Here are some things I think I am thinking about.
1) Is the Fed Committing Monetary Malpractice?
Neil Dutta of Renaissance Macro wrote a very nice piece this week saying that the Fed is way behind the curve and committing “monetary malpractice” by not being more proactive with rate cuts. His basic reasoning is that the labor markets risks are skewed heavily to the downside and that the sticky inflation isn’t nearly the problem that some make it out to be. The market seems to be agreeing with him to a large degree as interest rates have drifted steadily lower all year and are showing virtually no worries about a resurgence in inflation.1
Neil does great work. And I think he’s more right than wrong. I am not sure I’d call it “malpractice”. The Fed doesn’t have the luxury of being super proactive. They are heavily data dependent by necessity. So it’s easy to stand on the sidelines and say they’re wrong (I do it all the time). And while I understand both sides of this argument I do find their current stance a little strange. I won’t explain my rationale again here, but I do lean towards the Dutta camp on this one because the underlying labor market trends have been trending worse and worse. And we saw that again this month with the newly released labor report on Thursday. When you look under the hood we see wages falling to 3.78%, job quits near 5 year lows, long-term unemployment climbing again and on and on. There are numerous signs of a softening labor market. At the same time, there really aren’t many signs of a resurgence in inflation. So, I think the policy stance has to lean towards rate cuts in 2026.
Then again, I am not sure it matters too much. I am fairly certain that no matter who Trump appoints, that person will be amenable to lower rates….
2) Do We need a Long Bear Market?
Here’s a thought provoking piece from the WSJ arguing that this market could use a big bear market to help reset expectations and build a more sustainable base for future price action.2 Ben Carlson had a typically great piece on this. But it’s a weird topic to think about because there’s a good deal of bias that goes into this thinking. For instance, a portfolio of 50/50 US/Foreign stocks has earned 5.8% real returns over the last 50 years. Since 2010 it has done 7%. Since 2015 it has done 6.6%. And since 2020 it has done 6.25%. But where things get interesting is when you look at the USA. In the last 50 years the US market averaged 6.6%. But since 2010 it averaged 10.5%. Since 2015 it averaged 9.2%. And since 2020 it averaged 9%. So, one of these things doesn’t look like the other. The returns have been hugely concentrated, at the global level, to the USA, and then hugely concentrated within the USA itself (mostly tech).
I guess what I am getting at it is that the collective “we” seems to be wrong here. “We” do not need a bear market. The global stock market has done pretty close to its average historical returns in recent years. And so I do think there’s a stronger argument that the US market, and especially, US tech, could actually benefit from some tempered expectations and lower prices. After all, that’s what high valuations really are – high expectations. And that’s also what can make them dangerous. When expectations are high you have higher risk of disappointing. And that creates a bumpier and less predicable sequence of returns, which is the thing every stock market investor dreads.
Speaking of which, it was super interesting thinking this thru as it pertains to the 15+ year bucket in our Defined Duration strategy. I pointed out a few weeks ago that the Defined Duration of the global stock market is now about 24. That’s really unusual and I built the methodology largely around the fact that the historical Defined Duration of the global stock market has been between 15-20 years. So, 15 years seemed like a pretty reasonable baseline metric from which to tilt allocations for the asset-liability matching purposes. It’s not too short and it’s not too long. And if you wanted to create something more aggressive than the average you might time-weight to 20 years because that’s the long end of the range. But what happens when the Defined Duration gets crazy high because you have really high valuations? Well, in that case you have to overweight elements that have a lower average Defined Duration so you can hit that 20 year target. Which is really crazy to think about in this context because you have an inherently aggressive target that gets forced to be relatively conservative because the market is so wildly expensive.
It’s fun to think about this stuff in specific temporal contexts because I wouldn’t even say I am bearish about US tech. I would just say that if you have 15 year expectations then expect some unusual volatility. You can be very bullish about things like AI in this environment, but in my opinion you need to have tempered expectations in the short-term and more patience. If I were bucketing out a tech sleeve in an ALM portfolio I’d align it with 20-30 year liabilities. So, you don’t have to be bearish, but you do have to be patient with this stuff if you’re insistent on owning it and maintaining a reasonable perspective.
3) The Golden Rule & Warren Buffett.
Warren Buffett wrote a farewell letter of sorts last week. It was typically wonderful. But I just loved this one part:
“Greatness does not come about through accumulating great amounts of money, great amounts of publicity or great power in government. When you help someone in any of thousands of ways, you help the world. Kindness is costless but also priceless. Whether you are religious or not, it’s hard to beat The Golden Rule as a guide to behavior.”
You may not know this, but I was an altar boy back in my youth. The Golden Rule was beaten into my head every single Sunday. And while I’m not as religious as I once was (I’m probably more spiritual these days than religiously monotheistic) I agree with Buffett that the world could do with a lot more Golden Rule. I’ve said it a million times in the past – there’s more to learn from Buffett’s letters than perhaps anything else in finance. And the best part is you learn a lot about life along the way. I hope this isn’t the last we hear from him. The world needs messages like this more than ever.
Whether you practice religion, spirituality or nihilism I hope you’re having a wonderful weekend. And of course, stay disciplined.
1- This one is interesting as well given that everyone had declared bonds dead over the last few years. But the bond aggregate is up 19.5% in the last 3 years for a CAGR of almost 6%. Not bad.
2 – This narrative is interesting in this context because it’s a version of the old “this [insert painful event] will put hair on your chest”. It’s not all wrong and it reminds me of the narratives going around that claim younger generations are screwed because the world they’re growing up in is soft. There was a viral post going around Twitter this week about a study from UCSD showing that 25% of students in remedial math couldn’t answer the equation (6 + X) = (7 + 2). I couldn’t believe it because it just seems…well, unbelievable. So I immediately wrote the equation out in bubble form and asked my daughter. I video taped it to see her response because I was very confident she knew the right answer. And she got it faster than I expected. She has my wife’s genes so she’s extraordinary in almost every way, but she’s also only 5 years old. But there’s a broader point here. Aside from being a silly cherry picked example (which turned out to be a sample of just 134 students to begin with) I am just not sure how much it matters that they don’t know math. We now have a super technology that can answer any sort of language problem in seconds. AI may not be very good at subjective reasoning (yet), but understanding languages like math, coding and literal languages is something it excels at. We’re focused on the wrong “problems” and the things we worry about with young people aren’t always the right things. Personally, I think math is one of the last things we should be alarmed about. In my opinion the world of the future is going to be dominated by kids who are creative, social, adaptive, resilient and resourceful. I don’t think we’re teaching our kids those skills. In fact, we’re pulling back from those skills in a lot of ways. And that’s a much bigger worry than whether kids are learning basic math.