donut where, you know, the FICA threshold, let's say, is 200,000 and then you get a break between 200 and 400 and then it kicks back in of incomes above 400,000. You're going to make it less of a good deal.
Bill O'Grady:But also still probably try to make it good enough for less affluent households to maintain, some semblance of, of, of income. So, you know, the the old line about this is Bill Gates doesn't need Social Security and and he doesn't. Where it gets tough is is that, how far down do you go in the income wealth scale before you you start taking it away?
Mark Keller:I had someone explain to me in a number of years ago that the Social Security problem is is from is really a math problem. And and and it's not difficult math either. No. It's it's really it's
Bill O'Grady:pretty easy. Politically hard.
Mark Keller:It's politically very, very hard. And, eventually, you get to a place where the politics change, and and it may mean that Us Us boomers have to move on to our reward before things change. But I think I I think that's relatively easy, and at one there'll become a time when it is politically feasible. The problem the the tough one is is Medicare, Medicare, which is almost as big as Social Security, and it isn't easy math. It is extraordinarily complex.
Mark Keller:And and we don't have time in the rest of this broadcast to go on how complex it is. But that that to me is gonna be a really tough nut to crack. And I'm and I'm not sure how it's the two of them together are are are are gobbling up the federal budget at a rapid pace. And until we address both of them, this this business about balancing the budget is just just talk.
Bill O'Grady:Right. No. That's right. Let's get to the last question of the day. Do we anticipate the Fed to increase, decrease or hold Fed funds rate during the second half twenty five?
Bill O'Grady:Are we concerned about the independent of the Fed? Will Powell be renominated? Let's do the last one first. No. There's absolutely no chance in in in any world that Jerome Powell gets another swing at this.
Bill O'Grady:My own contention is we we get one rate cut between now and Powell's exit next year, which I believe is in May. And then after that, we see a rapid succession of cuts, probably five to six quarter point cuts. I think Powell is desperate not to become the next Arthur Burns, and he will stick to that legacy. In terms of that whole anti immigration thing we discussed earlier, that is going to keep the labor markets tighter than they otherwise would have been and provide cover for him to maintain steady policy. But once we get a new fed chair in, I think he will he or she will not be appointed without being a dove.
Bill O'Grady:I I just don't think there's any way around it. And then finally, are you concerned about the independence of the Fed? Yes, I am. One of we don't have time to go through it completely here, but, one of the reasons you study history is to try to figure out exactly why and we know what happened. We don't know exactly know why it happened.
Bill O'Grady:And I'm convinced that what Paul Volcker did was more about giving people faith. The policy makers would implement austerity because up to that point, there'd been no evidence that they would. And if we end up in a situation where the executive branch is dictating monetary policy, even if the Fed is nominally independent, it will be de facto under the thumb of the executive branch.
Mark Keller:I got a question for you. What are the odds actually, a two part question. What are the odds that Trump nominates someone and who he thinks is gonna be his Arthur Burns and much as George H. W. Bush nominated Justice Souter.
Mark Keller:And and it turns out to not be the guy you you you thought you were you were getting. Yeah. Number one. And what would be that's number one. That's part a.
Mark Keller:Part b is what would be the markers that you would look for in seeing how this this new Fed chair is gonna behave?
Bill O'Grady:Just looking at the people, Kevin Warsh, whose name has been kicked around a lot, I think he would end up becoming a grave disappointment to the White House, that I think he would actually try to maintain a a, the independence of the Fed. If he felt like there was trouble, he would he would push back against it. Waller, who's governor Waller at the Fed, might be that surprise candidate because he's saying, oh, yeah, we need to cut. We need to cut. We need to cut.
Bill O'Grady:But he's steeped in in fed world. And I could easily see a situation where he comes in, cuts a couple times and then says, I think we've done enough. And that's not what the white house wants to hear. So if there's a surprise candidate out there, I think it's probably Waller would turn out to be less compliant than they, than they expect. I think if they want somebody really compliant, they're gonna have to go outside the Fed.
Bill O'Grady:Mhmm. Yeah. You know, they they tried with Judy Shelton, and she couldn't get through the senate. Mhmm. But that's the kind of person.
Mark Keller:I I agree. I think they're gonna be looking for another Judy Shelton. People from inside the Fed, they don't wanna be the next Arthur Burns or g William Miller. They they they wanna be, you know, William Machesney Martin or or Paul Volker, people who stand up to to the White House because they they think, you know, they think about their legacy. Mhmm.
Mark Keller:And so I think it's gonna be a tough one to to pull off. Gonna say all the right things, I think, upfront.
Bill O'Grady:That's you're hearing this talk about how move over. And it could turn out percent surprises them too. But he would be I think I'm looking for an outsider. If they stay on the inside, I think they're gonna really be disappointed.
Mark Keller:Good enough. Yeah, I guess that's that's a good way to analyze it.
Bill O'Grady:All right. I think we'll wrap up here. Again, as a reminder, if you want to submit a question, send one to mailbagconfluenceim dot com. Today's discussion is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice.
Bill O'Grady:This information does not constitute a solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stoll.